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Giving it more than 100 per cent

Giving it more than 100 per cent

Rishi Sunak doesn’t really want Britain’s national debt to exceed the size of its economy. But what if he changed that?


There have been times in this past year when it’s felt there are only two kinds of story, both foreshadowed by the much, much too quoted Yogi Berra. Either “it’s deja vu all over again”; or “when you come to a fork in the road, take it”. 

I’m James Harding, I’m the editor and co-founder of Tortoise, and in this week’s Editor’s Voicemail, I want to make the case that Rishi Sunak, the UK Chancellor, and the Treasury, are seeing the fork in the road and they’re taking it. They’re leading the country up not just one garden path, but two.

Because Sunak is promising both fiscal prudence and to do whatever it takes. He’s determined to show that he’s a classic Conservative who, as soon as humanly possible, will get the public finances back in order, reining in government spending, identifying new taxes and reducing public borrowing. And at the same time, he’s also promised to support families through the pandemic, to sustain critical businesses and to fund the Prime Minister’s various promises on social care, on the armed forces, on the greening of the economy and on levelling up.

Of course, no one knows how long the pandemic is going to have the economy up on cinder blocks. Sunak, more than most, should know the price by now of optimism bias: he owns a fair share of the responsibility for the delay to lockdown in the Autumn. But there’s relief – relief right now in Downing Street as well as relief all across the country at the successful rollout of the vaccine programme. And yet doesn’t that too risk another bout of wishful thinking, another bout of optimism bias? Because we still don’t know levels of infection or transmission among vaccinated people; the vaccine’s effectiveness against variants or, in fact, the variants to come. If you look at Israel, there’s every reason for uncertainty too. Israel leads the world in numbers vaccinated, the stringency of its lockdown rules and the efficacy of its test and trace regime and yet still, for all that, the Kent and South African variants have kept their infection numbers stubbornly high. All this suggests that the pandemic may last longer than we like to think. And so in these circumstances, it’s unreasonable to expect that the Treasury can either say when it will stop borrowing, or to start slapping on taxes to pay down the debt now. 

But the Chancellor of the Exchequer can do one thing in his 3 March Budget: he can set expectations. He can make a choice. He can signal whether the UK is willing to bear significantly higher debt to GDP well into the 2020s or not.

Government debt at the end of 2020 was £2.1 trillion, or equivalent to just over 99 per cent of GDP. And 2020 saw the highest debt ratio since 1962. That’s because government borrowing was more than £200bn higher in the first nine months of the year than it had forecast as it pumped money into furlough schemes, healthcare, test and trace etc. And, for the time being, it’s clear that the Treasury is going to have to extend furlough schemes, going to have to keep on going with government support, spending and borrowing, therefore, even more. Lower spending and higher taxes now would throttle any hope of recovery. And the cost of borrowing makes this unusually easy: interest rates are very low. It’s in fact one of the reasons why the cost of borrowing is less than a third of what it was in 1962.

But it’s still an unenviable choice, both economically and politically. The question Mr Sunak faces – should he tell the country that he as a Conservative chancellor is willing to borrow more? – is difficult, for several reasons.

Mr Sunak’s instincts are to signal to his Conservative colleagues and the financial markets that he won’t let debt get out of control. That he has his eye on keeping that debt ratio as close to 100 per cent of GDP as possible and, that when growth returns, he’s going to begin to bring it down. And the market arguments for this fiscal responsibility are always compelling. The UK has not just amassed a lot of debt; it’s running a big deficit, i.e. there’s a gap between what the Treasury spends and the tax revenue it receives, so the debt is going to continue to keep on rising. At some point, there’s the real risk that one or both of these things happens: inflation prompts an interest rate rise and/or the markets lose confidence in Britain’s ability to pay. And that would mean a crippling increase in the government’s cost of borrowing, potentially a financial crisis and a boomerang back to emergency cuts in public spending. In other words, the Treasury’s worst nightmare. 

On the other hand, if the Treasury stands firm on the 100 per cent, it faces years of increasingly public battles between No. 10 promising things and No. 11 taking them away. The Treasury will be seen again as the blocker rather than the enabler of Government. And Mr Sunak is going to be wrong-footed by every Marcus Rashford-style plea for government support for people in real need. Politically speaking, it is death by a thousand cuts.

The academic thinking around debt and spending is on the move. Jason Furman and Larry Summers, two of the US’ best-known economists who both served in the Obama administration, argued in a paper last year that was titled “A Reconsideration of Fiscal Policy in the Era of Low Interest Rates” that it’s “time for revolution rather than evolution” – i.e. government can and should borrow more, keeping an eye on debt service costs rather than just on debt to GDP ratios. And so, if it does that, it’s going to be able to pour more public money into funding growth and addressing inequality. Perhaps it’s not surprising, that this is the choice that the Biden administration has made with its $1.9 trillion stimulus package. And it’s one of the reasons that the US, even though wracked by Covid-19, boasts among the best prospects for an economic bounce-back in the Western world. 

This points to the real fork in the road. The acceptable level of public debt in the wake of a pandemic is just not set in stone. If the UK’s debt is now £2.1 trillion, well, what’s reasonable level of it at the end of the year to come – 2.3? 2.5? What about 2.9 trillion? And then, ask yourself this question, what’s the right level (if there is such a thing) for debt to GDP? Is it 100 per cent, is it 115? Is it 130, even? (To give some context of the range here, Germany’s debt to GDP is 70 per cent, the US 107 per cent, Japan nearly 180 per cent.)

So ask yourselves this question: what if Mr Sunak set the Government’s public debt target at 125 per cent rather than 100 per cent of GDP? What if he set fiscal rules based on the cost of servicing the debt rather than the size of it? What if he made clear that in this Parliament he was prioritising economic growth rather than fiscal responsibility? The point is this: Mr Sunak is the Chancellor of the Exchequer at an unprecedented time. He doesn’t need to be bound by past Treasury conventions; he can now set his own.

And if he does, if he does establish and explain a new set of expectations on public spending and debt, he can free himself and his Government up to do three things. The first is to spend more for longer to support people and business if the pandemic persists and recurs. The second is to commit funds to addressing the structural problems in the UK that have been exposed by the coronavirus, such as social care reform, investment in skills, pump priming green technologies and infrastructure and committing the significant public spending that’s going to be needed to deal with regional inequality, AKA levelling up. And the third thing he can do is avoid a bust-up with business over taxes. Instead he can embark on meaningful tax reform (it will take time) to bring in a carbon tax, to tackle the digital tax problem, to address inheritances, wealth and incomes. 

A reset on debt is not without risks. It won’t come naturally to a chancellor who, so far, has shown he’s got plenty of PR flair, but is economically cautious and incremental. And it would take the courage of his convictions. It requires a choice, not a fudge. But if Rishi Sunak is willing to reset the political argument around debt within his own party, to reset the working assumptions of the Treasury and to reset the market expectations for the UK, he has the opportunity to be a compassionate and consequential Chancellor.