One of the great rhetorical clichés used in Irish politics currently is one familiar to fans of the Simpsons. It’s the Helen Lovejoy argument, about the effect of our actions on future generations. Whether it be angst-ridden letters to the broadsheets or politicians passing the buck, worrying about how our grandchildren are going to cope with banking debt in particular has become a national pastime to replace property speculation in Bulgaria.
But just how much should we be worrying about the monthly household budgets of our grandchildren come the 2050s? That’s a question I hope to shed some light on below. Before we can look at how much they’ll be forking out for our folly, though, the necessary starting point is to figure out just how much debt there will be in the first place. In my opinion, we can think of three kinds of debt: pre-crisis debt, banking debt, and then what you could call crisis-era deficits.
Scale of the debts
Before the crisis hit in 2008, Ireland had a pre-existing stock of national debt of about €40bn. All told, banking shenanigans will add probably about €50bn to Ireland’s national debt (it could be more, but it could easily be less as well if recapitalisations are repaid in some form down the line). So we are up to about €90bn in debt.
What about other debt? Well, to get a figure for that, let’s assume that Ireland’s austerity measures deliver a balanced budget by 2016. In that scenario, government deficits from 2008 to 2015 (i.e. crisis-era non-banking debt) will add another €90bn or so Ireland’s debt. Given that Ireland’s non-banking debts in an optimistic scenario (most people believe the deficit will be down to 3% by 2016, not 0%), it’s amazing how public anger and grandkid-angst is focused almost exclusively on the banks. (The point could be made that we feel it is money down a black hole, but that ignores the fact that these monies have preserved our €160bn or so in savings.)
But a debt figure of €180bn is just a stock of debt. No-one really lives in a world of stocks, we live in a world of flows, like monthly income or GDP. So what is the flow equivalent of all this debt? Let’s first take a high 6% interest rate. This would mean that Ireland’s annual debt servicing bill would be just over €10bn. Spread across 1.8 million households, this represents a monthly income tax bill of €200 for the average household, with another €215 coming from consumption taxes. Put another way, the monthly cost of Ireland’s “deposit insurance” recapitalisations of the banks will be about €115 per household.
At a 4% interest rate, the equivalent figure would be about €75. Certainly expensive deposit insurance, but small even compared to non-banking debt (€200 a month per household at a 4% interest rate). More importantly, it is considerably smaller than the money the typical household will spend on on-going services like education (€325), health (€540) or social welfare (€770).
Think of the grandchildren!
Still, something like €115 or even €75 a month adds up month on month and year on year. What sort of burden will that represent to our grandchildren?
The important thing to remember here is how compound growth really adds up over time. It seems like a tempting rule of thumb to think that if say GDP growth is 10% a year, in 10 years GDP will have doubled, in twenty years trebled and so on, so that in forty years, GDP will have increased five-fold. However, 10% growth for forty years would mean GDP increased not by a factor of 4 but by a factor of 45! Growth year-in year-out can really mess with the mind.
Now, I’m not for a minute suggesting that any economy – let alone Ireland – will have average growth of 10% every year for the next four decades. But the point about compound growth remains, however, even if what we should be expecting is growth of 2% a year over coming few decades.
Why 2%? Well, while there are the inevitable snakes and ladders of boom and bust, the developed world has seen relatively steady growth in income per capita of the order of 2% a year over the last century. There is little to believe that this will change substantially over the coming century. Much as we love to think “Ireland is different”, sure enough if you look at the last century, the same rule applies. In 1900, per capita income in Ireland was on average – in modern euro terms – €4,100 a year. By 2000, that had risen to €33,000, a rise of just over 2% a year on average.
If Ireland does indeed average 2% growth a year between now and 2050, our grandchildren will have an average income of €77,000 a year, in our purchasing power terms, i.e. adjusting for inflation. Just think how much less we’d be worrying about our debts if our income was more than twice what it is today!
Of course, not only that, over coming decades we should also expect “price stability”, i.e. inflation of about 2% per year. This means that while in terms of how far your euro would go today, our grandchildren will be earning €77,000 a year on average by the 2050s, their P60 certificates will report an annual income of €170,000.
The compounding nature of both economic growth and inflation are hugely relevant before we fret too much about how bad our grandkids have it. At the moment, the typical household has 1.5 incomes, with average output per head €35,000. This means that servicing the debts due to bank recapitalisation represents about 1.8% of the typical household’s income.
By 2050, inflation and economic growth will mean that banking debt will be about 0.4% of the typical household’s income. Worried about the great-great-grandkids? Well, 2% growth and 2% inflation would mean that by 2100, servicing the bank debts would cost one twentieth of one percent of the typical household income.
Keep Calm & Carry On
So would our grandchildren gladly swap to be in our position? I think we’ll find it’s extremely unlikely.
So do your best to ignore those who says things like “Every man, woman and child in the country is in debt to the tune of €25,000 because of the banks”. And don’t pay any attention to someone who says “Our grandchildren and who knows even their grandchildren will still be paying for our mistakes.” Both of these statements are completely true but completely meaningless.
One the first, it is recurring costs of debt matter, not the stock of debt. On the second, the important thing to remember about a country’s debt is that it is never repaid. Because countries, unlike households, never die, a country’s debt is only ever rolled over and at some point growth and inflation mean that it has become too small to worry about.
Remember, all Ireland’s debt from the 1980s never actually got paid off. It was rolled over until the Irish economy grew by enough that we no longer worried about it. Likewise, taxpayers in the UK are still paying off the debts of the Napoleonic Wars of the early 1800s and those of the Anglo-Dutch Wars of the 1650s and 1660s and probably those of actions taken even further back in the mists of time!
Does that mean that any one of us would gladly swap with our ancestors to live with guineas of debts, rather than billions? Of course not!