On Britain’s debt and deficit

The new economics foundation recently claimed that is a myth that Britain is ‘broke’ citing several points in support:

  •  The national debt to GDP ratio is low compared to ratios seen in the last 300 years and low compared to other countries, e.g. Japan, the US and Germany.
  • The amount the government spends on debt interest payments as a %age of GDP is lower than at any time from WWII up to the year 2000.
  • The interest rate of government debt is low and has dropped since 2008.
  • They also cite the fact we have our own currency and central bank and thus more flexibility than places like Greece.

It seems to me that the argument presented fails on several grounds:

  • The fact that we’ve had high levels of debt before does not mean that it was a good thing or that there were not deleterious effects from such high levels of debt. I also note that Britain had an empire for much of the period concerned which will have provided opportunities to mitigate those consequences (in the later stages by letting the colonies go to ease finances by reducing the costs of running the empire) but that’s no longer the case.
  • That some other countries have higher levels of debt does not mean we can assume the current levels of debt are safe or that increasing them won’t cause harm.
  • They ignore the high deficit – spending £120 billion per year more than is received in taxes cannot be sustained for very long before the size of the debt interest payments starts to impinge on the ability of the government to spend money on welfare, public services, etc and on the economy as a whole to produce wealth. This gap has to be closed either through increased tax receipts or reduce spending. Realistically it’ll be a combination of both.
  • National debt effectively represents the total future tax bill that’s been run up by current and previous governments, and thus constrains future governments spending and tax policies. The fact that we have a high debt level implies a drain on national resources stretching far into the future. The fact we have a high deficit implies that the future tax bill is rising quickly too.
  • The official debt figures ignore “off the books” items such as PFI liabilities, pension liabilities, etc that weren’t major issues in the past.
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The impact of the coalition’s plans on Britain’s debt

When considering the impact of the coalition’s spending plans it’s worth noting the impact they claim it will have on the Britain’s debt. There are 3 key figures to consider:

  • The total public debt. I.e. the total amount the government owes. According to the June budget, the official public sector net debt stood at 53.5% of GDP in 2009/2010 and was projected to rise to 74.4% of GDP by 2014/2015, had we stuck to the previous government’s plans. Under the coalition’s plans, the figure for 2014/2015 is just under 70% of GDP by 2014/2015, peaking at just 70.3% the previous year and falling to 67.4% by 2015/2016. In other words, even with the additional reductions in planned spending and increases in tax, the UK’s debt as a proportion of GDP will still grow for the next 4 years.
  • The budget deficit. This is the shortfall between total public spending and tax revenues for any given year. Again according to the June budget, the public sector net borrowing stood at 11% of GDP in 2009/2010, and was projected to fall to 4% of GDP in 5 years time under the previous government’s plans. Under the coalition’s plans, the deficit is projected fall to 1.1% of GDP by 2014/2015, and the “cyclically adjusted” deficit is project to be eliminated that year and go into surplus in 2015/2016.
  • The interest paid. This the minimum amount the government has to spend to service the debt (more needs to be spent to reduce it). This figure was projected to rise from £30.3 billion in 2009/2010 to £67 billion by 2014/2015 under the previous government’s plans. It is now project to rise to £63 billion in 2014/2015 and £66.5 billion in 2015/2016.

Thus the difference between the coalition’s plans and the previous government’s plans is that the former would see the deficit eliminated and the debt as a percentage of GDP starting to fall by 2015/2016, where both would still be increasing under the latter. And these figures are all dependent on economic growth projections being realistic. If growth is slower than expected, then eliminating the deficit within the current timescales will require even larger reductions in planned spending or bigger increases in taxation than we’ve seen thus far.

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On the size of the coalition’s spending cuts

The home page of the TUC‘s campaign against the coalition’s spending cuts describes the campaign as being “against the Government’s deep, rapid cuts in public spending” (emphasis added). A blog called “A Thousand Cuts”, dedicated to critiquing the coalition’s plans has “The slashing and burning of Britain’s public services” as it’s sub-title. The BBC claims the Institute of Fiscal Studies described the cuts as “longest, deepest, sustained period of cuts to public services spending at least since World War II”.

In other words, we’re being told by various sources that the cuts to public spending are going to be larger and more severe than we’ve seen in recent decades. But what are the numbers behind these claims?

The Adam Smith Institute (ASI) summarises the figures on total managed expenditure as follows:

Year TME (£ bn) Nominal change (%) Real change (%)
2010-11 696.8
2011-12 699.8 +0.43 -1.54
2012-13 711.0 +1.60 -0.39
2013-14 722.0 +1.55 -0.44
2014-15 737.5 +2.15 +0.14
2015-16 757.5 +2.71 +0.70

Meanwhile they summarise current spending (covering the vast bulk of “front line services”) as in the following table:

Year Current Ex. (£ bn) Nominal change (%) Real change (%)
2010-11 637.3
2011-12 651.1 +2.17 +0.16
2012-13 664.5 +2.06 +0.06
2013-14 678.6 +2.12 +0.12
2014-15 692.7 +2.08 +0.08
2015-16 711.4 +2.70 +0.69

From these tables we see that under both measures of spending, the budgets will increase in nominal terms every year, and current spending will increase overall in real terms. Note that these figures come from the budget documents themselves and assume inflation of 2%. The ASI conclude:

Now, OK, these are not exactly big rises – but nor are they swingeing cuts that will (a) have any significant effect on the economy or (b) on the public services-using population at large. What the coalition’s spending plans really amount to is a five-year, real terms freeze of current expenditure, combined with three years of significant falls in capital expenditure. The overall impact of that is a a very small, real terms drop in TME (roundabout 1.5%) between now and 2015-16.

I’m not so certain the cuts will be quite as small as that in real terms. Current official measures of inflation are significantly higher than 2%. According to the BBC, the Consumer Price Index was last measured at 3.1% whilst the Retail Price Index (which used to be the main official measure of inflation) was measured at 4.7%. At 3.1% inflation, the current expenditure of £637.3 billion would rise to £742.40 billion by 2015-16 in real terms. The projected £711.4 billion would thus represent a 4.18% cut in spending in real terms rather than a 0.69% increase. At 4.7%, the £637.3 billion would rise to £801.82 billion and the projected £711.4 billion would represent a more significant 11.27% cut.

All of these figures are a far cry from the picture of “deep, rapid” cuts or “the slashing and burning of Britain’s public services” offered by some. Of course, a freeze or small reduction in spending represents a major shift compared to the constant increases in spending under the previous government. Also, it may be that within individual departments there will be more severe cuts than this picture represents since e.g. health spending is being protected.

Nevertheless what we’re actually getting is something in between a freeze and a modest reduction in total spending in real terms.

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On the impact of public spending cuts

Via this comment on a post at Liberal Conspiracy, I came across this argument from Anthony Trew against cutting quangoes that equally applies to cutting public spending in general:

With every quango abolished there will be a number of their employees losing their jobs. With every person losing their jobs there is an inevitable impact on their families. With every family affected there will be a lessening of the spending power of that family. With every family affected spending less money, local businesses will suffer. With each local businesses suffering, economies in whole areas and regions will be affected. With every local business affected every national business that supplies them will be affected too. With every business suffering, their profits will inevitably fall. With the profits of every business falling, tax receipts will fall too.

Given the above, how the hell will we not end up with a double dip recession?

The problem with this argument is that it considers only one part of the picture. One could equally validly argue against increases in public spending (and by implication against the existing public spending we have) as follows:

With every increase in public spending there will be a number of people paying more in taxes(*). With every person paying more in taxes there is an inevitable impact on their families. With every family affected there will be a lessening of the spending power of that family. With every family affected spending less money, local businesses will suffer. With each local businesses suffering, economies in whole areas and regions will be affected. With every local business affected every national business that supplies them will be affected too. With every business suffering, their profits will inevitably fall. With the profits of every business falling, tax receipts will fall too.

Given the above, how the hell will we not end up with a double dip recession?

(*) The government could fund things via borrowing, but that is really just deferred taxation.

In both arguments, the loss of spending power of those affected is claimed to undermine the country’s economic performance. In reality, assessing the impact of spending cuts on the economy will be a matter of balancing the positive impact of the reduced need for taxation  against the negative effect of making public sector workers unemployed and reducing or eliminating the services those workers were providing. If the former is greater than the latter, then the cuts will be a boost to the economy overall. If the latter is greater than the former, the cuts will undermine the economy.

Now I haven’t shown here that the government’s cuts will be either harmful or beneficial to the economy, my point is that simply looking at the reduced spending power of those made redundant via the cuts involves focusing solely on the negative impacts of the cuts.

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Britain’s pre credit-crunch borrowing

Update: Corrected the link to the ONS data.

A lot of commentary regarding Britain’s economy focuses on the huge debts that the government have built up and the effects of the “credit-crunch” and recent recession. When considering this issue, it is worth remembering that Gordon Brown, as chancellor, built up large debts prior to the credit crunch. Using figures taken from a recent bulletin from the Office for National Statistics (see page 15), Britain’s debt going back to 2001 was:

Year Debt (£ billions) Debt (% GDP)
2001 323 30.9
2002 348.1 31.5
2003 380.1 32.4
2004 424 34.5
2005 465.1 36.2
2006 500.9 36.7
2007 634.4 44.2
2008 733.9 51.7
2009 866.2 61.4

Thus we can see that by 2007, the year that Northern Rock ran into trouble, the government had increased the national debt from 30.9% of GDP in 2001, to 44.2% of GDP. This during a period when the economy and tax receipts were both growing.

The government was constantly spending more than it was receiving in taxes from 2002 onwards.

As a result of the credit-crunch and resulting recession, we’ve seen the debt shoot up to 61.4% of GDP since 2007. Had Brown balanced the budget in the years 2002 to 2007, the debt would have been over 13% of GDP lower when trouble hit, and the government would have had more room for maneouvre, probably resulting in a less severe recession as a result.

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Britain’s GDP has fallen by almost 5% since Gordon Brown became PM

Wat Tyler writes:

For the first time ever, Her Majesty has a Prime Minister who has presided over a fall in GDP per capita – and not a small fall either. Since the idiot Brown took over less than three years ago, per capita GDP has fallen by a catastrophic 5%.

Here’s the complete Prime Ministerial record up to end-2009 (per capita GDP at basic prices; ONS data and BOM calcs):

Churchill (1953-55) +7%
Eden (1955-57) +2%
Macmillan (1957-63) +15%
Douglas-Home (1963-64) +4%
Wilson (1964-1970 and 1974-1976) +15%
Heath (1970-74) +12%
Callaghan (1976-1979) +7%
Thatcher (1979-1990) +26%
Major (1990-97) +13%
Blair (1997-2007) +27% (yes, on this measure, he beat Thatcher)
Brown (2007-2009) -5%

Please take a moment to absorb that list. Brown’s record is miles worse that Callaghan’s – despite all those Red Robbo strikes and the Winter of Discontent. And it’s miles worse that Eden’s – widely reckoned to be our worst post-WW2 PM.

Indeed, the damage suffered under Brown has been so extensive, average incomes have now fallen back to their level five years ago – the most dismal five years we’ve seen since the Coronation.

Of course Brown isn’t out of office yet and the final result when he does go may be more favourable to him. However we’ve just experienced the deepest recession of the post WW-II era, and it’s possible it may not be over yet. Also, if the comment about GDP falling back to where it was 5 years ago is correct, it means that the gains made since Labour were re-elected for their third term have been wiped out.

One might complain that in the case of e.g. Thatcher and Major, they both experienced recessions but were in power for a sufficiently long time to see growth return, whilst the current/most recent recession hit Britain not long after Brown became PM and has thus dominated the statistics for his period in office. The problem with this line is that Brown as PM is reaping the consequences of his earlier policies as Brown the Chancellor, i.e. he is primarily responsible for the problems that led to this mess. In the case of the Tories, that was true of the early 1990s recession but the early 1980s recession was an inheritance from the previous Labour government,

An interesting comparison is to look at the GDP with each of the last few recessions and figure out how many years growth were wiped out in each case. Looking at the GDP for each year from 1948 to 2009, courtesy of the ONS, we can see that the 2009 had a lower GDP than 2008, 2007 and 2006. In the previous recession, 1991 was the lowest yearly GDP (though the recession didn’t end until 1992), lower than 1990 and 1989 respectively. In the recession of 79-81, the GDP for 1981 was lower than 1980 and 1979 respectively. In other words the recession has been worse than either of the recessions the last Tory governments had to deal with.

This is reinforced when you look at the %age drop in GDP from the previous high point for each of the recessions. Using the yearly figures, in 2009 the percentage drop was 4.85% (from a high in 2008), for the previous recession it was 1.39% (from a high in 1990) and for 1981 it was 3.38% (from a high in 1979).

Using the quarterly figures, for Q3 2009, the most recent low point, the drop from the previous high (Q1 2008) was 6.03%, where for Q2 1992 (the low point of that recession), the drop was 2.54% from the previous high (Q2 1990). For Q1 1981 the drop was 6.00% from the previous high in Q2 1979. Admittedly, on this measure, that recession is almost as bad as the 2008/9 one in terms of the drop from the previous high, but the 2008/9 recession achieved this drop in a shorter timescale, i.e. it was a sharper recession.

Also, it’s possible the economic woe for the 2008/9 recession isn’t over yet.

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We were misled about the revised growth figures

On Friday, 26th February the BBC (and this misleading ONS press release) were reporting (e.g. this report) that revised figures showed an 0.3% rate of growth in the final quarter of 2009 vs the original 0.1% estimate that quarter, implying things weren’t as bad as had been initially estimated.

What such reports failed to mention (as Edmund Conway reports on his Telegraph blog) was that the ONS revised figures affected earlier quarters of 2009, that the recession was deeper than originally estimated and that we finished 2009 with a lower GDP than was originally estimated!

For example, the current estimate for 2009 Q4 growth, states that the GDP is 3.3% lower for Q4 2009 compared to Q4 2008, where the previous preliminary estimate said it was only 3.2% lower than for Q4 2008.

I.e. according to the new estimates, our economic situation was worse, not better, than the old estimates suggested, yet by focusing on the 0.3% vs 0.1% figure for growth in the final quarter, the BBC and the ONS press release implied that the revisions suggested things had not been as bad as feared.

Background Links:

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