Spend now, squeeze later

19th February, 2011

Are we bankrupt? Are countries like the US and the UK in as much fiscal trouble as Ireland or Greece? The bond markets say no: they’ve been quite content to lend to the UK and the US as though they were low-risk propositions, and perhaps they are right.

But even if bond holders look safe enough, citizens may not be. Diane Coyle, author of a new book, The Economics of Enough, argues that we need to go beyond traditional measures of debt in thinking about future obligations.

Consider contracts under the private finance initiative, in which private contractors spend cash now in exchange for service contracts later. Gordon Brown launched his ill-starred campaign for re-election in a spectacular new hospital in Birmingham – but the hospital, which cost several hundred million pounds, hadn’t been paid for.

I have no problem with the idea that governments often rely on contractors to build and even run prisons, hospitals and schools – but PFI seems beloved of governments because much of it is a kind of shadow debt that does not appear in the national accounts. In its 2009 Green Budget, the Institute for Fiscal Studies estimated that future payments under PFI contracts, appropriately discounted, would be around £130bn. (For context, official British government debt is fast closing in on £1,000bn.) It would be cheaper – but would raise official debt – to borrow from bond markets and pay the private contractors up front.

Then there are public sector pensions, which would add around £750bn to £1,000bn to our tally of unofficial government debt. All these look like legally binding promises to me, even if swindling nurses, teachers and soldiers out of their pensions would not trigger an official bond market default. On the plus side, as an Office for National Statistics paper on “wider measures of public sector debt” points out, the government does own several hundred billion pounds worth of roads, railways and buildings.

There is more. In the UK, we expect the government to take care of us when we are sick and to provide some kind of pension when we are old. These promises are by no means firm: women born in the spring of 1954 are now seeing their retirement date recede with alarming speed. But governments will always feel obliged to do something for the sick and the old, and demographics are not on our side. The state pension alone likely represents a current liability of well over £1,000bn.

In the US, the situation is yet more alarming. Laurence Kotlikoff, a US-based economist, reckons that the US has promised to pay out over $200,000bn more in the long run than it seems inclined to collect in taxes – this is roughly 15 times bigger than both the official US national debt and the US economy. Even a tiny tweak to taxes or spending can raise many billions over the decades, but if Kotlikoff’s estimate looks huge, it should: to close it would require halving spending on everything in the US government budget from this point forward, or doubling every tax.

Kotlikoff, with Roberto Cardarelli and James Sefton, produced “generational accounts” for the UK 11 years ago and concluded that all was well – providing NHS spending did not grow too quickly and the state pension was linked to prices, not wages. Gordon Brown did not stick to those provisos. George Osborne also seems committed to pensions and health spending. This means spending elsewhere must continue to fall relative to the size of the economy, or taxes must rise.

Keynesians would argue that now is not the time for fiscal tightening, and perhaps they would be right. The problem is that for an elected politician, the best time for a squeeze is always after the next election. Tomorrow’s taxpayers should be looking carefully at tomorrow’s spending promises.

Also published at ft.com.

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