Things could be worse for Rachel Reeves, but not much. The economy is stagnant. Donald Trump has decided the UK will not be exempt from tariffs on steel and aluminium exports to the US. Stock markets have taken fright and share prices are tumbling.
Five years on from the start of the Covid-19 lockdown, the scars of the pandemic have proved to be deep and long-lasting. The spring statement on the economy that Reeves will deliver later this month will announce cuts to welfare in order to prevent the government breaking its own borrowing rules.
Echoes of the 1920s and 1930s are everywhere. The return of protectionism is but one way in which the years between the first and second world wars are being reprised. Just as the 1920s saw failed attempts to turn the clock back to a world economy overseen by the gold standard, so for more than a decade and a half central banks and finance ministries have been seeking a return to the rapid growth of the 1990s and early 2000s.
As in the interwar years, the multilateral system is being weakened by US isolationism. Middle-ranking European powers such as Britain and France are being asked to shoulder the burden of collective security. As then, there is a sense of liberal values being under threat. Ukraine is the new Czechoslovakia and I see Vladimir Putin as the new Hitler – to be appeased at Europe’s peril. The peace dividend – higher social spending paid for by spending an ever smaller share of national income on tanks, planes and ships – is considered to be a thing of the past.
There has been no repeat of the Great Depression of the 1930s – at least not yet – but there is no real sign that a long period of ultra-low interest rates has resulted in stronger economic growth. But in the past month, a new narrative has developed. Countries such as Britain will, as a result of Trump’s reticence about deploying US power for the defence of Europe, have to increase military spending. The boost to the defence budget will help the government’s growth agenda because the extra money will provide a stimulus. After all, didn’t khaki Keynesianism eventually bring about full employment and the end of the depression?
If this all sounds like too pat an explanation, that’s because it is. Given that nothing else has worked, it was perhaps inevitable that sooner or later policymakers would eventually alight on arms spending as the cure for stagnation, but the idea that there can be a return to the 1939-45 war economy is a fantasy.
For one thing, the evidence of the late 1930s and early 1940s suggests that the current government’s plans are insufficient either to boost growth significantly or prepare the UK to fight a major continental war. Defence spending rose from 2.2% of GDP in 1933, the year Hitler came to power, to 6.9% in 1938 when Neville Chamberlain signed the Munich agreement.
At its peak in 1944, defence spending accounted for half the UK’s national output. Keir Starmer has raided the aid budget to pay for defence spending to be raised from 2.3% to 2.5% of GDP and has the aspiration of further increasing it to 3% of GDP, but these are modest increases.
Then there’s the question of how the extra defence spending is to be financed. During the second world war, this was done through a combination of borrowing, taxation and rationing. The national debt rose to 250% of GDP, while the need to divert resources into armaments meant there had to be a squeeze on consumer spending. Without higher taxation and rationing, an overheating economy would have suffered runaway inflation.
The stance being adopted by Reeves is different. The chancellor is not prepared to break her fiscal rules to pay for higher defence spending, so extra borrowing is not an option. That leaves her with a choice of either further increases in taxation or cuts in spending. It is not just that there is no longer a peace dividend; rather, the peace dividend will go into reverse, with cuts to the peacetime economy paying for additional military spending.
Germany is planning to ease its borrowing rules, which means its rearmament will have an impact on growth, but Britain is not. There will be no change to the size of the UK economy or its growth rate, and the government’s attempt to suggest otherwise is nonsense.
All that said, the debate about military Keynesianism matters because it proves resources can always be found if the need is considered great enough. When faced with a crisis, governments can always come up with the money. There were three chancellors of the exchequer between 1939 and 1945, all peripheral figures, and that’s because, first, national survival and then the pursuit of victory meant fiscal rules were ditched and the influence of the Treasury diminished.
While Starmer harks back to this era with his talk of the economic benefits of higher defence spending, he is really offering military Keynesianism-lite. What’s more, the climate crisis poses a bigger existential threat to this country than Putin does – or ever will, so if money can be found for the military there’s no reason why it couldn’t also be found to accelerate the drive for self-sufficiency in clean energy. That might really do something for national security.
Larry Elliott is a Guardian columnist
