Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 13 February 2024

Detoxifying government debt, part 1. Debt is also an asset


Perhaps Labour scaling back its proposed green investment is just a pre-election ploy, and will have no implications for what they do in government. Perhaps. But perhaps they genuinely think the country can only afford a modest increase in public investment; much less than the economy and public services need. As we shall see, this idea that the nation cannot afford to increase worthwhile public investment because it requires more government borrowing is quite wrong.

In my last post I noted that both Shadow Chancellors Rachel Reeves and John McDonnell had adopted the falling government debt to GDP fiscal rule, even though it has the real potential to hold back valuable public investment for a prospective Labour government. [1] I know in John McDonnell’s case, and strongly suspect with Rachel Reeves, that the reason for doing this has nothing to do with good macroeconomics, and everything to do with public perceptions about government debt.

In either case it looks like we need to unlearn once again all the myths about government debt that the media constantly feed us. Any advances those who argued against austerity might have felt they made may have been undone in the UK by misinterpretations of what happened under the leadership of Liz Truss. In contrast, as I showed last week, the US government under Biden has ignored worries about government debt, and partly as a result is currently in economic terms the international success story. So this post will be the first in a series that tries to unpick why politicians, the media and large parts of the public think high government debt is a bad thing, and why they are wrong to think this. My apologies in advance to those who are already familiar with some of these arguments from my earlier posts, MMT or elsewhere.

Let me start with some basic economics. There is no empirical evidence or economic theory relevant today that tells us that the level of government debt currently in the UK is too high. Advanced economies like the UK after WWII had much higher levels of debt to GDP than we do today, and that was the start of a golden era of economic growth. Serious econometric studies find no causal correlation, and one that did and got a lot of publicity around 2010 quickly fell apart on inspection.

What economists are concerned about is that fiscal plans should be sustainable, which means debt shouldn’t be constantly increasing as a share of GDP. That implies something like the golden rule, aiming to roughly match day to day spending with taxes, but it does not imply current debt to GDP is too high and needs to come down. There is no economic basis for the falling debt to GDP rule. That rule is there for political reasons, and perhaps in Labour’s case because they believe the media and the public want it there.

That people can be made to worry about government debt is not surprising. The idea of debt worries many people, and people have been conditioned to believe that they should also therefore worry about government debt. This, probably more than any political bias, was why the media completely adopted the necessity for austerity before, during and for many years after the 2010 election.

As I argued here, for both individuals and firms it is understandable that debt is worrying, because the consequences of having too much can be devastating. But I also pointed out that debt is at the same time a wonderful device, because it (in the form of mortgages) allows most individuals to buy their first house, and it allows many firms to invest and grow. Our society would be a lot poorer if debt didn’t exist.

However government debt is not like an individual’s debt or a firm’s debt in many crucial respects. One in particular means that government debt should not be something people in general should worry about. Government debt is not society’s debt, because it is also society’s asset. Most government debt is owned domestically by domestic residents or institutions, so from society’s point of view it is debt that it owes itself. You could think of it as a loan from domestic savers to taxpayers, one that both savers and taxpayers are grateful to have..

Imagine you were someone that had a mortgage purely for tax purposes, but you also had personal wealth in the form of liquid financial assets of a similar amount. Every time your mortgage interest rate changed, the interest on your savings changed by exactly the same amount. Would you worry about having to pay your mortgage in those circumstances? Of course not, because you can pay it back at any time of your choosing.

For society as a whole, in most advanced countries, government debt is just like this example. People don’t think about it this way partly because taxpayers are a different set of people to savers, and savers may not realise they hold government debt through their personal savings or pensions.

Does the fact that a significant proportion of government debt is owned overseas change this logic? Not really, because equally UK residents own the debt of overseas governments. Roughly speaking, for every £ of UK government debt there is a similar asset owned (directly or indirectly) by UK residents. To go back to the analogy with an individual with a mortgage and equivalent financial assets, it would be more realistic to imagine an individual who has a mortgage and also holds most of their personal wealth in liquid financial assets whose interest rate moves with their mortgage rate, but a proportion of their wealth is in other overseas financial assets where the interest rate might be higher or lower.

So for society as a whole, government debt is nothing like the personal debt of a normal individual with a mortgage and few financial assets. The question that is never asked when people talk about government debt is debt to whom. If instead of the term government debt we talked about non-government financial assets in government issued instruments, and talked about the government deficits as the increase in those non-government assets, I suspect many people’s views about government debt and deficits would change.

In passing we could note an interesting contrast here. When the government reluctantly raised a windfall tax there were articles in the right wing press about how this would hurt savers and pension holders who indirectly owned shares in these companies. Such claims were not empirically valid, but when it suited certain interests the connections between assets and individuals were made. So it would be perfectly possible for the media to note that UK government debt was a key asset for many savers, but this is rarely done.

What is sometimes done is divide government debt by the population or number of households and say, or imply, that this is some kind of personal liability for each person or household. This alone is just wrong, because it completely ignores that most of this debt is held as assets by domestic residents or households (and the remainder is held in the form of other financial assets). Government debt is not collectively our debt, it is collectively our debt and our assets.

Another implication is that it is wrong to say 'the nation cannot afford' more public investment financed through borrowing. Additional government borrowing creates an asset for those who buy the debt, and as we have noted most government debt is domestically owned. So directly or indirectly domestic residents are lending willingly to allow the government to invest. UK politicians would be delighted if firms increased private investment through borrowing, and are very unlikely to suggest they cannot afford to do so. It makes no sense to think in different terms when it comes to public investment.    

One reason people don’t think like this is that the media doesn’t talk about domestic residents directly or indirectly owning or buying government debt, but instead talks about ‘the markets’ doing so. For most people ‘financial markets’, like the economy itself, is something mysterious and a little frightening, because a crisis that affects everyone adversely can occur when the markets go wrong. But once again, this gets things backwards, as I will explain in a subsequent post.

[1] As James Meadway reminded me, McDonnell’s rule involves the ratio of debt to trend GDP, which is better than using actual GDP but still is likely to unnecessarily constrain public investment.

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