Tuesday, 5 April 2016
Deficit? Which deficit?
By an amazingly successful piece of perception management our government has succeeded, since 2010, in convincing us that the government's internal deficit, or excess of current expenditure over current income, is way out of control and that our most important political objective must be to reduce it and, indeed, run a surplus of £10bn year by 2020. This is to be achieved by "austerity" which in practice seems to mean cuts in expenditure, particularly to the poor, and cuts in grants to local government.
"Britain must pay its way," says Gorge Osborne, Chancellor of the Exchequer, again and again and again.
It sounds common sense (especially when compared, as Mrs Thatcher so often did, to household economics) but is in fact nonsense.
First we need to distinguish between the government's current deficit and its accumulated deficit, otherwise known as the national debt.
It is orthodoxy among macro-economists that wise governments should not allow the national debt to exceed 60% of GDP. Indeed that was the qualifying level of joining the Euro and Britain could have met it easily, since when the Euro was launched our national debt was about 40% of GDP, as indeed it remained, (under a Labour government, remember) until the world financial crisis of 2007/8. Then it soared upwards to about 70% of GDP, through a combination of bailing our the banks and a fall in tax receipts as a result of the recession.
This level is higher than orthodoxy recommends, but not dangerously so. These were and are exceptional circumstances. Indeed in even more serious exceptional circumstances, the post 1945-50 period, our national debt was nearly 250% of GDP, but somehow the then government managed to establish the NHS and do all sorts of other useful things.. (The Debt/GDP ratio from 1945 to 2010 is clearly illustrated on an easy to read graph here)
Now to look at the current spending deficit, the one that George Osborne is so anxious to reduce.
It is well above the permitted maximum of 3% or GDP which orthodoxy recommends, and has been so since the crash. However, a look at this graph here shows that until 2007 the Labour government's borrowing was well within this range, much less profligate than the previous Conservative government, and that from 1999 to 2003 the much pilloried Gordon Brown even ran a surplus (ie took in more income than he spent.)
Now what has to be understood is that this national debt is largely "money we owe ourselves." As rich individuals, savers, institutions such as pension funds, insurance companies and other financial institutions, we lend to the government and the interest the government pays us finances our pensions, income from "gilts," insurance policies, unit trusts and other investments. Anyone who has some National Savings holds a part of the national debt. When the "oh-so-anxious-to-be-seen-as-thrifty" George Osborne offered we pensioners a share in the debt at about four times the going rate of interest I was happy to buy a chunk of it.
Clearly the government's borrowing, currently about 5% of GDP, needs to come down to the 3% figure, and even below because that figure should be a long-run figure, less in the good times, but more in the bad times, such as now.
It may surprise some, but steady borrowing at a long run rate of 3% of GDP will actually, because of growth and inflation, reduce the Debt:/GDP ratio. A permanent surplus, as envisaged by Osborne, is nonsense.
Now we come to the deficit that really matters, the Balance of Payments on Current Account. This is the difference between the value of the foreign currency we earn by exporting and what we spend by importing. If there is a surplus then we are more than "paying our way" in the world. If there is a deficit than we are indeed "living beyond our means."
This "balance of payments" dominated the economic headlines from the post-war period up to the 1980s. It is widely believed that the publication of some adverse figures, a flea-bite by today's standards, just before the 1970 election lost it for Harold Wilson., and Denis Healey's need to borrow from the IMF in 1976 for ever besmirched his reputation. (As it happened all the borrowing was paid back before the next, 1979, election, but that didn't impinge on the public's perception, and Mrs Thatcher was elected..)
This balance of external payments account has been in permanent deficit since the present government and its predecessor took office in 2010, and the deficit is getting worse rather than better, as this article and its graph explain. Last week' figures showed the largest deficit since records began in 1948. For the whole of 2015 the deficit was 5.1% of GDP, and was running at a yawning 7% for the final quarter.
This, unlike the government's internal borrowing, is not money within the family, but money which someday has to be repaid to others We are in increasing debt to the rest of the world.
Repaying this debt is the burden we are placing on future generations. It can be done in several ways.
First we can continue to sell off the country's productive resources to foreigners. This means that future generations will be deprived of the profits they make, which will go abroad rather than remain within the country. Or we can improve our productivity. This means that future generations will have to work more efficiently in order for our products to become competitive abroad. That's the hard way. The easier and more likely way is to further devalue our currency. One commentator, Brian Gould recommends a devaluation of 20%. That would mean future generations will have to pay 20% more for their imports, which include the cost of foreign holidays, and work 20% harder or longer or more effectively to finance the same volume of imports.
Righting this Balance of Payments on Current Account (just to spell it out in full again so there's no mistake) is the true test of a government's economic competence and it is the measure on which the Cameron- Osborne partnership should be judged.. So far they are failing miserably.