Economic Theory

What Jeremy Corbyn doesn’t know about government debt

Jeremy Corbyn’s BBC interview with Andrew Neil last week caught the headlines for its discussion of the Labour leader’s views about terrorism and its causes. He thinks Western foreign policy is responsible for Islamist terrorism. He might be wrong, but the idea isn’t plainly ridiculous.

By contrast, you could write a book about the errors he peddled in the subsequent economic discussion – or, at least, a short article, such as this one.

The Labour Party promises that, if elected, they would spend £250 billion over ten years on infrastructure projects. But they will not fund this by increasing taxation, which they reserve for their increases in day-to-day government spending.

Neil asked how much extra government borrowing would be required for this infrastructure spending? This is an odd question because the answer is obvious. The amount borrowed will be exactly equal to the amount spent.

Corbyn replied: “What we will do is for the public ownership elements there’ll be an exchange for [sic] bonds for shares in it”. Neil suggested that this was still borrowing. “No, it’s not [borrowing]”, Corbyn replied, “it’s a swap of shares for a government bond”.

There are two errors here. First, Neil is right. When the government issues bonds, it borrows. A bond is a promise to pay a specified sum of money at a specified date to whoever owns the bond on that date. The government raises money by selling these promises. Promises to pay people money are debts.

Second, a Labour government would not be swapping bonds for shares. Rather, the government would issue bonds to raise cash. This cash would then be used to buy the shares of water companies, for example. No bonds would have been swapped for any shares. Rather, the government would have acquired new liabilities by issuing the bonds and new assets by buying the water companies.

Neil repeated his view that issuing a bond is borrowing. Corbyn replied thus: “Issuing bonds that we own which would be paid for by the profits from the industries”. The idea that, when the government issues bonds, it comes to own them is the exact opposite of the truth. Every day, more than £1 billion worth of government bonds are traded between private parties. How is this possible if the government owns them?

Perhaps sensing the impossibility of getting any sense on the matter of debt, Neil changed tack to examine the second part of Corbyn’s response: “You’ve said you would cut the water utilities’ profits. You might not have enough money to pay for the bonds”.

Corbyn replied that, “Instead of the profits being syphoned off, they would remain here. That’s an advantage, surely”. This fails to answer Neil’s question. If the profits remained in the UK but fell to £1, they would be insufficient to service the debt acquired in purchasing the water utilities.

But Corbyn’s talk of “syphoning off” is not only irrelevant; it also reveals another, unfortunately widespread economic confusion. He seems to endorse the view that foreign ownership of UK businesses harms the domestic population because profits flow to the foreign owners.

To see the error here, consider the simple case where a foreigner buys a British business. The value of a business depends on its expected future profits. The seller of a company is in effect swapping the profits he would have got over future years for a lump sum he gets today. The purchase price represents the present value of the future profits.

When a foreigner buys a UK business, all the expected future profits of the business come into the UK in the purchase price. When the actual future profits then go out to the new owner overseas, there is no net loss.

In fact, the transaction must involve a net gain for the UK. By hypothesis, no Brit valued the future profits as high as the foreigner did. Otherwise the foreigner would not have been the highest bidder. So the amount any foreigner pays for a UK business must exceed the present value of its future earnings to any Brit.

When the government buys a foreign owned business, the profits will of course then be “remaining here”. But if the profits fall below the expected earnings that determined the market price the government paid for it, the purchase will have been a loss to the government: that is, to the future taxpayers who pay for the purchase by servicing the debt.

Corbyn wants to cut the profits of the water companies that his government will buy. If this were achieved solely by cutting the prices of what they supply, then the result would be a simple transfer from the taxpayers who bought the company to people who use water. But if the water companies also became less efficient, as state owned businesses usually do, there would be a net loss to the population. The extra cost to taxpayers would exceed the gains to the water users.

I doubt Corbyn is any worse than any other leading British politician. His economic errors are more evident – in part, at least – because he is an unusually plain-speaking politician who avoids the rigid devotion to slogans and clichés that makes so many other politicians excruciating to hear. But one of the virtues of openness is that it helps us to identify error. And, hopefully, to avoid it.

Further IEA Reading: The Government Debt Iceberg; Taxation, Government Spending, and Economic Growth; Why privatisation always trumps nationalisation 

Former Director of Research

Jamie Whyte is the former Research Director at the Institute of Economic Affairs. Prior to joining the IEA, Jamie was the leader of ACT New Zealand as well as the Head of Research and Publishing at Oliver Wyman Financial Services. He has previously worked as a management consultant for the Boston Consulting Group, as a philosophy lecturer at Cambridge University and as a foreign currency trader.

3 thoughts on “What Jeremy Corbyn doesn’t know about government debt”

  1. Posted 07/06/2017 at 15:59 | Permalink

    This is the world of Argentina and Venezuela. Which Corbyn loves uncritically. Ruin credit rating, hyperinflation, failing public services because of no reinvestment, keep prices low to get the populist vote and give pensioners a cheap life. Corbyn has been in Caracas and La Habana and never understood any financial reality. He probably does not understand that Pinochet saved Chile from this. Thatcher did understand.QED

  2. Posted 16/06/2017 at 14:30 | Permalink

    “When a foreigner buys a UK business, all the expected future profits of the business come into the UK in the purchase price.”

    ALL the expected profits? Really? What’s in it for the buyer?

  3. Posted 22/06/2017 at 09:18 | Permalink

    Ben.. The actual future profits… The buyer has paid up front based on the value of project value of the future profits… That money is paid here to the seller… The actual future profits generated leave to go to the overseas buyer…. If the future profits are higher than the projected future profit for which he paid a purchase price today, probably at a discount… Then the buyer would see the purchase as a success.. If the future profits fall he would effectively have made a loss in relation to purchase price… The potential risk is future performance… Which will have been factored into the pricing… Never the less the immediate purchase price funds stay in the UK

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