National Debt is an Irrelevant Statistic
The unifying framework of Sunak’s budget is that the size of the national debt is a critical concern. Hence, he has done the minimum possible to get the country through the next 6 months while sending a clear signal that there will be a return to austerity and increased unemployment will be tolerated, so that the national debt can be reduced.
Labour needs to confront this unifying framework directly and state boldly that the size of the national debt is an irrelevant statistic. The relevant statistics, that should be used in determining economic policies, are the rate of unemployment and the rate of inflation. The existence of unemployment is, if anything, a clear indication that the size of the fiscal deficit is too small.
The claim, that the national debt is an irrelevant statistic, will no doubt startle many readers of this column. It is indeed a difficult idea to grasp. We shall consider below, why this is the case and discover that national debt might be more appropriately renamed as national wealth. First, however, let us make an additional claim: the Labour Party will never be able to effectively oppose the reimposition of austerity and advance the cause of working people if it does not understand why the national debt is an irrelevant statistic.
Without understanding the irrelevance of the size of the national debt in determining economic policy, the Party will end up sounding inconsistent and unconvincing. In this context it is interesting to consider Keir Starmer’s response to Sunak’s austerity budget on 3rd March. Starmer made strong and valid points about the last 10 years of austerity-led economics. The following day, Shadow Chancellor, Anneliese Dodds, and Shadow Works and Pensions Secretary, Jonathan Reynolds made equally strong condemnations of 10 years of Conservative austerity. This works reasonably well in the House of Commons debating chamber. However, in interviews on ‘Newsnight’ or the ‘Today’ program or ‘PM’, listing the failures of austerity has limited value. Labour has to put forward its own policies but then the question, ‘How will you pay for it?’, always leaves Labour interviewees struggling. The Labour Party believes that national debt does matter but cannot explain how its policies can be implemented without increasing the national debt. This leaves it sounding confused and inconsistent.
It is not easy to grasp that the size of the national debt is an irrelevant statistic. Our natural tendency is to assume that government debt is the same as household debt. We all know that household debt is a burden. If you have a mortgage, you have to allocate part of your monthly income in interest and capital payments. These payments will typically continue for some 25 years. In particular you know that, if you do not make all the required interest and capital payments, you may lose your house. So everyone, quite understandably, sees debt as a burden.
How can it be that private debt is a burden while national debt is an economic irrelevance?
To answer this question let us first clarify what national debt is. Each year a government spends money. It also levies taxes. If, in any year, the government spends more than is levied in taxation, that difference is known as a fiscal deficit. If the government levies more in taxation than it spends, the difference is known as a fiscal surplus. The national debt is just the cumulative sum of fiscal deficits and fiscal surpluses over time.
If an individual wants to spend more than they earn, they must borrow from a third party. But it’s not the same for the UK government. Because it is a currency-creating state, the UK government does not have to borrow money to finance expenditure. That is the critical difference between the economics of a household and the economics of the UK government.
When the UK government wants to buy products or services it simply instructs the Bank of England (BoE) to mark up the bank accounts of the suppliers of those goods and services. The BoE by law must do as it is instructed. When Rishi Sunak, correctly, decided that the health of the nation required that some 20% of the workforce should not go to work, he instructed the BoE to mark up the bank accounts of those furloughed workers with 80% of their pre-pandemic wages. Sunak did not have to check whether he had the funds available to do this. The UK state is a currency creating state and can always purchase anything that is for sale in its own currency including labour.
As a result of furlough spending and a pandemic induced decline in economic activity, the difference between government spending and taxes levied, the fiscal deficit, increased by some £400 billion pounds in 2020-21. Since the national debt is just the cumulative sum of fiscal deficits over time, therefore, in 2020-21, the national debt increased by £400 billion to a total figure close to £2,000 billion.
Since our personal experience of debt is that it is a burden, it is only natural to think that an increase in the national debt must be a bad thing.
But the term national debt is misleading. We associate debt with borrowing from a third party. UK National Debt does not involve borrowing from anyone. It is simply the cumulative difference between what a currency-creating state has spent into the economy and what it has levied back in taxes. National wealth might be a better name than national debt since, if the state has spent more into an economy than it has taxed out, the private sector is wealthier by that amount. When the UK state issues bonds it is not increasing the national debt. That has already happened since the state has already spent more money into the economy than it has taxed out. The private sector is wealthier by that amount of money. Issuing bonds simply allows the private sector to convert this money into a riskless interest-earning asset.
A currency-creating state is not financially constrained. It does, however, face real resource constraints. Rishi Sunak discovered this in the first wave of the pandemic. He had limitless funds to buy PPE for frontline NHS staff but there was no PPE to be bought.
It is important that members of the Parliamentary Labour Party understand the true nature of government spending in a currency-creating state. They will then realize that the size of the national debt, or national wealth, or whatever we choose to call it, is an irrelevant statistic. They should instead focus on the statistics that are important: unemployment and inflation.
Unemployment and inflation are the main statistics that members of the PLP should use to evaluate and criticize government policies. From this perspective, how should we then evaluate Rishi Sunak’s proposals to raise corporation tax in 2023 by 7%, freeze personal allowances and limit NHS wage increases to 1%?
The first effect of government taxation is to reduce demand because people have less disposable income. A drop in demand will likely increase unemployment. However, if a government spends back into the economy an additional amount, equal to the increased taxation, it will add demand back into the economy and so increase employment. The net employment effect of the increased taxation and increased government spending will be close to zero.
Rishi Sunak does not intend to match his increased taxation with increased spending, because the purpose of his increased taxation is to reduce the national debt. But, increasing taxation without increasing government spending will increase unemployment. The Labour Party should therefore oppose any increase in corporation taxation whose sole purpose is to reduce that irrelevant statistic, ‘the national debt’.
For equity reasons Labour could support an increase in corporation tax that is matched by an equal increase in government spending. The only time an increase in taxation should be supported, without a matching increase in government spending, is when the rate of inflation is too high, which is certainly not the case in 2021. In a situation of high inflation, taxation can be legitimately used by a government to take demand out of the economy.
Freezing Personal Allowances from 2023 until 2026
Freezing personal allowances will, like a tax increase, reduce disposable income. It will therefore reduce demand and will likely increase unemployment. Since the Labour Party should evaluate government policies by considering their effect on employment and inflation, rather than their effect on the irrelevant national debt, the Labour Party should oppose the freezing of personal tax allowances without additional actions to increase demand and therefore employment. Yet we understand that the Labour party has decided to support the freeze for the same reason that Sunak proposes it – because it will reduce the fiscal deficit.
Wage increases for NHS employees
Should Labour support a wage increase of more than 1% for NHS workers? Would a greater than 1% wage increase lead to increased inflation or unemployment? Let us assume that the chancellor will not try to match the increased costs of the NHS with an increase in taxation. Then demand in the economy will likely increase by the extra disposable income that the 1.6 million NHS workers have received. If it is not possible to increase production to match this increased demand, then there might well be a small inflationary effect. However given that unemployment is likely to rise to at least 6.5% over the next year, it seems likely that extra production could be achieved, and so there will be no inflationary effect. Indeed, there would instead be an increase in production and a reduction in unemployment. So that’s a win-win result.
Another possibility is that other workers might resent the decline in their wages relative to those in the NHS and attempt to bid up their wages resulting in an inflationary wage spiral. This seems unlikely. It is widely accepted that NHS workers were generally exemplary in their efforts to protect the population and save lives.
So, using our criteria for evaluating economic policy, asking whether it increases unemployment or inflation, we could support a larger increase for NHS staff as it will likely reduce unemployment but not increase inflation because more can be produced to match the increased demand and, furthermore, the increase in NHS wages will not be resented by other workers.
Unemployment and Inflation are the relevant statistics
We end this column by stating, in summary, that the size of the national debt is an irrelevant statistic, that the relevant statistics, that should be used in evaluating economic policies, are the rate of unemployment and the rate of inflation and finally, that the existence of unemployment is a clear indication that the size of the national debt is too small.