Insights

For Rishi, it gets harder from here

19/06/20

The UK government borrowed more than £55bn during the month of May. This was more than the Treasury borrowed during the whole of last year. Public sector borrowing is on track to hit £300bn in the current financial year. Despite these eyewatering numbers, the UK government is almost certainly doing the right thing. The cost of servicing public sector debt is still low by historic standards. At around £1 in every £40 of the public sector budget, the cost of interest repayments is below the average since the Second World War.

One of the core functions of any government is to step up when the private sector jumps back. To do otherwise would be colossal act of self-harm and scar the UK’s economic prospects for years to come. Compensating businesses and households for their forced inactivity makes the suppression of the virus and protection of the economy complementary, rather than substitutes. That in itself is good policy. Those teeing up these two aims as in direct conflict have had a bad crisis.

As a result of this activist response, the Chancellor Rishi Sunak and his Treasury team have rightly earned plaudits. Whilst certain self-employed groups feel they have been forgotten, some of the innovations in creating support programs at short notice have shown the UK state in its best light. Those tipping Mr Sunak for the top job in UK politics should, however, remember a key lesson from financial markets: the only time to judge the quality of an investment is through the whole cycle. Chancellors are accorded rather different reputations when cutting spending or raising taxes during a sluggish recovery. Just ask the soon-to-be former editor of the Evening Standard, George Osborne.

The good news is that as the UK economy recovers there is no rush to cut public spending. Interest rates demanded by investors to buy public sector debt are near their all-time lows. Furthermore, the intellectual candles that flickered for rapid austerity a decade ago have long since burnt out.  This backdrop helps enable public spending to support the economy until the recovery is well-established. It won’t, however, be enough to stop the Chancellor facing some difficult judgements over the coming months. These fall into four broad categories.

First, during economic crises governments may as well bury bank notes in shallow holes in the ground and leave them to be dug up. Metaphorically at least this helps the economy quickly recover. This approach is particularly helpful when getting money into the economy is urgent. The financing of home building, upgrading rural broadband or sponsoring research often comes with an unsuitable time lag. As the crisis phase eases – as it is beginning to show welcome signs of doing – the focus switches back to public spending that maximises value for money. The challenge here is that many of the areas where the government is currently spending money do not fall into that category. Contracts that were procured in haste, may be repented at the Treasury’s leisure. Switching the spending taps off will prove rather harder than switching them on. Marcus Rashford, the footballer and highly proficient political campaigner, will be back making the case for Free School Meals during the summer of 2021. Whatever the individual merits of this policy, a precedent has now been set that it will be hard to walk back from.

Second, public spending needs to make a pivot from protecting existing jobs and businesses to pulling back support for those with no viable future. Higher productivity – the long-term objective for economic policy – requires a destructive phase. The juxtaposition of COVID-19, the end of the Brexit transition and the ongoing flux of the fourth Industrial Revolution will create an extraordinary number of new jobs and businesses. It is likely, and indeed necessary, that a similar number will disappear. Balancing the siren voices of protecting the old, with enabling the new has made a fool of many of Mr Sunak’s predecessors. Against this backdrop it is a worry that Lord Tyrie this week stepped down as chairman of the Competition and Markets Authority (CMA) – citing the “inherent limits” of the position. Healthy capitalism requires virile, if disruptive, market forces to force out the old and usher in the new.

Third, the UK is overdue a tax and spending strategy, which deals with the inevitable increase in spending that comes with an ageing population. Even before COVID-19 emerged, the Office for Budget Responsibility (OBR) estimated UK public sector debt would grow from 80% of the UK economy, to 280% over the next fifty years. Successive Chancellors have ducked decisions to put the financing of these liabilities on a sustainable footing. They have been helped by the long-term decline in interest rates, but also by the lack of decision-making on long-term issues like social care and pensions. The current incumbent in Number 11 Downing Street may assume he can take advantage of these same factors. The challenge for the new head of the OBR, Richard Hughes, will be to put greater focus on the long-term sustainability of the UK’s public finances. The celebrated British Economist, John Maynard Keynes, was wrong when he noted that in the long-term we are all dead. There will be plenty of Britons around in fifty years’ time.

Finally, the inevitable public inquiry into COVID-19 will come up with a series of recommendations on how the UK builds resilience to deal with future pandemics. Some of these recommendations will require seed funding from the government, others will require ongoing latent capacity in areas of healthcare spending and civic infrastructure. The aim will be to boost capability to respond quickly to unpredictable events. Such capacity will often appear like an inefficient use of public money and will quickly fall foul of Treasury spending guidelines. The Chancellor’s judgement of what capacity survives – as the memory of the pandemic fades – will be key.

So far, the UK’s fiscal authorities have had a good crisis. But it gets harder from here.

A version of this piece appeared in The Times.

 

Simon French

Economics & Strategy