Austerity is officially over as both parties have outlined lavish spending plans. Overseas, too, spending and borrowing are back in fashion. Will the bond markets put up with it? Simon Wilson reports.
The last rites have been read over Britain’s decade of austerity. Both Conservatives and Labour are promising debt-funded largesse on a scarcely imaginable scale. Last week the chancellor, Sajid Javid, who had already announced a 4.4% increase in real-terms current spending next year, promised a further £100bn of spending on capital projects over five years. Not to be outdone, Labour’s John McDonnell announced a “social transformation fund” worth £150bn over five years, plus a green transformation fund worth £250bn over ten years. This week he added that he would give the NHS in England £26bn a year by 2023, £5bn more than the Tories have pledged.
What exactly are the Tories promising?
They have decisively turned their backs on the Osborne/Hammond era, scrapping the goal of seeing overall government debt fall as a share of GDP each year. They’ve also junked the target of keeping annual borrowing below 2% of national income in 2020-2021, as that year’s deficit (or annual overspend) was on course to be bigger than that. Javid has likewise abandoned the goal of balancing the budget by the mid-2020s. Instead, he has announced new rules giving a new Tory government more latitude to boost spending on infrastructure. He will seek to balance the current budget (ie, excluding public-sector net investment) by the middle of the next parliament. He’ll limit borrowing for investment to 3% of national income (up from 2% now). And he’ll aim to keep debt servicing costs below 6% of tax revenues (it’s now at 4.6%). The upshot? About £22bn in extra capital spending each year.
What about Labour?
Even more new spending – in fact more than twice as much – and debt on a rising path. While the Tories propose debt-funded spending of up to 3% of GDP a year (a level last seen in the 1970s), Labour is proposing there should be no formal limit on spending at all, so long as that spending creates value on the government balance sheet. The scale of Labour’s proposed spending is vast, at up to £55bn a year extra – more than doubling net capital spending to £100bn a year. But while there are clear differences between the two parties, the “even bigger difference”, according to the Resolution Foundation’s James Smith, is the one “between the UK’s recent economic past and its plans for the future, as both parties have signalled a major shift towards a far bigger, investment-focused state”.
What’s going on?
Partly this is about politics: the Tories fear a repeat of their lacklustre, spending-light 2017 campaign, while Labour has an ambitious, far-left agenda. But it also reflects a broader, global shift in attitudes towards government debt in an era of ultra-low interest rates. Economists think that the age of low interest rates could endure for many years yet. In addition, it is fashionable now to believe that in a low-growth environment, state borrowing and spending is good for a nation’s economy and may not compromise fiscal sustainability. The International Monetary Fund’s former chief economist Olivier Blanchard said earlier this year – in what is seen by some analysts as a turning-point – that higher government debt “may have no fiscal cost” if growth rates outstrip interest rates, as is the situation today.
So it’s fine to pile up debt?
Not fine, necessarily, but the risks appear significantly lower. For example, according to the Harvard professor and ex-Obama adviser Jason Furman, “it is hard to look at Japan and think those deficit risks are not a lot smaller than a lot of people have been saying for a long time”. Japan’s debt-to-GDP ratio is well above 200%. By contrast, the UK’s most recent official figures put our debt at 84.2% of GDP. Not nothing, then (in fact £1.822trn), but not shockingly high by international standards. Even in debt-averse Germany, economists and business leaders are pressing the government to scrap its balanced-book pledge, says Tom Rees in The Daily Telegraph.
Isn’t massive borrowing a massive risk?
Yes, there are risks associated with the kind of spending splurges we are about to see in Britain – even assuming that (a) there are enough shovel-ready projects to spend tens of billions on; and (b) a lot of it isn’t wasted. If the favourable borrowing environment comes to an unforeseen halt, then refinancing the debt pile becomes a potentially destabilising burden. In coming decades, warns Paul Johnson of the Institute For Fiscal Studies, the UK will need to boost public spending to cover the health, pensions and social-care costs of an older population. “Racking up debt now might not be the best way to prepare” for the “adverse demographics” down the line, he cautions. Still, bond markets remain calm about the prospect of fiscal loosening in the UK.
Why is that?
Even fixed-income managers sceptical of UK gilts, such as Pimco’s Andrew Balls, say there are “powerful forces acting against an explosive sell-off and a spike in yields”. More than $13trn in government bonds, mostly in Japan and the eurozone, are currently trading on negative yields, which means that any spike in UK gilt yields would quickly draw in buyers . “Governments will be tempted to borrow and spend without fearing an attack of the bond vigilantes.” These skittish investors, who ditch bonds at the first sign of state profligacy, have been rendered impotent by a decade of central-bank money printing that has kept bond prices high and yields low or negative. Critics say governments “have a poor record in spending wisely”, concludes Lex in the FT. “But… as long as growth rates exceed interest rates, more borrowing makes sense”. Just watch out for the return of inflation and dearer money.