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28 November 2017

Bemoaning the cost of national debt is missing the point – we must invest in the economy

A country that stops investing in public infrastructure will find everything it does becomes more difficult.

By Simon Wren-Lewis

The latest media fad seems to be to ask John McDonnell about the debt interest costs of his plans for additional borrowing to fund new public investment. Labour’s shadow chancellor has said he cannot possibly know, because it depends on what interest will be in the future, and has also suggested that the question itself misses the point. This had led some to suggest he is not being transparent or even that he is not on top of his own proposals.  

But what McDonnell has said is right. He could make up a figure to keep the interviewer happy, but I suspect he doesn’t because the question is a political trap. Once you give a figure, then the response would be that with that money you could employ more nurses or teachers. It becomes a game that only has one winner. An impersonal and abstract idea – more public infrastructure investment – is put against whatever concrete spending the questioner chooses that will most resonate with their audience.

How often have we heard people say that we should reduce debt because the money spent on interest could be better spent on more nurses or teachers. It sounds plausible, because no one asks how we are going to get debt down. The recipe that people who complain about debt interest normally have to reduce debt is to spend less money on teachers and nurses.

Journalists should know better than to play this kind of game, because it encourages an anti-investment mentality. We can see much the same thing happen whenever the time comes for a spending squeeze (what economists call a fiscal consolidation).

It is almost always public investment that gets cut first. This is what happened in 2010 and 2011 under the Coalition government. Investment gets cut first because these cuts do not resonate with the public, and will be largely invisible to most people. Cut the number of teachers or nurses and the public will notice very quickly. Cut spending on new schools or hospitals or roads or railways and it is less immediately noticeable.

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One of the things the Coalition government cut back on was investment in new flood defences. In 2007 the Pitt review said the government should rapidly increase investment in flood defences, because climate change was likely to bring a sharp increase in freak weather events. The Coalition government cut back that spending sharply in 2011 as part of its austerity programme.

No one noticed at the time. But ever since, almost every year, we have seen pictures of houses and shops ruined because of some “once in a century” weather event that brought flooding on a scale that existing defences could not cope with. Some of these floods would have been prevented if we had carried on investing more in flood defences.

For a government to always cut investment first is bad for the longer term health of the economy. In this sense, a government is just like a company. A firm that chooses to carry on working with the machinery it bought decades ago will not have to pay much debt interest, but it will gradually lose out to competitors that invest in more productive, efficient machines.

A country that stops investing in public infrastructure will find everything it does becomes more difficult. The private sector will get less productive, as roads become more congested. If the government puts less money into research and development, so will private sector firms. As the Budget made clear, the big problem for the UK since 2010 has not been the deficit, but poor productivity growth. Public investment, if it is well chosen, can help improve this.

Of course there have to be limits on public investment. But the way we judge an extra package of investment, like the one proposed by Labour ahead of the 2017 election, is not to ask how much the debt interest costs will be. No large firm judges whether to invest based on the size of interest payments on any borrowing. What it does is compare the return, which for the firm is additional profits, with the interest rate on borrowing. If the profit rate is sufficiently greater than the interest rate, the firm should invest. The same is true for government.

Looking at the debt interest costs of investment is wrong because it looks at just one side of the equation. If the investment the government undertakes increases economic growth, the government collects more taxes which could easily exceed the debt interest costs. When interest rates are as low as they are now, public sector investment can easily pay for itself. Even if it does not, it makes us all better off because average incomes will be higher.

Those who go on about debt interest are making a similar mistake to those who said we had to reduce the deficit rapidly in 2010, because otherwise the markets would stop buying our debt. Again, they were only looking at one side of the equation. The recession meant people were borrowing less and therefore saving more, so the demand for UK government debt was going up faster than the deficit increased the supply. We know that, because interest rates on UK government debt came down.

What about the idea that any extra borrowing in order to fund public investment needs to be paid off at some point. Again, this is an example of looking at just one side of the equation. Dynamic firms do not worry about paying off their debt if that borrowing allowed them to purchase productive assets to set against that debt. Exactly the same is true for the public sector. We still use roads and schools and hospitals that were built as a result of government borrowing many years ago.

For the last seven years, our economic policy has been run by those who have wanted to cut public spending and investment, and it has been a disaster. As the Budget forecasts showed, just as growth in the rest of the world is picking up, growth in the UK economy is slowing. In part that is a result of a failed strategy that has put cutting government debt, and debt interest, over and above the health of the economy.

It is now time to invest in the economy, and the media needs to recognise this. The question interviewers should ask is not what debt interest costs will be, but how politicians will pick the projects that will be good for the economy rather than white elephants.

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