Covid-19: Mending the Economy, Repairing the Public Finances

An Unprecedented Shock

The COVID shock to economic growth and the public finances is unprecedented in the modern era. To find anything with a similar economic impact, it is necessary to go back beyond the days when reliable economic data were being collected. Quite simply, the economies of the UK and most developed nations “fell off a cliff” in the spring of this year. As tax revenues disappeared and governments rushed to support their economies with extra spending, public borrowing ballooned. A decade of hard work to reduce Britain’s budget deficit appeared to be unwound within a matter of weeks.

Just as the impact of the current economic crisis is unprecedented, its cause is too. For once, a nosedive in activity has not been caused by economic developments, but by calculated government actions to shut down businesses and society in the face of a worldwide pandemic. As the economic shock has been government- determined, governments have also stepped forward with unprecedented economic support – cutting taxes, boosting spending, and nationalising a large part of the private sector payroll.

The Correct Short-Term Response

Borrowing and debt have soared, but governments and central banks have rightly taken a relaxed approach to this – they have no alternative, if they wish to provide any sort of underpinning of their economies. The judgement that Finance Ministers are making is that we have suffered a one-off shutdown of the economy, which has made us permanently poorer. That will be paid for not by short-term austerity, but by adding to the stock of debt, and paying the bill over a long period – perhaps over the next 50 or 100 years. 

Usually, when borrowing rockets and debt expands, economists would worry about “sustainability”. The extra government borrowing increases debt service costs, which expand as a share of the national spending budget. That causes borrowing to rise even higher, or it squeezes out other spending on services such as health, education or social security. 

But on this occasion, the economic collapse is so enormous that interest rates are low – often zero, or even negative. So, governments can borrow vast sums of money without it having an obvious short term impact on the affordability of other areas of public spending.

Interest rates seem likely to remain at these all-time, history-making, lows – not least because central banks are “printing money” and buying up government debt. For once, soaring government debt isn’t causing the type of “fiscal crisis” experienced by countries such as Greece, Italy and Argentina. 

Economies Remain Weak

But, if we assume the worst of the economic crisis is behind us, what happens next? Well, perhaps not much for some time. Economies are still extremely weak, and critical economic support is in some cases being withdrawn over the months ahead – this is no time for higher taxes or more public sector austerity. Already, withdrawal of support schemes could lead to a lagged rise in unemployment, as firms decide that they can no longer afford to pay the wage costs of employees previously met by “furlough” schemes.  

There could also be one or more further waves of the pandemic. In short, Finance Ministers and Prime Ministers will be highly nervous about increasing taxes and cutting public spending until they know that their countries have survived the plunge in activity, and are back onto more solid economic ground.

It could therefore easily be a year or more before some governments can think of raising taxes or cutting public spending. In the UK, the current crisis follows a decade of tough spending control – which means that any “easy” savings have already been banked. 

Policy Withdrawals and Policy Replacements

So, over the next year we are likely to see the withdrawal of some government financial support, but its replacement by certain other measures. They could be selected cuts in tax, and more investment in infrastructure. There might also need to be more support for employment and retraining schemes, and welfare budgets may be under some upward pressure. 

An Ageing Population

If we assume (hope?) that in eighteen months or so, the UK and world economy are on a clear path to recovery, what comes next? Well, at that time Finance ministers will need to consider what actions are necessary to bring public borrowing back under control. In the UK, this may be even more pressing than in some countries because of the expected ageing of the UK population over the next few decades. This will reduce the share of the population in employment, and push up spending on pensions, health care and social care. 

The following issues will particularly need to be considered: whether the uprating of the state pension is made less generous than the “triple lock”; whether the state pension age needs to rise again; whether employee national insurance contributions should be extended to include people of pension age who are in work; and whether further charges will need to be levied to cover social care costs. 

Taxation

On taxation, governments will consider whether further revenues need raising from the more affluent, who are likely to come through the Covid crisis relatively better off than those on low incomes. Will pension tax reliefs become less generous? Should national insurance rates be raised for higher earners? Other means of raising tax revenues will also surely be considered – should be self-employed pay more, and is it time for a new swathe of “green” taxes?

Public Spending

On wider public spending, it seems unlikely that there will be a public appetite for big cuts to “priority” areas of spending, but rates of growth of spending will be less than they would have been in the absence of the Covid crisis. Welfare spending could continue to be squeezed, and there may be more pay restraint in the public sector.

 Issues for Post-16 policy makers

In this context, two critical issues stand-out for post-16 policy makers:

1. First, how does post-16 further education spending avoid losing out to schools and higher education in another round of budget tightening?
2. Second, how can the post16 further education sector help government to avoid a large rise in unemployment amongst 16-24 year olds, as employer reduce recruitment in the period ahead?

Rt Hon. David Laws, Executive Chairman, Education Policy Institute

 ‘Revolutionary Forces‘

In the immediate aftermath of the Covid-19 pandemic, it is easy to forget that there were wider revolutionary forces at work on the UK’s economy before the virus outbreak.

With issues such as Brexit, the rise of automation in the workplace, longer working lives, and poor UK productivity brought into even sharper focus, education and skills organisations, NCFE and Campaign for Learning (CfL), jointly commissioned the ‘Revolutionary Forces’ discussion paper.

Published on 6 July 2020, the collection of articles, penned by experts from the FE sector, as well as labour market economics, employment and mental health, urges Government to ensure that the plans outlined in the forthcoming post-16 white paper are sufficiently flexible to meet the immense changes faced by the UK economy throughout the 2020s. The authors explore some of the key challenges facing the nation throughout the 2020s which the DfE needs to take into consideration when writing their recommendations:

The authors are:

• Rt Hon. David Laws, Executive Chairman, Education Policy Institute – Covid-19: Mending the Economy, Repairing the Public Finances