Debt: Fast or Slow Payback?
Professor Joe Nellis
Steve Macaulay
Welcome to the latest economic update. As usual, Professor Joe
Nellis is joining me in the studio. Today we are going to concentrate
on debt.
Now, Joe, why is debt so important? There seem to be two schools
of thought about debt. One is it is a bit like a household, you have
got to watch your budget, you have got to get it down. The second
one is leave it be, growth will take care of things. Now, where are
we?
Joe Nellis
Well, there are indeed two schools of thought, Steve. That on the
one hand a household, if you borrow a lot of money, you have got to
pay it back because you have got a finite life and banks therefore will
not want you to die without paying back the debt – that is fairly
obvious.
In the case of country it is not quite the same of course, countries
don’t die as such. But the real problem is this; as a country like
Greece or the UK, as it builds up its national debt then the problem is
that of interest charge on that – the debt servicing cost – that
becomes a larger and larger proportion of tax revenue in any one
year. And of course, if more tax revenue is paying the interest then
there is less taxes used to do other things like build hospitals, road,
defence. That is the real problem here; it’s servicing the debt which
is the issue, not the actual size of the debt per se.
Steve Macaulay
Now in the UK, the European Commission, as you know, is saying we
need to speed up the level of repayment of this debt.
Joe Nellis
And precisely for that reason. Their concern is that if the debt is
allowed to get much bigger there will be less freedom for the
government to help the economy to grow. A slower growing UK
economy burdened with debt is not good for Europe either. We
trade with Europe to a very large extent, more than half of our
exports and imports come from Europe. So they want the UK to
grow strong because it helps the European economy.
Steve Macaulay
We talk about a big debt or a little debt; how much should a debt be
as a proportion of GDP?
Joe Nellis
Well there is not a precise science to this, Steve. If you are a
member of the Eurozone, as Greece is, that is easier to answer
because within the Eurozone, membership means you must keep
your national debt to no more than 60% of GDP. Well Greece is
probably double that today. So they have a problem purely from
Knowledge Interchange Online© Cranfield University
March 2010
1
Professor Joe Nellis
the membership of the Eurozone.
In the case of the UK, we are not restricted in that sense. However,
as our national debt grows as a percentage of our GDP then the
financial markets become more concerned, for the reason that I
have said in terms of can we service that debt out of tax revenue
without putting pressure on the economy. And the financial
markets then will build in a greater risk premium on the cost of
borrowing from them and that is the real danger we face here – the
cost of borrowing will go up.
Steve Macaulay
So if I put you on the spot and say if you were Prime Minister, what
would you do?
Joe Nellis
Well I would not go for a quick fix. I think that is correct. Gordon
Brown in that sense is correct. To pull the plugs, as it were, on fiscal
stimuli immediately this year would be a serious risk and I would not
recommend that. I think this year for the UK it is going to be a very
slow recovery and all the figures that are coming out support that
view so far.
I would, of course, not want to wait too long to balance the
government’s account. The government has said they hope to
reduce the national debt within four years. I think that may be the
longest timescale they should envisage.
So, certainly I think next year and the following year we should see
some very definite signs of debt reduction, but not this year.
Steve Macaulay
Joe, I think we are going to have revisit this at some point in the
future and see how your predictions and the predictions of the gurus
turn out. Thank you.
Joe Nellis
Thank you, Steve.
© Cranfield University
February 2010
2