Greatest hits

For most of the last 40 years I have listened to politicians misrepresenting fiscal issues. In the 1980s the Thatcher government in the UK talked about “living within our means”, treating the government budget constraint as if it were a household. This never made any sense because whilst households have a finite lifespan, governments – in theory – do not which raises their borrowing capacity because they can repay debt on a multi-generational basis. A decade ago, George Osborne adopted a similar approach, arguing that if the UK government did not rein in its budget deficit it would suffer similar fiscal consequences to Greece. Never mind the fact that UK debt levels were lower, or the fact the UK had an independent monetary policy or indeed that it issued debt in a currency which it controlled.

For the present we appear to have put the need for wearing a fiscal hair shirt behind us. Instead politicians like to boast of their fiscal largesse, even though a large segment of the public is increasingly asking who will pay for it. Ultimately, it is the tax payer although not necessarily the current generation. But just as politicians have overdone the fiscal rectitude in the past, so they may be guilty of exaggerating their largesse today. At the end of June, Boris Johnson announced a plan to spend £5bn on infrastructure which was portrayed as a “new deal” along the lines of Franklin D Roosevelt’s 1930s plan. It was, of course, nothing of the sort. FDR’s plan amounted to a splurge equivalent to around 40% of US GDP at the time whereas Johnson’s equates to around 0.2% of UK GDP. The BBC Fact Check team looked at the details of Johnson’s speech and concluded that large parts of the plan merely involved allocating funds that had previously been announced.

Chancellor Rishi Sunak, who has performed creditably during the crisis, did come up with a more substantive plan in his Summer Statement last week. His plan to provide additional support of £30bn (1.4% of GDP) included a Job Retention Bonus which promised a subsidy to employers for each furloughed employee they retain until end-January 2021; a package of measures to help the hospitality sector and a housing Stamp Duty holiday. There are many reasons why the package is badly targeted: A subsidy of £1000 per employee will not do much to dissuade employers from making job cuts and it also runs the risk that taxpayers will foot the bill for workers who would otherwise have been re-employed anyway. A Stamp Duty holiday will be of most benefit to those in the south east of England where house prices are highest, which is not exactly consistent with the government’s plan to level up the economy by helping those regions which have fallen behind. Yet for all that, we do have to give the Chancellor credit for pulling out all the stops after a decade in which fiscal policy has been relegated to the back burner.

The plan came too late to be fully incorporated into this week’s Fiscal Sustainability Report (FSR) from the OBR. Nonetheless, it dutifully ploughed through the fine details and found that the Chancellor has been even more generous than he admitted. The OBR pointed out that the Treasury “’has so far approved £48.5 billion of additional expenditure on public services’, of which £32.9 billion had not previously been announced.” On my maths, this implies a fiscal boost equivalent to almost 3% of GDP.

For those with the time to browse it, the FSR was an excellent, sober overview of the current problems facing the UK economy and how it might perform in future (chart 1). The scenario set out in April always felt a little rushed – understandably – but having had time to reflect on events, the OBR set out three possible long-term scenarios. The central case looks for output to get back to pre-recession levels by end-2022, which is achievable although I fear it could take a bit longer. In this scenario, the deficit balloons out to 16% of GDP this year before falling back to 4.6% by fiscal 2024-25 with the debt-to-GDP ratio remaining above 100%.

Indeed it is the long-term implications of the economic crisis which are particularly interesting.  A debt ratio in 2025 of around 100% is far lower than in the late-1940s when it went above 250%. A combination of favourable demographics, rapid growth and low interest rates allowed the ratio to halve between 1947 and 1957 and it halved again within the next 15 years. We are unlikely to see such a rapid reduction this time around unless there is a miraculous transformation in the potential growth rate. Indeed, the OBR’s central case scenario suggests that based on assumptions for demographics, pensions and health care spending, the debt ratio will rise to 320% on a 50 year horizon (chart 2). Whilst we should not take the figures at face value, they do highlight that in the absence of counteracting measures the debt ratio is not going to decline anytime soon and the OBR’s illustrative calculations suggest that fiscal tightening of around 2.9% per decade will be required to get the debt ratio back to 75% over a 50-year span.

All of this is, of course, subject to a huge degree of uncertainty and it is purely an illustrative scenario. But the point is made that even in the absence of COVID-19, the UK (and indeed all industrialised countries) face major fiscal challenges. Governments will have to make major decisions about what kind of debt levels they are prepared to tolerate and what level of services they can realistically provide. Societies as a whole will have to make decisions about how much tax they are prepared to pay. Whilst I have been an advocate for greater use of fiscal policy over the past decade, like most people I never expected to see the kind of hit to public finances which we have seen in just the last four months. In the coming years we will need a proper debate about the role of the state in the economy. Political blustering on fiscal issues will no longer suffice.