A dangerous and remarkable delusion

Cometh the General Election this year, we can expect most political parties to keep harping on about the national debt crisis. The way the media and politicians collude, you’d think we’re about to become a third world country, cutting services left, right and centre to appease the IMF.

Is it that bad? I’ve been reading a few really interesting papers that show the problem is massively exaggerated.

First, how big is government debt? In a fairly readable report, the National Institute of Economic and Social Research calculates that it will increase to 93% of GDP by 2015. This, as I wrote earlier, is a good deal lower than in the US, Japan, Germany and Italy.

The main problem with government debt is that you have to service it, which means both paying the interest and trying to reduce it when it’s too high. This means that, short of incredible “efficiencies”, we have to cut public expenditure on useful things like schools and nurses or increase taxes to balance the books. But as the NIESR further point out, this is only really a problem if the debt is unusually high (which it isn’t) and if the interest rate is greater than the rate of economic growth (which it is unlikely to be in the medium term). So economic growth will provide the extra taxation which means we can probably afford to pay off our historically moderate debts without too much pain.

The other problem to receive a lot of media attention is the claim that we might lose our credit rating. The NIESR give this short shrift and points out that “historically, since the country has managed levels of debt higher than those in prospect, it is hard to see why the market for UK debt should be affected by rating agencies’ views”.

The NIESR also explain a third problem that you don’t read a lot about. Put simply, people invest their savings in three ways: productive capital (like shares in a company perhaps via an ISA); fixed assets (like a house, or technically the land); and government debt. Only productive capital fuels useful economic growth. If we have a much higher national debt then proportionally more savings will be invested in that government debt, taking it away from useful productive capital investments. This means you get a short-term boost from the spending that causes the rise in debts, but future generations are lumped with a less healthy economy in the long-term. The NIESR reckon that this effect will reduce the nation’s stock of income-producing assets by about 30% of GDP. Now that is bad!

To the rescue come the Green New Deal group’s second report, The Cuts Won’t Work. They elegantly explain how public expenditure in the right areas will provide a major economic boost, almost covering the cost of the debt incurred. It will also help stimulate areas of our economy that the Government has so far failed to support, which handily are a good long-term prospect, unlike short-term consumption boosts such as car scrappage.

So we learn that our public debt isn’t that massive; servicing it won’t be that hard; it shouldn’t case a credit rating catastrophe; and that a fiscal stimulus could create long-term benefits to offset its potential drag on the economy.

A final word on priorities. While the Conservatives and Labour harp on about public debt, the NIESR point out that there are much larger burdens being heaped on future generations. Housing, something I wrote about recently, is an obvious one. The above-inflation price increases amount to “a powerful integenerational transfer” from the young (who can’t afford it) to the old (who own most of it). The Tory/Labour vision of an economic recovery on the back of rising house prices supported by cuts in public spending is, they suggest, “a dangerous and remarkable delusion”.