Will borrowing save the economy?

16 Apr 2013

There are two major economic concepts governments tend to use in times of economic doldrums. One is borrowing – the practise of borrowing money to pay off expenditure when income cannot cover it. The other is saving – the practice of making decisions to save, reduce and cutback spending in certain areas. The coalition government plan in 2010 was not to borrow more but to rescue the economy by making savings – the idea of everyone pulling their weight to rekindle our coveted economic prosperity. But, as borrowing seems to be rising now, what good will it do for the economy?

 

The financial crash occurred in 2007/2008 when Gordon Brown was in Number 10 and Alistair Darling in Number 11. They were considered experienced politicians who could handle the economy. But, unfortunately, when the banks went bust and the different ‘arms’ of banks got confused (i.e. savings being used from retail to bail out wrong corporate investments) the financial prosperity of the boom came crashing down. Quickly, the government bailed out the banks and many of them became partly if not majority owned by the state. With other measures of desperation deployed, borrowing quickly rose. When debt was rising and economic prosperity was turning red, the electorate had enough with Labour in the Treasury and in government and instead voted in a coalition. Osborne’s pre-election plan was to make savings and not to borrow because he believed it was the wrong direction to go in; but even though he is making savings, he is still borrowing quite a lot. An example is in this financial year, we are borrowing £114billion in the hope of producing growth. And with the AAA rating gone and the UK seeming to be heading for a triple dip recession, why do governments and more specifically this government want to borrow?

The ethos many in government use is this; when you have a deficit (income is lower than expenditure), the government needs to pay the bills off, so they borrow the money to pay the bills, but also to invest in the economy (by capital spending etc.) in the hope that the money can kick-start and create jobs and businesses which can add economic growth. Then, they can repay the borrowed amount because the economy will now be growing. This sounds all very rosy but there are a few snags.

The first snag with this assumption many governments have taken over the years is that this idea doesn’t always work. We see with today’s government that they borrow some money to invest in say building roads etc. – infrastructure. In the process, they will hopefully be able to produce jobs which mean they get more people in work with money in their pocket which can circulate around the economy. Then, this can all lead to growth which in effect can help combat the deficit. But in reality, only a few jobs are produced, money earned can’t be spent in the economy because living costs are rising, so it doesn’t add a whole lot to the economy. That is the first problem. Secondly, if you have borrowed money to invest and the investment has fallen through, then you have not taken away from the debt but you are actually adding to it because when you borrow money, you have to repay it back with interest.

These are some serious downsides but why do they still do it? Why do they still follow this ethos when in many cases, it doesn’t work? The view is that borrowing may in short term add to the deficit but in longer term will give growth which the country so desperately needs. This argument is a valid one, but when you are in debt, you need to make sure you don’t deepen the debt.

Making savings (the government’s plan) is designed to make borrowing not an option – in a situation where you can make up the revenue shortfall by reducing expenditure, there being then no need to borrow. But the problem with this is that you could cut too quickly which could in effect, shrink the economy. A shrinking of the economy would mean a lack of growth and jobs and mean that the government would need to try and invest more to create growth again. This can then add to the deficit in the long term.

The Chancellor said on Budget Day that there would be a gradual reduction of borrowing from now until 2018, with savings in the subsequent financial years being; £11b, £10b, £16b, £19b. Borrowing is a big part of his plan but not in the way we would imagine. Here is a trip into the Chancellor’s mind: more savings and some tax cuts on things like corporation tax will help create funding for more private infrastructure projects which can add jobs and hence create growth, with the savings tackling the structural deficit and the growth the cyclical deficit. Whether this will come true, we will have to see.

So what is my conclusion? Borrowing is one huge risk. It is taken to try and create growth but can accidentally add to economic debt. I would say that the current government needs to keep borrowing closely monitored. Borrowing is another way they are able to generate growth but care needs to be taken; the economy and the economic recovery needs to not just be about meeting targets for re-election campaigns in two years but ensuring growth in the long term. This is difficult especially when we have debt at our current level, but who said it was easy?

By Sam Kenward

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