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The unhelpful comparisons surrounding Britain’s Covid debt

Chancellor Rishi Sunak on a visit to the Imperial Clinic Research Facility at Hammersmith Hospital - Credit: Getty Images

JAMES BALL on the mounting national debt, and what should be done about it.

Think, for a moment, about your home. This should not be a difficult task for most of us, given we’ve all been spending a lot more time than usual stuck there.

There’s probably a bed, a kitchen, hopefully a TV – but is there, anywhere in your house, a bank? How about a money-printing press? Does your home employ millions of staff (or indeed any staff)? Does it have a standing army?

If the answers to the above questions are “no”, then your home – like mine, and everyone else’s – doesn’t bear much resemblance to a country. It’s a shame, then, that so often in politics – especially in the week of a budget – we start talking about government finances as if they work like a household budget.

It’s not a helpful analogy and misses out the bigger picture. And in the case of our debt, that is a much bigger picture.

For a household, budgeting is about accounting: making sure what’s going out (bills, rent or mortgage, debt repayments and so on) is, ideally, less than what’s coming in.

But for a government, it’s really a matter of economics – when your actions can affect the whole economy of the country you manage, concentrating on the spreadsheets and the accounting can cost you far, far more than it saves.

We generally measure countries’ debt as a percentage of their economy (GDP). Just like it’s very different to have £20,000 of household debt if you earn £15,000 a year than if you earn £100,000, it’s very different for a country to owe $1 trillion if its economy is worth $5 trillion than $0.5.

By this measure, the UK’s debt has definitely rocketed over the last 15 years or so.

Before the 2008 global financial crisis, the UK’s national debt was around 35% of GDP. For most of the decade afterwards, it was around 80% of GDP. In the wake of the coronavirus crisis, it’s now sitting at 110% of GDP – clearly a huge increase.

Understanding debt

Here, we might see another way in which the household debt analogy falls down: if you’ve just bought a new home, your debt is likely around four to five times your annual income – and that’s seen as normal and okay. Whereas the UK’s national debt of 1.1 times its national income is a serious high point: our debt has not been so high since the years immediately after the Second World War, when the country (and Europe) relied on US debt to rebuild after the expense of defeating Nazism.

Even on the face of it, though, this is hardly a case of wasteful governments routinely making terrible spending decisions – both of the big step changes in our recent debt came in response to major crises.

The jump in debt post-2008 came from the decision to bail out the banks and boost the economy through quantitative easing (QE, a process by which the Bank of England in effect creates new currency backed by public debt to boost bank reserves, allowing them in theory to lend more), and part of the jump in debt in 2020 came from a further round of QE and the significant increase in spending required to support the country through the pandemic.

But in practice, a big part of that jump in the crucial debt-to-GDP ratio came because UK GDP plummeted in 2020 – meaning that even if we hadn’t borrowed an extra penny, the ratio would have gone up. But in that counter-intuitive observation comes potential for seeing why our way out of the debt situation we are in is not as simple as just paying it all back.

Is the UK’s debt a problem?

On a household level, your debt isn’t really a problem provided you can pay it back and provided it’s not so high that other lenders don’t cut you off. In a more complex way, the picture is a very similar one for countries.

The national debt matters if it makes people believe a government might renege on repayments, or else be otherwise unable to supply vital services or afford necessary infrastructure investment.

That can have a chain reaction of negative effects: the government finds it more expensive and difficult to borrow, but also private sector companies become reluctant to invest if they suspect a crisis is coming – creating a crisis.

The size of the economy is critical to government finances in two ways: firstly, if the UK grows more rapidly than its national debt does, its debt-to-GDP ratio will go down even if it doesn’t repay a penny. If that continues over time, the cash amount of the debt won’t change, but it will become an ever-diminishing fraction of the economy. Countries can grow their way out of debt without ever really paying it down.

Growth also helps the government because most of its revenue comes from tax, which is a percentage of the economy – if GDP shrinks, the tax take shrinks, meaning there’s less money on hand to cover essential spending, including debt repayments.

That means confidence in the government and in the economy are more important than any cash amounts of level of repayments: provided the government can reassure would-be investors in the UK that it is a strong, growing economy, everything else will look after itself. The people first in need of that reassurance, of course, are the people who hold the UK’s debt.

Who owns the UK’s debt?

If you have life insurance or a pension plan, you are among the holders of the UK’s debt – a majority of it is owned by private sector investment funds based in the UK and overseas. Only a small fraction is owned by overseas governments or central banks, leaving them little ability to cause crises or coerce the government.

Somewhat counter-intuitively, the Bank of England is the biggest holder of the UK’s national debt – despite itself being owned by the UK state. We do, in effect, owe ourselves hundreds of billions of pounds.

The obvious suggestion, then here would be to just wipe out that debt – especially as it’s largely from the QE measures used to try to boost bank lending, meaning that if the Bank of England base rate went up, so would the cost of servicing this debt.

This is where the confidence problem really kicks in: the Bank of England’s primary responsibility is to manage inflation and keep it low, to make sure investors can be confident in putting their money in the UK.

If investors started to believe the Bank would shirk this duty to help the UK with its debt position, that would undermine their confidence – potentially creating a lot of inflation and damaging the UK economy, and thus our national debt. When you’re a government, even owing yourself money matters.

What is true, though, is that government debt is as cheap as it has ever been – repayments are tiny, and it is currently possible for the UK government to fix those rates (much like a fixed-rate mortgage) for 50 years at incredibly low rates.

A future rise of interest rates would remain a risk to UK debt repayments, just as it would to UK private sector debt, but we could easily lock in the current low rates for a huge portion of our debt for a very long time.

Given that, the obsession with certain parts of our political system on micro-managing our debt and making it the central focus of our politics is a weird one: the best thing we can do to keep our debt manageable is to make sure our economy bounces back strongly from coronavirus and the resulting, multiple lockdowns.

That means boosting consumer confidence, boosting business confidence, attracting investment, and improving infrastructure.

We can’t spend as if we entirely don’t care about the public finances, but responsibility isn’t the same as penny-pinching. Growth is our way out of the crisis, our way out of the doldrums (going out and partying does, in fact, contribute to growth), and can be our way out of the debt.

We don’t need to sweat the penny if we can go and earn the pounds.

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