Britain is staring into a £3tn debt abyss
"“Britain is bust.” Those were not the words of a politician or a scaremongering economist.
They were uttered in 2012 by Sir Robert Chote, then head of the Office for Budget Responsibility (OBR).
He warned that unless the government acted by either spending less or taxing more, the national debt risked spiralling out of control.
At the time, Britain’s national debt had recently surpassed £1tn and alarm bells were already ringing.
Today, the country stands on the brink of another symbolic milestone.
Within months, the United Kingdom’s national debt is expected to exceed £3tn for the first time, a threshold that could be crossed as early as September.
For most people, the moment will probably pass unnoticed. Others will dismiss it as a meaningless figure that says little about Britain’s actual ability to service its debts.
Yet after years of economic crises, rising borrowing, higher spending and repeated failures to reduce the debt burden, the consequences are becoming increasingly difficult to ignore. Changes in market interest rates are blowing up budgets and mere words uttered by politicians can add billions to the nation’s interest bill in a near instant...
Senior economists are raising uncomfortable questions. Chief among them: will the International Monetary Fund (IMF) soon be called back to Britain?
Public debt is currently ticking up at £7,500 per second. That’s an extra £27m every hour or £650m a day as the cost of the financial crisis, lockdown and huge energy subsidies in the wake of Russia’s invasion of Ukraine continue to mount...
When Sir Tony Blair came to power in 1997, it equated to just under £6,000 for every person – adult and child – in the country.
By the time Lord Cameron of Chipping Norton moved into No 10 in 2010, the debt was almost £16,400 per person.
Now our share of the nation’s tab is £42,000 each. By the end of the decade, it will be closing in on £50,000.
The size of public debt matters. But debt as a share of the economy matters even more because it tells you whether the bill is large relative to a country’s ability to pay.
In the coming years, Britain’s debt burden is projected to rise above 96pc of GDP. The last time debt reached that level was in the early 1960s, when the country was still paying down the enormous borrowing accumulated during the Second World War.
At its peak, wartime debt exceeded twice the size of Britain’s annual economic output, a level not seen since the aftermath of the Napoleonic Wars.
However, as David Miles of the OBR points out, there is a crucial difference. Back then, the debt trajectory was moving downwards. Today, it is heading in the opposite direction...
“It is more likely that military spending will be rising as a share of GDP than falling from its currently relatively low levels.”
As well as increased pressure to spend more on defence, Miles warns that an ageing population will continue to pile pressure on the public finances, with updated projections to be published in July set to show spending on health and welfare will increase substantially in the next 50 years, while public debt heads towards 300pc of GDP.
“In the light of this it would seem ... that fiscal policy is on an unsustainable path in the UK,” Miles warns in his paper. “At some point, the stock of debt will have to deviate from that path.”...
Sir Charlie adds that while much of the increase in UK borrowing costs this year has been driven by the Iran war and predictions of fewer interest rate cuts, domestic concerns have not gone away.
Since the conflict began, borrowing costs have risen by more in the UK than in other countries including the US and Germany.
“I would put that down to an element of concern about the direction of fiscal policy in this country if there’s a change in the Labour leadership,” says Sir Charlie.
Andy Burnham, the Labour leadership frontrunner, is causing fear and anxiety in the market as he measures the curtains in Downing Street. However, the current Chancellor hasn’t exactly been the paragon of fiscal rectitude.
Reeves came into office claiming the Tories had left a £22bn black hole in the public finances. She then shocked businesses – and voters – with the scale of her £40bn tax rises in her first Budget.
But what was more remarkable was her spending increases of around £70bn per year, requiring yet more borrowing justified with a new, looser set of borrowing targets.
Unfortunately she left herself with very little headroom to hit those targets.
When the economy repeatedly underperformed, the Chancellor had to ramp up taxes further to get her plans back on track – spooking investors and risking undermining growth once more.
The result is rising borrowing costs amid growing fears in financial markets that Labour is struggling to keep a lid on debt. The expectation of yet more spending if Burnham becomes prime minister only adds to the upward pressure on market interest rates.
Part of that concern is the Augustinian “Lord, make me chaste but not yet” attitude to balancing the books that successive governments have adopted. Reeves is planning to raise more taxes but many of the measures will not kick in until a year before the next general election – a timeline many see as unrealistic.
“It is difficult to get politicians to take tough decisions for the longer term, particularly if they think they will be penalised at the ballot box,” says Sir Charlie.
As debt continues to ratchet up, economists are thinking the unthinkable: will the UK need an IMF bailout?
Ken Rogoff, a former chief economist at the IMF, believes it is becoming increasingly likely.
Rogoff, now a Harvard professor, fears the US may struggle to pay its bills. He has previously warned that there is a significant probability of the US entering a debt crisis in the next 10 years, which could lead to a deep recession.
However, he adds pointedly, “What might save us is that the UK might run into problems first.
“The UK is definitely in more trouble than the US because there isn’t a growth story in the UK.”
While Rogoff doesn’t believe Britain is “about to fall apart”, the combination of higher debt and “toxic” politics is forming the recipe for a crisis.
He, like many others, looked on through his fingers as Reeves was forced by her own backbenchers into a humiliating about-turn over £5bn of welfare cuts.
“There’s just no stomach to reform things,” says Rogoff.
Investors are now fearful of where a Burnham premiership may take Britain.
The Mayor of Greater Manchester wants more state control of public services and housing. While he has committed to following Reeves’s borrowing rules, he has also declared he does not want to be “in hock” to the bond market.
Those comments alone led to a rise in market borrowing costs.
Even those who have signalled in the past that debt is a free lunch are slowly changing their minds.
Olivier Blanchard, whose economic textbooks are staples in most classrooms, says he’s “worried” about rising primary deficits, which measure how much a country borrows, excluding debt interest.
“I think it may take at least a mini fiscal crisis ... to get some governments to do what they need to do.”
It’s been 25 years since a British government last ran a budget surplus. Through good years and bad since 2001, every prime minister has added to the national debt – sometimes little by little and in other years by piling on vast new borrowing.
Combined with the failure to repair the finances after each crisis, this gives rise to fears Britain is inexorably turning into another Argentina – a once-rich nation that borrowed itself into disaster, with repeated defaults on its debts.
But the South American basket case is not the only example Britain could follow.
Across the North Sea is a nation now considered a model of fiscal probity but which was not so long ago a recession-stricken, debt-ridden warning to the rest of the world.
Sweden suffered such a severe crisis in the 1990s that its politicians still, by and large, stick to rigorous borrowing rules which have cut its debt by half in the past 30 years...
Magnusson says cooperation between the governing and opposition parties on financial packages helped ensure the debt kept falling steadily. Official figures show debt has fallen from around 70pc of GDP three decades ago to the low-30s today...
“We learned our lesson fairly well,” says Magnusson.
Britain’s failure to follow a similar path, even after decades of its own fiscal rules and 16 years on from the establishment of the Office for Budget Responsibility, appears baffling by comparison.
“We realise it is hard to get some kind of political momentum going for a stricter fiscal policy. It is, on the one hand, a bit strange because you have a Labour majority in Parliament. You would expect Labour probably should be able to pull this off because of its big majority,” says Magnusson.
“Maybe one reason why it is hard to fix is that it is just not bad enough. What really set this off in Sweden is that [the crisis and recession] was so much worse.”
This is an ominous message for Britain...
“In a situation like this, the IMF would be called in for technical support,” he says.
The reason is simple: politicians always need a scapegoat.
“If you reach a point where you have to have some form of budget adjustment, you want to blame it on someone, so they would call in [the IMF]. They don’t need the IMF but they would call it [in the same way] McKinsey will often get called in by a company that knows it needs to fire its CEO.”
Sir Charlie, who is one of Britain’s most respected economists, believes a bailout may be inevitable.
“Whether it’s needed is an open question,” he says. “But I think it might well come to that. It is difficult to get politicians to take tough decisions for the longer term, particularly if they think they’re going to be penalised at the ballot box.”
He adds that the idea of the UK needing to call the IMF was unthinkable a few years ago...
What could trigger a crisis?
Rogoff says Russia invading a Nato country could do it, though Sir Charlie believes the trigger is far more likely to be domestic than geopolitical.
He warns: “Markets would be much less forgiving if you had a government with a new leader who says, ‘well, we don’t want to be in hock to the bond market and we’re going to continue to run large deficits’.”
Some investors fear that Labour leadership frontrunner Burnham could embark on an unfunded spending spree if he secures the keys to No 10.
Rogoff has seen this all before.
Back in 1982, he was a fresh-faced junior economist at the IMF in Washington when François Mitterrand, the newly elected French president, launched one of the most ambitious Left-wing economic programmes in modern Europe.
That agenda included widespread nationalisation and wealth redistribution, covering banks as well as major stakes in the steel, chemicals, arms and electronics industries.
The aim was to stimulate growth and employment. Instead, the programme pushed up inflation and caused capital flight, piling enormous pressure on the franc and fuelling further price rises.
“Mitterrand came in [like] Andy Burnham and the markets collapsed,” says Rogoff. “I was at the IMF at the time, I was a junior economist and we were all studying French to try to help them out.”
Eventually, Mitterrand abandoned the experiment in what became known as the “tournant de la rigueur” or “turn to austerity”, implementing deep spending cuts and a more orthodox economic policy.
It was a reminder that electoral mandates do not grant governments immunity from market discipline.
Britain enjoys the luxury of having a central bank that can always print money to save the day. However, even Liz Truss found out the hard way that this does not grant invincibility, after her mini-Budget tested investors’ limits and blew up the market...
“I never worried about this before but for the first time, I’m more worried about advanced countries needing to resort to [unorthodox] policies in order to deal with their debt problems,” he says.
That could mean allowing price rises to try to inflate the debt away. Financial repression is the other option: where private wealth is either encouraged, corralled or taxed in some way to finance government debt.
India, for instance, requires lenders to hold 18pc of their deposits in state bonds or other approved assets. In Europe’s banks, government bonds receive favourable regulatory treatment...
If the IMF were ever called in, it would mark the end of a political career. In an emergency, support would probably come with strict conditions – IMF lending programmes always do.
Sir Charlie recalls a familiar joke: “IMF doesn’t stand for International Monetary Fund but ‘I’m fired’.”"
