Expert comment: Austerity will make nations finances worse

Dr Syme said: “In preparation for today’s Autumn Statement, there has been a lot of reference to a £50bn ‘black hole’ in the public finances. In other words, the mount of public finances that will be needed to ensure that the public debt to GDP ratio is lower in five years than it is now.

“Whether this black hole exists or not has been debated by economists. Jo Mitchell and Rob Calvert Jump last week showed that if the government used the accountancy rule employed before 2021, when Rishi Sunak was Chancellor, the £50bn black hole disappears and instead there is a £14bn excess.

“The issue is one of fiscal sustainability at a time when public debt is almost 100 per cent of GDP. Given the impact of the pandemic on the government’s finances, isn’t austerity necessary to bring that level of debt back to ‘sustainable’ levels?

“One answer can be found by looking at the last time such debt levels were reached in this country. At the end of the Second World War, public debt reached 270% of GDP, before falling to 200% by 1950 and then to 50% by 1970. It was a remarkable reduction in public debt at a time when Harold Macmillan could claim that “most of our people have never had it so good”. There was little talk of austerity. Does this mean there is an alternative to austerity in order to achieve fiscal sustainability?

“There is a well-known economic formulation that shows that for the public debt to GDP ratio to be stabilized, the required budget surplus (as a percentage of GDP) is directly related to the average yield on government debt minus the rate of inflation minus the growth rate of real GDP.

“This means the public debt to GDP ratio can be reduced in two ways without recourse to austerity: (i) ensure that the interest paid to the holders of government debt is lower than the rate of inflation; and/or (ii) the economy grows in size, and so, by implication, does government revenue if taxation is progressive.

“The OBR has itself published researched on public debt after World War Two and focused on this real interest rate/GDP growth rate differential as the key reason for the 80% reduction of the public debt ratio over a thirty-year period. The differential between real interest rates and GDP growth rates should be at heart of the current discussions of fiscal sustainability

“At the moment, while inflation runs eight points higher than yields on UK government bonds, there are already the processes in place to reduce the debt ratio without austerity.

“Over the coming years though, as inflation should return to ‘normal’ levels, the focus of today’s Autumn Statement should be on how to raise productivity and living standards in the UK.

“UK productivity growth was extremely low in the 2010s by any standard and austerity was a major contributory factor. A return to austerity will only make that problem worse and, as the above relationship show, will make financial sustainability even harder to achieve.”