Massive UK energy subsidies could spell economic disaster – The Irish Times

Over the past six months, governments across Europe have responded in different ways to the energy price crisis. Since the crisis arose very quickly, due to the war in Ukraine, governments did not have time to produce well-thought-out measures to protect families and their broader economies. The result was somewhat chaotic. Initial measures were ad hoc, explicit rather than targeted, and all consumers supported. The cost of these interventions amounted to more than 1 percent of the European Union’s GDP, according to the Bruegel Institute.

With more time to think, governments are now able to introduce additional and more focused measures to help those most affected.

Until the end of August, British support measures were on a scale similar to those in the European Union. As all governments, including ours, look to do more for families and businesses this fall, the new British government’s announcement last week of an additional support package of up to 5 per cent of GDP is likely to dwarf EU policy interventions. If the proposed interventions were better targeted at those who need them most, they would be more efficient and cost much less.

On top of this spending, the UK government under newly elected Prime Minister Liz Truss is also planning to cut corporate tax, and reverse the increase in social insurance contributions, costing an additional 2 per cent of GDP – a total of 7 per cent of GDP. It is financed by borrowing.

The huge sums the UK government plans to borrow should come from abroad and not from domestic savings

There has been very limited consideration in the UK of the macroeconomic importance of these interventions. While the new borrowing will still be less than the borrowing made during the pandemic, from a macroeconomic point of view, it is quite different in nature. During Covid, additional spending in individual countries was funded by the increase 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, as households come under pressure from higher prices, savings will fall below normal. Corporate loans will rise to weather this crisis. Thus, the huge sums which the UK government plans to borrow must come from abroad and not from domestic savings.

By August, before these additional spending plans, the UK was facing a balance of payments deficit of 7 per cent of GDP for 2022. This financing meant that the UK was already borrowing heavily from abroad, or draining its assets. The plans now announced will significantly increase the UK’s external financing needs this year and next.

Provided the rest of the world believes that UK government policy is sustainable in the medium term, funding will be available offshore at a reasonable rate. This is great then. As we well know, if financial markets lose confidence in government policy, interest rates can rise dramatically. The British pound will come under pressure, exacerbating inflation. So this is a dangerous path. The stakes are compounded by the decision to fire the respected Treasury Chief, Tom Scholar, a pair of Safe Hands.

1970s humiliation

The UK has been here before, and it didn’t end well. In the 1970s, the then Labor government borrowed heavily to protect the economy from the loss of income caused by rising energy prices. However, by 1976, foreign lenders humiliatingly dried up, and the UK had to seek IMF support. I remember that year when I attended the OECD meeting as a junior Treasury official, hearing Alan Greenspan (future head of the US Federal Reserve) and Hans Tetmer (future head of Germany’s Bundesbank) criticizing the UK government’s corrupt “socialist” policies, in the comments unusually political.

The gas price crisis is likely to last until 2024. And our government needs to organize itself, and keep reserves for the coming years.

This time around, the profligate policies of the new Conservative government could create similar difficulties for the UK economy if its lenders lose confidence. In principle, the Bank of England, if it continues to be independent, can try to stop the slide in sterling by raising interest rates. However, such a solution would deal a severe blow to economic growth in the UK.

The weakness of the UK economy is a serious concern for the Republic, not only because the UK economy matters to us, but because of our close personal ties to many UK residents.

The gas price crisis is likely to last until 2024. Our government needs to organize itself, and keep reserves for the coming years. We need a wiser approach than the UK’s, with a policy of targeted interventions to focus assistance where it is most needed.