We can’t borrow our way back to growth

This week’s manifesto launches have made the poor state of the public finances clear – simply put, there’s very little money for any party to play with. One reason for this is that lockdown continues to exert an anaconda-like grip on our spending capacity. The policy of paying people to do nothing has proved to be disastrous.

But this was the second of two major shocks to public borrowing and debt in the past fifteen years. The first of course was the financial crisis of the late 2000s.

When Gordon Brown took over as Chancellor after Labour’s overwhelming victory in 1997, public sector debt was 36 per cent of GDP.  All credit to Brown, in 2007 it was essentially the same, at just 37 per cent.

The financial crisis led to both a recession and the bailing out of banks. By 2010, when the Conservatives came to power, debt had rocketed to 70 per cent of GDP.

George Osborne as Chancellor was ruthlessly pilloried by the left for his policy of so-called austerity, of restraining public spending.  

The reality is that public sector borrowing was so large during the 2010s that the debt to GDP ratio continued to creep up inexorably. In 2019, the year before the pandemic, it was 85 per cent. Now, of course, it stands around 100 per cent.

A direct consequence of all this is that, for any given level of public spending, more of it goes on interest payments on the debt and so less is available for the provision of services.

The Office for Budget Responsibility (OBR) estimates that in the current financial year debt interest spending will total £89bn. That would represent 7.3 per cent of total public spending and is equivalent to nearly 3.2 per cent of national income. 

As governments – no matter who wins the election – continue to borrow large amounts and as debt issued during the period of near-zero interest rates is rolled over and replaced by debt at current rates, the figures will continue to rise.

Against this background, the growth performance of the UK economy has been abysmal. Such growth as there has been, is mainly due to an increase in the labour force fuelled by immigration.  

Per head of population, the economy is only some four per cent larger than it was prior to the financial crisis. Living standards for most have stagnated. No wonder the Conservative government is unpopular.

According to conventional wisdom, the combination of high public sector debt and low economic growth puts any government into a Catch-22 situation. On this view of the world, more public spending, and therefore borrowing and an increase in debt, is needed to revive growth. But this risks higher interest rates, which depress growth.

In fact, high levels of public debt are one of the causes of low growth. There are certainly other reasons, but this level of indebtedness has a negative impact on the confidence of the private sector, both companies and individuals.

During lockdown, for example, the ONS estimate that households accumulated a massive £180bn of so-called “excess savings”. Conventional wisdom argued that once the restrictions were lifted, people would spend and run these down.

But on the contrary, households are saving more than they did before the pandemic, not less.

In the fourth quarter of 2023, the proportion of household income saved was 10.2 per cent. This compares to just six per cent in the year immediately before the onset of the Covid pandemic.  

This is an entirely rational decision. The surge in government debt implies both a stream of interest payments to meet in the future, and the repayment of that debt.  Households are saving to meet the increase in taxes which will be required to finance this.

A substantial reduction in public sector debt will not depress the economy.  It is one of the ways to achieve growth.

As published in City AM Wednesday 10 June 2024
Image: Pexels

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