Osborne’s Lack of Austerity

“Why have international investors and domestic savings institutions not sold off British government debt in anger at the slow progress on budgetary restraint?”

Economy Marketplace
Crisis: Greek anti-austerity protests in Athens, 2011 (photo: Kotsolis)

Should George Osborne worry about the national debt? When the coalition government came to power in May 2010, the Greek financial crisis was in everyone’s minds. For some years after the introduction of the euro, Greece had run a budget deficit and incurred a large national debt not much less than gross domestic product. With an interest rate of about 5 per cent, the annual interest cost was roughly 5 per cent of GDP: rather high, but manageable.

However, in 2009 and 2010 the Greek government admitted that it had been telling lies about both its deficit and debt numbers, and that the debt was nearer 120 per cent of GDP. Financial confidence was lost.

Investors sold government bonds and pushed up the yield into the low double digits. So the interest cost — with, say, a 12 per cent rate on a debt of 120 per cent of GDP — might approach 15 per cent of GDP. Because of the leap in the interest charge, and fears of riots, the government could not bring its deficit under control. Greece was bust. In 2012 the debt/GDP ratio soared to 170 per cent and the bond yield exceeded 30 per cent for a few months.

The Greek problem arose partly from the difficulty of controlling the non-interest deficit, but more fundamentally from the wild gyrations in interest rates as financial market confidence ebbed and flowed with the stream of official mendacities. The lesson was not lost on Cameron, Osborne and Clegg as they hammered out the coalition agreement. A priority was to ensure that the UK’s own budget deficit — a shocking 11 per cent of GDP in 2009 — was brought down to a more respectable and sustainable level. If not, the markets might punish Britain in the same way they had punished Greece.

The 2014 Autumn Statement is behind us. As commentators start to think about the next government’s fiscal plans, it is a good time for stocktaking. Osborne took a lot of stick from Keynesian economists in 2011 and 2012 about his commitment to curb the budget deficit and to enforce “austerity” in public spending. Amazingly, the Keynesians continued to urge “fiscal expansion” just as the unfolding Greek disaster ought to have served as warning against another public expenditure extravaganza of the type seen in the last two-thirds of the Blair/Brown  government.

In the event Osborne has not been particularly austere. True enough, general government spending on goods and services has grown much more slowly (about 1 per cent a year) under the Conservatives than during the Labour period. But it has grown and is now at an all-time peak. Taxes have risen as a share of national output since 2010, but that has been due to the recovery in the economy rather than to any significant change in tax rates or the structure of taxation. The current fiscal year is now expected to see a budget deficit of about £100 billion. This may be down from the peak in 2009/10 of over £170 billion, but it is still far in excess of the figure originally planned and not enough to prevent the debt/GDP ratio rising further.

The UK’s deficit, relative to national output, is now well above the figures in our eurozone neighbours and the US. Osborne may have antagonised the Keynesians but he is no great favourite of the balanced-budget school. When he took office in 2010 the government’s gross debt was just over £1,100 billion.

If and when Osborne leaves office in May 2015, it will almost certainly be over £1,600 billion. No other Chancellor will have borrowed as much as George Osborne.

Why have international investors and domestic savings institutions not sold off British government debt in anger at the slow progress on budgetary restraint? Part of the explanation is that a big chunk of the new government debt has been absorbed by the Bank of England’s Asset Purchase Facility, created to implement “quantitative easing” for monetary policy purposes. But more basic has been the extraordinarily low level of government bond yields.

The stock of British government debt climbed rather alarmingly, altogether by over £400 billion, in the first four years of Osborne’s chancellorship. If the UK’s government bond yield had been in double digits (as they were in the 1970s), that would have added perhaps £50 billion to debt servicing costs. Far greater expenditure cuts or tax increases would have been unavoidable. But the last few years have seen the almost miraculous combination of an increase in government debt from £1,100 billion to £1,500 billion and a virtually constant level of debt interest payments on that debt. Interest payments were £46.6 billion in 2010/11, £48.7 billion in 2013/14, and are likely to be about £50 billion in 2014/15. There has been some austerity under Osborne, but not much, and low government bond yields have given him a much more relaxed spell at the Treasury than seemed likely in 2010.