Public debt

A country's national debt - also known as its public debt - is a matter of economic and political significance. It has often been the subject of controversy, and some have considered it to have moral significance.

(terms shown in italics in this article are defined in the glossary on the Related Articles subpage)

Definition

The OECD's broad definition of public debt as "the external obligations of the government and public sector " is in general use, but national definitions differ in detail and produce figures that may not be comparable. The European Union's definition embodied in its Stability and Growth Pact of "General Government Gross Debt" differs in detail from the complete OECD definition.

Overview

Template:TOC-left It is customary in normal times for governments to use borrowing to finance investment, and it is current practice for the main industrialised countries to allow national debt to accumulate to between 40 and 60 per cent of GDP (except Japan and Italy, with percentages of over 100). It is also normal practice for governments to allow national debt to rise to between 70 to 100 per cent of GDP during major recessions - as a result, mainly of the operation of their economies' automatic stabilisers, but also from the use of fiscal stimuluses, intended to compensate for reductions in private sector spending.

Such policies are not uncontroversial, however, and even relatively modest levels of national debt, amounting to no more than 50 per cent of GDP, commonly meet with expressions of concern as being "unhealthy" or even dangerous. Such popular concern may be attributable to an instinctive belief that saving is virtuous and borrowing is discreditable, or to the belief that it imposes unfair burdens on future generations, or to the once universal reverence for balanced budgets - but it is also attributable to rational fears of harmful economic consequences. Public choice theorists oppose government expenditure, even for the purposes of investment, on the grounds that the politicians concerned are mainly motivated by personal gain, rather than a desire to serve the public interest. Austrian School economists argue that fiscal stimulus expenditure is ineffective, partly because of the "Ricardian equivalence" argument that it is nullified by increases in private sector saving and partly out of scepticism about the ability of politicians to manage the economy. Other economists have demonstrated that the use of deficit financing is bound, if continued long enough, to lead to a "debt trap" from which a government cannot escape except by defaulting on its obligations or by expanding the money supply. The 1931 German hyper-inflation, which was caused by the use of "monetisation" to manage high levels of postwar debt, has come to be seen as a dramatic warning of the dangers of deficit financing , and sovereign defaults such as the 1998 default by the Russian government as a reminder that governments are not immune from the dangers of insolvency. Sovereign default among developing countries is not, in fact, uncommon, and although the danger that it it could happen to a major industrialised country is generally considered to be remote, there is fear that a persistent rumour of its possibility might alarm investors to the point of making it self-fulfilling.

The history of national debt

The British experience

In the 18th century and before, it had been the practice of kings to finance their wars by borrowing. It was cheaper than collecting taxes - and it was risk-free because a king could not be called to account for defaulting on his obligation to repay - and "sovereign default" was a frequent occurrence. In England, however, Charles II's "Stop of Exchequer" of 1672 was the last time it happened, because the "Glorious Revolution" of 1688 was followed by the "Financial Revolution" during which Parliament assumed effective control over the national debt. The culmination of that revolution was the creation in 1749 of the "Consolidated Fund" , and the issue of undated bonds known as "consols". Members of Parliament were concerned from the start to reduce the level of national debt, as evidenced by the passage of the National Debt Reduction Act 1786 . Their intentions were frustrated, however by the need to finance Britain's part in the Napoleonic War, and between 1743 and 1815, Britain's national debt increased from £245 million to £745 million, which was twice its national income. A further attempt signalled by a second debt reduction act was more successful and the ratio of national debt to national income was reduced to less than 50 per cent by 1900. But further two wars and the intervening Great Depression raised it again to over 100 per cent. According to researchers at the Institute of Fiscal Studies , it rose to over 150 per cent during the first world war, remained at above that percentage for most of the years between then and 1955. After then it was reduced steadily to about 50 per cent by 1975, and remained at between 45 and 55 per cent between 1975 and 1990 and between 35 and 55 percent through the 1990s.

The United States national debt

In 1783, the United States Congress was given the power to raise taxes, but in 1785, it was found that tax revenues were insufficient to meet the government's expenses and Alexander Hamilton argued the case for the raising of public, arguing that "A national debt, if it is not excessive,will be to us a national blessing." In 1789, Congress established The Treasury Department, naming Alexander Hamilton, as its Secretary, in 1790 it passed the first Funding Act, and by February 1792, interest-bearing government bonds were on sale and the national debt rose to about 25 per cent of national income. However, a strong preference for the maintenance of a "balanced budget" was evident from the beginning, and in a 1793 message to the House of Representatives, George Washington advised them that  "No pecuniary consideration is more urgent than the regular redemption and discharge of the public debt: on none can delay be more injurious, or an economy of the time more valuable." 

Jefferson's Secretary of the Treasury, Albert Gallatin, was a chief critic of Hamilton's methods of debt management, and made it his priority to reduce public debt. This worked for a time, reducing the public debt to $45.2 million by 1811, but was derailed by Jefferson's "Louisiana Purchase."

Debts incurred during the American Revolutionary War amounted to $75,463,476.52 by January 1, 1791. Over the following 45 years, the debt grew.

By January of 1835, for the first and only time, all of the government’s interest-bearing debt was paid off. Congress distributed the surplus to the states (many of which were heavily in debt). The Jackson administration ended with the country almost completely out of debt!

Notably, the public debt actually shrank to zero on January 8, 1835, under President Andrew Jackson. But soon after, it quickly grew into the millions again. The United States went to war with Mexico in May, 1846, over the annexation of Texas and California. The total cost of the war was estimated to be $64 million, and Congress authorized the issuing of additional debt to meet these obligations.

This war of ours, in its magnitude and in its duration, is one of the most terrible. It has produced a national debt and taxation unprecedented, at least in this country. It has carried mourning to almost every home, until it can almost be said that the 'heavens are hung black'."

Abraham Lincoln, 1864, Speech at Great Central Sanitary Fair, Philadelphia, PA

The American Civil War resulted in dramatic debt growth. The debt was just $65 million in 1860, but passed $1 billion in 1863 and had reached $2.7 billion following the war. The debt grew steadily into the Twentieth Century and was roughly $22 billion as the country paid for involvement in World War I. The buildup to World War II brought the debt up another order of magnitude from $51 billion in 1940 to $260 billion following the war. After this period, the debt's growth closely matched the rate of inflation until the 1980s, when it again began to increase rapidly. Between 1980 and 1990, the debt more than tripled. The debt shrank briefly after the end of the Cold War, but by the end of FY 2008, the gross national debt had reached $10.3 trillion, about 10 times its 1980 level.