Skip to content

Government Deficits: The Basics – Why Voting For Labour or is the same as Turkeys voting for Christmas

January 20, 2013

There is a huge amount written on government deficits. Very little of it is clear, much of the data is confused and the underlying causes of the deficit are not really explained well. This post seeks to set out what a deficit is, how it happens and what can be done about it. This post also proposes a solution to the current debt crisis in both the UK  and abroad – namely by providing security for debts created by governments as a means to restrain uncontrolled political spending.

WHAT IS A GOVERNMENT DEFICIT

A deficit is the difference between the amount a government spends in a year and the amount it collects. Governments collect revenue from taxation (in all its guises) and spends money on a whole variety of projects, the largest areas in the UK being the welfare state including pensions, education and the health service.

There are two types of deficit. A cyclical deficit (which is ok) and a structural deficit (which isn’t). Dealing first with the cyclical deficit:

The government attempts to ensure that tax is collected and spent so that the books balance, however, during periods when the economy is doing very well, it is likely that the amount of tax collected will increase (given more people will buy more things hence increase VAT income for the government, buy more houses hence increase stamp duties, increase corporate profits and hence corporation tax, earn more money and therefore pay more in income tax). At the same time government spending typically reduces when the economy is doing well because fewer people will need to claim benefits in the form of unemployment allowances and houses allowances etc.

When the economy is doing badly, the reverse will happen and governments expect taxation receipts to fall and welfare benefits to rise causing their balance to go negative. This whole process is known as the economic cycle or business cycle. Governments, therefore try, or claim they are trying to balance the books over a cycle taking into account the natural ebb and flow or breathing of the economy. Governments are not really worried about creating a deficit when the economy is doing badly as this allows money from the State to flow into the economy when it is most needed, and governments are not troubled by taking too much out of the economy in the form of excessive tax receipts when the economy is doing well because it takes the steam out of a booming economy and allows the state to build up money for the next period of bad times. This process of allowing the government to take out and put in money counter-cyclically is known as automatic stablisation.

The business cycle is as old as the Bible (think Joseph in Egypt during the years of famine and the years of plenty). One has to be very weary of politicians who claim to have overcome them (Brown: “No more booms, no more busts’ – how eloquent from a man who created and resided over he biggest boom and bust in the UKs history). Surpluses and deficits that even each out over the economy cycle are unsurprisingly called cyclical deficits and surpluses. Sensible governments will recognise when the economy is in a cyclical upturn and save money for the inevitable slowing down. Government run by ignorant or short sighted politicians and civil servants will find themselves getting over exuberant and spend the money during the good times leaving the cupboard bear for the downturn.

When one of the ex-Labour Minister’s, Liam Byrne was thrown out of office, he left a note for the new Minister. It stated :”there isn’t any money left”. Gordon Brown, Ed Balls, Liam Byrne and the rest of the Labour administration had spent all of the money during the good times, leaving nothing in the pot for the bad times. Most of the old Labour team are seeking re-election. Be afraid. Be very afraid. It would be a little like voting for Fred Goodwin or Bob Diamond to sit on the remuneration committee of a bank. The Labour administration squandered more money between 1997 and 2010 than every other British government in history, combined. The notion that something had to be kept back was completely absent from their thinking as pay, employment rights and staffing in the public sector ballooned out of control. When the business cycle turned negative, as it has been doing for hundred of years, there was no saving for a rainy day.

STRUCTURAL DEFICITS

A structure deficit is a very different thing to a cyclical deficit. It is something to be concerned about and something that can’t be sustained over any period of time.

A structural deficit is a situation in which the amount of money being spent by government is greater than its tax receipts, even taking into account the economic cycle. A good way to think about this would be to compare it with a persons salary. Each month a person receives their salary in their bank account. From their salary, they have to pay their bills and the amount in their bank reduces and keeps reducing until they receive their next salary payment. If over time their bank balance keeps falling, even taking into account their salary – they are running a structural deficit. In other words they are spending too much money and need to change their habits.

THE BOND MARKET AND THE EURO CRISIS

So, what happens when someone spends more than they have? Well, they have to get someone to lend them the money. Governments are exactly the same. Whilst we as individuals might have to borrow money in the form of a loan or an overdraft, the government has to borrow the money from the bond market. In the UK, the government will issue bonds, known as “Gilts”. These bonds are loans that people are prepared to make to the UK government. If you add up all the money that the UK government owes, mostly in the form of gilts – you will get a handle on the national debt. We currently owe more than a trillion, that is:

£1,000,000,000,000!

For more numbers a good site is:

http://www.debtbombshell.com/

Lending to governments is a pretty safe thing to do. Or at least it was, to most governments. Following defaults (a default is where the person you lent to doesn’t pay you back) in Argentina and Russia along with an assortment of countries in Africa, investor confidence in government bonds became more restricted to G7 nations. After all, it wasn’t likely that the largest economies in the world would default.

The confidence of investors was well founded. Up until 1999, each of these nations were capable of simply printing currency to make good on the debts albeit with a potentially inflationary after taste. Following the establishment of the Euro a number of countries lost control of their currency, but not their ability to raise money in the bond market.

The socialist influence on politics across the Euro-continent from the period of 1997 through to 2012 represented a period of the most grotesque profligacy in history. A lesson in how not to run a country – our own brand of political fool came in the form of Balls, Byrne and Brown.

In short, these politicians ran systematic structural deficits. Their wasteful spending manifested itself in a whole host of ways – spraying their client groups (people who they wanted to vote for them) with money. There were huge rises in pay across the public sector, vanity building projects costing billions, huge increases in employment in the public sector and importantly significant reductions in pension ages. In Greece certain members of the public sector were able to retire on full pensions in their 40s – with the State happy to pay pensions for 40+ years on a working life of less than half of that figure. Of course, the entire enterprise was bound to collapse and it did.

The financial crisis discussed in the previous posting didn’t cause the government crisis that followed. It merely preceded it and acted as a catalyst for something that had to happen in any event at some stage. As the world economy started to tail spin, resulting from the financial crisis, socialist governments from Spain, to the UK to Greece began to realise they had nothing in reserve to cope with an economic downturn. They had spent the lot.

These governments began to do what they did best and borrow – from the bond market. The bond market, however, started to look at the capacity of these countries to be able to repay back the debt and this eventually turned into a full blown bond market panic. It was Greece that won the ugly contest out of the Euro-socialist line up. The term “PIIGS” was coined to pick out the countries who had been caught “swimming naked when the tide went out” i.e. had run out of money when the economy down turned. Portugal, Ireland, Italy, Greece and Spain were forced to either apply for a bailout from their EU partners or be presented with de facto budgets. In short, the governments of these countries had lost control of their countries like a common bankrupt looses control of their own finances. The northern Europeans, namely the Franco-German alliance had to dictate terms.

SOLUTIONS

The most obvious solution to a debt crisis is to ensure that politicians of any colour in any country are restrained from spending more than they receive. Of course, the danger here is that politicians will claim they are only running cyclical deficits – Brown, Balls and Byrne did exactly that. One solution to this, would be the prevention of governments from running a deficit during times when GDP is above a certain figure e.g. 1.5% (the reason this figure isn’t zero is due to the fact that there is a natural rate of GDP growth one would expect in an economy due to population growth and technological advances – there is much debate about this figure but is certainly a positive number). Once GDP rises to a certain level, if political spending implies a deficit, then spending cuts ought to automatically be put in place to ensure some funds are saved for a rainy day.

The second solution to incontinent political and civil service spending is to self impose limits on money that can be raised from the bond market. The bond market is without a doubt the most powerful group of investors on the planet. A US political advisor, James Carville once said he would like to come back as the bond market – so he could intimidate everyone!

The bond market, like any lending sensible “institution” is concerned with two things. The most important is faith that the borrower will give them their money back at some point. The second is that they receive a reasonable rate of interest for taking the risk as lender. When investors get worried, the simply won’t lend. This happened when various Euro-governments were shut out from the bond market and it could easily happen to the UK.

To solve the problem, governments would be well advised to only issue paper (bonds) that were asset backed – rather like a mortgage. Investors who were buying these bonds would then be prepared to lend at much lower rates of interest (given the reduced risk) and there would be a finite number of “securities” to lend against – given the finite amount of assets held by the government. There would be huge political pressure (as there is with a household mortgage) to get the debt paid off – rather than the current situation where the national debt is simply rising. Governments who hit the debt ceiling (the US has a self imposed ceiling unlike the UK) then decisions would have to be made in regards to cutting spending.

FINAL WORD

Without a doubt, the two largest problems for government spending are health and pensions. It would be possible to double health spending at any given moment in the cycle. Health represents an area through which we could channel unlimited spending. Most of this money would be spend keeping patients alive for incrementally longer periods. I am not advocating we don’t spend more and more money on the health service, but I do think it needs to be said that the amounts we spend in this regard are with due concern to what can be afforded – namely in regards to our national debt and budget deficits. It is currently political suicide to suggest health spending is somehow controlled – but one thing should be borne in mind which is that the majority of funds are spend on salaries, not on health care.

The second issue relates to pensions of civil servants, quasi-government officials, teachers, nurses, doctors and others in the public sector. The fact is we are living long. Retiring at 60 or 65 is no longer something the state should or ought to afford. If the pension age were increased to 70, the deficit would be wiped out in a stroke. We need some serious thinking on pensions reform – specifically linking the pension age with life expectancy – if we don’t we will end up like Greece.

I am aware that many socialist writers would say the solution is to increase the tax rate on the rich etc. However, government revenue is likely to actually fall if tax rates rise – due to the fact that few wealth creators are going to take additional risk, employ additional staff and add to GDP. I have written elsewhere on this blog on this subject and will continue to do so.

 

Advertisements

From → Uncategorized

Leave a Comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: