Ben Wray: 10 things about ‘the deficit’ the No campaign won’t tell you


Common Weal head of policy Ben Wray explains why it’s vital the Yes campaign gets its head around Scotland’s deficit and kills the myths

EVERY DAY the No side fumes over an independent Scotland’s hypothetical government deficit – the difference between what the government spends and what it collects in revenue each year. 

It has become a statement of the obvious to say that the reason for this is the No side really has lost most of its intellectual armoury over the course of the last couple of years: ‘the deficit’ is one of its last weapons and it intends to wield it frequently and furiously.

The most recent spark in the debate came when economist and tax expert professor Richard Murphy expressed his view that there is no proper data on the Scottish economy and that GERS is partly made up of estimates from a number of mainly UK-wide data sets that extrapolate figures for Scotland, and that it is not likely to be totally accurate. 

We have to start challenging the premise that a government deficit, even a sizeable one, is the problem that the No side makes it out to be.

There’s really no good reason why this should be contentious, other than the fact that treating GERS as the holy grail suits the No campaign’s interests at the moment as it shows a hypothetical state deficit in an independent Scotland of nearly £15bn. 

Murphy’s call for better data to be gathered on the Scottish economy should be something that can be supported on both sides of the constitutional divide. The fact that most on the No side appear to be incandescent about such a proposal is telling. 

All of Murphy’s proposals, including focusing positively on what an independent Scotland could do to improve its economy over the medium and long term, I am in agreement with. 

But I also think we have to start challenging the premise that a government deficit, even a sizeable one, is the problem that the No side makes it out to be. This deficit obsession is utterly wrong, misses the real threats to the economy and is rooted in an ultra rightwing view of the post-crash world that has much more to do with an ideological fervour for privatisation than any real evidence that lowering the deficit supports economic security.

So let’s unpack it.

1.) Governments build up debt and finance it using government bonds – this is how states work

Since the 2008 financial crisis the bankers have scored a remarkable victory over our minds, distorting what was really going on to suit their needs. They managed to convince people that a crisis of private sector commercial banking was really a problem of public sector debt, because the public sector poured trillions into keeping afloat collapsed banks and make their rich owners even wealthier. 

This is what economist Yanis Varoufakis calls “bankruptocracy”: rule by bankrupt banks, which make the rest of society – including the state – subordinate to their interests.

Bankruptocracy has been remarkably successful in creating hysterical fear about ‘the deficit’. In reality, states (including the UK state) have had levels of debt as a percentage of GDP (the key indicator) at much higher rates than today over much of the past 300 years.

What actually matters with public debt is the ability of the national economy to finance it. This is done through government bonds, where international money markets invest in the debt knowing a state is highly unlikely to not be able to pay it back due to its role as a creator of money and collector of taxation.

This is how states work – they are uniquely positioned to accumulate debt because of their special role in a national economy. The bankruptocracy and their representatives in the Conservative party have convinced us to draw a totally facile comparison between the state and a household budget that has no basis in reality. 

We need to start being honest – it’s nonsense. Unlike the state, you and I can’t collect taxes and can’t print money.

2.) Increasing the deficit at a time of economic stagnation can be a good thing for the economy as a whole

Anyone that knows the most basic Keynesian economics knows that letting the government deficit grow at a time when private sector investment is especially weak is a smart move, especially if the spending is used to boost infrastructure, improving productivity and encouraging private sector investment. Private sector investment has remained weak in the decade of stagnation since the financial crisis. 

Government borrowing to invest was what the Labour government did after the Second World War, at a time when government debt as a percentage of GDP was three times as high as today. It built the NHS and two million council homes, and created almost full employment. 

We should remind Labour supporters of this today when they wax lyrical about an independent Scotland’s hypothetical deficit – Nye Bevan and his generation would have had no truck with their deficit-obsession politics.

3.) Economies work through sectoral balances – a lower state deficit means a higher household, corporate and trade deficit

When former chancellor George Osborne proposed a budget surplus law which would make running a deficit illegal in times when the economy is strong, 79 world renowned economists signed a letter in The Guardian opposing the move, and in the letter they explained to Osborne how sectoral balances work.

It stated: “Economies rely on the principle of sectoral balancing, which states that sectors of the economy borrow and lend from and to each other, and their 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 economy is always in balance as a result, if just not at the right place. 

“The government’s budget position is not independent of the rest of the economy, and if it chooses to try to inflexibly run surpluses, and therefore no longer borrow, the knock-on effect to the rest of the economy will be significant. 

“Households, consumers and businesses may have to borrow more overall, and the risk of a personal debt crisis to rival 2008 could be very real indeed.”

This graph below shows sectoral balances in the UK in 2015.

The UK actually does have a major deficit problem – it’s just not the state deficit. The UK’s trade deficit – the difference between what it imports compared to what it exports to the rest of the world – is monumental. 

In the 1970s, balance of trade was the main indicator of economic performance before it was relegated to the margins under Margaret Thatcher’s reign. UK household debt is rising fast, too, reaching £1.5 trillion for the first time last January with unsecured credit card usage through the roof. 

If interest rates rise, there is a clear danger of mortgage defaults and a housing crash, which could once again trigger a financial crash. The IMF has also warned of particularly fast rising debt in non-financial corporations, warning that companies are becoming unsustainably leveraged.

There is good reason to believe trade, household and corporate debt deficits are much more of a threat to economic stability than a high state deficit and, to be clear, cutting the state deficit heightens the problem of deficits elsewhere in the economy.

4.) There’s not even any evidence cuts reduce the deficit or the debt – in fact the opposite can be true

The Financial Times reported last week that Portugal now had its lowest deficit for 40 years at 2.1 per cent, brought about by an anti-austerity government. A government that invested, rather than cut, had brought the deficit down. The Portuguese government now expects an upgrade from credit rating agencies.

Meanwhile, Greece has been aggressively pursuing austerity since 2013 and, while in the last two years that has led to substantial budget surpluses, this has hardly put a dent in the country’s debt to GDP ratio which is now just below 180 per cent. Greece’s devastating recession has shrunk GDP falls and harmed tax revenue collection.

In fact, there is scant evidence from anywhere in Europe that cuts are a good way of reducing debt to GDP ratios or even the deficit. The IMF admitted as far back as 2012 that it had significantly underestimated the negative effect of austerity on the wider economy, and changed its fiscal multiplier calculations so that for every £1 the government cuts up to £1.70 can be assumed to be reduced from GDP.

The assumption that an independent Scotland would have to make cuts to reduce the deficit – something Scottish Labour leader Kezia Dugdale repeats constantly as if channelling her inner Osborne – has no grounding in the evidence.

5.) International money markets make investment decisions based on more than just a country’s deficit

Some of the commentary around an independent Scotland’s hypothetical deficit seems to assume an automatic process whereby a high deficit triggers some sort of immediate economic collapse.

In reality, a decision would be made by international investors as to whether to sell or buy Scottish Government bonds based on an assessment of whether, in the future, the value of those bonds are going to go up or down. 

In making that forecast, investors do not make that assessment simply on looking at that year’s government deficit. Perhaps some do, but they are unlikely to be very good investors. Instead, investors will look at a whole range of economic indicators, including total debt, productivity, population demographics, trade deficit, personal debt, median income, potential growth areas, energy resources, and so forth.

The point is this: the deficit Scotland starts with is not as important to investor calculations as where they think that deficit will be in 10 years’ time. 

One area they will examine will be the plans of an independent Scotland’s government to change the country’s fiscal position over the short, medium and long term (remember that all of an investor’s thinking is about what is likely to happen in the future). 

If it can present an effective case for how in the future the economy is going to be in a stronger position to service its debt then it’s likely to attract significant investment from the money markets that will see Scottish bonds as an attractive option, driving down the cost to the government of servicing its debt.

The point is this: the deficit Scotland starts with is not as important to investor calculations as where they think that deficit will be in 10 years’ time. 

Whereas investors look at a country like Greece and see years of recession ahead due to Eurozone and European Central Bank-enforced austerity programmes, an independent Scotland faces no such penury. Those arguing that it would are either not being honest or don’t understand how investors make decisions on government bonds.

6.) The evidence shows the relationship between economic performance and government bonds is complex

Those who argue that Scotland will start with a high deficit, will therefore have a bad credit rating and will therefore be attacked by international money markets, making the cost of debt very expensive and interest rates surge, have to explain why that pattern of investor behaviour does not hold true internationally.

As Common Weal head of research Craig Dalzell has pointed out, there is no absolute correlation between credit ratings and bond yields until the credit rating reaches ‘junk’ status (see graph).

When the UK’s credit rating was reduced from AAA to AA status after Brexit, bond yields continued to fall.

Neither are government interest rates necessarily linear with rising national debt as a percentage of GDP. As this graph below shows, the opposite has actually been the case in the UK over the past 20 years.

7.) Government bonds are at historically low levels – government debt has never been cheaper

In June 2016, UK bond yields actually fell to their lowest rate on record, before bouncing back slightly since then, but still at a historically very low level. 

In some countries – like Sweden, Switzerland and Japan – bond yields have turned negative in the past year – investors are actually paying states to take their money.

While there is different economic theories as to why this is happening, a common view is that there is a glut of global capital controlled by too few people as wealth inequality surges. With nowhere to go, investors seek refuge in the state.

What that means for an independent Scotland is that it is not likely to find it difficult in the slightest to attract international investment in its bonds. In fact, investors are likely to see it as a safe haven for their money. Bond yields will likely be higher than in the UK, but still at levels that makes government debt very, very cheap. 

Of all the things we have to worry about in the current economic climate, the cost of government debt really isn’t one of them.

8.) Even the IMF thinks governments should be borrowing to invest, not cutting

The reality of what has been dubbed ‘debt deflation’ has led even neoliberal institutions like the IMF to push governments to take advantage of cheap public debt to borrow and pour billions into infrastructure, partly in order to try to address the problem of over indebtedness in other parts of the economy (see point 3).

Even the UK Government has responded to this in the post-Osborne era, abandoning plans for a budget surplus law and increasing government borrowing for infrastructure investment, albeit to a far too limited extent.

Those rattling the deficit-obsession drum on Scottish independence have not caught up with the fact that the rest of the world is waking up to reality.

9.) Independence will likely mean Scotland’s debt will be cheaper than the UK’s due to re-financing

While current bond yields are at historic lows, much of the UK’s debt was bought a long time ago and is therefore being paid back at a higher rate. In a report on debt and assets for Common Weal’s White Paper Project, Dalzell shows that an independent Scottish Government would have to issue new debt and therefore start with all of its debt at current bond rates, as the UK Government has already confirmed that it is legally responsible to honour all existing UK debt. 

The amount saved will depend on the specific approach taken to debt and asset negotiations, but it could be up to £2bn per year.

10.) Scotland’s deficit could also be lower than its current share of the UK’s deficit if we make some smart decisions

In Beyond GERS, Dalzell uses an additive model to start building an independent Scotland’s year one budget, rather than just assuming we would make the same spending decisions on matters currently held reserved to Westminster.

Using this model, there is some obvious savings: having a Scottish defence system that is actually about defending the country’s sovereignty, not imperial power projection, could save around £1.1bn, for instance. Other savings include UK pension liabilities, lower debt interest, revenue from civil servant jobs moving to Edinburgh and closing the tax gap. 

All in all, a conservative estimate is a Scottish year one budget at deficit parity with the rest of UK.

And all of this is before you even get to Richard Murphy’s advice about taking a very different medium and long term approach to economic development than the UK’s hyper-financialisation model.

I know that talking about bonds, yields, fiscal multipliers and so forth can be technical and sound very complicated – but the overall point I want to get across is decidedly straight forward: deficit-obsessive economics is Tory economics, it’s economics that makes you think the only thing that matters to the future health of an economy is the state not spending too much in order to justify policies that favour the super-rich at the expense of the rest of us.

Don’t be misled by it when making a big decision on independence.

Picture courtesy of Mario Antonio Pena Zapatería

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