The latest Government Expenditure and Revenue Scotland (GERS) report published yesterday presented Scotland’s public sector accounts until 2013/14. It showed that Scotland had a net fiscal deficit (i.e. a gap between government spending and tax revenues) of £12.4bn in 2013/14. Expressed as a percentage of GDP and including a geographic share of North Sea oil revenues, this represents a deficit of 8.1%.
This level of deficit is high. The deficit for the UK as a whole is 5.6% of GDP. But even the UK’s deficit is high relative to its European counterparts. Of 30 European countries for which comparator information is available from Eurostat, Scotland has the third largest deficit. Only Slovenia and Greece have larger deficits (Spain’s deficit is 6.8%, Ireland’s is 5.7%). Most of these countries are trying to reduce their deficits through some form of “austerity” policy.
All UK political parties are committed to reducing the fiscal deficit. This is a precondition for reducing debt as a share of GDP, which is forecast by the OBR to peak at 81.1% of GDP next year before starting to decline. This debt/GDP ratio is high by the standards of the recent past (since the late 1960s), and is high in relation to other advanced economies (although some, including Italy and Japan, have higher levels). Debt tends to increase during recessions. But the UK experience has been particularly bad during this recession partly because of additional borrowing to support the financial sector, and because recovery has been painfully slow compared with past recessions.
There are three reasons why such a high level of debt may be undesirable. First, unless the debt is being used to finance assets that future generations can enjoy, it forces these future generations to pay for services that are being consumed today. The interest charges on UK debt have increased from £21bn in 2002-03 to £49bn in 2013-14. Scotland’s population share of UK debt interest payments in 2013-14 would have been £4.1bn, slightly more than the combined revenue from council tax and non-domestic rates. These interest payments would form part of Scotland’s annual payment to the UK government if it were granted full fiscal autonomy.
Second, high levels of borrowing make economies less resilient to unexpected shocks, such as recessions. Given that borrowing tends to rise when an economy slows down, entering a recession with already high levels of debt creates a risk that additional borrowing is associated with higher borrowing costs. There are exceptions to this argument, the most notable being Japan, where the debt to GDP ratio is now a staggering 227 per cent of GDP. Its ability to fund such a high level of borrowing is partly explained by its current account surplus, which creates a pool of capital that can be invested in government bonds and partly by high levels of saving within the Japanese economy. Japan is able to fund more than 90 per cent of its borrowing from domestic sources, whereas the UK is reliant on foreign creditors who hold around 30 per cent of UK government debt.
Third, there are known changes to the UK and Scottish economies that will increase upward pressure on public spending and downward pressures on tax revenues over the next two decades at least. Principal among these is population ageing: between 2015 and 2030 the number of pensioners per working age adult in Scotland will increase from around 0.28 to 0.41. Moderating spending growth at present will make more manageable the inevitable increase in spending that will follow from demographic change.
So most parties agree on the need to reduce UK debt as a share of GDP. The key argument is how quickly the deficit should be reduced. Too rapid a reduction may weaken growth, causing the debt to GDP ratio to increase if GDP growth is weakened or arrested. The OBR estimates that the austerity policies in 2010-12 reduced UK GDP by 2%. Further, interest rates are currently very low in most countries, due to the weakness of the world economy. Monetary authorities therefore have little latitude to stimulate demand, leaving fiscal policy as the only macroeconomic instrument available to kick-start growth.
The Conservatives aim to achieve fiscal balance by the end of the next parliament, while Labour and the LibDems aim to only borrow for capital spending by the end of the parliament. Current spending on day-to-day government services should be funded through current revenues. The SNP also accepts the need to reduce the UK debt, but has argued for a slower pace of consolidation than that contemplated by any of the main Westminster parties. As mentioned above, there are grounds for a slower pace of consolidation: faced with an ‘output gap’ (i.e. spare capacity in the economy), and with interest rates as low as they can go, fiscal stimulus (extra spending) could be used to close the gap. This would imply a deferring of austerity but such delay could only be temporary. The arguments listed above for reducing the deficit would still apply.
The SNP is arguing for a slower pace of consolidation at UK level while Scotland itself is in a comparatively weaker fiscal position than the UK. This is arguably somewhat paradoxical. If Scotland was now in the process of becoming an independent country, its weaker finances suggest that it would be having to plan for a more extensive fiscal consolidation than it is currently advocating for the UK as a whole (unless you believe that an independent Scotland would not inherit any of the UK’s existing debt).