We can’t go on like this…but who is going to stop us?

Just after Christmas a number of members of the IEA’s SMPC wrote to the Sunday Times about the dire need for a fiscal plan to deal with government borrowing. In this context, it is worth coming back to the issue of implicit debt mentioned by Nick Silver in A Bankruptcy Foretold. He argued that the UK’s real national debt was already 276% of GDP in November 2008 – and this was a conservative (i.e. low) estimate. What has happened recently in terms of projected government borrowing does not increase this larger figure significantly.

In this context, does it make that much difference that the government plans to increase official borrowing to 70% of GDP from 40%, thus adding about one tenth to the total national debt including implicit items?

The simple answer is “yes”. The implicit debt that Silver and others have written about is implicit because it is not funded voluntarily. Essentially, public sector workers are promised a pension by the government (that creates implicit government debt). The corresponding “asset” held by private individuals is a government pension promise. That asset is not tradable and a nurse cannot think, “I don’t like the look of these dodgy UK government pension promises, so I shall sell them and buy some Swiss bonds instead.” On the other hand, all the new debt that the government is piling up has to be funded voluntarily by investors who can choose to buy other assets.

The explicit debt could also be regarded by investors as being subordinate to the implicit debt. Will the government default on its pensions before it defaults on its bonds? Probably not. Thus UK sovereign bond investors should be concerned about the ballooning deficits which are in addition to existing, alarming and higher priority implicit pension debts.

But the arguments against government debt are not just about funding – which is why we should be concerned with implicit debt regardless of its impact on funding. Some argue that we will grow our way out of debt. We may. But it is not inevitable. This is especially so because our ability to repay debt depends not on growth in national income per head but on growth in total national income. Population may decline. The argument that we owe the national debt to ourselves also does not hold water (at least, not much water). People value the savings that government bonds represent in pension funds and so on. But effectively, these savings are wiped out by the equal and opposite liability of future tax obligations necessary to repay past borrowing. Do the members of private pension funds know this?

Personally, I think that government borrowing has a moral aspect and it always surprises me that the churchmen who jump on political bandwagons or leftists who bring up moral aspects of inequality (as they see it) do not ever bring this issue up. One generation living it up at the expense of another generation which has no choice in the matter is not acceptable. But I suppose, when you think about it, it is obvious why the left never bring this issue up. Look at the graph below. Government borrowing, implicit and explicit is expanding because the state is not able to finance its own largesse from the explicit taxes it raises on citizens. That is the real problem. Government debt, implicit and explicit, must be cut by cutting government spending.

Ratios of UK General Government Expenditure and Private Expenditure to UK GDP at Factor Cost 1900- 2008 with Implied Budget Forecasts for 2009 & 2010

Ratios of UK General Government Expenditure and Private Expenditure to UK GDP at Factor Cost 1900- 2008 with Implied Budget Forecasts for 2009 & 2010

9 thoughts on “We can’t go on like this…but who is going to stop us?”

  1. Posted 08/01/2010 at 14:22 | Permalink

    […] The IEA doesn’t like debt, surprise surprise.  I would like to see them reflect on Wagner’s Law). Possibly related […]

  2. Posted 08/01/2010 at 15:57 | Permalink

    Richard, I think your ‘moral’ point is a little melodramatic and one-sided. The future unborn depend on us in all sorts of ways, by definition. They benefit from us doing things better, growing fast, keeping the environment clean, educating ourselves to a decent standard, and any number of other things that are related to our current spending levels. The government debt is just one aspect of an intergenerational contract that has thousands.*

    Of course, you at the IFS do not think that there is any tradeoff in terms of more debt/more growth – it’s always 1980 in IFS land . . .

    *The IFS have written about this nicel

  3. Posted 08/01/2010 at 15:58 | Permalink

    Whoops, I meant Philip not Richard, my apologies

  4. Posted 08/01/2010 at 17:46 | Permalink

    Accountants think in terms of ‘maintaining capital’ in measuring profit or loss. This can be thought of as saying you should pay your own way through life (not every year, but over a lifetime). That applies to generations as well as to individuals.

    I wonder if Philip is correct in suggesting that implicit liabilities are ’senior’ to explicit liabilities? My feeling is that the political elite have such contempt for voters that they may well think they can get away with cheating them (e.g., for some implicit liabilities, by debasing the currency, or fiddling the inflation index). It may be harder to cheat on explicit liabilities with hard-headed investors already quite suspicious.

  5. Posted 08/01/2010 at 20:32 | Permalink

    I thought my phraseology was quite moderate – “a moral aspect” was the phrase I used: not very melodramatic surely. And I think there is a moral aspect. If the debt were incurred for investment, I might think that misguided, inefficient and subject to capture by all sorts of interest groups, but probably not immoral. Also, there is no “inter-generational contract”. The next generation do not have any choice in the amount of debt we incur – even through that rather imperfect method of voting – we simply impose it on them. And with regard to the implicit items we do everything we can to hide it from young voters.

  6. Posted 09/01/2010 at 09:27 | Permalink

    Apologies, I was thinking of the classic attack showing babies born with debt around their necks, not your formulation.

    But I still think this focuses too one-sidely on one of the aspects. The rolling generations nearly always have better conditions than their forebears; lower working hours; deeper capital; higher levels of technology; higher rights and so forth. The next one will perhaps have a higher retirement age than us/the baby boomers, and certainly a greater environmental problem. But in most regards, a sufficiently better life than previous generations that having 5% of GDP spent on debt interest, rather than, say, 3%, does not sway the matter away.

  7. Posted 09/01/2010 at 09:28 | Permalink

    Also, on Prof Myddleton’s point: Buiter pointed out on his blog a while ago that many future invisible liabilities are real, not nominal. Pensioners demand incomes that are a certain proportion of the real prevailing wage. These obligations cannot be inflated away. Only those fixed in nominal terms, like govt. debt.

    I myself have called for more index linked debt to make it clear where the govt stands on this one.

  8. Posted 09/01/2010 at 11:42 | Permalink

    I agree with Giles re. index-linked implicit debt. Public sector pension liabilities are both wage linked and contractual (as are sovereign debt interest payments of course). There is no easy way to default on pension liabilities in real or nominal terms and the government would find itself in court if it did. Which debts are easiest to default on is a different matter, but it is by no means clear cut that public sector pensions would be subordinate to debt interest.

  9. Posted 12/01/2010 at 08:22 | Permalink

    […] does not mean repudiating the very idea of debt or calling it ‘immoral’ – see the argument on the IEA blog.  Our children have to repay our debts: they also inherit our assets.  Alex Smith […]

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