When will the debt get back to normal? Not in your lifetime!

A couple of weeks ago on Kiss FM (I know, I know, but it’s piped through the speakers at my gym) they were asking for examples of things you’ll say which will shock future generations. The primer was “I was born before Google was invented.” As I sat there, recovering from my workout, I thought of one: “I can remember when the public debt was less than 40 percent of GDP.”

Because, even if you look at the most optimistic projections in the last OBR report, I will be older than my mum is now by the time we get back to pre-recession debt levels. Going by most of their scenarios, I will probably never live to see it. For most, if not all, of the rest of my life, the public debt will be well over 40 percent of GDP.

Are the OBR just being a miserable bunch of doomsayers? Probably not. As I’ve noted before, their projections of ageing costs are less pessimistic than many others. Then last week, the IMF came up with growth forecasts significantly below the OBR’s, as this table from Duncan Weldon shows.

So, if anything, it looks as though the OBR may have under-estimated the costs of ageing and/or over-estimated GDP growth, so even their ‘Central’ debt-t0-GDP projections may be optimistic.

You can look elsewhere but you’ll find similar projections from the IMF, the OECD and the IFS, which predicts higher debt for decades.

What’s the problem with that? We had debts of 100 percent of GDP as recently as the 1960s and at the end of the Second World War it was over 200 percent.

True enough but the reason it came down so rapidly during the postwar years was because our economy grew. And growth, of course, is almost always how governments reduce their debt levels.

Politicians who talk about ‘paying down the debt’ should, to borrow John Band’s phrase, be taken out and horsewhipped. Governments rarely pay down debt at all. Since the Second World War, governments have reduced the total amount of debt by small amounts in the early 1970s, early 1990s and early 2000s. For the most part, though, the amount of debt has risen.

There are two ways you can reduce a percentage. You can reduce the number on the top of the fraction, in this case the amount of debt, or you can increase the number on the bottom, in this case the GDP. And that’s what we did after the war, with a sustained 25 year period in which growth averaged around 3 percent per year. As time went on, the growth periods were punctuated by recessions but the booms still averaged something close to 3 percent annually.

Most of the reduction in our debt to GDP level, then, has been achieved by reducing the number on the bottom of the fraction. The debt has, for the most part, kept on rising but the GDP has risen faster so, relative to the size of the economy, the debt has come down.

All we have to do to get the debt down, then, is to grow the economy like we did after the war. And that’s where the problem starts. Based on current projections, growth rates of 3 percent over a sustained period don’t look very likely. The chances of seeing any repeat of those 4, 5 and 6 percent growth years we saw in the past are slim. Even the OBR’s 2.3 percent between now and 2020 is looking optimistic. In short, the boom, if and when it comes, is unlikely to be as boomy as those we have been used to.

There are all sorts of reasons for this, not all of which can be blamed on Cameron/Osborne or Blair/Brown. Some of it is caused by factors which affect many western economies. To avoid this piece becoming too long, I’ll discuss them in a later post but these pieces by Chris Dillow, Tim Worstall and Edward Hugh explain much of it.

Combine already high debts with low growth and increasing spending pressures and the debt graph goes ever upwards.

Is high public debt a problem? Again, one for another day but debts of over 60 percent of GDP don’t leave us with much room to manoeuvre, or much of a buffer against another recession or financial crisis. For the public sector, high state debt means that, even under a left-wing government, spending increases that can’t be shown to contribute to economic growth are likely to be vetoed. Ed Balls almost said as much earlier this year.

What is almost certain, though, is that, for the foreseeable future, we are stuck with a level of public debt we thought we’d left behind in the 1960s. Most people reading this probably won’t live to see the debt back at its 2007 level. It is just one more indication that we are now into an economic scenario quite different from that which most of us have been used to. Lower growth, higher debt and, for the public sector, permanent austerity. Gordon Brown’s 40 percent debt ceiling has been well and truly smashed. Most of us won’t live to see it rebuilt.

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8 Responses to When will the debt get back to normal? Not in your lifetime!

  1. Pingback: When will the debt get back to normal? Not in your lifetime! - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  2. John D says:

    While I agree with much of the objective content of your article, it displays – in my opinion – an outdated approach towards the situation you describe. It is possible to quibble with definitions of GDP and whether or not they make any kind of real sense but putting that to one side, what your analysis reveals is a need for fresh and different thinking on all parts.
    Reduced consumption and people living more frugally/sustainably can help to reduce the effect of the top part of the debt/GDP equation. People are already adjusting towards this kind of life style. The truth is that for many people that has been their reality for the last 30 years or so. People who have saved money for a rainy day have seen the real value of their savings decline. Another way in which the top part of the equation can be reduced is if central, regional and local government starts to reduce the the levels of taxation upon ordinary people and enterprises in this country. It may well be that we will have to countenance spending a lot less on our present welfare state, as well as reduce spending in areas like defence. We are a much reduced nation yet this has yet to be reflected in defence spending. The idea that we can afford to spend £60 billion on a replacement nuclear weapons systen which relies upon US guidance technology has always struck me as absurd. Let’s not even go into talking about aircraft carriers that do not have aircraft to carry…. Giving development money to countries like India which has its own space programme (which we cannot afford) and which then hands on our money to other countries in order to gain influence is clearly absurd and represents an area where government spending could be curtailed.
    I see locally the steady increase in young educated Eastern European familes, who are growing our population in the South East part of our country. I believe they represent the best of what this country will have to offer in the future. They are hard working and entrepreneurial. The best could yet be to come if they are given a fair start and support in our shared country.

  3. Let us not forget that the current situation looks much worse than it is because we’re in recession, and that this recession (like all others before it) will end at some point. Even modest annual growth of 1% in GDP would start to eat away the net debt. The counter argument that an ageing population and increased health and welfare costs will prevent this is questionable. The UK reduced net debt from roughly 200% in 1951 to 50% in 1971 at a growth rate of 3%, but this was done at the same time that the welfare state was implemented – i.e. government spending rocketed after 1948 but net debt came down all the same. You don’t need much growth at all.

    The OBR aren’t necessarily doomsayers, but they are constrained by their brief. They can extrapolate current tax revenues (many in decline for structural reasons) but cannot factor in new or substitute revenue streams (which we know will be turned on). This means their view on future revenue, and therefore annual deficits, is artificially pessimistic. (See more here).

    We should also bear in mind that the bailout of the banking system has left us with large contingent liabilities in respect of bank assets (e.g. credit guarantees and asset protection), plus actual assets (e.g. bank equity). Assuming the banking sector returns to some degree of health (likely, as we still need banking), this promises a potential windfall that could cut large chunks out of the debt, albeit this may be a decade away.

    Finally, the fear that a service-based economy will suffer from lower growth due to a lower rate of labour productivity growth is well-founded, however that in turn is based on an economic model in which productivity gains are partly spent in the creation of supernumerary white-collar jobs that add zero to future productivity. (See more here).

  4. It wasn’t growth alone that reduced national debt/gdp. Much of the World War II debt was inflated away. We had persistently high inflation through most of the 60s, all of the 70s (it touched 27% per annum in 1975) and the early 80s. There was also financial repression – national savings paid returns well below the inflation rate.

    I don’t regard national debt as anything like as large a problem as private debt. It is deleveraging of private debt, together with general worries about the future, that is keeping the economy in such poor state – people and businesses are paying off debt instead of spending, and businesses are not investing because people and other businesses aren’t spending. It’s a vicious cycle which would depress economic activity even if our national debt were much lower.

  5. asdasdasd says:

    As is pointed out above, the public debt after WW2 wasn’t just reduced merely growth, but also by inflation.

    If nominal GDP goes up, debt (public and private) to tends to fall.

    If inflation increased to 4% per year, nominal values of debts would be halved in a decade.

    4% inflation isn’t exactly unprecedented, inflation (RPI) was above 4% for all bar 1 year from 1968-1991. Funnily enough, debt to GDP fell from 80% of GDP to 28% of GDP over this period.

    Economic growth has been worse over the last five years has been worse than at any point in the last 100 years. Output growth has been far worse than during the stagflation of 70s. It’s hard to see how higher inflation would hurt.

    Despite this, Mervyn King and the MPC, (in their infinite wisdom), appear determined to inflict deflation on the economy. The CPI has already fallen for the past couple of months. Short term inflation break evens (RPI) are currently 1.9%. I.e. well below the 2% CPI target. The BoE inflation projected inflation to be below target for the next few years in their most recent inflation report.

    See:

    http://uneconomical.wordpress.com/2012/08/10/a-plea-to-new-keynesian-economists/

  6. Keith says:

    I very much agree with the last two posts. I think the National debt is irrelevant to the real economy. All the alarmist talk about state debts is a political con to justify public spending cuts to benefit the wealthy, and evidence of economic ignorance.

    The world economy and British economy is suffering from a hard money policy based on right wing economic ideas that form a irrational ideology. Economic crisis arise from the private capitalist economic sector and it is there that demand needs to be restored. The Government deficit is useful in a crisis as a balancing factor to bolster demand. If necessary higher short term debt can be repaid from higher future growth, tax rises, and if necessary inflation. The simplistic idea that there should be zero inflation and no Government borrowing is childish and smacks of historical ignorance. All mainstream political parties and their leaders have been inveigled into this set of hard money deflationary ideas by finance capital and their propagandists in the economics profession. It is a rerun of the 1920s and 1930s. Epic fail from the world economic establishment.

  7. John D says:

    What is needed is a new and fresh approach. Instead of taxing work, production and income, the government should be taxing personal consumption expenditure. Before the UK joined the EC, we had a purchase tax, which was primarily levied on discretionary expenditure items such cars, fur coats, precious metals and precious gems. This meant that the burden of taxation was shifted from ordinary people to rich people. We should reduce taxes on work and increase taxes on consumption of luxury and semi-luxury goods and services. This may mean having to leave the EU, which is one more good reason for doing so. When I studied applied economics, we were told that inflation can be of two types: demand pull and cost push. If the amount of money income in an economy rises without any corresponding increase in output in the economy, you end up with “too much money chasing too few goods”. In a market economy, the price mechansim then kicks in by way of the cost of goods increasing in price, even though the quantity of goods are unchanged. If labour and other production costs rise and are passed on in the form of increased prices, this causes demand to decline but the price rise is inflationary. Inflation is a sign of a poorly behaving economy, in that the market mechanism is failing to damp down or keep steady prices. If the market is working properly, then price rises (or, put another way, the effective fall in the real value of money) should be offset by encouraging new suppliers into the market, who should be attracted by the higher prices and increased profit prospects. Arguably, the market system has been failing over the last 30 years and all we have witnessed is the steady enrichment of the rich and the steady impoverishment of the poor. This can only be changed if new thinking and new policies are adopted which ensure – as a Tudor Elizabethan economist once remarked – “money be like muck – no good unless it is spread around”.

  8. The State Debt Lie & Why Constitutional Law Is Covered By Commercial Law

    http://statedebtlie.wordpress.com/

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