11 November 2019

History shows the folly of not dealing with our debts


With the General Election campaign in full swing, we are starting to learn more about the policies of the main parties. On both sides that means turning on the spending taps, although Labour’s plans are far more spendthrift than the Tories’, and both parties have said they will fund the extra commitments through increased borrowing.

No one would dispute that a wealthy country like the UK should have world class public services. Taxpayers fund them and deserve value for money, and the are also crucial for the most vulnerable people in our society.

However, a borrowing splurge that will add to our already spiralling national debt is not the way to go about things. Indeed, that debt is already projected to reach unsustainable levels within the next few decades. That’s a serious problem, given that higher debt levels will mean an increase in the yields paid on UK sovereign bonds. The logic behind that is obvious: if investors think the UK risks defaulting on its debt, or trying to inflate it away, they will need a higher yield to justify the risk of buying our bonds.

High debt can also have a very negative impact on economic growth. For one thing, there’s the classic problem of ‘crowding out’  as investors loan money to the government, rather than to the private sector. Academic evidence shows that nations typically see growth slow when their debt levels reach 90% of GDP, with the median growth rate falling by 1% and average growth falling by even more.  Research focusing on the US has found that raising the Federal deficit has an adverse effect on the economy by reducing private sector investment, economic growth, and employment.

At a time when the UK is preparing to leave the EU and growth in industrialised economies is generally low, it is important to be cautious. Far from preparing to ramp up spending, the Government should be getting the public finances in order now so it can respond to any future downturn.

There’s also a moral argument against having a large national debt. Money which is borrowed today will have to be paid back at some point in the future, perhaps by people who are yet to be born. As a result of the profligacy of current governments, a burden will be placed on future generations who will have to pay higher taxes and have less money to spend on essential services. It’s the same reason that one of the defining principles of Parliamentary Supremacy that Parliament cannot bind its successors – it would be an affront to democracy to allow future generations to be bound by previous generations.

One of the counter-arguments you often hear to this is that the UK has experienced higher levels of national debt in the past, and so it’s really nothing to get too het up about. A popular variation on this theme has been to look to the aftermath of the Second World War when the nation was heavily indebted but still managed to build the Welfare State and the NHS.

Today is Armistice Day, when we rightly remember the human cost of wars over the centuries. As well as remembering those sacrifices, it is worth looking at how governments have responded to the economic turmoil that wars so often produce.

Take the Napoleonic Wars, during which the British government racked up huge debts. Once Napoleon had finally been crushed, the Earl of Liverpool’s government adopted a policy of eradicating the national debt by running budget surpluses. Effective though this was, it’s worth noting that back then the franchise was much narrower and the state much, much smaller, so the government did not have to concern itself with the demands of ordinary people or funding essential public services.

A century later, the aftermath of the First World War saw another government struggling to control the national debt. Despite running large surpluses, a fall in prices and the large difference between real interest rates and real growth rates meant that the public debt to GDP ratio had risen to 1.76 by 1923. High real interest rates made debt reduction difficult. The UK delivered an average primary budget surplus of 7% of GDP between 1921 and 1929 but the debt-to-GDP ratio at the end of this period had risen to 1.58 compared to 1.47 at the start.

As for the aftermath of the Second World War, it’s true that We did manage to found the NHS and build the Welfare State, but the circumstances were quite different to those we face in 2019. The end of the war meant a huge fall in military spending and the return of huge numbers of men to the labour force, all of which had a pronounced effect on the health of the economy, notwithstanding the very tough conditions faced by ordinary people.

If they want to improve our public services, whoever wins the election should focus on making savings in other areas, rather than just borrowing inexorably with little thought to the potential long-term consequences. History offers ample lessons about the pitfalls of failing to get on top of the national debt.

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Ben Ramanauskas is an economic researcher at Oxford University.