GOVERNMENT DEBT EXPLOSION – THE REAL DAMAGE

Economic Perspectives 142 - November 2023

Much of what befalls people is intertwined with their behaviour. This is equally true of governments, though on a much larger scale,. An individual with a poor credit-record will find it difficult to borrow, and  any government struggling with a debt level unmatched by a capacity to repay it, will suffer a credit downgrade that renders further borrowing unavailable.- a situation that will inevitably be reflected in the exchange value of its currency, causing import prices to rise in step.

The stories of Venezuela, Zimbabwe, Argentina, Zimbabwe, and many others, are case-studies on the descending path from economic wealth to bankruptcy, usually involving corruption in high offices. The British now face the lessons that citizens of these countries had to learn - even after enjoying many years of democratic government. But they lacked the principled foresight needed to forestall hyperinflation, high unemployment, political instability and, in particular, an inability to maintain the pretence of limitless welfare affordability.

Twenty years ago Britain’s debt stood at less than 30pc of its GDP, but the 2008-2012 financial crisis, Covid lockdowns and the Ukraine war have taken the level of debt to GDP to over 100pc - way beyond the limits of sustainability for a country like the UK, with its entrenched commitment to welfare provision, despite taxes being at their highest level in 80 years. 

Successive “conservative” governments have been enacting socialist economic policies for a dozen years, and  there is now a deep disconnect between an ageing population’s health and pension demands and the state’s ability to meet them. The Public Accounts Committee predict that, based on its employment requirements, the NHS is on the way to employing one in eleven workers in England. It just keeps growing, sucking in workers from more productive parts of the economy.

Yet the pressure for still more spending knows no bounds: defence, infrastructure, subsidies for green industries – putting us on a trajectory of borrowing just to meet interest charges on existing debt., a situation equally applicable in other leading economies. The chief executive of HSBC, with the concurrence of the World Bank’s chief economist, has stated that the global economy could be approaching a “tipping point” for fiscal deficits. 

As ever, the key to fiscal sustainability is to allow the economy to grow at a rate that exceeds the interest cost of the nation’s debts. I emphasise the word “allow” because economic growth is a natural phenomenon and state interference always disrupts it. When that happens the country will be on a different “growth” path – that of explosive spending and debt. The Office of Budgetary Responsibility (OBR) proposes brutal spending cuts and still higher taxes that would wreak even greater damage to private sector enterprise – a twin-pronged approach that would be economically (and electorally) disastrous.

For the past 12 years the Bank of England, ECB, the Fed and other central banks have had flagrant recourse to counterfeiting money out of thin air with successive doses of quantitative easing (QE), at best a makeshift expedient to which they became totally addicted. Indeed, Andrew Bailey of the B of E expressed outrage when the Chairman of the House of Lords Economic Committee, Michael Forsyth, used the word “addiction” for the Bank’s repeated recourse to QE. Repaying the debt created by the QE splurge was never faced, because government never faced the true cost of what it was actually doing. Lockdowns were a holiday from reality and people quite liked being paid to stay home.

The short-termism of UK economic policies, having crippled the market-rating of its debt, now leave it with bond yields so high that borrowing is no longer an option. In theory, therefore, this leaves tax rises as the sole means of avoiding a repeat of Britain’s 1976 cap-in-hand appeal to the IMF.

But let’s be clear: for this government, increasing taxes is no longer a viable option. In 1976 James Callaghan’s Labour government established a convention to raise income tax allowances and thresholds in line with inflation. Yet, even as Chancellor, Rishi Sunak breached this convention in a spectacular way by (i) freezing income tax allowances and thresholds until 2027/2028; (ii) extending  the freeze to that pernicious employment tax, national insurance; and (iii) presiding over policies that guaranty price inflation at heights exceeding previous forecasts. By this means those surreptitious “freezes” represent a massive increase in stealth-taxes - that will double the number of higher-rate taxpayers to almost 9 million, or the equivalent of raising income tax rates by six percentage points, or raising VAT from 20 to 26pc. 

To escape from this hell-bound trajectory we come back to growth. But growth can happen only when the private sector is freed from the burden of state. Irrevocable decline is the alternative. 

[EMILE WOOLF]