RISHI Sunak has been lauded. But will his generosity come back to haunt us? Britain’s response to Covid-19 has been one of the most lavish on the planet. Furlough is now extended for a further five months until March, vaccine or no vaccine. By then the state will in effect have subsidised 80 per cent of the salaries of (at the peak) almost nine million employees for nearly a year.
Unsurprisingly with so many schemes from furlough, to mortgage holidays, to business grants the official unemployment data remains close to a 40-year worst case. This official definition of unemployment is thus, in this environment, close to meaningless.
Due to above schemes and more, increased NHS and public spending generally and a reduced tax take, as the economy fell 19.8 per cent in Q2 to date, HMG has borrowed £208billion in the first six months of the year. This is only the start. It is on target to borrow some £400billion this year alone, some 20 per cent of GDP.
Numbers so large are hard to comprehend but to put £400billion in context, between the Napoleonic Wars and Tony Blair becoming Prime Minister in 1997, Britain’s entire outstanding national debt was just £352billion. This Government will therefore blow what was accumulated over almost 200 years in under 11 months.
We should be under no illusions about the severity of this medicine, but the decline in the stability of Britain’s public finances and the growth of the state has been a long time in the making. The latest episode is simply an acceleration of the rather odd belief that the state knows better than the individual.
The story of Britain’s public finances undoing really starts around the turn of the millennium. Blair and Brown, elected in 1997, inherited a recognisably strong position from Chancellor Kenneth Clarke and promised to continue his fiscal responsibility. This was to be no return to the spendthrift Labour of the 1970s, or so they claimed. They kept their word for around three years.
They then let rip with sustained increases in public spending on and off balance sheet. The real scale was rather greater than the headline, given contingent liabilities built up with often inefficient PFI contracts. Slowly but surely the carefully nurtured public purse was weakened. The Conservative Party, demoralised after the Major years and rather starstruck by Blair, didn’t really cotton on. This was a terrible mistake as it started to become complicit in the policy.
The spending growth went largely unnoticed as Labour claimed and the Tories signed up to the illusory concept of ‘sharing the fruits of growth’. The problem was the Government was building the economy on cheap credit and growing public spending rather than private-sector innovation. This policy was sustainable for a while but it could not cope with a shock.
Unfortunately the Global Financial Crisis (GFC) put paid to that. While clearly not of the Blair government’s making, the impact was devastating. Public debt doubled from £550billion in 2007 to £1,120billion just three years later, or 68 per cent of GDP. The UK economy, with other developed nations, was re-floated by an unprecedented monetary policy. Interest rates were slashed from 5 per cent to 1 per cent and the UK central bank printed £400billion through the imaginatively named ‘asset purchase’ programme where, through quantitative easing (QE), the Government bought its own debt.
While this was sold as a temporary measure, a decade later the Bank of England still parks the ‘asset purchased’ debt on its balance sheet. No one seriously believes it will ever be unwound.
Further, QE had the double benefit to HMG of ‘suppressing the yield curve’. In effect this means it enabled the Government to borrow very cheaply indeed. This policy had a number of consequences. It encouraged Government to spend more as there was not the penalty of a true free market interest rate; it caused private investors to invest in real assets such as property over arguably more productive assets, and it undermined savings, leading indirectly to a private-sector pension crisis. Who would put money in the bank if it offered a return of under 1 per cent? It acted as a distorter of decision-making.
Increasingly the yield curve was controlled by the central bank, rather than by market forces. No rational investor would buy UK ten-year gilts currently yielding under half a per cent (42bp at the time of writing) when the notional supply of gilts was escalating and inflation was typically 2 per cent. But they did, as the central bank in effect mopped up the demand, manipulating the yield yet lower. Who would bet against the central bank?
Post toppling Brown in 2010, Cameron and Osborne devised an odd marketing message. ‘We will give the people austerity to balance the books,’ they said. They did this presumably to calm the nerves of bond markets as a sign of fiscal rectitude. Perfectly wise – except that while VAT was increased following the election public spending was not cut despite their branded rhetoric.
While it is true that Government spending growth was lower than the previous decade, public spending rose each and every year. Certain departments did see real cuts but in the round the perception of austerity triumphed over the reality of spending growth. For example, despite the lowest unemployment for 40 years, the Social Protection budget grew consistently year-in-year-out from £223billion in 2010 to £274billion last year, a real increase of around 10 per cent accounting for inflation.
Moreover, despite stealth tax rises taking the tax burden to the highest level since 1984, the Government got a reputation for being callous with spending. The truth is quite the opposite, but if you say you’re a murderer, don’t be surprised if people believe you are a murderer. This reinforced, in the mainstream media at least, the view that right-leaning people were selfish welfare cutters when the reality was the opposite.
Then – after a decade of ultra-low interest rates, QE, tax rises and some public spending growth – comes Covid-19. The UK, in common with a number of EU countries, entered the pandemic fiscally weakened with a weary population believing there has been austerity. The narrative now is spend, spend, spend.
The response of Government is extraordinary but the problem is that while some of the public spending will recede once the Covid-19 crisis is over, much will not. This government fought an election saying there was no magic money tree only to outspend even Corbyn in his wildest dreams. How can the Conservatives ever criticise the Big State again?
Sure there is a difference: this Government would claim they are philosophically against a large state and the current policy is simply out of necessity, but at each and every turn they have adopted the statist, centralised response, rather than the market-driven and personal responsibility response. In effect, forced or not, they have vacated the ground as the low tax, personal responsibility, small state party. Regaining that trust will be exceptionally difficult.
While a debate for another day, much of this ‘necessity’ was of its own making with lockdown after lockdown. Now we face a situation where the Government will borrow £400billion this year. But worse, it is embedded. Sure this will be ‘peak borrowing’ but don’t expect the deficit to normalise any time soon.
This Government is addicted to substantial real increases in spending across the board. My consultancy has forecast that the ongoing ex-Covid-19 deficit will likely be embedded at over £200billion each year for many years with well over £1trillion of new borrowing likely over the life of this Parliament.
How will the Government get out of this mess? The truth is that it cannot by conventional means. The entire income tax take last year was £205billion and all corporation tax raised £52billion. Taxes are already at their highest level since 1984 and further increases would have to be massive to make any difference in this situation, killing the economic recovery in the process. Any such policy would be totally counter-productive as any student of Arthur Laffer will know through the Laffer Curve analysis which demonstrates that tax rises can actually diminish the take. Clearly such a policy would not only be self-defeating, it would also be illiberal, albeit this Government may well be tempted further to breach trust with yet more stealth taxes to fund their largesse.
The truth is, like a drunken sailor this Government will likely continue to spend, stung by media criticism of alleged inequality and unfairness of its own making – and will further tip the dial in favour of the state. In conjunction with the Bank of England I believe the Government will choose to take, as its primary policy tool, the path of least resistance and will run the printing presses further.
I have argued that the ‘asset purchase’ programme will run to over £1trillion-plus over the life of this Parliament, suppressing the yield curve, encouraging the Government into yet more spending but – here is the rub – crowding out the productive private sector and dislocating asset decisions from the productive to property sector and the like.
With the intellectual, media and political environment largely oblivious to the toxicity of the measures enacted, this cannot end well. I have forecast a short post-Covid-19 boom puffed up by a near-zero cost of borrowing, a massive and almost certainly inefficient Keynesian public-sector pump primed, the Darwinian effect of Covid-19 on private enterprise adjusting effectively to the new normal and a desire for circus and beer by a weary population – who will likely party like it is 1920 – and who can blame them?
But behind this self-congratulatory statist response is a policy built on sand. It is unprecedented in history, with interest rates at their lowest in 800 years of monetary policy, a huge monetary printing programme and large increases in both public spending and regulation.
The state today accounts for over half of British GDP and while this may be a cyclical high, as the private sector recovers from its enforced slumber, we live in a world where the Man from the Ministry holds the levers of much of the private sector through controlling regulation, be it energy markets, bank lending criteria, financial services generally, or even tighter regulation and control in almost every sphere.
The Conservative leadership has moved so far from prudent conservative management of the economy as to be almost unrecognisable. Janus does not have a look in. The pass was sold really when the decision was made to run the printing presses post the GFC. Ultimately Government attempted to abolish failure, or in the economic sense the business cycle. You might say ‘Fine’ but it simply stores up greater problems for the future. Step by step individual freedoms are subdued.
Conservative and Labour have both worn the same clothes. Sure, at the margin emphasis might have been a bit different but the philosophical strain has been the same. Government knows best, we will spend and regulate. You are not responsible enough to make your own decisions. Just as it took that approach with Covid-19 so it has done the same with the economy.
All the language comes from those arguing for re-distribution and regulation with very few voices arguing for personal responsibility, a light state and private enterprise. It cannot continue, for ultimately if we cannot turn the clock back from an ever-growing state, regulation and centralised command and control, the very bedrock of a free society will be fatally undermined. The simple lesson that prosperity and liberty comes from innovation, hard work, enterprise, family ties and local community – and not the state – urgently needs to be re-learned.
This article first appeared on Brexit Watch on November 12, 2020, and is republished by kind permission.