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Try as he may, Osborne cannot “eliminate the deficit”

Osborne digging a hole, based on original by by coljay72The Fabian Society invited Nicola Smith of the TUC, Dan Corry – once a Labour government adviser – and me to address their Summer Conference ten days ago. The theme: how can Labour restore its economic credibility with the electorate? The audience was large – about 300 earnest, well-informed and assertive Fabians. The discussion was lively, with a buzz, as the session immediately following was to be a hustings for Labour leadership candidates.

The need for the biggest British opposition party to restore a degree of economic credibility is urgent – both in its own interests, but also in the public interest. But it will be tough, with little help expected from a majority of the economics profession.

Economists are divided into two camps, with microeconomists – those who specialize in the branch of economics that analyses the market behavior of individual consumers and firms – the dominant majority within academia and amongst economic commentators.

As a result, in discussing the economy as a whole, most economists tend to draw macroeconomic conclusions from microeconomic reasoning. In other words they tend to extrapolate from the experience of an individual, household or firm – to government and the wider economy. Like George Osborne they discuss the government’s finances as if the government can be compared to a household.

This has confused the electorate (not to mention politicians) which rightly believes that households should “live within their means”, “balance their budgets” and “eliminate their deficits”.  (Although of course, many households, with both assets and a relatively secure income, make sensible long-term investments in for example, a home. We do so by borrowing large sums long-term.)

But governments do not operate as households do, as explained below. This has not prevented the Chancellor from pretending that government can.  He’s so determined to maintain this flawed, and blatantly ideological narrative: and members of the opposition Labour Party are so eager to echo the narrative, that I feel it only right to rehearse the opposing arguments again…and again.

So as a guide to a series of rebuttals, I will reference the Chancellor’s recent speeches – including one delivered on 20 May, 2015 to the CBI.

“We’re going to ….eliminate the deficit”

Despite his five year experience of failing to “eliminate the deficit” the Chancellor had this to say on 20th May, 2015:

So in this Parliament we’re .. going to deal with our debts and eliminate the deficit….. fixing the public finances so our country lives within its means”

What’s the problem with this statement from the man at the top of a department – the Treasury – that boasts some of the cleverest economists in the country?

Just this: no matter how determined he may be, the Chancellor cannot eliminate the deficit – the balance between government income and expenditure.

While you and I can cut our overdrafts by cutting our spending, or by increasing our income – the all-mighty Chancellor cannot do the same. The public sector deficit is not dependent on his actions, or the government’s policies. It is dependent on economic activity in the economy as a whole. If the economic ‘cake’ (that is employment) shrinks, the government deficit will rise. As the ‘cake’ expands, the government deficit will fall.

The OBR puts it well:

Movements in the budget deficit are in part the result of the ups and downs of the economy. When the economy is strong, the deficit will be lower as taxes flow in and welfare costs are reduced. The opposite is true when the economy is weak.”

The budget deficit is an outcome – of decisions made by both the private and public sectors to expand or contract activity; of the levels of both public and private employment; of the amount collected in tax revenues. However while the Chancellor can’t “eliminate the deficit”, he can cut government expenditure and investment. Or increase government expenditure and investment.

In other words, it is not possible to assess the stance of the Chancellor’s fiscal policy from estimates of the public sector deficit – the outcome. But an expansionary fiscal policy can lead to growth in activity and employment, so that, in a recession, public sector expenditure and investment creates employment, generates tax revenues, saves on benefits and welfare payments and thereby reduces the deficit.

A policy of fiscal consolidation or contraction, at a time when the private sector is in a slump, suffering from an overhang of debt, weak productivity, a lack of confidence and is hoarding cash and withholding investment, will cause the deficit to rise.

So the debate is not between those who would “slash the deficit” and those who would “postpone” the reduction in the deficit.

Instead the debate is between those who would cut expenditure and investment in a slump, as opposed to those who would stimulate public expenditure and investment at times of private sector weakness.

Mr Osborne knows full well, and from bitter experience that he cannot cut the deficit.  As Business Insider notes: “the government’s June 2010 projections forecast that the budget would be balanced by 2014/15, the fiscal year just gone.” But that was not to be.  Despite substantial cuts to government spending, “the [OBR’s] March 2015 outlook put the 2014-15 deficit at 3.3% of GDP.”  That’s a lot of red ink. The Office for Budget Responsibility expects the deficit to be about £75 billion in 2015-16 in total, or £46 billion excluding investment borrowing. The deficit of 3.1% referred to by Business Insider is for the current budget, i.e. excluding investment borrowing.  With investment borrowing, it amounts to around 4% of GDP.

It gets worse. Contrary to Mr Osborne’s fervent hopes and promises, the OBR expects UK public sector net debt to peak relative to the size of the economy in 2014-15 at 80.4% of national income – the highest ratio since the late 1960s. (Net debt, the OBR notes, was less than 40 per cent of national income prior to the slump that followed the financial crisis.)

This chart from HSBC Economist Liz Martins shows why Mr Osborne failed to “slash the deficit.”  He cut spending and public investment, and the outcome was that tax revenues fell, and the deficit rose. The dotted red line shows what Mr Osborne expected would happen to tax receipts if he cut government spending. The red line shows what actually happened.

The black line shows the steep decline in government expenditure as a percentage of GDP.

Which all goes to show: unlike a household, cutting government investment and spending when the private sector is weak, can increase, not eliminate the deficit.

 

This article first appeared at Debtonation

 

15 Comments

  1. this is a valid analysis, but the big issue is the public do not understand this.

    how do we get people to understand that the government is not like a household – and that he already planned to eliminate the deficit and this was not achieved in 2014-15?

    its impossible at the moment for Labour to do this and almost inevitably will be with the economists letter this week getting a poor response. Some wider initiative is needed, linked to the democratic deficit which is also growing

    A false analysis says that as we are short of money, cut the number of councillors and MPs

    trevor fisher

    1. Robert says:

      But labour will try to explain they can, because the Tories can so labour will also.

      This is why you get they are all the same.

      Labour we will not tax or spend we will not borrow, and you get they are all the same.

      Labour is playing the Tories game and the Tories are better at the pack of lies.

    2. Matty says:

      Maybe, we can remind people of Herbert Hoover who made balancing the budget a top priority after the Wall Street Crash with disastrous results. We can look at Greece today as well.

      1. J.P. Craig-Weston says:

        The abject poverty imposed on Romania by Nicolae Ceaușescu in the 1980’s is also worth remembering for much the same reason.

        1. Robert says:

          We will have Brown and Cameron to remind us all.

      2. Rod says:

        The PLP haven’t bothered to counter the Tory argument because they propose the Tory solution.

        It’s not credible to say the Tories are wrong then offer the same Tory solution.

  2. J.P. Craig-Weston says:

    I find myself somewhat uncomfortable with this line of argument, (that has almost become an article of faith,) although I agree completely that in a sovereign economy, (and there perhaps is the rub,) with control of it’s own currency etc the deficit as such it not necessarily the real issue.

    I also think as do many other people, that Osbourne’s obsession with American neolibral economic policy is simple a spurious rational, a cheap excuse if you will, for other more political social policies that will already be only too familiar from the modern American history. The history of American intervention in the third world, which is what the UK increasingly comes to resemble.

    Under the American financial rules, enforced by the World Bank and the IMF, governments are now only permitted to spend our money on private, (read American operated,) commercial projects and with private companies, (again read American,) and are not allowed to operate anything, (like the NHS,) independently of the, run for profit, private sector.

    Even our massive foreign aid budget, (both absurd and grotesque, whilst here in UK benefit claimants are being turned away by the job centre; to steal, beg or just to starve or even to die of neglect and poverty,) is simply another form of corporate welfare, (disaster capitalism,) and funds what are effectively international commercial corporations not or at least not directly, the starving and desperate children that are alway being waved in our faces to justify it.

    The real problem with deficit spending as with Keynesian economics is that it is supposed to create conditions under which at some point the economy is supposed to, almost magically, recover, (which was not the experience of FDR’s new deal for example, which had almost run out stream by the time WW II came round and changed the game; despite repeated injections of cash into the American economy from government.)

    So what can we spend it on that will create a long term and sustainable recovery, creating real jobs and prosperity for the majority of people here in UK and not just massive wealth for the chosen few?

    Post industrial Britain, (which has sometimes been described as, the Detroit of Europe,) has no significant adds value manufacturing or services base left, most UK companies are now foreign owned and controlled, paying little or no tax and what few natural resources we still have, (shale gas for example,) are being exploited, (in the true sense,) by these same foreign owned and controlled corporations and are therefore in practice of little or no real benefit to people living the UK.

    So how do we earn our way in the world?

    1. Mervyn Hyde says:

      J.P. I agree with much of what you say, as you may well have read on Michael Meacher’s Blogs I have indicated that in a world where we import most of our finished goods from the far east, we need a totally new perspective.

      That is achieved by printing money directly into the economy to fund our public services and infrastructure projects, such as council housing and local government expenditure.

      The private sector are sitting on mountains of money accumulated in the good times, now that we need them to spend those resources to create jobs, they refuse to as they fail to see monetary gain in doing so.

      That said the public sector is being shrunk and it’s assets disposed of whilst the needs for public provision increase.

      This catch 22 situation is as you describe a Neo-Liberal project where the benefits travel upwards and the costs are transferred to those that can least afford it.

      The only way out this impasse is to completely reject Neo-Liberalism and return to a planned economy based on debt free money supplied from the Bank of England and not as it is today issued as debt through the private Banks.

      In short nationalise the Banks, utilities and transport and spend money into the economy to pay for all the necessary requirements of people.

      We have the money for public expenditure and when politicians tell us we are broke, the country has run out of money, they are just lying to us.

      We have the money, the only limits to our economy are, human and natural resources, and in the middle of a depression as we are, there is a huge pool of labour that would welcome the opportunity to get a real wage and escape from subsistence living.

      1. J.P. Craig-Weston says:

        Thank you, I think that real problem is domestic economic policy in the UK, indeed throughout most of the world is being largely dictated by post war American foreign and economic policy, open markets, the dollar gap, Free Trade etc, that have historically proved so divisive and so antidemocratic and we no longer have the kind of political independence to chart our own course.

        Greece and Venezuela have both stuck their heads over the parapet on this, as it were, and look whats happening to them as result.

        1. J.P. Craig-Weston says:

          Mind you anyone reading the American as well as the UK newspapers as I like to, (or who has visited the US,) can only be struck and forcefully so by the current desperate state of America society; some of worst poverty that I’ve ever seen in my life, coexisting, (at least for now,) with the most obscene wealth and privilege with predicable, (historically,) consequences, but particularly for America’s poor.

  3. J.P. Craig-Weston says:

    American financial rules, TTIP, TAFTA etc…..

  4. Barry Ewart says:

    Good stuff by Ann but I wonder if the Tories have one policy really – and the key one of Neo-Liberalism – CHEAP LABOUR and they are coming for the professions too!
    This it could be argued reduces the tax base and tax contributions, increases taxpayers subsidies for poverty pay (£11b and £1b alone to major supermarkets who make billions in profits) and of course unemployment – the industrial reserve army – increases the welfare bill, so perhaps the Neo-Liberals have painted themselves into a corner.
    As Streeck also argues quantitative easing (printing money) has only bought off the financial crisis for a few years and perhaps in his words – the rich and powerful haven’t a clue what to do.
    Marxists would probably argue that the rich and powerful also legally nick our surplus labour and what is missing from our narrative perhaps is that a Left Wing Government could try to get more of this wealth back – massive windfall taxes on big business (as Ann has argued they are sat on £800b), tax the rich & land, and a 1% EC Financial Tax (and include tax Greece in this).
    And more democratic public ownership with staff and communities having a say like rail, mail, some banks, pharma, some airlines, and these could break even but the publicly owned utilities could pay citizens a community dividend like the old Coop Divi – some could be public social enterprises and we could have different models but all would be democratic with communities having a say.
    End PFI and all major contracts to the usual private big organisations when they run out and scrap tendering and replace with dynamic community public social enterprises who give back to the community.
    But I do agree a Left Government should also have state-led public investment (and the private sector would pour in behind to feed the chain) but we also need to work with sister parties so we all try to meet global human need and have a global living wage (by country) etc. and we are all pursuing the same things and we could then have a global feel good factor.
    So perhaps there are more policy tools in the toolbox than perhaps we realise.

    1. Robert says:

      A sister party of labour these days would mean the Tories.

      1. John says:

        When Davd Blunkett or John Reid were home secretaries they ere far too the right,of any previous Conservative home Secretary

    2. J.P. Craig-Weston says:

      Marry me.

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