Saturday, March 16, 2013

How Big's The Deficit?

Rather bigger than we're led to believe

Dave and George have long boasted about cutting the deficit by a quarter. And if you look at the official numbers, they're right: over their first two years (2009-10 to 2011-12), Public Sector Net Borrowing fell from £159bn to £121bn, equals 24%.

But as you may have seen elsewhere, everybody's authoritative fiscal expert - the Institute of Fiscal Studies (IFS) - now reckons there's a greater than 50% chance that borrowing will go back up again this year. So despite the boasts, and despite all that "austerity" the BBC keeps banging on about, borrowing is actually going up.

Well, when we say borrowing's going up, what we mean  is that it's going up if we strip out a couple of fiddles George has inserted to make sure that the headline total goes down.

Fiddle 1: This year's investment spending total has been artificially reduced by netting off £28bn of investment assets transferred in from the Post Office pension fund. That transfer arises from the government's decision to take direct responsibility for paying retired postman their pensions, so it is very far from being free money. It is a one-off receipt against which taxpayers are now on the hook for a liability well in excess of £28bn. Yes, it's another one of those off-balance sheet jobs that G Brown used to do so well.

Fiddle 2: Government income has been artificially increased by taking into the Treasury's coffers the interest receipts earned by the Bank of England from its Quantitative Easing (QE) programme. As you know,  the Bank has bought £375bn of interest earning assets (mainly government gilts), and had been keeping the income in its own accounts. Now George is taking it, which will cut borrowing by an estimated £6.4bn this year. And yes, that's another stroke that reduces borrowing today, but increases it tomorrow - almost certainly by a lot more than today's reduction.

In fact, the QE programme could end up costing taxpayers quite a lot. Because at some stage, the Bank will have to put the programme into reverse, selling all those gilts it has been buying since 2009. If gilt prices have fallen by then, it will make a capital loss. And gilt prices are highly likely to have fallen because there will be a major seller in the market (ie the Bank), which had previously been a major buyer: instead of propping up prices, the Bank will be undermining them. True, the Bank itself currently reckons the price falls will not be sufficient to wipe out the gains previously made. But in reality, by the time of the sales, inflation is likely to be a whole lot higher than now. Which means interest rates will have ramped up, gilt prices will have crashed, and taxpayers will be on the hook for tens of billions of losses.

Stripping out these fiddles, the IFS reckons that government borrowing is set to increase from £121.4 billion in 2011–12 to £125.4 billion in 2012–13 (or from 7.9% to 8.0% of national income).

As for government debt, during those 13 years of Labour profligacy, the official national debt increased by just over £400bn. Under the Coalition, in just 5 years, debt is projected to increase by around £600bn. Absolutely effin' brilliant.

Of course, there are plenty of people who will tell you we needn't worry about high government borrowing or mounting debt. We're in the middle of the biggest recession since the 30s, and government needs to keep up spending to get us through. Government borrowing may be high in the short-term, but once the economy recovers, tax revenues will come pouring in, spending can be throttled back, and the government finances will be back in the black. So stop worrying!

Sounds great, but how can we be sure the economy will recover enough to do that? If the economy doesn't recover, then tax revenues won't come pouring in, and we won't be able to throttle back on spending. We'll just go on building up a bigger and bigger national debt, until something goes bang. And we most assuredly wouldn't enjoy that.

Economists attempt to get a handle on this by distinguishing between the government's actual budget deficit and what's known as its structural deficit. And indeed, George's main fiscal rule is to eliminate the structural deficit on current spending by five years in the future.

The idea is that the year to year deficit is driven in large part by the temporary effects of the economic cycle, and to get a proper fix on its underlying fiscal position we need to strip out those effects, which will correct themselves as the cycle reverses. That is, as we enter the upswing, tax revenues will automatically grow, and social security spending will automatically fall (the famous automatic stabilisers).

Last December the Office for Budget Responsibility (OBR) estimated that public sector borrowing next year (2013-14) will be about £100bn. And of that £100bn, getting on for £40bn will be temporary cyclical borrowing, the stuff we don't need to worry about.

So straight away we can see that £60bn is not temporary. And of that, well over half is current spending (ie it's not investment). Which is spending we need to rein in soonest.

Moreover, although in theory it's easy to distinguish between the structural and the cyclical components of the deficit, in practice, it's very hard. Nobody actually knows how much of our current economic weakness can be put down to temporary factors, and how much represents a permanent state of affairs. Nobody knows how much of the downturn is cyclical and will reverse, and how much is a loss of all that frothy unsustainable business that built up during the Brown bubble.

The cyclical shortfall between the actual level of output in the economy and potential output is known as the output gap. For 2012, the OBR estimated that the gap was about 3%. However, outside analysts reckoned it could be anywhere between 1% and 5%:

Without going into all the arithmetic, that range of opinion on the output gap translates into a range of opinion on next year's structural deficit running from £40bn up to £90bn. At the high end, that implies that nearly all of next year's deficit will be permanent: it will not automatically disappear as the economy recovers back to its full potential output.

So where's borrowing now?

We'll get the latest detail in George's budget next week, but net of fiddles, it looks very much like it's increasing. It's likely to be higher this year than last, and looking forward, those so-called automatic cyclical factors may not bring it down nearly as fast as many hope.

Spending cuts, George. More of them, and soon.


  1. Anonymous10:35 am

    Great, isn't part of the problem being that welfare including pensions is funded from taxation and not assets? So we had a body of people with an asset backed pension fund, which we didn't have to worry about replaced by a tax payer funded policy.

    When will we be rid of these idiots on all sides of the House?

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  2. "[T]he Bank has bought £375bn of interest earning assets (mainly government gilts), and had been keeping the income in its own accounts. Now George is taking it, which will cut borrowing by an estimated £6.4bn this year."

    I feel very foolish asking this question, but would really appreciate an explanation: How can it be right that a government institution (the nationalised Bank of England) can be conjuring money into existence (QE) and then using it to "buy" government assets (gilts) from ANOTHER government institution (HM Treasury)?

    Perhaps I've missed a step (likely), but it seems very much as though you're describing a process of government printing money and then using it to buy gilts from itself, on which it then has to pay interest. To itself.

    What purpose is being served, here? I absolutely do not understand the thinking behind the process.

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  3. Anonymous2:04 pm

    I've never understood how Government ministers get away with this.

    A company director can't buy a Ferrari on a 50 year HP agreement in the last month of the financial year and put £500,000 as an asset on the balance sheet but only £50 expenditure - the interest - in the profit and loss account.

    Why can't we prosecute ministers?

    I know, I know, they make the law, turkeys and Christmas and all that, but the current war to maintain a free press is worth diddley squat if they never use their freedom to point this stuff out.

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