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Government debt is not consumer debt... not even for housing

Yesterday, Communities Secretary Sajid Javid declared that the government should borrow more to invest in building new homes. That's a good move, because the plummeting amount of social and affordable housing is causing an acute crisis for local councils and their working-class residents. Spending money to resolve major social problems is what the government is for, and that includes borrowing for it.

Rather than take that line, though, Tories are opting to pretend that what they're doing doesn't really count as borrowing:
If you borrow to purchase an asset, then your balance sheet position doesn't change, because you've got a new offset that (almost) exactly offsets your new liability. This is the kind of thinking that underlies Labour's fiscal rule under John McDonnell: you borrow to make sound investments, not to fund your day-to-day expenses, and that way you stay out of trouble. So people are gleeful at another point on which the Conservatives have caved to Labour thinking.

Except that Labour thinking on this point is a bit of a muddle. It's not John McDonnell's muddle - the 'borrow to invest' line is a very common one - but it's a bad one. It only works by convincing people to believe in an analogy - between household debt (like credit cards) and national government debt - which is flawed and deeply hostile territory for Labour.

The argument Nick Boles is pushing has plenty of more detailed variants. The asset you build or acquire is security for the loan; it doesn't affect your overall balance sheet; when interest rates are low, it's foolish not to take the money and make investments with a higher return than the cost of borrowing. These are all good points, if you are an individual making your individual financial decisions. Borrowing against collateral means that the loan (hopefully) won't imperil your other finances, since if need be you can clear the debt by selling the asset. And if you can borrow at 3% per year and invest in an asset that will return you 6%, that really is a very good reason to take the loan.

But the government is not an individual investor. It doesn't need security, because it cannot be taken to court and forced to spend money on its debts instead of its ongoing necessities. The UK government can unilaterally change the terms of all its debt, and has considered doing so quite recently. (There would be some consequences, of course, but we'll get to that.) Whether newly-issued debt is used to acquire an asset or not really doesn't make much difference to the stability of the government finances.

The idea that the government should take advantage of low interest rates to make high-return investments - usually shiny infrastructure is what people have in mind - is also a mistake, because government 'investments' do not earn the government a return. That sounds confusing, because big projects get studies done to determine how much 'return' they will generate, but that's a return that accrues to the whole city/region/country. These studies do matter in deciding whether a government undertaking is worthwhile, but since the return is a completely different beast to ordinary investment returns, it really doesn't matter what the interest rate is. If you or I want to make an investment that yields us a 4% return, then the difference between an interest rate of 3, 4 or 5 per cent is the difference in whether we lose money, break even or profit. If the government wants to make an investment that yields the whole country a 4% return, the government is definitely not going to make a profit no matter what - that's not the nature, or the point, of the investment! - so whether the interest rate is lower or higher than the 'return' is basically irrelevant.*

But that's a pretty technical aside to the core point, which is that government borrowing is a tool of economic policy, not of for-profit investing. The budget should be managed not with a view to making sure the government doesn't go broke, but for the purpose of maintaining good economic conditions for the country. Borrowing and spending has various benefits, depending on what its for. The principal downside is that if the government issues a lot of debt, its interest rates will rise; investors will prefer to lend to the government rather than build factories and so on; so growth will slow and living standards will fall. Higher interest rates also mean the government has higher borrowing costs, which sooner or later forces a choice between raising taxes and spending less on government services, borrowing more and delaying the choice, or just deciding not to pay the debt, which also has costs.

Happily, interest rates in the UK - in general, and on government debt in particular - are incredibly low. They're higher than they were before the Brexit vote, but they are still lower than they have been maybe ever. There is no near-term prospect that government borrowing will damage the economy, whether or not the borrowing is for housing or infrastructure or other 'assets'.

The borrow-to-invest argument tilts in the right direction: that the UK, in a time of economic weakness, should use some government borrowing to address an important social need. So why does this matter? In 2010 what the country needed was to keep borrowing until it could shake off the crash. What it got instead was a ruinous programme of cuts that caused incredible pain, on the basis that, like individual households, the government shouldn't be relying on borrowing when times are tough. Thinking about the budget deficit's macroeconomic effects would have delivered the right answer. Talking as if the government budget had anything to do with household financial decisions caused a catastrophe. Relying on that analogy, even if in 2017 the outcome is good, is not going to be helpful for a future Labour government, or healthy in Britain's probably-rocky economic future.


* This is not quite right. In theory, if the government doesn't borrow this money, it'll get invested somewhere else, and the prevailing interest rate should be an approximation of the returns that investment would generate. So roughly speaking, the return being lower than the interest rate means that the money would be better used somewhere in the private sector, instead of for this particular public project. But the money might not actually get invested in something more productive, and even if it does the private return won't be the same as the social return, so it's still very possible that the government project will be more beneficial to the economy in its entirety.