The covid-19 crisis has been likened to a war. We are limiting people’s liberty and shutting down large parts of the economy. Commentators have argued that the government should accumulate large amounts of debt as they would do during war time. However, influential voices are far too sanguine about such a policy. They argue that debt will just disappear due to economic growth and, if it doesn’t, we can simply print more money. Recent articles in The Economist and by commentators Roger Bootle and Nick Timothy express exactly this view.
But we should wary of apparently easy answers. The first big debt peak in modern times was after the Napoleonic wars after which the national debt reached about 160 per cent of national income. It then fell below 40 per cent by 1913 before the First and Second World Wars took the national debt to a whopping 240 per cent of GDP. Once again, debt fell below 40 per cent in the early 2000s: then the financial crisis hit.
Can we not just pull off the same trick again? Not necessarily.
Falling debt requires a combination of favourable conditions. It helps if interest rates are low, economic growth is high and if the government makes a budget surplus. You could argue that debt will fall if inflation is high too – but that is just cheating. Paying people back with devalued pounds is just another way of not paying them.
After the Napoleonic Wars, the government ran large surpluses of tax receipts over government spending – in other words it practised major fiscal austerity. This is precisely what the “debt cavaliers” are telling us we should not do and the electorate has certainly not shown any appetite for these sorts of measures. There was also pretty strong economic growth in the aftermath of the Napoleonic Wars. We had a continuing industrial revolution and were about to enter a period of laissez-faire economics with deregulation at home and free trade abroad.
The debt cavaliers particularly marvel at how we reduced debt so rapidly after the Second World War. They regard the period from 1945-1980 as a great epoch which shows how we can cut our debt painlessly. Funnily enough, I don’t remember anybody saying that in the 1970s.
Essentially, we defrauded people of their savings and took Britain to such high levels of inflation that we had to endure the trauma of depression in the early 1980s to cure the problem. After three centuries of stable prices, the pound lost 90 per cent of its value between 1945 and 1980. This was not pain-free.
High inflation would be even worse today with an ageing population. With the purchasing power of savings declining, how will people afford to retire? How will the elderly afford long-term care? And with high inflation will come high interest rates. What will happen to young people trying to buy houses when interest rates are 15 per cent rather than 1 per cent – unless, of course, there is a house price crash of 60 per cent or more?
In fact, the situation today is even bleaker than that. Twelve years ago, there was a financial crisis. We have not even turned the tide of rising debt caused by that crisis and along comes another “once in a century” shock justifying piling up further debt. The UK electorate have shown no desire to follow policies such as deregulation that would promote faster economic growth or policies of lower government spending that would lead to fiscal surpluses. And there is no sign that will change after this crisis. Debt has become the peacetime norm and things will get worse.
After the Second World War, we had a young population, growing tax revenues and little needed to be spent on pensions and healthcare. The last Office for Budget Responsibility (OBR) Fiscal Sustainability Report suggests that, if nothing else changes, debt will explode to 275 per cent of national income in the next 50 years. This is not wartime: this is a result of not raising enough in taxes to cover normal spending in peacetime. The OBR notes that “in practice policy would need to change long before this date to prevent this outcome”. Piling up more debt and assuming that it would look after itself is not the policy change they had in mind.
I am not pretending that there are easy answers. But we should not just assume that the debt will look after itself. Countries have sometimes managed to reduce massive debts and lived to tell the tale. Even then there is normally pain. But Mexico, Greece, Argentina, and many other countries throughout history, have demonstrated the dangers of high debt: it has often led to social destruction. And, if we peer into the future, the omens do not look good for Britain.
Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham