The UK: Individual Liability for Government Debt

My original plan for this post was to highlight the disconnect between the stock market and the underlying state of the UK economy. However, there may be the start of a panic in stock markets, so it may be that the disconnect is starting to correct itself (see here for the UK and here for the US). As such, I will devote this post to a more general discussion of the current state of the UK economy, and the relationship between government debt and you as an individual.

Before starting, it is worthwhile providing some context on the UK economy. UK GDP sunk again in the third quarter, and the following are some of the reactions of analysts to the news:

James Knightley, ING

"UK 3Q09 GDP is awful with no positive news within the report ... More worryingly from sterling's perspective is the fact that the UK may be the only major economy to have contracted in 3Q09."

Brian Hilliard, chief economist at Societe Generale

"Very disappointing, the surprise comes in services where the business surveys seem to have been a little over optimistic. So we are significantly lagging the euro zone in terms of exiting the recession."

Unlike these analysts, I would not have been encouraged even if there had been 'growth' in GDP, as I do not believe that 'growth' derived from government debt accumulation is 'growth'. It is simply the foregoing of future wealth. I have written on this subject many times, and you may wish to read my most recent post on the subject (in relation to the US, but the principles are applicable to the UK). The key point is that GDP measures flatter the underlying state of the economy, as government debt accumulation drives GDP upwards.

As for more general indicators, over the last 12 months we have had a $bn 130 trade deficit, industrial production is down 11 percent on a year ago, and the official unemployment rate is just under 8% (from the economic and financial indicators in the Economist print edition). For the last indicator, I think that most people now recognise that the official measure is a fiction, and real unemployment is actually much higher.

Although there has been a brief uptick in sterling, the general trend appears to be relentlessly down:

But given the extent of the pound's rebound this week and lack of any major UK economic data or event on Friday, some analysts say the pound may give back some of those gains as attention turns to the Bank of England's policy meeting next week.

[and] "We have little doubt that the long-term fundamentally based sterling outlook has remained convincingly bearish, but there is a window where sterling could develop a `dead cat bounce'"

At present, the only significant increase in output comes from the Bank of England's printing presses (not literally, as they no longer physically print the money), and this may well be about to accelerate:

The Bank announced yesterday that it had reached its current £175 billion limit in asset purchases under its scheme of QE [quantitative easing, or QE - a euphemism for printing money], but the majority of City economists expect that it will seek permission from the Treasury to extend this limit next week.

Two thirds of the 62 economists surveyed by Reuters this week said that they expected QE to be extended by at least £25 billion, with many forecasting a £50 billion increase.

Yesterday’s money supply figures came after dire gross domestic product (GDP) figures last week, which showed that the economy was still in recession in the third quarter, contrary to economists’ expectations.

Regular readers will know that this printed money is being used to purchase UK government debt, and that it is therefore supporting the government's expenditure. It must be remembered that this printed money does not represent any kind of real growth in the UK economy, and simply (temporarily) hides the underlying state of the economy. I highlight this point because of the complete irresponsibility of government borrowing is being supported by the Bank of England (more of that later).

So what is the state of the government debt in the UK. The first problem is the matter of how to calculate debt. In a recent post on Conservative policy, I was encouraged to have identified that they are going to include Private Finance Initiatives (commonly known as PFIs) in the national accounts, a these have been used to hide government liabilities:

The Financial Reporting Advisory Board (FRAB), a body which advises the Government on its accounts, has indicated that the Treasury's previous definition of what PFI debt should fall on its books should be scrapped. A FRAB working group said the way the Government accounts for PFI makes it too easy for it to manipulate the figures so they either fall inside or outside its own debt totals.

The finding, which is expected to be endorsed by the FRAB, undermines recent calculations from the Office for National Statistics finding that only £5bn worth of PFI debt should be added to the national accounts. Its figure was far shy of the combined £48bn value of all PFI projects - but only because NHS debts were classified as belonging to the private sector.

The FRAB's working group warned that many of the PFI debts were being left off the balance sheets of both private and public sectors. It has urged the department to withdraw the system no later than 2008-09.

In addition to this, there are the many liabilities that are simply unfunded and unacknowledged. This is a report that describes the analysis of total government liabilities by the Centre for Policy Studies:

Brooks Newmark, the Conservative MP for Braintree, Essex, says in The Hidden Bombshell, published today by the Centre for Policy Studies, that government debt is actually £2,200 billion. In the book, Mr Newmark argues that the UK’s public sector net debt is equivalent to £85,610 per household and in the last year has risen by £346 billion — or by £11,000 a second.

Mr Newmark arrives at his figure by saying that official numbers do not take into account the full cost of projects financed through the private finance initiative (PFI), which by his calculation adds £139 billion to the public debt. “A major attraction of PFI is that, in theory, it transfers the risk of failure of a project from the Government to the private sector. However, in reality, the Government carries most of the risk ... £139 billion is a cautious figure as it does not include local PFI projects, some of which may fail,” Mr Newmark says.

Unfunded public sector pension liabilities, which the Government will need to pay, are also omitted and add a further £1,104 billion. Contingent liabilities, such as Network Rail, add another £22 billion. Finally, the £130 billion cost of recent interventions in the financial sector needs to be factored in — bringing the total “hidden liabilities” to £1,395 billion and the total debt to £2,200 billion.

You will note that there is some significant variation in the figures between the two reports above. However, whichever way the problem is regarded, the liabilities of the government far exceed the official liabilities. As such, the official figures for UK government debt and liabilities are gross distortions, if not outright lies.

We are now (I hope) all aware of the rate of growth in the UK's debt, which is increasing at an astonishing rate. The latest news suggests that the government does not think the rate of debt accumulation is enough, and are planning to further increase spending:

GORDON BROWN is planning a final public spending spree to help pull the economy out of recession and put pressure on the Conservatives over their plans for deep cuts.

The prime minister is keen to use the autumn pre-budget statement to announce a new “fiscal stimulus”, with billions of pounds of extra money for housing, infrastructure projects and training.

Recent figures showing that Britain is still in recession have convinced Brown that more spending will be required next year to support any faltering recovery.

However, perhaps the most worrying part of this is that the overall debts have been generated both through the 'good' and 'bad' times, and the recent spending spree just accelerates the trend. The worry this creates is that the deficit is structural and, looking forward, there is every sign that the problem will get worse. For example, the figures given above do not address the problem of government revenues, which will be strained due to demographic changes:

The population of the UK is ageing. Over the last 25 years the percentage of the population aged 65 and over increased from 15 per cent in 1983 to 16 per cent in 2008, an increase of 1.5 million people in this age group. Over the same period, the percentage of the population aged 16 and under decreased from 21 per cent to 19 per cent. This trend is projected to continue. By 2033, 23 per cent of the population will be aged 65 and over compared to 18 per cent aged 16 or younger.

The fastest population increase has been in the number of those aged 85 and over, the ’oldest old‘. In 1983, there were just over 600,000 people in the UK aged 85 and over. Since then the numbers have more than doubled reaching 1.3 million in 2008. By 2033 the number of people aged 85 and over is projected to more than double again to reach 3.2 million, and to account for 5 per cent of the total population.

As a result of these increases in the number of older people, the median age of the UK population is increasing. Over the past 25 years the median age increased from 35 years in 1983 to 39 in 2008. It is projected to continue to increase over the next 25 years rising to 40 by 2033.

This is a dual problem. As people get older, they demand more resource from the state, and as the population ages, the size of the tax base also diminishes. In other words, the output within the economy is going to be constrained at the same time as government costs will rise. If the UK currently has a structural deficit, this structural deficit is going to grow. Even if, and it is a very big if, the UK were to return to genuine economic growth, it will need to be very significant growth to offset the effects of demography.

The fundamental problem that the UK is facing is that there is no sector of the economy that is currently offering such opportunities for real economic growth. I have, on several occasions (even in the Guardian newspaper Comment is Free section) asked for answers on where the growth in the economy might come from. The problem was that I asked for specifics; which sector, and why the sector might grow? I have never once had a clear answer.

Without such growth, the borrowing of the UK government can not be sustained. Moreover, the current contraction in the economy may linger for many years to come (and I believe will become far, far worse). In sum, the structural size of the deficit is likely to continue to grow. In the face of this politicians of all hues simply hope that (as if by magic) the UK will grow itself out of debt, without ever explaining how. This is a hope with no foundation whatsoever. The world has changed and is a more competitive place, and there is nothing to indicate that the UK is well placed in the competition. It returns to the question of which sector will produce the growth.

All of this serves as context for the current state of government borrowing. Even with the massive levels of government borrowing, which flatters the actual state of the UK economy, the UK economy continues to shrink. Not only is the borrowing expanding at unprecedented rates, it is expanding faster than forecast, and that is before the latest proposed increase in spending:

Figures from the Office for National Statistics show that national debt is now equivalent to 59% of the UK's gross domestic product after borrowing grew by £14.8bn in September, compared with £8.7bn for the same month a year ago.

Total net public borrowing now stands at a record £824.8bn, up from £695.2bn (48.4% of GDP) a year earlier.

The £14.8bn borrowing in September was, however, lower than economists' expectations of £15.3bn.

The Treasury has officially stated that it expects borrowing for the current financial year to reach a record £175bn but economists expect it to be revised higher in the Pre-Budget Report, expected next month.

Vicky Redwood of Capital Economics said: 'At this rate, borrowing still looks likely to reach over £200bn, compared to Alistair Darling's £175 billion forecast.'

The fiscal position is indeed dire, and the problem is just going to get worse. Furthermore, even as government revenues continue to collapse, along with the collapse in the UK economy, there are still no firm plans to address the gaping deficit. The Conservative party is making some vague gestures in the direction at reducing the rate of debt accumulation, but not actually addressing actual reduction of the debt:

George Osborne, the shadow chancellor, laid out a detailed “austerity package” at the Conservative conference last month with £23 billion of cuts to Whitehall spending, quangos and public sector pay.

This is hardly an 'austerity package' but represents some tinkering at the edges, and I suspect that much of it will disappoint if enacted. I would normally give a figure for the debt that is accumulating, but will instead point you to the UK debt clock here. When you look at the clock, you should note that this is based upon treasury forecasts, not the real size of the actual debt. You will note the speed of the accumulation. Even on such inaccurately low figures, the debt is as follows:

£13,536 for every individual in the UK. That includes children, pensioners and the unemployed, none of whom contribute to servicing the debt. And it is growing at a record rate.

If the Centre for Policy Studies is correct that the real liability is three times the official figures, then the liability is nearly £40,000. However, within these figures there is a mix of potential and actual liabilities, so that it is hard to see where the final debt might lie. Even if we were to accept that the real liability is just half as much again, then the figure would jump to something like £20,000 per individual. And I repeat, it is growing at a record rate.

The purpose of this discussion is to highlight something about government borrowing - that the borrowing is actually being undertaken in your name, and that you are liable for the borrowing. Barring a few quasi-commercial entities, the only income the government has is the income of individuals and businesses. I highlight this point, because it always sounds more comforting when we hear the abstracted terms 'government borrowing' and 'government spending'. The terms hide the essential reality that the government is adding debt that you will pay. It seems an obvious thing to say, but I am not sure that most of us really overcome the abstract way that government debt is presented.

A useful way of thinking of government debt is if the government borrowing were to appear in your letter box every month in the same format as a credit card statement, with your individual share of the debt allocated to you. Although there is considerable argument about the real state of the overall debt, imagine if each person in your household were to receive a statement showing a debt of £20,000, and a demand for repayment of a percentage of the total debt (to continue the credit card analogy). This is what you would see on the credit card type statement over the last year:

• Your monthly payments on the debt
• The debt increasing faster than your payments
• The minimum payments on the debt increasing in absolute terms
  
• The increase in debt reflecting in a higher amount of interest repayments per month, as you are paying more and more just to service the previous debt
  
• The speed of the increase in the size of the debt accelerating at an ever faster pace
• An overall massive increase in your debt
• That a greater proportion of your income will be needed to service the debt, month on month
  

If you were to see this on a real credit card statement, and if you are financially responsible, you would want to know that your future income would certainly increase, your costs were about to decrease, or a combination of the two. Without this you would be worried. The trouble is that there is every indication of increasing costs and decreasing revenues, so most sensible people would call a halt, before getting into deeper debt. The answer of the UK government is to increase the rate of debt accumulation.

Returning to the arrival in the letterbox of our personal portion of the government's debt obligation, how might your children feel if they saw their statement suggesting that they already hold a debt of £20,000, and they can see that the obligation is growing at an ever faster rate? Furthermore, how might they feel if you tell them that their share of the debt, by the time they start working, will grow as there are ever less people actually servicing the overall debt. The demographic change means that they will see more and more debt loaded into their statement, as the numbers of individuals retiring from the workforce increases. Their debt burden is set to explode, unless there is a magical period of hyper-growth of real output within the UK economy.

The debt on the statement that you hand to your child will already be something like £20,000, and, I am guessing that they will not have too much optimism about the future. Not only will they have to pay for the huge interest on the debt, maintain repayments on their share of the debt, they will also have to pay taxes for current expenditure.

The problem is that we have simply become used to thinking about these government debts as abstracted from ourselves as individuals. If you think of opening your credit card type statement, and seeing this actual debt accruing, you would be outraged. The way that the government gets away with profligacy is by abstracting away from the reality that they are putting you in debt. It is in their interest that you never see the debt in this way, but the reality is that this is what is actually happening. For example, when the government spends money to stimulate the economy, it is like you spending money on your credit card. In both cases your personal debt obligation has increased, in both cases activity in the economy increases. Whilst government pays a lower interest rate than you might (for the moment at least), in both cases your personal debt burden has increased.

The point of this post is to serve as a prompt for you to think about the underlying reality of what the UK government's debt means for you as an individual. It is not really the government's debt, but is in fact your debt. The government will not pay back this debt, you will. The politicians pretend that debt accumulation is a solution. But how convincing a solution would it appear if the consequences were to appear every month in your letter box, in the same form as a credit card bill? I suspect that the pseudo-intellectual arguments that are presented to the public would never withstand such an open approach. If the reality were presented in this way, not as an abstraction, you would see the justifications for the accumulation of the debt for what they are. Fantasy or outright lies.

Whatever your personal political affiliation, my suggestion is very simple. When the government borrows money, take it personally. It is you that they are putting in debt. When minister 'x' of minister 'y' self-importantly makes an announcement of spending more on 'a' or 'b', think of how it might look on your credit card type statement.

Take it personally because they are adding to your personal debt.


Note 1: The credit card type statement is, of course, an impossibility due to the overly complex tax system, and changes in each individual's life circumstances seeing alterations in their share of the obligation. Also, for some individuals, such as the retired and unemployed, they would not see any obligation at all on their statement. However, I hope that it is an interesting way of seeing government debt.

Note 2: There are more calls for expansion in quantitative easing, and I am certain that the Bank of England will continue. Inflation has finally fallen close to the 1% point at which they must write a letter of explanation. This from the Telegraph:

The Bank's Monetary Policy Committee, which is meeting this week, will be pushed by economists to raise the amount of bonds and gilts it plans to buy by a further £50bn, following the recent news that unlike almost any other major economy Britain remains mired in recession. The increase would mean the Bank would soon be holding bonds worth more than 15pc of Britain's entire economy in its balance sheet – unknown territory for any developed world central bank in modern history.

The only problem with the scenario of falling inflation is the weakening £GB, which will see inflation imported in higher prices for goods from overseas. Just as I predicted a continuing inflation before QE, specifically because of the fall in the value of the £GB, the same will happen again. Just as before, there will be a time lag due to orders already in the system, but inflationary pressures will reappear. Whilst the $US has also been suffering, and trade is still (for the moment) largely priced in $US, the UK economy is in a worse state than the US, is printing proportinally more money, and the £GB will therefore trend lower against the $US over the short to medium term. Comments on this welcomed.

Note 2: It seems that the UK is about to break up the too big to fail banks, which is a rare piece of good news. It appears that this is being imposed upon the government by the EU, rather than being domestic policy. However, it is happening, and it is finally something with which I can agree. On the other side of the coin, I suspect that there may be some further interventions and other shenanigans, but have not had a chance to look into the detail. If you have more details, please feel free to add something on this, as it may be a while before I post again.

UK Comprehensive Spending Review - Post 1

I have just been having a look at the UK government Comprehensive spending review which can be found here (for the brave only). Whilst reading through the report, I found endless points where I thought 'I should write about that'. I therefore decided to post as I perused. My original intention was to analyse where government money is being spent, but there were so many points in the general text that demanded attention that I have been distracted from my original purpose. As such, the review of spending in the specific will have to wait for another time.

I will try to ruthlessly edit myself, as there is far too much content worthy of comment. As such I will just note particular points that grab my interest, and comment very briefly. I would like to take the time to dissect this review but, as ever, time is not on my side.

A starting point- this is 'box 2.2' on inflation and pay (p26):

The UK economy is experiencing both an unprecedented period of growth and its longest period of sustained low and stable inflation since the 1960s. Low inflation has provided the platform for record employment levels, higher investment, productivity and economic growth. [.....]

In contrast to periods of higher inflation in previous decades, the credibility of the UK’s monetary policy framework has kept inflation expectations anchored and earnings growth has remained subdued.

The first problem with this wonderful section is that the government is taking credit for the low inflation. It seems that, when inflation is low, then it is down to the government, but when inflation is high, it is down to external forces. The reality, as I have made clear in past posts is that inflation and wage restraint has been the direct result of a massive number of new workers entering the world economy. That the government claims credit during the good times, and refuses blame during the bad is just dishonest.

I am tempted to comment on the 'Golden Rule' and other such nonsense in the report, but am not sure I can add anything to the discussions that have been provided elsewhere. As such I will not waste time on the farce, except to say that the Golden Rule is a sleight of hand, and makes no sense on any level whatsoever.

There is one point that emerges in discussion of the 'Golden Rule that demands attention. This is the endless use of the word 'investment', where the government actually means spending. I have argued elsewhere that the idea of government borrowing to 'invest' is unsupportable, but in many places in this report, the word investment is actually a direct synonym for spending, and can not even make (albeit flimsy) claims to be investment. Why has the media allowed this word to be used in this way? It is one of the great mysteries.....

Just to illustrate the point:

investing in Britain’s future, with total public spending over the CSR07 period
rising from £589 billion in 2007-08 to £678 billion in 2010-11 – an average increase
of 2.1 per cent a year in real terms consistent with the fiscal rules – enabling
further investment in the Government’s priorities of education, health, transport,
the Olympics, security and housing. Within these plans the continued strength of
the UK’s public finances have enabled an addition of £2 billion to the plans set at
Budget 2007 to take forward vital capital investment in public services;

Apparently, investing includes paying for a person to deal with your tax return, or to pay for a frigate, or to pay a nurse, or a social worker, or to... I could go on. The point is that all of this is apparently 'investment'. And the return on buying a frigate is how much? What is the return on the Olympics?

The curious part is that, at other points in the review there is an acknowledgement that this is spending. But how many people read that far? e.g.

spending on the National Health Service is nearly 90 per cent higher in real
terms;

Moving to a different point entirely, apparently the UK is in a good position for the long term.

2.46 The most recent assessment, published in the 2006 Long-term public finance report, shows that the UK fiscal position is sustainable over the long term. The UK is in a strong position relative to other developed countries to face the challenges of an ageing society. A further discussion of long-term fiscal sustainability is included in Annex B.(p30)

This statement would be amusing if it were not serious. The UK long term fiscal situation is dire. The UK has an unfunded pension system, an ageing population, and ever growing health care costs (that are likely to increase ever faster with an ageing population and ever more expensive treatments). No doubt the government will suggest that the UK is in a better position on pensions than, for example, some European countries, but that is like comparing a man with broken arms and legs with a man with a broken back. If we also consider that this long term is one of sustained economic growth, then the scale of the erroneous thinking becomes clear. This is a big subject, and I will return to it in the future, including some proposals for reform.

I will now quote a paragraph, and will not even comment on it. I will let you be the judge of the merits of what has been said:

third, value for money for the taxpayer – ensuring that world-class public
services are not just pursued through increased spending alone, but by
targeting resources on the most effective policies, reforming delivery to raise
productivity and increase efficiency wherever possible – thereby ensuring
sustainable levels of public spending which entrench macroeconomic
stability and maintain the UK’s competitive position in the global economy. (p31)

It is a bit later that we come to a rather frightening section as follows:

3.3 These increases in spending have been made possible by the stable and sustainable economic growth described in the last chapter, with falling debt interest payments and low unemployment releasing resources for key priorities, as illustrated by Chart 3.1. (p36)

I say scary because they then show a chart that gives growth in expenditure from 97-98 predicted out to 2010-11. Included in this projection is that the servicing of government debt will fall by approximately 1.5%. This is positively Orwellian. The truth is that debt is increasing, and this chart is based upon a continuous high growth rate in the economy. Instead, the economy is sinking fast. Furthermore, as the economy sinks, along with the £GB, borrowing is going to get much more expensive, if anyone is going to lend at all (excepting the IMF).

The other obvious point is the talk of stable and sustainable growth. Bearing in mind the state of the economy at the moment, the idiocy of the statement is already evident.

The report later starts to talk about improvements in front line services (they switched back to 'investment' again here rather than spending). I give an example as follows:

deaths from cancer have fallen by 14 per cent, and from heart disease by 31
per cent. In total, over 200,000 lives have been saved since 1996 as a result of
reductions to mortality rates from cancer and circulatory diseases among
people aged under 75; (p37)

At this point, it might be mentioned that cancer was one of the targets that were measured by government. I quote below something that I wrote on another occasion on the Balanced Scorecard (BSC), which directly addresses the problems of targets (sorry for the change of font).

There are some inherent risks in any measurement system. Neely, in the performance Prism, [1] describes an incident in an airport business. A senior executive in the airport noticed a baggage handler running with a bag towards a carousel. When he enquired about why the man was running it became apparent that the baggage handlers were measured on the time that it took from an aircraft landing to the time that the first bag went on the carousel. As soon as the start button was pushed, the time was recorded. Clearly, the intention was not to have handlers running with and individual bag, but was intended to ensure speedy disembarkation of luggage.

The point in the example is that measurement systems cause distortion in the behaviour of those being measured. This is one of the greatest risks in the BSC system, despite Kaplan and Norton’s warnings against the dangers. Taking an example from the real world it is possible to discern examples of measurements distorting behaviour. One famous example was apparent in the last UK election. Doctors were set targets for appointment booking times, and the system created a distortion such that appointments were delayed in order to ensure that a booking target was met.

At this point, I will leave this post, as real life is demanding my attention. However, I will return to this subject in the future, time allowing. In the meantime, I strongly suggest that you take a look at the report (I am afraid 286 pages of it). However, if you look at nothing else, look at where government money comes from and goes to. It can be found at the start of the report. As you look at the charts, just ask yourself:

'Where is this money actually going?'

This is a subject I will certainly cover in the future. My apologies for an incomplete post, but I can either read the report or write a full post. In order to comment, I need to read the original, which does not leave much time for comment. As such, a compromise. I would wait, but it seems that I have a growing regular readership, so like to add fresh content whenever I can.

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[1] The Performance Prism, Neely A. et al, 2002, Pearson Education, 1^st Edition, UK