Number 2: The UK Spending Deficit What is it and must it be eliminated now?

Transcription

1 Economics: the plain truth A series of plain briefings for Reps and Activists Number 2: The UK Spending Deficit What is it and must it be eliminated now? By squeezing families and businesses too hard, choking off the recovery and so pushing borrowing up, not down, the government s economic plan has completely backfired. Rachel Reeves, Shadow Chief Secretary to the Treasury, FT, 22 November 2012 The UK government raises revenue from taxation, from charges for services and from the sale of assets, such as property or mobile phone licenses etc. And it spends money on health, education, welfare benefits, defence, infrastructure investments etc. If a government raises more money than it spends in a year, it is called a budget surplus. These are not common but the UK had a budget surplus in 1998 and in 2000, both under a Labour government. If a government spends more money than it raises it is called a budget deficit. In this case a government has to make up the shortfall by borrowing from institutions in Britain, like pension funds, or from abroad. So there is a strong link between the UK government s annual budget deficit and Public Sector Net Borrowing for that year and analysts tends to focus on the government s annual borrowing figure, rather than the actual deficit on spending. Any new borrowing during a financial year will be added to the government s existing national debt, which is the outcome of the government s surpluses and deficits over the years. Can I look at one year s figures and know if the UK is on track? No, you have to look at figures for many years together and you cannot look at one month, or even one year as a snapshot. Why? UK Governments hope that our economy will grow, such that the total value of goods and services produced in the UK, (Gross Domestic Product, GDP), increases each year. But even when we exclude unusual factors such as wars and natural disasters, it is clear that the pattern of growth is irregular. There have been periods of years when the economy grew more quickly than average, followed by periods in which growth was weaker. This has been called the economic cycle, and in the past it was thought to be typically years long. When Gordon Brown claimed to have abolished boom and bust what he meant was that he had evened out the rate of growth and eliminated the impact of the economic cycle. It is known that the instability resulting from the economic cycle depresses business investment,

2 and causes unemployment, so eliminating the little boom and busts was seen to be an important aspiration. On a graph, in exaggerated form, the economic cycle looks like this: The aim is to remove all the little jagged edges or shark s teeth, to enable businesses to have a stable environment in which to make investment decisions. This graph shows the variations in the rate of growth for each quarter, and you can see how it is an unstable environment for a business to formulate plans in. It also shows the big recession in and the huge recession that began in 2008 from which the UK economy has not yet recovered. But if you are going to understand the significance of the figures for government deficits today, you have to understand what the figures are typically like, and what they have been like in recent history; or you will be susceptible to spin, the abuse of statistics and lies. What has the economic cycle to do with deficits and surpluses? We should not expect the government s expenditure and income to balance each and every year, rather its expenditure and income should balance across the economic cycle. In a period of slow growth we should expect the government to have less income from personal taxes and corporation tax and for its expenditure on welfare benefits to increase, causing a cyclical deficit. In the periods of stronger growth we should expect government to have a higher income from personal and business taxes and a lower expenditure on welfare benefits, generating a cyclical surplus. This relationship is called the economy s automatic stabilisers. In a downturn a government is supposed to run a deficit!

3 So the surplus should balance the deficit across the length of the economic cycle? Sorry, it is not quite that simple. It is accepted that governments may choose not to balance their income and expenditure over an economic cycle if the cumulative deficit incurred is spent on investment projects, such as infrastructure or stronger education and training resources. These investments must increase the productive capacity of the economy in future generations. In UK this is called the government s Golden Investment Rule. So what is a structural deficit? At the end of an economic cycle, in normal times, economists can analyse the sequence of annual surpluses and deficits that a government has incurred. After adjusting for the proportion of debt that can be set aside as investment, that will reliably produce growth, the government s finances should balance. If a deficit remains it is called a structural deficit. This part of a government s deficit has in reality been used to pay for current spending on services. If a government continues to run a structural deficit year after year eventually lenders will become cautious, demanding a higher rate of interest for loans made to it and that country will potentially be in a spiral of worsening debt and possible default, when it cannot repay its loans. Enough of the theory, how bad is the UK s deficit? Look at the chart below and you will see that governments in the UK, Labour and Conservative, have routinely run an annual budget deficit. UK budget deficit and party in power Source: The Guardian Whilst the UK economy was growing at a more or less constant speed, and the world economy was growing too, those deficits were not unstable and the ratio of government debt to GDP rarely exceeded 40 per cent, and was often much lower. The Labour government up to 2007 was not reckless with spending and neither the annual deficit nor the accumulated national debt was a problem. The 2008/2009 global financial crisis was a game changer that the UK, and other countries, were not prepared for. Now the table on the next pages looks scary, but do not be afraid. People who are trying to deceive you do not give you all the information you need. The statistics opposite are produced by the Treasury. They show the real story of the government s expenditure and income, and of its annual deficit. And the real story about the government s debt accumulated, and sometimes paid off, over many years.

4 The first column is the financial year. The second column shows whether the government had a deficit or a surplus on its current expenditure, basically was government income more or less than the money it spent on public services, defence and welfare benefits. Key Fact: Notice how in some very strong growth years governments, Labour and Conservative, had surpluses and paid off some national debt; 88/99-90/91and 98/99-01/02. Key Fact: Notice how in the majority of years, government s run small deficits, the aim being to keep the ratio of government debt to Gross Domestic Product below 40 per cent. Key Fact: Notice how when there is a recession, such as in 1991/92 and 2008/09 government finances worsen as tax revenues decline and spending on benefits increase. This happens to any government, Conservative or Labour. What is important is to ensure that growth returns quickly to the economy, to generate bigger income tax, VAT and corporation tax revenues and then to pay off the debt by running surpluses. This is what Labour did in 1998/99 and the years up to 2001/02. Key Fact: The recession in 2008/09 is deeper and longer than the recession in 1991/92. The third column shows the annual government deficit as a proportion of the size of the economy in that year. One of the conditions of the Maastricht criteria is that governments would have annual deficits less than 3 per cent of GDP, because this is believed to be a sustainable level of debt in a growing economy. Key Fact: In the 29 years until 2008/09 the UK s government deficit was always below the 3 per cent target, even before the target existed, except for the four years associated with the recession under the Conservatives, when the deficit to GDP ratio was 5.6, 6.3, 4.8 and then 3.3 per cent. Economic recessions cause all governments to have budget deficits, what is important is the policies that those governments then follow policies to promote growth. The fourth column is government investment in things like school and hospital buildings and infrastucture. The figures tend to get larger over time, because of the impact of inflation. These investments should increase the productive capacity of the economy and the new taxes generated should make them self-funding, paying off the borrowing. Key Fact: The Labour government increased investment spending in the period 2001/02 and 2007/08 and the higher deficits in those years were because of increased investment not unaffordable spending on current services. The fifth column is the government s borrowing for that year, to fund the difference between current spending and investment and its income from taxation etc. Key Fact: Government borrowing in 2007/08, even without compensating for inflation, was lower than in 1992/93, 1993/94 and 1994/95 under the Conservatives. Key Fact: The economic crash of 2008/09 massively hit the government s tax revenues and the government invested heavily in an effort to make the recession less deep and brief. The sixth column shows the government s accumulated debt over time. Key Fact: in 2007/08, before the crash, the ratio of government debt to to size of the national economy was 36.7 per cent, within the 40 per cent target, and much lower than the ratio it inherited from the Conservatives in 1997, when it was 42.1 per cent. The crash in 2008 destabilised the government finances, just as it did in 1991/92.

5 Year Gov t Spending + or bn Surplus/ Deficit % of GDP Gov t Net Investment bn Gov t Net Borrowing for year bn Gov t Debt % of GDP 1979/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /13 (-95) (-6.0) (-3.4) (92.0) (71.9) 2013/14 (-74) (-4.5) (23.4) (98.0) (75.0) 2014/15 (-52) (-3.0) (23.1) (75.0) (76.3) 2015/16 (-30) (-1.6) (21.8) (52.0) (76) 2016/17 (-1) (-0.1) (22.1) (21) (74.3) Commentary Thatcher wins the election in In the next 10 years the government runs small annual deficits and the ratio of government debt to GDP decreases The recession at the beginning of the 1990s causes a massive deterioration in public finances, with very large deficits on current spending. Government debt to GDP ratio rises substantially. Labour wins election in 1997, and begins a programme of running surpluses on current spending and paying off government debt, so the debt to GDP ratio falls rapidly, seeking to build a reputation for fiscal responsibility. Government expenditure on investment increased and so its annual deficits increased, funded by increased borrowing, but still within the Golden Rule. Some analysts argue that the deficits and borrowing were excessive and that the UK had developed a structural deficit. More spending on unemployment benefits, the fall of tax revenues and the cost of stimulus programme caused a massive increase in the government s annual deficit. These are projections from the Office of Budget Responsibility and are dependent upon the Government s austerity programme working. The outcome might well be worse than this. The UK Budget Surplus, Deficit, investment and National Debt: Source: Treasury Statistics

6 In 2009/10 the UK government borrowed 159 billion, that is 159,000 million. Could the UK sustain that level of budget deficits? In the long-term the answer is no, public finances do have to be brought back into stability. The Coalition s declared aim was to eliminate the deficit on current expenditure by It has missed its own growth targets by a very long way so far and so it has already pushed back the elimination of the projected deficit on spending on services to 2016/17. Soon it will extend its austerity programme even further into the future, because its policy is failing. And here is the mother and father of all controversies The Coalition government believes the best way to bring the UK s finances back to balance is to reduce the budget deficit by increasing taxes and drastically cutting government spending. This is known as Fiscal Conservatism. However, the government s austerity programme, introduced to reduce the deficit, has stalled the economic recovery and contributed to the double dip recession we saw in the UK at the end of 2011 and the first half of The alternative economic analysis is that at a time of recession, or weak economic growth, it is the government s duty to invest in new productive capacity to create the environment in which existing businesses can grow, in which new businesses can be formed, and that a government should invest in public services at this time. This creates quality jobs, in turn bringing the government new corporation tax and income tax revenues and it simultaneously reduces expenditure on unemployment benefits. This is not irresponsible spending. It is still important to balance the government s finances, but it is only possible when growth and employment has been promoted. This is called counter-cyclical fiscal policy, because in a recession a government injects money into the economy to boost growth, and in a boom period, the government should take money out of the economy to stop the economy from over-heating, thus tempering inflationary forces. In the long term there should be controlled deficits, controlled surpluses and effective investment that is self-funding and so there should not be a structural deficit. This policy is derived from Keynesian economics, and it was the mainstream economics view in the Western world. It is based on the analysis of, and response to, the Great Depression in the 1930s. The Coalition s focus on short-term deficits is politically motivated and deeply ideological. This policy of fiscal conservatism has been tried before, in the 1930s, and it failed catastrophically. Counter-cyclical policy can be seen at work quite clearly in the Conservative government s response to the recession in the UK in 1991/92. The recession caused 6 years of large deficits when the government s income fell and its expenditure on services and benefits increased, meanwhile the government investment during those years was also raised. Critically, this was followed by a period of stronger government finances and some national debt was paid off, ironically, by the Labour government. If you oppose spending cuts today you are not a deficit denier. You have facts, history and economic theory on your side. SERTUC is the Southern & Eastern Region of the TUC Congress House, Great Russell Street, London WC1B 3LS Briefing published 24 November 2012