The plan for a budget surplus law is not financial prudence, it’s economic vandalism – Ben Wray explains why
CHANCELLOR of the Exchequer George Osborne is proposing a new law that will make budget surpluses at “normal economic times” legally binding, so that Government’s are not allowed to run a deficit.
It’s the height of fiscal reponsibility, isn’t it? A budget surplus – taking in more in taxes than you spend – will mean public finances are safe and secure and we won’t have another economic crash.
Or so George Osborne wants you to believe–and the Labour leadership contenders appear to have accepted.
These five graphs–from such radical anti-establishment sources as the Office for Budget Responsibility and the Office for National Statistics–paint a very different picture.
The ‘Osbornomics’ of a budget surplus will actually help to imperil the economy, putting more pressure on household debt and private bank lending, and lead to the same sort of circumstances that caused the economic crash in 2008.
1. What goes up must come down – public surpluses = private deficits
As 79 world renowned economists pointed out in a letter to Osborne about his budget surplus proposal, if the public sector runs a surplus–more coming in from tax than it spends–another part of the economy must be spending more than they are bringing in, i.e running a deficit.
“Surpluses and debts must arithmetically balance out in monetary terms, because every credit has a corresponding debit. In other words, if one sector of the economy lends to another, it must be in debt by the same amount as the borrower is in credit,” the letter read.
Economists call this ‘sectoral balances’: what goes up in one part of the overall economic finances, must come down in another.
As Graph 1 from the OBR shows, as Osborne has reduced the deficit, the amount of corporate and household net lending has fallen into the red. If Osborne meets his projections to get a primary fiscal surplus in public finances, corporate and household debt will increase further.
Lets bare in mind–it wasn’t public debt that caused the economic crash. A combination of unsustainable household debt and corporate debt is a much better place to look to understand why the crash happened.
Poor house owners given mortgages they couldn’t afford began to default too frequently, triggering a panic in private banks as they realised that they weren’t going to get back many of the loans that they had sold. As these loans were repackaged throughout the financial economy, all the big banks were liable, leading to the crash and the subsequent bailout, which is why the red line in Graph 1 collapses in 2008-09, not because of an unsustainable level of debt.
Therefore, reducing the amount of money in the economy by insisting on budget surpluses could have the opposite effect than intended–it could be fiscally irresponsible in the long run.
As Kingston University economics professor Steve Keen has pointed out , the rate of increase of private debt “has gone from as low as 4 per cent of GDP in 1954 to as much as 15 per cent of GDP before the crisis of 2008”.
“The problem with relying upon an ever-increasing level of private debt should be obvious: you can’t rely on it, because at some point the private sector will refuse to take on more debt. That’s what happened bigtime in 2008–and led to the economic crisis as both the amount of money in the economy and the economy itself actually shrank,” he continued.
Professor Keen’s conclusion?
“The responsible thing is to run a deficit so that the private sector doesn’t have to rely excessively upon borrowing money from the banks.”
2: Debt can fall while deficit rises – and the current debt is not at historically high levels
The important thing about public debt – the historic amount in which the state is in debt – is not the amount in total, it is the amount of debt as a percentage of GDP. This is what determines whether the debt is sustainable or not and a strong guarantor for the national economy.
Therefore, the deficit can come down, but the debt can go up if the economy is not growing or contracting. Just as the deficit can increase, but the debt can come down if the economy is growing strongly.
This latter example is what happened in British capitalism’s golden age from 45′ until ’73, where the deficit increased year on year but the debt fell because of sustained economic growth over two decades.
Graph 2 shows debt as a percentage of GDP in the late 1940’s reaching a 200 year peak due to the costs of the second world war and the massive borrowing by the 1945 Attlee government to build the NHS and a huge council house programme. The debt then rapidly declines over the next twenty years, not due to austerity, but due to rapid economic growth. In fact there was a nearly PS100bn increase in public expenditure over this period.
The experience of the post-war boom is that certain types of government borrowing support growth, like long-term government investment in infrastructure projects. It may increase the deficit in the short-term, but in the long-term it can boost GDP, increase employment and incomes and boost productivity, therefore raise tax returns. The alternative of private borrowing to fund investment – as we will see – is much more risky and can create more debt in the long run.
But UK debt should not be of particular concern at the minute. Graph 2 shows debt as a percentage of GDP is not at a historically high level. The IMF has described UK debt as at a “sustainable” level, and said that trying to reduce it too fast could puncture economic recovery.
3: Borrowing from the private-sector increases corporate debt and impoverishes people and the public-sector in the long run
Graph 3 takes some explaining, but it is useful as a good case study in how trying to reduce the deficit can increase public debt in the long-run.
When George Osborne became Chancellor in 2010, he increased the rate at which local authorities could borrow from the UK Government’s Public Works Loan Board by one per cent. It might not sound like alot, but the Local Government Association warned that it could cost local councils 25 per cent in interest payments.
Councils went elsewhere to get loans – 90 per cent switched over in one year to commercial banks. The banks offered low “teaser rates” of interest to sucker them in, before hitting them with hikes up to nearly two times the amount it cost to borrow from the government, known as ‘Lobo’ loans.
Councils overnight started going to RBS rather than the government for loans, and have got RBS shareholders rich whilst impoverishing the publc. Therefore Osborne may have got some debt off the Treasury balance sheet, but it adds on more for future generations to pay off at local government level.
The same can be said for PFI’s. PFI’s became popular with politicians in the Tony Blair era as a way to get things done without borrowing from the government. But the reality is that PFI contracts were made in such a way as to become more costly over time, with councils paying back much more than they put it in, increasing its debts.
It is cheaper for government to borrow money than a private company because it is a very wealthy guarantor. Putting extreme limits on government borrowing just means more risky, rather than more secure, investments are made, like PFI’s and Lobo’s.
4: Household debt as a percentage of income is set to rise to historically high levels
Graph 4 shows the projection for household debt as a percentage of income by 2021: up to a level above what it was at when the financial crisis hit in 2008. As mentioned above, surpluses in the public sector create deficits elsewhere in the economy, but these could be managed if overall incomes were rising significantly. They are not: while there has been a small wage rise in the UK over the past two years, it has not nearly offset the decline in income since the beginning of the crisis. The budget announcement of a four-year public sector pay freeze and reductions in in-work incomes will only indebt households further.
Why does this matter? Because the UK economy is so overly reliant on consumption rather than producing and exporting things, even a slight dip in the ability of consumers to spend on retail and mortgage payments could undermine confidence in the UK financial system. Analysis by Jo Michell of the University of the West of England has shown that even if the economy grew at a rate of two per cent, consumption spending would rise to a record-breaking 69 per cent of GDP.
The point is that Osborne’s budget surplus helps recreate the same mistakes of 2008: unsustainable levels of household and private-sector debt, and at the same point, like in 2008, the levy will break.
5: The UK’s balance of trade with the rest of the world is in severe deficit
There is one way that Osborne could run a surplus in the public sector without running a deficit in the rest of the UK economy: if it was causing deficit in other parts of the world through exporting more than it imports. But, as noted above and as evidenced in graph 5, this is far from being the case. Indeed, the UK’s balance of trade with the rest of the world is reaching historically dangerous levels of indebtedness.
As Jonathan Perraton, Senior Lecturer in Economics at the University of Sheffield, pointed out in February , the most recent figures of the UK’s current account are the joint worst since ONS records began in 1955 at – 6 per cent.
“It is widely held that a country’s current account enters the danger zone for sustainability at around 5 per cent of GDP,” Perraton notes.
Pre-Thatcher, the balance of trade payments was the key indicator of economic performance as economies were judged on their output relative to the rest of the world. With industrial decline, the focus has moved away from balance of trade, but it still matters because it is a good indicator of a national economies real dynamism, as opposed to fictitious growth from financial services which, we should always remember, doesn’t actually produce anything.
Since the start of the 1980’s overall industrial output in the UK has actually declined, Italy being the only other country in the EU in which that is the case. The rise of the service sector has offset this to some degree, but as graph 5 shows Britain is importing much more in trade and services than it is exporting.
The way to change this is to invest. Invest in things that increase productivity and boost exports, like manufacturing. But the UK has one of the lowest rates of investment in Europe, and imposing an artificial budget surplus will mean the UK Government is incapable of boosting investment.
Picture courtesy of CommonSpace