Former Tory cabinet minister Nick Boles has called on the Chancellor to “end the age of austerity” in his Budget. Mr Hammond, he says, should scrap his deficit reduction target and unveil a “massive boost” in public investment. “Our urgent problem in this economy,” he argues, “is that wages aren’t growing. They are not growing because productivity isn’t growing and productivity isn’t growing because our rate of investment is too low, both in the public sector and the private sector. That needs to be a priority now. The age of austerity is over. We now need an age of investment.”
He’s not alone. Voices both inside and outside the Conservative Party are arguing that the Government should jettison its commitment to cutting the deficit and balancing the books. Pressure is growing on Philip Hammond to increase borrowing.
The most frequently cited reason for doing so is that interest rates are at historically low rates and so governments can borrow at lower rates – an argument espoused by economists such as Paul Krugman, Bradford De Long, and Michael Summers. It’s an idea which also has currency among members of the Cabinet. The Communities Secretary, Sajid Javid, recently argued that the Government should borrow money for house-building.
But a low rate of interest is not a legitimate excuse to increase borrowing. Analysis conducted for a new paper by the TaxPayers’ Alliance reveals that a modest increase in interest rates will lead to a very high increase in the national debt.
Moreover, interest rate notwithstanding, borrowing is never free. The UK has a floating exchange rate and so has a small fiscal multiplier. Therefore, if capital does not come from other parts of the UK capital market, it must come from other economies which results in the real exchange rate rising. This has a negative impact on the competitiveness of UK exports which, at a time of uncertainty during Brexit, would be bad for the UK’s economy.
Increased borrowing can hurt the economy in other ways. It can, for example, crowd out other investment as investors loan money to the government, rather than to the private sector. And to make an obvious point, a raise in borrowing would also increase the UK’s national debt, which already stands at an eye-watering £1.7 trillion – equivalent to 89.3 per cent of GDP.
As a percentage of GDP, our national debt is the eighth highest in the EU. It is also the fifth highest in the OECD. In the financial year ending March 2017, the UK’s national debt increased by £68.1 billion. This is the equivalent of £5.7 billion a month and £186 million a day. More borrowing would make things worth.
At this point, those in favour of increasing borrowing might point to our high levels of debt in the past – specifically after major wars – as an excuse to go down that path again. But this is to spectacularly miss the point.
Although the UK did have high levels of debt after the Napoleonic and World Wars, the socio-economic situation was very different. In the aftermath of the Napoleonic war, there was a commitment to eradicating the debt by running budget surpluses, a task which was made far easier by the electorate being more narrow than today.
Furthermore, although the Second World War saw the UK’s national debt as a percentage of GDP increase dramatically, our situation today is very different. The end of the Second World War resulted in the reduction in military spending, the return of young, able-bodied men to the labour market, increases in free trade, and the economic recovery of Japan and West Germany.
As for the aftermath of the First World War, the post-war government embarked on a number of schemes to reduce the national debt, including running budget deficits. However, it was difficult to reduce the national debt due to a number of socio-economic conditions largely outside of its control.
Increasing the national debt can have further negative consequences for the UK economy. Research conducted by Reinhart & Rogoff found that nations typically see growth slow when their debt levels reach 90 percent of GDP, with the median growth rate falling by one per cent and average growth falling by even more. Research focusing on the US has found that raising the Federal deficit has an adverse effect on the economy by reducing private-sector investment, economic growth, and employment. It can also result in an increase in the yields to be paid on UK bonds.
Let’s not forget the debt has to be paid back and interest also has to be paid. Government currently spends £48.4 billion each year on debt interest payments – money which could otherwise be spent on healthcare, education, or providing care for the elderly.
There are also significant moral implications for increasing the national debt. Money borrowed today will probably have to be paid back by people who are yet to be born. Our profligacy today, places a significant burden on future generations. It’s morally unsound.
So instead of recklessly putting the future in hock, the Government should commit to balancing the books by reducing borrowing and taking a responsible approach to public spending. Not only will the economy be strengthened, future generations will thank us.