Why Britain's debt is on a dangerous trajectory

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The most important, and very worrying, economic report in recent weeks came a few days ago from the Office for Budget Responsibility. For what it said about the outlook for the public finances and in particular the explosion of government debt in coming decades it did not get the attention it deserved.

The OBRs fiscal sustainability report does what it says on the tin, it looks at the sustainability of the public finances over the long-term. They are not, judging by its latest report, remotely sustainable. Let me provide a little context.

Before the global financial crisis, one of Gordon Browns two fiscal rules as chancellor was the sustainable investment rule. This held that public sector debt should be limited to no more than 40% of gross domestic product over the economic cycle.

When the crisis hit, inflicting profound damage on the public finances and exposing Labours aggressive increases in spending in the run-up to it, it was a shock to discover that it would take a generation to get over the effects of the crisis. The debt soared, both in absolute terms and as a percentage of GDP. Projections showed that, even on the basis of tight spending controls, it would not be possible to get debt back down to 40% of GDP until the early 2030s. As hangovers go, this was a very long one.

It got worse. The OBRs June 2015 fiscal sustainability report, published a month after the general election that year, suggested that George Osbornes policy of achieving a budget surplus by 2020, and maintaining it, would succeed in reducing government debt from more than 80% to 54% of GDP by the early 2030s, but then it would then start to rise again, reaching 87% of GDP by the mid-2060s, largely because of the impact on spending and to a lesser extent tax revenues of the ageing population. That self-imposed limit of 40% of GDP under Browns chancellorship, swept away in the crisis, appeared gone for ever.

If that seemed very gloomy, let me tell you that you aint seen nothing yet. The OBRs new projections show that in the short-term, government debt will come down, from 85.6% of GDP in 2017-18 to 80% by 2022-23. Figures on Friday showed that this process has begun. After that, however, the OBRs baseline projection is for debt to exceed 100% of GDP by the early 1930s and to be a massive 282.8% of GDP by 2067-68. Ignore the decimal point and the precision of the numbers and this is still very scary. It would imply, in todays prices, public sector debt of nearly £6 trillion, or more than £90,000 for every member of the population.



To put it in context, the all-time high for government debt to GDP was reached in the immediate aftermath of the Second World War, 252% of GDP in 1946-47. Then, there was a clear route to running down the debt by reducint the huge proportion of the economy claimed by the public sector in wartime. This time, the debt would still be on a rising trend half a century hence, although as the OBR puts it pithily: Needless to say, in practice policy would need to change long before this date to prevent this outcome.

How have things got so much worse so quickly? Three years is not, after all, a very long time but, it seems, has resulted in additional net debt of nearly 200% of GDP in 50 years time.

There are several reasons. What happens now matters a lot for the trajectory of government debt and Theresa Mays abandonment of Osbornes targeted budget surplus by the end of the decade, or at least its postponement to the mid-2020s (well beyond current political horizons) matters a lot.

Last months 70th birthday present for the National Health Service, as yet unfunded, has a big long-term impact. The OBR assumes that NHS spending will continue to rise from the new higher base to accommodate demographic and other cost pressures. The effect builds over the long-term and is huge. In the absence of the boost to health spending government debt to GDP would be 57.9 percentage points lower than is now projected.

There is, as the OBR confirmed, no Brexit dividend to pay for this NHS largesse. In fact, the public finances will be worse, and could be considerably worse as a result of leaving the EU. Britains demographics, meanwhile, look less favourable, putting additional upward pressure on spending. By 2067, 7% of the population will be 85-plus, compared with 2% now. And 27% will be 65-plus, against 18% now.

The debt cannot be allowed to rise as far and as fast as the OBRs baseline suggests. How can it be stopped from doing so? The government is not about to reverse Brexit, or tax people and businesses to the hilt, though if it did so the negative effect on growth would make the public finances worse rather than better.

Cutting immigration to the tens of thousands is government policy, even though it appears to more of an aspiration than a firm aim. Contrary to popular opinion, allowing higher immigration would be far better for the public finances. The OBR assumes net migration of 165,000 a year. A high migration alternative, 245,000 a year, would reduce the debt to GDP ratio by around 30 percentage points, while low migration, 85,000 a year, would increase it by 40 points, to over 300% of GDP.

There is also, given the importance of the new NHS settlement in the projections, scope for higher NHS productivity and healthier lifestyles to alter the trajectory for debt very significantly. It could happen but whether it will is another matter.

Rising government debt has been the story of the past 20 years. In cash terms the debt has risen from £359bn in 1997-98 to £557bn in 2007-8 and almost £1,800bn in 2017-18. The deficit has come down but the debt has increased exponentially.

Even at low interest rates, debt interest now costs more than the government spends on the police and the armed services. If the debt interest bill was a government department it would have the third largest spending in Whitehall, after health, welfare and education.

In the end, the only way to secure the public finances in the long run, and prevent debt rising to unsustainable levels and provoking a fiscal crisis, is to lock in the reduction in the budget deficit achieved since 2010. That was the argument for aiming for a small but permanent budget surplus which the Treasury would still like to achieve. It may already be too late.

