Earlier this year I gave oral evidence to the Economic Affairs Committee of the House of Lords on the state of the public finances. I’m pleased to say they included many of my thoughts in their final report, available here.
Some excerpts.
On the level of the debt-to-GDP ratio…
31. When considering the implications of high debt-to-GDP ratios, witnesses also raised questions about causality. Julian Jessop pointed out that a country might have a high level of debt if its economy is weak, not because the debt itself is causing the weakness. This reinforced his doubts that “there is a particular magic level of debt that you can identify as being a problem level.” Carl Emmerson also questioned any discernible relationship between debt and growth. He said: “Countries that cannot have big debt are often poorer countries that have more scope for growth than bigger, richer economies. I suspect there are quite a lot of other factors causing those correlations that we can see in the data.”
34. Given the importance of whether debt is rising or falling (as opposed to its level), witnesses emphasised the significance of the expected trajectory of debt and associated variables in the sustainability ‘equation’. Julian Jessop remarked: “I do not think it really matters whether that debt level is
100% of national income or 120%, but I am concerned about the trends.” Elaborating on this point, Professor Chadha told us: “When we think about sustainability, we are really asking ourselves whether debt will grow without bound relative to national income. It inherently involves some judgement about the future path of expenditures and revenues over time”. However, Professor Goodhart argued that the level of debt matters as well as the trajectory, saying that “it would be a lot easier if we were starting from a debt ratio of 40% rather than a debt ratio of around 95%.”
On ‘financial repression’…
Any government looking to pre-empt a looming ‘debt trap’ can see it resort to ‘financial repression’, in which it circumvents market forces in order to secure adequate levels of affordable funding. The IMF defines financial repression as “legal restrictions on interest rates, credit allocation, capital movements, and other financial operations”. Julian Jessop delineated between “some soft forms of financial repression we have already had over the last few years and decades”. He said this included “a long period in which … financial institutions in the private sector were encouraged to buy government debt through prudential regulations”; and “something more sinister, more the sort of thing that might happen in an emerging economy where private sector institutions are forced to lend to the Government”. The latter, Mr Jessop noted, was “very unlikely in an advanced economy” but, he added that “there will clearly be more pressure on central banks to keep interest rates lower for longer than they would otherwise have done, because of the need to finance a massive public debt.”
On the high foreign ownership of UK government debt…
58. Professor Chadha felt that foreign ownership might act “as a further constraint and examination of our fiscal position” while Sir Robert Stheeman commented that the UK has “a healthily diverse investor base.” However, Richard Hughes has said that the UK’s “fickle and flighty” foreign buyers of its government debt presents a growing risk to the stability of the gilt market. Asked if foreign financing of the UK’s debt was really a problem, Julian Jessop told us: “I think it is … it is relatively easy for foreigners to decide not to invest in the UK.”
63. Witnesses also depicted potential risks stemming from other specific countries or blocs. Julian Jessop noted that in recent decades, Japanese debt has offered near zero yields which have been unattractive to foreign investors and “if that changes, that is another challenge to the UK”. Peder Beck Friis also stated that G7 debt dynamics would look “much worse than they did pre-pandemic” should the emerging market “savings glut” dry-up given that it has allowed governments to run deficits and high debt levels.
On the role of productivity…
119. Julian Jessop noted that “since the [2008] global financial crisis, it is noticeable that some of the biggest slowdowns were in two sectors: financial services and the energy sector. Both have seen quite big increases in regulation for various reasons. Simply reversing that could make a big difference to productivity.” However, witnesses tended to be of the view that successfully promoting higher productivity, and hence growth, is far from straightforward. Moreover, Professor Miles considered it a “risky strategy” to rely on productivity growth to prevent ever increasing debt to GDP ratios. He said: “Past evidence suggests that government policies to bring it about cannot be relied upon to transform the fiscal outlook. In their absence the balance between taxation and spending does not look as if it can continue as is.”
On the optimal level of government spending…
124. Sir Dieter Helm told us that “since the Second World War, there has been an incremental addition of government functions, one upon the other.” Accordingly, he suggested that we need to ask: “Where is the balance between the take of tax … and the functions that we want government to have? What you cannot do—it is what democracies tend to do—is keep expanding the functions then not provide the money to do them.” In relation to the overall level of public spending, Julian Jessop considered that the “number could probably be a lot lower than some other people might think … I find it difficult to understand why the Government need to spend more than about 40% of national income—or certainly more than 50%, as is the case in many European countries.” Professor Chadha similarly questioned whether there were any ways for government expenditures to be curtailed: “Can we automatically uprate retirement age with life expectancy? Are there things that we should do with the triple lock on pensions, which will cost 1% more of GDP over the next four or five years than we might have anticipated? Are there things that we have committed to … that we should move away from because they are a residual risk to the ultimate level of public finances in the economy?”
147. … Speaking to us before the July 2024 General Election, Julian Jessop said that “the big problem for the next Parliament, whoever wins, is that they will be looking at a set of fiscal forecasts based on an implausible set of public expenditure assumptions.”
On alternative balance sheet rules (for example, targeting Public Sector Net Worth)...
153. Nevertheless, while some witnesses were open to some form of debt management approach incorporating a more direct role for the public sector balance sheet, they struggled to envisage its practical implementation. Julian Jessop pointed out that a school, for example, delivers important economic and social benefits, “but it does not pay for itself. It is not necessarily something that the markets would look at and say, ‘This makes it easier for us to justify buying government debt’”. Moreover, Mr Jessop alluded to the problems of defining investment, noting that “if you are doing a lot of current spending on healthcare or education, to what extent is that also an investment in the future? … It is a good example of where we sort of agree on the principles, but whether it would be an improvement in practice is debatable.”
ps. I wrote more on PSNW here
Plain-speaking Economics 