Last week saw the chancellor publish the government’s spending review for 2015/16. The substantial projected reductions in government spending are indicative of the coalition’s view that it is necessary to continue to reduce government spending - and attempt to avoid further public borrowing - in order to reduce the public sector deficit.
The Labour Party meanwhile has committed itself, if it gains power in 2015, to adhering to the coalition government’s current spending plans for 2015/16. Borrowing would only be permitted, if at all, to fund capital investment. On borrowing, Ed Miliband suggested in his recent speech to the Labour Party Policy Forum, that they should learn from the post-1945 Atlee government and aim for public sector surpluses.
The apparent consensus from the three main UK political parties seems to confirm that – despite an economy which has been at best flat-lining; a national infrastructure which is inadequate, and real income which has fallen by 5% over the past 3 years – further public borrowing will, at best be severely constrained for the foreseeable future.
Media commentators’ questions on the economy are always directed at how can we afford this or that item of public expenditure, given that we should not be borrowing more.
So is this consensus view correct? Is public borrowing the ‘sin’ which is being suggested? Of course, it would be wrong to argue that increasing public borrowing in all economic situations is the thing to do. Nor would I maintain that having to make substantial interest payments on the national debt is not a problem, as it necessarily reduces the public revenue available to spend on desirable items such as the health service and public infrastructure.
In fact, there is no appropriate level of debt/GDP ratio which is determinable. What matters is the direction of travel, as with the deficit/GDP ratio.
So let us deal with the deficit. In any economy there is an ex post accounting identity. The deficits and surpluses of the public sector, the private sector, and the trade balance must be ‘sum to zero’. If there are net private savings, and a net import balance, there must be a public sector deficit. This indicates that, without the public sector deficit to maintain the size of the economy, it will shrink.
The public sector deficit entails that public borrowing will increase. Hence, with the private sector not supporting growth, the only way to avoid the economy shrinking is for the public sector, via increased public borrowing, to do the job.
The alternative approach, which the coalition government is following, is for the economy to shrink (it has done) and adjust to a substantially lower level of public sector provision (a smaller state); and, eventually, to start growing again, albeit from the lower base.
This of course, obscures the socio-economic pain; the foregone national income, and the unwarranted reduction in public sector provision in getting to the new position.
It is also important to understand, that the nation is not a household. Private debt is debt. As a household the alternatives are to increase household earnings or reduce household outgoings. For the UK as a whole to reduce expenditure will lead cumulatively to lower incomes for all.
It should also be noted that public debt is not the same as private debt. When government bonds are issued this actually increases the wealth of the private sector, and provides interest income – for the pension funds and others who buy the bonds. An alternative, for a government, is to reduce taxation on the majority of the population, for example by reducing VAT.
But public borrowing for the UK is also, in general, not a problem. The UK is monetarily sovereign. It issues its own currency and it has a flexible exchange rate. This means that it can never become bankrupt. Moreover, the average maturity of UK government debt is some 14 years, and 70% of bonds are held by UK organisations and citizens.
A final note. The remark made by Ed Miliband on the post-1945 public sector surpluses (which actually only existed over a 2.5 year period until 1949/50) is somewhat misleading.
The Atlee government was substantially increasing public expenditure at the time, and the relatively small, surpluses occurred principally because of the demobilisation of the armed forces after the war.
