A Fate Worse than Debt
Stephen Hester on his charger
The most useful power the Smith Commission could grant the Scottish Government is the ability to get itself as deeply into debt as possible.
That seems counterintuitive. After all, politicians of all stripes agree that government finances are in crisis. The Conservative’s big pitch for the general election is that only they will take the hard decisions needed reduce the deficit. Labour pair every promise of a spending increase with a commitment to cut spending elsewhere. Uniquely, the SNP pledged that an independent Scotland would borrow more money, but even they felt the need to emphasise that the increase would be “modest.”
Readers who have been paying close attention will have noticed that Britain’s debt has continued to increase even as George Osborne has cut government services further and further (see for example recent LSE research ‘Were we really all in it together?’ with Joseph Rowntree).
The Office for Budget Responsibility reports that public sector net borrowing in September was in fact £1.8 billion higher than a year ago. Osborne’s economic policies are somehow leading to more debt, not less. Thankfully, there is only so much damage he can do, as Britain can currently borrow at a real interest rate of -0.7% after inflation is taken into account. The European economy is in such a dire state that investors will pay the British government to keep their money safe.
It is a mistake to imagine that government finances are are like household finances. When a household is spending more than it earns, the right course of action is to tighten belts, eat out less, take the kids to Banff instead of Benidorm this year. Quite the opposite is true of governments. During a recession, the private sector is cutting back spending, and unless the government plugs the gap the entire economy spirals downwards. As employment falls, so do tax receipts. Welfare spending rises, and the government deficit increases. Austerity reinforces the downturn by throwing yet more people out of work. In a recession, spending cuts and tax rises actually increase the deficit.
We’ve been here before. Throughout the 1920s and 1930s, Britain endeavoured to run a primary budget surplus. In his 1929 budget speech then-Chancellor Winston Churchill famously headed off Liberal demands for public infrastructure spending by claiming that “The Treasury view… is that when the Government borrows in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise”
The “Treasury View” soon became a byword for wrongheaded policy. Britain’s debt stubbornly refused to shrink no matter how many cuts were made. The global economy only recovered from the Great Depression after huge public infrastructure spending. Roosevelt’s New Deal, Chamberlain’s rearmament, Hitler’s autobahns, and World War 2 itself restored employment and hence demand, at the cost of increasing public debt in the short term. With growth back on track, Western economies outgrew their debts in the 1950s and 1960s.
Tax-varying powers are not enough. The Scottish Parliament can only end austerity if it is granted both significant borrowing and taxation powers. Borrowing to invest in infrastructure is the key to growing the economy, and can only be afforded if the Scottish exchequer receives the increased tax take and reduced welfare spending this will bring.
Unlike local councils, the Scottish Parliament cannot borrow through state mechanisms at all. From 2015, it will be allowed to borrow approximately £240 million per year up to a total of £2.2 billion. This is wholly inadequate. The Scottish Government has had to resort to the PFI-lite of the Non Profit Distributing model for its capital borrowing, which incurs higher costs and legal complexity.
When Scots say they want more powers for the Scottish Parliament, they are expressing a desire for their country to follow a fundamentally different path to UK austerity. It is not enough to redistribute the pain, to be allowed to choose between spending cuts and tax rises. If the Smith Commission is to save the Union, only the devolution of full borrowing powers will do.
Reblogged this on VIVIMETALIUN.
Reblogged this on Alistair Davidson.
“If the Smith Commission is to save the Union, only the devolution of full borrowing powers will do.”
Only full devomax will do and that as a stepping stone to full independence.
“It is a mistake to imagine that government finances are are like household finances. When a household is spending more than it earns, the right course of action is to tighten belts, eat out less, take the kids to Banff instead of Benidorm this year. Quite the opposite is true of governments. During a recession, the private sector is cutting back spending, and unless the government plugs the gap the entire economy spirals downwards.”
All true, but governments do not necessarily have the capacity to plug that gap. Having to borrow in someone else’s currency puts a government at the mercy of either the issuer of that currency or ‘the markets’ which hold it. This is why Eurozone countries are still circling the economic toilet and tens of millions of people there continue to suffer.
The UK government borrows in its own currency; it ‘borrows’ the very thing which it, and only it, can create. It’s not real borrowing; the interest paid on government bonds is whatever the government lets the markets get away with, and no more. It does not even need to issue debt in the first place.
A Scottish government racking up debt in a currency it doesn’t issue would face the same dangers as the Eurozone countries, dangers which simply don’t apply to the UK – or the US, or Japan, or other currency issuing countries.
There are only two sustainable ways to solve the problems Scotland suffers: a fundamental change in the British political system and British voting choices, such that those problems are addressed throughout the UK, or independence combined with a Scottish currency. A requirement in either case is a government which understands, and has the will to do, what’s necessary.
One of the reasons why economic health should be calculated by GNP rather than GDP. A balance of payments surplus represents net income to the country. It makes it much easier for governments to borrow and makes the borrowing more sustainable. The UK government has pulled the stunt of artificially pushing up asset values to maintain creditworthiness but the strain eventually causes recession. Houses become unaffordable, infrastructure investment becomes less attractive and ultimately companies in the private sector end up eating themselves to preserve stock market value. One of the first signs is downward pressure on incomes of workers. This is an easy way to preserve profit margins as infrastructure investment falls are always followed by falls in investment by private companies. This process is well-understood but, as Alistair has pointed out in his article, Conservatives have been promoting it for generations – it is genetically implanted in Tories.
Danny Blanchflower has just issued a broadside to the government on this subject, – the more Osborne cuts the budget, the more pressure there is on borrowing. Ultimately all services will be cut and the UK will be permanently up to its ears in debt.
I agree with the arguments Alistair has put forward but it simply underlines the necessity for full independence and setting up our own currency no matter the cost – it will pay in the long run.
I agree with pretty much everything you say. The UK is increasingly run for the benefit of the wealthy, the financial sector, and financialised corporations. Asset prices are goosed, short-termism reigns and inequality be damned. I don’t agree with your position on the sustainability of borrowing though:
“The UK government has pulled the stunt of artificially pushing up asset values to maintain creditworthiness but the strain eventually causes recession.”
The UK will always be ‘creditworthy’ as long as it issues its own currency; it could stop issuing debt entirely.
It goes back to what Alistair said about governments not being like households, but it’s even more stark than he says. Households do not issue their own currency, they have to acquire currency from others, either from income or borrowing, before they can spend. The same is true for governments that don’t issue currency, and for governments with convertible currencies.
Governments which do issue their own currencies – and let them float – face no financial constraints other than those they place on themselves, and self-imposed constraints can be removed at will. For a currency issuing government the constraints are all in the capacity of the economy, and spending beyond that capacity will cause increasing inflation.
“…the UK will be permanently up to its ears in debt.”
And it won’t matter. The UK has been ‘up to its ears in debt’ for longer than anyone has been alive, at times at far higher levels than now.
Issue your own currency.
Issue debt – if any – in that currency.
Let the currency float.
Do those things and the financial markets have no power.
If governments are so poor, so constrained by the power and demands of the financial sector, how is it that governments were able to bail out the financial sector when it imploded?
The truth is the financial sector has no power, or rather it has no more power than governments choose to give it. Provided those governments issue their own currency; the Eurozone is a different, appalling, story.
“…underlines the necessity for full independence and setting up our own currency no matter the cost…”
Yes, not that the cost would even be that high.
FlimFlamMan,
I have a question.
Currently 30% of UK debt has been bought by overseas investors (it was around 10% 10 years ago). We rely on foreign investors heavily to buy our gilts.
What happens if they stop buying or a recovery in the eurozone makes those countries debt more lucrative than the UK’s and they decide to move ?
tartanfever
The UK, like all countries with ‘soft’ currencies, ie. currencies not backed by a commodity such as gold or by some other currency, has no need to borrow. If you can create the currency you use you have absolutely no need to borrow it from someone else.
There’s a new piece on Bella about money creation, and while I don’t agree with important details of the Positive Money proposals, they are right about money being created out of thin air. This is also true of the actual currency – not debt based bank money – issued by governments.
Borrowing made sense in the days of the Gold Standard, the days of ‘hard’ currencies, because governments couldn’t issue currency without acquiring gold. The Gold Standard is over, and good riddance. It caused no end of problems due to its imposition of meaningless but binding constraints.
You need more nurses?
You have trained nurses available?
You have hospitals in which they can work and medical equipment for them to use?
Excellent! Oh, you have no money, and no gold to issue new money?
No nurses for you.
Forty years after it ended gold standard type thinking is still causing damage. If a currency is not ‘backed’ by any promise to convert it to some other currency or commodity then its issuer can create as much of it as they like, though not without consequences.
Create, spend, too much – more than the economy has the capacity to absorb – and you build inflation. Don’t do that then. We currently have enormous unused capacity, not least in the millions of un- and under-employed.
So, since the UK doesn’t need to issue debt anyway we do not ‘rely’ on anyone to buy our gilts. Those buyers, and buyers of debt issued by other sovereign countries – countries with their own currency and debt issuance in that same currency – rely on us for their risk free, guaranteed interest income.
What happens if they stop buying? They lose their guaranteed income. Since the vast majority of these buyers are financial institutions I will not weep.
Is devo max where we get to run our country but London gets all our profits, or is it something else?
According to SCOTLAND’S INFRASTRUCTURE: Delivering Firm Foundations for the Future (N56 Scotland Means Business) – In the UK, public sector investment has declined from 7% of GDP in the mid 1960s to 1.5% of GDP now, with the UK ranked 24th in the world for quality of infrastructure.
And most of that money is being spent in and around London. Although limited in what it can achieve, the Scottish Government did go ahead with the new Forth bridge, but much more needs to be done to make Scotland more competitive and boost its economy. So Smith needs to deliver significant powers, otherwise we could find ourselves with less than we started with.
Infrastructure spending in the UK is a disgrace:
There’s an interesting breakdown from Alex Massie in ‘The Spectator’:
http://blogs.spectator.co.uk/alex-massie/2013/12/london-is-different-the-government-will-spend-money-there/
‘Ed Cox, from the IPPR, tweeted that the per capita spending on transport infrastructure comes out at: south-west £215, north-east £246, Yorkshire and Humberside £303, north-west £839, London £4895.’
FlimFlam Man: “Governments which do issue their own currencies – and let them float – face no financial constraints other than those they place on themselves.” Can this be totally correct in the case of debt? Surely all Governments which issue debt are to some extent at the mercy of those who decide whether to lend?
The fate of a new currency would be dependent on the policies of an independent Scotland. It’s the credibility of these policies which will determine if the currency rises or falls. (Incidentally, that’s why I think the FM’s remarks about repudiating a fair share of the UK National Debt were counterproductive. Who would want to lend to a Government that is prepared to walk away from a fair – whatever that means – share of the UK debt? Of course there are some, but the price tag would increase accordingly.)
So if a future Scottish Government wants to issue significant amounts of debt it will have to ensure that its policies are in accordance with the requirements of its lenders. That’s where the constraints come in.
Don’t get me wrong. I’m in favour of a Scottish currency because without it we’ll never be truly independent. But it’s not a magic bullet.
You’re right about government policy affecting the value of a currency; policies which improve the long term wealth, economic capacity, and stability of a country boost the value of its currency. But if that country has its own currency it does not need to borrow. Borrowing is a relic of the gold standard, or for countries which don’t have their own currency.
If a future independent Scotland has its own currency it can either control the interest it pays or, better still, simply not issue debt at all.
The usual response from mainstream economists to such proposals is that without borrowing reserve levels will grow and cause inflation, since most economists still think banks ‘lend out’ reserves.
The simple realities of bank operations show that banks do no such thing; they make loans they think will be profitable, and then acquire the necessary reserves – necessary to meet regulatory requirements – later. Up to a month later.
Over the years since the 2008 crash we’ve seen QE operations in both the UK and US which massively boosted reserve levels. Over the same period in both countries inflation went down.