The government’s policy is to borrow as much money as possible without alarming the bond markets, and to do this every year indefinitely. This is not just the policy of Rachel Reeves. It was also the policy of Jeremy Hunt and it will almost certainly be the policy of whoever follows Reeves. It is an unspoken political consensus.
Reactions to yesterday’s spring statement were universally hostile, but none of them rejected the consensus that Reeves should continue to max out the credit card. The left wants to change the fiscal rules so the government doesn’t have to make cuts. The right wants to make more cuts so the government can reduce taxes. The far-left wants to introduce a wealth tax so the government can spend more. None of them intends to reduce the deficit, let alone the debt. And yet it is the debt that is the source of our problems.
The government’s fiscal rule is to not borrow any money for day-to-day spending. This sounds thrifty until you remember that day-to-day spending does not include the movable feast of “investment”, nor — crucially — does it include the interest on the national debt. Debt interest payments now comfortably exceed £100 billion and are expected to rise further for the next few years at least.
The Office for Budget Responsibility published a disturbing graph yesterday. It shows public spending as a percentage of GDP. It shot up after the 2008 financial crisis but was gradually on its way back to a normal level when it flew into the stratosphere during the pandemic. The scary thing is that since the Covid spike, there is no sign of it returning to normal. There seems to have been a step-change in public spending which now hovers close to 45 per cent of GDP, not much lower than big spending social democracies like Sweden. No British government has ever found a way to extract this much money out of the public during peacetime.
If the state has grown so large, why doesn’t anything work? There are a lot of answers to that question, but part of the reason is that the graph above does not really show the size of “the state”. Vast, inefficient and intrusive though it is, the state spends a lot of its money on cash transfers: nearly 11 per cent of GDP is spent on welfare. A further 3.9 per cent is spent on those pesky debt interest payments. Before the pandemic, we were spending less than 2 per cent of GDP on debt interest. In 2022/23, it was 4.4 per cent.
In other words, half of the step-change in public spending since 2019 is the result of paying more money to service the debt. We are servicing that debt entirely with more borrowing and no one has any intention of breaking the cycle.
Borrowing during the pandemic has exacerbated the situation but it is not the main cause. The government borrowed £311 billion for “pandemic-related support measures”, but the national debt already stood at £1.8 billion before anyone had heard of COVID-19. Since 2001, public sector net debt has risen from £600 billion to £2,800 billion today. Pandemic-related spending hasn’t helped, but the interest payments we are saddled with are overwhelmingly for borrowing from other years.
This, we were told, was money that we would be fools not to borrow at such low interest rates, especially since we needed to invest in the NHS/stimulate the economy/build HS2/achieve Net Zero. Those of us who cautioned against borrowing vast sums of money every year when unemployment was low and there was no recession were assured that government debt is not like household borrowing and that “the state’s budget is nothing like a credit card”. Since it was basically free money, we should be borrowing more of it, said the Sensibles. Most of the debt was shrewdly locked into government bonds that wouldn’t expire for 10 years or more and much of the rest was index-linked, so there was nothing to worry about. Tomorrow would never come and central bankers had beaten inflation. If the worst came to the worst, the Bank of England could always print more money. Merely borrowing between £40 billion and £140 billion a year, as the government did throughout the “austerity” years was therefore a short-sighted and spiteful “political choice” designed to starve our precious public services of cash.
But then tomorrow came and it turned out that the credit card analogy was accurate in the only sense that mattered. Like credit card debt, the national debt accrued interest that had to be paid, and the more of a credit-risk you are, the more interest you are charged. Central banks printed huge sums of money in 2020-21 and inflation soared. Interest rates and bond yields followed suit, albeit only returning to something approaching historic norms. Our public finances were not prepared for normality.
In Britain, the process was accelerated by Liz Truss’s infamous “mini-budget” which Rachel Reeves claimed “crashed the economy”. This was a lie, but an important lesson was learned: the British government could not borrow unlimited sums of money without an OBR-approved plan for staying solvent. Making some attempt to balance the books, no matter how half-hearted, was not a “political choice” but an economic necessity.
Where the line is drawn can be debated, but the existence of a line is no longer in doubt and Reeves’ fiscal rules bring us very close to it. As of last month, the government has borrowed £132 billion in this financial year so far. This is more than the fiscal rules allow, hence the cuts yesterday. In real terms, the government is now borrowing more than it ever did during the financial crisis and is paying considerably more to do so. Yields on 10 year UK government bonds are now higher than Italy’s and they have been higher than at the peak of the mini-budget “crisis” since January. Exceeding the mini-budget peak has symbolic value since that is what Reeves says crashed the economy, but it is the financial impact that should worry us. We have normalised borrowing upwards of £130 billion a year when the cost of borrowing is at a 17 year high. And, to use the hated analogy again, we are borrowing on one credit card to pay the interest on the other.
Once Jeremy Hunt became Chancellor, this policy of borrowing up to one’s neck and no further became more or less official. It has since gone unchallenged. The difference between a Conservative debt junkie and a Labour debt junkie is minimal. Hunt used what little “headroom” was leftover to cut National Insurance. Reeves used her headroom to sprinkle money on the public sector. Anything else would be austerity and the public were bored of austerity.
Why are we doing this? Why is it that no matter how much the government takes in tax, it always needs an extra £100 billion? There is no Keynesian justification for it (unemployment is low) and the idea that it stimulates the economy has been discredited by 15 years of pitifully weak economic growth. The reality is that we are doing it because we can. As Jeff Goldblum says in Jurassic Park, we have been so preoccupied with whether or not we could, that we haven’t stopped to think if we should.
