Coronavirus: Who will pay for this bailout?

How can the UK afford such a massive financial support package? Where will the money come from?

Ben Chu
Economics Editor
Wednesday 18 March 2020 15:05 GMT
OBR head Robert Chote: failing to spend on a large scale now will prove a false economy

When the Chancellor Rishi Sunak unveiled his economic aid package for UK businesses on Tuesday he was keen to stress its sheer size.

Mr Sunak said his intervention in the economy would be “on a scale unimaginable only a few weeks ago”, adding that the size of the loan guarantees the government would be offering – £330bn – were equivalent to 15 per cent of the UK’s GDP.

And that was not all. “If demand is greater than the initial £330bn I’m making available today, I will go further and provide as much capacity as required,” he pledged.

But how can the UK afford such a massive financial support package?

Where will the money come from? Who will ultimately pay for it?

Is this really all government spending?

It’s important to distinguish between government spending and state loan guarantees.

The Chancellor’s £330bn of loan guarantees are a contingent liability for the UK state. If the loans made by banks to suffering private companies are not repaid the state will have to compensate the commercial lenders.

So it’s certainly a considerable financial support commitment. But it’s not direct government spending.

What does count as direct government spending are the grants which are to be made available to smaller firms.

According to the Treasury these grants – along with the forgone tax revenues due to the business rates holiday – will add up to £32bn this year, or 1.6 per cent of GDP.

So the government isn’t actually providing as much support as it claims?

If take-up of the loan guarantees from firms is not high then this will be the case.

Yet the government is still working on its fiscal response.

There are likely to be more tax cuts and spending commitments for businesses in the coming days. Individuals are also likely to be targeted with support.

Fiscal spending seems likely to be go higher than £32bn in 2020.

Some economists say that government borrowing could even shoot up as high as it did in wartime.

During the two conflicts of the 20th century borrowing was more than 20 per cent of GDP.

That would be double the borrowing at the peak of the 2007-09 financial crisis.

How will the government pay for all this spending?

By borrowing. Raising taxes to pay for it would defeat the object of the support by sucking spending power out of the economy.

The government will issue more debt to the financial markets.

Will the markets lend the money?

Almost certainly.

Indeed, the UK government’s cost of borrowing on the financial markets has collapsed to historic lows, a reflection of investors’ strong appetite for financial assets traditionally regarded as safe.

In theory it’s possible that markets would not buy the new debt issued by the government – or charge a punitive interest rate to do so – but analysts think that is very unlikely to happen.

And if it did, economists point out that the Bank of England could – in extremis – print money and buy the government’s new debt itself, preventing a fiscal crisis.

But won’t our debt levels rise?

Any increase in the deficit has this effect.

Government debt currently stands at around 80 per cent of GDP.

Expect this to go considerably higher as a result of this crisis.

But who will bear the cost of that?

All of us who live and work in the UK. When the crisis (hopefully) ends, the government will have a higher interest bill to service.

That may mean fewer resources for other areas of public spending like health or education.

Presuming future governments wish to bring the debt burden down as a share of GDP that will also impose a cost in future.

In the wake of the Second World War the UK had a debt worth more than 250 per cent of GDP, far higher than today.

This descended as a share of GDP partly thanks to strong GDP growth but also thanks to a combination of rising prices and the “financial repression” of households, with savers effectively being compelled through the banking system to accept returns lower than inflation.

This is another way that the cost of government debt spikes have historically been distributed.

So can we afford this bailout spending?

The better question is whether we afford not to do it.

Economists identify the gravest threat in the current environment not as falling economic activity – that is a necessary by-product of dealing with the health emergency – but as the long-term damage to our productive capacity.

If the Government undercooks its stimulus or bailout packages today, during the crisis, more businesses than otherwise will go bust and unemployment will rise further and this will scar the economy long into the future.

The rise in the nominal debt burden might be lower, but it will be supported by a smaller and weaker economy than otherwise.

In other words, failing to spend on a large scale now will prove a false economy.

This point was made by Robert Chote, the head of the Office for Budget Responsibility (OBR), in evidence to the Treasury Select Committee on Tuesday.

“This is not a time to be squeamish about one-off additions to public sector debt. It’s more like a wartime situation,” he said.

The OBR is the government’s official spending watchdog and its officials are not normally supposed to give ministers policy advice.

The fact that Mr Chote decided to ignore the rule on this occasion shows how extreme the situation currently is for the UK economy.

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