Carsten Jung is Senior Economist at the IPPR.
On Wednesday the Chancellor announced a spending review that was bold in ambition but actually surprisingly timid in numbers. Rishi Sunak may have political reasons for holding back, but mainstream economic thinking suggests that there are questions we should ask about the size of the Treasury’s response.
The human cost of doing too little could be large. A stimulus too modest, that does too little to strengthen the economy, would disastrously dampen the economic ambitions of the young and future generations.
On one hand, some consider the overall bill of £400 billion of the pandemic so far is evidence enough that spending now needs to be trimmed back. But on the other, the fundamental insight gained from a century of economic crises is:that the state is uniquely able to boost economic activity when other economic players – businesses, workers and households alike – are still licking their wounds.
Developed by Keynes,and reflected in economic theory almost ever since, is the finding that public spending can keep bad things from happening, and that this can be economically optimal. Right now, this means that keeping firms and their workers from going under is economically superior to the train crash of an economic disaster, with otherwise viable businesses going to the wall amid a wave of bankruptcies.
Of course this isn’t just theory – it’s been generally accepted in practice by governments of all political stripes. The Chancellor understands that it’s the Treasury’s job, especially in a crisis like this one, to stabilise the economy and help it back on a path to sustained growth. The question is: will this week’s measures achieve that?
Arguably not. The IPPR estimates that the economy will receive only just over a quarter of the boost it needs to fully stabilise and restore the economy. We calculate that a total stimulus of £164 billion would be needed to achieve this – at first sight an eye-watering sum, and of course subject to margins of error. But whatever the exact numbers, there is a strong case to argue that the Chancellor’s measures are too modest.
Some might argue that the state ought to get out of the way and allow business to drive the recovery instead. But this ignores the harsh environment in which businesses currently find themselves. With demand still well below the pre-crisis trend, and balance sheets ballooning with debt, it would take an unusually brave entrepreneur to embark on an investment spree right now. For this reason, business investment is still a hefty 20 per cent below its pre-pandemic level – itself far below our international peers – and is not expected to recover until 2023. No wonder many business groups strongly favour the government catalysing investment and supporting demand.
Many might agree that a much bigger boost would be desirable for the economy, commerce and jobs, but ask: can we really afford it? As some commentators observed this week, the UK appears already to be running up debt so great that at first sight it appears dangerously unaffordable.
But that is the appearance, not the reality. Ultra-low interest rates mean that the UK will pay £20 billion pounds less – not more – to service its debt next year than before the crisis.
Moreover, experience shows that spending less can actually be counterproductive for the public purse. That is because the longer the crisis is allowed to run, the more permanent the damage to the economy. That means less investment, fewer profits, lower wages, less consumption, and significantly lower future tax returns.
Our calculations, based on widely-used economic modelling, suggest that public debt as a proportion of GDP could actually fall, were the Government to embark upon a more major investment package that further boosted jobs and growth. It could be 0.5 per cent lower at the end of the first year, and more so over time, because faster and more resilient growth would mean the economy growing more than government borrowing.
Contrary to widespread belief, government finances are not at all akin to a household’s. They are more like those of an entrepreneur who spots a lucrative business opportunity. For them, it can be more profitable to borrow, invest, and reap the benefits of increased growth later.
The same applies to the state. Smart investments today mean more tax revenues in the future. The economic potential is even greater while interest rates are low, and likely to stay that way for years to come.
The IMF makes a similar argument. It argues that “tightening too fast could undermine the recovery” and says “a further increase in debt in the short term would appropriately balance the pro-growth and debt sustainability objectives over the medium term”. In other words, spending more now will make it easier to manage government debt later.
As counter-intuitive as it may sound, borrowing more to spend now would make it easier to balance the books later. Surprisingly, fiscal stimulus is fiscal responsibility.
What could we invest in? None of this would be about building ‘bridges to nowhere’. There are many projects in dire need of investment, starting with our hospitals and social care infrastructure. Three quarters of buildings are falling short of energy efficiency standards. Much public transport infrastructure is suffering from years of neglect, not least in the towns and cities of the North and other English regions.
Last week, the Prime Minister announced a ten-point plan to tackle the climate and emergency and restore nature; in March we calculated that the UK needs to invest an extra £33 billion a year to meet our environmental targets. Only a small part of this gap has been plugged by the welcome announcements so far.
Such investment in future growth prospects can unlock job opportunities and is the best way to address the widely-feared economic “scarring” from the pandemic. And these are no moon-shot projects either. We already have the technology. We can start tomorrow.
All this suggests a question we should sincerely ask the Chancellor. Could more spending bring the economy back quicker? And apart from all the other advantages, wouldn’t it be more cost-effective to ensure public finances are on a sustainable footing?
Because doing too little now will also come a great human cost. We have all been hit hard by the pandemic, but for the young in particular it has been a disaster. They face a future with an economy severely damaged and permanently below potential, without enough good jobs, and with permanently over-stretched public services. Not only are they having to endure the rigours of social isolation during the pandemic, they also face the prospect of a future denied. Little wonder that their mental health has fallen more than that of any other group during this crisis.
So in addition to having benefits for the long-term health of our economy, a bigger fiscal stimulus could prevent us committing a historic mistake: leaving the next generation without enough jobs, without an intact environment, often without the financial means to move out of their parents’ homes – and for some, without hope. From the Chancellor, that would have been a bolder and a better answer.