The forces behind Britain’s deepening budget crisis

By British standards, the budget presented by the new British Labor government in late October caused a sensation. Chancellor of the Exchequer Rachel Reeves has pledged annual investment of around £70bn (almost 79bn Swiss francs), with around half of this to be covered by new taxes and new debt.

As a result, the United Kingdom is increasingly becoming more like continental European countries with its high tax revenues and large state. According to calculations by the Independent Office for Budget ResponsibilityGovernment spending has stabilized at about 44% of gross domestic product; this is almost 5 percentage points higher than before the pandemic.

Meanwhile, the tax-to-GDP ratio, the sum of all taxes and public charges related to economic output, will reach an all-time high of 38% by the end of the decade. Reeves also plans to take on additional debt thanks to the loosening of rules limiting the size of the deficit. However, the negative reaction of the markets to this news shows that the policy will bring a higher debt interest burden to the state.

Difficult political legacy

Most experts agree that Reeves doesn’t have a good option. After being in power for 14 years, the Conservative Party left the country facing serious problems. Prisons are overcrowded, hospitals are overcrowded, and many schools are in need of renovation. Sinistral Commentators have attributed the poor state of the country’s infrastructure to the Conservative Party’s “austerity policy”.

But the UK does not actually subject its public finances to strict austerity. Public debt currently accounts for around 98% of GDP. The country hasn’t been this deep in debt since the early 1960s. And the tax burden during the last phase of Conservative government was higher than at any time since the post-World War II period.

How did it get to this situation?

A look at government spending trends provides some insight. While Margaret Thatcher downsized the state in the 1980s, spending rose again at the turn of the millennium under New Labor under Tony Blair and Gordon Brown. In the 2008 financial crisis, the state spent 137 billion liras to save banks. In 2020, another unplanned explosion in public expenditures occurred due to the pandemic.

Even before the financial crisis, the UK’s structural deficit was one of the largest in the group of developed countries. As the Organization for Economic Co-operation and Development noted at the time. This was among the reasons why Conservative Prime Minister David Cameron, elected in 2010, along with Chancellor of the Exchequer George Osborne, launched an “austerity programme” aimed at restoring balance to the public finances.

Budget deficits despite cost-cutting measures

The government actually cut spending significantly in the years after 2010, according to Beatrice Boileau, an economist at the Institute for Fiscal Studies think tank. “Social benefits were cut, municipal budgets were reduced, and even the military had to find savings.” he says. He adds that the government is reducing its ongoing costs by laying off employees and cutting the real salaries of civil servants. But government investment also fell by almost a third in the early years of the 2010s. Boileau notes that this contributes to the poor state of the country’s infrastructure.

So can this really be called austerity? Although austerity measures reduced the amount of new debt taken on, the UK continued to run a deficit every year. Boileau attributes this partly to the healthcare system, which is absorbing ever-increasing amounts despite austerity: and currently consumes around a third of all spending on public services. The inefficient National Health Service is seen as a sort of political third rail in the UK, funded directly from public coffers and with almost no cost-sharing from patients.

Low economic growth rates also mean tax revenues are lower than projected, Boileau says. This, he notes, makes it impossible for the government to make new investments in infrastructure following austerity measures. The reasons for anemic growth in the years since the financial crisis range from notoriously low productivity levels to the significant uncertainty following the Brexit vote in 2016. For example, corporate investment has still not recovered from the negativities of the referendum.

Serious pandemic consequences

By the time Boris Johnson became prime minister in 2019, the national debt had risen from around 70% of GDP in 2010 to over 80%. With this, Johnson officially announced the end of the country’s austerity policy. He touted the possibility of massive infrastructure investment and promised to close the economic gap between former industrial areas in the north of England and the developing south.

However, what made the mountain of debt even higher was the epidemic. An IMF review It shows that countries including Switzerland, Italy and Germany made most of their aid policies during the epidemic in the form of loans, loans or guarantees. By contrast, in 2020 and 2021, the UK devoted almost 20% of its GDP to irrecoverable pandemic-related support in the form of direct payments and lost tax revenue.

Johnson’s government spent money on protective equipment and introduced a subsidized short-time work program overnight. But not giving companies the option of continuing to employ staff on a part-time basis created perverse incentives and led to high costs for the government.

A 150 billion lira aid package was added to this in the autumn of 2022.It’s a project launched by Prime Minister Liz Truss during her short term in office to ease the impact of high energy prices. The government subsidized the energy bills of all households rather than focusing on those in need. The Tory government’s approach drew little criticism, as Labor, then in opposition, unconditionally supported both multibillion-dollar Covid-19 spending and untargeted energy payments.

The epidemic has further affected public infrastructure. Waiting lists have increased significantly in the healthcare industry. There is a backlog of cases in the justice system, further contributing to prison overcrowding. The rising cost of care for people with chronic diseases is contributing to the increasing number of patients. Local councils underfunded and heading for bankruptcy.

Is Labor turning to austerity?

Because of these facts, the IMF welcomed the Labor government’s plans for significant increases in infrastructure investment. But Boileau of the Institute for Fiscal Studies notes that these additional investments are concentrated in the first two years of the current parliament’s term and will likely last until 2029. Many temporary problems can be quickly solved with money. But it is not yet clear how the government plans to structurally reform the NHS to stop the long-term explosion in healthcare costs.

The pessimistic interpretation would be that the government is using the short-term spending increase to distract from the fact that it will have to make additional decisions on spending and budget cuts in the medium term. Osborne is the former Chancellor of the Exchequer of the Conservative Party. already discussed He said Labor would return to the austerity policies it once helped shape in just two years.

Strong economic growth could save Labor from this dilemma. But Chancellor Reeves is asking companies to pay more by increasing payroll taxes and raising the minimum wage, which in theory would lead to such a rise. OBR’s somewhat discouraging forecasts We already predict that annual growth rates will be only 1.5% starting from 2026. And the threat of tariffs and trade restrictions following Donald Trump’s US election victory is further deteriorating the outlook.

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