Could the UK government go bust?

Dr John GathergoodSchool 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)

– i.e. Income = Expenditure– In this model, there is no government borrowing

T G V Tax Revenue = Government Spending + Government Transfers

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

1 1 1( ) ( )g g gt t t t t t tT B B G V i B

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

1 1 1( ) ( )g g gt t t t t t tT B B G V i B

Tax Revenue + Net Saving / Borrowing = Government Spending + Government Transfers + Interest on Debt

DEFICIT 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?

RussiaUK

South KoreaJapan

Saudi ArabiaAustralia

USCanada

ChinaGermany

ItalyFrance

South AfricaTurkey

IndiaMexico

IndonesiaArgentina

Brazil

-14 -12 -10 -8 -6 -4 -2 0 2

-11.7-10.6

-7.8-7.5

-7.0-6.8

-5.6-5.2-5.2

-4.9-4.8-4.8

-4.2-3.3-3.3

-2.6-0.9

0.71.2

Percentage of national income

Change in Government Budget Balance, 2008 - 2010

16901705172017351750176517801795181018251840185518701885190019151930194519601975199020050

25

50

75

100

125

150

175

200

225

250

275

UK: public net debt as % GDP 1692-2014Note: 2010-2014 are HMT forecasts

% o

f GD

P

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)

1975

-76

1976

-77

1977

-78

1978

-79

1979

-80

1980

-81

1981

-82

1982

-83

1983

-84

1984

-85

1985

-86

1986

-87

1987

-88

1988

-89

1989

-90

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-200

020

00-0

120

01-0

220

02-0

320

03-0

420

04-0

520

05-0

620

06-0

720

07-0

820

08-0

920

09-1

020

10-1

120

11-1

220

12-1

320

13-1

4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0Public sector net debt interest

Budget 2010 forecast

Financial year

Perc

enta

ge o

f nati

onal

inco

me

Cost of Servicing U.K. Government Debt, 1975 - 2015

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 non-

health / 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 / debtU.K. government could go bust, but not this time