Friday, 9 September 2011
Here is a chart that should give everyone sleepless nights. During the last fiscal year, public expenditure amounted to 47.1 percent of GDP. Revenues, on the other hand, were only 37.2 percent of GDP. That left a hole in government finances amounting to a staggering 9.9 percent of GDP.
Here is the funny thing about government finances; although snotty economists might tell you otherwise, government finances are not a difficult to understand. There are four concepts one needs to grasp; revenues, expenditures, debt and deficits. Moreover, it is all just common sense.
If expenditure is higher than revenues, then the government has a deficit and it must borrow to meet the shortfall. If countries keep running up deficits, then the overall level of debt will rise. That will work for a while, so long as creditors are willing to cover your shortfall. However, if a country keeps increasing its debts, at some point creditors might call time. That is what happened to Greece, Ireland, and Portugal. It is as simple as that.
How does a country escape from a deficit of almost 10 percent of GDP? The least painful option is economic growth. If GDP is rising faster than expenditures, then over time, the expenditures to GDP ratio will fall. Revenues are also closely linked to growth. If GDP is growing rapidly, then so are taxes. This of course, assumes that expenditures are kept under control while GDP and tax revenues are growing.
Sadly, the UK economy is barely growing. Instead, our much beloved coalition must rely on more painful methods to balance the books. It must either raise taxes or cut expenditures. Osborne has already hiked VAT. He has also started the painful process of downsizing the government.
But what about this man Keynes? Didn't he have a grand old theory about spending your way out of a recession? Well, the previous government tried that trick and it didn't work. Hard to say what went wrong, and in the grand scheme of things, it doesn't really matter. The plain facts are that the UK has a huge deficit, government debt is exploding, and this can't go on forever. The economy is not growing and therefore a return to fiscal sustainability will be painful.