Thirty years at the Treasury has made Macpherson suspicious of new orthodoxies. Photo: Kirsty O'Connor/PA Archive

In defence of austerity

Free money is in vogue—but there’s no such thing, says the former head of the Treasury
January 26, 2021

This year the British state is set to borrow almost £400bn. That’s a peacetime record. The national debt—a mere 27 per cent of national income in 2001—is set to rise to almost 110 per cent by 2023. Yet the markets haven’t batted an eyelid. The government can issue 10-year debt at an interest rate of 0.3 per cent, and sterling is stable.

A cosy consensus has emerged across left and right that borrowing does not matter. Look at Japan, the argument goes: its debt levels are double the UK’s and the sky hasn’t fallen in. Look at the average maturity of British debt—almost twice the length of other G7 countries. Borrow now, and the UK won’t have to re-finance it for years. The best way to cut debt is growth, and only borrowing can generate that.

Thirty years at the Treasury has made me distrustful of new orthodoxies. The Conservative and Labour parties, and TUC and CBI, all supported entry into the Exchange Rate Mechanism in 1989. Three years later, we were out. The case for fiscal rectitude remains as strong as ever.

That does not mean there should be an immediate tightening. Rishi Sunak has been right to let the deficit take the strain, just as Alistair Darling was in 2009 amid the banking crisis. In the short term the Bank of England can buy Britain’s debt. But that will not last indefinitely. The Bank took many years to win its independence. It takes its mandate seriously. The moment the vaccine allows an economic recovery, concerns about inflation are likely to revive.

Of course, other economies are in the same boat. But the UK is borrowing more than any other major one bar Canada (which starts with relatively smaller public debts). Market pressures tend to build for economies that stand out too much. And the UK looks increasingly like it is doing so, partly because the current wave of coronavirus is hitting us hard and partly because of our more profligate interventions.

Unlike Japan, the UK doesn’t have an effective “captive market” of savers. The British people, and the governments they elect, have always favoured consumption over investment. That means the UK has to rely on the kindness of strangers, as former governor Mark Carney once put it, to finance deficits. Foreign investors own a little under 30 per cent of Britain’s debt. Lose their confidence and we have a problem. 

The UK crises of 1976 and 1992, and the global one in 2008, involved a slow build-up of risk, followed by an inflection point as investors lost confidence and the dam burst. The government should be careful.

Interest rates are unlikely to rise soon. But when they do, the consequences could be painful. A sustained 2 per cent increase in the rate payable on our debt would carry a long-term cost of over £50bn a year. The same as England spends each year on schools, squandered on servicing the debt.

Even pre-Covid, demography was ramping up the pressure for health spending. It is time for a serious debate about how these pressures will be financed. The government could wait for a crisis to force its hand, or get ahead of the problem by setting out a coherent plan to stabilise the debt. The PM may not like the term “austerity.” But in the end, expenditure has to be paid for.