Rachel Reeves and the ‘maxed out credit card’

Kate Deer takes a critical look at the new government’s claims that Britain has ‘maxed out its credit card’.

When Rachel Reeves stood up in the House of Commons earlier this week to present the state of the nation’s finances, she warned that she had inherited ‘the worst set of economic circumstances since the Second World War.’ It is easy to find some truth in that. After more than a decade of austerity, the nation’s infrastructure and services have been pushed to the absolute brink. The NHS is now so underfunded that it has resulted in more than a million excess deaths since 2011; schools are missing teachers; and the social care system is in absolute disarray, lacking more than 150,000 carers.

It won’t be an easy job for Reeves, the first ever female chancellor. Ahead of her move into 11 Downing Street, the bathrooms had to be refitted to remove urinals: an illustration of the inherent sexism in British policy making if there ever was one. She is aware that she has big boots to fill as the first woman in charge of Britain’s finances. But she will do so by relying on the economic orthodoxy she has adopted ever since taking on her first graduate job as Economist at the Bank of England. Her policy style can best be described as ‘fiscally conservative’.

What does that mean? In a nutshell, she believes that her main priority must be to bring government spending to more sustainable levels without interfering too much with the free market. In other words, just like the Tories, she sees austerity and privatisation as the main tools to manage the budget deficit.

This ideology celebrates macroeconomic indicators like debt to GDP ratios as somehow objective standards that must be adhered to at all times. Since the 1990s, the UK government has set itself fiscal targets which vary marginally but roughly aim for government debt not exceeding 3% of GDP. These rules, despite being cast as iron clad, are in fact arbitrary. But when Reeves talks of a ‘black hole in the nation’s finances’ and ‘the nation’s credit card being maxed out’, she makes it sound like there really is no alternative to austerity measures. This is being used as the ideological justification for further cuts.

It is not an easy time to sell fiscally conservative policies to the public. Reeves takes on her role after Britain has seen more than more than a decade of austerity.  While public borrowing levels have been rising ever since the 2008 global financial crisis, they are now at the highest levels since the 1960s.

How bad are debt levels really?

This is bad for two reasons. While debt in the 1960s was high as a result of the Second World War, Britain’s GDP rose, which meant that up until the 2008 crisis, debt to GDP ratios had steadily come down. But GDP growth is now relatively flat at 0.1%. Given that Britain’s debt is being measured against economic growth, that means the relative levels of debt become a lot higher What is missing from the picture is a vision of society that moves beyond an obsession with economic growth. After all, it fails to acknowledge that economic growth pushes the planet past its boundaries, and does not consider other factors such as health and quality of life.

But stuck in the paradigm of fiscal prudence, both the Conservatives and Labour remain obsessed with economic growth. Added to that are the costs of high interest rates which make it a lot more expensive for the government to take out new debt.

Traditionally, fiscally conservative politicians would address high debt levels by implementing austerity measures and privatising public sector assets, in other words pretty much exactly what the Tories have done for the past decades, with terrible consequences. Since the 1970s UK income inequality has risen steadily in the UK, as shown by the Gini coefficient in the diagram below. The Gini Index is a measure of statistical dispersion that shows the gap in income between the richest and the poorest; the higher the percentage, the greater the inequality.

Source: ONS bulletin.

A large driver for inequality is taxation. Over the past decades tax cuts implemented by fiscally conservative politicians have disproportionately benefited the richest. On the surface, it appears people in the UK on higher incomes are now paying more taxes – 45% on incomes in excess of £100,000. But this ignores the fact that, for the very rich,  much of their wealth is held in investments, and capital gains are taxed lower than income from work. Another reason for the rise in inequality is a decade of real term pay cuts, real wages (adjusted for inflation) are now lower than in 2008, according to the TUC.

These are some of the reasons why Britain is now one of the most unequal countries in the OECD. Given the lack in pay growth, the fact that Reeves is considering ‘above-inflation’ pay rises for the public sector represents some progress, although they will not be enough to reverse years of falling real wages, underfunding, staffing shortages and overwork. The question is, how to fund them?

If there is one thing fiscally conservative ideology does not like, it is tax increases, because they contradict the belief that the free market will regulate itself. This is why the Conservatives are so obsessed with portraying Labour as the party of tax hikes. And this is also why Rachel Reeves had ruled out any changes to VAT, income tax or even capital gains tax before the election. This has been pitched as not wanting to tax ‘hard working people’, but really, it means Labour is attempting to avoid any redistributive policies.

Fiscal conservatism has no interest in the potential redistributive power of taxes. There is a huge difference between hiking VAT on basic consumer items or national insurance for the lowest earners, which would disproportionately hit the poorest people in Britain, and taxing the rich more, something which the Conservatives have consistently avoided doing. Indeed, Rishi Sunak had indirectly hiked taxes for the lowest earners by freezing tax thresholds, whilst introducing new exceptions to the already overly general capital gains tax.

Reeves now seems to have backtracked from her earlier pledges. Having revealed a £20bn ‘black hole’ in public finances earlier this week, she warned that she could increase taxes this autumn. But she accompanied this announcement by a series of austerity measures. The cruellest ones are perhaps the ditching of the social care plan, which would have capped the amount old people have to spend on their care to £86,000, and ditching the winter fuel allowance for the vast majority of pensioners, while the refusal to increase funding for local authorities will have a devastating impact on the provision of vital social services from care to schools to housing

While she has also taken some good measures such as scrapping the monstrous Rwanda Scheme, she has not changed her fiscally conservative stance. John Maynard Keynes once said that ‘anything we do we can afford’ reflecting the idea that public investment could lead to large scale developments of social infrastructure. In her speech this week, Reeves has turned those words on their head, warning: ‘If we cannot afford it, we cannot do it.’

Should we just not worry about government debt?

What are the alternatives? There is one school of thought, backed by some on the left, which argues that we should just not worry about government debt at all. Advocates of Modern Monetary Theory (MMT) say that governments should not worry about sovereign debt at all, because they have a monopoly over the issuance of their own currency. Advocates of MMT can be found on the political right and the left, with Warren Mosler and Stephanie Kelton being some of its most famous backers.

They do have a point, in the sense that the definition of what is ‘sustainable’ debt is fundamentally subjective and political. For example, the US has significantly higher debt to GPD levels than Britain, yet still enjoys a strong credit rating due to its political power. A lot also hangs on how you are being perceived by bond traders. Or, as Financial Times columnist Katie Martin put it, whether you are borrowing money wearing ‘a suit or a clown’s costume.’

However, it doesn’t take long to see the fundamental flaw in MMT logic. Borrowing costs for countries are strongly influenced by markets, and policy makers ignore them at their own peril. A good example of that is the Liz Truss government, which announced drastic unfunded tax cuts which led to a sudden surge in borrowing costs of government debt. This made it instantly more expensive for the government to borrow, and nearly collapsed the entire government bond market.

Of course, progressives could just argue that we should ignore the government bond market, but the consequences can soon become very real, as many households have felt in the wake of the 2021 bond market crisis. Moreover, borrowing adds to intergenerational inequality, because debts have to be repaid with interest that accumulates and is now unfortunately a lot higher.

The Bank of England responded to Liz Truss’ crisis by buying more than £60bn in government bonds to normalise prices, through a process called quantitative easing.  But now that the Bank is unwinding its bond buying programme, it sells these bonds back to the market at a loss. Because of the way the Tory government has set up quantitative easing, this loss is footed by the treasury. Last year alone, the repayments cost the treasury nearly £45bn.

There is however some wriggle room. Since Labour took power, yields on long-dated government debt have been falling, indicating that markets are seeing Reeves very much as the suit wearing type, unlike Liz Truss. In other words, she could get away with increasing borrowing somewhat.

It would also be good to acknowledge the growing political power the Bank of England holds. The Bank sells bonds supposedly to control inflation, but in reality, it has very little impact on price rises.

It is economic orthodoxy to believe that the Central Bank is an a-political institution. In reality, the Bank of England could opt to free up billions of pounds by simply deciding to slow down the sale of its bond sales.

The problem with public-private partnerships

But for now, Reeves still appears to hold on to the myth that the Labour government can wriggle its way out of this mess through a combination of high economic growth and attracting private investment, especially from pension funds.

There are at least two problems with this belief. One is the fact that UK growth forecasts are low. The OECD predicts it will hit just 1%, the lowest level among all OECD countries. UK growth is low precisely because the government has invested so little so more austerity can hardly be the answer.

Another is that Reeves is so far mainly hoping to attract this capital from private investors. She has spent her first few weeks in office meeting one industry bigwig after another. Aviva, Phoenix, Schroders and Legal & General; the biggest institutional investors all went to see Reeves in the first weeks of her becoming chancellor.

Labour also launched a National Wealth Fund, which is backed with more than £8bn in public money, and hopes to attract three times the amount of private investment. The problem with that is two-fold. Firstly, the total amount of money committed is miniscule compared to how much is needed. Labour itself started off by promising £28bn per year, and has now scaled this back to £8bn by the end of the decade. However, hundreds of billions are needed to fund the energy transition.

However, private investors are in the market to make a profit. On conventional infrastructure investments, they can expect double digit returns, and any deals Labour offers them would have to be either less risky (the state underwriting some of the risk) or offer high returns. It is easy to see how this could become a lot more costly than the state funding the infrastructure itself.

All in all, the term National Wealth Fund is a bit misleading. It aims to replicate the national wealth funds that powerful oil producing countries like Norway and the Gulf States have built over the past decades. The trouble is, Britain throughout that same period privatised its national wealth, and the billions made from fossil fuel exploration in the North Sea went instead to oil giants like Shell and BP.

That isn’t to say that Britain is broke or has no national wealth. On the contrary, quite a lot of it is in the hands of the UK monarchy, which remains the biggest landowner in the world. It owns more than 6,600,000,000 acres of land around the globe, including most of the UK’s seabeds. The Crown Estate has used that control to effectively double its profits to more than £1bn last year through deals with offshore wind developers.

What then is the answer?

To cut a long story short, it by now is hopefully clear that Rachel Reeves won’t be able to get Britain out of its financial difficulties by adhering to the same ideology of fiscal prudence that conservative politicians have pursued for the past decade.

It should also be clear that the credit card isn’t maxed out – the money is there, just in the wrong hands. Any genuine alternative would have to start off by addressing Britain’s inequality problem by increasing taxes on the richest and on corporations. For example, simply increasing capital gains tax to align it with taxes on income could free up billions of pounds, something which would be backed by a vast majority of the British public. Three quarters of Britons would also support the introduction of a wealth tax on millionaires.

We should also keep a close eye on deals the government makes with private investors and demand that the government does not underwrite risks and stands to profit from the returns. Private investment can’t be the answer to tackle decades of austerity and underfunding. We also need to highlight the wealth of the monarchy – in a country that is already vastly unequal, why should the monarchy control so much of the nation’s wealth?

Starmer fought and won the election on the promise to deliver change – but on the evidence of Reeves’ speech Labour’s plans simply amount to more of the same.