The UK is on track to record the largest decline in annual GDP for 300 years, with output falling by more than 10 per cent in 2020. Those are not my words, they are the conclusion of the latest Fiscal sustainability report (FSR) from the UK government’s Office for Budget Responsibility (OBR). I am far less optimistic, as I believe that the material basis for economic growth in the UK is no longer present and that far from a “V-shaped,” “U-shaped” or “tick-shaped” recovery – the three scenarios presented by the OBR – we are now facing a prolonged period of economic decline.
Nobody dares say this directly, of course. And so we are left to unpack veiled warnings such as:
“The pandemic has hit the public finances at the end of two years during which fiscal policy has already been eased materially. This started in June 2018, when Prime Minister Theresa May announced a large NHS spending settlement, and was accelerated in Chancellor Rishi Sunak’s Spring Budget this year. In it, he set out plans to borrow significant sums on an ongoing basis and merely to stabilise, rather than reduce, the debt-to-GDP ratio.
“A key risk to this pre-virus fiscal strategy was that the highly favourable financing conditions the Government currently enjoys might not persist. In that event, the longer-term pressures from health costs and demography we routinely highlight would need to be faced against the background of greater upward pressure on the ratio of debt to GDP. In the short term, the pandemic has seen borrowing costs fall even further, which all else equal increases the scope for running a fiscal deficit while keeping debt stable as a share of GDP. But higher public debt also increases the sensitivity of the public finances to higher interest rates, increasing the risks from pursuing a fiscal strategy that assumes that financing conditions will remain favourable over the longer term…”
Left unspoken are the reasons why first Mrs May and then Chancellor Sunak had eased fiscal policy – that is, chose to increase public spending. After years of austerity that had crushed all non-financial sector growth from the economy, GDP growth, wages, taxes and inflation remained at historically low rates. The pre-pandemic hope had been that a large injection of new currency into the economy via public spending would serve to kick-start a new round of economic growth. It didn’t. By the end of 2019, the retail apocalypse was gathering pace, leading to widespread insolvencies and store closures. Unemployment was ticking up and consumption was falling. It is likely that even without Covid-19, the UK economy would have faced a recession in 2020.
SARS-CoV-2 was a game changer. So much so that despite initial government attempts to promote business as usual, sufficient numbers of people began self-isolating – avoiding crowds, working from home, shopping online, etc. – to make a wave of insolvencies inevitable unless government intervened. To their credit, rather than simply repeating 2008 and handing currency to corporations with no strings attached, the – albeit far from perfect – Coronavirus Job Retention Scheme aimed at protecting jobs rather than simply lining the pockets of corporate owners and senior managers. Nevertheless, the scheme, together with the various bail-outs, grants and government-backed loans served to push UK public debt above 100 percent of GDP.
This raises the thorny question of where do we go from here?
The religion of progress dictates that economic growth is the solution to our problems. And so, all three of the OBR scenarios assume some relatively rapid return to growth. Even so:
“In all cases the public finances would clearly be on an unsustainable path, with interest costs taking up an ever-larger share of GDP – a conclusion that has been common to all our FSRs to date. And while our upside scenario delivers a long-term path similar to that which we would have seen on the basis of our March forecast, the central and downside scenarios show a materially worse picture thanks to larger primary deficits that are for the purposes of these projections assumed to be left unchecked. Addressing this via a decade-by-decade fiscal tightening would require around one-and-a-half times more tightening in our central scenario than it would have pre-virus, and around twice as much in the downside scenario.”
Even with a return to economic growth, a degree of fiscal tightening – that is, higher taxes and public spending cuts, aka austerity – is inevitable. This sets up the predicament which the establishment media is beginning to exercise itself with. With an almost gleeful masochism, establishment journalists are now demanding that the government spell out the cuts and tax increases that will have to be made. Calmer heads at the Bank of England, Treasury and OBR– quite reasonably – retort that the emergency ain’t over yet; and if the dreaded “second wave” arrives, things could still get a lot worse.
For the moment, there is no reason for government to raise taxes or to cut public spending. Even with the base interest rate at just 0.1 percent, there are plenty of investors queuing up to buy government bonds; meaning that there is no short-term impediment to government borrowing. More importantly, with millions of people losing their jobs as a consequence of the response to Covid-19, the government would have to be suicidally insane to add public spending cuts and higher taxes to the list of things which stand in the way of restoring economic growth. On the other hand, governments – and economists – tend to pay too much attention to headline GDP and too little attention to most people’s declining discretionary incomes (the amount left over after the bills have been paid) when making decisions about taxation. As Surplus Energy Economist Tim Morgan explains:
“[G]overnments have, over an extended period, managed to slightly more than double tax revenues whilst maintaining the overall incidence of taxation at a remarkably consistent level of about 31% of GDP.
“This has led them to conclude that the burden of taxation has not increased materially, even though their ability to fund public services has expanded at trend annual real rates of slightly over 3%. When – as has happened in France – the public expresses anger over taxation, governments seem genuinely surprised by popular discontent.
“The problem, of course, is that, over time, GDP has become an ever less meaningful quantification of prosperity. When reassessed on the denominator of prosperity, the tax incidence worldwide has risen from 32% in 1999, and 39% in 2009, to 51% last year (and is higher still in some countries). On current trajectories, the tax ‘take’ from global prosperity per capita would reach almost 70% by 2030, a level which the public are unlikely to find acceptable, especially in those high-tax economies where the incidence would be even higher.”
The dilemma facing the UK government (and other governments around the world) is that the government bonds which are sold in order to keep interest rates low must, ultimately, be repaid with taxes on future economic activity. There is nothing exceptional about running a public debt in excess of 100 percent of GDP – we did it in two world wars; and in the wake of the Second World War it was not until 1960-61 that public debt fell below 100 percent of GDP. What makes our current situation far more dangerous is that in those days the UK economy was experiencing unprecedented increase in productivity growth resulting from the switch from a coal-powered to an oil-powered economy. With a low Energy Cost of Energy, there was plenty of surplus energy to grow the economy. As energy per capita increased, high levels of public and private (mainly corporate) debt were manageable.
In the wake of the 1973 and 1979 oil shocks and again after North Sea production peaked in 1999, the Energy Cost of Energy rose and energy per capita plummeted, leading to the economic malaise of the 1970s and early 1980s and the long period of stagnation which worsened after the global peak of conventional oil extraction in 2005 and the ensuing financial crash in 2008. Adding more high-energy cost energy to the mix – as the US fracking industry has done – does nothing to halt the downward trend; meaning that the days of broad economic growth are behind us.
In the short-term business failures and growing unemployment will likely encourage even more demand for government bonds – as an apparently safer investment than private investment vehicles. This will guarantee low interest rates (when the price of bonds goes up, the rate of interest falls and vice versa). Problems begin when investors raise questions about the UK government’s ability to repay the debt. Business failures and unemployment mean a big hit to the government’s tax income just at the point when public spending – such as on unemployment benefits – is rising. If economic growth cannot be restored relatively quickly, the risk is that investors lose confidence in the government’s ability to repay its debts, and seek safer investments elsewhere. This might mean swapping UK debt for US or Euro debt if these are considered safer, or it might mean a flight to precious metals or some other asset believed to have more long-term value.
If this happens, the UK government would have little choice but to increase interest rates in order to lure investors back. This, though, raises two additional problems. First, it makes the repayment of government debt even harder. Second and more profound, it risks creating another round of insolvencies and job losses as businesses and households which had been just about getting by find that they can no longer service their private debts. Were this to happen, it is doubtful that the banking and financial sector could withstand the shock. And with government debt already too high there would be no possibility of bailing them out. That which was “too big to fail” last time around will be “too big to save” this time.
Generalised tax increases look inevitable in the medium-term, since this is the only means by which the government can avoid losing control of interest rates. The question is which taxes have to rise, and by how much? For the moment, the establishment media are pinning their hopes on peripheral taxes; for example attempting to close loopholes used by the wealthy to avoid taxes. But while such changes would no doubt be popular, the problem is that there are too few wealthy people domiciled in the UK for this to be sufficient. Moreover, the usual duties for government to hike – fuel, alcohol, road vehicle and tobacco – are in decline because of the recession. Further increases are more likely to deter use of the things being taxed than to raise additional income for the Treasury. For better or worse, four taxes – income tax, corporation and capital taxes, national insurance and value added tax – make up 60 percent of the UK government’s tax income. And while we have yet to discover just how much these taxes would have to increase, in the worst case we might be looking at an economy-crushing 50 percent increase on all four for decades to come; particularly if the OBR’s worst case scenario proves optimistic.
At this point, what initially appeared as a crisis begins to look more like a predicament – it cannot be solved but must somehow be lived with:
- Increased taxes and spending cuts will result in little or no economic growth
- Little or no economic growth mean no increase in revenue based on current tax and spending rates
- No tax revenue growth threatens confidence in bonds, meaning higher interest rates
- Higher interest rates crush economic growth, making it even harder to raise tax revenue.
Although this may take months, if not years, to become apparent, interest rates will very likely be a trigger point. So long as the UK government – and, indeed, governments around the world – maintains control over interest rates, borrowing can continue to be used both to cushion the impact of recession on businesses and households and to attempt to kick-start economic growth. Once the government loses control of the interest rate, only one further option presents itself… “Helicopter money!” This is the idea that government can simply print and distribute as much new currency as it chooses – including dropping newly printed banknotes from helicopters so that people pick them up and spend them.
A more sensible approach would be some version of Steve Keen’s Debt Jubilee in which newly created currency is distributed equally to every adult in the economy with two requirements:
- If a recipient has debt, the currency must be used to pay off the debt
- If the recipient doesn’t have debt the currency must be spent.
The former writes down the value of investments (many of which are based on “fraudulent” debt-based currency anyway) the latter writes down the value of the currency itself. Everyone gets the nominal value, but the amount of value of the energy – either direct or embodied in goods and services – that the currency is a claim upon will have fallen. For importing economies like the UK, this means an uncomfortable period during which imported goods (including foods and medicines) which we used to take for granted will become too expensive. Eventually, however, a more localised, less energy-intensive and less material domestic economy should rise from the ashes.
On a global scale, the days of the US petro-dollar must surely also be numbered. As the US grip on the global oil trade – which is conducted in US dollars – slips away, there is ever less reason for foreign investors to hold US dollars. Thus, while in the short-term investors may flee into the US dollar in the belief that it is the safest place to be, in the longer-term even the dollar – at least as it is currently configured – is going to come tumbling down. This suggests that one outcome of the current recession will have to be the negotiation of a new international currency system such as occurred in 1944 and in 1974.
When most of the developed world went into lockdown in the spring, the establishment media attempted to paint a picture of a benign “new normal” in which our economies remained as wealthy as they had been, but where we eschewed the material trappings of a consumer society in favour of a more socially coherent community-based future. Now, as the shape of the final bill emerges it is clear that what we are facing will be new, but it is going to be anything other than normal. Indeed, all of the things that we have taken for granted about how an economy works are about to be exposed as little more than the transitory benefits of a surplus of fossil fuel energy. In the energy-constrained future which awaits us, much of what we currently take for granted – such as a varied diet, travel beyond walking or cycling distance, continuous electricity supply, specialised medicine and higher education – is likely to become a luxury available only to a privileged few. The only question still to be answered is the means by which we get there. And the rise of political extremism of both left and right variants with ideologies that simply do not understand the role of energy in the economy suggests that things could quickly get very ugly.
As you made it to the end…
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