The National Debt in Perspective

By Robert Neild

The nation is now being persuaded that the problem of the national debt is so bad that we cannot avoid years of misery. A look at the history of the debt suggests a rather different picture. Prof Robert Neild, University of Cambridge, provides a historical perspective.

Britain, a leader in the management of government finances, has maintained a national debt without default for more than three centuries. The ratio of debt to GDP has often been far higher than it is today.

Some history

After the Napoleonic Wars, the debt reached 260 per cent of estimated GDP. For more than fifty of the previous hundred years, Britain had been at war. Our tax system, though superior to that of most countries, and strengthened when Pitt introduced the income tax in 1798, could not produce nearly enough revenue to match wartime military expenditures, including the subsidies we paid to allies.

There followed ninety-eight years in which we were not engaged in a Continental war. The debt fell to 24 per cent of GDP. That reduction resulted scarcely at all from reduction of the debt, almost entirely from a more than eightfold increase in the money value of GDP. That is an annual rate of growth of just over 2 per cent, compound. Since the price level was reduced by the influx of cheap food from the Americas and Antipodes late in the century, the burden of the debt was aggravated by deflation.

The financing of the 1914-1918 war was so loose that the debt went up 12 times, but since the price level doubled the debt ratio rose only to 127 per cent. In the years following the war severe measures to tighten the budget were repeatedly introduced, but they were frustrated by the reduction in GDP caused partly by those very measures. The ratio of debt to GDP went up, not down. Although prices fell substantially, the money value of the debt was not reduced in any inter-war year significantly below the 1919 level.

The aim of official policy after the 1914-1918 war was to cut expenditure in order to reduce taxation from wartime levels and reverse inflation to the point where the pound could be returned to gold at pre-war parity. Sharp cuts briefly reduced the deficit in 1920, but in the depression that followed debt went up and GDP went down. Consequently the ratio of debt to GDP rose to 176 per cent in 1923, in which year recorded unemployment reached 12 per cent, and the wage rate index had been reduced by 30 per cent since 1920 amidst industrial unrest which culminated in the General Strike of 1926. By 1929 there was some recovery, but the Wall Street crash, together with the British government’s deflationary response, caused unemployment to reach 20 per cent in 1933 and the debt to GDP ratio to reach nearly 180 per cent. A reduction in the debt ratio came after 1933 when GDP rose in response the devaluation of the pound in 1931, the introduction of cheap money and, later, the loosening of the budget (substantially disguised by window-dressing) for the sake of rearmament.1

Variations in GDP had a stronger effect on the balance in the budget in the inter-war years than before. Social benefits and progressive taxation had been introduced in 1911-12, and the level of government expenditure and taxation had settled at roughly 20 per cent of GDP after the war, compared with 10 percent before. But budgetary orthodoxy did not change. It was still held that the budget should be balanced: that a deficit, by diverting funds from productive to unproductive uses, ‘crowded out’ private investment. The Keynesian insight that expenditure cuts and tax increases might reduce output and hence weaken the budget was not entertained.

A radical change came at the beginning of the 1939-1945 war, brought about by the acute needs of war and the ingenuity of Keynes in devising means of meeting them. In his General Theory, published in 1936, Keynes, using the case of a market economy with no taxation or public expenditure, had shown why persistent unemployment may come about through inadequacy of total demand for the potential output of a market economy.2 In three newspaper articles published in 1939, and re-published in 1940 in a pamphlet entitled How to Pay for the War, he compared the wartime prospects for total demand in the economy with potential production, using early national income accounts.3 ‘The huge rise in government expenditure, he argued, would create more demand than the economy could meet, unless private spending were to be sufficiently curtailed by taxation; if it were not so curtailed, the gap would be closed by inflation. In the budget of 1941, this doctrine was adopted as official orthodoxy.’4 The politicians did not fully implement the wartime measures proposed by Keynes, which included a scheme to supplement income tax with temporary taxation to be repaid after the war. Much reliance was placed on direct controls to limit demand and to hold down prices. But the understanding of budgetary policy was transformed. It was seen to be a matter of demand management.

In the period of post-war reconstruction and the period of Cold War rearmament that followed, the task was to contain excess demand. Then, as normal times returned, the task was to stimulate or check demand so as to induce full employment. The balance in the budget no longer guided policy. Rather, it was assumed, rightly, that if demand was managed so as to employ the economy just to the full and foreign trade was kept in balance, the government's borrowing (or repayments of debt) would match the savings (or dis-savings) of the private sector: the balance in the budget was now the tail, not the dog.

In the twenty-five years from 1945 to 1970 this policy led to the reduction of the ratio of debt to GDP from 225 per cent to 67 per cent: while the national debt increased by just over 50 per cent, GDP went up more than five times. Inflation, which averaged 4 per cent a year, caused more of the increase in money GDP than growth in the volume of output, which averaged 2 per cent a year. Compared with the miseries of the inter-war years, this was an age of great prosperity. ‘You’ve never had it so good’ and ‘Invest in Success’ were Conservative Party slogans of the era. With the welfare state now established, the level of taxation and public expenditure were 40 per cent or more, twice as high in relation to GDP as in the inter-war years: the reaction of the balance in the budget to changes in GDP was correspondingly greater.

Since 1970 the debt to GDP ratio has not changed greatly. Having fallen to 67 per cent in 1970, it declined further in the next two decades and then rose recently to 76 per cent in 2010. This is substantially higher than the figure used by the government — 53 per cent for 2010 — which is net of the assets it holds, including bank shares acquired in recent rescue operations. To achieve historical continuity I have stuck to the gross debt.

The small change between 1970 and 2010 in the relationship of debt to GDP has been the consequence of the debt increasing 32 times and the GDP 28 times, one almost in step with the other. Inflation, which reached an average of 14 per cent a year in the 1970’s when Heath and Callaghan were faced by surges in the price of oil and by the reaction of the then-powerful trades unions to the consequent squeeze on real wages, was at first the main cause of the increase in the money GDP; but in each subsequent decade inflation declined, till from 2000 to 2010 it averaged only 2½ per cent. Real GDP grew at an average rate of two per cent or more in each decade till 2000 to 2010.

This history suggests two lessons for today. First, today’s ratio of debt to GDP does not look abnormal, let alone alarming. Second, the coalition government’s policy of trying to tighten the budget by sharp cuts in expenditure is a near repetition of the policies of the inter-war years. It is having the same counter-productive effects: by depressing GDP it is preventing the intended reduction in the budget deficit, and it is causing social distress. It has been justified partly by invoking again the primitive doctrine of the balanced budget, partly by the alarmist suggestion that cuts have been urgently needed to prevent a loss of confidence in our national debt comparable to that afflicting Greece and some other fiscally-ungovernable countries.


Was this alarmism necessary? Was the government right when it suggested that foreigners might take fright at the size of our budget deficit if dramatic action was not taken?

The guarded but unmistakable message of alarm from the Chancellor in his emergency budget speech on 22 June 2010 (Hansard col. 166) was this:

This is an emergency Budget, so let me speak plainly about the emergency that we face. The coalition Government have inherited from their predecessors the largest budget deficit of any economy in Europe, with the single exception of Ireland. One pound in every four we spend is being borrowed. What we have not inherited from our predecessors is a credible plan to reduce their record deficit - this at the very moment when fear about the sustainability of sovereign debt is the greatest risk to the recovery of European economies. Questions that were asked about the liquidity and solvency of banking systems are now being asked about the liquidity and solvency of some of the Governments who stand behind those banks. I do not want those questions ever to be asked of this country. That is why we have set a brisk pace since taking office.

To obtain some evidence by which to judge this alarmism I have put together statistics of the budgetary position of Britain and a selection of European countries in 2010, together with an index of the level of corruption in each country. The budget and debt figures follow standard European definitions and so differ slightly from the British historical figures above and from those used by the government and Office of Budget Responsibility. The corruption index has been included to serve, in the absence of anything better, as a proxy indicator of the ability of a country to cut government expenditure or raise tax if that is needed to correct the balance in its national budget. If a country has much corruption it is likely to have weak government with limited ability to enact or enforce budgetary restraint; and vice versa. The index ranks countries by their perceived levels of corruption, as determined by expert assessments and opinion surveys.

  1. Top are two ‘good’ countries: Denmark which is first-equal on the corruption index with New Zealand and Singapore; and Sweden which comes second-equal with Finland. In both, debt in relation to GDP is relatively low at about 40 per cent; the budget is close to balance; taxation is high.
  2. In the second group are Britain, France and Germany. Their scores on the corruption index are very respectable. In all three government debt as a percent of GDP is close to 80 per cent, with Britain’s slightly the lowest of the three. All have significant budget deficits. Britain’s deficit is the largest at 10.3 per cent; its taxation is lowest at 40 per cent of GDP.
  3. Next are Spain and Portugal with significantly worse corruption scores, rather high budget deficits at around 10 percent of GDP; debt is 61 percent of GDP in Spain, 93 per cent in Portugal; both have low tax revenue in relation to GDP.
  4. Last come two ‘bad’ countries, Italy and Greece. Italy comes sixty-seventh on the corruption index between Rwanda and Georgia; Greece comes seventy-eighth. Greece’s figures show debt of 145 per cent of GDP, a deficit of 10.6 per cent and low tax revenue. Linked to its bad corruption score, that looks a toxic mixture, as it has proved to be. Italy’s figures are not so bad: debt at 118 per cent, a deficit under 5 per cent and tax revenue at 45 per cent of GDP.

How would one judge the British government’s credit if one looked at these figures alone? Our deficit — the one figure picked out by the Chancellor — is high, but our debt to GDP is average and our tax ratio is low. Our good corruption score indicates that we are capable of raising tax or cutting expenditure. And, it might be added, our history is outstandingly good. Few if any other countries have managed their national debt for 300 years without default. One would conclude that some action was needed, but not that there were any grounds for alarm.


The application again of the balanced budget policy of the inter-war years, justified by alarmism, is leading us into an unnecessarily deep recession.

The remedy lies in judiciously loosening the budget and keeping the exchange rate down so as to boost demand. Then the GDP will recover, the budget balance will improve, unemployment will decline, and it may become appropriate to tighten up again. Only if demand is revived will the measures being taken to encourage business investment and improve the training of labour bear fruit. With inadequate demand for their products, businessmen will not invest; with inadequate demand for their labour, trainees will not get jobs.


  1. See Roger Middleton, Towards the Managed Economy: Keynes, the Treasury and the fiscal policy debate in the 1930s, London, 1985, pp.80-83 and 106-109.
  2. J M Keynes, The General Theory of Employment Interest and Money, London 1936.
  3. John Maynard Keynes, How to pay for the War: a Radical Plan for the Chancellor of the Exchequer, London, 1940.
  4. J C R Dow, The Management of the British Economy, 1945-60, Cambridge, 1964, p.7.


I have a comment on the contribution by Mark Harrison entitled ‘Surely you’re joking, Mr Keynes’ (Newsletter no.157, October 2011) concerning his critique of the regressions offered by Chick and Pettifor (C and P) as part of their Keynesian history of macroeconomics over the past century.1 In order to test how changes in the budget have influenced the debt/GDP, they chose as their measure of the budgetary stance (the independent variable) the change in government expenditure on goods and services, nothing else. They totally omitted changes in government revenue and changes in expenditure on social benefits (and other transfer payments) on the grounds that they are partly the endogenous consequence of changes in GDP. This might have been justifiable if changes in tax rates and in the rates of benefits had been negligible components of policy compared with changes in expenditure. But that is not so, except possibly in wars. Changes in tax and benefit rates have been a major feature of peacetime budgets for the past century, a point that can be demonstrated with some precision for those inter-war and post-war years for which cyclically adjusted measures of government revenue and expenditure are available.2 While C and P’s descriptive analysis is valuable, their regression analysis is suspect because of this peculiarity of their independent variable. Apparently unaware of this problem, Prof Harrison takes C and P’s data and, after specifying a different equation, finds the association that they found to be absent. From this result (and some rather combative arguments) he concludes strongly but imprecisely ‘Our country cannot afford to spend its way out of debt.’

I find this a worrying example of what has happened to economics since it became so heavily focused on the study of mathematical techniques rather than the careful analysis, in words as well as numbers, of the evolution of the world around us. It is surely a mistake to suppose that one has proved anything much about causation by finding, or failing to find, an association between two out of the mass of variables, measurable and immeasurable, that are in play in a complex problem like this.


  1. Victoria Chick and Ann Pettifor, The Economic Consequences of Mr Osborne: Fiscal consolidation: Lessons from a Century of Macro Economics,, June 2010.
  2. Roger Middleton, op.cit., p.135, for the years 1929-39, and T.S Ward and R.R. Neild, The Measurement and Reform of Budgetary Policy. Institute for Fiscal Studies, London, 1978, p.42, for 1964-1979
From issue no.156, January 2012, pp.20-22.

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