Why public debt should be taken much more seriously
Daniel Lilley, 22 November 2022
‘Sustainable public finances provide the stability and confidence that underpin the economy, supporting businesses and households across the country. By taking the responsible decisions needed to achieve fiscal sustainability, the government is providing the necessary conditions for economic growth.’
If you recognise this, well done for reading last Thursday’s Autumn Statement. This is the first paragraph of the first chapter. It tells us most of why, in the government’s own words, the UK needs to control its public debt.
The amount of debt a country has is generally measured in public debt as a percentage of Gross Domestic Product (GDP). Using this, the current debt level is 101.9 per cent of GDP (the Autumn statement marks it as lower, due to not counting Bank of England debts).
This is large. We are seeing the highest UK public debt ratio since the 1960s and it is three times the pre-financial crisis average – the debt level as a percentage of GDP was roughly 26-35 per cent for all of 2000 to mid-2007.
High debt, particularly with rising interest rates, has a huge cost implication. The Autumn Statement tells us:
‘The OBR expects spending on debt interest to reach £120.4 billion this year, the highest since the late 1940s, both as a share of GDP and as a share of revenue. If debt interest spending were a government department, its departmental budget would be second only to the Department for Health and Social Care’.
For context, it was £22.4 billion in 2020-21. The expected education spending for 2021-22 is £70.1 billion, and for defence it is £31.7 billion. It has basically increased in two years by total education spending plus total defence spending. This a serious situation.
As in the Autumn Statement, sustainable public finances are needed for stability and confidence, but they are also needed for economic growth. Unsustainable public finances ‘dampen economic growth over the long term’ and can risk a debt spiral and default – something we really don’t want.
‘Sustainable public finances’ relates to ‘the trajectory of public debt as a share of GDP’. That is, whether public debt is growing faster or slower than the economy. It should only be growing faster in periods of crisis and should be slower otherwise. In the government’s own words, ‘keeping the debt trajectory under control requires debt to fall as a share of GDP in normal times’.
Notably, for this debt doesn’t need to be falling, it needs to be growing slower than the economy – that way our ability to pay it back is improving.
It is okay to take on debt when you need to jump start an economy that has had a shock, but in normal times you should be generally ‘paying this back’ (or ‘growing it away’) otherwise you’ve become unsustainably reliant on debt.
The growth of government debt as a percentage of GDP (whether debt grows faster than the economy) depends on three things.
- How fast the economy grows. The faster the economy grows, the less likely it is that debt grows faster. If the economy is growing faster, the relative size of public debt is falling.
- The primary budget deficit. This is how much more the government spends than it receives and directly increases the amount of debt.
- The interest rate. The government has to pay interest on the debt that it already has; this costs money, increasing government spending, and contributing to increasing debt. This also increases in how much debt you have, as it is paid as a percentage on debt. The second and third together tell us how fast debt is growing.
The interest rates set by the Bank of England since 2009 have been utterly unprecedented. Records from the Bank of England going back to 1694 find no evidence in British history of interest rates getting so low, never mind staying so low for so long. This has closed channel three of those above, making it far easier to keep debt as a percentage of GDP down.
We have relied on unsustainably cheap debt for some time, and we’re not going to be able to anymore.
The end of this extraordinary period that we are now seeing, with the bank rate up to three per cent – a much more historically and economically reasonable level – will necessitate vast improvement in growth or our budget position in order to simply maintain the course, let alone try and create a healthier debt situation.
This interest rate rise is the cause of debt interest spending increasing from 0.9 per cent of GDP in 2020-21 to 4.8 per cent this year (2022-23). The increase of nearly £100 billion over two years is three quarters of the NHS budget. That is the fragility high debt has created.
The growth rate is also expected to plummet in real terms. The Office for Budget Responsibility (OBR) have confirmed that we are rolling into a recession as an economy. This adds to the debt problem as it means the economy is not growing faster than debt unless debt is not growing.
We are in a difficult situation with debt, and the government needs to behave wisely. For debt to be sustainable not only does economic growth need to get above the interest rate, but government spending can’t continue to grow how it has.
‘Debts cannot continue to grow for ever’ says the OBR. Countries can’t sustainably rely on debt to function. The argument that ‘the only consequence of debt is more debt so why not fund the NHS instead of obsessing over ‘debt debt debt’’ is bad economics and moral anathema.
Debt does create more debt: As debt increases, it becomes increasingly expensive to service it (pay the interest), making it harder and harder to avoid debt increasing, and debt tends to grow faster and faster. It is wrong, however, to suggest that this is the end of it – debt eventually comes to a head. Either the debt growth must be arrested and the books balanced, or default becomes inevitable.
Defaulting on your debt is catastrophic to the health of an economy and is to be fiercely avoided – you will find no economist anywhere who disagrees on that front.
This means governments must maintain the trust that they can and eventually will stop debt increasing. This gets more difficult and more expensive with every penny of extra debt, and so the longer the government waits before biting the bullet and addressing it, the more painful it becomes to do so.
It is already very painful; the government is already spending over £120 billion a year servicing debt, only £10 billion less than it is spending on the NHS and £50 billion more than it is spending on education. We are entering the highest tax burden since just after WWII and yet the debt ratio is still not expected to fall for many years.
This would have been far worse without the agonising austerity of the Osborne days.
Delaying this medicine because it is too bitter is morally and economically indefensible. Morally, it is the choice to continue to live beyond your means in the comfort that it is those in the future who will have to bear the almighty cost. Economically, it is the deliberate choice of fragility and the disregarding of future prosperity for the sake of avoiding the discomfort of reality.
Daniel Lilley recently graduated from Cambridge University where he studied Economics. He is currently supporting the research team at the Civitas think tank.