Fiscal Stockholm Syndrome

We are suffering from fiscal Stockholm syndrome. We’ve been released from a decade of austerity, with all of our political captors promising to increase the amount government spends annually and borrows to invest in the economy. And yet, we’re always asking ​‘can we afford it?’

But ​‘can we afford it?’ is the wrong question. The right question to ask is: what is state spending and investment for and what will it achieve?

Even if this was the right question, the answer would more often than not be ​‘yes!’ After austerity’s decade in the limelight, the UK state is worth a bit less than 40% of UK GDP and spending and investment pledges in some recent election manifestos might see this increase to a bit less than 45%. At this level, the UK would still be lower than the European average, on a par with Germany and well below France and most Scandinavian countries. Labour may say its manifesto is the most radical in modern times, but by this measure it isn’t.

Thanks to project austerity we are, in real terms, still poorer than we were before the financial crisis at an average of around £128 per person, and this sense of a lack of economic progress is deeply felt. In a recent survey, around 60% supported moderate or radical changes in the way the economy is run and less than 10% feel the economy works in a way that benefits everyone, with a majority highlighting high income earners and companies as the main beneficiaries of the current approach.

But ​‘can we afford it?’ is the wrong question. The right question to ask is: what is state spending and investment for and what will it achieve?

But our moment of crisis is not just limited to an absence of post-crash recovery. We are facing ecological emergency, economic inequality and a growing lack of trust in our democratic institutions. In this unprecedented context, it would be a much greater concern if the government didn’t significantly increase spending and investment.

Crises are not an invitation to throw away all economic discipline. We need rules to govern fiscal policy. But the New Economics Foundation argues that they should be developed around a more accurate assessment of the fiscal space the government can use at any time, and focused on the outcomes we want to see from spending and investment. So if we set out to increase investment to green our economy and boost wages, but ended up with higher carbon emissions and unemployment and lower tax revenues, voters would be within their rights to seek alternatives.

The household analogy has held our conversation captive for decades, if not centuries, but it is most often associated with Margaret Thatcher’s efforts to convince us to think of the government budget in the same way we think of our household finances. This fallacy, has been deepened since the financial crisis and through the age of austerity.

The household analogy goes like this. The government needs to live within its means. Like a typical household, if the government consistently spends more than it receives in income, the nation’s debt will ultimately become unsustainable, and the country will go broke. But this is wrong. It’s wrong because if a single household reduces its spending it has negligible (to the point of zero) impact on the economy at large, whereas if a government reduces its spending then it has economy-wide impacts, such as a fall in public sector wages.

In this unprecedented context, it would be a much greater concern if the government didn’t significantly increase spending and investment.

Reframing the government spending narrative to unseat the household view of public budgets will take time and the temptation will be to reinforce the notion that change requires a truly radical approach. An example of this is how organisations focussed on climate change often talk about the massive sums of public investment needed to avert catastrophe.

NEF thinks the UK government should be investing around 2% of GDP per year in a Green New Deal on top of current public investment, which would help insulate millions of homes, revolutionise the way we travel, transform our energy system and create masses of jobs. At current UK GDP levels, this is a bit more than £40bn per year, which sounds like a lot, but we should really avoid framing it as ​‘radical’ or ​‘exceptional’. That’s just the Stockholm syndrome talking.

For while even in pure government spending terms, tens-of-billions is not a trivial sum of money, what really matters is what it buys, how urgent the purchase is and what happens if we do nothing. If this sum is invested in things the country needs now and that will create productive economic activity, then it’s more a question of value for money than price tag. 

While tens-of-billions is not a trivial sum of money, what really matters is what it buys, how urgent the purchase is and what happens if we do nothing

It’s also important to note that, at this point in time and probably for the foreseeable future, the interest rates payable on government borrowing is the cheapest they’ve ever been; in fact, after accounting for inflation, it’s below zero in many cases. So in real terms, market lenders are currently prepared to pay the UK government to borrow from them.

But it’s not only about cheap borrowing; it’s about purpose. A government investing in the future of the nation’s economy creates new economic activity, which pays salaries, which are spent in the same economic system. Good government investment also establishes productive assets, such as energy infrastructure or well-insulated buildings, which earn or save money. This can flow back into the government’s budget, as is the case with building new social homes for rent, or circulate into the wider economy.

But the sweet spot for government investment is to boost people’s incomes and reduce inequality in the process of its spending and investment. Rewiring the economy so that it is fit for a climate emergency or providing better and more comprehensive services that improve health and wellbeing are good things in themselves. But, over time will also have the effect of widening the overall tax base, making future spending, including on debt repayments, more possible and enabling a balancing out of day-to-day spending.

Viewed like this, it is not only economically, ecologically and socially prudent for government to be spending and investing more, but it is irresponsible for it not to be doing so.

It is not only economically, ecologically and socially prudent for government to be spending and investing more, but it is irresponsible for it not to be doing so

There will be limits to public borrowing and investment. But ultimately these limits cannot be understood purely on the basis of measuring public debt in isolation from its wider economic impacts — positive or negative. Governments need more sophisticated fiscal rules and frameworks to remain within these limits, but with ecological, economic and democratic crises looming concurrently, a state such as the UK should be exploring the outer limits of spending and investment with great urgency.

Overcoming fiscal Stockholm syndrome requires effort. In this endeavour we need a concerted approach to make a new fiscal paradigm seem entirely normal. We need to re-educate policymakers and commentators and provide new evidence to win people around.

The price of success may be tens of billions of public sector borrowing and even some deficit budgets over the next few years to get the economy and our planet back on track. The price of failure, however, is certain to be much higher.

Image: Pixabay