The rise and rise of government debt

The public finances of many rich, ageing countries – Britain included – are on an unsustainable path.

UK government debt has reached £2.8tn, equivalent to 100% of GDP and up from 36% 20 years ago. The borrowing needed to counter the effects of the financial crisis of 2008–09, the pandemic and the energy crisis has led to a near tripling of UK public sector indebtedness. The last time public sector debt was at 100% of GDP was in the early 1960s when the UK was repaying debts incurred during the second world war. 

The 100% figure is an underestimate because it fails to capture the scale of future liabilities facing the government. If the cost of paying public sector pensions were included, UK public sector debt would rise from 100% to 150% of GDP. Add in the cost of welfare and health and the figure would rise far further. 

The Office for Budget Responsibility recently published long-term forecasts for public debt based on current policies. As the population ages and liabilities crystallise in the form of increased spending on welfare and health the OBR forecasts that UK public debt will reach 274% of GDP by 2074. 

The public finances of many other rich, ageing countries are on a similarly unsustainable path.

Despite good growth, the US is on course to borrow the equivalent of 7% of GDP, or $2.0tn, this year. Such levels of borrowing are almost unknown outside recessions or wartime. US public sector debt has risen from 36% of GDP in 2004 to almost 100% today. By 2054 the independent Congressional Budget Office (CBO) forecasts that it will stand at 166% of GDP.   

A modelling exercise run by academics at the University of Pennsylvania (UPenn) last year suggested that the US has no more than a couple of decades to turn things around: “financial markets cannot sustain more than the next 20 years of accumulated deficits projected under current US fiscal policy… financial markets are… effectively betting that future fiscal policy will provide substantial corrective measures ahead of time”. 

“Substantial corrective measures” means some combination of cuts to public expenditure and increases in taxes to arrest the rise in debt. Without such action the US government is, according to the UPenn team, likely to “default explicitly or implicitly” within 20 years (an implicit default meaning that the government runs high levels of inflation to reduce the real value of debt). 

The painless way out of this debt trap is through faster growth. Higher growth means increased tax revenues, lower welfare spending and less borrowing. No wonder Britain’s new government has put so much weight on raising the UK’s lacklustre growth rate. Yet if this were straightforward, the UK would not have a growth or a debt problem – nor would the US. Every government wants faster long-term growth. Few achieve it.  

While all governments pay lip service to sound public finances, in the West it hardly seems to be a pressing political priority. Low interest rates and the seemingly bottomless appetite of financial markets for government debt may have anaesthetised politicians and voters to the risks. It is striking that debt reduction is not a major issue in the current US election campaign nor features as a prominent concern for voters. 

It was not always so. Public debt, though far lower than today, was a major issue in US politics in the early 1990s and featured prominently in the 1992 US election. Having won that election Bill Clinton raised taxes and cut spending, which, in turn, helped turn the public finances from deficit to surplus. US public sector debt fell from 47% of GDP in 1993 to 31% by 2001 helped, it should be said, by strong growth and the post-cold war reduction in defence spending. 

The US and UK also achieved massive feats of debt reduction after the second world war. In the UK debt peaked at 252% of GDP in 1946. Debt reduction then was achieved through strong economic growth and artificially low (in fact negative) real interest rates. Governments also used ‘financial repression’, forcing banks to hold public debt, implementing capital controls and fixing exchange rates. 

Avoiding an ever-rising burden of debt today requires long-term planning, beyond the lifetime of any government or parliament. An example was the decision taken by the then Conservative government in 1995 to raise the UK state pension age in stages from 2010. Starting at 60 for women and 65 for men the UK retirement age will eventually reach 67 in 2027. The changes were announced 15 years before they started to be implemented, giving people time to plan well in advance and adjust their thinking on savings and retirement accordingly.  

Where does this all leave us today? Levels of public debt in many western countries are running at multi-decade highs. Meanwhile, the cost of servicing that debt has risen and the rate of GDP growth has fallen. Ageing populations and the rising cost of welfare and health will exert powerful upward pressure on government spending over coming decades. 

The IMF thinks America’s borrowing is so vast that it endangers global financial stability. The chairman of the Federal Reserve, Jay Powell, says US debt is on an unsustainable path. The long-term outlook in the UK and other western countries, including France and Italy is equally challenging. Politicians and voters need to start worrying about public debt.

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe and/or view previous editions of the Deloitte Monday Briefing here.