Friday, 7 January 2011

The UK deficit reduction - this is what it looks like

A quick primer in UK fiscal issues......

Issue one: We have a very big fiscal deficit

Everyone knows it, but it never hurts to remind ourselves just how big it is. It is massive, huge, gigantic, beyond large, humungus, excessive, and gargantuan.

It is running at around 10 percent of GDP.

Issue two: The deficit is big mostly because of government expenditure

Tax collections have fallen. The bulk of revenue falls occurred in 2008, when VAT was foolishly cut. That has now been reversed. However, public expenditure has continued to grow in terms of GDP.

Issue Three: The Coalition government want to cut the deficit by reducing expenditure

The coalition wants to cut the deficit by around 10 percentage points of GDP by 2016. Three quarters of the adjustment will fall on expenditures.

What does Alice think?

She thinks the adjustment lacks ambition and would like to see a more rapid decline in the fiscal deficit.

Her maxim is "if in doubt, cut it out".


Lea said...

It hurts looking at those charts.

Nationalist said...

Unfortunately if the government stopped borrowing $150bn every year and injecting it into the economy via public spending the economy would collapse.

They should never have got themselves into this mess. There's no way back from the brink, all they can do is hover over the abyss and try to avoid falling in.

Anonymous said...

But Alice,

The figures Osbourne released at the recent review were as follows:

2008/9 £621bn; 2009/10 £669bn; 2010/11 £697bn; 2014/15 £740bn.

This led me to conclude that they're cutting the deficit with tax rises rather than spending cuts.

I just don't see how they can cut the deficit whilst increasing the budget; in fact they can't, and they won't.

Their projections are bunkem, they're following the same bankrupt policies as New Labour


MentalCrumble said...

You are absolutely correct but the coalition have lacked a sense of urgency from the start; they may have missed their optimal window which was right at the beginning.

Immediately after the election the Coalition might have been able to get away with a "2 years of pain to gain," and sold the public with an immediate, harsh but finite austerity package. Unfortunately, they've got themselves bogged down with coalition niceties, Whitehall trade offs and quelle surprise, a burgeoning sense of their own importance.

If they don't grip the problem quickly they may miss the boat... it may already be too late.

Sobers said...

I think the financing costs take up most of the extra spending by 2015. Actual spending on services will be level at best. Allowing for for rises for 'school n hospitals', other departments will see cash cuts, even before inflation.

I personally think that interest rates will rise faster than predicted and financing costs will outstrip predictions, causing a massive crisis at some point.

We might get lucky tho, if the euro goes t*ts up at some point in the next few years, the pound might get a bit of safe haven support, reducing UK govt debt costs.

We are on a knife edge though, it could easily go very wrong as go OK.

Mark Wadsworth said...

What Anon says and what Mental Crumble says above, it's the same old, same old.

Seeing as the government spends about £450 billion a year* on quangocracy and purchases from/subsidies the 'private' sector (on top of £250 billion cash welfare and pensions, which seems like good value in comparison), reducing the quangocracy/leechocracy by a third would get us into balance in no time.

* There are only about 2 million front line public sector workers (teachers, doctors, coppers, soldiers, social workers, prison officers, dustbin men etc), so that works out at £225,000 per annum for each of them.

Alice Cook said...

These aren't Osbourne's numbers. They come from the office of budget responsibility.


Strategist said...

The way to cut the deficit is to reduce unemployment.

Government spending cuts that increase unemployment will have the tendency to increase the deficit.

You've fallen into the classic trap of mistaking whole economy budgeting for household budgeting.

Your prescription of doing it all in two years is insane. Not only would it cause social hardship & chaos, it wouldn't work in its own terms. Ie, the deficit would not fall.

Anonymous said...


There is a thing called Ricardian equivalence.

This theory argues that the private sector will adjust their behaviour, in particular their savings and consumption decisions, to counteract the deficit. A high deficit leads to the private sector cutting back on their consumption today because they know that taxes will rise in the future.

The opposite could also be true. A serious attempt to cut the deficit might increase consumption and reduce unemployment.

What is clear, however, is that the large deficit that we have now seems to be closely associated with rising unemployment.

Over to you......

Strategist said...

Pure standard issue Chicago School garbage.

Check out this analysis, approximately a trillion times more sophisticated than your own:

Alice Cook said...

Thanks for the comment.

Actually, all I intended to do in this post was post a few pictures. No analysis really, just a little casual reporting using some data.

Personally, I don't think the idea that the UK needs to reduce its deficit is that contentious. Does anyone seriously disagree?

Anyway, I looked at the post your suggested. I wasn't impressed.

I left the following comment.....

"The case against Labour is a little bit more sophisticated than the one you suggest in your post.

Under Labour, government expenditure as a percent of GDP increased. Initially tax revenues were buoyant, and the overall fiscal deficit did not increase sharply. However, the underlying primary deficit experienced a dramatic reversal, particularly from 2000 onwards. The fiscal position weakened sharply under Labour. It is just wasn’t so obvious when looking at the headline numbers.

These fiscal policies also made the UK particularly vulnerable to an adverse shock, which is exactly what happened in 2007. Northern Rock collapsed, tax revenues crashed, and the deficit exploded.

Currently, the UK tax base is insufficient to cover government expenditures. Public debt is growing at the rate of 8 to 10% of GDP a year. That cannot continue for more than another year or two. The country understands this, and most people recognize it is time to cut government expenditures and put an end to the Labour spendfest.

As for “savings glut” – over the last decade, the UK private sector had a savings ratio just a tad above zero, the government was also running large deficits. The current account balance was also consistently negative. So at the aggregate level, the UK was dis-saving.

But why are we talking about this? The matter is settled. Labour lost the election, having failed to persuade the electorate of its economic strategy.

This is last year's debate. Fiscal consolidation is the order of the day.

However, I will say one obvious thing in Gordon Brown's defence. He prevented the UK from joining the euro. For this, we must all be eternally grateful."


Alice Cook said...
This comment has been removed by the author.
james c said...

It is much more likely that the coalition will fail to implement the cuts.

Strategist said...

"Personally, I don't think the idea that the UK needs to reduce its deficit is that contentious. Does anyone seriously disagree?"

You have misread my point. My serious disagreement with you is that you think the only to cut the deficit is shock therapy reductions in spending now. This won't work. The way to reduce the deficit is to get the people working.

In a nutshell, my point is that it is you that is not serious about reducing the deficit. You want to do so, but because you don't know what you are talking about, you would increase it.

Although I think it's a classic fallacy to mistake what might be sensible for an individual's finances to be a prescription for dealing with the whole economy, what you are in effect advocating is something like -

an individual whose expenditure is exceeding income deciding to address this by cutting back on their commuting costs by no longer going into work. Then being surprised when they stop receiving their salary and their deficit position gets worse.

Meanwhile all we get from the Chicago School parrot chorus is a theory about crowding out. Which might be a good theory had it the remotest shred of supporting evidence from the real world of the last 10 years, which it most decidedly does not.

Alice Cook said...


I think your argument is in two parts. First, you expect a fiscal retrenchment to lead to a fall in output. Second, as output falls, you expect a more than proportional decrease in revenues, and more than proportional increase in expenditures. This is what gives you your increasing deficit.

In other words, you are making an empirical claim about the revenue and expenditure elasticities with respect to output. Your point can also represented in terms of fiscal multipliers. You think that fiscal multipliers are large.

Economic theory suggests that the size of the fiscal multiplier is larger if: a) “leakages” are few (i.e., only a small part of a stimulus is saved or spent on imports), b) the monetary conditions are accommodative (i.e., the interest rate does not increase as a consequence of the fiscal expansion), and c) the country’s fiscal position after the stimulus is sustainable. Fiscal multipliers are assumed to be larger if the economy is operating a fixed exchange rate.

In empirical studies, estimates of multipliers tend to be very low. They range from 0.3 on revenues, 0.5 on capital spending, and 0.3 on other spending. Estimates vary from country to country. Sometimes, one sees multipliers as high as 1.8 on capital spending, and 1 for other spending. In Low income countries, multipliers tend to be very low and sometimes negative.

I believe that UK multipliers tend to be very low. Furthermore, the UK is operating a floating exchange rate. Simple macro theory tells us that the multipliers will be very small. The savings rate increased as the crisis progressed, also suggesting that the UK multipliers are very small. Therefore, I don’t expect any serious implications for growth as the deficit is reduced.

Notwithstanding my skepticism about multipliers, my reasons for wanting a rapid reduction in deficit is more to do with fiscal sustainability, the threat of a disorderly adjustment as we have seen in Greece and Ireland, and the well-known and very reliable empirical regularity suggesting that high levels of debt adverse effects growth. This latter point is not normally associated with any economists from Chicago.

You also made the following claim:

Meanwhile all we get from the Chicago School parrot chorus is a theory about crowding out. Which might be a good theory had it the remotest shred of supporting evidence from the real world of the last 10 years, which it most decidedly does not.

I think you're making a statement about Ricardian equivalence. I am a strong believer in this proposition without necessarily adopting its most extreme propositions. I think there is some evidence to support it. For example, based on aggregate data, the 2008 U.S. tax rebate appears to have been largely saved, massively curtailing the US marginal propensity to consume and the size of multipliers.

Thank you very much for your comment.

Alice Cook

chefdave said...

Although Stategist has been a little rude I do think he has a valid point. Ever since Brown took up the reigns at No.11, and especially since the crisis struck during the 3rd quarter of 2007 the state has been relentlessly pump priming the economy. If that stimulous ceased GDP would nosedive and large numbers of workers would quickly find themselves out of a job.

We do need this - there are too many people in unproductive nonjobs - but it would be preferable imo to ease in the change at a steady pace rather than suddenly curtial demand and hope that the private sector takes up the slack.

State withdrawal combined with the current fiscal and regulatory regime is a recipe for hardship and Depressionary levels of unemployment, this could be avoided if the state found a sustainable way to stimulate the economy.

Unfortunately it's clear Osbourne doesn't trust us with the economy, which is why he's transfering demand from us to him with a VAT rise. This is only going to make the problem worse and the public even more dependent on state subsidies in the long term as we're increasingly prevented from providing for ourselves.

Alice Cook said...


Thanks for the comment. As for Strategist being rude, don't worry. I didn't take any offence.

Personally, I think the stimulus, along with low interest rates are destabilizing the economy. This uncertainty has reduced investment and consumption and exacerbated the financial crisis.

The economy has experienced the longest recession since the war, inflation is increasing alarmingly, unemployment is up, we have a huge fiscal deficit, government debt has almost doubled, and the financial sector remains weak.

Frankly, I haven't seen any tangible benefits of the Brown intervention.

Again, thanks for your comment and your continued reading of the blog.

It is all appreciated. I also appreciate the comments of Strategist. A rude comment is infinitely better than no comments!


Strategist said...

Well, I apologise for being a little rude.

I certainly intend to be rude to the band of libertarian trolls or what I called the Chicago School parrot chorus who go around the net being arseholes (eg Guardian CiF). I don't lump you into this category.

So thanks for engaging with the argument, despite my rudeness.

Yes I think you have got my argument correct. If you take 500,000 public sector workers and move them onto the dole, the government deficit will go up. It is not a good idea to shrink the public sector faster than the private sector can re-employ the workforce. Mass unemployment is an economic waste, as well as a social catastrophe.

I like your blog because at some level I like your moral approach to the issue that we have been living beyond our means. I know you take a moral approach to sound money and welcome the return of your blogging and enjoy getting your latest take on the moral outrages being committed left right and centre (eg Hester).

I think we part company when you move on to economic prescriptions. I rather like the fact that there is a blogger who wants us to suffer a colossal economic depression because we have been bad and we deserve to be punished. But I can't join you in really wanting that. Sound money fetishism or puritanism has its worth up to a point, and I don't go as far as you do.

On multipliers etc, I certainly believe cutting VAT to have been a dreadful waste of resources available for economic stimulus. I would have preferred vouchers for the needy. I would have preferred a big scheme to build us a Severn Barrage and ensure that we have some energy security in this country for the next 100 years. Target and get that 1.8 multiplier, which I assume even you would agree is a good idea.

I also worry that you fall into the trap of being over-critical of the public sector (although I am sympathetic to the merciless lambasting of Gordon Brown). Just because the public sector wasn't perfect over the past 12 years, is no reason to lay waste to public services now, with all the social hardship, chaos and crime that will entail.

Looking at the society we live in, I don't go into a state school or NHS hospital, or observe council social services from a distance and see disgusting, immoral waste, which demands far-reaching reform. That's what I see when I walk along Oxford St or Bond St and see a hyper consumerist society with grotesque wealth inequality. Each to his or her own.

Alice Cook said...


No apologies needed.

My starting point is that the UK economy policy has generated massive imbalances. One needs to be honest and say that adjustment to a reasonably balanced economy will be painful. I also think that any delay will make those imbalances larger. So I say, lets be adult about it and do what we need to do.

Yes, I believe in sound money, zero deficits, and low goverment debt. I also believe in socialised healthcare, a limited social safety net and greater choice in education. (Fpr example, I feel very strongly about religious education and the right of parents to bring up their children in the faith of their choice).

I believe markets fail, but most of the failures are due to the interaction of government and vested interests.

I am deeply distrustful of the financial sector, which I believe are little better than a parasite.

I don't believe that governments can stabilize output. I am definitely not a Keynesian.

I want tight policy rules that limit the discretion of politicians. In this regard, it is hard to express my disappointment at the psuedo politicians running the bank of england.

I fear inflation and the chaos that it brings with it.

And yes, I strongly believe there is a moral dimension to all of this.

Again, thank you for your comment and I hope it is not the last.


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