Many will welcome the May government’s more relaxed attitude to public finances than we became accustomed to during Cameron and Osborne’s austerity term. It’s not an insignificant shift to the centre that’s ensuing.
It’s easy to talk about the politics, though. The bigger question is, what does this really mean for the economics? The economic reality of today will drive the political reality of tomorrow – as Europe discovered in the 1930s, to give the most dramatic example.
The UK Government spends around 10% more than it receives in tax revenues, and borrows that deficit. The UK relies on foreign capital for more than one third of that debt. That debt is real borrowing – it’s not like QE. And it’s not being spent on infrastructure to increase business activity and tax revenues: it’s being spent to cover society’s basic cost of living. That really is like putting your electricity bill on your credit card.
It’s been cheap for the UK to borrow that money, because many foreign lenders have long seen UK assets as stable. But, a US investor who spent $2m on property in London in mid-2014, would have seen her investment diminished by 25% due to the devaluation of the pound. Faced with a further two or three years of political and economic uncertainty in the UK, is she going to invest another $2m in London before 2020? Is the enthusiasm of foreign lenders—who are faced with the same loss of value on loans they’ve made to the UK Government—going to continue unabated through the next two or three budgets?
As Ian Stewart, Chief Economist for Deloitte UK, pointed out in his excellent blog in 2013, at the height of the US debt crisis: in the past governments borrowed to fund wars, and balanced the books in peacetime. Peacetime spending today, however, includes social security, health, and education; and whilst wars tend to end, society’s expectations over entitlement spending are permanent, and growing. Worse, the cost of those entitlements increases during recessions, when tax revenues go down. It’s a rare example of the math behind the economics being stark in its simplicity.
So what are the options? One solution is for government to spend on infrastructure to create growth, so that each year’s deficit is funded by the increased tax revenues from economic growth. But relying on perpetual growth has long-term sustainability issues attached to it – strategically and, probably, ecologically. Other solutions include to increase taxes, or to reduce entitlement spending, but electorates only vote for these measures if the changes do not apply to their own constituency: net contributors don’t vote to increase tax contributions, and net beneficiaries don’t vote to decrease benefit entitlements. Elections play out in the context of this stalemate.
The alternative, therefore, is to sidestep the awkward politics, and turn to more foreign debt. And it’s essentially this approach that is now formally government policy. This is the economic reality underpinning whatever policies the nation will soon be arguing over. And economically, as we can see from the effect of sterling deflation on our hypothetical US investor above, it’s based on the most fragile assumptions of any solution I’ve noted.
As Ian Stewart said of the US debt crisis, British society must decide who gets what, and how it’s funded. Faced with the opportunity on the 23rd of June to shut the door on inward migration, the electorate awoke and decided the kind of society we’re going to live in. If it’s still serious about taking responsibility for that enterprise, it needs to now re-engage with those two questions. Who gets what, and how will we fund it. Because Brexit has fundamentally destabilised everyone’s preferred answer.
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