When is debt high?

In modern economics, however, funding capital expenditure is usually included in the calculation of government debt and deficits. In response to this constraint in the UK, governments have introduced schemes such as the Public Finance Initiative (PFI), in order to classify funding public infrastructure spending as private debt.

But even if this orthodox classification of capital spending is accepted, it can still be argued that the Treasury view, under which government spending is cut in order to balance the budgets, is misguided in times of recession. Rather than viewing this approach as ‘sound finance’, it can alternatively be labelled ‘debt alarmism’ or ‘fiscal scare tactics’. In this vein, Neild (2012) has compared gross levels of debt in the UK since 1816, as shown in Table 2.

Neild (2012) makes three main points. First, the gross debt for 2010 of £1 071 000 million – just over one trillion pounds – is a large amount of money, and can easily make its way into the headlines, but it is not so high in historical terms. To show why, Neild examines what economists call the ‘debt to GDP ratio’ (ratio of total debt outstanding to GDP). In 1816, just after the Napoleonic Wars, this amounted to 260%; after the First World War, in 1919, it was 127%; after the Second World War it amounted to 225%. So the 75% of GDP in 2010 does not look so alarming in this historical context. Keynes argued that British governments are far too unwilling to spend during times of peace. They are often willing to wage a war on the French or Germans – but when it comes to attacking unemployment, governments are unusually peace-loving in their expenditure plans.

Second, there has not been one occasion during this period, argues Neild, when the British government has failed to borrow what it requires to meet spending requirements. Not when Napoleon was hauling cannon across Europe; not when the Kaiser transported a million men to the French border on his newly built railways; not even under Hitler’s Blitzkrieg. No matter how much money Britain needed to borrow to face these threats, it did not fail to raise debt. It is somewhat alarmist, Neild and others argue, to pronounce that the British government is in danger of going bankrupt. For some this is a fiscal scare tactic used to justify an ideological prejudice against the public sector.

Finally, Table 2 is used by Neild to show the dangers of cutting government expenditure in an attempt to reduce debt. In 1923, after the Geddes Axe, the ratio of debt to GDP went up to 176% from 127% in 1919, as GDP fell from £5.83 thousand million 1919 to £4.39 thousand million in 1923. Unemployment, as shown in the table, increased from 3% to 12% over the period 1919–23. Similarly, a series of cuts by the Ramsay MacDonald government in the early 1930s, which Keynes railed against, led to a reduction in GDP from £4.73 thousand million in 1929 to £4.26 thousand million in 1933. The debt to GDP ratio increased from 158% in 1929 to 179% in 1933, with unemployment rising to 20%. For Neild, as also argued by Keynes, debt problems (as expressed in the debt to GDP ratio) are caused in peacetime by low GDP – not by wasteful spending by governments.

The Keynesian argument is that cuts in government spending can lead to an increase in the fiscal deficit; the best way to reduce deficits is by increasing output, and this can at times require injections of aggregate demand from discretionary fiscal policy. But this has not been the consensus among policymakers. The European Union, for example, has sought to put severe constraints on fiscal policy. Under the Stability and Growth Pact, set up in 1996, European countries were set a target for government deficits of 3% of GDP, and could be fined if this was transgressed. So when a recession comes along, even the automatic stabilisers must be taken off the policy bike if the 3% target is breached.

This inflexibility led to a relaxing of the 3% target in 2005, in order to allow for business cycle fluctuations. As shown in Table 3, in the economic crisis that swept across Europe, by 2010 even Germany, one of the most fiscally conservative of the European Union members, was unable to meet the 3% target. The entry −4.3 shows that in 2010 Germany had a fiscal deficit (indicated by this being a negative number) at 4.3% of GDP; in 2007 Germany had a surplus of 0.2% of GDP. In 2007, before the recession took hold, all the countries shown in Table 3 (apart from Greece) were either in surplus or had deficits that were within the 3% target. It was the combination of collapsing GDP and the use (automatic and discretionary) of fiscal stabilisers that led to the breaking of the target. The key question for macroeconomists is whether a more austere fiscal policy at the time would have worsened or reduced the deficit.