Could the UK government
go bust?
Dr John Gathergood
School of Economics
University of Nottingham
This Lecture
• UK confronted by global economic crisis
• New financial pressures on the economy
– Households face unemployment, falling wages,
lack of access to credit
– Firms face lower demand, higher cost of debt
– Government faces lower tax revenues, higher
welfare bills
This Lecture
• Pressure may be too much to bear
• Some economic agents ‘go bust’
– Households who cannot pay their debts may
suffer personal insolvency (bankruptcy, IVA etc..)
– Firms who cannot pay their debts may go into
administration and liquidation
– Why can’t governments who can’t pay their debts
go bust as well?
The Problem
• Governments, like households or firms have
unsustainable debts
• Struggling under burden of interest costs and
difficulty financing their debt
• Greece: bailed-out by EU / IMF
• UK: arguably in a worse position than Greece
– Could the UK Government go bust?
Theory I
• Governments have a budget:
– They have a source of income (e.g. tax revenue)
– They spend this on services for the country (e.g.
on the NHS) and transfers (e.g. benefits)
T  G V
Tax Revenue = Government Spending + Government Transfers
– i.e.
Income = Expenditure
– In this model, there is no government borrowing
Theory II
• Governments can get into debt:
– If they want expenditure > income, can borrow
– This isn’t free: debt has to be paid back and
interest has to be paid on outstanding debt
T  G V
Tax Revenue = Government Spending + Government Transfers
Tt  ( B  B )  Gt  Vt  it 1 ( B )
g
t
g
t 1
g
t 1
Tax Revenue + Net Saving / Borrowing = Government Spending + Government
Transfers + Interest on Debt
Theory III
• If government expenditure is more than
income, it is running a deficit
• Outstanding money owed by government is
known as government debt
Tt  ( Btg  Btg1 )  Gt  Vt  it 1 ( Btg1 )
DEFICIT
DEBT
Tax Revenue + Net Saving / Borrowing = Government Spending + Government
Transfers + Interest on Debt
The Financial Crisis I
• Before the crisis, most Western Nations were
running a deficit
– Governments spending more than their income
– In U.K., used to increase spending on NHS,
education, welfare benefits
• Plus most nations had positive outstanding
debt
– U.K. approximately 40% GDP (i.e. Income)
Central Government Budget Balances
as % of GDP, 1997 - 2008
The Financial Crisis II
• Financial Crisis and Great Recession
– Government tax revenues fell – e.g. rising
unemployment means fewer people pay tax
– Government spending increased – e.g. cost of
bank bailouts (RBS, Northern Rock etc..), cost of
welfare benefits, such as unemployment benefit
– Government DEFICIT increases, adding more DEBT,
how much debt is too much?
Change in Government Budget Balance, 2008 - 2010
Brazil
1.2
Argentina
0.7
Indonesia
-0.9
Mexico
-2.6
India
-3.3
Turkey
-3.3
South Africa
-4.2
France
-4.8
Italy
-4.8
Germany
-4.9
China
-5.2
Canada
-5.2
US
-5.6
Australia
-6.8
Saudi Arabia
-7.0
Japan
-7.5
South Korea
-7.8
UK
-10.6
Russia
-11.7
-14
-12
-10
-8
-6
-4
Percentage of national income
-2
0
2
0
1690
1700
1710
1720
1730
1740
1750
1760
1770
1780
1790
1800
1810
1820
1830
1840
1850
1860
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
% of GDP
UK: public net debt as % GDP 1692-2014
Note: 2010-2014 are HMT forecasts
275
250
225
200
175
150
125
100
75
50
25
Too Much Debt
• At some point, government debt becomes
unsustainable
– So much debt that interest costs are more than
the government can afford
– Investors lose confidence that government will be
able to repay
– Refuse to buy government debt / demand very
high interest rates (this hasn’t happened, yet)
Cost of Servicing U.K. Government Debt, 1975 - 2015
5.0
Public sector net debt interest
4.5
Budget 2010 forecast
3.5
3.0
2.5
2.0
1.5
1.0
0.5
Financial year
2010-11
2005-06
2000-01
1995-96
1990-91
1985-86
1980-81
0.0
1975-76
Percentage of national income
4.0
Government Debt Crisis
• If government cannot afford interest
payments / sell new debt, drastic action
– Tax increases to raise government income
– Spending cuts to reduce expenditure
• U.K. Emergency Budget June 2010
– Tax increases (V.A.T. increased, National Insurance
raised, 50p tax rate)
– Spending cuts (25% reduction in spending in nonhealth / foreign aid budgets)
Worst Case Scenario
• U.K. looks set to avoid ‘debt default’
– Unable to pay interest / unable to sell new debt
• In worst case ‘default’ scenario would have to:
– Massively cut spending / increase taxation
– Seek loan from another county (e.g. EU, IMF, U.S.)
– Sell assets owned by the U.K. government
Crown Jewels, £20bn?
Gibraltar, £100bn?
Is This Likely?
• U.K.’s credit rating (creditworthiness) is strong:
– Remains ‘AAA’, best possible: Spain ‘AA’, Italy ‘A+’,
Portugal ‘A-’
• Cost of insuring U.K. debt low (CDS margin):
– the UK’s premium has fluctuated: in Feb 2009 it
was 164 basis points but today is 80bp
– Greece & Ireland 280bp, Italy 180bp, UK is
bracketed with Spain, Austria, Portugal. By
comparison, France is 60bp, Germany 50bp.
Could the U.K. Government go bust?
• Yes, technically it could
– In much the same way as households or firms
become insolvent
• Financial crisis stressing government finances
– Highest-ever post-war debt
– But interest costs are low
– And new budget should reduce deficit / debt
U.K. government could go bust, but not this time