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We’re all economists now (part two)

a man pushing over the word "crisis"Part one appeared yesterday.

In order to make sense of the UK’s debt and deficit figures they need to be put into context.

In historical terms, the UK had the largest budget deficit since 1945, and the biggest since the early 1990s. Its current debt stood at the highest levels since the late 1960s. History tells us that the British Empire was in fact built on debt.

However, over the last 100 years, debt levels have been higher before. A lot higher in fact: at 250% of GDP at the end of the 1940s, and over 100% during the 20s and 30s; the result of having to fund two world wars.

And, as one economics commentator points out, the enormous debt built up during the 1940s also coincided with the creation of universal healthcare and the welfare state. Rather than paralyse Britain, this was followed by three decades of strong economic growth.

How does this compare to other countries?

By the end of 2010, the UK had the third highest budget deficit of all the nations in the EU, with only Greece and Ireland worse off.

For the same period, even though the UK had above average levels of debt, it was still less than France and Germany, and came ninth overall within the EU.

It is important to recognise that the EU, and other bodies such as the OECD, an economic think tank of the world’s wealthiest states, measure deficit and debt using a different methodology to the government.

For the EU, stats are compiled using methods prescribed by the 1992 “Maastricht Treaty,” which advised member states to avoid excessive debt, equivalent to 60% of GDP, or deficit levels exceeding 3% of GDP.

They therefore found UK deficit levels of 11.6% of GDP, and debt worth 71.2% of GDP, for the end of the 2009/10 financial year.

Globally, the Treasury pointed to OECD stats, which in May 2010, estimated that the UK would have the highest deficit of all its members, as well as IMF forecasts predicting that the UK’s 2010 borrowing would eclipse all other countries in the G20.

Final figures released by the IMF (p.121) for 2010 found the UK, pipped only by the US, in having the second highest budget deficit of all G7 and G20 nations, with Britain’s excess borrowing way above advanced economies and Eurozone averages.

Yet, the IMF also showed that, when it came to government debt, Britain had the lowest levels of all G7 states (p.127), and close to average levels of the countries in the G20.

So, those are all the necessary facts and figures out of the way.

Time for the blame game.

This government’s main line of attack against Labour is that the latter left the country’s finances in a mess.

They have made political capital out of arguing that Labour borrowed and spent too much, and didn’t save during the boom years. Now in office, the coalition has committed itself to tackling and then eliminating the deficit as its main priority.

The main charge, that Labour built up an unnecessarily huge deficit, is of course true if you just look at the raw figures but ignore the context.

Labour themselves inherited a small deficit in 1997, and then achieved a budget surplus for the next five years.

But, in November 2002, Gordon Brown, as Chancellor, admitted that Britain would have to borrow to pay for a huge public spending programme, as laid out in the 2000 Spending Review, investing in services that had been chronically underfunded by the Tories, such as the NHS and education.

He was also responding to an economic downturn, caused by world events, such as the global threat from terrorism.

The real spike in the deficit comes in 2008. Borrowing leapt from 2.38% of GDP in 2007/08, to 6.75% in 2008/09, and then peaking at 11.1% in 2009/10 (p.7). Essentially, rising from £33bn to £156bn in the space of just three years.

Whilst the reckless spending charge is easy to level, it deliberately ignores several crucial factors: 2007/08 saw the beginning of a worldwide economic downturn and then recession, the worst since the 1930s, affecting almost all of the world’s major economies.

It resulted in the collapse and then enormous bailout of many of the UK’s high street banks, crippling the public finances.

The 2009 budget had forecast a growth in revenue. Instead, the government suffered a spectacular loss, with 2009/10 bringing in about £112bn less than they had expected.

The downturn meant higher unemployment, lower tax receipts, and more people in need of state help. A 100,000 increase in unemployment costs the Treasury about £500m, with the reverse happening when the economy is performing strongly.

This therefore required a surge in public borrowing in order to compensate.

Thus, the bulk of the deficit taken on by the coalition came as a result of events beyond Labour’s control.

The final part of this article will look at what solutions are needed, and which aren’t.

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