The costs of Covid may be huge but there is no excuse to return to austerity

The economic damage from Covid is shaping up to be worse than from the 2008 financial crisis: a deeper fall in GDP and a wider, global, impact. The main casualties have been the UK, India, Spain, Italy and parts of Latin America and Africa. The budget implications, specifically, will eventually have serious implications for tax and public spending, with the UK currently topping the list of the 40 main economies in terms of the scale of budget imbalances. This year, the UK budget deficit is around 20 per cent of GDP, more than twice as big as the gap the coalition government had to deal with in the last decade.

Recent UK data from the third quarter gave a brief impression of economic recovery. There was a spectacular bounce-back from the lockdown-induced recession of the two previous quarters: 15.5 per cent growth in a quarter (July to September) is astonishing but is also temporary. It was the result of reopening shops and other businesses after the earlier lockdown and will now be going into reverse. The best estimates currently available suggest that the UK will be around 10 to 11 per cent worse off at the end of the year relative to the beginning, compared to 4 to 5 per cent for Germany and less for the US. Only China has actually grown.

Next year there will be much talk of boom conditions and recovery. Hopefully the lockdowns will be phased out and not return. A vaccine (or several) is on the way and expectations of it will generate optimism amongst consumers and lift what Keynes called the “animal spirits” of business. But there are three reasons not to get over-excited, even assuming that the vaccine works and is quickly distributed.

First, the economic scars will become more apparent especially when the extended furlough ends in February; unemployment will then rise from the current 4.8 per cent to around 7 per cent (three million people).

Second, the negative shock of a potential “no deal” (or very thin deal) Brexit is still to be factored in, over and above the long-term costs. Beyond the madhouse of British politics, no one in the outside world can understand why the government is risking this self-inflicted cost at such a critical time.

Third, the scope for a continued strong fiscal stimulus, urged by the IMF among others, is narrowing. In Britain, the Treasury is already in panic mode; in the US, congressional obstruction is likely to frustrate president-elect Biden’s valid ambitions for a big economic stimulus package; the Eurozone’s ground-breaking Recovery Fund is proving to be a very slow-acting mechanism; and the Chinese are much less inclined to come to the rescue of the world economy as they did a decade ago with an investment binge. Most emerging economies are having to watch for warning signals that their creditors are losing patience. In consequence, the coherence and cooperation manifest a decade ago with Gordon Brown’s G20 initiative have disappeared.

There are signs of alarm in the Treasury over the scale of the budget deficit and their overreaction is in danger of throttling the recovery. At present, there is no problem borrowing in the bond market, and servicing additional public debt is not an issue when interest rates are low. Nonetheless, insiders and Conservative backbenchers complain that “they have lost control” of public spending. The economic necessity of borrowing, combined with a political allergy to doing it is creating paralysis in Whitehall, as the government’s embarrassing inability to fund Marcus Rashford’s modest programme of free school meals proved.  

Meanwhile, there is a peculiar and damaging dichotomy occurring in public spending. In the NHS especially, spending appears totally out of control. The ONS suggests that there has been hyper-inflation of costs of almost 100 per cent over the last year. Ideologues of the right will say that public health care is inherently inefficient; ideologues of the left will blame rip-offs by private providers and corruption in handing out contacts to the government’s political friends. In fact, the problems have little to do with ideology. The NHS is always run flat out: always short of staff, equipment and beds with little or no spare capacity. When, as now, there is an emergency, there is a scramble for costly agency staff and imported equipment: hence, rampant inflation.  

By contrast, public spending elsewhere is still being controlled with the ferocity seen during the peak years of austerity. Local authorities are in a desperate financial state and several, latterly Croydon, are in effect declaring bankruptcy. As a result, social care is further starved of cash, and is feeding elderly people back into hospitals, with the risk of “nosocomial” (hospital acquired) Covid infection.  

To take another example: hospices are facing a real financial crisis, with about 80 per cent laying off staff and cutting back provision. Instead of medical intervention by the NHS to “save lives”, come what may, 200 hospices provide end of life, palliative care to 225,000 people who die every year of cancer and other terminal illnesses. They rely on charitable funding, topped up by the government (in the case of children’s hospices, only 10 per cent of funding is from the state). But charitable funding has dried up and, following an emergency £200m in April, the government has ceased to fill the gap. One casualty is the much-loved Shooting Star children’s hospice in my former constituency, in Hampton, which has just closed its doors.

The hope is that it will be possible to re-establish priorities once it is no longer necessary to throw billions at the NHS and short-term job saving schemes. In a rational world, the priority would shift to public investment which produces a return to society, reflects the government’s focus on “left behind Britain” and on the net zero-carbon environmental agenda. Such investment has an ‘economic multiplier’ effect, creating jobs. But securing it will necessitate a reversal of the longstanding Treasury antipathy to ‘invest to save’ schemes.

Another very high priority is a big programme of training, retraining and lifelong learning to help the unemployed and marginally employed adjust to the post-Covid and post-Brexit world. Sadly these priorities are spoken for, at education and the Department for Business, Energy and Industrial Strategy, by two of the weaker members of a weak cabinet. They are unlikely to get much out of the much-postponed multi-year spending review when it finally takes place.

Nonetheless, the Chancellor should listen to them, and he should deal with the Covid debt over a very long term. In doing so he should avoid arbitrary debt-to-GDP ratio targets of the kind deployed by the Treasury in the coalition years. Certainly the 90 per cent figure set a decade ago is hopelessly out of date. Unlike in 2010, much of the mounting national debt is not owed to unreliable foreigners and capricious market operators but is sitting on the balance sheet of our own nationalised money-printing industry – the Bank of England. That makes the government the creditor as well as the debtor so it is becoming increasingly surreal to worry about paying government debt back, as though it were a payday loan or a credit card.  

What is happening now is that the Bank is currently buying up government bonds as they come on the market much as is also happening in Japan. This keeps down bond yields (long term interest rates), making debt cheaper to service, and ensuring that there is no issue of markets losing confidence in the government’s creditworthiness. There is a legitimate question about how long that can continue without triggering worries about inflation returning, and the BoE governor’s team have been at great pains to deny they are “monetising” the deficit – for fear that seductive ideas of magic money should take permanent hold amongst the public and politicians. But using ‘debt’ as a reason for big spending cuts or tax hikes right now would be both economically and politically counterproductive. The reality is that the overall debt-to-GDP ratio at any given time is much less important than a phased, long-term plan to balance day-to-day government spending with tax receipts.

There will be plenty of worries to come about how the cost of Covid is to be dealt with, but ministers would do well to hold steady, and accept that fighting the pandemic has been every bit as expensive as fighting a war. As in the post-war era we should expect to pay off the costs over a generation.