Gareth Davies: This cheap debt can’t last forever

2 Mar

Gareth Davies is MP for Grantham and Stamford.

This Coronavirus crisis has led to our Government, and indeed governments around the world, spending record amounts to stabilise the economy and protect jobs. Here in the UK, the Chancellor has spent over £290 billion on support to protect jobs and businesses. There has been little sign of the fears of the past decade about an expanded deficit, and the kind of spiralling public debt that was witnessed under the previous Labour Government.

However, as the “crocus of hope” is apparently “now poking through the frost”, as the Prime Minister said recently, investors the world over have now turned their attention to the likely scale of our bounce back, and the implications for inflation and, ultimately, the cost of debt that has been built up over the crisis.

The Institute for Fiscal Studies telsl us that borrowing is the highest since the Second World War, and cheaper than at any time since the birth of capitalism itself. However, any economist will concede that, while the environment for borrowing with historically low rates may be fine now, these rates will not last forever. Indeed, a single percentage point raise in interest rates could cost the Treasury some £20 billion, as the Chancellor alluded to recently.

This poses a dilemma for him ahead of the Budget tomorrow, since many of the excellent programmes of support, such as the furlough scheme, cost multiple billions of pounds a month, and we are borrowing at record levels to pay for it. Keeping that support in place is the right thing to do in the short term – people need reassurance that they will be protected while the economy remains closed. But when we can reopen it and these schemes end, the fiscal demands on the Treasury will not abate, but rather continue.

Many have asked for the Universal Credit uplift to be made permanent, at an additional cost of over £6 billion every year, for example, and the Office for Budget Responsibility has estimated that, owing to our aging population, we will need to spend an additional £39 billion on pensions, health and social care per each future decade.

It seems this crisis has shown that there is a cross-party appetite for spending at higher levels than perhaps we have previously been comfortable with. This has led to the presumption that this will require far more borrowing, even after we re-open our economy, and it is also clear that tax must play its part as well.

This means reminding ourselves that we were only able to offer unprecedented economic support because we came into this crisis with robust public finances. Indeed, while we have seen first-hand the benefits of balancing the books in good times, to help us in bad times, we need to go further to outline the wider risks to people’s everyday lives.

We should be straight with the British public about what continued spending means, especially as this relates to increasing our national debt – and this should start with a reminder of what we inherited from the Labour Party in 2010.

When David Cameron entered Downing Street in 2010, the deficit was the largest in peacetime history. Between 2007 and 2010, public spending increased by over 15 per cent – an extra £120 billion in three years.  Debt was predicted to nearly double within five years to £1.4 trillion. Remarkably, under Gordon Brown, the Government spent more on debt interest than running schools – this is how far the UK was being governed beyond our means and what we must act to avoid now, as we come out of a period of sustained borrowing.

A strong fiscal outlook is an essential foundation for a thriving economy. Putting our nation on a sustainable fiscal path creates a positive environment for growth, opportunity and prosperity. Clearly, it is also a dividing line between the Labour Party and the Conservatives.

Growing our economy and experiencing a post-pandemic boom in economic activity will also help address the debt to GDP ratio, and boost revenues to both mitigate the need for further borrowing and help us service the debt. However, there are risks with this.

First, we have been told recently to expect a post-pandemic boom driven by consumption: Citigroup however, recently stated that they believe the circa £125 billion accumulated by households during the pandemic is flowing into assets, rather than being pent up for consumption on the high street. There are also concerns that we have all got used to online shopping and that, consequently, there may not be the stampede back to the shops some believe. If we do not grow the economy quickly, our debt to GDP ratio will remain high or higher, putting our credit rating and globally renowned reputation for fiscal management at great risk.

Secondly, let’s suppose that a boom does take place, and we see huge demand on the high street, mass hiring and unprecedented spending. This presents a potential surge in inflation. The Bank of England Governor, Andrew Bailey, has said this would be a nice problem to have, but I wonder how happy he would be with inflation shooting well over the Bank’s target. How long before the Bank decides to raise interest rates to cool down our boom and consequent inflation?
I would suggest therefore, this Budget’s long-term strategy should focus on three main points:

  • Focus on investment over general public spending. The national debt has been compounded by the massive amount of Government support and a reduction in tax receipts. We must seek to use the money we are borrowing to invest for growth. In a crisis which has seen incomes in the private sector decline sharply and those in the public sector rise, productivity and growth must be the focus of our spending. This will help to reduce the debt to GDP ratio which is a better way of looking at debt than arbitrary absolute debt figures, which tell us very little about the conditions and environment context for the debt we owe.
  • Use investment as seed capital for mobilising private capital. Government investment which can mobilise multiples of further investment brought in from overseas and the private sector will help reduce the burden on the taxpayer and facilitate new capital investment in the most productive projects across the country. This is good for our balance sheet by providing an alternative source of funding.
  • Be selective with tax incentives to focus on innovation and entrepreneurialism. Small businesses are the engine of future growth and job creation. While bringing down the debt is critical, fiscal incentives to unleash innovation and a new wave of start-ups should be made a priority.

If we do these things, we can grow our economy, enhance our productivity and maintain our global reputation for fiscal management.

Gareth Davies: A new British Development Bank could drive our national recovery

2 Oct

Gareth Davies is the Conservative MP for Grantham and Stamford.

Much has rightly been said about the perilous economic situation facing our country as a result of this dreadful Coronavirus. But talk to people in our towns and cities across the regions and they will tell you the pandemic has merely amplified economic problems that were there already. For decades our regions have been hampered by systematic underinvestment in businesses, infrastructure and transport links that have held back opportunity for large parts of the electorate. Last December, those voters demanded change.

They are right to do so. The UK faces an infrastructure gap of £8 billion a year, according to McKinsey, and a lack of infrastructure investment is one of the reasons we suffer poor productivity relative to our global competitors. Productivity issues are even worse internally – regional disparities in investment have led to disparities in productivity with average gross value added per hour worked in the UK 35 per cent below that of London and the South East.

We need a long-term strategy to boost infrastructure investment, stimulate regional development and leverage much greater levels of private capital in the process. Today I have published a plan to restructure our investments to target the regions and help mobilise billions of new private savings and investment to reduce the burden on the Treasury and the taxpayer at a time of great challenge.

Together with the think tank Onward, I am proposing the creation of a new British Development Bank with a specific mandate to invest billions in the regions. The UK has never had such an independent institution despite the model being a tremendous success in other countries around the world.

Germany pioneered the use of development banks with their own organisation called KFW. After the Cold War it was critical for “levelling up” the previously occupied East Germany. Since 1991 one out of every ten euros invested in East Germany has come from KFW and the inequality gap between East and West reduced significantly – this is in contrast to the widening inequality between England’s North and South.

We have long needed to rethink how and what we build in this country. We all know the history of PFI schemes which failed to demonstrate value for money for the taxpayer. Now is our opportunity to put in place a dedicated institution of genuine finance experts to drive and mobilise funding.

Infrastructure helps an economy to grow. The investment and construction of new assets creates additional jobs and supports supply chains. The eventual infrastructure supports productivity by connecting people whether it is a new train line, better broadband or more energy. Infrastructure makes our country a more attractive place to live and do business, and by reducing transaction costs makes Britain a more competitive player in the global economy.

Therefore, our pervasively poor quality, low stock infrastructure is a serious issue if we are going to level up and boost economic growth.

However, I entirely sympathise with the dilemma our Treasury faces, infrastructure is the one thing we need to grow our way out of the crisis and truly level up and yet it becomes more and more difficult to pay for as every day passes. This is why we must mobilise private capital to supplement public spending.

A British Development Bank will do three critical things. First, it will provide long-term targeted financing by project, business or region to ensure that investment is ring-fenced to where it is most needed. Second, it will mobilise private savings and investments by a multiple of four, meaning that for every £1 of government spend, £4 of private capital spend will be unlocked. Thirdly, it will provide “counter-cyclical” investment so that in times of economic downturn when mainstream banks’ risk appetite dries up, required funding flows will be maintained.

This new institution would be modelled on Germany’s KFW. To do this, we would move the existing British Business Bank (BBB) and the Commonwealth Development Corporation (CDC) under the one umbrella organisation of the British Development Bank to bring about huge efficiencies, but critically, the combined assets of these two organisations (which is several billion pounds) would enable the Development Bank to issue its own targeted infrastructure bonds. The domestic work of BBB financing SMEs would be bolstered by an increase in assets, as would the reach of our overseas schemes under CDC.

Backed by the Treasury, a Development Bank could borrow at very low rates to fund and encourage infrastructure investment the private sector would not otherwise build. The bank could also issue “guarantees” or could buy shares in infrastructure projects, taking the risks of infrastructure construction the private sector is unwilling to take.

This Government has an opportunity to not only set out a long term plan for levelling up in the upcoming National Infrastructure Strategy, it has the chance to put in place a financial institution that will serve the needs of our regions for decades to come regardless of who holds the keys to Number 10.