Debt: apocalypse now or much ado about nothing?
Reducing public borrowing and public debt is one of the Coalition Government’s main economic objectives. However, the UK's public sector debt rose by 19% to £910bn over the year to April 2011, and now stands at some 60% of GDP (excluding banking sector intervention). Public sector net borrowing for the same period was around £139bn (12% of GDP).
But what does this tell us, apart from showing that keeping borrowing and debt in check is easier said than done, particularly when economic growth is sluggish and tax revenues are falling? Is the level of debt something that all of us really need to worry about? After all, our debt is lower than that of the US, Japan and Italy (to name a few). In terms of current debt to GDP ratios, the UK is a mid-table performer: not quite Manchester United or Chelsea, but not West Ham either; Fulham perhaps? Before the global financial crisis, the UK was arguably pushing for a Europa League spot; its debt has since increased more quickly than most other countries reflecting the importance to the UK economy of financial services.
So, is the level of UK debt a ticking timebomb set to blow the economy to smithereens, or a damp squib that won’t go off? Is George Osborne a fiscal superman, saving us from the debt monster, or is he more akin to Freddie Kruger, slashing away at our public services in the stuff of nightmares, and making a difficult economic situation even worse in the short term.
We need to consider the level of debt alongside the budget deficit. A high budget deficit (as we have at present) is manageable in the short term as long as public debt is not already high and the Government is prepared to take subsequent steps to bring it down. All other things being equal, the Government’s austerity measures should act to reduce borrowing and debt. However, this needs to be countered against the potential for these cuts to further constrain demand and economic growth (and in turn tax receipts), which itself could result in the need for higher borrowing and more debt in the short term.
The difficulties faced by countries such as Greece, Portugal, Spain and Ireland mean that the Government does need to take firm action to control borrowing and debt (although we should be careful not to make direct comparisons: Greek debt was already well above 100% of GDP before the financial crisis began, and Ireland’s economy was in an unsustainable property fuelled boom, followed by a collapse in GDP). However, stabilising the debt to GDP ratio is important to reassure markets that the government can maintain debt repayments and to contain inflation.
This brings us back to the crux of the issue: whether the Government’s austerity measures are really necessary (albeit painfully so) to restore public finances and to lay the foundations for future growth or whether the Government “cutting too far, too fast” as some critics claim, which could end up costing us more. Whilst the OECD is broadly supportive of the Government’s approach, it also noted that George Osborne would do well to consider a Plan B after all, should growth remain sluggish during 2011/12.
However, even though the UK is trying to implement severe spending cuts, this is unlikely to reduce debt to GDP immediately given the scale of borrowing still required. Given the fragile state of the economy and the impact on tax revenues, I would expect the overall cuts package to be even more severe than those already announced, by the time it is completed.
So, what do we conclude? The UK is right to take measures to reduce borrowing and the debt to GDP ratio, and the UK fiscal tightening is unlikely to result in the country entering a deficit/debt spiral. However, the Government will face a challenge to meet it deficit reduction target for 2011/12; indeed, borrowing and debt may continue to rise until economic growth returns to its long-term trend. And if this is the case, the overall scale of the government spending cuts may ultimately exceed those already announced if the Government is to meet its medium term deficit and debt targets.
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