Bill Jamieson: Innocence of youth hides horrors of UK's debt

Published on Friday 25 March 2011 22:02

IS THERE any basic financial education undertaken in Britain's universities, schools and colleges these days? I mean, any at all?

As the clean-up and repair continues in central London after the weekend violence, window-smashing and break-ins at Fortnum & Mason in a protest against public spending cuts, a state of innocence appears to prevail about the state we are in, that somehow cuts are unnecessary, avoidable, and that public spending and borrowing can keep on growing.

So this morning I will make a simple, straightforward, cut-out-and-keep contribution to financial education by a focus on the two mountains that lie behind the annual budget deficit - our total debt and our debt interest.

All the figures I quote are taken from Office for Budget Responsibility projections set out in the Budget 2011 Red Book, pages 93-95.

A truly woeful state of innocence about public finance seems to extend right across our universities. It has done so for decades. Lecturers happily propagate their Leftist leanings as gospel truth when they have barely the faintest grasp of the fiscal problems we face. Prejudice is far too often passed off as learning.

This prejudice has been fuelled by a belief that "Keynesian economics" - a shorthand for debt-fuelled government spending - can be conveniently stretched to cover all and any unpleasant economic circumstance.

There is a belief that there is no limit to "Keynesianism" and thus to budget deficits and debt. For every unpleasant deficit-reducing "Plan A", there can always be an easier, softer, more popular "Plan B".

This innocence has not been helped by over-concentration on the immediate budget deficit. Enormous though this is, it is of course dwarfed by much bigger problems - the total of public sector net debt and the resulting spiralling cost of debt interest. Many assume that because the annual budget deficit is projected to fall over the next five years, our public finance problem will be solved. This is not so.

Last week I gave a post-Budget presentation at a breakfast seminar organised by the Edinburgh Chamber of Commerce. One of the charts I displayed showed how our annual debt interest charge would continue to rise - from 43.1 billion in the financial year just ending (already greater than the total annual budget of the Scottish government) to 66.8bn in 2015-16 - by which time debt interest will be more than absorbing all the revenue forecast to be raised by corporation tax in that year.

Clearly, I should have explained myself better. A member of the audience approached afterwards to ask why debt interest should continue to rise while the annual budget deficit was set to fall.

The annual deficit is not at all the same thing as government debt. What it represents is the amount by which we are adding to that debt each year.In broad terms, the budget deficit is the amount by which government spending in any one year exceeds the amount collected in revenue. This gap is made up by borrowing, typically through government bonds or "gilt-edge" stock.

This stock pays out annual interest to investors. Currently, the interest yield on ten-year UK bonds is 3.58 per cent.

This borrowing adds to the debt, and the debt figure is colossal. Currently, it stands at 909bn. In the financial year about to begin, it will, for the first time ever, smash through 1 trillion. And, on Office for Budget Responsibility forecasts, it continues to rise every year out to 2015-16 when it hits 1.4 trillion.

The bigger the debt, the more interest we have to pay. The more interest we have to pay, the less money is available for other items of government spending. For debt interest comes before all. In the 20011-12 financial year it will eat up 48.6bn. We could build lots of schools and hospitals, repair many miles of roads, and embark on many new infrastructure projects with this sort of sum.

But this is the price we have to pay for the money we have already borrowed to fund the spending we have already enjoyed. With a budget deficit at close to 10 per cent of GDP, we are truly "maxed-out" on the Keynesian credit card. Currently, because of the government's deficit reduction plan and the longer maturity dates on our debt, the UK is perceived as a good credit risk and enjoys a triple A rating from the credit agencies.

Were doubts to arise over our credit-worthiness, investors - including our own pension funds who are massive gilt-edge investors - would require a higher rate of interest to reflect the greater risk.

In Spain, the ten-year rate is 5.18 per cent. In Portugal, where a bail-out is increasingly likely, it is 7.78 per cent. In Ireland, now the subject of an IMF bail-out, it is 10.06 per cent. Drastic austerity programmes are now being pursued in each of these countries - far tougher than the one we are now facing.

There may be debate on how much of the deficit should be shrunk by tax rises and how much by spending cuts. I suspect that between Tory and "realistic" Labour plans there is really little difference, because too heavy tax rises would smash the frail recovery we have.

I am sorry to have to break the news to our universities, their staff and their students: life is not all Fortnum & Mason.