Sunday 18 July 2010

Possibly the Most Un-Sexy topic in the world: The true scale of our national debt. - Just how screwed are we?

The topic of our national debt and deficit has become in recent years one of the most important political issues our country faces. On a party political level it has been and continues to be the battleground of a consistent war between Labour, on one hand, and the Conservatives (and lately the Lib Dems), on the other.  It is an argument motivated by the explosion in the UK government deficit as a result of the recession of 08-09, and the crisis of confidence in government debt that has swept Europe and, to date, most dramatically affected Greece.  It is this issue that has motivated the recent government's emergency budget and the dramatic  package of cuts that will so define British political life over the next few years.

The basic problem is this. Like private individuals governments have to pay interest on their debts, which then sucks up revenue, forevermore, that could be spent on more useful things like public services.  Also, in a situation where market confidence begins to fall the interest rate we pay can start to rise sharply, which means that the costs of debt goes up sharply.  Further, as we are permanently running a deficit and our "loans" are only for about 15 years each, we are reliant on the markets not only to lend us more money (the deficit), but also to re-lend us all our current debt on a constant basis as those 15 year time limits runs out, and if the international market refuses to lend us more money except at a ruinous rate of interest then we could suffer what is basically a cash flow crisis, sending us bankrupt.  This is what happened to Greece before the EU stepped in to save them.  Other problems with ever increasing debts include that, for the above reasons, there is a practical limit on how much debt we can get in, and the more we borrow now the less room this gives us to borrow in any future crisis; and various externalities caused by the state borrowing so much, and hence effectively crowding out the private sector from credit, which then impacts the whole economy negatively.

All these are the reasons why more and more borrowing at the rate we are now, which in 2009-2010 will amount to £160 billion, is unsustainable in the long term.  One important measure of how sustainable this is in the short term, however, is, obviously, how much debt we already have.  You would think that this would be a simple question.  Surely we keep track of a figure as important as this?  The answer is, sadly, more complicated.  There is a figure commonly quoted as our national debt.  This is the figure for Public Sector Net Debt (PSND).  This is the amount of government bonds that have been issued, how much straight government debt is held by outside investors or governments.  However, there are other things to consider as well.  The last 20 years have seen the dramatic increase of what is known as "off balance sheet" liabilities, financial obligations run up that the government will have to pay in future years, but which aren't debt already issued.  Previously, though, there has been no official effort to properly calculate how much these off-balance sheet liabilities come to, until now.

In crude party political terms, the question is: did Labour take a responsible approach during their 13 years in power and leave us with a responsible level of debt, until the recession came along and sadly kiboshed all their plans?  Or, were they, as the Coalition accuses, wildly profligate, relying on fantasies of eternal growth and accounting tricks to avoid people noticing the debt, all to effectively bribe the voters with shiny new schools'n'hospitals in their years in power, but that would leave economic pain down the line?

A few days ago the Office of National Statistics (ONS) released their first attempt to calculate these liabilities (as well as the government's assets) and attempt to construct a full public sector balance sheet, revealing just how large these liabilities are.  This concluded that while the PSND is some £900 billion, the government also bears further off-balance sheet liabilities, previously un-collated, of some £3,800 billion. More than 4 times as much, a truly terrifying total, giving, with the actual 'National Debt', a total for public liabilities of £4.5 to £5.5 trillion.

The Independent ran with the story, with this headline, showing their usual love of pretty pictorial depictions of topics.  I remain amused by the Independent's love of of graphs and pictures. I still can't tell, though, whether these representations are merely a colourful attempt to grab people's attention on the newspaper stands, or whether the staff of the Independent just think their audience are actually stupid, and in fact can't really read.

Either way, the ONS' estimates for our national liabilities break down into:

- Future payments for the state old age pension: £1.1trn to £1.4trn
- Unfunded public sector pensions for teachers, NHS staff and civil servants: £770bn to £1.2trn
- Payments under private finance initiative contracts: £200bn
- Contingent liabilities (e.g. bank deposit guarantees): £500bn
- Nuclear power plant decommissioning: £45bn
- Impact of financial sector interventions: £1trn to £1.5trn
- The PSND: £900 billion (forecast to rise to £1.2 trillion over the next 4 years).

Which figure to go with then?  The relatively acceptable £900 billion, represented by the small coin, or the large, threatening £5 trillion, represented in the Independent's helpful picture by the big coin?  (Though they seem to have failed to add the PSND, making their entire headline semi-nonsense)

The Independent has gone with the most simplistic explanation of the ONS' findings, claiming the report reveals that the National Debt itself is 4 times what we previously thought.  However, in reality the situation is more complicated.  We are dealing with a number of different types of financial commitment that are more or less like the traditional national debt, and are hence less significant for the national finances.  These issues sound subtle but the difference they make is one of trillions of pounds. Sums that are not small beer, not even in the ridiculously bloated terms of bailouts and public sector budgets and national GDP.

The first and broadest issue is the difference between debt and a liability, which if you're anything like me is not something you are at all familiar with.  Basically, a debt is a type of liability. In accounting terms a liability is any financial commitment to pay out money in the future, which you enter into.  Examples include, purchasing from suppliers, debt repayments, taxes, pensions etc.  A debt is a particular type of liability.  A company's balance sheet is a comparison of their liabilities and their assets, which are stuff they own or people's commitments to pay them money in various forms.  A company is considered solvent if they have more assets than liabilities, i.e. if you ran through all the payments they had signed up for they would have any cash at the end.  It is in this broad sense of liability that the ONS has calculated we have £4.7 trillion of them.  This is not the same thing as a debt, though, and this can be seen by taking a quick look through the categories that make up this figure.

1. The PSND = £900 billion.

This is definitely actual debt.  It mostly consists of bonds held by foreign investors.  It has a well-documented rate of interest and strict limit on its maturity.

2. Unfunded Public Sector Pension (teachers, NHS staff, civil servants etc.) = £1 trillion

This is not actual debt held now.  But it is a legally binding commitment to hand over money at a future date.  The government cannot welsh on these promises without serious difficulties.  Mostly consists of the generous final salary schemes that continue to exist in the public sector but have practically disappeared elsewhere.  Government only requires relatively small contributions from its staff, the rest to be made up from general taxation.  This amount has ballooned from £450 billion in the early 2000's to around £1 trillion today, mainly due to the considerable expansion of the public sector.  This, combined with considerable pay rises, both of which push up pensions, has widened the gap between employee contributions and the actual financial commitments.

3. PFI contracts = £200 billion.

Another unavoidable and legally binding contractual commitment.  It doesn't come under the national debt, because it is only a commitment to pay various amounts of money, not an actual debt held by someone else.  In all practical terms, though, the equivalent of a mortgage, and so quite clearly debt.  PFI, the private finance initiative, was one of the  last government's favourite swindles (though in service of impartiality I'm ashamed to admit it began in the dying days of John Major's government).  It effectively meant getting a private company to build a school/hospital/other piece of infrastructure, and then the public sector renting it from them for a number of years, at the end of which, the piece of infrastructure would pass over to belonging to the government.  In practice, this meant the government could commission lots of shiny schools and hospitals now, for minimal cash outlay, only with the string that instead of shelling out £10 million for a school, now, the public sector would pay £30 million over the next 30 years.  This meant that the last government got to wow the electorate with all the shiny things they were building for them, the private contractors got a big wodge of guaranteed income, and the only people who lost were following governments and taxpayers who pay out the vastly inflated costs over the following years and decades.    

4. Nuclear Power Plant Decommissioning = £45 billion.

Again, not debt, but a real unavoidable future financial commitment.  Why the figure is so high, considering how few nuclear power plants we have, though, is anyone's guess.

5. Future payments for the state old age pension = £1.1trn to £1.4trn

This is where it all gets a bit dubious.  Yes, we do have a liability for future state pension commitments.  But, in reality, these are paid out of current government income (taxes).  Ignoring, for a moment, the wisdom of running a general state pension like a Ponzi scheme, in a time of ageing population, these commitments are no different, really, to any other area of state spending.  As Stephanie Flanders, BBC economics editor, said, you could just as easily produce eye-watering figures for the liabilities the UK government is accepting for the commitment of providing everyone with free healthcare into the future.  The difference between the state pension commitment and the public sector pension commitments (or the PFI), though, is that whereas the public sector pensions are legally binding contractual employment commitments, which the government cannot easily get out of, the state pension is effectively a welfare benefit, if a universal one.  This means that the government can increase it, decrease it, postpone the age people receive it, or, theoretically, even abolish it, all as ways of keeping expenses down, at will.  All they have to do is stick the necessary clause in the annual budget.  The same is not true for public sector pension commitments.  Calling the state pension commitments debt is like saying I have a debt for all the food I need to buy in the future.  Realistically I can eat more or less, not eat for a while, or eat cheaper food, depending on my income.  It is a liability in the technical sense, but it is not really the same as actual debt.  If they mean the old-age pension is going to be more and more difficult to fund as the proportion of pensioners in the population rises, then that would be correct.  It's different to saying it is a debt obligation now though.

6&7. Bank Bailouts, deposit guarantees etc, etc. = £1.5 - £2 trillion.

This is even more dubious.  This is the remaining financial risk the taxpayers are exposed to due to the financial crisis interventions.  It is mostly the possible cost of paying out deposit guarantees on banks, and the notional loss currently held by the government holding vast quantities of shares in banks that are currently worth less than the government paid for them.  However, there's no reason to think that the vast majority of this money spent nationalising/propping up banks won't be reclaimed. It's only a risk if the banks are going to default (not likely as that's what the bailouts avoided) or the shares are never going to get back to the price the taxpayer paid for them, and hence the money reclaimed.  Neither of these are likely, assuming the recovery ever actually happens.  Similarly, it's unlikely at this point that the government is going to have to shell out much more on deposit protection.  The ONS is right to say that it does have these as liabilities: commitments to pay money on certain conditions.  But they are not debt, and they will probably never become so.  These liabilities will, in fact, hopefully disappear entirely painlessly in the next year or so.

Out of these 7 categories and the £4.7 trillion of liabilities we started with, only the PSND, PFI, Nuclear decommissioning, and unfunded public sector pension liabilities are really debt in a significant way.  The rest are liabilities in a vague technical sense but not the same as debt at all, like the future old age pension.

Even only including these figures, though, gives us the following amount:
£900 billion PSND + £200 billion PFI + £40 billion nuclear decommissioning + £1 trillion unfunded public sector pension commitments + £200 billion (perhaps) of financial sector commitments we're never likely to get back.
............................... = £2.3 trillion      

This is obviously considerably lower than the original figure, but it is still enough to scare anyone without coming up with the type of bogus figures that the Independent splashed all over its front page.

It is possible to be more discriminating still, though.  It is fair to point out that even though I have added some £1.4 trillion of "debt-like" liabilities onto the PSND, they are not actually the same.

Our national debt, as traditionally considered, is money held and owed by outside investors that we must pay a stated rate of interest on, and on which the interest rate may vary with market conditions.  It is the cost of this £900 billion that may sharply rise should the finance markets start to get Greece-like worries about us.  There is no prospect of this happening with PFI payments, for example.  They are set in stone.  It is possible, then, to give three categories of government indebtedness, reflecting this core public debt, the PSND, wider 'off-balance sheet' debt-like liabilities, and wider more general liabilities.  By all means we should have a proper, full cross-public sector balance sheet as well as the traditional 'national debt', more facts never hurt anyone.  But we should still distinguish between, at one end, the broad liabilities we have, at the other end, the current debt we have issued in bonds, and in the middle what is, arguably, really our actual national debt.  These three categories would break down as follows:

Public Sector Net Debt = £900 billion
Wider 'National Debt' = £2,300 billion
General Public Sector Liabilities = £5 trillion.

This approach allows us to have a more realistic debate about the scale of financial problems we are storing up for future generations instead of merely referring to the traditional figure for national debt (£900 billion), which leaves huge financial commitments conveniently out of view, or just referring to all public future liabilities as our 'debt'.  The barmy-ness of this second method is illustrated by the ONS' conclusion that the public sector is solvent.  We have more assets than liabilities (schools, hospitals, aircraft carriers, things like that). This doesn't mean we don't have to worry about the national debt, though, just as these daft inflated liability figures don't mean the end of the world anytime soon.


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