Britain’s debt confusion

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Britain’s debt confusion

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Protestors attend a "Rally against Debt" in London. Britain's national debt continues to rise—even as the deficit falls (photo: The TaxPayers' Alliance)

The government debt and deficit have figured prominently in discussions of the UK economy over the last four years. This is in marked contrast to debate before then, when the focus was on economic growth, inflation, employment and unemployment.

The change of emphasis reflects both the large increase in the previous government’s deficits in its last two years of office and its relatively successful record in terms of economic growth, employment and inflation over the preceding 11 years. But it is not clear that the public fully grasps the economic concepts being discussed. In very simple terms, the government deficit is the difference between receipts and expenditures in a particular time period (usually a year), which deficit (positive or negative) is reflected in net borrowing. The debt is the total amount of outstanding borrowings. These measures are often presented, and most meaningfully discussed, as percentages of GDP rather than in absolute terms. This better reflects the real burdens which they impose and makes them more comparable through time and across countries.

Evidence of a lack of understanding of these concepts was provided in the early autumn by a public poll commissioned by the Centre for Policy Studies and reported in its paper A Distorted Debate: The Need for Clarity on Debt, Deficit and Coalition Aims. When asked to choose between three answers about the coalition government’s planned change in national debt, 68 per cent of those who thought they knew the answer said that the coalition was planning to reduce the national debt by around £600bn between 2010 and the end of this parliament in 2015. Just 10 per cent of those polled correctly identified that the national debt was planned to increase by around that amount over this period. Conservative supporters appeared to be the most misinformed, opting by a margin of 11 to 1 for the planned fall, rather than increase, of £600bn. This mistaken belief was also particularly prevalent amongst the older age groups—those most likely to vote at elections.

The authors of the CPS paper attributed these mistaken beliefs to widespread confusion between “deficit” and “debt” since politicians of all parties and the media have frequently muddled the two concepts. In particular Conservative politicians before the election, and Coalition spokespersons subsequently, have referred to the deficits more frequently than the debt. This is probably because the deficit had risen rapidly in the two years prior to the election and has subsequently fallen (at least until the current fiscal year), whereas the debt has risen throughout both these periods. Prior to the Conservative party conference, the prime minister correctly said that, under the coalition, the deficit had fallen by a quarter—but without adding that the debt had risen by a quarter.

This confusion is probably also reflected in mistaken beliefs about the changes in the debt and deficit prior to, and since, the 2010 general election. In Prospect, Norman Tebbit wrote of “the scale of the debts piled up by New Labour [being] so far outside normal experience.” In fact, during Labour’s first five years in power there was, on average, a surplus (of 0.8 per cent of GDP). Although there were then deficits of around 3 per cent of GDP in the period 2002/03—2007/08, the debt to GDP ratio did not attain the level inherited in May 1997 (41.9 per cent) until the end of 2008. The deficits in 2008/09 and 2009/10 were 6.9 per cent and 11.2 per cent respectively but, despite this, the average deficit to GDP ratio in the last five years of the Labour governments (5.2 per cent) was still less than that in the last five years of the preceding Conservative government (5.8 per cent).

The large increases in the deficit in 2008/09 and 2009/10 were not wholly due to higher levels of discretionary spending. The public finances were then being squeezed by the effects of the international recession on tax revenues (with the UK being particularly affected because of its large financial sector) and consequent increases in social security payments. At the time, it was also thought that demand had to be maintained in order to avoid an even deeper recession than might otherwise have occurred.

The deficit has since fallen to 9.6 per cent and 8.0 per cent in 2001/11 and 2011/12 respectively—though the figure for 2012/13 is likely to be higher than that for 2011/12. Moreover the increase in the debt to GDP ratio during the first two and a half years of the coalition government (from 53.1 per cent to 68.5 per cent, by November 2012) is now well in excess of the net increase over the whole 13 years of the previous Labour governments. Those in the coalition who refer so frequently to the inherited “mess” might care to reflect on these comparisons.

  1. January 15, 2013

    Steve

    This article is also somewhat misleading – of course the debt level will increase massively if you come into office at a time of rapidly increasing deficits unless you just put a complete stop on government expenditure or massively increase taxes – and it also seems to make virtue of the low deficit levels during the economic expansion that took place under New Labour. Surely the responsible thing to do in the good times would have been to run a surplus (as in New Labour’s first term) and build up a buffer for the bad times rather than further increase the debt?

  2. January 16, 2013

    Peter Whipp

    That political parties blame one another for these deficits is a silly game. The government’s Office for National Statistics goes to great lengths to prepare National Accounts which demonstrate that the Government’s budget deficit is the exact counterbalance of the net saving by the private and external sectors. There is very little that the government can do to influence this saving.

    The business sector’s current account is generally very close to balanced, foreigners save because we import more than we export and, in recent years, the household sector has been saving disproportionately in order to repay the mortgage debt that was assumed during the housing bubble.

    It is a shame that politicians do not take the trouble to study and understand these National Accounts, if they did, they might ask if they could not be prepared in a more timely manner and in a more user-friendly format.

    • January 26, 2013

      Rob Slack

      ” There is very little that the government can do to influence this saving.”

      Given the government can always choose to increase/decrease its own deficit it follows, because of the identity it can influence “this saving”.

      A government wishing to run a deficit might offer high rates on its debt to encourage saving elsewhere.

      • January 26, 2013

        Peter Whipp

        The point that I tried to make was that a government cannot choose to increase or decrease its deficit but that it automatically borrows the net saving of the external and private sectors over which it has very little influence.

        Given that the author, Philip Lund, is an economic statistician, it is a shame that he did not make this point in the article.

        • January 26, 2013

          Rob Slack

          “The point that I tried to make was that a government cannot choose to increase or decrease its deficit but that it automatically borrows the net saving of the external and private sectors over which it has very little influence.”

          But it can. If a government chooses to spend more without increasing taxes it can do so by borrowing. That may raise the rates on bonds (and many other assets)and induce more money saving and less money borrowing.

          That is, government action can increase private sector saving to finance government borrowing.

          It likely would increase imports and lower exports via a currency appreciation.; the counterpart of increased foreign saving.

           
  3. January 19, 2013

    paul elliott

    wish someone could have explained it so well before.
    Thankyou.

  4. January 26, 2013

    Peter Whipp

    Yes, a government can increase spending without increasing tax rates. However, demand will increase accordingly, firms will produce more in order to meet this extra demand, that extra production will require increased private sector employment which will reduce the government’s social benefit expenditure and increase its direct tax revenue and, as the new recruits spend their wages, this will further increase demand which, in turn, will cause further production which will fetch the government more indirect tax (predominantly VAT) and also require further private sector employment………. This process of fiscal rebalancing will eventually run its course but the budget deficit will always equal the net saving of the combination of the external and private sectors to the penny and at every minute of every day.

    • January 26, 2013

      Rob Slack

      So I think you must accept your original points:-

      “That political parties blame one another for these deficits is a silly game” &

      “Government’s budget deficit is the exact counterbalance of the net saving by the private and external sectors. There is very little that the government can do to influence this saving.”

      were seriously wrong. Whilst the identity to which you refer is correct, it is very clear governments can, and do, affect the saving or deficit position of the other sectors.

      (e.g.Crowding out).

  5. January 28, 2013

    Brian Scott

    It’s a pity that governments seem unable to carry out the other half of Keynesian macroeconomic management ie to reduce public spending during the good times to counter increased spending during recessions – to ‘take away the punchbowl just as the party gets going’ as a former Fed chairman put it. If Labour had reduced spending as the boom progressed up to 2006, it would have more credibility now in offering suggestions to the present coalition, which badly needs some good ideas.

  6. February 7, 2013

    Philip Lund

    Having returned from distant places I am now responding to the points made above.

    Peter is correct in stating that the sum of various sector surplus / deficit balances is constrained to zero through an identity but overstates his point by claiming that governments thus have little influence over their saving. They can and do and government deficits have fluctuated considerably over the past two decades.

    Steve is correct in stating that, starting with a high deficit, the debt is almost certain to rise for a period. However whilst that has been acknowledged in formal Parliamentary statements, the public seems to be unaware of it, the turning point in the debt has not yet been reached and its forecast timing is being pushed ever further forward.

    My article was intended to report on and clarify the facts and not to offer opinions. I am puzzled as to how it might be presumed to have made a virtue of the deficit levels in the years 2002/3 – 07/08: if I were to offer an opinion I would be more critical of these deficits than of the large increases in the following years due to external shocks.

  7. February 8, 2013

    Daryl Read

    I was under the impression things were improving in terms of both personal and government debt in the UK, but I just read this article which seems to show the complete collapse of the country! http://info.moneyweek.com/urgent-bulletins/the-end-of-britain/ What do people think of this? Is it just scare mongering?

  8. February 8, 2013

    Philip Lund

    I can assure Daryl that my article was not scare mongering; that it was based on official statistics; and also that the current UK government debt position is not quite as extreme as she now seems to imagine.

    Apart from the figures obviously reproduced from the CPS paper (itself obtainable online), all were obtained from a recent issue of the monthly Office for National Statistics Statistical Bulletin on Public Sector Finances. The most recent of these shows that the debt / GDP ratio had risen to 70.7% by the end of December 2012. The data is available from tables 8 and 9 linked to http://www.ons.gov.uk/ons/rel/psa/public-sector-finances/december-2012/stb—december-2012.html

    The main reason for the widespread public confusion is the frequency of references to the deficit rather than to the debt. Coalition Ministers seem to be briefed to speak about having cut the deficit by a quarter (which is true, but potentially confusing if recipients of this message interpret ‘deficit’ as ‘debt’). Occasionally they speak of having ‘paid back a quarter of the deficit”, which confuses a stock and a flow, or having ‘paid back a quarter of the debt’, which is incorrect and the exact opposite of reality.

    An easy way to distinguish between the debt and the deficit is to think of a bath tub. The debt is the amount of water in the tub and the deficit is the rate of flow of water into it. The Coalition has stemmed that flow – by a quarter – but the level of the debt is still rising. For the level to fall in a conventional tub it would be necessary for water to flow out through the drain (debt repayment) but this is a flexible tub, the size of which can grow (when debt is measured as a % of GDP) as GDP grows. Thus the recorded level of debt/GDP can fall, even if there is a small deficit, if GDP grows more than the debt.

    To complete the picture it is also necessary to know two further things. The first is that, although the current UK debt/ GDP ratio is high relative to its level in recent decades, it is much lower than that of many other countries – such as the USA, many members of the EU and Japan. It is also much lower than it was throughout much of the nineteenth century and at the end of World War II. The second is that however high the total of government national debts across the world they are only owed to people and organisations on earth – and much of the borrowings of individual governments, such as that of the UK, are from within their own country.

    On the other hand there is, and should be, concern about the current level of UK GDP which is now still well below the level attained in the first half of 2008 and some 14% below the trend level extrapolated from that time.

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Author

Philip Lund

Philip Lund is an economic statistician who has worked in universities, government and consultancy 




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