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The effect of a Corbyn government on the UK’s finances

    The Labour Party’s additional spending commitments in their 2017 manifesto came to around £100bn per year, according to a report by the Taxpayers’ Alliance. This did not even include John McDonnell’s plans for re-nationalisation, which could have an upfront cost of at least £176bn.

    The implications of such a huge expansion in current and capital spending were not sufficiently scrutinised in the 2017 election campaign. But let us pause for a second and think about a Corbyn government. While in 2017 this may have seemed like a distant possibility, the lion’s share of polls since last year’s elections have put Labour ahead. Given the internal struggles in the Conservative party and political uncertainty related to Brexit, a snap election may very well deliver a Corbyn victory.

    A Labour election victory would likely be associated with huge economic uncertainty and low business confidence. A report by Morgan Stanley considered a Corbyn administration as a bigger risk to UK markets than Brexit. Carolyn Fairbairn, the director-general of the Confederation of British Industry, has warned that Corbyn’s anti-market rhetoric is raising fears among investors whether it is safe to invest in the UK.

    Such uncertainty does matter for economic growth. When there is uncertainty, investors are not willing to invest their capital, but instead wait until the uncertainty disappears and the prospects for growth end up worsening.

    How will investors respond to Corbyn’s plans? If an investor (e.g. a pension fund) plans a capital injection in Royal Mail, for example, but knows that Royal Mail is next on Corbyn’s nationalisation list, the investor will think twice before investing in Royal Mail.

    Investors in other sectors of the British economy will also be worried. Corbyn has also promised an increase of corporate tax rates to 26% for larger corporations, which will shake business confidence further. Once Corbyn announces its nationalisation and taxation plans, investors such as investment banks will either postpone their plans, or may simply choose to invest elsewhere.

    Given the higher debt and more negative outlook for the UK economy under a Labour Government, credit rating agencies could end up downgrading the credit rating of the UK. This could make it more expensive for Corbyn’s government to borrow.

    Graph showing Italy's government debt to GDP ratio for 2007 to 2016

    The Eurozone debt crisis showed that high government debt can make a huge difference for the economy. Consider the case of Italy. Italy’s debt-to-GDP ratio has risen from 98% to 132% in the period 2008-2016. (Figure 2) Its deficit has remained above 2.5% every year for the last decade. The failure of Italy to reduce its debt has been one of the factors that have led to fears about a potential default. If the ECB had not start purchasing Italian government bonds in 2015, few investors would have touched Italian bonds amid fears of default.

    Italy is to hold general elections in March 2018. The populist Five Star Movement (M5S) has campaigned on a platform that advocates abandoning the Euro, launching a new currency and defaulting on its debt. Alarmingly, MS5 has led most opinions polls in 2018. Oxford Economics have concluded that if Italy defaults on its debt, not only will the Eurozone be harmed, but also 0.4% of the global economy could be wiped out.

    While you cannot directly compare Italy’s experience to that of the UK, Corbyn’s plan will naturally lead to an increase in UK’s government debt at least in the short run. There will be a period of huge economic uncertainty and low business confidence. Corbyn’s team should not be complacent about the consequences of high government debt.

    But perhaps my fears are unfounded. John McDonnell has recently recruited left-wing University of Westminster lecturer Richard Barbrook to design simulations of dangerous situations such a run on the pound or a capital flight following a Labour election victory. The shadow chancellor hopes that such “war-game type scenario planning” will convince consumers and firms that Labour is ready to cope up with all risks. While this strategy may sound promising, employing a self-proclaimed “cybernetic communist” like Mr Barbrook will not necessarily breed much confidence to investors.

    DISCLAIMER: The views set out in this blog are those of the individual author only and should not be taken to represent a corporate view of the Centre for Policy Studies

    Tzvetan Moev is an economic research intern at the Centre for Policy Studies.

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