On September 28 1976, Denis Healey, the then chancellor, was en route to Heathrow. In the morning, he was due to fly to Hong Kong for a meeting of finance ministers. This would be followed by a flight to Manila, and a meeting of the International Monetary Fund (IMF). When he arrived at the airport, literal and metaphorical clouds were settling.
More worrying than the weather was the state of Britain’s finances; the year before, inflation had run at a scarcely credible 24 per cent. Large government borrowing and mounting public debt were worrying potential buyers of government bonds, and interest rates were having to rise in an attempt to bring funds in.
By the time Healey had finished his gin and tonic in the VIP lounge, it was clear that he would have to return to Westminster. The next day, the government announced that it was seeking an IMF bailout.
When the cuts that this necessitated were announced, The Sun pronounced it “Britain’s shame”. But whatever else was achieved, it shortly became clear that Britain had reverted to type; the burden of debt was once again falling.
The 1976 bailout was unusual for more than its dramatic conclusion. Broadly speaking, the history of Britain’s national debt follows a simple pattern. As the Office for Budget Responsibility (OBR) has put it, we have “long periods where the debt-to-GDP ratio is broadly stable or gradually falling”, and “occasional large increases”.
In other words, the government responds to crises like wars and pandemics by opening its chequebook, and then lets economic growth and reduced borrowing shrink the burden afterwards.
The problem facing Britain today is that this no longer seems to be true.
It’s little wonder that the House of Lords’ economic affairs committee has announced a new inquiry into the sustainability of our national debt, and whether the Government’s fiscal rules are fit for purpose; we’re now expecting to borrow large sums during times of peace and plenty.
The baseline projection from the OBR is for the primary balance (the deficit excluding interest payments) to swell to 10 per cent of GDP by 2070.
Those debt interest payments will reach 13 per cent of GDP, and the total debt pile a staggering 310 per cent, still on an upwards trajectory. And if anything, this understates the issue; as the last few years have highlighted, assuming nothing bad will happen is optimistic to the point of foolhardiness.
How debt became unsustainable
The scale of the change is dramatic. Speaking to MPs on Thursday, Robert Stheeman, the head of the Debt Management Office, noted that in 2003, his first year in the job “the entire value of the gilt portfolio was £300 billion. This year, we’re borrowing £240 billion, and the entire value of the gilt portfolio approximately is about £2.5 trillion”.
In other words, the value of Britain’s outstanding debt is now eight times higher than it was 20 years ago.
James Bowler, the Permanent Secretary to the Treasury, added that if debt interest spending were “a department, it would be the second biggest department out there”.
The drivers of this debt blow-out are well known. The population is getting older, with the ratio of retired to working age people increasing from 1:4 to 1:3.
Health, social care and benefits spending are expected to rise even as tax receipts begin to drop. The Government, meanwhile, is piling up the spending commitments without seriously working out how to pay for them; the transition to net zero and rising defence budgets will bite a lot harder if the swingeing real terms cuts pencilled in for the 2020s don’t take place. History, after all, suggests that they will not.
The situation is so bad that the OBR is bluntly describing the current path as unsustainable. Then again, it’s been saying that for a while; the very first fiscal sustainability report in 2011 gave the same warning, as have reports almost every year since. Despite these alarms, the great ship of state continues serenely on towards the iceberg.
The root of the problem
The greatest contributor to our fiscal position is not our demographics, our healthcare system, or our desire for more than 157 working main battle tanks. It’s the unwillingness of our politicians to make hard decisions.
Britain’s debt mountain might be growing at an alarming rate, but Westminster is curiously calm. Given fiscal room by inflation eroding the value of tax thresholds, Jeremy Hunt, the Chancellor, chose to use this to fund a round of pre-election tax cuts.
That much of this room was generated by a heroic set of assumptions about restraining spending after the next election didn’t do much for the impression that we have a Government more interested in making noises about fiscal prudence than actually displaying it.
Then again, Mr Hunt is hardly unique in this behaviour. We may have only had one explicitly cakeist prime minister, but we’ve had a long line of “jam today” chancellors.
The Cameron-Osborne years, where the debt and deficit dominated the national conversation, were outliers. Even then, the rhetoric and the reality didn’t always line up perfectly.
While Lord Cameron spent the lead up to the 2010 election swinging hard at Labour’s profligacy, all he managed to achieve was slowing the growth in spending. Having said that Gordon Brown’s plan to double the national debt to £1.4 trillion was a “disgrace” that ran the risk of repeating Healey’s 1976 debacle, he presided over a government that hit that milestone anyway.
This wasn’t because his government didn’t want to make cuts, but because they are difficult to make in politically appealing ways. As Lord Cameron wrote in his memoir, in hindsight they “could have done more, even more quickly … Given all the hype and hostility, and yes, sometimes hatred, we might as well have ripped the plaster off … we were cutting just £1 in every £100 spent, but you’d think we had reinstated the workhouse.”
The problems facing politicians who want a more fiscally restrained state are numerous, but they can be boiled down to two simple statements: people like it when someone else foots the bill, and MPs would quite like to retain their seats.
The result is that Westminster is rarely confronted with a proposal for spending that doesn’t take the fancy of at least a few MPs. These range from the small – like chess tables for local authorities – to supported employment schemes for the disabled, a “Network North” to replace High Speed 2, access to talking therapies, pay rises for NHS staff; the list goes on.
Rishi Sunak, the Prime Minister, suffered his first defeat in the Commons when his own party rebelled to demand the speeding up of a planned compensation scheme for victims of the tainted blood scandal.
It would be one thing if we were running up these deficits to fund investment that would (eventually) pay for itself. Motorways, airports, bridges, train lines, desperately needed MRI and CT scanning machines for hospitals, functioning 21st century IT systems for government departments – the list goes on, and on, and on – could all go quite a long way to improving Britain’s dire productivity record, and generating some much needed growth.
Only about 11 per cent of government spending, however, counts as “capital”, with a substantial chunk of that sum consisting of business and student loans. The rest is spending on day-to-day consumption.
Margaret Thatcher’s habit of comparing running a government to household budgeting may have earned her opprobrium from economists, but her observation that “when there is only so much money to spend, you have to make choices” rings true. We’re making the wrong ones.
300 years of borrowed money
It was exactly the fear of this sort of behaviour that caused the House of Commons to give away its right to initiate spending in 1706. That these proposals are all worthy endeavours is exactly the point; politicians are asked to make difficult trade-offs, and instead find it easier to wave policies through.
After all, there’s a good chance they won’t be in office when the bill eventually comes due – and an even lower one if they start to impose fiscal discipline.
Cutting spending runs into the standard difficulties of collective action; a small number of people set to lose a large perk will kick up an almighty fuss, while a very large number of diffuse people losing a small amount will find it hard to effectively organise in favour. Raising taxes irritates everyone who pays them. Better by far to spend, and pass the buck on to the future.
“It is,” Stanley Baldwin wrote in 1919, “so easy to live on borrowed money; so difficult to realise you are doing so.” This is particularly true when you need never pay that money back.
It may be a sad fact of life that people do not live forever, but it does have its perks when it comes to public spending: by issuing debt, you can opt to have future generations fund your consumption. This makes debt-financing extremely tempting relative to paying taxes.
It’s even more so when you consider the tempting thought that it might never be repaid at all. The big difference between people and governments is that governments can go on effectively forever.
This opens up a new realm of fiscal possibilities; a government which really wants to can, in theory, keep rolling over its debt over and over again, never repaying it. All it needs to do is make sure that GDP grows faster than the stock of debt, and it’ll be on a sustainable path.
The magic formula
The magic inequality that makes this possible is: g > r. When the growth rate of the economy (g) is larger than the rate of interest (r), and deficits aren’t too large, the relative importance of the debt will naturally shrink.
There is, however, a catch: the inequality can flip. As Lord Norman Lamont, the former chancellor, puts it: “The real danger is that interest costs rise faster than GDP, which would be very, very awkward. With high inflation and high interest rates and indexed debt, it’s a bit of a problem.”
The latest OBR estimates support this analysis, gloomily noting that r and g are now roughly equal; barring a sudden surge in productivity from AI, we can no longer rely on growth to magic away the debt burden for us.
Instead, we will need to find a way to make our political system confront hard choices, rather than setting up harder choices for future generations.
This is easier said than done. As with Hemingway’s remark on bankruptcies, Britain’s fiscal slide happened slowly, then all at once. Labour ran deficits in a good economy before the twin crises of the 2008 crash and the pandemic blew huge holes in fiscal planning.
Now we have a population used to living beyond its means, angry at the degradation in services, and unlikely to take kindly to suggestions that more taxes or spending cuts are needed.
When many of those who will bear the burden of taxation in 2070 haven’t even been born yet, it’s difficult for our political system to put their interests on par with our own. This may not be good, or wise – turning again to Thatcher, it is “neither moral nor responsible for a government to spend beyond the nation’s means, even for services which may be desirable” – but it is a constraint that our democracy needs to work within.
Fixing the roof while it’s raining hard
How we start to tackle our growing mountain of debt, however, isn’t clear. One route would be to introduce legal barriers to politicians running up a tab.
We’re well used to watching across the Atlantic as US politicians agonise over the debt-ceiling. Introduced in 1939, this limits the amount of debt that the federal government can have outstanding at any given point. When the limit is hit, the government is barred from further borrowing.
This generates dramatic confrontations and stand-offs, with Republicans and Democrats pointing fingers across the aisle, and it certainly imposes some political costs to funding projects with borrowing. If you want to push through a new spending project, you need to be prepared for the clash that will follow.
The problems with this are twofold. The first is that it does involve an economic cost; part of the rationale for Fitch’s latest downgrading of the US credit rating was persistent brinkmanship over debt-ceiling negotiations, which raised the spectre of the US failing to make expected payments and triggering a global meltdown.
The second is that it doesn’t work. The US government has raised the debt-ceiling limit 78 times since 1960 – more than once a year – and is currently running a deficit of around 5.5 per cent of GDP.
The political costs haven’t been enough to make politicians act responsibly, and the mechanism is too extreme to be palatable to many; breaking the government over a couple of percentage points of debt goes too far.
Other countries with debt limits have a similar story to tell. Denmark, for instance, has managed to avoid brinkmanship by simply setting the debt limit at a level far above its stock of debt, and then doubling it when the 2008 crisis raised the risk of needing to borrow more.
Even imposing the rules in international treaties has a mixed track record; the European Union’s Maastricht provision that public debt must stay below 60 per cent of GDP hasn’t actually stopped countries breaching this limit. Indeed, debt across the EU is now an impressive 84 per cent of GDP, with several countries well over 100 per cent.
Germany, one of the successful examples of debt limit laws, is also a good example of why the approach is unlikely to work for Britain. Berlin incorporated a debt brake into its constitution in 2009. Once triggered, this limits borrowing to 0.35 per cent of GDP.
While suspended during the Covid-19 pandemic, it has proved broadly successful in limiting government spending, and recently resulted in the Karlsruhe court blocking a planned €60bn (£51.4bn) project, dealing a heavy blow to the ruling coalition. The result is that the Social Democrats are now looking to reform the rule.
And this, ultimately, is the problem with attempted legal solutions to British government debt. Parliament is supreme, and cannot bind future parliaments. Any law purporting to limit borrowing would be waived aside with the usual passage of bills on a simple majority vote. In order to get borrowing under control, we need a shift in our political culture to one where loading debt onto future generations is seen as unacceptable, and where economic growth is prioritised.
In other words, we need to get back to the way Britain has traditionally managed its debt. As Carl Emmerson, the deputy director for the Institute of Fiscal Studies, puts it, crisis spending takes place “for good reasons – we want to help households, businesses, public services”, but “if we are going to want to keep pushing up debt every time there’s a bad shock, I think we do need to be aiming to get it down when we’re not expecting those bad shocks.” And right now, that isn’t the plan.
In Lord Lamont’s view, this makes it “quite likely that public spending will have to be cut”. For Emmerson, barring a surge in growth: “I wouldn’t be surprised if the first 12 months after the next general election sees a net tax rise.”
The alternative is to continue on an unsustainable path, making our eventual reckoning with reality all the more painful.