Why budget crisis is worst in UK history

Allister Heath
T IS OFTEN said we shouldn’t worry too much about the UK’s national debt. Optimists argue that many Western governments have racked up greater liabilities than Britain and that the UK’s national debt was much larger in previous crises. Both facts are technically correct but miss the real point, which is that Britain is the only rich country to have completely lost control of its finances, with a budget deficit of 13 per cent and no credible plan to balance the books again.

It is true that Britain’s public debt hit 260 per cent of GDP in 1819 (at the end of the Napoleonic wars) and 240 per cent in 1947 after the Second World War, against 59.2 per cent in 2009. But today we are saddled with massive off-balance sheet liabilities, including unfunded public sector pensions, that didn’t exist previously; and the historic figures were inflated by war spending – military expenditure was over 40 per cent of GDP in 1939-45, yet it is negligible today.

Matters improved quickly when defence spending was slashed, something that cannot be replicated this time. As Citigroup’s Michael Saunders points out, the UK moved from budget deficits of 30 per cent of GDP in 1942 and 22 per cent of GDP in 1945 to just 6.5 per cent in 1946/47 and surpluses of 3-4 per cent of GDP in 1948-49. This wasn’t the end of the story, however: the stock of public debt was so vast – and the pressure to spend ever more on the welfare state so great – that in the end it was inflation, not hard decisions on tax and spend, that eroded the national debt. Ever-higher consumer prices meant that the stock of sterling-denominated official debt, which was not indexed to inflation, became progressively worthless as the decades went past, falling from 194 per cent of GDP in 1950 to 39 per cent in 1981. Investors were wiped out and interest rates forced up for the government as well as the private sector; it was only after the Bank of England’s independence in 1997 that gilt yields lost their inflation risk premium.

The Bank’s massive purchases of gilts is the only reason why the government’s borrowing costs haven’t already soared. Even if Alistair Darling hikes taxes on the better off again at his pre-Budget Report on Wednesday, the deficit will remain stuck at 7-8 per cent of GDP in 2013-14, with the national debt hitting 100 per cent in about four years’ time. The IMF is warning the UK needs to tighten its structural budget by a crippling 12-13 per cent of GDP by 2020 to return to sustainability (defined as a debt ratio of 60 per cent of GDP) by 2030.

The real reason we’re in trouble is that spending is way too high. The OECD predicts UK spending will reach 54.1 per cent of GDP in 2010, up from 52.4 per cent this year. It was 40.6 per cent of GDP when Labour was elected in 1997, falling to 36.6 per cent in 2000 after several years of economic growth and tight budgets. It was then that Gordon Brown started to crank up spending, triggering a relentless rise in expenditure to 45 per cent of GDP at the peak of the bubble. Only five OECD countries – France, Sweden, Finland, Belgium and Denmark – will have larger government sectors than Britain next year, and in every case only marginally so. The US will spend 42.8 per cent next year, Australia 37.4 per cent and Korea just 33.7 per cent.

Forget about windfall taxes that raise pathetically small sums: the only sustainable solution is for the government to spend much, much less. What a tragedy Darling won’t have the guts to admit as much on Wednesday.