How to tell your debt from your deficit

A quick clarification on debts, deficits and affordability
Tony Curzon Price
Tony Curzon Price
18 March 2010

Do we have to cut our national debt? our deficits? how fast? This is becoming one of the election issues - as opposed to leaders' wives - that is actually being aired.

Anthony Barnett on OK got taken to task in the comments for intuiting his way to the economic sense of the different parties comments on the deficit, and Rosemary Bechler's defense (in a comment) was an outright rejection of Micawberism.

So here are some very basic clarifications.

The public deficit measures how much more the government is spending than receiving. It is the current annual amount which the government is adding to the already existing national debt. By contrast, the debt is the accumulation of how much more the government has already spent than received. So one way of seeing the distinction is that our debt is what has happened and the deficit is what is happening. It can be confusing because when a paper runs a headline saying "The EU demands the UK cuts its debt" what it actually means is not that we pay down what we owe (ie the actual debt) but that we cut back the size of the deficit - the rate at which we are growing the debt. In the old days of financial innovation with mortgages that you could add your credit card balance to at the end of the month, you can think of the credit card balance as being the monthly deficit and the size of the mortage the debt.


A snapshot of where we are now is here:

Uploaded with plasq's Skitch!

The UK has a high deficit - that is to say we are currently adding to our debt rapidly (13% of income per year). But we have a relatively low level of measured debt. (Emphasis on measured because there are lots of accounting shenanigans to hide debt. Public Private Initiatives have been a favourite way of hiding debt. And we saw in the Greek crisis that the banks had got very creative over helping governments to massage debt numbers. Expect more government accountancy fiddles to come to light ...).

How high can government debt go? Well ... as high as your creditors will let you. As John Jackson pointed out in an email response to this note, high gearing in business (a high level of debt relative to your current level of activity) is a good thing when it signals that your business is believed ot have a great future ahead of it – high debt levels are precisely one way to invest in a promising future.

It's the same for a nation. Here is what UK debt looks like over time:

Uploaded with plasq's Skitch!

High after wars, and at a peak after the Napoleonic wars. It looks as if we can add to debt considerably before hitting historical highs. If we're adding debt at 10% of income per year, and have 180% to go until we hit the peak of 1815, can't we go on for 18 years?

Well ... the 1820s were financially turbulent, and the 240% we hit then might not be repeatable: Britain must have looked like a good bet back then.

What about now? Conservative Niall Ferguson has been continuing a running spat with Keynesians Paul Krugman and Brad DeLong over this. Ferguson says that you really start to suffer at the magic 100% level; people stop wanting to lend to you; your growth falls ... DeLong points out that there is not likely to be a shortage of willing lenders, because we are in a proto-depression precisely because households want to increase their savings. The government deficit is maintaining the spending that is supporting the incomes from which people want to save by lending to the government that is using the money to maintain the spending that is supporting the incomes ... you get the idea. (It is not complicated, but Ferguson seems to think it is).

Government deficits all over the world (except Martin Wolf's newly discovered land of Chermany, a combination of Germany and China) are replacing the private borrowing that was supporting employment and incomes before the crisis. Take them away and we'll have a deep recession, maybe even a depression. But leave them in place, and where is the motivation to get us to spend our energies on more sensible activities than building shopping malls and consumer goods? This is the point Paul Collier makes in the Guardian: it matters what you have spent your debt on.

Re-shaping our economy is a project of decades – less financial innovation, more technology; less energy per unit of output, more well-being per pound of GDP; fewer large TV screens, more trains etc. In the short term, Osborne is wrong – it would be mad to cut the deficit brutally. But who is making credible sense on the long term problem?

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