Can Britain afford to borrow its way out of the coronavirus crisis?

If the economy stagnates, there will be pressure to raise taxes and limit public spending, writes Sean O'Grady

Rishi Sunak has been praised for his measures to soften the impact of the pandemic (Getty)

Who will pay for the coronavirus crisis? Who, in other words, is going to pay back the large-scale debt being run up by the government on behalf of the British state? Can it even be paid back?

First, we need to take a quick look at the scale and context. What we have here is, in fact, a national version of the business that is seeing its revenues slashed and is having to borrow to keep itself alive for the best part of a year or so. There’s nothing that fundamentally wrong with it, and as soon as custom picks up things will get back to normal – except with that hangover of extra indebtedness, and the cost of carrying it and in due course repaying it.

It’s the same for the UK. The sharpest recession in 300 years will – or should – be followed by the sharpest recovery, because the fundamentals should be basically unchanged (though the longer the crisis persists, the less true that may be as investment falls, skills atrophy and industries have to adapt to the “new normal”).

According to the independent Office for Budget Responsibility, the state will have to borrow another £200bn or more to fund the various support schemes, tax holidays and higher social-security spending, ie on top of a planned budget deficit. The crisis will thus add 10 per cent or so to the national debt, like an average British household being lumbered with an unexpected “Covid bill” of a few thousand pounds – unwelcome and uncomfortable, but, with luck, manageable.

Overall, this would take the total British national debt close to about £2 trillion. That seems like a lot, and it is; but it has to be placed in context. It represents about one entire year’s British GDP. Not so long ago, the debt was well under half of that in terms of national income (it was 37 per cent of GDP just before the financial crisis).

Yet history has seen it far higher even than today. Emerging from the Second World War, when the UK mortgaged just about everything to survive as a free country, it stood at 252 per cent, an accumulation of debt including that from the First World War and the Napoleonic Wars, and which started with William III’s nine-year war with France. That, by the way, led to the creation of the Bank of England, charged with helping to raise the funding for this national emergency. This is a role the central bank is having to play once again.

The British national debt last stood at 100 per cent of GDP in the 1960s, so well within living memory, and many other relatively stable economies have similar ratios now, or soon will. In December – the month in which the first coronavirus case was reported – the International Monetary Fund suggested that public debt ratios were higher than before 2008 in almost 90 per cent of advanced economies.

As to how affordable the debt is, that rather depends on the rate of interest, who you owe it to, but most of all your capacity to repay the debt, ie how fast your economy is growing. At the moment the British state is able to borrow at extremely low rates, and for very long periods of time. The UK’s IOUs, the gilts, are being bought with the support of the Bank of England – so-called printing money.

Generally this carries a risk of inflation, but there is no sign of that in the present shocked and depressed economy. Provided the gilts are issued in sterling, at longer maturities and the average rate of interest on the debt stays low, then there should be no immediate cause for alarm. It is like a householder with an apparently crippling mortgage: provided the interest element stays within certain bounds, and provided a healthy wage rise is enjoyed every year, the debt will gradually get paid down and will look less intimidating.

Brexit will mean trade, investment and economic growth will be more sluggish than otherwise

In the UK context, that means that the economy has to grow at a respectable rate, and higher than the long-term interest rate to keep the debt under control. That, in turn, depends on future levels of growth in productivity and investment, which have been disappointing in recent years. In the short run at least, Brexit will mean trade, investment and economic growth will be more sluggish than otherwise. Even with rates as low as they are, the country will still be spending more on debt interest than, say, on its schools. Borrowing is not consequence-free. If the economy stagnates, then in the medium to long term there will certainly be pressure to raise taxes and limit public spending. One way or another living standards will suffer.

Since 1694, this country has been borrowing, sometimes lavishly, and not always to invest. Even so, the UK has, formally, never defaulted, one of the few countries in the world not to have done so (though historians argue that a renegotiation of repayments in 1932 amounted to the same thing).

Rather, the British have historically managed to erode their debt burden and evade their obligations through devaluation of the pound in relation to other currencies (directly hitting foreign owners of UK debt), and by inflation, more immediately hitting domestic consumers and savers. It may be that in the years ahead these old ruses will have to be resorted to again. For now, though, and to protect against a much more serious economic slump, the prudent course is to borrow like there is no tomorrow, simply in order to make it to tomorrow.