Over the next decade digitalisation, automation and the green economic transition will shake up our economic structure. At the beating heart of this transformation will be the convening power of both public and private sectors in financing the transition. This prompts the question; how will these seismic economic revolutions be funded? It is a question that can lose political party’s elections and forms the foundation of the enduring dog fight between treasuries and ruling governments. The answer from the treasury tends to be fairly clear cut, governments should finance spending and the consequential acquisition of national debt through taxation or austerity. In contrast, politicians tend to answer to the tune of “don’t tax you, don’t tax me- tax that fellow behind the tree”. However, as nations stitch themselves up with fibre optic cables, weave automated functions into the national infrastructure and plonk huge fields wind turbines offshore, like white molars rising in the horizon, nations will have to bring their heads together in finding a way of financing all this. One example of such spending was given in last week’s ABM insight on infrastructure, citing Biden's $1 trillion dollar infrastructure bill and the UK’s levelling up agenda. However, taxation is un-popular, austerity will be painful and hard stomach after the post-financial crisis cuts and borrowing shifts the burden to future generations. Thus, the question remains, what is to be done (no reference to Lenin intended)?
To quote Churchill, “for a nation to try tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”. For those unfamiliar with this logic, it tends to follow a chain of reasoning that can be summarised as an increase in taxation = decline in consumer spending, reduced business investment, lower incentives to work and according to the Laffer curve, a reduction in government revenue. This overly simplified equation of mine does well to highlight the main arguments against increasing taxation, whilst also avoiding the proverbial forbidden forest that is inequality (not discredit the subject of inequality, only that this isn’t the subject matter of this ABM insight). However, taxation is needed to fund government spending and it is government support of the early phase of economic restructuring (tend to be period of highest risk) that is needed for private sector investment to be incentivised. Governments could raise taxes on companies but risk deterring private sector investment or could raise taxes on consumers which would be unpopular and risk slowing macro-economic growth. Alas, we are left with a conundrum of financing government spending, deter private sector investment (fundamental in digitalising the economy, automation and implementing green tech) or risk upsetting the electorate (which all governments will be reluctant to do). In reality, the foundation of the UK’s national industrial policy is it’s £7.3 billion a year R & D tax credits and £1.1 billion a year patient box scheme. Therefore, at least when it comes to the private sector, the UK looks to be attempting to lower the tax burden, not increase it. This brings us to the scourging nemesis of the 2010s, austerity.
How should a nation maintain spending, like subsidies on clean energy installation, tax incentives on vital STEM industries or the grants incentivising firms to automate production, if they are limited to the amount of tax they can raise? For governments with bloated welfare states and generous defence budgets, the answer could be found in austerity. It lies in the belief that the private sector would have filled the void in service provision and allow national governments to focus on better economic policies. However, such a policy would go down like a lead balloon in most nations, especially as the memory of massive austerity programs in the 2010s still lingers. Additionally, it would be hard to justify spending the huge sums needed on the green energy transition if it meant cutting welfare or aid budgets. Academically, this policy bodes best with the small government, minimal intervention type. Monetarism until recently enjoyed centre stage in policy debates for decades but has since become marooned by swamps of government coronavirus spending and an active state industrial policy leaning to government-led intervention. Consequently, this leaves austerity as a way of stumping up new cash for structural changes in the economy unpalatable. Therefore, if taxation and austerity are both viewed unfavourably by business and the electorate, thus borrowing for now is the most favoured form of financing large government spending.
The coronavirus cost the UK government an estimated £400 billion through job retention schemes, business loans, vaccine procurement, to name a few aspects. If this seems like a large number, it is estimated that if the UK is to reach net-zero by 2050, it comes with the eye-watering bill of £1.4 trillion. In 2018, it was estimated that digitalising the NHS alone will cost £13 billion. The private sector will indeed play a large role in financing these technological advancements. Despite this, the government will have to borrow more money than ever and much of the funding from the private sector comes from cheap loans on the back of historically low-interest rates. The UK borrowed its way through the pandemic, but for it to support and gain from the third industrial revolution, it will have to be prepared to borrow a lot more. It would be wise to remember that a bar tab is eventually followed by the bill. Therefore, whilst interest rates are low and the economy recovers from the pandemic, high levels of borrowing in the private and public sector is justified. However, this should be carried out with restraint and proper financial analysis. We do not want to leave future generations poorer, even if they can enjoy a future powered by Britain’s bountiful capacity for wind power.
Therefore, the question of how government spending is financed tends to inspire a wide range of opinions, but not all that many durable solutions. Taxation upset’s business and the electorate alike. Whereas Austerity is uncomfortable as it involves pecking the state of its subsistence. Whilst borrowing is an essential form of raising funds but if investments are not beneficial and prudence isn’t applied, it is no better than robbing future generations of their wealth. Therefore, the muddling maze of financing the third industrial revolution remains unsolved. Ultimately, do you think we should tax more, make cuts, keep on borrowing or even point a finger at the magical explanatory force that is the ‘free market’?
By Henri Willmott