Why the Government’s Covid Debt Burden is Not Actually that Bad Laura Fallon lfallon@arlingclose.com

Other than the obvious worry of death and disease one of the main things concerning everyone (and especially the smaller group of lockdown sceptics) throughout the pandemic has been the effect on the economy. The government telling everyone to stay at home and mandating the closure of all non-essential services stopped a lot of people spending money almost overnight. To prevent the sudden onset of mass unemployment and poverty the government quickly introduced the furlough scheme alongside other support such as rate relief, bounce back loans and increases to benefits. These things haven’t come cheap and have all been funded by borrowing leading to an understandable concern about the impact of this on the UK’s future.

The UK’s debt currently stands at around £2.2 trillion which is approximately equal to everything that the UK economy produces in a year (known as Gross Domestic Product or GDP). So debt is now 100% of GDP. This is up from about 80% before the pandemic so a sizeable jump. However this has to be put into the recent context that the debt to GDP ratio jumped from 34% in 2007 before the onset of the financial crisis to its 80% pre-pandemic level: and that’s even after years of austerity that attempted to undo some of damage. In short, banking crisis’ appear to be much worse for the government purse strings than pandemics despite the somewhat smaller impact they had on most people’s day to day lives.

Why is this? Well some of it is that the impact of the pandemic has at least so far been for a shorter period. Whilst not over, the UK’s world beating vaccination programme has now allowed most areas of the economy to reopen about 18 months after initial closures. The financial crisis or ‘credit crunch’ started with an emergency loan to Northern Rock in 2007 and still isn’t truly over (the UK government currently owns 55% of the NatWest Group). The effects of the crisis caused stagnation in global economies for a long time with no vaccine equivalent silver bullet bringing it to an end.

The second reason is that the two crisis’ saw different areas of the economy affected. The pandemic has most affected industries such as travel and hospitality whereas financial services have largely been able to keep functioning just by moving bankers from central London offices to their kitchen tables. The financial crisis as the name suggests however primarily affected the financial services industry which for all its faults was and is a hugely successful and productive area of the UK economy that generates very significant tax revenues each year. The fall in these revenues alongside the well-publicised government bail outs were far more expensive than the complete closure of all our bars and restaurants for a number of months, NHS track and trace and the lot put together.

Prior to the financial crisis the next main piece of historical context comes from 1946 when the debt to GDP ratio was 250% dwarfing its current level. It turns out two World Wars* in relative quick succession are also worse than a pandemic. This should also be seen in the context that people and standards of living were far poorer in 1946 than today so this huge debt had to be repaid from a much lower starting point.

When it comes to debt it’s not only the actual level of debt that matters but the cost of interest on that debt. Interest rates are at historical lows so that makes all the extra borrowing that has been undertaken during the pandemic very cheap. This means that despite debt being 25% higher as a proportion to GDP than it was pre-pandemic the cost of interest is about 50% lower. Related to this is quantitative easing which has been done to help keep these interest rates low. What happens is that the Treasury (part of the government) borrows money by issuing bonds. 35% of these bonds have now been brought by the Bank of England which is also part of the government. So, 35% of the government’s debt is actually owed to itself which may lead some readers to conclude that the actual debt figure of what the government owes other people is smaller than the overall headline figure. Having said that quantitative easing is not designed to be permanent and in theory the Bank of England will sell these bonds to the private sector one day: if it doesn’t then this may lead to high inflation or loss of confidence in the UK government (or both) which would be a cost born by everyone just in a different way to interest repayments.

Of course, no increase in government debt levels is seen as a good thing and challenges remain. The threat from winter, ‘lockdown lites’ and new variants remain. Disruption to the old order from more home working will need to be adjusted to and the damage to children’s education caused by school closures will inevitably have an impact years into the future. The UK paid back its war debt whilst still raising living standards and creating the NHS by economic growth: but this is now more difficult due to an aging population, climate change and the law of diminishing returns (the move from bicycles to cars had a bigger impact on livings standards than the move from aeroplanes to space rockets will). However, seen in the context of history and the present really low interest rates the increase in borrowing does not seem like an insurmountable problem that will never be fixed – there remains hope for a bright future!

* and a flu pandemic

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