UK debt before and after the crisis

Spotlight on the UK economy: A Wheeler Institute webinar series

Andrew Scott and Paolo Surico, Professors of Economics at London Business School, were hosted by Elias Papaioannou, Co-Academic Director of the Wheeler Institute for Business and Development, to discuss the implications of COVID-19 on the UK, especially how public and household debt is interlinked, investigate how the pandemic crisis may leave permanent scars on the UK economy and consider appropriate policy responses from the government to ensure any response is sustainable for future generations.

Key Takeaways – UK Households

  • There has been a large drop in consumption in the UK, driven by wealthier households who own their homes reducing spend on non-essential items. For the first time in 10 years, the amount of credit card debt repayment has exceeded the amount of lending because people are consuming less.
  • Homeowners, mortgagors and renters are impacted in different ways from a labour perspective: for example, typically people who rent are younger, less skilled, and seven times more likely to be in a sector that shut down as a result of the crisis. Renters had very little relief from the state, while the main household policy intervention was in the form of mortgage holidays, which benefitted a group that was less exposed loss of income brought about by lockdown measures. 
  • Household debt is linked with liquidity; those with liquid wealth, such as outright owners of their homes are less constrained compared to those who are paying for a mortgage or renting. Homeowners are able to cut back on their spending to a greater extent, as most of their consumption basket consists of non-essential goods and services.
  • Renters and those who are repaying mortgages have contributed less to the fall in demand, but have had an outsized impact on their standard of living. There is a limit to the amount low income households can cut back spending, as most of their consumption is on essentials. ; low income households have seen their incomes drop by more and therefore they are relying on unsecured debt and their savings rate has gone into negative territory.

Potential Policy Responses:

  • Mortgage holiday measures should be passed onto renters when the homeowner acts as a landlord, providing relief for the tenant, not the owner.
  • Mortgage holidays need to be much more targeted to those who have been suffered a loss of income as a result of the pandemic; the level of income relative to mortgage payments needs to be taken into consideration, and only those who exceed a certain threshold of debt servicing to income ration should be eligible for a mortgage holiday.
  • There should be redistribution through a wealth tax based on housing wealth. The people who are suffering the most as a result of COVID-19 are the poorest, the rich are able to increase their savings during the crisis. However, any tax on wealth should be based on net-wealth rather than the overall value of the asset to take into account any mortgage debt households may hold.
  • Governments should send a prepaid card with an expiry date to households to boost consumption which will lead to people actually spending any handouts rather than saving them.

Key Takeaways – UK Government

  • The Government is expecting a huge reduction in tax revenue and an increase in expenditure, resulting in a massive change in net cash requirements. While the government borrowing climate is going to be immense and UK government debt has jumped to its highest level since 1963, from a historical perspective, this policy is sustainable.
  • It is plausible that the response to a once-in-fifty-years pandemic should take fifty years. There will be a persistent effect on Government debt. Governments need to set taxes to achieve long-run solvency; they can’t hurt the economy today by raising taxes during a recession – these need to be long-term.
  • There will be a higher level of borrowing, between 120%-150% of GDP as the government has stepped in with policy measures and become the national insurer of last resort. There should not be a target for debt as a proportion of the economy, the focus should be on ensuring the economy should be prioritised.
  • Taking a 300-year view on debt as a proportion of GDP, even if it reaches 150%, this is only around the average level across the broadest of timeframes. Government debt has been at this level before, and government debt has gone down before. Currently, government debt is around 3x tax revenue, but the fiscal position can be improved quickly by tax rises and cuts in expenditure.
  • The key to bringing debt under control in the long-term is decent growth in nominal GDP. While inflation risks have risen as a result of higher levels of debt, the focus has to be on growing GDP; short term fiscal policy should not be constrained by the fear of higher inflation. Similarly, deflation would cause issues for monetary policy because there is a limit to how negative interest rates can go as well as shrinking the economy and therefore the debt to GDP ratio.
  • There needs to a longevity dividend; people are living longer, healthier, more productive lives. However, as a result of the pandemic, a lot of people’s pensions will be adversely affected and high unemployment. Pro-growth policies need to focus on how to get the 50+ age group to carry on working.
  • Focus needs to shift to small firms and entrepreneurship, rather than giant companies and unicorns. Local entrepreneurship in the service sector needs to be supported. Technology also needs to find a way to help people at work, rather than automate their role entirely. In the aftermath of the crisis, we cannot allow firms to move ahead with automation in a bad way. Similarly, there needs to be a focus on the ‘green economy’.

Potential Policy Responses:

  • Allowing higher inflation would reduce the real cost of debt repayments, as does keeping interest rates near zero so funding costs remain low.
  • Bringing fiscal expenditure under control through reforms to the state pension and triple-lock as well as shifting the health budget so that there is more focus on preventative health.
  • A one-off wealth tax could also be considered, but there are questions over political feasibility.
  • The environment, ageing population and automation need to be at the centre of the government’s growth agenda, whether it be incentives through regulation, taxes or subsidies.

Conclusion:

The worst deterioration in the economy for 300 years we’ve seen the biggest increase in the fiscal deficit that seems right. There’s certainly scope for UK Government to go substantially higher and the current lower level of interest rates support. But this support needs to be for those who need it most, not blanket coverage. Measures to-date have enabled the wealthiest to increase their savings rate. The government needs to focus efforts on reducing inequality when focussing on the post-COVID pro-growth agenda. It has been a long time since there’s been a broad discussion about how the economy should function. Society needs to demand the government takes action when it comes to the environment, ageing and technology.


If you’re interested in following the Wheeler Institute COVID-19 series, check out our COVID-19 series.

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