The UK government’s decision on Wednesday to cancel a planned three-year spending review was a mistake. But it was a mistake that is understandable, instructive and not too late to undo.
The motive was, we are told, “100 per cent Covid” — the huge economic uncertainty caused by the pandemic. Uncertainty can, indeed, be a reason to hold off on large long-term commitments. When visibility is very low, it can make sense to stand still until the fog lifts. In economics jargon, households and businesses may do best to reap “the option value of waiting”.
But a government is not like a household or an individual business. We have learnt the hard way how the household analogy can go astray in fiscal policy. Public belt-tightening in a recession can make things worse, because government frugality adds to the private sector’s income loss. Something similar is true for the option value of waiting. Government indecisiveness adds to the private sector’s uncertainty.
The UK defence community’s reaction brings this out. Without long-term financial visibility neither procurement, which involves multiyear investment projects, nor strategic military planning can be adequately carried out.
What is true for defence is true for the broader economy. As one business leader has explained: “The problem with delaying [the spending review] is that it will completely stall any of the midterm investments that will enable business to recover.”
Two types of business decisions require taking a view of long-term economic conditions. One is investment. The second is restructuring — whether to plan to do business differently from before. A business must decide, for example, whether in the post-Covid world it will need more physical space or more staff than before to deliver the same product or service, or whether it should substitute robots for some tasks previously done by humans.
Put differently, decisions have to be made about the quantity and the composition of capital. Precisely because the crisis will force businesses to make large changes to both, government plans are unusually relevant for how they make these decisions.
Clearly announced long-term policy commitments serve as an anchor in the general drift. With an ambitious multiyear spending plan, a government can both co-ordinate private sector expectations for where economic conditions may be headed, and make it more profitable, through subsidies and other incentives, for the private sector to shift in the direction the plan points to.
Unlike the UK, the EU is giving itself the tools to do so. As part of its “Next Generation EU” recovery fund, national governments must submit plans on how they intend to green and digitise their economies with money from common borrowing. The existence of a tool is no guarantee that it will be used wisely. But at least the opportunity is there to give the private sector a surer sense of direction over the coming years.
Spending plans are not the only way to do so. Regulatory and tax commitments are another. Neither the EU nor the UK should wait to set out an ambitious yearly path for the level and coverage of carbon taxes well into the future. The EU should quickly do the same for its mooted carbon tariffs on imports from states that do not do their bit to combat climate change.
While medium-term decisiveness from governments can remove some uncertainty from the economy, much will remain until the virus is tamed. The UK government is not wrong to fear that public finances will be exceedingly volatile. The pandemic may wreak havoc with the government’s revenue and benefit spending, not to mention require new job and business support schemes.
It is wrong, however, to fall back to merely reactive short-term policymaking. The fear of political embarrassment over potential U-turns is a bad reason not to commit to a long-term trajectory. Instead, robust planning means accepting that to anchor some aspects of the economy the government must allow others to escape its control.
In this case, a multiyear spending plan would make government deficit and debt levels the balancing item. So be it. Both the UK and EU countries should make explicit that for several years to come, red ink in the public finances will not threaten otherwise important spending plans — above all public investment, which the IMF has insisted is crucial to a good recovery.
Just as cutting government deficits in a recession is a false economy for a country, so postponing all but the shortest-term public sector planning only creates a false sense of control.