Effects of the national debt on a country's economy.
The European Union was created by the Maastricht Treaty, which entered into force on November 1, 1993, replacing the European Economic Community. One of the policies adopted by EU countries (1993: 12 members) was that a country’s annual fiscal deficit should not exceed 3% of gross domestic product (GDP), and the overall government debt should not exceed 60% of GDP.
In March 2020, general government gross debt in the UK was £1,87 trillion, equivalent to 84.6% of gross domestic product (GDP). Thus 24.6 percentage points above the reference value of 60.0% set out in the protocol on the excessive deficit procedure. The budget deficit (or net borrowing ) was at 2.8% relative to UK's GDP, equalling £62.3 billion.
It is important to distinguish between the fiscal deficit (a budget deficit) and the government debt. According to Abel et al. (2019), the budget deficit is the difference between the governments' expenses and the income in tax revenues, while the national debt is defined as the total value of government bonds outstanding at any particular time. This definition comes from the fact that the excess of government expenditure, resulting in a fiscal deficit for a particular period, must be equal to the total amount of a new borrowing to cover the annual deficit and close the gap. In other words, the national debt is the net accumulation of the government's annual budget deficits.
Outstanding bonds are any bonds that have not been redeemed yet, i.e. the government did not pay the principal back to a lender which is due on their maturity, or so called redemption date.
Governments issue bonds or gilts (or gilt-edged security) in the UK to meet the country’s central government net cash requirements (CGNCR), which is the difference between the government’s expenditure and revenue. If a country’s revenue is bigger than the expenditure, then the term used to describe this rare phenomenon is budget surplus.
Debt represents the cumulative amount the general government sector owes to organisations in other UK sectors and overseas institutions, which is largely a result of government financial liabilities on the bonds (gilts) and Treasury bills it has issued.
Office for National Statistics (ONS), 2020History of national debt in the UK
In 1692, the ruling King of England, William III, ordered a syndicate of City merchants to market the government debt issue. That is how the first UK national debt originated. This syndicate then became the Bank of England in 1964 to primarily fund the war against France. History proved that wars had a significant impact on rapidly rising national debt. The Napoleonic wars' economic consequences resulted in a record-high national debt level of 237% of GDP in 1816, following the Battle of Waterloo (Chartered Institute for Securities & Investment, 2020: henceforth, CISI).
Ever since, the national debt started to fall until the outbreak of World War I in 1914; as a result, the British government's amount of debt sharply rose to 135% of GDP in 1919 from 25% in 1914. Following the economic depression of the 1920s, it rose to 181% by 1923. The new record high of debt was set in 1947 when it rose to 238% of GDP due to the tragic events of World War II. The debt then started to decline and reached a low of 25% in 1992. It remained well below 50% until the Great Recession of 2007-09, which resulted in the rising levels of debt that moved above the 50% mark once again.
The ongoing battle with the Covid-19 pandemic has already had an extremely negative impact on labour markets and national income, with the economic recovery expected to take years, likely resulting in increasing levels of the national debt. In January 2021, a reported increase of £34.1 billion UK government borrowing took the budget deficit to nearly £271bn for the first nine months of the financial year.
Table 1. UK national debt expressed as a percentage of GDP between 1994 and 2019 (ONS, 2020)
According to Maastricht Treaty, the debt reference value is 60%, with the ratio recorded every year in March. Thus, the fiscal year of 2018/19 starts at the beginning of April 2018 and ends at the end of March 2019. The latest annual data regarding the national debt was reported for the financial year of 2020 ending in March, which happened to be roughly the time the British Government introduced strict lockdown measures. Therefore, the impact of the Covid-19 pandemic on new national debt levels has not been addressed in the latest report for the financial year of 2019/20.
Does too much debt matter?
According to various Nobel Laureate economists, the amount of national debt does not matter in the short-term. Paul Krugman argues that even if governments have substantial budget deficits, they still must spend enough money to build infrastructure, help education, and work on the economy's future growth. Robert Reich, former US Secretary of Labour, explains that when there are so much unemployment and underutilised economic capacity, like during the pandemic, governments must be the spender of last resort. Consequently, it will result in soaring national debt levels. However, the debate has attracted both people who think the high national debt is not a big problem for countries and individuals with opposing views. US National Intelligence Director Dan Coats claimed that debt is a dire threat to our economic (US) and national security.
Nonetheless, governments of well-developed countries can sustain a high level of the national debt because they can raise more taxes or print more money. Unfortunately, this is not as easy as it sounds. Producing more money without relative growth in output within the economy is likely to increase inflation. Interest rates in the current economic environment are historically low. However, as the economic recovery progresses, interest rates are likely to rise, making the debt even more expensive to finance.
In the video produced by the Economist "Public Debt: how much is too much?" authors suggest that as long as the country's GDP is growing faster than the country's debt is accumulating interest and the government keeps additional borrowing in check, the nation can effectively grow its way out of debt at no fiscal cost. On the contrary, it is a lot more difficult for less developed countries to raise money through borrowings. The credit rating on their bonds may be lower than for debt instruments issued by countries such as the USA, Germany, or the UK. In such a case, poorer countries must provide investors with higher interest rates on bonds, making it more difficult to issue a large amount of cheap borrowing.
With the vaccine program, we can look into the future with more positivity. However, we still do not fully know how big an impact the pandemic is likely to have on countries' national debt and whether the national debt should be a key concern to policymakers.
Bibliography
Abel, A.B., Bernanke, B. and Croushore, D. (2019). Macroeconomics, Global Edition. 10th ed. [ebook] Pearson. Available at: https://www.perlego.com/book/1356515/macroeconomics-global-edition-pdf
The Economist (2020). Public Debt: How Much is Too Much? [online]. Available at https://www.youtube.com/watch?v=AaS3ywvuuTQ&t=323s
CNBC (2020). Does the National Debt Matter? What’s Next For The US Economy? [online]. Available at https://www.youtube.com/watch?v=1POexHDKoS8