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Government Debt is Good, Actually…

Economists find it hard to enjoy election campaigns. The quality of political discourse, especially regarding economic policy, is poor. From an economics point of view, the perpetual sin of equating economic competence with fiscal restraint never seems to die out. Myths of maxed out credit cards and magic money trees, play into the misguided perception that deficits and debt are markers of economic incompetence. Governments are often judged by the public through analogy, normally analogy to households or businesses. This common vernacular acts as a strait jacket on governments, and explains a series of policy failings over the past fourteen years. 

This is the response of the Guardian to Labour’s manifesto: “The manifesto was intended to be business-friendly, targeted at former Tory voters and aimed at restoring the party’s economic credibility.”. Here competence means no borrowing. This betrays what has been almost standard economic theory for over 80 years and the lessons of the past fourteen years. Our reluctance to borrow, especially to invest, is a mark of economic incompetence.  

There is a pervasive idea; governments exist like households or businesses. Borrowing when they spend too much is ruinous. For households and businesses, budgets must balance at some point. To finance budget deficits, they can either borrow or sell their assets. Typically, the latter is a final resort and a hint toward imminent bankruptcy. Governments, as all economics students learn, have another lever they can pull. They can print money. A government issues the currency, its own debts are denominated and cannot default on its debt unless it chooses to do so. The Government can always reach down the back of the sofa and pull out a coin for however much debt it owes. Households and businesses cannot do so. 

Government spending is constrained only by the availability of real resources. When all our builders are at work, a government commencing a massive construction project won’t increase output but will bid up wages and prices for the resources needed. However, if all our builders are unemployed, a government construction project eliminates spare capacity.

Keynes’s main idea was during recessions, there is a lot of spare capacity, workers are unemployed, factories and other capital is available for use, hence fiscal stimulus can be employed without risking vastly higher inflation or crowding out (replacing) private output. This produces a fiscal deficit. The debt is repaid through budget surpluses (higher taxes, lower spending) during boom years. 

The past fourteen years of economic policy in the UK reversed this. Government spending was cut massively, to supposedly crowd in private investment and raise growth. Thus, by cutting spending and raising growth debt/GDP would fall over time. How wrong these economic vandals were (see chart below).

Figure 1: UK Public Sector Net Debt

Source: OBR Public Sector Net-Debt. 

Our recovery was sluggish with wages in many regions still yet to recover. Moreover, our credit card was not maxed out; debt kept rising through the 2010s. 2010 was a terrible time to cut public spending, the economy was in a fragile state, with ample spare capacity for government spending to be absorbed. On top of this, and as I’ve mentioned before, productivity growth slowed to a crawl. No doubt, some of this is the result of falling public investment, an area Osborne slashed, to protect pensioners. Investment is the main driver of economic growth over the medium and longer term. The Conservative coalition; funded by present cuts in spending with future decreases in growth. Taking from the future to pay for today. When considering the ultra-low interest rates paid out on government debt at the time, cutting public investment and reducing debt was a catastrophic blunder. 

They focused too much on the debt part of the debt burden. They assumed private investment would increase without public investment, it didn’t. In other words, short term liabilities were paid off by selling long-term productive assets. 

To the present, Jeremy Hunt likes to compare the UK’s economic performance since 2008 to that of Germany. Yet Germany’s dire economic performance over the past record emanates from their government’s similar aversion to budget deficits. In true German fashion, they have a constitutional rule banning deficits of larger than 3% of GDP. Again, this had the effect of prolonging the downturn, weakening the recovery. There is also the additional problem in the Eurozone, where monetary union is not matched with fiscal transfers. The main point is, Germany has underperformed for the same reasons as the UK: an unwillingness to borrow. 

Compare the recent economic performance of Germany and the UK with the US (see charts below). Even before Covid, the gap between Europe and the US was growing. Yet, the post-Covid picture is clear. A strong US recovery, with the UK and Germany squandering the past three years. In the US, both Presidents engaged in huge fiscal stimulus. Coming out of the crisis, Biden achieved the IRA (Inflation Reduction Act 2022); a massive investment project. Borrowing to invest in the future. The IRA sought to update US infrastructure, which will support future growth. Meanwhile, the UK and Germany started fiscal tightening almost as soon as the lockdowns ended. 

Figure 2a: Real GDP Per Capita- US, Germany, UK, with Pre-Covid Trends

Figure 2b: Real Consumption Expenditure Per Capita

Source: OECD. GDP PC. Final Consumption Expenditure. 

This is not to say, borrowing can be done without limit (my next piece is on the threat Trump presents to the sustainability of the US’ finances). There are limits to how much governments can borrow. However, borrowing to invest is necessary for long-term economic growth. Fiscal deficits during downturns speed up recoveries, reducing unemployment and spurring wage growth. Our current aversion to borrowing in any kind is a simplistic narrative which impoverishes our future. It has left the UK with European taxes and US level services. Now that is economic incompetence. 

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