Rescuing the economy – the Keynesian way

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Just about everyone is aware of the huge increases in government spending in the last seven months, as the government bankrolls the economy in a world where many workers have been furloughed or made redundant.

Not only has government expenditure increased, but the 20 percent reduction in economic activity means that tax receipts have fallen and the government is running a large deficit. In consequence, national debt has increased and the UK’s national debt to GDP ratio has risen above an eye-watering 100 percent.

Clearly this is not a good place to be fiscally, and increasingly people are talking about the chancellor’s need to cut spending or raise taxes – or both. This talk is frankly ill informed and wrong-headed.

Wars, like a universal serious pandemic, have a profoundly dislocating effect on economies. In 1945, as the Second World War drew to a close, the UK’s debt to GDP ratio stood at 250 percent – two and a half times worse than where we are today. We recovered from that via, among other things, wise (Keynesian) policies and we can do the same over the next decade.

The priority for the government’s economic policy must be to ensure that all individuals and all families in the UK have access to the necessities of life – at least enough to keep body and soul together. Hopefully most of those who previously had jobs will continue their employment, earn income and resume their consumption activities. Their consumption will add to demand in the economy – and that’s what keeps the economy functioning.

Elsewhere, where people have become unemployed or remain furloughed by their firms, the government needs to continue to step in with sufficient ‘transfer payments’ (such as benefits and furlough subsidies) to provide the wherewithal for those individuals and family units to engage in consumption.

In recent years, the concept of a universal basic income (UBI) has aroused increasing interest. The economic dislocation caused by the covid pandemic has brought the UK more quickly than it might have expected to the point of putting the UBI concept into practice.

But how is all this to be paid for?

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The good news is that in the UK, interest rates and inflation are at historically low levels. Additionally, the Bank of England is free to act as ‘lender of last resort’ and as an agent for the government in helping reflate the economy. The government knows that it can borrow, for the moment, almost without limit (the potential constraints to this are inflation and the level of market interest rates – neither of which are currently an issue).

We are in an age not only of pandemic dislocation but also of climate change. This requires a different way of thinking, with potential opportunities. If for example, with the labour market awash with workers who have been made redundant, the government comes up with a series of schemes for building flood defences that give a 10 percent rate of return on investment on money borrowed at 2 percent, then society is 8 percent ahead of the game. A positive return – future generations might be ‘saddled with government debt’ as the Daily Telegraph might say, but the generation paying off the debt is that which benefits from flood defences.

A second example might relate to the Calder Vale railway line that is well overdue for electrification. Again, if this electrification could be financed with borrowing at 2 percent, any return above 2 percent justifies the investment. And all the while, we are bringing the unemployed back into work, giving custom to suppliers of materials and components, and increasing tax receipts while expenditure on unemployment benefits falls. A win-win … win.

Bur what happens to the accumulation of debt in the long run?

The most optimistic or benign scenario is where the economy recovers to such a healthy position that tax receipts outmatch government payments and the budget moves into surplus. This happened in the years 1997 to 2000. Given a budget surplus, the national debt could be paid down without increasing taxes or reducing government spending.

Less optimistically, there may be a need for tax increases or reductions in government expenditure. The huge mistake in the period 2010–15 was to operate policy so that the most vulnerable carried the bulk of the adjustment burden. It has to be an absolute priority that, in addressing the debt and the deficit, the burden of adjustment falls on the broadest shoulders.

Apparently, the Treasury has been circulating options papers for tackling the deficit, which include suggestions such as a two-year public sector pay freeze, ending the ‘triple lock’ that safeguards old age pensions, and raising corporation tax from 17 percent to the international average of 21 percent. In my view these are too small a scale and going in the wrong direction – ‘pissing into the wind’ as it were.

Far better options for serious fundraising lie with the higher taxation of wealth. The adverse economic effects of Covid-19 are likely to be medium term rather than chronic. There is a real chance that in five years’ time, the UK economy will have re-balanced and the deficit will be under control. Hence, what is needed is a medium term – even ‘one off’ – effort to pay down the debt overhang.

Wealth in the UK is very unevenly distributed. In 2018, the top 0.1 percent of wealth-holders here owned 9 percent of all wealth, with the top 10 percent owning 45 percent. The bottom decile own just 2 percent of all wealth. In the last ten years, the number of billionaires in the UK has almost doubled and their collective wealth has more than doubled. Levying a 10 percent one-off capital surcharge on all wealth held above £500,000 would raise sufficient revenue for the Treasury to pay off all the costs incurred by the government in managing the budgetary effects of Covid. At a stroke, our debt to GDP ratio would be brought down to well under 100 percent. (For Gordon Ramsay, recently photographed with his nine Ferraris, it might mean moving down to just eight).

Other tax changes that could fall on the broadest shoulders would include: an effective inheritance tax (death duties); charging capital gains tax on principal private residence; a land tax in the form of site value rating; and ending tax exemptions for school fees, private schools (VAT) and pension pots over and above that necessary to create the median income in retirement.

Following the financial crash of 2008, the politically powerful and the wealthy in the UK seized hold of the policy agenda. The debt and the deficit had to be reduced as a priority and the way to achieve that was by imposing austerity. This policy severely delayed the recovery but achieved their parallel objective of reducing the size of government, including shrinking the welfare state. 

The poorest and weakest in society bore the brunt of austerity. We must not let that happen again.

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