This thread is for you to say what you think should be done about the deficit.
- How much do we need to cut the deficit by?
- When should we start cutting?
- Over how many years should we cut it?
Let’s leave the detail of what taxes to raise, what services to cut, and what the ratio should be between tax rises and spending cuts. There are other threads to discuss those issues.
Let’s also leave the partisan politics to one side. These are difficult questions, no one really knows the right answer. And the answers aren’t necessarily leftwing or rightwing. So let’s be generous in our responses to each other.
The Office for Budget Responsibility estimate the 2009/10 deficit to be £156bn, but most commentators aren’t worried about the temporary part of the deficit that is due to the recession. The big worry is the structural deficit, the £86bn or 6% of GDP deficit that will, according to the OBR, persist even when the economy has recovered.
There is some controversy over the structural deficit. The figure of £86bn is only an estimate, as the Treasury acknowledge. But, if we’re to plan for long-term stability in the nation’s finances, it’s useful to have some idea of the long-term deficit we are faced with, even if it’s only an approximation.
All three parties have talked about eliminating the structural deficit, in the previous Labour government’s case by 2017, in the current coalition’s by 2015. The IFS have described these plans in their budget briefings.
There’s been a lot of heated debate on this site about when to start cutting. I think the disagreement has been over-hyped. The coalition have introduced £5.7bn cuts in spending for this year, but if you look at the chart on page six of the IFS briefing, these are only a fraction of the measures planned for following years.
So the second question, of whether to delay these cuts, may not make much difference to the deficit reduction programme, or to the pace of economic recovery.
The third question, over what time frame we should act to reduce the deficit, is the big one.
If we ignore the smaller measures for this year, the big difference between the Darling and Osborne plans is whether the measures should be concentrated over four years, from 2011 to 2015, or over six years, from 2011 to 2017. By spreading the pain over six years, Darling could plan cuts and tax rises of around 1% of GDP each year. By mostly concentrating over four years, Osborne increased the pain to 1.5% of GDP a year.
To put it simplistically, the difference between the Osborne and the Darling plans is, to get the pain out of the way by 2015, or spread the pain till 2017.
There are arguments in favour of either approach.
- If we spread the pain, then we reduce the pain to the economy while it is still fragile from the recent recession. If we don’t spread it, some fear this could cause a double-dip recession.
- If we allow more time to make cuts, we can soften their impact. It allows more time to shed staff through voluntary redundancies. More time to identify areas of inefficiency. Less of a shock to the general public, with some services steadily downgraded, rather than suddenly cut.
- The pace of the Darling plan may be more realistic. It may be politically impossible to make the kind of sudden cuts that the Osborne plan envisages.
But there are downsides to slowing the process.
- In the three decades from 1970 we had three recessions, about once every ten years. If this cycle were repeated, we should expect a further economic downturn from around 2017. If this happens while we still have a structural deficit, and a nation debt approaching 80%, the government may not be able to raise the finances to fund a stimulus to mitigate the effects of that recession.
- Immediately after an election is the easiest time to take tough decisions. If the government delays, it may find the political situation in the run-up to the 2015 election makes it impossible to act.
- The UK credit rating has already been downgraded in China. If other agencies believe the UK may use inflation to downgrade its debt, or think there is the remotest chance that a future government could default, then we will lost our AAA rating. If we were downgraded to AA+, it is estimated that it would cost an extra £5bn a year in debt interest payments. Further downgrading would be even more expensive. And ratings agencies have specifically warned that the Darling plan is not enough.
- Every year we delay cutting the deficit is another year we are adding to the debt. If delay adds 6.5% of GDP to our debt by 2015, that will add to future interest repayments.
So, that’s enough from me, now over to you.
(I’ve tried to be balanced in my analysis, but the need for brevity has forced me to be simplistic. I’d welcome any critiques, especially if they include links to articles specifically relevant to the UK situation)
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17 Comments
Thanks for this useful essay, which I’ll post a link to on the Twickenham & Richmond Lib Dem site, which I edit; perhaps Vince will post a comment under a pseudonym!
One thing I would like to see is councils that started cutting last year being rewarded rather than being expected to make the same level cuts as those that didn’t bother cutting early.
Very incisive article, George, thank you very much indeed.
Nothing more need be said. Just repeat until sunk in.
@Chris Squire
Thanks, I’d be delighted if you repost the above.
It should be added of course that if we slow down growth or even worse go into a recession then our debt will get even worse.
The way the government is making cuts now is simply reckless. I don’t see much evidence that the government has looked into the knock on effects of what it is doing. Many of these cuts will cause even bigger problems that will require more resources to fix them. Expenditure around projects to tackle global warming should be increased rather than cut. No one seems to be thinking about the costs of global warming. We all applauded Lord Stern when he published a report recommending 1% of GNP should be spent tackling this. Now we seem to have forgotten him. Cutting benefits will incentivise some people to resort to crime to make ends meet.
Somehow in your essay you forgot to mention the contribution of the market failure of the banking system to our national debt. How are we supposed to make sense of the governments policy to tighten regulation of the banks (a good thing), whilst deregulate the rest of the economy? Are banks uniquely bad? Can’t bubbles and short-termism happen else where, like in the oil industry for example?
So yes I am opposed to “shock therapy”, which failed in Eastern Europe, notably in Yeltsin’s Russia and I think we will see similar results here as well.
But your point about 10 year economic cycles is an interesting one, made more unpredictable given the rise of China, India and Brazil, plus the impact of global warming, and in the UK the diminishing oil reserves in the North Sea (and possibly on a global level as well).
Maybe the game is up? As a nation we have been rich for a long time. Is it reasonable to assume that will always be the case? Maybe the trick now is to consider how to mange our economic decline in the most humane way possible?
Martin Wolf in the Financial Times endorses Ed Balls’ economic analysis:
http://www.ft.com/cms/s/0/119c59ac-b6c3-11df-b3dd-00144feabdc0.html
“If the government were wrong on its gamble on recovery through retrenchment, the result would be a disaster for the country, not to mention the coalition. Economics offers no certainties: the bet that the UK can cut its way to prosperity may yet pay off if the confidence fairy sprinkles enough magic dust. Yet growth has to be achieved, despite a structural fiscal tightening averaging 1.6 per cent of gross domestic product a year, over five years. I consider this a foolhardy bet.”
“the market is screaming its lack of concern about UK fiscal credibility. UK government 10-year bonds are yielding 2.9 per cent and the real interest rate on index-linked bonds is below 1 per cent. Yes, markets can be wrong. But these are the most liquid and transparent markets of all. Moreover, those now doubting the wisdom of markets are the strongest believers. Why do they have these doubts? Furthermore, there is no sign of crowding out of private spending by government borrowing. Finally, UK government debt is long-term with an average maturity of 14 years and denominated in the domestic currency. We are terrified of a confidence bogey who is asleep.”
“How would the government respond if its plans generated a recession, as is possible and, in my view, probable? I have no idea. It would presumably rely on the Bank of England. There are reasons to doubt whether the latter would be very effective.
So what, finally, are the alternatives? Mr Balls agrees that “Labour does need a credible and medium-term plan to reduce the deficit and to reduce our level of national debt, but only once growth is fully secured and over a markedly longer period than Mr Osborne is currently planning”. Reasonable people can argue about how fast those cuts should be and when they should begin. I am more hawkish than Mr Balls. Reasonable people can differ, too, over how much of the deficit reduction should come from tax rises, instead of spending cuts.
Yet Mr Balls is right on two central points. First, a parliamentary term is a political reality, not an economic one. Second, plans for cuts must respond to the economy itself.
The “Treasury View” of the 1930s is back. If the government could not borrow, there would indeed be no alternative. But it does; so there is. Mr Balls is quite right to say so. He is right, too, to warn of the risks. The economic ”hurricane” he foretells might arrive rather soon.”
It depends on whether you have swallowed the entire supply side economic arguement as your party leadership has seemed to do ever since joining the Tories (I voted Lib Dem, I am not a party member, hence “your”)
I run a small business, cutting my corporation tax will have absolutely no impact on my ability or desire to hire staff. What the economy is lacking is demand, not supply.
Massive cuts in public spending, coupled with massive contractions in credit and an unstable private business environment mean that I have absolutely no interest in investing in the future of my company.
The supply of capacity within the economy is not the issue, demand is the issue and austerity is the enemy of demand.
A one sided question of “what should we cut” ignores the fundamental debate of how should we grow the economy.
Good to get comments, but I think it’d help the debate if people had a go at answering the questions. So perhaps I should set an example.
– How much do we need to cut the deficit by?
We should cut the £86bn structural part of the deficit. The cyclic part will go as the economy recovers.
– When should we start cutting?
The comparatively small cuts this year were probably worthwhile, simply to reassure the markets. We should start serious cutting next year.
– Over how many years should we cut it?
Tentatively, I’ll go for a compromise between the Darling and the Osborne plan, so about 1.25% of GDP per year over five years.
@donpaskini. Thanks, I don’t get to read all Martin Wolf’s pieces as I only have limited access to the FT. But, what would you do about the deficit?
@Geoffrey Payne. Thanks for a substantial response. I’ll answer in detail later.
“@donpaskini. Thanks, I don’t get to read all Martin Wolf’s pieces as I only have limited access to the FT. But, what would you do about the deficit?”
The point that Wolf and Balls make is that the size of the cuts depend on the state of the economy, which is very uncertain next year, let alone in five years time. It makes no economic sense to commit to a fixed %age of GDP every year irrespective of what is best for growth.
You can cut spending and end up with a bigger deficit, with the government spending more money on unemployment benefits and less money on useful social programmes. That’s what we did in the 1930s and 1980s. Similarly, you can increase spending and end up reducing the deficit if it leads to higher growth, as we did after 1945. And as you mentioned no one knows, to the nearest £10 billion, how much the “structural deficit” actually is anyway.
So here are some principles to govern our future economic policy:
– for starters, we should have a “do no harm” principle. For example, we shouldn’t try and save money by cutting housing benefit when the net effect will be higher costs to the taxpayer from increased homelessness and widespread misery and suffering.
– we should focus on reducing unemployment, because the best way to grow the economy is to ensure that as many people as possible are working and contributing.
– we should cut wasteful spending programmes immediately, whether that is Trident, Michael Gove’s school “reforms”, or Lord Freud’s attempts to give billions of pounds of welfare handouts to private companies.
– we should have a strategy for ending the UK’s financial dependency on the City of London and supporting the development of new industries.
– we should raise taxes on higher earners, for example through a bank levy, mansion tax and other sensible policies which the Lib Dems supported up until the election.
In other words, I think you are asking the wrong questions. We should cut some spending immediately, but because it is wasteful, not because of any given economic situation. We could set a target for how much to cut spending / raise taxes by, but this target will have to be very flexible because it depends on the changing economic situation (I’d go for £23 billion tax rises and £23 billion spending cuts over the next 4 years). And worrying about a default or downgrade is ignoring what the markets are telling us, while the scale of the cuts will cause misery, shift spending onto social failure and slow the growth in the economy.
If the economy starts growing more quickly, then we can cut more. If growth is slower, we shouldn’t.
Incidentally, very well worth looking at the ideas from Ed Balls, Ed Miliband and David Miliband on all of this.
Although I hate his tribalism, I have been impressed with Ed Ball’s position on economics. Of course he downplay’s Labour’s contribution to the mess we are in, but I find it interesting to see that Martin Woolf is agreeing with Ed Balls. This is the same Martin Woolf that was praised in Vince Cable’s book; The Storm.
The deficit needs to go and should go soon. Ideally, we’d be stimulating the economy with money saved during the fat times, but that isn’t possible right now. But we should start with genuine efficiency savings. You can’t save billions by cutting back on pot plants and dialling the thermostat down by a degree. But the NHS spends millions on management consultants that are an enormous waste of time and money, money that could be better spent on improving the well being of its staff and so reducing the very high cost of their sick days. Benefits like winter fuel allowance should be means tested and better targeted at those who genuinely need it. Defence spending could be moved away from companies in this country who have consistently over promised, over charged and under delivered. The jobs lost might be easier to make up than you might think, as an article in a Birmingham newspaper a few days ago claims that local manufacturers are facing a skills shortage of 90000 employees over the next 5 years. Cuts like these need to be identified and made asap. When cuts have been made via genuine efficiency and streamlining, then we should re-assess and see where further pain will be needed, but it’s irresponsible to make cuts until all genuine waste has been excised.
You guys identify a key area of debate. Whether an aggressive policy of reducing the structural deficit will undermine recovery, and mean lower tax revenues and an even slower reduction of the deficit.
I agree that it’s likely that keeping the deficit going will give us slightly higher growth in the short term. But both the OBR and the independent economic research institute, NIESR, think the effect on growth is much milder than you do. Ray Barrell of NIESR has said that Osborne’s budget is unlikely to cause a double dip, this is only likely if there is another major crisis.
NIESR have done work
to quantify the cost of measures to reduce the deficit. This work indicates that while the deficit reduction measures will marginally reduce growth, and increase some costs, they will significantly reduce the deficit.
It the nature of debt that it defers problems to tomorrow. The curse of easy credit is that there is always a temptation for politicians to keep doing this. This is an even bigger temptation for politicians, whatever their party, if they are in opposition and years from any likely chance at government.
I’m afraid, while I will read what the Labour leadership contenders say with interest, I won’t take their opinions too seriously. Their political imperative to win a Labour leadership campaign. The measures that Darling proposed before the election are a much better indication of what Labour would have done if they had won.
I have respect for Martin Wolf. The article quoted above is full of rhetorical flourish, but in other pieces he has been much more measured. He is honest enough to acknowledge that, though he is a “postponer”, no one really knows what will happen. (If you have access to the FT site, his
article on the different positions on this issue is worth a read) Nor does he have the same position as Ed Balls. He says, “I am more hawkish than Mr Balls.”
But I disagree with Wolf on a number of issues.
When he argues that the financial markets are not particularly worried about the UK fiscal credibility, that’s because, prior to the election, the markets assumed that the country would pursue an aggressive policy in reducing the deficit, probably under the Conservatives, or if not, probably a harsher version of the Darling plan.
Nor do I agree with his downplaying of the importance of political realities. Labour were widely criticised for not holding a spending review prior to the election. Economically, a spending review would have helped. Setting out a phased programme of cuts over the coming years, with flexibility to alter the programme as and when appropriate, would have sent a stronger signal to the markets that the government was serious about reducing the deficit.
But the political reality is that a review last year would have given ammunition to the opposition, and no government would have allowed that.
Political reality was important then, and it still is.
I’m very uneasy about the attitude that we should delay cuts until we are 100% sure the economy is fully recovering. How long will it take to be sure of that? If the government doesn’t start cutting now, immediately after the economy has grown 1.2% in a single quarter, and we have to wait until the economy has had two years of solid growth behind it, we’d just begin the process of reducing the deficit when the next downturn in the economic cycle begins. The long-term consequences of that could be disastrous.
Where I agree with Wolf is the need to respond to changes in the economy. There is a risk that the coalition will become a prisoner of its own rhetoric, and if the situation changes, and it becomes clear the measures need to be delayed, the coalition will find it very hard to change course. But, I don’t think the coalition has a choice. This is another example of political reality. If the coalition didn’t use this rhetoric, it would be even harder to carry through their policy.
@donpaskini
I’ve deliberately tried to focus this thread on cutting the deficit, and avoid the details of where the cuts will fall. I started a previous
thread which focused on cuts, and some thought I was asking the wrong question there too!
I won’t respond to your thoughts on cuts here, but if you read that thread, you’ll find I agree with some of what you say.
@Geoffrey Payne
While market failure is important, the issue I’m trying to address is not how we got here, but how we deal with the current situation. There are, of course, important questions about how we avoid future market failure, but I think those are for another thread. As for bubbles and short-termism happening in other places than the banking sector, absolutely. The housing and dot com bubbles are just two examples.
You’re right that we don’t talk enough about global warming. I keep submitting posts and frown at myself that, yet again, I’ve not mentioned this hugely important issue.
While I don’t think the game is up, I think there’s a strong
possibility that this century will be a lot tougher than the last.
If so, the next generation will curse us if we don’t tackle this deficit. I think that other challenges, like an ageing population and, yes, global warming, are very relevant to this issue. And without the flexibility that will come from healthy finances we may struggle to meet these future challenges.
@Timak
Thanks for your comment. It’s useful to hear from a small businessman about the challenges the present situation is creating. But what is your alternative? There’s clearly a cost to tackling the deficit now. Do you think it would be better to take the pain in a few years instead?
@Thomas
I’m very much in sympathy with what you say. It’s a real shame that the government are still ring-fencing health. By doing so, they’re imposing too much pain in other areas. Health has had a bonanza of spending in recent years, there must surely be savings in health that would be less damaging than much deeper cuts in other departments.
Regarding efficiency savings, I fear we don’t have time to wait for these before making cuts to front-line services. I think we have to do both.
@ George Kendall: I’m pretty positive that cuts to front line services are necessary too, and very soon. My thinking runs thusly: by initially focusing on making efficiencies, it helps to maintain morale and encourage departments and staff to really work hard and try and find those efficiencies to try and mitigate against future cuts. It also avoids the temptation to simply shed staff in the front line as a pr stunt to rally people against the cuts generally, a common reaction. But frankly, efficiencies and good practices shouldn’t have to wait until crises to be put in place and these should have been worked on for years. As you said, political factors constantly play their part, as no one really wants to be seen advocating cuts when times are good.
My opposition to Darling and, even more so, Ed Ball’s plans is that it will leave us with what we would in any other time still consider a seriously large deficit, even 5 years after the recession ended. Some £60 billion in 2015 for Darling’s plan and presumably more like £80 billion a year at that point in Ball’s putative plan.
5 years after a recession ends is a long time. 5 years after the last recession was 1998. If we are talking some possible even slower plan its more like 7 years and we’re still £60 in the red. Taking a decade is like waiting until 2003 to balance the books from the last recession and all that time piling up debt at tens of billions of pounds a year.
I appreciate the argument that while the economy is weak excessive cuts may damage the recovery. Presumably this danger is greatest in the first few years after we leave recession, i.e. now. I don’t really see how cuts 5 years after the recession ends are going to doom the economy, presuming it picks back up alright now. So there may be an argument for going easy for the first year or so and then cutting hard.
I think significant cuts are necessary. It is important to remember that we were running a £30 billion deficit even before the recession, which according to Keynes was a really bad plan. Something the sudden enthusaism for keynesianism amongst labour conveniently forgets. Also, tax revenue before the crash was artifically buoyed by corporation tax from the finanical sector due to the banking bubble and stamp duty from the housing bubble. So we cannot assume tax receipts will rebound to the level they were.
Government pre-crash was a junkie spending big on pro-cyclical borrowing and asset bubble tax receipts, in direct contravention to Keynesian policies. We are also spending more money on debt interest now than pre-crash due to all the borrowing. This is why spending must eventually come down hard. For these three reasons we cannot just hope to happily return to the status quo ante.
This is before we even get into the obvious fact that the economy has contracted by 6% and the tax base has shrunk accordingly, and so it would require a much higher general level of taxation to even go some way to closing the deficit gap. Not to mention the fact that significant tax hikes are even worse for the economy than spending cuts and the eventual moral of this story is that we must make big cuts whether we wait the first year or so to get properly started or not.
We need to balance the budget, not focus on cut the deficit.
Implement a Land Value Tax, and then, take the budget from the Lib Dem´s manifesto, anyone remember that publication from back in the spring?
There´s a balanced budget in that one.
Why not support that one, wouldn´t that be quite OK if Lib Dem´s supported a Lib Dem budget?
@Thomas
In principle, making early efficiency savings before real cuts sounds a good idea. But I recently heard an interview with Andrew Dilnot on this (ex-head of the IFS), and he said it was a constant rule with new ministers that they demanded large efficiency savings, and were always disappointed. So the risk of going for efficiencies first, is that you probably won’t get many, and you’d just delay the real cuts more than you intended.
@Stephen W
I agree that we need to think how far into the future a six or eight year deficit reduction programme would take us. If we imagine an ongoing structural deficit after the 1980-1982 recession, the picture is even more alarming than the one you paint. Because the next recession happened only eight years later, in 1990.
I recently read an old independent article from 2007, which indirectly talks about why we had sixteen years without recession after 1993, and sheds light on why our recent recession was so severe.
http://www.independent.co.uk/news/business/news/exgovernor-george-says-bank-deliberately-fuelled-consumer-boom-441160.html
It reports ex-Governor of the Bank of England, Eddie George, admitting the Bank deliberately fuelled a consumer boom between 2001 and 2003. He said he was “very conscious” that stimulating consumer demand could give rise to problems in the future.
And we are living with those problems now.
@Anthony Binder “We need to balance the budget, not focus on cut the deficit.”
Sorry, I don’t understand. Aren’t those the same things?
I’ve just quickly looked at the manifesto, and while it has a lot more detail than the other manifestos, it doesn’t specifically answer the question of the pace of deficit reduction. It suggests a Council of Financial Stability, involving all the parties, to determine the pace of the deficit reduction.
I know in his speeches, Vince Cable spoke of the Darling plan as a good starting point, but indicated that it would have to go further.
What do you think the pace of deficit reduction should be?
No a balanced budget is a budget that has a balance between revenue and expenses, revenues can be raised through taxes and through issuing of government bonds, that is especially useful for long term investments such as infrastructure, housing, green energy developments. The bond financing of the economy is not only unavoidable in macroeconomics, it is inevitable if a country wants to develop, grow, increase wealth, increase fairness etc. All the structural change that a Lib dem policy and economic was talking about in the manifesto and during the process of develop the paty policies over the years rely on investments that has to be financed through bonds. This financing is what the debate nowadays label public debt. Remember that Thomas paine stated that a country without public debt wasn´t looking after it´s citizens.
So public debt is not a bad thing, it is a necessity and should therefore be included as a way of financing the country´s expenses.
Implementing a Land Value Tax of about 2% in the UK would create a revenue to the state of about £70bln over this parliamentary period or around 10-15 bln annually aswell.
Scrap the Trident on top of that and you have a revenue surplus, and the discussion should be about what to do with the surplus. I for one would argue for infrastructural investments, more schools, smaller classes, development of green energy to start with. I would strongly argue against cutting the public debts, or the government´s own bond with i´s citizens to paraphrase Thomas Paine.
We can also include a mansion tax.
I see this debate as a threat against the party´s identity. The core of the Lib Dem´s is all of a sudden under discussion since we accept as a matter of fact that public debt is a bad thing and therefore any revenues from bond issuing is a deficit, since we only acknowledge tax revenue and therefore we must scrap and abolish the key policies that made the party unique, and walk the line where the other two have walked for years.
The UK rating downgrade by Dagong is, as I am sure you are fully aware of, only a political and ideological expression and has nothing to do with reality.
A balanced budget has revenues streaming in from taxes, customs, bond issuing and national levies and fees, and expenses that match that revenues.
We are close to a congress that has excluded discussions about a fee/levy on the banks issuing of new money, something that could generate more than £500mln if the levy was connected to the BoE rate. We have a congress that won´t take up the issue of Land Value Tax. And I am afraid we will have a congress that decide that we no longer should oppose the nuclear power/weapons.
Tragic, I hope I am wrong, cause I can´t see any Lib Dem´s if that is the outcome of the congress