Austerity or Investment: Navigating the Covid-19 Economic Crisis

By Calum Muir

The United Kingdom, as a result of the economic damage and fiscal response to COVID-19, is facing one of the greatest economic crises in its history. Once the immediate threat from the virus falls to a manageable level, focus will swiftly shift to finding policy solutions to mitigate further economic damage and help quicken the economic recovery. Austerity was tried and tested during the ‘Great Recession’ and even if the deficit was reduced, a great deal of disagreement remains concerning its merit.  It is not only austerity’s ability to bring down a deficit that its critics take issue with, but also its wider social and economic impact. Unlike 2008-2009, politicians on all sides of the House seem less inclined to see austerity policies repeated, instead favouring a range of investment-based policies to stimulate economic growth – while attempting to tackle many of the UK’s social issues at the same time. One of the ways such an investment strategy could be pursued by government is through a national investment bank. 

​The Economic Downturn:

​COVID-19 represents one of the worst global health crises in living memory, its ramifications for the economy cannot be overstated. Official figures released by The Office for National Statistics suggests that the UK economy shrunk by 20.4% during the first full month of full COVID-19 lockdown restrictions. In other words, in the month of April, the UK economy contracted by a rate three times greater than the entire ‘Great Recession’ of 2008-9 - representing the greatest economic downturn since the ‘great frost’ of 1709. Furthermore, the Treasury is paying the wages of some 8.9 million British workers through the furlough scheme and 2.6 million self-employed workers through a similar programme, while the number of people claiming benefits rose by 856,500 in April. From a fiscal perspective, this means that government tax revenue will be significantly lower than previously projected, while government expenditure has skyrocketed – with a leaked document from the Treasury predicting that the UK will run a £337bn budget deficit in 2020. 

​While expenditure will naturally drop off with the end of the furlough scheme and other similar programs, the shrinking economy will lead to a more long-term increase in the deficit as a result of lower tax revenue. Broadly speaking, this economic crisis presents the government with two starkly different policy choices come the end of lockdown. Impose sweeping cuts to public spending in an attempt to minimise the deficit and national debt - in a similar manner to the policies which followed the 2008 financial crisis - or borrow even further in order to invest in the UK economy in an attempt to increase productivity and GDP, and hope that over time this will reduce the deficit by stimulating economic growth and increasing government revenue.  

​With the notable exception of George Osborne, politicians, commentators, think tanks and business seem to all largely agree that austerity should not be the policy pursued by the UK government during the impending recession. To do so has the real potential to jeopardise and hinder the UK’s economic recovery – which economists suggest may take at least three years to return to pre-COVID levels. 

​So, what could both of these options look like?

​Austerity:

​It is understandable why a return to austerity measures may attract the support of some members of the electorate who believe that, when the health crisis of COVID-19 comes to an end, the UK must return to living within its means. However, excluding the moral arguments against austerity - which to many are sufficiently conclusive - austerity measures, while effective in decreasing a deficit, often harm rather that help economic growth. A 2016 study by the International Monetary Fund found that the increases in inequality, which austerity fosters by reducing funding to crucial social institutions, limits and decreases the sustainability of economic growth in a manner that outweighs the benefits of deficit reduction. 

​Furthermore, one of the first areas which could face expenditure cuts as a result of a new austerity measures would be impending capital projects planned pre-pandemic – in areas such as transport, energy and housing. However, such projects, when properly administered, have the potential to play a significant role in kick starting the economy and safeguarding thousands of jobs within the construction and manufacturing industries within the UK. 

​Pro-Investment:

​There are already signs suggesting the government is inclined to follow such a pro-investment approach as Boris Johnson has recently distanced himself from historic austerity policies and in May, the government and CCLA Investment Management established a new £40 million Clean Growth Fund “to supercharge green start-ups” – with expectations that this fund may grow to £100m by next year. Such policies will not only help stimulate economic growth but have the potential to help the UK reach its target of net-zero carbon emissions.

​However, given the size of the economic downturn, such small funds can only do so much. Considering that interest rates now stand at an all-time low and demand for government bonds has surged, the government has been presented with the perfect opportunity to take a more proactive approach to investing in the UK economy and to help secure the swift economic “bounce back” which the prime minister is hoping for. 

​One policy option is the creation of a national investment bank. Such an institution was established in Scotland in 2019 and will officially be launched later this year. The new Scottish National Investment Bank was created with the purpose of supporting important infrastructure schemes and new companies, but Scottish ministers now plan for the bank to play a significant role in fuelling Scotland’s green recovery and supporting at risk business – in a similar manner to Rishi Sunak’s Project Birch (a scheme which ensures companies vital to UK prosperity and success remain afloat). 

​A UK national investment bank could be used to provide funding for start-ups as well as the expansion of existing companies which aim to fill some of the gaps which COVID-19 highlighted within the UK economy. This would help to ensure that in the case of future pandemics or more general global disruption, we are less reliant on foreign imports – be it food, personal protective equipment or manufactured goods which, at times during this crisis, have been in scarce supply. Investment could also be directed towards new infrastructure projects which would not only benefit the economy by offering employment but help to reduce the negative economic impact associated with poor and deteriorating infrastructure in the future. This highlights the potential for a national investment bank to be used for more than purely economic and fiscal gain. Instead, investments can be targeted towards companies or projects which aim to tackle socioeconomic issues such as climate change, broadband connectivity or homelessness which, in the long term, have the potential to yield significant societal and economic benefits.