Government debt, policy and creative destruction

Government policy and debt

Interestingly Government policy seems to be reverting to the post war era ideas known as Keynesian economics.  Basically Keynes argues that when things are bad the government should spend money to encourage growth.  Quite the opposite of Thatcher’s monetarism and Osborne’s policy of Austerity. Certainly the May announcements of support for the cost of living challenges seems to be following that approach.

The downside of that support is the increase in government debt and a further stimulus to inflation. We have the largest level of debt for over 50 years; since we incurred the costs of the second world war.

Ironically though the high levels of inflation are really useful to the government fiscally. Inflation reduces the real value of the debt AND also increases taxes without the need for any announcement as things like personal allowances become relatively smaller and fixed % vat is applied to higher prices. That impact (called fiscal drag) together with the National Insurance increases this year, the resumption of VAT on hospitality and corporation tax increases already announced mean we currently face rates of tax as a share of national income not seen for fifty years.

Source: IFS

Creative destruction

The tone of this overall article may seem negative.  That isn’t my full view.  I do think we will face a lot of challenges over the next couple of years. But my full view is that those challenges have to be seen as a transition to a new normal.  The economy is much more dynamic and entrepreneurial than it was in the 1970s. Assuming we don’t stymie the ability of business to respond to the myriad of challenges we face I am optimistic that things will be in a better place by 2025. Assuming the Ukraine crisis doesn’t lead to a full blown world war of course.

This cycle of painful disruption followed by efficient growth was identified in the 1920s by an economist Schumpter.  He suggested that a crisis and difficult times forces innovation and over the medium term results in a more productive economy. He suggested that when things get tough businesses are forced to innovate to survive and prosper. The smart, agile businesses become more efficient and badly run businesses fail, leaving just the better businesses. Overall, this results in a smarter, more efficient economy.