Over the past six months, governments across Europe have responded in different ways to the energy price crisis. Because the crisis has arisen so rapidly, due to the war in Ukraine, governments have not had the luxury of time to produce well-thought-out measures to protect households and their wider economies. The result has been rather chaotic. Initial measures have been ad hoc, and blunt rather than targeted, supporting all consumers. The cost of these interventions has amounted to over 1 per cent of EU GDP, according to the Brussels Bruegel Institute.
With greater time for reflection, governments are now able to introduce additional, more focused, measures to help those worst affected.
Up to the end of August, the UK’s support measures had been on a similar scale to those in the EU. While all governments, including ours, are looking to do more for households and businesses this autumn, the announcement by the new UK government last week of an additional subsidy package amounting to up to 5 per cent of GDP is likely to dwarf policy interventions in the EU. If the proposed interventions were better targeted at those most in need, they would be more efficient and cost a good deal less.
On top of this expenditure, the UK government under newly elected prime minister Liz Truss also plans to cut taxation on companies, and to reverse the increase in social insurance contributions, costing a further 2 per cent-plus of GDP – in total 7 per cent of GDP to be financed through borrowing.
The huge sums the UK government is planning to borrow will have to come from abroad rather than from domestic savings
There has been very limited consideration given in the UK to the macroeconomic significance of these interventions. While the new borrowing will still be lower than that undertaken during the pandemic, from a macroeconomic viewpoint, it is very different in character. During Covid, the extra expenditure in individual countries was funded from the surge in household savings as people were unable to spend in lockdown. In other words, governments, in the UK and elsewhere, were borrowing from their own citizens rather than from abroad.
This time, with households under pressure from rising prices, savings will fall below normal. Company borrowings will be rising to tide them through this crisis. Thus, the huge sums the UK government is planning to borrow will have to come from abroad rather than from domestic savings.
Already by August, before these additional spending plans, the UK was facing a balance of payments deficit of 7 per cent of GDP for 2022. Financing this meant the UK was already undertaking large foreign borrowing, or running down its assets. The plans now announced will dramatically raise the UK’s external funding needs this year and next.
Provided that the rest of the world believe the UK government policy is sustainable in the medium term, the funding will be available abroad at a reasonable price. That’s a big if. As we know too well, if financial markets lose faith in government policy, interest rates can rise dramatically. Sterling would come under pressure, aggravating inflation. So this is a dangerous course. The risks are heightened by the decision to fire the respected head of the Treasury, Tom Scholar, a safe pair of hands.
1970s humiliation
The UK has been here before, and it didn’t end well. In the 1970s the then Labour government also borrowed heavily to insulate the economy from the loss of income arising from an energy price surge. However, by 1976 the foreign lenders had dried up and humiliatingly, the UK had to seek IMF support. I recall that year attending an OECD meeting as a junior Department of Finance official, where I heard Alan Greenspan (future head of the US Federal Reserve) and Hans Tietmeyer (future Bundesbank chief) decrying the profligate “socialist” policies of the UK government, in unusually political comments.
The gas price crisis is likely to persist into 2024. Our Government needs to pace itself, holding a reserve for future years
This time round, the profligate policies of the new Conservative government could create similar difficulties for the UK economy if its lenders lose faith. In principle, the Bank of England, if it continues to be independent, can attempt to halt a slide in sterling by jacking up interest rates. However, such a solution would deal a severe blow to UK economic growth.
The vulnerability of the UK economy is a serious concern for the Republic, not just because the UK economy matters to us, but because of our close links personal ties with so many UK residents.
The gas price crisis is likely to persist into 2024. Our Government needs to pace itself, holding a reserve for future years. We need a wiser approach than the UK’s, with a policy of targeted interventions to focus help where it is most needed.
