The UK’s second coronavirus wave is nothing like its first, but its effects are beginning to bite. Next week Boris Johnson is likely to impose tighter restrictions on the north of England, in line with those imposed on pubs and restaurants across Scotland this week. It is unclear if either measure will arrest the rise of Covid-19 cases – countries that have been more successful at controlling the virus, such as Japan, have not needed to introduce such restrictions.
Some of the government’s decisions may even be fuelling transmission rather than preventing it: cases continue to rise most in the local areas with the greatest restrictions. We know very little, as the government has not shared any scientific data justifying its measures, nor any data proving their success. (It is also failing to encourage other scientifically proven steps to prevent transmission, such as telling everyone to ventilate every indoor space they are in.)
But there is one thing we do know: the government’s measures will only further imperil the hospitality sector, an increasingly fragile limb of the British economy. Rishi Sunak, the Chancellor, is therefore expected to announce an extension of the furlough scheme for workers in local lockdown areas. The economic costs of coronavirus will rise. And the UK will continue to rack up a debt bill that it must, in theory, eventually repay (the national debt is now £2trn or 102 per cent of GDP).
The Covid-19 debt has already redefined the politics of the 2020s. One Tory MP I recently spoke to was wistful about the political bounty that has been lost. The Conservatives are, they argued, usually elected to fix the public finances. But in 2019 Johnson was elected to spend. For the first time in decades, a new Tory government with a large majority had money to spare.
That money is now gone. “The first half of the 2020s is going to be a debate about how much to raise taxes and on whom,” Torsten Bell, the chief executive of the Resolution Foundation, told me. Sunak himself, in his Conservative conference speech earlier this week (5 October), spoke of the party’s “sacred responsibility” to “balance the books”. Hard choices, Sunak said, “are everywhere”. In the coming years taxes will rise, and No 10’s plans for new public spending will either be constrained or cut.
But Sunak’s analysis is incomplete, as George has noted this week, and as the history of the British economy shows. There are a few crucial points to note. First, there is nothing unprecedented about the UK’s current debt levels. Twice before – in the 18th century and the 20th century – the UK has run up debts far greater than its GDP. In the 1820s, in the wake of the Napoleonic Wars, the UK’s debt was 260 per cent of GDP. In the late 1940s, in the aftermath of the Second World War, it reached 240 per cent. Both debt surges provoked much hand-wringing: how would the public finances be restored to health?
The answer was different in each case. In the 19th century, the debt was reduced not through a wave of spending cuts or tax rises but through that rarity of economic history: genuine innovation. The Industrial Revolution – “the stupendous inventions and discoveries of Watt, Arkwright, Crompton, Wedgwood and others”, as one 19th-century economist put it – paid for the debts of war, falsifying “all the predictions of those who anticipated national ruin and bankruptcy from the rapid increase of the public debt”.
As Duncan Needham, the economic historian, has written, “debt was cut to a tenth of its 1820 level [as a share of GDP] by 1913”, despite the UK’s nominal amount of debt falling by only a quarter. With a surge in GDP, austerity becomes largely unnecessary, and borrowing need not be costly. Innovation offers an escape from a mountain of debt.
After the Second World War, the UK faced a similar challenge and reduced debt in a different and less adept fashion: partly through economic growth, but primarily through inflation (a phenomenon that played little part in debt reduction over the course of the 19th century). Inflation reduces the value of debt in real terms. For instance, £100 of debt incurred in 1946 was worth only £3 by 2008: the price level rose more than thirty-fold over that period. This allowed postwar governments to borrow money, adding to the nominal debt total, but avoid the political costs of that burden: debt fell as a proportion of GDP from 240 per cent after the Second World War to 29 per cent by 2002.
These are the two routes out of the debts the UK will be left with after the Covid-19 crisis: innovate or inflate. But the second choice is not, unfortunately, really a choice at all – debt reduction via inflation is a happy by-product of an economic scourge that no sensible government would pursue. Price stability is a bedrock of economic activity, and the low levels of inflation in the UK since 1990 have been long prized by policymakers. Governments should not aim for high inflation, Needham tells me, as “once it’s out of the bag, it’s very difficult to put it back in”.
That leaves only innovation, something the modern British economy is poor at. Since the 2008 financial crisis, the UK’s productivity – the central measure of “innovation” – has not materially risen. Britain lacks the 19th-century figures whose inventions paid for the cost of its 18th-century wars.
If the UK cannot inflate, and it struggles to innovate, it is left with the unpalatable choice of dealing with the debt directly through tax rises or spending cuts, as Sunak has forewarned. But there is a caveat. The UK need not pursue austerity in the near future. Sunak does not have to tackle the debt now, next year or the year after, or even perhaps for the rest for the decade. Why? Because the cost of government debt has never been so low, and debt only matters when it is costly.
Despite a surge in the UK’s debt burden this year, the cost of servicing that debt has fallen. This is the counter-intuitive reality of the current crisis. The UK’s debt, which absorbed as much as 13 per cent of the government’s spending in the late 1970s, and 5 to 6 per cent over the past two decades, is forecast to cost the UK only 4 per cent of its revenue in the next few years. It will, in other words, impose an unusually light burden. As Olivier Blanchard, a former chief economist of the IMF, wrote recently, in a world of low interest rates, “public debt may have no fiscal cost”.
For now we live in that low interest-rate world, as Andrew Bailey, the governor of the Bank of England, discussed with me. “This is not a prediction about what is going to happen to interest rates and monetary policy,” he said in July, “this is a long-run trend point: they [rates] will stay low for the foreseeable future.”
Low interest rates make the UK’s debt cheap, and for now largely immaterial, even if the long-term risks posed by that debt have risen. As long as interest rates – the cost of money – remain subdued, that risk will remain dormant.
The economic error may therefore be to treat the UK’s debt as burdensome when the reverse is true. In wanting to tackle the debt quickly (by curbing annual borrowing), Sunak is abiding by traditional Tory ideology. As he put it this week, if the Conservatives do not tackle the debt, “what is the point in us?” This is a view that will also be welcomed inside the Treasury. As one former Treasury adviser put it to me recently, “you don’t get to the top of the Treasury by believing in deficit financing”.
It is not clear, however, that Sunak needs to act soon. By rushing to reduce the debt, he risks inflicting the same economic pain that followed the austerity imposed by George Osborne a decade ago. Sunak is a far more popular chancellor than Osborne ever was, and has a far greater chance of achieving his predecessor’s aim of moving into No 10. But by clinging to traditional Tory and Treasury ideology, Sunak may soon thwart these hopes.