Covid spending spree cannot last forever

There are three principal reasons why I cannot stop worrying about the debt timebomb

Margaret Thatcher
Many economists were left angered by the tough fiscal policies of Margaret Thatcher’s government Credit: PA

Undulating fashions and trends apply just as much to the world of economics as they do to clothes and cosmetics. Ideas peak and trough in terms of their popularity, much like the economic cycle itself. At this point in time, conventional wisdom holds that rising government spending and escalating sovereign debts carry little danger, with any concern to the contrary often considered ignorant and anachronistic.

The balance of opinion on fiscal policy was already shifting steadily over the last two or three years, a move that has accelerated in 2020.

While both the Conservatives and Labour went into December’s election with high-spending plans (the Liberal Democrats, in fact, proposed the most austere manifesto), Jeremy Corbyn’s party was rightly distrusted for the casual manner in which it piled a string of pledges – some costing tens of billions, some hundreds of billions – on top of each other in a desperate and ultimately counter-productive bid to win votes.

Tories at the time branded Corbyn and John McDonnell dangerously irresponsible, for good reason.

Since then, the world has changed, and exceptional circumstances require exceptional measures. Historically elevated levels of fiscal stimulus pumped into western economies such as Britain’s are of course necessary when governments have forced businesses to stop operating and still have the brakes applied to many areas of the economy.

Ultra-low yields make the policy palatable, with the cost of servicing the public debt actually falling.

However, an assumption has crept into the political discourse that maybe, after all, such spending is inherently harmless – and in fact beneficial. Each time Rishi Sunak, the Chancellor, unveils a wave of support, the quickest and loudest replies ask: why not more? And why not keep going for longer?

Such responses can be heard across the spectrum, no longer limited to the hard Left. From all corners of the room we are urged to deliver a bigger and bigger punch bowl, with a growing belief that, for too long, the risks of a hangover have been overstated.

Call me a party-pooper, but there are three principal reasons why I cannot learn to stop worrying and love the debt timebomb.

Firstly, demographics. Prior to Covid-19 (and, indeed, Brexit), there was a pointed awareness of the expanding cost of an ageing society, given that our fiscal system was designed on the basis of a much stronger workers-to-retirees ratio.

Lively debates were already taking place on how to manage the spiralling price of social care, not to mention the core NHS budget, with the political dilemma arguably costing Theresa May her parliamentary majority thanks to the bungled handling of a proposal dubbed the “dementia tax” by opponents.

This problem has not gone away; in fact, it has worsened to a terrifying extent. In late 2018, the Office for Budget Responsibility expected public debt in 2060 to be roughly the equivalent of 175pc of GDP. Now, its projections show it exceeding 300pc of GDP. The West’s big political challenge, which will still be dominant once we have combated Covid-19, is how to solve this conundrum.

A major baby boom is societally unfeasible, while the levels of immigration required to balance the books remain politically unfeasible.

The state will become deeper, due to the rising costs of social care, healthcare and publicly funded pensions; but in order to be remotely affordable, the state will also have to become narrower. We will increasingly need the political will to say “no” to all manner of tax-funded activities that are not absolutely core to the responsibilities of government.

This does not sit well with the prevailing appetite for state spending which frequently assumes a generous multiplier effect, without pausing for evidence, and ignores the propensity of governments to allocate resources inefficiently and for their own 
political ends.

Secondly, while the conditions for borrowing are ripe, and have been for much of the past decade, how do we manage a situation in which borrowing costs rise while the state, as outlined above, is becoming more expensive every year? It is possible, albeit not welcome, that many western nations undergo a long period of “Japanification”, with ongoing aggressive monetary and fiscal stimulus required to combat a deflationary swamp. But we simply do not know if this is what the future holds, or if things will move in a sharply different direction.

While it is true that sovereign debt levels are relative, and the UK’s will not be as high as in certain peer countries, there must come a point at which the size of the pile becomes uncomfortable and, indeed, negative for growth.

Proponents of ever-rising spending must answer: where does that point lie? 150pc of GDP? 200pc? 300pc?

Thirdly, there is a matter of timing. Exactly when do we reach the point at which fiscal restraint has to be exercised? The worrying element of the penchant for higher public spending is that its proponents always seem to loudly declare when it’s a good time to open the taps, but rarely when the time has arrived for them to be tightened. Since the early Eighties, economists have famously written furious letters opposing, at that point, Margaret Thatcher’s fiscal policy, and 30 years later the path chosen by David Cameron and George Osborne.

The Keynesian objection to retrenchment at times of difficulty is understandable, but where are the letters of protest when governments, urged on by the public-choice instincts of Whitehall and the political incentives of the electoral cycle, overspend during periods of economic calm?

Germany has proven an interesting case in point during the pandemic, with the generosity of its stimulus plan attracting plaudits from many people who spent years deriding Angela Merkel’s stubborn consolidation. Such arguments – Germany has finally relaxed its approach, hallelujah – do not address the fact that yesterday’s parsimony makes today’s splurge, at a time of great need, more possible.

Again, the timing can be questioned; perhaps recent years were not sufficiently strong to justify the full extent of German restraint. However, the overall point stands that basic Keynesian theory works both ways, yet the cries only ever intensify at the points when higher spending is justified, not at the stages when governments are imperilling their future ability to loosen purse strings.

Therein lies the danger of the current fashion for cheering on profligate government spending and soaring deficits; in the context of the coronavirus pandemic, it is certainly valid, but at the first sign of a working vaccine we must seek a return to normal and remind ourselves of the virtues of fiscal discipline.