Thursday, November 21, 2024

Britain is on course for an almighty fiscal reckoning

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The Government is taxing a lot more, but it is also spending and borrowing more, with the net effect that the nation remains up to its neck in debt, with very little prospect of improvement in any foreseeable future.

It scarcely needs saying that the country is just one crisis away from complete catastrophe, where debt reaches unsustainable levels that markets would refuse to finance.

That virtually all major advanced economies are in exactly the same boat gives little cause for comfort; the veritable tidal wave of advanced economy debt now coming on to the market only further steepens the task of finding buyers for UK government bonds (gilts) at affordable rates of interest.

At a jaw-dropping 260pc, the UK national debt was of course much higher relative to GDP in the immediate aftermath of the Second World War. Yet by 1970 it had been managed down to just 55pc, and by the early 21st century to less than 30pc.

A short history of how this was done is instructive, but also depressing, for none of the conditions that made such a dramatic erosion in public indebtedness possible in the past is around today.

Certainly, it had little or nothing to do with fiscal policy. The second half of the 20th century was not a time marked by notable fiscal austerity. The size of the state rose significantly throughout much of this period, with hugely more spent on health, welfare and education than had ever occurred before in Britain. Despite much higher taxes, the UK also ran a budget deficit throughout much of this period.

So how did we manage to reduce our debts by so much? There were five big overarching factors at work. One was demographics and greater labour market participation, particularly among women. This ensured a steady flow of relatively young, new workers into the labour force to feed economic growth.

A second factor was the growth in white-collar work, a veritable labour force revolution which saw workers moving en masse out of older factory jobs and domestic service into office-based work.

These trends added significantly to economic growth, and with occasional and sometimes persistent bouts of inflation, meant that nominal GDP generally rose rather faster than spending. In the jargon, the denominator (the size of the economy) rose faster than the numerator (the size of the debt).

Equally important, real interest rates were held in negative territory, so that the increase in the government’s debt servicing costs was most of the time kept below the rate of growth in the economy – a practice known as “financial repression”. The result was a massive transfer by stealth of wealth from household and corporate savers to the state.

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