Sunday, March 29, 2020
Whatever it takes - but with an eye on the public finances
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

For those of us who were not around at the time, one of the most impressive things that happened during the Second World War was that, even when the outcome was highly uncertain, planning for a post-war future took place. The Beveridge report, which formed the basis of the post-war welfare state, was published by the wartime coalition government in December 1942. The Bretton Woods conference in America, which put into place the post-war architecture of the international economic and monetary system, notably the International Monetary Fund and World Bank, was in July 1944.

The coronavirus crisis is not a war, though it has been widely described as our biggest peacetime challenge since then, including by the prime minister. It has not yet reached its peak.

The view of most economists is that there is a path to the other side and that this year’s terrible numbers will be followed by a strong bounce next year, partly a statistical effect arising from year-on-year comparisons with the very weak numbers in prospect for coming months.

Some, it should be said, are gloomier. Nouriel Roubini, who made his name during the global financial crisis, and became known as Dr Doom, warned last week of “persistent depression and runaway financial market meltdown” as a result of “uncontained pandemics, insufficient economic-policy arsenals” and other risks.

We shall see. But to return to my theme, you see the hand of post-coronavirus or at least post-crisis planning in the way the Treasury has approached its response. Though the chancellor, Rishi Sunak, has repeatedly promised to do “whatever it takes” and the government has been urged by many people to spend big now and ask questions later, the Treasury is keen to avoid doing now what the country, and the public finances, will regret later.

The chancellor has been criticised for the fact that his 80% income support for the employed will not be available until next month, and for the fact that the generous 80% support scheme for the self-employed will not be available until early June. That delay, which is understandable, together with a hint that the tax treatment of the self-employed will change in the future, predictably met with a very mixed response.

Sunak and his officials resisted what many urged on him, to introduce a universal basic income (UBI), even on an emergency basis. A UBI, a guaranteed weekly sum payable to everybody, has had many advocates, including Silicon Valley billionaires – as a response to artificial intelligence, not the coronavirus – for some time.
Its flaws in normal times have been pointed out here before. Welfare systems are complicated for a reason; people have different needs. Providing a UBI to everybody would discriminate against those with needs and provide free money to those that do not need it. Setting the UBI at more than a very low level would require punitive taxation. And, crucially is the current situation, there is no obvious way of delivering it, particularly to low-income people without bank accounts.

So the Treasury is right to resist it, and I hope that resistance continues. Similarly, while exceptional times require an exceptional response and justify a ballooning in government borrowing and a sharp rise in public sector debt, care has to be taken, not just to avoid saddling us with bad policies, but also an unnecessary burden.

There were strong expectations last weekend of a big rescue package for the airlines, including the possibility of the government taking equity stakes in them. But the Treasury remembers the last time it took equity stakes, in the banks, and how long it has taken to get rid of them.

The Resolution Foundation is a think tank devoted to improving the lot of those on low incomes. But, in a paper published a few days ago Richard Hughes, a research associate at the Foundation, also stressed the importance of keeping the public finances sustainable. Hughes, a former senior Treasury and International Monetary Fund official, looked at the experience of previous pandemics for his paper, “Safeguarding governments’ financial health during coronavirus; what can policymakers learn from past viral outbreaks?”.

As he puts it: “During all of these past outbreaks and even more during the current coronavirus pandemic, governments played a central role in not only treating the sick and containing the spread of the virus, but also in mitigating its impact on people, businesses, and the economy as a whole. To do so, however, governments have to keep their own finances in good health in the midst of unprecedented pressures on their expenditure, revenues, and traditional sources of financing.”

The economic lessons of past crises are that the falls in gross domestic product (GDP) we are likely to see could be in double digits or high single digits, that the longer social distancing measures have to be kept in place, the more protracted the downturn, and that we can also expect high single digit or double-digit budgets deficits as a proportion of GDP. This translates into big numbers. Paul Johnson of the Institute for Fiscal Studies suggests that we could be looking at a deficit of £175bn for the coming fiscal year, 2020-21, bigger than the financial crisis peak of £158bn, though slightly smaller as a percentage of GDP.

Hughes sets out six rules that governments should adopt to ensure that the public finances are sustainable after the crisis. They are that they should target financial support and avoid universal or open-ended offers; should avoid fiscal policies which unnecessarily exacerbate supply disruption (for example providing people with short-term incentives to spend); and that their spending priorities should be focused on funding healthcare systems and supporting individuals and firms.

He also says that governments should examine how they should finance themselves during long periods when expenditures will exceed revenues and, in this context, if markets are illiquid, the central bank, the Bank of England, may have to directly buy government debt with newly created money. This, monetary financing, normally brings shudders for governments and central banks, and would be a last resort measure. But It may have to be done.

Hughes also calls for governments to avoid introducing capital controls to protect their funding sources and for there to be more international economic and monetary co-operation is responding to the crisis.:

The last is one example where the wartime spirit has been lacking. Central banks have been working together but there has been nothing like the government-level co-operation and co-ordination we saw as recently as the financial crisis. America and China have been engaged in a trade war and, when G7 foreign ministers cannot issue a communique because the US secretary of state Mike Pompeo insists on calling it the “Wuhan virus”, you know we are a long way from the spirit of 2008, let alone 1944.

The Treasury under Sunak is by and large following Hughes’s rules, though some of its commitments, with a promise to roll over 80% support for incomes beyond the initial three months, if necessary, could become open-ended. The longer the crisis goes on, the more difficult it will be even for strong businesses to keep most staff on, on existing pay. One way or another, either through paying 80% of normal wages for employees, or 80% of profits for the self-employed, or through universal credit for the unemployed, the government could find itself with a very hefty and long-lasting wage bill, and without the revenues to pay for it. It has to hope, as we all do, that the shutdown is short-lived.

There are other things we should be thinking about post-crisis, beyond the sustainability of the public finances. They will, I hope, provide themes and food for thought in coming weeks, as we see how this plays out.

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