Christopher Walker: Have politicians found a magic bullet to solve climate change?
What are the hidden costs from massive bond issuance for a green transition?
At last global warming is at the top of the political agenda. On both sides of the Atlantic serious proposals are being made to re-engineer our economies in a way that seemed pure fantasy only a few years ago. But the costs involved are massive, and any consequent punitive taxation is an obvious vote-killer.
So, at a time of historically low interest rates, manifestos are now pledging to tap bond markets instead. This is in tune with some economists who say that current circumstances offer a "free ride," a painless opportunity for change. But can this really work? What are the hidden costs from massive bond issuance?"
Green issues are dominant as never before in the current UK election campaign. The ruling Conservative party boasts of its success in carbon emission reductions, and promises massive investment in offshore wind power.
The opposition Labour Party’s published manifesto opens with its proposed “Green Industrial Revolution.” A £250 billion transformation fund targeting “a net-zero carbon energy system within the 2030’s,” and the upgrading of the UK’s twenty seven million homes to “the highest energy–efficiency standards.”
Even the maverick Brexit Party calls for a “global initiative on planting trees on a massive scale.”
Perhaps this is not surprising. The UK is now the clear leader in tackling climate change amongst the largest economies.
Compare Britain’s 36 percent reduction in carbon emissions since 1990 to what has been achieved elsewhere in Europe. Even Germany has only fallen 22 percent, while Italy has come down 16 percent and France a mere 12 percent.
UK per capita emissions at 5.7 are now nearly half those of Germany’s (9.7), and a third of the United States (15.7). They are even below those of China which uses the per capita argument to justify catch-up.
So, no wonder the UK might be the first major economy to move to the next stage of climate action. Others may follow. It’s notable every single one of the US Democratic party presidential candidates has signed up to the Green New Deal in some form.
Where they struggle is on how to pay for it. Costs make voters queasy. A survey from AP showed that Americans ideally want to pay just $1 per month. At $10, 68 percent would be opposed. The estimated cost of America’s green new deal is $7 trillion.
So here’s the politicians conundrum. They want to make this great leap forward, but how can they get voters to pay for it? Politicians who propose tax rises tend to lose elections. This is certainly true in the UK. Jeremy Corbyn’s radical spending plans are being shoe-horned into a pledge not to increase taxes for 95 percent of tax payers. Some people even believe it.
Paul Collier of Oxford is proposing “increased investment in economically productive public assets …financed by debt.”
How is the UK funding its Green Industrial Revolution? Both sides give the same answer - “debt.” The massive issuance of Government bonds.
There certainly seems to be something of an historical opportunity globally. Unless you’re a ‘basket-case’ like Argentina or Venezuela, there has never been a cheaper time for Governments to issue debt. Academic economists have been banging this drum recently, and not just the ‘loony-left’ ones.
Paul Collier of Oxford is proposing “Plan A+” – “increased investment in economically productive public assets …financed by debt.” He mocks “debt phobia” saying it is laughable that “in surveys Germans place fear of inflation ahead of cancer.” At least in Britain most people are able to “understand the difference between a credit card and a mortgage.”
All of which is very plausible. But will this economist’s conjuring trick really work?
Certainly the UK Government does have some scope to increase borrowing. Thanks to austerity, the deficit has fallen from around 10 percent of GDP in 2009-10 to 1.9 percent in 2018-9.
But another key measure for bond markets is the level of debt as a percentage of GDP. This ballooned under the Gordon Brown Government, as he massively increased Government spending to counteract recession (a fact incidentally too often forgotten when the toll of austerity is itemized). Until that point debt was comfortably below 50 percent. It is now 84 percent.
Ok, the nouveau Keynesians argue, this may be high compared to history, but look at other European countries. The UK is well below France (98 percent), let alone Portugal (128 percent), Italy (131 percent), and Greece (180 percent).
But then thanks to membership of the Euro the so called ‘Club Med’ are protected by those inflation-fearing Germans (whose ratio is 64 percent). Advocates of ‘Scandinavian-style economies’, should likewise note how carefully those countries manage their purse strings.
Sweden’s debt/GDP ratio is 39 percent, Norway’s 37, and Denmark’s 35. Under Labour, the UK's debt to GDP ratio would exceed 100 percent.
The question therefore is how high could the UK raise its debt ceiling without causing a crisis of confidence? Two factors must be present – a credible commitment to balancing income and expenditure, and an investor-friendly environment.
Here the UK must be careful, particularly under a Labour government. “Day-to-day spending” is set to rise by £82.9 billion, supposedly matched by tax rises.
However, most of this comes from areas where tax-take may fall as behaviour changes. Corporate tax hikes (£30 billion), capital gains tax (£14bn), and the financial transactions tax (£8.8bn) all fall into this category. Labour are even hoping to raise more from “tackling tax avoidance” (£6.2 billion) than from income tax (£5.4 billion). This is not credible.
"It would appear that massive bond issuance by the UK must be approached with great caution"
Furthermore, a careful separation of “structural spending” and “daily spending” was blown apart by Jeremy Corbyn opportunistically throwing £58 billion at compensating women for state pension changes.
This is not structural investment, and yet he said this would be raised from investors. Along with the £250 billion green investment, the £150 billion social transformation fund, and £196 billion for renationalisation of utilities.
And those very investors who would be asked to lend the Government these vast sums of money would still be reeling from a string of other measures.
Nationalisation of the utilities, a financial transactions tax, massive hikes in corporation and capital gains tax, and the appropriation of 10 percent of all companies to distribute to their workers. Hardly an investment-friendly environment.
For all of these reasons it would appear that massive bond issuance by the UK must be approached with great caution. There may be some headroom, but failure to get this balancing act right would leave a future Government struggling to sell bonds and possibly having to raise interest rates. It could also mean immense pressure on Sterling.
Older investors remember the last time this happened to the UK. In 1976 a free-spending Labour Government was forced to request a bail out from the IMF.
That’s one element of history which must not repeat itself.
Christopher Walker is a writer on business and politics. He sat for several years on the asset allocation committee of a major asset manager.