Government debt under labour 1997-2010

Government debt under Labour was a major factor in the elections of 2010 and 2015. But to what extent did the Labour government really plunge the economy into debt during 1997-2007?

Usually, when people say ‘it’s debt that got us into this mess’. They tend to view all types of debt as the same – equating government debt to financial debt incurred from selling sub-prime mortgages in the US. However, this is deeply misleading. The consequence of bad debt defaults in the financial system is very different to government debt financed through selling bonds.

Government debt

debt-under-labour

In 1997, public sector debt as % of GDP:

  • 1997/98 – 40.4% of GDP
  • 2007/08 – 36.4% of GDP
  • 2010/11 – 60.0% of GDP.
  • May 2019 – 82.9% of GDP

At the start of the great recession in 2007, public sector debt had fallen from 40.4% of GDP to 36.4% of GDP. This was despite increased real government spending. After the start of the crisis, public sector debt almost doubled in the space of three years.

If we look at just actual government debt, there is a significant increase.

In 1997, the total public sector debt was:

  • 1997/98 – £352 bn
  • 2007/08 – £527 bn
  • 2010/11 – £902 bn

public-sector-debt-total-hmT

Debt to GDP statistics were helped by the period of strong economic growth – a reminder that economic growth is as important at debt levels. It is also worth bearing in mind UK public sector debt in comparison to the post-war period.

Read moreGovernment debt under labour 1997-2010

Budget deficit targets

Politicians are often keen on making targets to eliminate budget deficits by a certain year. There is a strong political motivation to be seen as strong and committed to reducing government debt. Politicians who are vague about the debt are often heavily criticised and it is seen as poor politics. An advantage of budget deficit targets is that it ensure politicians have a stronger commitment to make politically difficult choices – raising taxes or cutting spending.

However, from an economic perspective targets for reducing budget deficits are not always as helpful as they may seem.

Benefits of budget deficit targets

There can be many sound economic reasons for reducing government borrowing. Just because a government can borrow, doesn’t mean it is desirable to.

  • It can prevent politicians choosing politically popular policies, such as tax cuts and spending increases. A deficit target can help prevent politicians putting off making difficult choices.
  • Without deficit reduction targets, some economists fear that there is an incentive to keep increasing the size of government spending, which crowds out more efficient private sector spending.
  • It can reassure markets that the government have a ‘responsible attitude to debt’ and are less likely to rely on printing money to finance the deficit and rely on inflation to inflate away the debt – which can reduce the real value of government bonds.
  • In some cases reducing the budget deficit can help lower bond yields because – with lower debt available on the market there is downward pressure on bond yields.
  • Some argue that budget deficit reduction gives consumers more to spend and firms to invest because the private sector have more confidence when the government is reducing its debt and is acting in a ‘responsible manner’. Others criticise this as being wishful thinking (see: Confidence fairy)

Problems of a budget deficit target

  • To stick to a strict budget deficit target may require tax increases / spending cuts at a time which is not appropriate for the economy. e.g. the UK economy is recovering, but if we increase income tax rates to improve tax receipts it may lead to lower growth and be counter-productive. See: Austerity can be self-defeating
  • Experience of Eurozone economies trying to meet budget deficit targets has been a deep recession.
  • Achieving an overall budget deficit means government have to finance investment spending out of tax revenue. But, arguably there is a better case for allowing government to borrow to finance investment.
  • A zero budget deficit is of doubtful value compared to other macro-economic objectives such as full employment, sustainable economic growth and low inflation.

Read moreBudget deficit targets

The bizarre logic of deficit reduction increasing UK growth

The Prime Minister has got into a bit of pickle by trying to maintain the view that deficit reduction policies have not reduced economic growth, and in fact have had the opposite effect.

“They (are) absolutely clear that the deficit reduction plan is not responsible (for low growth); in fact, quite the opposite.” (link)

There is an economic logic to arguing that given the size of  the UK budget deficit, the government need to consider policies to reduce it. Economists will disagree over the timing of deficit reduction. Some economists argue that the deficit shouldn’t be reduced whilst we are still in a recession. Others may argue, we have no luxury of waiting.

I favour the former view that recovery should come before austerity. But, I can at least understand the argument that we should cut the deficit now. However, what I can’t understand is the belief that if you cut public spending in the middle of a recession, that it will have not have some negative impact on economic growth – and in fact spending cuts will have the opposite effect in boosting economic growth. It is really a bizarre logic to hope that cutting spending at the present time will increase economic growth. With falling output, falling construction output  there is no evidence of any ‘crowding in’ in the UK economy. There is however plenty of alternative evidence, e.g. IMF reports, that austerity has caused a negative multiplier effect and reduced growth.

I wonder if there are any economists who really believe that cutting government spending during a period of private sector deleveraging will actually increase economic growth? If David Cameron wrote an A-level essay on ‘discuss the impact of a fall in government spending’ – he would really struggle to get an E grade, and would probably fail.

Has the UK responded to news of public sector wage freezes and lower government spending by rejoicing at the planned reduction in the budget deficit and gone on a spending spree to celebrate?

UK consumer confidence

The impact on confidence has been the opposite. Relatively minor spending cuts have created pessimistic expectations. There has been no confidence fairy miracle. As you would expect spending cuts in an already depressed economy have further reduced real GDP.

Read moreThe bizarre logic of deficit reduction increasing UK growth

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