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A cool look at the current deficit hysteria
Samuel Brittan Financial Times 02/10/09

The British political classes are going through one of their occasional bouts of masochism, with party leaders vying with each other on the theme of who can cut public spending faster and more effectively. Spice is added by talk of leaks and secret plans; and ideology by arguing about the balance between tax increases and spending curbs. My own bottom line is that all this is in response to a largely imaginary budget crisis. If we have a normal economic recovery the red ink will diminish remarkably quickly. If we don't, it won't and won't need to.

All the secrecy and conspiracy-mongering is quite unnecessary and would soon disappear if ministers read the documents to which they attach their names and if opposition leaders, instead of searching in rubbish bins, did the same thing.

I hope readers will forgive me if I follow the official practice of talking in terms of percentages of gross domestic product. Even the most inveterate number-crunchers must have become dizzy with all the figures in billions and trillions of pounds and dollars launched on the world since the credit crunch.

The key document is the 260-page Treasury publication with the sensational title Budget 2009 (popularly known as "the Red Book"). The key table - surprise, surprise - is Table 1.1. You will see here the famous or infamous pledge to halve the Budget deficit in four years. Public sector net borrowing is projected to reach a peak of 12.4 per cent of GDP in the current financial year, declining gradually to 5.5 per cent by 2013-14. This is based on the assumption that GDP itself recovers by a modest 1 per cent next year but returns to an above-trend rise of 3ΒΌ per cent by 2011. The Red Book even shows the tax take (defined as net taxes and national insurance contributions) rising over the period by 2.3 percentage points of GDP, of which 1 percentage point is accounted for by an increase in the income tax take. This is before the slash and burn offensive hinted at by one opposition party or the "progressive austerity" by another.

The Treasury is understandably coy about giving more details about how the fiscal tightening is to be achieved. The Institute of Fiscal Studies estimates that, allowing for expenditure not under immediate government control, departmental spending would have to be cut by an average of 2.9 per cent a year in real terms to achieve official objectives; and in practice the axe would fall particularly severely on Labour's beloved public investment.

Suppose we turn our attention from annual deficits to public sector debt. The Red Book shows it rising from about 30 per cent of GDP at the beginning of this decade to 65 per cent in the current financial year. The pace of increase begins to slow down in the coming decade; but debt is put at 76 per cent and still rising slowly in 2013-14. The Treasury is of course well aware of the hazardous nature of these projections and how they depend on all sorts of guesses about interest payments, social security spending and many more unknowables. But it believes that is erring on the side of caution in what it presents to ministers. The debt projections look horrifying internationally only if we look at rates of increase. The ratios themselves, as projected by the International Monetary Fund, show Britain well below the US and only slightly above France and Germany. UK official estimates will change slightly in the pre-Budget report, due out in a couple of months, but are unlikely to be radically different from those in the last Budget.

Debt ratios of this size are historically far from unprecedented. In the early Victorian period the ratio was nearly 200 per cent and almost reached that level again in the early 1920s. In 1956 it was just under 150 per cent. Harold Macmillan, who was chancellor at the time, quoted the historian Lord Macaulay: "At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever." In fact the debt was gradually reduced from the peaks mentioned above without any heroic gestures.

The danger of premature tightening was illustrated in the US in 1936-37, when the ending of a war veterans' bonus and the introduction of social security taxes helped push the US back into recession when recovery from the Great Depression was far from complete.

The big error of the current discussion is to confuse the budget balances of individuals and companies with the government budget balance, which needs to be in deficit so long as attempted savings exceed perceived investment opportunities. Gordon Brown more or less understands this, and I wish he would use his talents to explain such fundamentals instead of stirring up an outdated class war.

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Contact - samuel dot brittan at ft dot com