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Why COVID-Led Surge in Public Debt Has Become a Double-Edged Sword for the UK Economy

UK public debt has exceeded 100% of gross domestic product for the first time since 1963, breaching £2 trillion ($2.6 trillion) following the government’s £26.7 billion ($34.9 billion) borrowing in July. Economists have explained how Britain found itself under such a massive debt burden and whether they can get it under control.

“Debt at the end of July 2020 was 100.5% of gross domestic product (GDP), an increase of 20.4 percentage points compared with the same point last year”, the Office for National Statistics (ONS) reported on Friday.

The government is stepping up borrowing to cope with the devastating effects of the coronavirus pandemic. Earlier this month Chancellor Rishi Sunak admitted that the UK had officially entered a recession for the first time in 11 years as its economic output slid by 20.4% in the second quarter.

Vicious Cycle of Growing Public Debt

“The pandemic-led surge in public debt appears to be a double-edged sword for the UK economy”, suggests Dr Sheikh Selim, a programme director for economics at the University of Birmingham Dubai.

Although initially the additional debt was aimed at bolstering economic activity, “the uncertainty of the crisis allowed very little scope for the UK economy to think strategically”, Dr Selim points out. In particular, it was unclear how to manage the debt in the short to medium term, as well as how exactly the extra funds would be used towards economic revival given the huge losses in output and employment.

“The Institute of Fiscal Studies’ view that the debt recovery entirely depends on economic tolerance of taxpayers (e.g. a mix of tax rises alongside the acceptance of high debt) does not deliver a clear strategy, and such direction of travel will definitely lead to losses of welfare and economic resources”, the economist highlights.

The UK is facing a dual challenge posed by the COVID pandemic and post-Brexit refurbishment of the economy, according to the academic.

He foresees that “any mainstream tax rise or fiscal stress to recover debt will result in loss of investment and human resources”, explaining that “investors will seek the least distorted returns, and best brains will fly out”. “Social welfare measures will not hold either of them back”, Dr Selim stresses.

Furthermore, tax hikes on consumers, workers, or corporations won’t save the day but “will hurt the core welfare of taxpayers amidst loss of income and business”, according to him.

“With the pandemic-led loss of employment, a heavy tax burden coupled with extensive social welfare measures may lead to moral hazard amongst UK residents, by providing them the undue incentive to either leave jobs and resort to involuntary or disguised unemployment, or to work less and add more complications to UK productivity, which unfortunately has been an ongoing problem for the UK economy”, the economist outlines.

Still, he does not have any doubts that tax hikes are “imminent”.

“The challenge for the UK economy is choosing the taxes through which HMRC can afford to implement a bigger wedge (e.g. the non-dom tax, or Tobin taxes), and redesigning the threshold of different mainstream taxes which could increase revenue with the minimum distortion in incentives and welfare”, the economist elaborates.


A traveller receives a coronavirus disease (COVID-19) test at a corona test centre at the Markusberg service station at the A64 motorway direction Luxemburg near Trier, Germany, August 7, 2020.

COVID Crisis: UK is in the Same Boat With European Economies

The UK is not the only developed economy hit by the COVID-related lockdowns and mobility restrictions. The European Commission admitted that the outbreak has been an unprecedented shock to the EU economy and society.

“Compared with the same quarter of the previous year, seasonally adjusted GDP decreased by 15.0% in the euro area and by 14.4% in the EU in the second quarter of 2020, after -3.1% and -2.5% respectively in the previous quarter”, a Eurostat newsletter released on 31 July reads.

The plunging economic indicators have prompted major European states like Germany, the UK, and France to pile up massive debts to cope with the COVID-related crisis and reinvigorate their economies.

“None of the leading economies were prepared or sufficiently resilient about the crisis, and the UK is in the same boat”, admits Dr Sheikh Selim.

In addition, one should bear in mind that European countries had been heading towards an economic before the pandemic struck, notes Professor Michael Ben-Gad, a distinguished economist at City, University of London.

“There are underlying issues in nearly every Western country regarding unfunded liabilities due to the slowdown in productivity and growth, falling birth rates, increasing life spans, and the desire to protect the living standards of older, more politically influential parts of the population”, Ben-Gad underscores.

Discussing the ways to overcome the crisis Dr Selim advocates a comprehensive strategy, “laid out with a metrics of measurable outcomes, monitored and accomplished properly”. Otherwise, “debt will become a vicious cycle”, the economist warns. There is no way a debt amounting to 100% of GDP can be recovered solely through fiscal measures, according to Dr Selim.

“The plan to economic [sustanability] vis-a-vis debt recovery must be via productive channels, and the entire process must be consistent with managing the environmental, social, and governance (ESG) risks, i.e. the full package must tick the environmental, social, and governance targets of economic sustainability”, the professor emphasises.

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