Monday, March 10, 2008

National Debt Statistics - Problem of Government Borrowing

In a previous post we looked at the problem of personal debt in the UK. However, problems of debt are not just confined to the private sector, government borrowing also is a major issue.

Just a couple of years ago, the Government could boast about the national debt being reduced to just 29% of GDP. By international standards this is pretty impressive. This reduction was due to
  • Several years of economic growth and lower unemployment
  • strict limits on public spending, started by the Conservatives and continued by the Labour Party
  • Windfall from sale of mobile phone licenses
However, despite continual economic growth, the public finances have shown a worrying deterioration. National Debt is £612 billion and is forecast to rise to 44% of GDP. In 2008/09 the UK government will have to borrow over £42 billion; a very high amount for this stage in the economic cycle.

National Debt Chart

national debt

National Debt is actually a lot Higher

A public debt of 44% of GDP is not unmanageable; but the real problem for the government is the fact that public sector liabilities are actually much higher. In a way the government are underestimating the true level of national debt. The Institute of Fiscal studies suggest that the true level of national debt is actually much higher. This is because the government is currently excluding

  1. Public Sector Pension provision. Public sector pensions are a liability that the government has to pay out of current spending. There is no 'investment in a pension plan'. Pension liabilites are very high and expected to get worse with an ageing population.
  2. Private Finance Initiatives. The government has been keen to promote private finance inititatives which involve projects financed partly by the government and partly by the private sector. At the moment, the government do not include these spending committments, but effectively they are public liabilities.
  3. Guarantee of Northern Rock. The government have given guarantees to Northern Rock for upto £100bn. Hopefully, the government will not lose money, but it remains a liability
  4. Demographic Factors will Make the National Debt worse in years to come. The UK is facing an ageing population. This will become particularly an issue from 2016 onwards. Around this time, the baby boomer generation will start to retire. This will reduce the size of the labour force and increase the dependency ratio (the number of non workers to active members of the labour force). Therefore, the government will receive lower tax (e.g. income tax) and is committed to paying pensions. The government is trying to alleviate this by raising retirement age to 68. But, with life expectancy increasing, this is unlikely to be insufficient

Problems of National Debt.

To what extent should we worry about National Debt? It is something that the UK has experienced for a long time and there are many countries with a more serious problem. However, there are many good reasons to be concerned about a National debt.

Interest Payments.

People do not lend to the government with any sense of charity. The government have to pay interest on debt, like anyone else. Last year the government spent £31 bn on interest payments alone. To put this into perspective this equate to the equivalent of 15 p on income tax. It is more than the UK spends on National Defence. Government borrowing for 2007/08 is forecast to be £42 billion - a similar figure to the amount the government pays in interest payments.

Crowding Out.

The argument is that government debt crowds out the private sector. If the government have to borrow they sell bonds to the private sector. Because the private sector are buying bonds this leads to less private sector investment. Furthermore it is argued that government spending tends to be more inefficient than private sector spending.

Financial Crowding Out.

If the government have to borrow a lot of money, interest rates on bonds may need to rise to attract sufficient lenders. If bond interest rates rise, this can put upward pressure on general interest rates. The higher interest rates in the economy will reduce spending and investment and lead to lower growth in the long term.

Tax rises for the future.

Growing public sector debt means that future taxpayers will end up picking the bill. Even if the public sector debt is not reduced, future taxpayers will have to pay the interest on the debt. This is particularly a problem because, as has been mentioned, changing demographics will mean that government finances will be placed under increased pressure, even without borrowing from today.

Limits Fiscal Policy

Ideally, the government should be able to pursue expansionary fiscal policy if the economy is facing a downturn and possible recession. If the government have a very large public debt then it limits the scope for cutting taxes to boost Aggregate demand. For example, the government should really be increasing taxes or cutting spending in this 2008 budget. But, that is not desirable given that a slowing housing market is already causing problems.

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