Nick Clegg on the scale of the economic challenge


Video of Nick Clegg’s speech to the Institute for Government also available here.

This morning Deputy Prime Minister Nick Clegg made a speech on the economy (above) at the Institute for Government, putting the case for cutting debt sooner rather than later. He said that the debt crisis in Europe and Labour’s “terrible legacy” necessitated urgent action:

The choices that were available to us just two months ago are no longer available. We have to take action now so that we can still be in control of our future.

This evening, Nick emailed Liberal Democrat members with this summary:

This morning, the Office for Budget Responsibility – an office established by this Government – published its first assessment of the public finances. Regrettably the problems facing our country are even more serious than we had originally realised.

We and many others have been warning for some time that the growth forecast in the March Budget was optimistic. The Office for Budget Responsibility confirms this. And because trend growth is lower than expected, the structural deficit is larger than anyone realised. In 2010/11 it’s going to be 8% of GDP – that’s £118bn; £11 billion more than Labour told us, rising to £13 billion next year. So the scale of the problem is even bigger than we thought.

The OBR’s independent analysis paints a stark picture. We are now facing the highest budget deficit in Europe, the highest deficit in the G20. Government borrowing this year will be ten and a half per cent of GDP, with debt topping 60%. As we always suspected, and as confirmed by this report, the downturn did more damage to the economy than Labour admitted. This is the reality that confronts us.

Labour’s approach is clear: deny the problem, play games with the numbers, and promise money we don’t have.

We have always said that we would not shrink from this task. There are tough choices to be made, but we will make them now while we can do so in a way that is both fair and just. This government, Liberal Democrats and Conservatives together, will see through the deficit reduction that is an absolute prerequisite for turning Britain’s fortunes around.

Make no mistake: this is not a task we relish. Nor was it our choice. This is the legacy that we, as a new government, and we, the British people, were left. It is the only way we can get our public finances on a sound footing. To do anything else would not only be irresponsible; it would be a betrayal of our progressive values. There is nothing progressive about denial. And there is nothing progressive about condemning ourselves and our children to decades of debt, higher interest rates and fewer jobs.

We must deal with this problem now so we don’t leave our children to pay the price later.

Best wishes,

Nick Clegg MP
Leader of the Liberal Democrats & Deputy Prime Minister

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46 Comments

  • I agree with Nick, regrettably not Clegg, Starling for a change.

  • I guess if you were looking for positives from Nick Clegg’s speech (and it is difficult to avoid the conclusion that he is rather more on board with the Conservative agenda than the rest of the Lib Dems) he was reasonably positive about the need to make sure that if the public sector is going to be required to suffer then it is also important that the banks are held to account for their part in the current financial predicament. This is a part of the agenda that must not get lost if the Coalition’s claims that we’re all in this together are to have any credibility at all. Yet even then talk of structural reform (a modern day version of the US G-S Act) is being kicked into the medium term – when many commentators find it extremely disappointing that more hasn’t been done to reregulate the banking system already. This is disappointing.

    Nick Clegg’s protestations (in response to a question) that there is nothing ideological about the need to rebalance the government’s fiscal position primarily through reductions in public services (rather than tax increases) rang a little hollow. The Conservatives are a neoliberal party to their core. We have been told that the broader agenda is a rethinking of the role of the state and a reduction in state activity in favour of private and voluntary sector provision. That is not necessarily a bad thing, of course, but the suggestion that it is not ideological is clearly wrong.

    There were two more specific things that I found concerning about the speech.

    The first was the frequent invocation of ‘our children’ and the damage we would do their prospects if we don’t cut now. This seems completely out of proportion. No political party was talking about not cutting the budget deficit. The option is cut now or cut in two and three year’s time. Our children will still be children! Only in the most lurid and implausible scenarios where failure to act *now* is the only way to avoid economic armageddon are the implications for our children likely to be severe. This seems to be a rather cheap rhetorical device.

    The second is that the prescription of fiscal austerity and development of an entrepreneurial private sector as a substitute lacks any realistic sense of timescales. Cuts in public services are imminent, but even a spectacularly positive response to structural change initiatives in the private sector is going to take many years to make much of an impact. As an agenda for fairness this is rather hard to rationalise.

  • “The option is cut now or in two or three years time. Our children will still be children!”

    That may be true, however if the country’s credit rating drops from its current AAA level then we would end up paying more on our borrowing. This means that it would take longer to repay.

    We also would have a much bigger debt to start with. Potentially carrying the debt into the next generation.

    As much as I hate cuts, they are essential now. If our credit rating drops, we could end up like Greece. The difference being that we’re not in the Euro, so wouldn’t get the bailout.

  • Anthony Aloysius St 15th Jun '10 - 12:23am

    “As much as I hate cuts, they are essential now. “

    So what you’re saying is that Clegg and Cable were talking dangerous nonsense throughout the election campaign. And Clegg is now saying the precise opposite.

    So why did you vote for them? Did you vote for them?

  • Terry Gilbert 15th Jun '10 - 12:32am

    To be fair, I think Chris’s point is that the Greek crisis has occurred since the election, and this has raised the spectre of a falling credit rating, which might affect us if we do not tackle the deficit in the way he, Clegg, Cable, and the Tories suggest.
    Personally I think Mervyn King was probably nearer the mark when he said that the proposed cuts this year are rather small compared to the overall deficit, so their timing probably won’t have that much effect. However, as a qualified social worker, I would add that while they won’t have that much effect on the deficit, some of them will have a great deal of effect on the vulnerable. This effect could be offset by raising progressive taxation, and focusing on areas such as military spending.

  • Anthony Aloysius St 15th Jun '10 - 12:56am

    “To be fair, I think Chris’s point is that the Greek crisis has occurred since the election …”

    Or, to be precise, in the few hours between the polls closing and the start of the negotiations with the Tories the following day?

    I think everyone knows that what really happened is that there were negotiations and the Lib Dems accepted the Tory position. Not that the global economic situation was completely transformed within the twinkling of an eye, causing the Lib Dems to execute a spontaneous U-turn.

  • Anthony Aloysius St 15th Jun '10 - 1:02am

    Andy

    You honestly believe that something happened in Greece during the course of Friday May 7th to cause the party to alter fundamentally its economic standpoint? And that it was a complete coincidence that that happened during the precise 24 hours when they were trying to negotiate a compromise agreement with the Tories?

    Honestly?

  • Andrea Gill 15th Jun '10 - 1:02am

    Nothing in what he said disagrees with our policy on deficit reduction – we always said we’d do it when necessary, not based on political dogma. I do however feel that it was a mistake IMHO to deliberately oppose early cuts during the campaign (which does not gel with what the manifesto said) just to seemingly have a big point to disagree with the Tories on.

    Having said that, I am pleased when some things this gov’t does are *not* Lib Dem policy – because if it’s all stuff we could 100% agree with, then frankly why would anyone vote Lib Dem instead of Tory next time?

    PS: Clegg did seem a bit distracted, not just in this but also during the HoC debate afterwards. Hm…

  • Andrea Gill 15th Jun '10 - 1:14am

    Lib Dem Manifesto 2010:

    dealing with the deficit

    The health of the economy depends on the health of the country’s finances. Public borrowing has reached unsustainable levels, and needs to be brought under control to protect the country’s economic future.

    A Liberal Democrat government will be straight with people about the tough choices ahead. Not only must waste be eliminated, but we must also be bold about fi nding big areas of spending that can be cut completely. That way we can control borrowing, protect the services people rely on most and still find some money to invest in building a fair future for everyone.

    We will base the timing of cuts on an objective assessment of economic conditions, not political dogma. Our working assumption is that the economy will be in a stable enough condition to bear cuts from the beginning of 2011–12.

    Working assumption, based on advice from BoE at the time. This advice changed over the past few months. IMHO it was wrong to go on against earlier cuts once the situation started changing. After all it was in our manifesto that we’d be realistic and not stick to dogma come hell and high water.

  • Andrea Gill 15th Jun '10 - 1:19am

    Sorry the last para in this was my comment, the cite tag didn’t work

  • Andrea Gill 15th Jun '10 - 1:54am

    @Andy – Agree, as hopefully made clear with my posts 🙂

  • @ Anthony

    You honestly believe that something happened in Greece during the course of Friday May 7th to cause the party to alter fundamentally its economic standpoint?

    Hmm, you wouldn’t be being deliberately disingenuous, by any chance?

    The party had a very nuanced manifesto policy on deficit reduction in the first place (as Andrea has explained too). When the election was called, the decision was made to campaign on a platform of deferring cuts til next year. But as the campaign went on the Greek situation deteriorated beyond what even most pessimists predicted.
    In light of that, starting cuts this year became the more sensible option, but Nick and Vince couldn’t really switch policies mid-campaign as the media would’ve had a field day and the very reasonable arguments for the change would have been drowned out in the general media noise of an election.

    A lot of your gripe seems to be that the Lib Dems didn’t stand for the things you wanted us to stand for in the first place. The obvious answer is, don’t vote Lib Dem. As Andy said, we are not – and never have been – the Labour party in a yellow hat, any more than we’re now – nor ever will be – the Tory party in a yellow hat.

  • Anthony Aloysius St 15th Jun '10 - 2:25am

    “A lot of your gripe seems to be that the Lib Dems didn’t stand for the things you wanted us to stand for in the first place. The obvious answer is, don’t vote Lib Dem.”

    Well, at least we agree about something!

  • Anthony Aloysius St 15th Jun '10 - 2:43am

    Andy
    “I’m sorry, but I don’t accept the party has “alter[ed] fundamentally its economic standpoint”.”

    OK. I’ll rephrase my question. You honestly believe that something happened in Greece during the course of Friday May 7th to cause the party to alter its economic standpoint from arguing that cuts should be deferred until next year to arguing that they should happen immediately?

    You’re willing to put your hand on your heart and say you believe that the party changed its viewpoint because of what happened in Greece on Fruday May 7th, and not because – by pure coincidence – it happened at precisely that time to be negotiating with the Tories and agree on a common platform?

  • Grammar Police 15th Jun '10 - 7:57am

    @ Anthony Aloysius St – the Party’s positition was always based on the economic condition. Things did change over the course of the campaign; and of course, there were negotiations as to a common position. That’s what happens with compromise and negotiation. The party’s leadership can only really be criticised if it’s negotiated away a core value. I’m not sure that the precise timing of fiscal retrenchment goes to the core of being a Lib Dem – but protecting the most vulnerable in our society does. And you never know, maybe Osborne convinced Nick and Vince that he was right (and perhaps upon “looking at the books”, things are different). At the same time, we got a commitment to raising the lowest paid out of tax and a pupil premium, to be spent by headteachers in schools based on the number of kids on free school meals. As I understand it what Nick is saying here is that not cutting in the short term means spending more on debt in the long term, and therefore less on front-line services. And I don’t think there is anything particularly ‘progressive’ about paying even larger sums of money on debts.

  • stop, stop this abstract romanticised view of Labour now it’s in opposition. Labour in power was virtually neo-con, with tacit support for gun runners and mercenaries, and a city free-for -all that resulted in the credit crunch. It’s instinct was to remove the 10% tax rate whilst the Lib Dem’s are wanting to raise personal allowances to help the low paid.

    Who in their right minds would believe that if Labour had won that it would not be talking tough about the deficit now and how things are much worse since the Greece/Euro crisis. It would be the poor who would get hit the most as they hanker after the middle class votes. I do believe the coalition will be more progressive in its policies.

  • Dave Orbison 15th Jun '10 - 8:52am

    I voted Lib Dem for the first time because I thought that they had a more progressive manifesto. All I see now is that Nick Clegg, seemingly intoxicated by the vapours of power, is running round as if a man possessed, fronting a ‘Cuts Cuts Cuts campaign’ to the glee of his new-found Tory friends. There is an awful lot that Labour did wrong. They lost my trust but they did some good too. It is disingenuous to blame the current economic mess on Brown alone. The banking crisis is a global event and EVERY government is having to pick up the tab. However, I have already heard enough to realise that I was conned by the Lib Dems. I actually feel sorry for many dedicated activists in the Lib Dems who have earnestly fought their corner over the years and campaigned to differentiate you from other parties. In a matter of weeks your years of work has been undermined – you have been sold out by your Parliamentary colleagues. Just as Blair became mesmorised by Washington, the Lib Dem leadership has sold out for a few seats round the Cabinet. You can delude yourselves all you like by trying to justify the Nick & Co are doing the ‘right thing’ and hype it by telling us that they are acting in the National Interest. To say that Labour would have done this anyway just doesn’t begin to justify the betrayal. Very, very disappointed and certainly the last time I will ever vote Lib Dem.

  • Anthony Aloysius St 15th Jun '10 - 9:33am

    Andy

    I have to say I find this quite bizarre. Now you’re suggesting they secretly changed their minds earlier on, but during the campaign kept pushing the old line in public (quite vehemently, remember), even though they didn’t believe it any more. Do you really think that would be a point in their favour?

  • I am getting very concerned that Clegg seems to think that the Daily Mail offers sensible policy advice to liberals, rather than hate-filled nonsense. Yesterday’s attack on public sector pensions is possibly the most stupid thing I’ve heard him say.

    Yes, there have been abuses – none more than the Parliamentary pension scheme, which offered ridiculously high rates of accrual (and was voted for by members of all parties, to their shame). But fundamentally the pension promise is part of the overall pay package, which in many cases – particularly senior Whitehall jobs – is much less valuable than private sector comparators. It is pandering to (generally highly paid) right wing journalists to say that it is ‘unfair’ for taxpayers to fund pensions for public sector workers. And frankly, it isn’t going to save the Exchequer much over the long term if Clegg helps the Tories repeat the savaging of pension provision that their city chums have presided over in the private sector – many of those hard working nurses, teachers and other public sector workers will end up on state benefits because the market has shown that it isn’t interested in helping any but the richest save independently for retirement.

  • It might worth some of you reading Anatole Kaletsky’s article in yesterday’s Times entitled “Osbourne must heed Japan’s mistakes”. He quotes Adam Posen, a recent recruit to the MPC, as saying “growth in the Japanese economy has been repeatedly stfled by premature tax rises and the withdrawal of public investment and and zeroing out of public consumption. He also questions whether or not the Chancellor has forgotten the first lesson Keynsian economics: to achieve a balanced budget, sustaining economic growth is more important than any conceivable reform of Taxes or public spending.
    It seems to me however that a reduction in the structural deficit is important, but cutting the public sector too rapidly will reduce the Tax take and at the same time increase equally rapidly the number of people on benefits. I think that increasing the tax on the wealthy either via CGT, Pension Tax relief, Mansion Tax and a clamp down on Tax avoidance is not just a matter of fairness but also a safer way forward than drastic cuts in Public spending immediately. However there are areas of Public spending that must be addressed sooner rather later, and I would name Public sector pay and ‘gold plated pensions’ which are clear;ly unaffordable.

  • @Roger – the problem is that this Mansion Tax doesn’t just affect super-rich people, but also those whose ONLY assett is a property that has either been in their family for decades/centuries, or that happen to be in areas where house prices have risen disproportionally.

  • I think that we need to keep what is happening regarding the UK deficit in broader comparative and historical context.

    Fiscal policy has been transformed and thrown into reverse across Europe over an incredibly short period of time. The putative cause of that is the Greek sovereign debt crisis, the risk to credit rating and fear of a negative reaction from the markets. But is the contagion theory of market reaction credible? The analogy between UK and Greece just doesn’t stand up to a moment’s scrutiny. The structural problems Greece is facing are longstanding, the structure of their government debt is completely different (more short term), they lack the possibility of adjustment through a floating exchange rate, etc. The experience of Greece offers no real guidance on what is likely to happen to the UK. That doesn’t mean that the probably of the rating on UK government debt being downgraded is non-zero but neither is it high (if you look at the risk premiums being demanded in the market).

    The deficit issue is only partly an economic issue. And the economic relationships involved in this are much looser than the sort of iron laws of inevitable disaster in the absence of swift action that we are being presented with in the political narrative. The narrative is, however, vitally important. It would be possible to narrate the current situation very differently but nonetheless credibly, without creating what John Eatwell recently described as ‘deficit hysteria’. It is clear that other countries – notably the US – are concerned about what is happening in Europe, where the deficit hawks have rather rapidly established a stranglehold on policy. It seems to me that the current situation has a strong whiff of groupthink about it. Many EU countries have been convinced themselves that they must act to cut savagely: that doesn’t mean that they aren’t all spectacularly wrong. Joseph Stiglitz has spoken out against the move again today, as has Paul Krugman repeatedly over the last few weeks.

    We appear to be seeing a reassertion of the pre-Keynesian Treasury view of the world where fiscal conservatism is the default option. Reflection on the economic trajectory of the 1930s, the last time this view held sway, might be instructive. It is a fundamental mistake to think that the finances of a country should be managed in the same way as the finances of the household. That isn’t for one minute to argue against taking action and having credible plans for deficit reduction, but we must recognise that the perceived robustness of the economy and the public finances is not independent of how it is narrated and debated: a narrative pushing the necessity of savage cuts to ward off imminent Armageddon does not serve the country well, even if it serves particular sectional interests.

  • No-one, anywhere, is arguing that we shouldn’t get the budget deficit under control. But there are different ways of doing this. The Conservative position, that 80% of the measures should come through spending cuts and 20% through tax rises, is completely arbitrary, and there is no reason why it can’t be changed.

    I agree with Roger Shade, who favours “increasing the tax on the wealthy either via CGT, Pension Tax relief, Mansion Tax and a clamp down on Tax avoidance” ahead of draconian cuts in public services. If the coalition is seen to target public services and those on benefits, whilst going easy on the better-off (as Osborne’s hints about CGT seem to suggest), there will be massive public anger and the LibDems will be the targets just as much as (if not more so) than the Tories.

  • The one BIG mistake Clegg and Cable made during the election is not to stick with what our manifesto actually said, which is NOT TO time the cuts on political dogma but based on the market and economy at the time – and instead stick to the anti-Tory “no cuts this year” line, even when it was fast becoming clear that this was no longer an option.

  • Anthony Aloysius St 15th Jun '10 - 11:49am

    Andy

    Top marks for effort, anyway.

  • gramsci's eyes 15th Jun '10 - 1:10pm

    To compare Greece with the UK is nonsense. Greece has a formal economy the size of a few London boroughs , and has a culture that avoids paying tax. About 35% of it’s GDP is the black economy.

    If Clegg’s mind has been changed by Greece then I fully expect him to start talking about the economy as a cake or as a family budget,. Two sure signs that either the politician is treating you as a fool, or that they are a fool.

    If Cable’s arguement was to stimulate demand to avoid a double dip, then not only has he and his ilk renegaded on that as an economic policy, but have compounded this by totally undermining consumer confidence with politically motivated scare stories of war time like austerity.

    Every time I think of him I cannot get rid of the image of Uriah Heep.

  • Roger Shade 15th Jun '10 - 1:43pm

    Gramsci is quite right, to compare the UK with Greece is total nonsense. Britain’s debt is in Sterling and much of it is designated in long-term Gilts which will sell if to nobody else the UK Pension funds, so far there has been a reasonable appetite to buy Gilts and I personally do not see this changing. The opinions of many of these so called credit rating agencies like Standard & Poors et al must, after the last few years be called into question. Most Bankers will make up their own minds as to the credit worthiness of a country, and to misquote another quotation, Credit ratings are for the guidance of wise men and the distraction of fools.

  • Alex Sabine 15th Jun '10 - 3:03pm

    I think we need to separate the three issues of (a) the timing of deficit reduction, (b) the required extent of deficit reduction, and (c) the split between tax rises and spending cuts.

    On the timing point, I agree that the panic in European markets did not suddenly arise after the election – it had been simmering for several months – but it did gather pace in early-to-mid May (including the period when the coalition negotiations were taking place).

    Vince Cable had always made it clear that the risk of an adverse market reaction might necessitate earlier cuts than would be ideal from a macroeconomic (demand) standpoint – and the balance of risks clearly moved in this direction during the spring.

    I agree with Alex M that equating the UK and Greece does not bear serious scrutiny: our stock of public debt is much lower, the average maturity is much longer so we are unlikely to have the same refinancing problems, and we do not have the same structural competitiveness problem of rising costs locked in by a fixed exchange rate with our main trading partners. (Indeed our floating exchange rate and independent currency has undoubtedly cushioned us from what would otherwise have been an even more severe recession.)

    HOWEVER, the crisis in European markets is not just about Greece. Spain has been forced into early austerity measures even though it does not share the same chronic underlying problems as Greece (and indeed has a significantly smaller budget deficit than the UK), and there was a clear risk of contagion leading to a full-scale sovereign debt crisis and then a second banking crisis unless measures were taken to restore confidence.

    Recent announcements, including the massive eurozone support package, might have reduced that risk – but it is still very real. Given that deep and continuing anxiety about sovereign risk, it is essential for countries like the UK (with one of the largest annual deficits in the developed world, much larger than many eurozone countries) to set out a credible plan for deficit reduction, and in my view – and, more importantly, that of Mervyn King – that means making a modest ‘downpayment’ this year as an earnest of our intentions.

    It is much easier to talk about cutting the deficit than to actually do it, as markets are fully aware, and the St Augustine line (‘give me chastity and continence, but not yet’) will no longer wash.

    The timing of when to start cutting was always going to be a judgment call, not some great shibboleth as some people here seem to believe.

    As Andrea says, it was unfortunate that the party’s rhetoric hardened during the election campaign from the more sensible and nuanced position that the timing of cuts involved weighing up the risks of premature action against the risks of inaction into something close to Labour’s dogmatic stance.

    But it would have been even worse to have boxed ourselves into a corner on this and made it a sticking point in the coalition negotiations with the Tories in spite of the mounting evidence that the balance of risks now clearly supported an earlier start to deficit reduction.

    In fact, I gather that the Lib Dem negotiating team was sufficiently convinced by this case that it insisted on faster deficit reduction in its talks with Labour; Peter Hain and others have explicitly cited this as a reason why they couldn’t support a deal with us. So the accusation that it was merely about placating the Tories isn’t borne out by the facts.

    None of this is to deny that there are risks involved in withdrawing demand this early, when the recovery is still fragile.

    But there were huge risks in doing nothing, particularly as the government wouldn’t be in a position to announce details of FUTURE cuts until the autumn spending review.

    It is doubtful investors would have waited that long before demanding higher yields on government bonds. Instead – partly because of investor confidence in the coalition’s plans – bond yields have fallen and there is a decent chance that the Bank of England won’t have to prematurely tighten monetary policy.

    It was always clear that – given the massive fiscal deficit – we would have to rely on monetary policy and improving the flow of credit in the economy to support demand. Failing to deal with the deficit decisively would put us in the double-bind of higher debt service bills – necessitating even bigger spending cuts in the future – and higher interest rates killing off recovery in manufacturing and the private sector.

  • Disappointed with Nick joining so closely with Osborne and Cameron on this issue.It is the worst of the old politics.
    There are two views amongst polticians, public and economists about when to cut, how much and the proportions of cuts to tax. The Conservatives have one legitimate view, Labour have another. We have moved from being closer to one to adopting the other view almost wholly. Leaving aside whethe this is right or wrong I would have liked us to:
    – focus on policy and not as Clegg has done to seek to rubbish that part of Labour’s record, not only do his comments sound shrill and partisan but they are not wholly in tune with the OBR report
    – explain more clearly why we have changed tack – many of us are having to defend this change and we need the arguments to be clear and policy based not a Tory style attack on Alastair Darling.

    This issue will raise much debate with non Conservative voters. If we cannot find some diffferentiation on this issue we will face difficulties.

  • Alex Sabine 15th Jun '10 - 4:31pm

    As regards the required scale of cuts, this involves a judgment about the portion of the deficit that is structural rather than cyclical – ie that won’t go away with economic recovery.

    it’s interesting to note that Vince Cable argued last September that this problem was likely to be even worse than the Labour government had then set out.

    “The clear implication is that the fiscal adjustment…has been underestimated and will have to be bigger than this Government has budgeted for,” hee wrote then.

    See: http://www.reform.co.uk/LinkClick.aspx?fileticket=RQ0obqjHA9A%3D&tabid=118

    At that point the government indicated that the structural ‘hole’ that needed to be filled was about 6.4% of GDP; Cable estimated that it was more likely to be about 8% of GDP.

    As it happens, this is exactly the figure the OBR puts it at for 2010-11 – 8% of GDP, or £118bn.

    The overall deficit peaked at 11.1% in 2009-10 and would be 10.5% of GDP in 2010-11 assuming no change from Labour’s policies. So around three-quarters of the deficit is believed to be structural and therefore needs addressing by discretionary tax increases and spending cuts.

    Some of the structural gap pre-dated the recession, because Labour imprudently ran substantial deficits during the years of plenty, but most of it reflects the impact of the financial crisis and the recession (about 5% of GDP, or £74bn) – or, to put it another way, the fact that boom-time revenues that our whole political class assumed were permanent turned out to be temporary.

    The structural deficit on the ‘current’ budget – ie, excluding capital investment – is 5.2% of GDP, or £77bn. But since capital spending was set to bear a disproportionate share of the cuts under Labour’s projections, the structural current deficit would still be 1.6% of GDP in 2014-15 while the overall structural deficit would be 2.8% of GDP.

    So, to eliminate the structural deficit we need a fiscal tightening of £118bn in today’s terms by the time the task is completed. To put that figure in perspective, the in-year spending cuts announced by the coalition so far amount to a net £5.7bn, or slightly less than 5% of what is required…

    So it is a monumental task. But it must be done, and it is doable.

    In the mid-1990s the Canadian Liberal government completely eliminated a headline deficit of 9.1% in three years following its far-reaching Program Review that Mark Pack blogged about on Lib Dem Voice a few days ago. Within five years it had reduced public debt by a third.

    For those who feel spending cuts necessarily decimate the economy, consider this: In the period 1995 to 2000, while the Program Review cuts were being implemented, the Canadian economy grew at just under 4% per year – significantly above the OECD average of 3.2% and above that of the US and UK over the same period. That doesn’t prove the economy wouldn’t have grown without the review, but it does suggest that public spending can be reduced without tanking the economy.

    Of course, the circumstances were different in that Canada benefited from a booming US economy and had previously enacted trade liberalising measures that underpinned GDP growth.

    This time there is a much less favourable world economic backdrop, so I don’t expect our GDP to grow at those sort of rates and we will in all likelihood make slower progress in tackling the deficit.

    If the aim is to eliminate just the structural current deficit – allowing the capital spending component of it to continue – over the next five years, then the coalition will need to tighten by about £75bn in today’s terms. That’s £15bn, or just over 1% of GDP, per year in discretionary policy measures.

    That overall scale of consolidation is by no means unprecedented. By comparison, UK Labour and Conservative governments – under Chancellors Denis Healey and then Geoffrey Howe – turned a structural deficit of 8.1% of GDP in 1974-75 into a structural surplus of 1.5% of GDP in 1981-82 – a turnaround of 9.6% of GDP over seven years, or 1.4% of GDP per year.

    The squeeze in the 1990s under Norman Lamont, Ken Clarke and then Gordon Brown (the prudent Mark I version) was slightly less severe: the structural deficit peaked at 5.5% of GDP in 1992-93, was eliminated by 1998-99 and became a structural surplus of 1.1% of GDP in 1999-2000 – a turnaround of 6.6% of GDP over seven years or just under 1% of GDP per year.

    (The depressing footnote to that is that Brown then turned a structural surplus of 1.1% of GDP in 2000-01 to a structural deficit of 3.2% of GDP by 2004-05 – a deterioration of 4.4% of GDP over four years, or 1.1% of GDP per year, at a time of sustained economic growth.)

  • Alex Sabine 15th Jun '10 - 8:00pm

    To clarify, a tightening of £75bn would take care of the structural deficit on the *current* budget, but the last Labour government’s plans assumed a sharp drop in capital spending, from a peak of 3.6% of GDP last year, to 2.7% of GDP in 2010-11 to 1.3% by 2013-14. If the coalition were to stick to that profile of capital spending while closing the current budget gap, the overall tightening would be approximately 6.6% of GDP, or £97bn in today’s money.

    Regarding the composition of the deficit reduction, the Conservatives have proposed a ratio of spending cuts to tax increases of 80:20. As far as I know neither Labour nor the Lib Dems have explicitly stated their desired split, but the IFS worked out that Darling’s last budget in March implied a 67:33 (or 2:1) split, and they inferred from our manifesto a figure in between the Tory and Labour ones (around 72:28).

    So, while there were differences between the three parties on this, they all assumed that at least two-thirds of the tightening would come through spending cuts rather than tax rises.

    This is sensible. International experience suggests that fiscal consolidations which rely mostly on spending cuts tend to be more successful and sustainable – for a quick primer on this, see http://www.instituteforgovernment.org.uk/pdfs/The%20composition%20of%20fiscal%20consolidations%20a%20review%20of%20selected%20literature.pdf.

    Moreover, the British government is currently spending around 48% of GDP (or 52% of GDP on the OECD measure) – close to the peacetime record set just before the Labour administration went cap-in-hand to the IMF. So the starting point for public spending is very high by historical standards, much higher than when the last squeeze began in 1993 for example.

    The average level of public spending from the mid-1950s (the earliest point from which comparable figures are available) to 2007-08 was 41% of GDP, while the average for the 20-year period 1988-2007 (including Brown’s post-2000 spending spree but not the spike from 2008 onwards) was 40% of GDP.

    Tax revenues, on the other hand, are much closer to their historical trend level. They were depressed by the recession, but have already bounced back more strongly than expected. The OBR estimates that they will amount to 37% of GDP in 2010-11. The average for the mid-1950s to date is 39% of GDP, while the average for the past 20 years is around 37.5% of GDP.

    In fact, if you look at the data there is a clear pattern of British governments finding that 38-39% of GDP is about the maximum sustainable level for tax revenues. Temporary spikes above 40% of GDP are swiftly reversed, while structural deficits arise when governments push spending above 40% of GDP in normal times.

    This would suggest that the 80:20 split is probably a sensible distribution of the tightening, if the aim is to minimise the damage to medium-term economic growth.

    Interestingly, Vince Cable – wrongly seen by some commentators to be on the party’s left wing – suggested in his Reform paper last September that the starting point should be aim for the vast majority of the deficit reduction to be done by spending cuts.

    http://www.reform.co.uk/LinkClick.aspx?fileticket=RQ0obqjHA9A%3D&tabid=118

    Note these comments in particular: “The sudden deluge of funding (in relation to comparable OECD countries) has been likened by Reform to a “flash flood” and there is a strong argument for focussing on how resources can be better spent rather than validating current spending levels with higher taxes.

    “In addition, direct taxes create disincentives to save, work and take risks while indirect taxes are generally regressive.

    “So the emphasis should be on spending control; though the magnitude of the fiscal adjustment required is such that taxation cannot be ruled out…

    “But to commit to additional tax revenue raising from the outset undermines any commitment to setting priorities in spending.”

    Personally, I doubt the government will be able to cut £100bn, so I suspect there will be at least £20bn of tax rises – but clearly a fundamental reappraisal of what government does, on Canadian lines, is required.

  • Andrea Gill 16th Jun '10 - 5:37am

    Just realised I never got this email!

  • Anthony Aloysius St 16th Jun '10 - 8:42am

    “Labour activists whinny about the difference of £6 billion in savings but they can’t say where they would save the other £150 billion that would protect the poor from the IMF.”

    What a marvellous new slogan to keep up morale as the government cuts public spending and raises indirect taxation – “Protecting the Poor from the IMF!”. Something tells me the poor may not show proper gratitude for that boon, though.

    And yet again, the implication that everyone who is concerned about spending cuts must support the Labour Party. But if you think about it, you’ll see why it may not be a good idea to repeat that too often…

  • Andrew Suffield 16th Jun '10 - 10:25am

    It’s funny how certain parties want to make out that Clegg’s been on board with this stuff since the election. What we had at first was a cautious acceptance of statements from the Tory side that they could immediately identify several major areas of spending which could be cut easily (most of which I agreed with, since they were just Labour pork projects – funnelling absurd amounts of government money to companies favoured by ministers).

    If you pay close attention to what we’ve been hearing since then, it’s apparent what has happened. Ministers on both the Tory and Lib Dem side have had time to examine the state of the government finances and promptly wet themselves. I rather suspect that Labour’s unwillingness to enter into coalition was based significantly on their knowledge of what was hiding in that cupboard, and the fact that a coalition with the Lib Dems would not permit them to keep hiding it.

    Nobody in the government wants to come right out and say “we’re completely screwed”, but the undertones are there. Perhaps we’ll find out what’s going on when the emergency budget arrives.

  • David Allen 17th Jun '10 - 6:34pm

    “To eliminate the structural deficit we need a fiscal tightening of £118bn. …. So it is a monumental task. But it must be done.”

    Er, why, exactly? Why not £78bn, £98bn, or come to that £138bn or £158bn? Why must we precisely balance the budget?

    “International experience suggests that fiscal consolidations which rely mostly on spending cuts tend to be more successful and sustainable”

    I think what this is saying is that, if you are determined to cut your deficit above all other objectives, then you’d better do it by slashing long term spending commitments, which tend to hit the poor. Whereas if you want to take action on your deficit but you also worry about things like recession, unemployment, social cohesion, fairness, then you may prefer to stress tax rises, which tend to hit the rich. Now, it is of course reasonable to argue that the deficit does need to take a pretty high priority right now, and that cuts do therefore have to be a big part of the mix. But, to suggest that there is some sort of fundamental economic principle which effectively says that the rich must always get things done their way is, well, standard self-serving Conservative propaganda.

    “We are all in this together” they say. Reminds me of Maggie quoting St Francis of Assisi, or Bush calling himself a “compassionate conservative”. If we actually meant it, we would also be making very sure that those in the City who became stinking rich while our deficit ballooned should now be paying us all back something!

  • Alex Sabine 18th Jun '10 - 3:47am

    @David Allen: “Er, why, exactly? Why not £78bn, £98bn, or come to that £138bn or £158bn?”

    As I thought was apparent from my marathon post, I didn’t pluck the figure of £118bn from thin air. It’s simply the result you get using the OBR figures for the size of the structural (or ‘cyclically adjusted’) deficit and for GDP, taking this financial year (2010-11) as the baseline. The OBR forecasts nominal GDP of £1,476 billion and a structural deficit of 8% of GDP in 2010-11, and 8% of £1,476 is £118bn.

    Of course, as the OBR goes out of its way to acknowledge, forecasting the cyclically adjusted deficit is a tricky business since it depends on an assessment of the current position of the economy relative to its trend. By comparison it is easier to forecast the actual level of borrowing the government will incur (but still far from easy, of course, as we’ve seen with recent revisions).

    The advantage of adjusting for the economic cycle is that it indicates what portion of the deficit will not simply disappear with economic recovery, but will persist unless there is a “discretionary” tightening of fiscal policy (through spending cuts, tax rises, or both).

    The reason we have such a big fiscal problem in the UK is that so much of our deficit is judged to be structural, not cyclical. If it was all cyclical we could sit back and let the recovery do the work. Unfortunately, the OBR believes that of the projected deficit for 2010-11 of £155bn, only £37bn is cyclical and £118bn is structural.

    So that was the reason why I referred to £118bn rather than the other figures you quote.

    Of course, there are still economic and political judgments to be made. Eliminating the structural component of the deficit would seem a sensible goal for the coming fiscal consolidation, but it may not be the one the government chooses; for example, it may choose to target the actual borrowing total instead, or to stabilise the debt:GDP ratio by year X, or to adopt a number of targets rather than a single one.

    And once those goals have been set, there is also the question of what the pace of tightening should be and therefore how long the process will take to complete.

    I do not suggest that any of these decisions are scientific – as Jens Henriksson (who was a key advisor in the big Swedish fiscal consolidation undertaken by the Social Democratic government of the mid-1990s) has written, “fiscal adjustment is an art rather than a science”.

    But despite the perils of economic and fiscal forecasts, Chancellors need some lodestars to guide them and to hold them to the course they have set. Their task is to make sure their policies are robust against inevitable errors in forecasting, and to respond to unexpected events in a sensible way – not to use the uncertainty of the future as an excuse for inaction or the wrong actions. Pursuing policies that were robust against future shocks is what Gordon Brown signally failed to do… (Previous Chancellors have done the same, but usually in a less spectacular and reckless fashion.)

    “Why must we precisely balance the budget?”

    I didn’t say that – at least, we don’t necessarily need to balance the budget in each and every year. What we do need to do is get to a position by the end of the fiscal consolidation that we are balancing the budget in normal times.

    Most non-Keynesians agree that it is acceptable and can even be helpful to run a deficit in a downturn – ie to allow the ‘automatic stabilisers’ (falling tax receipts and rising spending due to unemployment increasing) to operate. But the corollary is that we should allow surpluses to accrue during periods of above-trend growth, and not spend the money.

    And those (including many Lib Dems) who believe in Keynesian demand management should understand that Keynes never intended this to be a licence for lax fiscal policy. Instead he argued for counter-cyclical fiscal policy as a means of stabilising the economy, which is cyclically unstable. That means, yes, injecting demand during recessions but also withdrawing demand – by running a surplus – during booms.

    In fact, the more Keynesian you are – the more you believe active fiscal policy is effective in countering recessions – the more you need to build a large surplus during the good times, so as to give yourself maximum scope to boost demand when the economy turns down.

    Jens Henriksson puts this point nicely: “It is not a problem if a country runs a deficit as part of active stabilisation policy. But if you argue like that, you have to be consistent and be just as strong an advocate of running a surplus in good times.

    “It is easy to get support and friends when you argue for running a deficit during downturns, but it and they will disappear when the good times come. Then you [as finance minister] will be fighting alone. Remember, the future has no lobbyists.”

    I’m not convinced that Lib Dems who regard themselves as impeccably Keynesian grasp this point. I certainly don’t remember them arguing that the government should be running a surplus rather than a sizeable deficit in 2001-08. In fact, when Gordon Brown started on a prudent course and had built up a surplus by 2000, we as a party argued that he should spend his ‘war chest’.

    Vince Cable did check this tendency once he became our Treasury spokesman, but considering that he (quite rightly) warned that the asset price bubble was likely to be unsustainable, why did he assume that the tax revenues that resulted from it were sustainable? This is a serious flaw in our claim to have foretold the crisis, and not one that I have heard a convincing answer to (other than political expediency).

    So, as a general rule, we should aim to balance the budget over the course of an economic cycle, allowing manageable surpluses and deficits to form when the economy is running above or below trend. This is not some ultra-orthodox 1920s ‘Treasury view’, but a perfectly mainstream one shared by many well governed countries.

    We should also build in a margin of caution, not in the forecasts (which should be based a ‘central’ view, as the OBR has done) but in the measures and overall fiscal targets. So, for example, one of Sweden’s targets is to run an average surplus of 2% of GDP over a business cycle.

    Running too large a surplus might unnecessarily ‘socialise’ capital formation, but I don’t think we need to worry about the dangers of running excessive surpluses where British governments are concerned! And it is sensible to build in some caution so that the public finances are reasonably robust against future shocks.

    An outcome that resulted in a balanced budget over the cycle would be satisfactory in normal times, but given the huge rise in our stock of debt we may need to run structural surpluses once the fiscal repair job of the next few years is completed. The aim should be to get our debt:GDP ratio to a low enough level that we have maximum leeway to counter the next crisis (the Keynesian economist Roger Bootle suggests it should really be as low as 20% of GDP, which may take some time…).

    Finally, it’s really important to emphasise that fiscal rectitude should not be – and indeed is not in many other countries – something right-wing parties believe in and left-wing parties don’t (ignoring the difficulties with those labels for a moment). The two successful big fiscal consolidations that have attracted a lot of attention recently were carried out by centre-left and centrist parties – the Swedish Social Democrats and the Canadian Liberals. The Clinton administration was a model of fiscal conservatism compared to Reagan and Bush.

    Running large persistent deficits has many disadvantages whatever political objectives you support. An obvious one is that it means a large chunk of government spending is swallowed up in debt interest payments. If investors lose confidence in the government’s ability to service the debt or suspect it will use inflation as a form of soft default, they will demand higher short- and long-term interest rates. These in turn worsen the government’s finances and depress private sector investment, eventually leading to a debt spiral and forcing a very harsh adjustment.

    Moreover, the higher your deficit the more dependent you are on the global capital markets (unless, like in Japan, domestic savers are prepared to buy all the bonds) and the fewer choices are available to democratic governments. As Jens Henriksson says:

    “A country with deficit and debt problems is closely monitored by the financial markets, by international organisations, by other countries and, not least, by its own citizens.

    Being closely monitored by the financial markets means that power shifts from the open chambers of the people’s elected representatives to the closed rooms of the financial markets in London and New York.

    This is of course truer for countries that are not members of a currency union. But sooner or later even those countries which are, in the short term, shielded from the turmoil of financial markets will face the consequences of large deficits and debts.”

    (He wrote this in 2007 – how prophetic that last comment now seems…)

    He adds: “Some people argue that it is undemocratic that markets have this power over elected representatives. That is a view I do not share. A country that each and every day has to borrow money, either to service the debt or to finance the deficit, is in the hands of its creditors.”

    That is the point that Nick Clegg and Lord Myners (among others) have been making in their recent statements about there being “nothing progressive” about complacency towards deficits and debt, and it is spot-on.

  • Alex Sabine 18th Jun '10 - 5:05am

    @David Allen: “I think what this is saying is that, if you are determined to cut your deficit above all other objectives, then you’d better do it by slashing long term spending commitments, which tend to hit the poor.”

    No, that’s not what the evidence is saying. What it’s saying is what I wrote, that most successful fiscal consolidations (ie those that are sustained after the painful measures have been taken and do not unravel, and those that do less damage to economic performance) rely more heavily on spending cuts than on tax increases.

    Jens Henrikkson again: “There is both theoretical and practical evidence that consolidation packages consisting mainly of expenditure cuts are more successful. The higher tax ratio you have, the more likely it will be that the taxes will create distortions and, in the long run, all expenditure has to be paid by taxes.”

    For more specifics on this question of the optimal split between cuts and tax rises, see the link in my post above. No one is saying it has to be all one or all the other, but the evidence in general supports consolidation packages based on spending cuts (hence why Vince Cable has argued that net tax rises should be a last resort).

    Interestingly, there is some empirical evidence to suggest that – paradoxically – left-wing governments get more credit with the public and financial markets if they show a willingness to cut spending, while right-wing governments get credit for being willing to raise taxes. The point being that by daring to confront your own constituency you will signal a greater sense of purpose/determination and thereby obtain a confidence effect. This is important because it boosts economic growth and makes the task that bit easier to accomplish at a lower social and economic cost.

    “Whereas if you want to take action on your deficit but you also worry about things like recession, unemployment, social cohesion, fairness, then you may prefer to stress tax rises, which tend to hit the rich.”

    It’s not a question of wanting to “take action” on the deficit but having a long list of other priorities – when you have a STRUCTURAL deficit of the magnitude we do, it has to be the overriding objective.

    Whatever one’s view on the vexed question of timing (whether and how much to cut this year – this boils down to a judgment on the balance of risks), tackling the deficit in a credible way is a precondition to the other nice things we all want (sustainable economic growth, falling unemployment, social cohesion, fairness).

    That’s not to deny that the adjustment can be painful – in the short run there might well be an increase in unemployment, for example (although in fiscal tightening episodes internationally there often hasn’t been) – and therefore we must ‘socialise’ the costs of the adjustment by helping the unemployed. But to pretend that there would be no unemployment if we carried on spending is just fanciful.

    It was instructive to hear the advice of former Swedish PM Goran Persson (whose social democratic government undertook an exceptionally large fiscal tightening in the mid-1990s) on the Daily Politics the other day:

    http://news.bbc.co.uk/1/hi/programmes/the_daily_politics/8730627.stm

    In many ways sorting out a big budget deficit is like sorting out a bout of inflation – there are transitional costs but you move onto a more sustainable path that underpins future economic growth. Tackling the underlying problem is a precondition of the growth, not an alternative to it.

    I suspect even the supposed short-run costs of early fiscal tightening may be exaggerated. For example, there has been a significant fall in bond yields, and part of this is attributable to increased market confidence in the UK’s deficit reduction plan in the light of measures taken by the coalition government. The IFS notes that market expectations for interest rates have fallen, thus reducing the cost of debt servicing now and in the future (by more than £6bn per year by 2014-15).

    “…To suggest that there is some sort of fundamental economic principle which effectively says that the rich must always get things done their way is, well, standard self-serving Conservative propaganda.

    No one is saying that. And it won’t just be the poor who will suffer from spending cuts – in fact, in terms of transfer payments, the reality is that it will be above-average earners who lose out (some estimates suggest as much as one-third of welfare payments go to households with above-average incomes, and this is surely likely to be scaled back).

    Also, remember that we are pressing for a tax cut on the basis that it helps the poor (or at least low-paid taxpayers). This is an expensive policy and increases the total amount of money that needs to be found from other sources, including spending cuts, VAT or whatever (since the budget will have to raise money to pay for both deficit reduction and tax cuts).

    Of course, the purpose of raising the tax threshold is to partially compensate the lower-paid for the other austerity measures that will affect them – but it isn’t helpful if your aim is to reduce the scale of spending cuts, since even if it were to be fully funded by other tax rises, it is money that isn’t available for deficit reduction and thereby to scale back the cuts.

    More generally, I wasn’t stating “some sort of fundamental economic principle” but the empirical evidence about the types of fiscal consolidation that are most sustainable and do the least economic damage. That might be inconvenient from your point of view, but it does seem to be what the majority of international experience points to.

    There is also the point that we are starting from a position where public spending as a share of the economy is at hisorically high levels in the UK (52% of GDP on the OECD measure, 48% on the Treasury figures), while tax revenues are already nearly back to their long-term trend level (37% of GDP compared to a long-term average of 38-39%). It is doubtful that increasing the tax ratio to (say) 45% of GDP would be helpful in nurturing the growth that we need to underpin both the recovery and deficit reduction.

    “If we actually meant it, we would also be making very sure that those in the City who became stinking rich while our deficit ballooned should now be paying us all back something!”

    Firstly, I expect we will see a bank levy in the budget as well as the 50% income tax rate being maintained (despite the economic case for it being pretty threadbare, it serves a political purpose especially for the Cameron Tories).

    There’s no doubt a lot of people in the City became “stinking rich”, and some of them played a big part in incubating the financial crisis.

    However, as I mentioned in my other post, I didn’t notice many in our party complaining about the tax revenues that came flooding in on the back of their activities during the boom years, which financed Brown’s spending spree that we supported… In that sense the Lib Dems were just as complicit in the Faustian pact as Labour and the Tories.

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