A sideways look at economics
At the tender age of 51 I have, for the first time in my life, found the need to employ a team of builders. This is turning out to be a stressful experience, not because I doubt their ability or indeed their honesty, but simply because of the sums of money involved. Over the next few months, I shall be spending something close to 20% of what my lender judges to be the current market value of my home on improvements, involving structural changes to more or less every room. Spending this sum of money has caused me more mental anguish than my original decision to purchase the property. But should it have done?
Having previously owned nothing but a new-build flat, which came with a ten-year NHBC guarantee, before renting for a while, I finally bought a late-Victorian terrace, in a quiet Sussex street, in early 2021. My single viewing, conducted during the pandemic summer of 2020, was something of a whirlwind tour, complete with rubber gloves and a face mask. It was only after moving in that I realised my new home needed some attention – and more than just a lick of paint. But that is in the past, and there is no point crying over spilt milk. Am I now wrong to be spending such a significant sum improving my property? In short, no. At least, that is what my own internal mental accounting process is telling me.
A house, or a dwelling to use the national accounts terminology, is part of the capital stock. Capital, at least physical capital, depreciates.[1] According to the ONS, dwellings have a lifespan of 50 years. What that means, to a first approximation, is that every 50 years, a homeowner will need to spend the entire value of the bricks and mortar, and the fixtures and fittings, that make up their property on repairs. There is an important distinction here. In the national accounts, a dwelling is literally the house itself. Land is treated separately, depreciates at a far slower rate if at all, and makes up some two thirds of what we pay when we buy a freehold property. Crunching through the arithmetic, then, I am spending on renovations close to 60% of the value of the bricks and mortar, and the fixtures and fittings, that I own. That is a lot, undoubtedly, but it is what I should expect to pay given that, in my assessment, the property I bought had remained largely untouched since the late 1990s.
So I have justified my decision to spend such a large sum of money by labelling it as investment. Because I label it in that way, and because my lender does too, I was able to extend my mortgage to cover some of the cost – the money finally arrived in my account this morning, thankfully. There is a lesson here for both current and future UK governments.
Back in 1997, following the election of Tony Blair’s ‘New Labour’ government, the then Chancellor Gordon Brown introduced, for the first time, a set of fiscal rules. Under what he referred to as the ‘Golden Rule’, the government committed, over the economic cycle, to borrow only to invest and not to fund current spending. Over the economic cycle, from peak to trough, the current budget should be in balance. So far, so good.
Unfortunately, the ‘Big Clunking Fist’, as Mr Blair referred to his chancellor (with questionable affection), had a second rule. Much harder to justify, this required that government debt should not exceed 40% of GDP. The global financial crisis of 2008/09 put paid to that aspiration and ushered in a long period of much tinkering. Nevertheless, the sensible commitment to balance only the current budget was retained by successive chancellors until 2015, when following the Conservative’s outright election victory, George Osborne introduced a new ‘fiscal mandate’, promising to run an overall fiscal surplus, across both current and capital accounts, by 2019/20 and in every subsequent year. The commitment to borrow to invest was gone and has never returned.
But return it should. In 2022, the UK had the lowest overall investment-to-GDP ratio in the G7 and has done in 28 of the past 42 years. In an accounting sense, consumption and investment are not one and the same thing. I can appreciate that, as a mere mortal. As a nation, the UK has a much longer planning horizon, and should call a halt to this policy of fiscal Micawberism.
[1] Knowledge capital arguably does not, at least not in terms of its value to society.
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