How important is it to cut the public debt?

Business Editor Matt Freathy on the UK's level of government debt

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GOVERNMENT DEBT HAS taken a far more prominent position in the public eye since the world was rocked by the financial crisis of 2007/08 and consequent global recession. Amid widespread unemployment and plummeting incomes politicians seized on calls from the public for greater fiscal restraint in government by asserting that in order to restore the economy to health, sweeping austerity measures were necessary to reduce the size of the debt and deficit.

After years of systematic cuts to public services the deficit has fallen, but has not been eliminated as George Osborne claimed it would be by 2015, with debt stagnant at 89 per cent of GDP. Regardless of their otherwise mixed economic record, the pledge to stem the tide of increasing public liabilities has long been the cornerstone of Conservative economic policy, a promise now unlikely to be fulfilled until well into the 2020s. This arguably constitutes failure on the part of the Chancellorships of Osborne and Philip Hammond. But it doesn't matter all that much, and it never did. Public sector debt in the UK has been massively over-politicised, a phenomenon caused by misinformation concerning the causes of the crisis and the nature of public debt.

The financial crash which sparked recessions in 31 of the 35 member states of the OECD and cost the world economy an estimated $22 trillion was, shockingly, not the fault of the British Labour Party overspending. High debt was not a cause of the crisis, but a consequence of having to bail out the very banks whose behaviour caused it.

In fact, the only significant risk from accumulating public debt is if the burden of interest rate payments causes the government to default on its debts. With this estimated to occur once these repayments reach around 12 per cent of GDP and the UK's current payments standing at less than 3 per cent, this is of no immediate concern. As long as a government can be relied on to pay what it owes and thus maintain access to credit then debt in itself is mostly benign with regards to the performance of the economy.

In the wake of World War II British public debt peaked at 238 per cent of GDP, well beyond current levels. Instead of cutting the provision of public services to a country already ravaged by war, Clement Attlee's Labour government created the NHS and the welfare state. Over the following decades debt sank to below 50 per cent of GDP and remained there until 2008, demonstrating that high levels of debt are not necessarily an impediment to prosperity and that such levels can be effectively tackled by investing in public services and social security.

A frequently asked question about public debt is: who exactly do we owe all this money to? For the most part the answer, perhaps surprisingly, is ourselves. About three quarters of the UK's national debt is owed to British citizens and institutions, with pension funds and the Bank of England being the government's largest creditors. 25 per cent of the debt is actually held by the public sector, for which the government pays itself back, including interest payments. This may seem odd, but many of the finer details of the issue of debt are fundamentally intangible and can be somewhat separated from the average person's economic reality.

This is by no means a suggestion that governments should spend recklessly without fear of consequence, and it is healthy for governments to cycle between periods of surplus and deficit during good and bad times. But debt is not the bogeyman it is commonly made out to be, and is more often symptomatic of broader economic trends than a cause of them. Fiscal responsibility is a key aspect of good governance - and efforts should be made to eliminate genuinely wasteful spending and inefficiency - but it is not synonymous with ideologically driven and potentially harmful debt aversion.

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2 Comment

Bill Ellson Posted on Wednesday 28 Oct 2020

The NHS and Welfare State were wartime coalition policies, for the end of hostilities, agreed across parties. The UK was propped up after the war by huge U.S. loans.


Matt Freathy Posted on Wednesday 28 Oct 2020

Exactly, the loans from the US allowed the UK to fund the investment necessary to rebuild the country and economy. In that instance taking on some extra debt was highly beneficial. I take your point about the NHS and Welfare State being a joint effort.


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