Rarely has a chancellor had to publish economic forecasts as downbeat as those in last month’s budget, but so far the political fall out has been minimal. Philip Hammond has had a good couple of weeks.
That is partly explained by the focus on other matters, such as the investigation into Damian Green and, of course, Brexit. But an added bonus for Hammond is that the post-budget attention has not been on him but on John McDonnell, his Labour shadow.
McDonnell’s problems began on budget day when he was asked by Andrew Neil how much Britain was paying each year in debt interest. The shadow chancellor clearly did not know the answer (£48bn) and tried to wing it. In a subsequent interview, he bridled when questioned about how much Labour’s spending plans would add to the national debt (impossible to say), replying that was why his advisers had iPads.
That was the cue for a concerted attack on McDonnell and his plan to borrow an additional £250bn over the next decade for investment in Britain’s infrastructure. There was much talk about leaving future generations with an intolerable debt burden, with the political subtext being that a man who could not give a straight-forward answer to simple questions could not be trusted with the nation’s money.
In all honesty, this was not the shadow chancellor’s finest hour. He came across as overconfident and underprepared. It is hard to imagine Gordon Brown, for example, not knowing how much the Major government was paying in debt interest back in the mid-1990s.
Having said all that, McDonnell was right. In the short term, extra borrowing certainly means an increase in the national debt and higher debt interest payments. But that is not the real issue.
Imagine the chief executive of a FTSE 100 company going on TV to announce that the company was planning to go to the City to finance a new plant. The interview would not centre on what the investment meant for the company’s debt interest payments: instead, the chief executive would be asked about what it meant for jobs, earnings and profits.
In the event that the chief executive was asked about the cost of the investment, she/he would give the same answer McDonnell did: we believe that at current rates of interest the investment will more than pay for itself, because otherwise we would not be doing it. Our debt interest payments will depend on what happens to interest rates and to inflation, but our best judgment is that the investment will wash itself.
Instead of obsessing about the red herring of debt interest payments, more attention should be paid to the things that do matter. Firstly, Labour is planning to borrow to invest not to cover day-to-day government spending and that makes sense if the return on the investment is higher than the cost of financing the extra debt.
Governments do not go bust, which means that they can borrow more cheaply than companies. Since the financial crisis of a decade ago, interest rates have been historically low and if he chose to do so, Hammond could borrow money at a cost of little more than 2%, below the current rate of inflation.
All very well, McDonnell’s critics may say, but what happens if a chancellor’s public investment plans spook the markets and force up interest rates? In those circumstances, higher public investment will make private investment more expensive and so less attractive. This would certainly be a plausible argument were Britain at the height of a raging boom, but the chances of that any time soon look pretty remote. The financial markets currently think that in 2027 10-year bond yields (how much it costs the government to borrow for 10 years) will still only be just over 2%.
As Michael Burke noted in Socialist Economic Bulletin, the returns to commercial investment are on average around 12%. “Any government, or business, which can borrow at such low interest rates for such high investment returns would be foolish to pass up this opportunity. It is reckless and extreme that the Tories have passed up this opportunity,” the Irish economist wrote.
This raises a second issue: namely whether a future Labour government would get a commercial rate of return on its investment. That means choosing the right projects, which Labour says it would do after consultation with industry and expert bodies. The £10bn cost of a Crossrail for the north would unlock £85bn of additional economic growth, the party says, while electrification of the Great Western Railway would cost £750m but generate economic benefits two and a half times as big.
Debt levels were high – albeit declining as a share of GDP – in the 1950s and 60s when governments borrowed money to build houses and the motorway network. They were right to do so. Equally, there were some real turkeys, most notably Concorde and nuclear power stations, and Whitehall – witness HS2 – is still a sucker for a vanity project. The highest rates of return are often on unglamorous local projects, but they are available.
The criticism aimed at McDonnell in the past couple of weeks is a sign that the government and its media allies are worried, as they should be because the last seven years are littered with mistakes, spurned opportunities and missed targets, all of which have resulted in austerity lasting for 15 years rather than five.
It was reckless of George Osborne, as chancellor, to cut capital investment so deeply in 2010 in the belief that there would be a fillip to private-sector confidence from his tough approach to deficit reduction. The private sector investment boom never happened, growth slowed and the government missed all its deficit and debt targets. When the newly formed Office for Budget Responsibility made its first forecasts in the summer of 2010, it predicted that debt as a share of national income would peak in 2013-14 at just over 70% of GDP. With a bit of creative accounting, Hammond says the peak will now be in the current financial year, 2017-18, but at 86.5% of GDP. Interest payments on the debt are expected to run at just over £50bn a year for the next five years.
As Lord Robert Skidelsky said in a recent House of Lords debate, since 2010 the government had made “liquidating the deficit and reducing the share of the national debt in GDP their top priority. No matter that they keep missing their targets, they return to them every year, but each time with a longer timeline.”
Skidelsky added that it was the government’s obsession with deficit reduction that left them with no money to finance its new industrial strategy. “We could put it technically. What they have done is concentrated on reducing the numerator – the deficit – without considering its harmful effects on the denominator, which is the economy.”
McDonnell is suggesting the opposite approach. Not before time.