As professional accountants we recognise that borrowing can be a valuable tool to finance capital investment, for example in infrastructure, which creates economic and social benefits. However, it has increasingly become normal for governments in developed countries to borrow in order to pay the day to day running costs: so called deficit spending. In the past, growth in tax revenues has been roughly correlated with growth in the domestic economy. Consequently running a small deficit was a workable economic policy in periods where there was strong growth in the economy.
Unfortunately in recent years that economic growth has faltered in many of the developed economies. There is some evidence to suggest, that due to structural changes in developed economies, the correlation between economic growth and tax revenue growth is not as strong as it was. There is also the impact of demographics. Almost all the populations of developed nations are aging with a double impact on the public finances. At the same time as a the proportion of the population active in the workforce is falling, the demands on public services for pensions, social care for the elderly and healthcare are growing. Without some form of change in policy or a substantial increase in the tax take, social provision on the current scale is not likely to be sustainable over the long term.
With the reversal of quantitative easing and interest rates beginning to rise, there are real questions about whether governments will be able to manage their public debts. The exposure to changing macroeconomic conditions is real. Taking the UK as an example, over £700bn of public debt will have to be refinanced in the next five years, quantitative easing has ‘swapped’ a large proportion of fixed rate gilts into deposits paying floating rate and over a quarter of our £1.7trn of public debt is index linked.
The traditional response to unsustainable public debt has been to use inflation to ‘inflate away’ the debt so that it falls relative to the size of the economy. This policy choice comes at a cost as it erodes the value of saving and investments in the domestic currency. It may also be harder to realise in a more interconnected world where central banks have been mandated to keep inflation low.
ICAEW believe the accountancy profession has a role to play in helping governments formulate policy in response to the whole question of debt sustainability. Our recent report “The Debt of Nations” is written from a public interest perspective aims to highlight some of the issues relating to public indebtedness. In doing so we aim to improve public understanding, improve the quality of public debate about public debt and call for a more robust approach to its management.
We believe accountants can be valuable when analysing public debt. The current system of measuring it is based on economic statistics with a wide range of measures in use. The UK alone publishes 12 different measures for public debt and comparing public debt between countries is difficult. There is also little requirement on governments to demonstrate their resilience to economic shocks. Economists like to compare debt to GDP as a measure of sustainability. We believe this is a flawed approach. Aside from there being significant problems with the way GDP is calculated (or we should say estimated), it is also prone to manipulation.
GDP does not represent a sum of money available to a government to service its liabilities. At best it is a distant proxy and takes no account of the different fiscal structures between countries.
France has a higher public debt burden as a proportion of its economy, but it also raises more tax as a proportion of its economy than the UK, so is better able to cover its public debts. A little accounting expertise to improve both of these situations – the ratio of government revenues to balance sheet liabilities or to annual debt service – are far better measures.
“The Debt of Nations” policy insight explores these issues and provides a range of analysis and reflections on borrowing by government. We believe we need a better public understanding of how public debt is measured and managed to know whether borrowing by government is truly under control and our economies will be resilient in the face of future economic crises.
Ross Campbell is ICAEW director of the public sector