Why High Debt Isn’t Likely to Imperil Growth

All over the world, governments’ huge fiscal responses to COVID-related fallout has debt in the headlines. Notably, UK national debt crossed the £2 trillion threshold for the first time—surpassing gross domestic product (GDP, a government-produced measure of economic output).^[i] Some worry about the implications of this inauspicious milestone, arguing high debt creates future economic problems or will inevitably lead to crushing austerity (meaning, tax rises and public spending cuts). However, based on our research, debt doesn’t automatically become more problematic when reaching a certain level—other factors matter more.

One common—and somewhat sensible—way to discuss debt is comparing it to GDP. Scaling (comparing one measurement to another in order to provide perspective) is a helpful way, in our view, to make sense of huge-sounding numbers that otherwise lack context. However, we don’t think UK debt surpassing 100% of GDP is too telling. Going over that threshold tends to evoke comparisons to long-struggling economies like Greece, but we think that actually illustrates the fallacy. Governments don’t pay all debt at once. The UK Treasury pays interest and principal on maturing gilts, and they don’t pay it with GDP. Instead, they generally use tax revenues to pay interest and refinance maturing gilts by selling replacements. Our research shows the inability to do that is what led Greece into its severe debt crisis in the early 2010s.

We think the best way to gauge debt’s sustainability is to measure affordability—interest relative to tax revenues. In the UK, interest payments were just 4.7% of tax revenues in 2019, the lowest level over the past 20 years.^[ii] Though this number likely rises based on recent debt issuance and revenue declines due to the recession (a broad decline in economic activity), it likely won’t prove onerous to the UK economy—particularly with newly issued debt carrying historically low interest rates, which are generally a strong indicator of creditworthiness. 

Yet many financial commentators we follow in the UK seem resigned to future spending cuts or tax rises to make the debt manageable. Focus on future austerity seems premature, in our view. Importantly, carrying debt doesn’t stymie economic growth. Consider the United States following the end of World War II. US net public debt (a measure that excludes government-owned debt, which is money the government owes itself) last exceeded 100% of GDP back in 1945 – 1946—reflecting the government’s borrowing for the war effort.^[iii] But the debt-to-GDP ratio fell in the following years even though the absolute level of net debt outstanding didn’t meaningfully dip.^[iv] The reason: Rather than tank, the US postwar economy expanded robustly, outpacing outstanding debt.

Now, history fans might point out that the US Federal Reserve and Treasury had a wartime financing deal. However, the war still added about $192 billion to net debt.^[v] The government didn’t pay off most of this debt. Instead the Treasury rolled over the maturing debt, which is still on the books more than 70 years later according to our analysis. Carrying that debt didn’t prevent the US economy from becoming the world’s largest as measured by GDP. Even if future growth isn’t as swift as it was in the postwar era, we think what matters more is slowing or ceasing—rather than materially shrinking—debt’s relative size to GDP. This doesn’t seem like a stretch to achieve, in our view, given the spike in government spending is likely a one-off response to the steep, COVID-driven contraction—which also skewed GDP downward and seems poised to reverse.

Similarly, the UK shows a competitive economy can carry debt for centuries without hamstringing growth. In 2015, the UK government redeemed the last four undated bonds in its portfolio. These gilts were tied to financing going back as far as the 18^th century—with some related to government bailouts following the South Sea Bubble of 1720.^[vi] Carrying this debt for more than two-and-a-half centuries didn’t hinder growth because the dynamic UK economy kept expanding—shrinking debt’s relative burden on the country’s finances. Some point to austerity in the last decade, but that was a political decision, not an economic one. Moreover, our analysis of UK budget plans going back to 2010—when the UK’s austerity programme began—has found that government spending grew at a slower rate than initially projected rather than shrinking outright. In our view, that isn’t convincing evidence that actual austerity ever happened in a meaningful manner.

We aren’t saying countries can continually take on debt without consequence. However, reality is a bit more complex than presuming a certain amount of debt will tip an economy into troubled waters.