The Liberal Democrats propose to tackle the deficit in a way that means the country would cut less than the Conservatives and borrow less than Labour. Essentially, the economic message delivered in their manifesto is that austerity is necessary as the current debt levels are too high. This will be achieved by a combination of tax increases as well as spending cuts.
But on closer inspection of the manifesto, only £5 billion of the current £27 billion structural deficits will be raised through tax increases. The rest of the savings will come from tackling tax avoidance, departmental savings, as well as welfare savings.
The Liberal Democrats’ claim that cutting the deficit is essential for growth and employment is that it increases business confidence. This statement is misleading and is a result of a general lack of clarity over what government debt is and its effect on the health of a country’s economy.
How important is government debt?
Government debt is the total amount the government owes. The government deficit, on the other hand, refers to the total outgoings of the government when they are larger than its income within a year. This is why although the coalition government has reduced the deficit, the total amount of debt has increased. So, even though the deficit is lower, the UK still needs to borrow money to fund the deficit, which in turn adds to the total debt.
What matters is not the debt itself but rather our ability to pay back the debt. We pay back the debt through our national income which is measured by GDP. This is why the debt to GDP ratio is important as it is a signal of how sustainable the current debt levels are. This ratio has been increasing under the coalition government due to increases in debt and lower growth in the aftermath of the financial crisis.
High debt to GDP ratios can be a problem if it looks like the government cannot pay back its debt. This is because it increases the cost of borrowing for the government and can lead to situations such as Greece where default is a possibility. Even if we think the current debt to GDP ratio is too high, how fast we should decrease this ratio is the most important question facing the UK economy.
How fast should we pay back the debt?
The Liberal democrats (like the Conservatives) want to create a budget surplus by 2017-2018 in the hope that this will bring debt to GDP to a “sustainable level” by the middle of next decade. But what is a “sustainable level” of GDP is a matter of debate. What we do know is that by trying to pay back the overall debt too fast comes at the overall cost of economic growth.
Austerity measures have a negative effect on growth and hence are also hurt by our ability to pay back the debt. This is especially problematic in the current economic climate as monetary policy is currently ineffective in boosting growth.
Although credibly committing to bring down the debt to GDP ratio is important for long term stability, the Liberal Democrats continuation of austerity (even if done more progressively than the Conservatives) will undoubtably come at the expense of growth.
The Conversation’s Manifesto Check deploys academic expertise to scrutinise the parties’ plans.