How and Why do Countries get into Debt?
Friday, February 12th, 2010
If you are a homeowner and a family man and you have, at some time, lived beyond your means in an effort to provide for your family all the things that they want- then you will know roughly how many Western governments feel at the moment.
If, at some time, you had a cash problem and decided the only way to get out of trouble was to rashly throw more and more money into the hat, just to keep things moving and prevent your personal “economy” from collapsing around you. If you kept that going for a long time and then finally realised you could do no ore, had no way out and need help- then you know exactly how some governments feel at the moment.
Governments provide for the people in their countries. Depending on the country involved, they will provide for law and order, health services, upkeep and maintenance of the towns around you, transport (Including roads), education, social services and the vast mechanism needed to keep the life of that country running.
To do all that they need money- a lot of money. They raise most of the necessary funds from all of us, through taxes.
The problem is to get elected they have to make promises and to keep the people who elected them happy (so they will vote them in again) they sometimes (!) promise more than they can afford to deliver. Then something bad, maybe a recession comes along and their revenues fall just when more money is needed for things like the social services, helping the unemployed etc. Either the government cuts back on spending, raises revenue (i.e. taxes) or it borrows money and runs a budget deficit.
Most governments decide that a certain level of deficit is inevitable from time to time, a country can’t keep switching services on and off. At the moment the level of deficit widely regarded as being acceptable, sustainable (and manageable) is 3% of GDP.
Then a bigger problem comes along- say a credit crunch like that of 2007 and governments face a bigger problem. They decide that they need to spend huge amounts of money to keep things running and prevent whole sections of their finely crafted way of life from collapsing. This would cause great hardship and, by the way, make sure they never got elected again!
So- they run up massive government deficits. Greece, the UK, Spain, Portugal, the USA and others all have deficits many times the level that is comfortable. Well over 10% of GDP in many cases. They now face the problem that many struggling families face. They cannot borrow that much without the interest payments becoming totally unaffordable. Indeed, people may not be prepared to lend it to them anyway.
What do they do? They can still try to raise revenue, but where economies are concerned, it’s not that simple. There is a point at which raising tax rates damages the economy so much that little or no extra revenue is raised. It’s also a deeply unpopular thing to do, so it won’t happen anywhere near election times.
Besides, as anyone who’s had to go to any form of debt counselling will have been told, there is only one certain, long term solution for someone who is running up more and more debt and that is to spend less.
That is why whoever wins the UK General Election this year will have to announce huge cuts in government spending, far more severe than any of them are talking about before the election. It is why countries like Greece are announcing cuts severe enough to cause strikes and riots when people heard the measures proposed.
But this is medicine which must be taken, In the USA; the worrying thing is that when budgets appeared aimed at cutting the deficit to $1.3 trillion in the second year, members of congress and the senate immediately started worrying whether these cuts were possible.
They have to be- we, the people, have to understand that these measures need to happen. This is our money governments are spending and they’re doing it to provide us with services... admittedly- they don’t always get it right and much is wasted. However, if the money is not there, then spending levels must be cut before problems get even worse. After all- countries can go into bankruptcy as well and that’s no fun for anyone involved.
Article by Peter Matthews
The views expressed are the subjective opinion of the article's author and not of FinancialAdvisory.com
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