Why a Keynesian stimulus is best for both the economy *and* public finances

There is no trade-off between supporting workers and fiscal sustainability

December 03, 2020
Keynes's central insight. Photo:  TopFoto/PA Images
Keynes's central insight. Photo: TopFoto/PA Images

The economic costs of the pandemic are mounting up as we approach the depths of the long Covid winter, with firms crumbling under large piles of debt. The Debenhams bankruptcy alone will likely trigger 12,000 job losses. However, a full-blown jobs and economic disaster is not inevitable. The Chancellor Rishi Sunak has the tools to prevent enduring economic damage, preserve businesses and jobs, and spur the private sector into creating new ones. Crucially, by doing so, he can also strengthen the public finances and stabilise debt. The question is whether he is willing to use these tools.

The pandemic has necessitated rapid and bold policymaking throughout. In the first chapter of the crisis, the Chancellor acted quickly to boost support for the NHS and to introduce a furlough scheme to protect jobs. The spending amounted to sums similar to those we saw in other countries, such as Germany and Japan. But since those first decisive days, Sunak’s promise to do “whatever it takes” has faltered. A series of tweaks and eventual U-turns on the furlough scheme will have resulted in needless job losses. Most recently, his Spending Review failed to deliver the cash needed to boost aggregate demand over the coming fiscal year.

The Chancellor should think again; staying on this overly cautious path would be the wrong choice economically, but also the wrong choice for fiscal sustainability. The IPPR estimated in November that without further policy support, in 2021-22, the economy will be more than 7 per cent below what we expected pre-pandemic. In other words, the UK risks being stuck in a “93 per cent economy,” where activity improves, but in many sectors remains far below where it could have been. Correspondingly, more than one million additional workers could become unemployed compared to today, many of them for the long term as the labour market stutters.

A Keynesian stimulus could get us out of this crisis by stabilising demand, protecting jobs and investing in future growth. We estimate that a stimulus of £164bn would be needed to achieve this: four times the amount committed by the Chancellor in his most recent Spending Review. There is no shortage of ways in which this money could be spent to build a fairer, stronger and greener economy and meet the government’s promise to “build back better.” The UK economy is in desperate need of investment. According to our calculations, an additional £33bn per year of green investment is needed to address the climate and nature crisis, yet only a fraction of this has been committed in recent announcements. Take housing and transport, two of the three most emitting sectors in the UK: two thirds of homes don’t match the government’s own energy efficiency standards, and a third of trains still run on diesel, not electricity. Investing in these sectors, together with targeted retraining, could help generate jobs for people out of work due to the pandemic.

Alongside investment, supporting the incomes of those hit hardest by Covid-19 could help ensure we don’t enter a negative spiral of cutting consumer spending, which ultimately hits businesses, thus further reducing spending. Keynes’s central insight was that such a downward spiral can leave us in an under-employment equilibrium, where everyone is worse off. A boost to welfare spending—which in the UK is one of the least generous in the developed world—could stabilise demand and prevent such a cycle. These are among the ideas we propose for a fiscal stimulus package.

These may look like proposals for a left audience in favour of a larger state. But in the current circumstances, a fiscal stimulus is also needed for sustainable public finances, the self-professed strength of the right. There are two simple components to this argument. Firstly, conversations around debt-to-GDP ratios too often forget the denominator: the size of the economy. In the current circumstances, a fiscal stimulus would boost GDP by more than it would increase nominal debt. This would prevent a downward spiral of demand, boosting current and future tax receipts in the process. Second, currently near-zero interest rates mean that markets are, in effect, giving the state “free money.” Consequently, the UK will pay £20bn less—not more—to service its debt next year than was expected before the crisis. This has made a higher debt level more sustainable, which can in turn be used to stabilise the economy.

It’s for this reason that many mainstream economists—including those not typically associated with the left—now say that injecting a big stimulus is the right course of action, even in purely financial terms. The financially conservative International Monetary Fund, for instance, says that “fiscal stimulus is not just economically sound policy but also the fiscally responsible thing to do.”

This does not mean we don’t need more structural change, for example to the tax system. Taxes serve a number of purposes beyond revenue raising, and can shape the economic recovery we want—one that is fair, strong and green. Candidates for reform include equalising taxes on income from work and income from wealth; an excess profits tax; and taxation of polluting emissions. All those could and should be put in place now. And once the pandemic is over, more concerted tax reform will be needed to support a resilient and protective welfare state.

But for now, it is key that in his next interventions, and before the damage is too deeply inflicted, the Chancellor rises to the challenge posed by the pandemic and delivers a big Keynesian stimulus. It is the right thing to do for workers, who might well remember his actions when they visit the ballot box. It is also the best thing Sunak can do to meet his own party’s demands to stabilise the national debt. Not taking this option would be economically dangerous, and politically risky.