Sunak spends big to kick-start the economy

The fact that Sunak, a Conservative Chancellor whose party spent the last decade rolling back government spending, has loosened the public purse strings to such an extent speaks volumes about the scale of the current economic crisis. In normal times – even in a normal recession – these spending measures would be baulked at. But this is no ordinary recession. With the whole world forced to reduce its economic output, the government has had to intervene on a level never before seen in peacetime.

With that in mind, we would do best to avoid the usual “how do we pay for this?” rhetoric. Payment for these extraordinary measures – most likely in the form of higher taxes – will eventually come due. But it will not happen in the next couple of years, or before we get back to normality. Thanks to the Bank of England’s enormous bond buying program, interest rates on government debt are pegged at historic lows, giving the Treasury the leeway to spend what funds it deems necessary.

As such, the question is not what we can afford but what we need. On that front, the Treasury faces two main challenges. The first involves plugging the gap between now and normality, and the second is in laying the foundations for solid and sustainable growth afterwards. Sunak’s initial spending measures in March were almost entirely focused on the first problem, but this new package is aimed squarely at the second. With businesses slowly opening up around the country, the government’s attention is now on getting people back to work and boosting consumption.

On the employment side, the £1,000 promised for each employee returned from furlough is designed to help businesses keep workers on even when short-term emergency measures wind down. In addition, the kickstart scheme for under-25s promises six-month work placements for young people “at risk” of long-term unemployment, as long as those jobs are “additional” (that is, where subsidised young workers are not just cheaper replacements for existing workers).

On the consumption side, there will be a temporary 5% cut in VAT on food, accommodation and entertainment and, in August, customers will get a discount of up to £10 a head on restaurant orders (Monday to Wednesday). Homeowners can also benefit from government support when planning on improving the energy efficiency of their home (with £3 billion earmarked in the spending package).

According to a report from the Institute for Fiscal Studies (IFS), the crucial issue in these plans is timing. Fiscal spending is a powerful tool, but only if it is used at the right time and not cut off too early. For instance, the IFS highlights that much of the money spent on returning workers could end up as dead weight, as firms that already planned on bringing back employees will be eligible for the £1,000 bonus, while others that cannot yet open could miss out. This would undoubtedly be a boost for some businesses, but might well end up disproportionately benefitting those not struggling as much.

Timing is even more important on the consumption side. Strong consumer demand is a vital pillar of the economy, but the country can only consume as much as is supplied. Social distancing has forced pubs and restaurants to operate at reduced capacity. If that capacity is already full, a boost to demand will have little effect. As such, the IFS has warned that the VAT cut could well be absorbed by higher business revenues, rather than passed onto consumers.

The even bigger concern comes at the other end. At the moment, most of these measures are set to run out around the end of the year. But that could be when we need them the most. Even when social distancing measures fade, the scarring effects of the pandemic – either through lingering virus fears or reduced consumer confidence – are likely to remain. If government support wanes while the economy is still struggling to find its feet, we could end up with a longer and more damaging recession.