Deloitte-uk-the-fiscal-taps-are-opening

This morning we are launching our third quarter “Global economy in charts” report, available here – https://blogs.deloitte.co.uk/mondaybriefing/2019/09
/global-economy-in-charts-q3-2019.html

Created by my colleague Debo, the report examines the big global macro trends and challenges. Charts can be cut and pasted into your own presentations and reports. Do drop Debo a line at dde@deloitte.co.uk with ideas and comments.

Imagine a world in which you could borrow €100 for ten years and, at the end of the period, pay off the debt for €94. Instead of paying for the use of borrowed capital you are, in a reversal of the normal rules of finance, being paid to borrow. That is the world of negative interest rates, one in which the German, Swiss, Japanese and many other governments are effectively being subsidised by the private sector to borrow.

Negative interest rates increase the attractions of borrowing to fund value-producing public infrastructure. Given the poor state of infrastructure such as energy networks, bridges and railways across many Western countries there are plenty of gaps to fill. Such investment offers part of the solution to the slow productivity growth afflicting most Western economies – and to the challenges of climate change. Theory and experience show that infrastructure contributes to future growth.

The case for public investment is reinforced by the looming economic downturn. Global growth is slowing and recession risks are rising. Central banks have responded by cutting rates. But in the rich world borrowing costs are already at record lows. Monetary policy is stretched, especially in the euro area, where three-month interest rates are negative.

The message from the European Central Bank and the OECD is that fiscal policy needs to play a greater role in countering the slowdown. Earlier this month the ECB’s president, Mario Draghi, said that, “now is the time for fiscal policy to take charge”. In a thinly veiled reference to Germany, Mr Draghi urged governments to support growth through increased public spending.

Several countries have already eased fiscal policy – though much of the new spending takes the form of tax cuts and new hiring rather than investment.

The US landmark income and corporate tax cuts took effect in January 2018 and have pushed America’s budget deficit close to 5% of GDP. The French government, in concession to the gilets jaunes demonstrations, cancelled planned tax hikes, and last week promised €10bn of tax cuts in the 2020 budget. The UK government has declared an end to austerity and announced higher spending on education, healthcare and the police. India recently announced a surprise corporate tax cut and China has cut taxes and increased support for infrastructure spending.

In Europe the countries with the strongest finances, those running budget surpluses, are in central and northern Europe. The major surplus economies are the Netherlands, Sweden, Switzerland and Germany.

Germany’s economic scale means that if it eased fiscal policy it could provide a material boost to European growth. Yet for years Germany has shrugged off calls for it to act as the engine of European demand. Germany is committed to balancing the public sector budget through its so-called schwarze Null (the black zero rule) and its constitution puts strict limits on debt accumulation. Just as German consumers are debt averse in their own lives, so too are German governments and voters. (For example, household debt accounts for 53% of GDP in Germany and 87% in the UK; government debt accounts for 65% of GDP in Germany and 105% in the UK.)

This may, just, be starting to change. Last week the influential head of Germany’s business lobby, Dieter Kempf, called for shelving the black zero, at least temporarily, in favour of boosting investment spending by €10-15bn a year on digital infrastructure and energy efficiency. Wolfgang Schaeuble, the former finance minister who masterminded Germany’s balanced budget rule, last week hinted that a re-think of fiscal policy is needed to meet the challenges of climate change and digitisation.

The temptation today for governments facing a downturn will be to boost short-term spending, by, for instance, cutting taxes or increasing public sector jobs. They put money in the pockets of consumers and businesses and are popular with voters. Many governments are doing just this.

Locking in permanent increases in entitlements and wages adds to the burden of debt while doing little to raise future growth. Ageing populations mean that public spending and debt in most Western countries are already on an unsustainable path. The OECD recently estimated that on current policies the ratio of public debt to GDP in rich economies will rise from around 100% of GDP today to 330% by 2060. It’s not only fiscal hawks who worry about the prospect of a tripling of public sector debt within the lifetime of today’s under-40s.

Increasing public sector infrastructure spending would enable governments to benefit from low debt costs and support growth now and in the future. Unlike transfer payments, such as benefits and public sector wages, infrastructure spending is time-limited.

The need is clear. The American Society of Civil Engineers produces a report card, analogous to a school report, for the nation’s infrastructure assets. US public assets achieved a score of D+ in 2017, down from an unimpressive C in 1988. As Joe Biden, a former US vice-president and candidate for the 2020 Democratic nomination for president, has said, "If I took you blindfolded to LaGuardia Airport in New York, you'd think, ‘I must be in some third-world country’." Or consider Germany, long thought of as a paragon in the infrastructure stakes. Much of its roads and bridge infrastructure are in need of repair, while internet access is patchy and slow and heavily reliant on old-fashioned copper lines.

There will always be a role for short-term fiscal stimulus, perhaps through time-limited tax cuts, to support growth. As global growth slows that case gets stronger. But as they contemplate today’s vanishingly low-borrowing costs governments also need to consider the future – on filling gaps in infrastructure and on containing potentially explosive growth in public debt.