The Office for Budget Responsibility (OBR) is an independent body, created to help us hold the government to account. It’s their job to check the government clears the structural deficit within this parliament. So it’s pretty important that we understand what is meant by “structural deficit”.
But what exactly is the structural deficit?
The word “deficit” is bad enough. A lot of people confuse it with “debt”, and that’s not just in inadvertent typos. However, if you stop and think, it’s not so bad. ‘Debt’ is what we owe, and ‘deficit’ is how fast our debt is increasing.
The structural deficit isn’t so simple. The FT’s
definition is: “A budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on one-off or short-term factors.”
Unfortunately, that definition doesn’t tell the whole story. To understand an OBR report, you have to understand other phrases, such as the “current deficit”, and the “cyclically-adjusted current deficit”.
The current deficit is the deficit, excluding capital spending. Capital spending is on items with a useful life of more than one year, so long term assets, like a new hospital or, er … the Millenium Dome. Current spending is on items which are consumed, like salaries or drugs in a hospital.
Some argue that the capital spending part of a deficit doesn’t matter, because it is investing in a long-term asset which will improve efficiency. But this isn’t always true. What about the aircraft carrier that’s being built, only to be mothballed? And are all replacement buildings so much better built and designed that they will pay for themselves in improved efficiency?
So there’s room for debate about whether we should worry about the capital spending part of the deficit.
In 2010, the BBC reported the OBR saying that the structural deficit would widen from 7.3% of GDP in 2010-11 to 8%.
But is that really what the OBR said? If you look at the OBR
report, you will search in vain for the words “structural deficit”, instead, they use terms like “cyclically-adjusted net borrowing”. In this case, the BBC used the phrase “structural deficit” to mean “cyclically-adjusted net borrowing” – in other words the structural deficit, including capital spending.
However, most commentators use the term in the same way the government does, in its target to balance the structural deficit excluding capital spending.
So, when you’re reading serious articles about the deficit, be careful how you read the figures. Different “experts” can mean different things by the same term. Their only consistency is that they don’t give you a glossary that explains exactly what they mean.
And I find that worrying.
The whole point of the OBR was that it should allow the voter to hold the government to account for its financial responsibility. If even financial journalists get confused, what chance has the poor voter?
The OBR publishes lots of useful data for academics and economists. But this isn’t enough. The OBR need to work harder at making their material more accessible to the general public.
A decent glossary would be a start.
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19 Comments
cthe capital expenditure component matters because not all capital expenditure is on items which have an economically useful life after 1 year( a hospital is socially not economicalloy useful??) and becayse you are borrowing yto pay for it…..the interest has to be paid back over more than a year..widening the actual deficit for no economic return
“The Office for Budget Responsibility (OBR) is an independent body, created to help us hold the government to account.”
There is nothing on the OBR’s website about them enabling “us” to hold the government to account. You may want it to be that way but I can imagine they have an entirely different perspective.
Also, “we” hold the government to account through elections, not quangos. Who holds the OBR to account?
Find me 2 economists who agree on what the “structural deficit” is and I’ll find you two people pretending to agree with each other.
I am an economist by training and to be frank pretty much everything in economics can be challenged with basic logic and shown to be utter nonsense.
Still find it amazing people listen to economic “experts” when they are correct as often as a monkey using a dartboard to select outcomes
@Timak – Harsh but fair 😉
After I submitted this piece, I showed it to some friends, and it soon became clear that I’d better hammer out a glossary myself.
Debt – what the country owes
Deficit – the amount the debt increases each year
Current deficit – the deficit, excluding capital spending
Capital spending – spending on items with a useful life of more than one year
Cyclically-adjusted – adjusted to take out the effects of the economic cycle (such as increased welfare payments and lower taxes)
Cyclically-adjusted net borrowing – deficit, excluding the effects of the economic cycle, including capital spending
Cyclically-adjusted surplus on current budget – deficit, excluding the effects of the economic cycle, excluding capital spending (note: this is a negative number, and Cyclically-adjusted net borrowing is a positive number)
Structural deficit – cyclically-adjusted deficit. Usually, it excludes capital spending, but sometimes it includes it
@davidjthorpe “capital expenditure component matters ”
I agree.
Capital spending on a well designed hospital building may be cheaper to heat, and help its staff to work more productively than the previous older building, and it may well be an investment in the sense that it allows more patients to be treated. But, in practice, capital projects like this increase ongoing spending, rather than decrease it, because they are linked to increasing the number of beds in the hospital, and the number of staff working there. If the extra spending is sustainable and is meeting a real need, that is a good thing. But, long-term, the NHS is planning to move more spending into primary care, which may mean bigger buildings aren’t a good investment.
See http://www.usaycompare.co.uk/health-insurance-news/article/more-hospitals-must-be-closed-to-meet-budget-demands-800721082 “According to the King’s Fund, too many hospitals provide duplicate services and as a result they are chasing too few patients to maintain high standards”
@Julian
The OBR’s stated aims include “We judge progress towards the Government’s fiscal targets”, “We assess the long-term sustainability of the public finances”, “…We then state in the EFO and the Treasury’s costing documents whether we endorse the costings that the Government finally publishes as reasonable central estimates”.
Personally, I’d regard that as helping us to hold the government to account.
@Timak “Find me 2 economists who agree on what the “structural deficit” is and I’ll find you two people pretending to agree with each other.”
I completely agree that we should treat what economics experts say very cautiously, but I don’t think we should ignore them.
In March this year, in the OBR publication, “Economic and fiscal outlook – March 2011”, Robert Chote, Steve Nickell, and Graham Parker estimated the cyclically adjusted net borrowing (ie structural deficit including capital spending) for 2010-11 as: 7.4% of GDP. They said “take full responsibility for the judgements that underpin them and for the conclusions we have reached.” Doubtless they have slightly different opinions and I don’t suppose they’d dispute that, but this was the figure they came to an agreement on, and, while only an estimate, the OBR is the best we have.
Is the figure precisely correct? Of course not. Each time the OBR produces a report, they constantly say that these are estimates, and they adjust previous estimates to reflect new information. But just because they involve subjective judgements, doesn’t make them useless. Robert Chote himself talked about this issue, when he ran the IFS. He acknowledged that these figures are estimates, but said: “in the face of uncertainty it is sensible and prudent to build in a safety margin as it is easier to deal with pleasant surprises than unpleasant ones.”
There are some economists who disagree with the use of the term structual deficit at all, http://blogs.ft.com/money-supply/2010/03/04/britains-structural-deficits-disease/#axzz1dgOjblCj , but, in my opinion, it’s useful to try to estimate what the deficit would be if you take out cyclic factors, and therefore what part of the deficit can’t just be justified because we’ve recently been in recession.
As Timak said, “to be frank pretty much everything in economics can be challenged with basic logic and shown to be utter nonsense.”
I don’t have the advantage of being an economist so for a very long time I was puzzled by the fact that “proper” economists seemed not to know how the world worked. It was as if they had only studied to a very elementary level, certainly not beyond GCSE, where they had learned all sorts of gross simplifications like the one in school where you are told to “ignore air resistance”. Not a good plan when you are designing an airplane and in an economist not good when you are running an economy.
Eventually I twigged that there are many schools of economics and that the dominant “neoclassical” one is complete and utter tosh. Far from being the queen of the social sciences it is a cargo cult like theology whose main purpose is to legitimise the establishment doing as it likes – in which it’s been stunning successful.
I suggest you read Steve Keen’s “Debunking Economics” of which the econd edition is recently out. It’s fairly wonkish, but I think you might enjoy it.
It’s less puzzling once you realise it’s simply true. Economics is an unsolved problem; nobody really understands how it works. We observe that some things (like large deficits) are often followed by unfortunate events (like Greece), and try to avoid those things, and that’s about all there really is to it.
It’s more like 16th century physics. They got a lot of things right, a lot of things slightly wrong, and some things very wrong. Over time they got more accurate.
You make some good points. However, I’d rather start with some basic improvements in “management information”. We now have a good and useful monthly update on the progress of tax revenues from HMRC available here:
http://www.hmrc.gov.uk/stats/tax_receipts/tax-receipts-and-taxpayers.xls
which allows us to see how tax revenues are shaping up against budget projections tax by tax (although we have to dig the projections out of the Red Book). The monthly breakdown of spending given in the ONS’ PSF tables is however extremely limited, and makes it very difficult to see which areas of spending are heading off course. It would make sense to break out spending at least to the level of Table C4 in the Red Book, and preferably broken down still further like this:
http://image.guardian.co.uk/sys-files/Guardian/documents/2009/09/16/Public_spending_160909.pdf
Departments and quangos ought to offer more detail on their websites – again with monthly updates. I was interested to discover that the UKBA treats fees for visas etc. as negative spending – and that it was reported that they intended to achieve their £500m of savings through collecting more fees, though it was unstated whether they expected to do this through higher charges or issuing more visas.
By publishing details in this way it becomes more obvious what are the areas of spending that need more attention (especially if there is ample back history available in similar format so we can ask whether we are really getting value for increased spending), and which taxes are working well and which are not.
We are so far away from fiscal balance that angels on pinheads arguments about what the cyclically adjusted deficit might be become distinctly moot points – it’s not the sort of vital sign that is of first rank importance in the middle of a liquidity trap. Demonstrating an ability to manage in line with a plan and to justify changes to that plan are the first key to financial credibility: something that a certain Mr Alexander has made a significant contribution towards, I’m pleased to say. Perhaps the OBR could be tasked with coordinating this approach.
@Liberal Eye
I see it more as @Andrew Suffield does. That economics has made progress, but there is a great deal of uncertainty. But even if it is not a precise science, we need it. Without it governments would make far more serious mistakes.
@It doesn’t add up…
I’ve not taken the time to do the detailed work you have, investigating budget projections tax by tax, but you’re probably right that we need much more detail. I’ve been trying to understand the overall picture of government finance in the OBR reports, which, to my mind, is as far as you can get from “angels dancing on a pin”.
The difference between the “Cyclically-adjusted net borrowing” and the “Cyclically-adjusted surplus on current budget” is not some minor detail. For 2010-11, the first was estimated to be £109bn, the second was £68bn. £40bn pounds is not pocket change.
However, explaining the jargon is only a first step in the discussion I’d like on the OBR on this site. I’m planning an article which will raise other questions about the way the OBR reports are produced.
That said, these articles won’t be anti the OBR. The OBR is still developing its role, so of course there is room for improvement, and that doesn’t mean it isn’t already doing a very useful job.
Thanks George. I am not an economist which means I can’t find a reason to disagree as economists feel compelled to do. I therefore find your article helpful.
Accounting for capital spending might be OK for companies -They can write off (depreciate) the spend over the life of the capital item. So a new pyramid might be written off over say 2,000 or more years. This makes their profit and loss account look OK.
But the cash has to be found now to pay the wages of the pyramid bulders, and as we are running a deficit has to be borrowed.
Since 1973, 69% of Greek finance ministers have held a PhD in economics.
Good post George – I like your go at the glossary!
I was so impressed I wrote a blog of my own
http://jiltedgeneration.blogspot.com/2011/11/is-economic-literacy-improving-with.html
When some economists continue to propound clearly false and falsifiable propositions I find it an inadequate explanation to propose, as Andrew Suffield does,that economics is “more like 16th century physics”. Clearly this is true to a point but how can it be that, uniquely among all disciplines, they are still stuck in the pre-modern era?
Maybe it is as simple as that.but the alternative view that it often serves, possibly unwittingly, as a tool to legitimise the status quo explains why paradigms continue to live zombie like long after they are refuted. Suppose someone did some reseach proving beyond doubt that concentration in the media is a bad thing. Do you suppose the Murdoch press would take it up or would they just ignore it and continue to push the line that all restraint on business is harmful and pay economists prepared to opine to that effect to write their editorials?
In short, economics always was and no doubt always will be muddled up with propaganda. That doesn’t mean that there aren’t important things to lean – quite the opposite in fact – but it does mean that we should be careful. I have long believed that part of the political weakness of the liberal cause is that we have been negligent of developing our own economic thinking.
@Liberal Eye “In short, economics always was and no doubt always will be muddled up with propaganda. That doesn’t mean that there aren’t important things to lean – quite the opposite in fact – but it does mean that we should be careful”
In full agreement with you there. It’s one of the reasons I wrote this article. When even respected commentators use the same word, “structural deficit”, to mean very different things, if we are to understand the real figures behind the propaganda, we need to be able to read an OBR report.
What I find extremely frustrating is that world famous economists, if they have strong political opinions, will spin as badly as Peter Mandelson. And they will assert as fact, things that are widely disputed among economists, giving the false impression that the entire community of economists agrees with them.
@Liberal Eye
I think one of the biggest problems economists face (other than that they can’t run controlled experiments) is that people are not rational actors.
And, for a lot of models, they are supposed to be.
“will improve efficiency”
it’s not to do with efficiency, it’s to do with return. If you purchase champagne in a bar on a credit card, then after the night out all you have is memories, but you are still paying the debt off. But if you buy a tumble dryer, you get to use it over a number of years, so your debt repayments can be seen like rental costs, ie incurring in line with the benefits.
Similarly if you build a road, the benefits incur every year, not all in one go. Or a hospital, etc.
@Matthew
I said: “will improve efficiency”
You said: “it’s not to do with efficiency, it’s to do with return … if you build a road, the benefits incur every year, not all in one go. Or a hospital, etc.”
The question of whether a deficit caused by capital spending is a problem hasn’t received enough attention in the press. I may write an article devoted solely to that subject in future. So thank you for your comment, Matthew.
I don’t think we are necessarily disagreeing.
Let me use a hypothetical situation to illustrate.
Two countries are running balanced revenue budgets, but when capital spending is taken into account, they run deficits.
Country A’s capital spending makes their deficit £30bn/yr.
Country B’s capital spending makes their deficit £29bn/yr, except in the first year, when they spend £39bn.
So the total deficit spend for both countries over 10 years is £300bn.
As you say, the benefits of capital spending come about over a long period, so the fact Country B runs a deficit of £39bn in the first year isn’t such a problem. Their lower spending over the following years means that, over 10 years, they are broadly in the same situation as Country A.
My criticism would not be about that one-off £39bn, but the average £30/yr deficit of both countries.
If that capital spending were on items that would bring financial long-term benefit, like reduced heating bills, and transport projects which increase economic activity and so increase revenue from taxes, all well and good. These projects could, in the long run, result in a balanced budget.
But, in my opinion, this is only a minority of capital spending.
That’s not to say it’s wasted. Some projects, like the mothballed aircraft carrier, are wasted. But most is on improved public services – for example, a new leisure hall. This improves our standard of living, but it doesn’t pay for itself. So, if the government is constantly adding new facilities like this, it should budget to pay for them, not out of permanent debt, but, over time, it should pay off a temporary debt out of taxes received.
When I was a councillor, this was done with a capital fund. When part of the council wanted to build a new leisure hall, there was an internal loan from the councils capital fund, and they budgeted to pay off the internal loan in the following years. But we didn’t kid ourselves that the leisure hall would bring in extra revenue, and so if it caused a debt, we didn’t pretend that the debt wouldn’t eventually have to be paid off.
Similarly, just because much capital spending brings long-term benefits to our standard of living, doesn’t mean we shouldn’t budget to, on average, pay for it as we go.