National debt has increased rapidly over the past few years. In 2006/7 general government debt was £577.8bn or 42.9% of GDP. In 2009/10 it was £1000.4bn or 71.3% of GDP. It is set to go higher, with government debt forecast to be around 87% of GDP in 2011. This compares with forecasts of 82% for Germany, 87% for France, 103% for the USA, 134% for Greece and 195% for Japan.
Getting the deficit and debt down has, not surprisingly, become an issue in many countries. In the UK it has become the major current pre-occupation of the Coalition government and on 20 October it is set to announce major public spending cuts as a means of achieving this.
To get a flavour of the government’s thinking and the message that ministers are putting out to the electorate, the following are quotes from the Prime Minister’s and then the Chancellor’s speeches to the Conservative Party Conference:
This year, we’re going to spend £43 billion pounds on debt interest payments alone. £43 billion – not to pay off the debt – just to stand still. Do you know what we could do with that sort of money? We could take eleven million people out of paying income tax altogether. We could take every business in the country out of corporation tax. That’s why we have acted decisively – to stop pouring so much of your hard-earned money down the drain. We are already paying £120m of interest every single day thanks to the last Labour government. (David Cameron)
It’s the borrowing that doesn’t go away as the economy grows, and we have £109bn of it. It’s like with a credit card. The longer you leave it, the worse it gets. You pay more interest. You pay interest on the interest. You pay interest on the interest on the interest. We are already paying £120m of interest every single day thanks to the last Labour government. Millions of pounds every day that goes to the foreign governments we owe so they can build the schools and hospitals for their own citizens that we aren’t able to afford for ours. How dare Labour call that protecting the poor? (George Osborne)
Let’s unpick this a bit. Who earns the interest? The answer is that it is paid to holders of government debt in the form of government bonds (gilts), national savings certificates, premium bonds, etc. In other words it is paid to savers, whether individuals or pension funds or companies.
Does it all go abroad? In fact 29% of gilts are held abroad. The rest are held by British residents. Thus some 70% of the interest rate paid on government debt goes to British residents and supports pensions and savers. It can thus be seen as a transfer from taxpayers to savers.
Because of the record low interest rates many pensioners who rely on savings interest have seen their incomes fall dramatically. Others draw income from a ‘self-invested personal pension’. The amount that can be drawn each year is based on tables according to a person’s age and the current 15-year Treasury gilt yield (currently 3.45%). Thus the lower the rate of interest, and the less the yield, the less that can be drawn.
So who are the gainers and losers from high general government debt and attempts to get it down? Read the following articles and look at the data and then try answering the questions.
Articles
Britons have donated £7m to help pay off the national debt (but that’s a drop in the ocean) Mail Online, Daniel Martin (9/10/10)
A trillion and rising: Britain’s £1,000,000,000,000 debt means it is now paying as much in interest as it does for defence Mail Online, Hugo Duncan (1/10/10)
Spending cuts “not enough”, say small firms Telegraph, James Hurley (8/10/10)
UK public finances post record August deficit Guardian, Julia Kollewe (21/9/10)
Another paradox of thrift The Economist, Buttonwood (16/9/10)
Data
The gilt market UK Debt Management Office
Gilt market data UK Debt Management Office
Overseas gilt holdings UK Debt Management Office
Public sector: current position ONS (30/9/10)
Public sector finances ONS Statistical Bulletin (21/9/10)
Government deficit and debt under the Maastricht Treaty ONS Statistical Bulletin (30/9/10)
Contributions to the government deficit and debt ONS Statistical Bulletin (31/3/10)
Questions
- Explain the difference between central government, general government and public-sector deficits and debt.
- Who loses from a rising public-sector debt? Who gains?
- Conduct an international comparison of (a) the level of the government deficit and debt and (b) their rate of growth over the past few years.
- What is meant by the ‘yield’ on a particular gilt?
- If gilt yields fall, does this mean that the government pays less on existing gilts? Is it likely to pay less on new gilt issues? Explain.
- How do cuts affect the distribution between savers and borrowers?
This week, we have seen some major potential changes in the UK’s welfare state. One key change involves child benefit. (see Who won’t benefit from child benefit?) However, a more recent development stems from a problem that has built up over a number of years and is not just peculiar to the UK: Pensions.
As technology advances and medical procedures improve, there has been a general increase in life expectancy for both men and women across the world. People are living for longer and longer and hence pensioners can be in retirement for over 30 years. This is over double the retirement time we used to see decades ago. Therefore, pensioners are eligible to receive their state pension or their private pension for much longer and hence the cost is becoming unsustainable.
Lord Hutton has led a review into public sector pension schemes and has concluded that public sector workers should be paying higher contributions. Lord Hutton has said that employees should be working for longer and hence retiring later. This would increase their contributions throughout their lives and also reduce the time period over which they receive a pension, hence cutting costs. There was also a recommendation that ‘final-salary pension schemes should be scrapped and changed to so-called ‘career-average’ schemes. The final-salary scheme benefits high earners and not those who make gradual progression up the career ladder. This possible change should certainly reduce the pension you are eligible to receive and hence should positively affect the sustainability of pension provision in the UK.
However, public sector workers who may face higher contributions and have already, in some cases, faced pay cuts or pay freezes, are unsurprisingly upset. They argue that accepting work in the public sector means accepting a lower wage than they could achieve in the private sector. The compensation, they argue, is the reward of a higher pension, which could be about to change. However, the independent review has found that the contributions made by the public sector do not reflect the true cost of the benefit they receive in their pension. This is likely to be a contentious issue for some time to come. Below are some articles considering this, but keep a look out for further developments.
Articles
Public sector pensions report explained BBC News (7/10/10)
Public sector pensions review: Q&A Telegraph (9/10/10)
Pensions reforms to focus on high earners Independent, Simon Read (9/10/10)
Why Lord Hutton could make public pensions bills bigger … not smaller Financial News, Mark Cobley and William Hutchings (8/10/10)
Lord Hutton: I busted the myth that public sector pensions are gold-plated Telegraph, Lord Hutton (8/10/10)
Key points of UK public sector pension review Reuters (8/10/10)
Public pensions review recommends higher contributions BBC News (7/10/10)
Public sector workers paying ‘less tax’ due to generous pension rules Telegraph, Myra Butterworth (8/10/10)
Asda closes final salary pension scheme Telegraph, Jamie Dunkley (9/10/10)
Hutton report: he’s no friend of gold-plated pensioners Guardian, Patrick Collinson (9/10/10)
Asda to close final salary pension scheme BBC News (8/10/10)
Lord Hutton: what the pension revolution means for public servants Telegraph, Emma Simon (8/10/10)
Report
Independent Public Service Pensions Commission: Interim Report Pensions Commission, Lord Hutton October 2010
Questions
- What is the purpose of a pension? Think about the idea of redistribution.
- Why should average-career pension schemes be less costly than final-salary pension schemes? Which is the most equitable arrangement?
- What are the key problems that have led to the pensions problem in the UK?
- What are the main recommendations of the independent pension review?
- How is opportunity cost relevant to problem of pensions provision?
- Is it fair that public sector workers should pay higher contributions towards their pensions?
- The BBC News article, Public sector review recommends higher contributions states that: “The recent decision to uprate pensions in line with the consumer prices index (CPI) rather than the retail prices index (RPI) has shaved 15% from the cost of the schemes.” Explain why this is the case?
Some numbers are a newspaper editor’s dream! One such number this week was -3.6%. This was the fall in house prices in September reported by the Halifax (part of the Lloyds Banking Group). This certainly helped to alert a large audience to the downward momentum in house price growth that has been underway since about the start of the summer. While the Nationwide Building Society reported a 0.1% rise in September it is significant that both Halifax and Nationwide estimate that across the three months to September house prices actually fell by around 0.9%. In other words, the average UK house price fell by 0.9% in the third quarter of the year.
The annual rate of house price inflation, as the name suggests, compares house prices with the same point in time a year ago. The impact of the house price falls in the third quarter has been to reduce the annual rate of house price inflation to around the 3% mark. While the annual rate is still in positive territory, an obvious concern is how long this will be the case. Well, we can expect the annual rate to fall further because the UK saw strong house price growth in the final quarter of 2009 – the Nationwide estimates this to have been 2.2%. If I (Dean) was to throw my hat in the ring and hazard a guess as to the annual rate of house price inflation in the final quarter of 2010, I’d be inclined to say that it would be around the zero mark. If my crystal ball is found to be right, it would mean that house prices will end 2010 no higher than they finished 2009.
Now this is going to surprise you, but there has been considerable agreement amongst economists as to the reasons behind the recent house price falls. In short, it has been shifts in housing demand and supply. The evidence, such as that from estate agents, points to increases in houses prices during the second half of 2009 and the early part of this year as having induced additional housing supply. This means that estate agents saw instructions to sell increase strongly. People felt a little more confident about putting their property on the market and there was also a recovery in the volumes of new homes constructed.
So far, so good, you might think. But, as this year has moved on growing uncertainty about the economic environment and the on-going difficulties facing many potential buyers, especially first-time buyers, in obtaining mortgage credit, has contributed to a weakening of demand. The impact on the number of potential first-time buyers has been particularly acute because, by being increasingly credit-constrained, they have in effect become increasingly deposit-constrained too. The point is that buyers, especially first-time buyers, are being asked to find relatively large deposits to compensate for limited mortgage credit and both their limited ability and willingness to find these deposits is impacting on housing demand. So with a weakening demand we have been left with what Rightmove describes as a ‘supply hangover’. The effect has been for prices to fall.
It is a feature of housing markets that demand–supply imbalances induce considerable volatility in house prices. Going forward, it will continue to be the relative magnitudes of instructions to buy (housing demand) and of instructions to sell (housing supply) that will determine the path of house prices. Just how imbalanced will those estate agents books remain? How long will the supply hangover persist? Could supply increase further as people rush to sell and thereby further destabilising the market? Or will sellers begin taking property off the market, deciding that now is not the time to sell? Questions like these help to show just how real and how exciting the concepts of demand and supply are. Demand and supply are not concepts confined to the pages of textbooks they are alive and at work. The UK housing market demonstrates just how alive they are!
Articles
House prices record worst monthly fall ever Independent, Alistair Dawber (8/10/10)
Regions slip behind in bleak housing market Financial Times, Norma Cohen (8/10/10)
What next for house prices? Telegraph, Kara Gammell (8/10/10)
Fears grow for new market crash as house prices plummet Daily Record, Holly Williams (8/10/10)
Property price plunge blamed on need to sell The Herald, Helen McArdle (8/10/10)
Housing market crash feared after average house prices take record plunge Guardian, Jill Treanor (7/10/10)
UK house prices fell 3.6% in September, Halifax says BBC News (7/10/10)
Data
Halifax House Price Index Halifax (part of the Lloyds Banking Group)
Nationwide House Price Index Nationwide Building Society
Rightmove House Price Index Rightmove
Live Tables on Housing Market and House Prices Department of Communities and Local Government
Questions
- 2010 has been a year of contrasting fortunes for house prices. See if by using a demand and supply diagram you can illustrate the impact of demand and supply shifts on house prices in the first half of the year and then do the same again for more recent months.
- What do Rightmove mean by a ‘supply hangover’? What factors do you think will determine whether this effect persists?
- You become an estate agent. You buy 2 big books. One is to be used to record instructions to buy and the other instructions to sell. You have a meeting with your staff where you discuss those factors that you think will determine how full these two books will be from period to period. What factors do you think you are likely to identify? What impact would one book being fuller than the other have on house prices?
- Explain what we mean by a potential house buyer being credit-constrained. What is meant by a potential buyer being deposit-constrained? Why might first-time buyers be more deposit-constrained than other types of buyers?
- You often hear people talk about the housing market. But, what do we mean by a market? And what do we mean by a housing market? Do prices in all housing markets behave in the same way?
- We’ve seen that there are several institutions that publish an average house price figure. How do you think the likes of Halifax and Nationwide do this? What of Rightmove? Are there any other ways of estimating the average house price? Can you think of any problems that might arise with these estimates?
- It’s now your time for you to dust-off your crystal ball. Imagine that you are employed to write a monthly commentary on UK house prices. What would you expect to be reporting in the coming months?
Multinational companies bring many advantages to host nations. Whether it is creating jobs, income, investment or sharing technology, governments across the world try to encourage firms to set up in their country. However, once a multinational has been set up, it’s natural for the owners and managers to favour their own countries when decisions have to be made. If there is some new investment planned, where to put it will be a key decision and not just for the firm. New investment may mean new jobs and better working environments. If job cuts are necessary, the decision-maker’s country of origin may determine where they occur.
This so-called ‘Headquarters effect’ is apparent in the case of Siemens, which has guaranteed the safety of all German jobs, both now and in the future. Those employees in the UK are understandably concerned. If job cuts are needed and German workers will not be affected, it takes little intelligence to realise that their jobs may be at risk. The following discussion by Robert Peston considers this issue.
British jobs, for German workers BBC News blogs, Peston’s Picks, Robert Peston (7/10/10)
Questions
- What is the ‘Headquarters effect’?
- The article states: “The HQ effect implies that when a British plant is owned by an overseas company, it may be more vulnerable to being closed down if the going gets tough”. Why is this the case?
- What are the advantages and disadvantages of multinational investment to (a) the multinational company and (b) the host country?
- How is multinational investment affected by the business cycle?
- It Trent UK were to shut down or if a particular office was closed in one part of the country, what type of unemployment would be created?
In his speech to the Conservative Party conference, the Chancellor of the Exchequer, George Osborne, announced that from 2013 child benefit would not be paid to any household where one or both parents had a high enough income to pay tax at the 40% rate. This means that if either parent earns over £43,875, they will receive no child benefit for any of their children. If, however, neither parent pays tax at 40%, then they will continue to receive it for all their children. Thus if both parents each earned, say, £43,870, giving a total household income of £87,740, they would continue to receive child benefit.
Not surprisingly, people have claimed that it is very unfair to penalise households where one person earns just over the threshold and the other does not work or earns very little and not penalise households where both parents earn just below the threshold. So what are the justifications for this change? What are the implications for income distribution? And what are the effects on incentives? Are there any people who would be put off working? The following articles look at these questions.
Articles
How benefit cuts could affect you Guardian, Patrick Collinson and Mark King (5/10/10)
Q&A: Child benefit measures will be messy Financial Times, Nicholas Timmins (5/10/10)
Cameron Defends Cut in Child Benefits for Stay-at-Home Mothers Bloomberg Businessweek, Thomas Penny and Kitty Donaldson (5/10/10)
Three million families hit by child benefit axe Telegraph, Myra Butterworth (5/10/10)
George Osborne’s child benefit plans are characterised by unfairness Telegraph letters (5/10/10)
Child benefit: case study Telegraph, Harry Wallop (5/10/10)
Child benefit cuts ‘tough but necessary’ say ministers BBC News (4/10/10)
Child Benefit Changes – Should Parents Take a Pay Cut? Suite101, John Oyston (5/10/10)
No such thing as an easy reform BBC News blogs: Stephanomics, Stephanie Flanders (5/10/10)
Child benefit saga: Lessons to be learned BBC News blogs: Stephanomics, Stephanie Flanders (6/10/10)
Speech
Higher rate taxpayers to lose child benefits from 2013: extracts from speech BBC News, Nick Robinson (5/10/10)
Our tough but fair approach to welfare Conservative Party Conference Speech, George Osborne (4/10/10)
Data and information
Child Benefit: portal HMRC
Child Benefit rates HMRC
Income Tax, rates and allowances HMRC
Questions
- Assess the fairness arguments for not paying child benefit to any household where at least one person pays tax at the 40% rate.
- For a family with three children, how much extra would a parent earning £1 below the threshold have to earn to restore their disposable income to the level they started with?
- What incentive effects would result from the proposals? How might ‘rational’ parents respond if one parent now stays at home and the other works full time and earns over £43,870, but where both parents have equal earning potential?
- What income and substitution effects are there of the proposed changes?
- Discuss other ways in which child benefit could be reformed to achieve greater fairness and save the same amount of money.
- What are the arguments for and against tapering the reduction in child benefit as parents earn more?