As the chart below
shows, the story of UK government debt since 1900 (as a share of GDP)
is a story of crises (source).
The ratio of debt to
GDP rose rapidly during WWI, stabilised thereafter and then started
to fall in the second half of the 1930s, only to rise again during
WWII. After WWII it fell slowly but steadily, returning to pre-WWI
levels by the end of the century. It rose again during and after the
Global Financial Crisis, finally rising a bit more during the
pandemic.
As I
explained here recently, government debt is a device
that avoids sharp changes in taxes or government spending during bad
times. It is therefore entirely right that during a crisis, like a
world war or a financial crisis, government debt should increase
substantially. To put it simply, the alternative of raising
everyone’s taxes sharply would only compound the negative impact of
the crisis.
For example if
governments had raised taxes during the 2009 recession then the
recession would have been even worse than it was. Consumers would
still have increased savings and reduced borrowing during the crisis,
so consumption would have fallen further than it did because taxes
were higher. When governments did try to reduce their own spending
and raise taxes after 2010, it caused considerable damage.
It was therefore
natural for governments around the world to treat the Covid pandemic
as just the kind of crisis where government debt needs to rise, to
help pay for additional government spending during the pandemic. In
Europe that additional spending was mainly paying large sections of
the workforce to stay at home (furlough), while in the US it involved
much higher unemployment benefits and other payments.
I will take the case
for additional government spending during the pandemic as given. This
is not yet another post from me about the wisdom of early but
comprehensive lockdowns before vaccines became available. What I want
to ask here is whether the reaction of most governments to keep taxes
unchanged was correct? The reason that question should be asked is
what happened to household savings during the pandemic. Here is the
UK, and you will see a similar pattern in other countries.
In financial terms,
the pandemic was not hard for most (not all) households. Instead most
ended up saving much more than normal. The reason is straightforward,
and goes back to something I have written
a great deal about: social consumption. Most people
substantially reduced their spending on activities like going out to
the pub, restaurants, entertainment and travel. Sometimes this is
because they were told to do so, but there are good reasons to
believe this would have happened to a considerable extent anyway as
people tried to avoid getting the virus from others. Social
consumption amounts to about a third of total consumption, so it was
inevitable that most households ended up saving a great deal during
the pandemic.
There was therefore
substantial scope on average for governments to pay for their
additional spending during 2020 by temporarily raising taxes rather
than increasing government debt. Most consumers would not have had to
reduce their consumption further because they were paying higher
taxes. Instead these taxes would have simply taken the place of large
increases in personal savings during the pandemic.
If the pandemic was
not like previous crises in that there was scope for the government
to raise taxes temporarily in 2020, that does not necessarily imply
that is what they should have done. For example higher taxes of
whatever type will not perfectly match to reductions in social
consumption, so there might be important distributional problems in
raising taxes. Higher taxes might have discouraged some from working
whose work was vital to keep the country going. Perhaps higher taxes
would have reduced social solidarity at a time when it was most
needed.
Whatever your view
on this, I hope it suggests that higher government debt during a
crisis is something that needs justification rather than something
that should happen automatically. But strangely we do not seem to be
having this conversation about the biggest global crisis facing the
world today, which is climate change. So far at least the need to
green the economy has not led governments to pay for that spending
using deficit funding. I
have talked on previous occasions about why climate
change, and the need to green the economy to reduce carbon emissions,
should be considered as a crisis which requires increases in
government debt. Yet very recently we have seen the German
courts prevent their government from increasing debt
to pay for financing climate change expenditure.
The case for using
deficit finance to pay for greening the economy is far stronger than
paying for furlough during the pandemic. Although in theory carbon
taxes fit the polluter pays model, the reality is that government
spending and financial incentives have
been much more effective at encouraging green energy
production. As with most government investment, it is not clear why
the current generation should pay for something that will mainly
benefit future generations.
Why do some
within Labour worry about the Conservatives
weaponising their £28 billion a year pledge on green investment, and
propose cutting back on those plans? Perhaps its because throughout
most of the media, reducing government debt is either considered more
important than preventing climate change, or the two are not
connected in people’s minds. I want to propose a collective New
Year resolution. If anyone claims that it is important for this or
the next government to reduce their debt to GDP ratio, please someone
ask why climate change isn’t the kind of crisis that should see
government debt rise?
