The public sector deficit through the looking-glass

The government is ignoring the flip side of the its deficit reduction targets: they require us all to spend more.

Reducing the public sector deficit has been the Coalition's number one economic goal from the start. Inheriting a record deficit in 2009/10 – Labour’s last year – equal to almost 11 per cent of GDP, no new government, even if had wanted to, could have done anything else. 

The underlying reasoning – that a deficit this big is a sign of a something seriously amiss in the economy – was and is completely correct. Since the late 1980s, this deficit had averaged 2.5 per cent. In that period, the biggest it ever got was 7.5 per cent in 1993/4 as the economy began its recovery from the early 1990s recession.

But the approach of trying to reduce that deficit by cutting spending and putting up taxes alone is wrong. The reason why is that the public sector deficit does not exist in isolation. Instead, it is part of a chain of 'imbalances' linking the public sector with the household, corporate and overseas sectors. By definition (and measurement errors aside), these four imbalances, some surpluses and some deficits, always add up to zero.

The graph below shows the public sector deficit as a percentage of GDP, year by year from 1993/4 (the previous record deficit year). The figures up to 2011/12 are actual figures. Those for 2012/3 and beyond are the OBR’s latest forecast published last week. The odd-looking 2012/3 figures themselves are due to some one-off financial transfers between the corporate and public sectors. In the big picture they can be ignored.

Sources: ONS Quarterly National Accounts (to 2011/2) and Office for Budget Responsibility, March 2013 Economy Supplementary Tables, table 1.8, (from 2012/3)

Since there is nothing on the graph labelled ‘public sector deficit’ how can it be a picture of it? On the face of it, the graph shows the other three sector balances, with surpluses above the line and deficits below it. The public sector deficit is the total of these three. In years when all three are themselves surpluses, the public sector deficit is measured by the top of the bar stack: for example, just under 11 per cent in 2009/10. In years when one or more of the other balances is itself a deficit, this has to be subtracted from the top of the stack to get the measure of the public sector: for example, just under 7 per cent in 2008/9. This is a picture of the public sector deficit as Alice might find it, through the looking-glass.

This picture provokes questions. Let’s take three of them here. First, if the public sector deficit has this double life, as both itself and as this mirror image of the other three sectors, can we say which causes which? In simple terms, the answer is no; both sides of the mirror have a life of their own. This answer is enough to undermine the basic idea of ‘austerity’; that if only a government bears down on the public sector hard enough, all, eventually, will be well.

Second, what should we make of the economy in 2017/8, the last year of the OBR’s forecast? With a public sector deficit projected at 2.5 per cent (the long term average) and (though this cannot be seen in the graph) public sector debt at last falling as a percentage of GDP. Osborne would regard this as vindication. But by looking at the reflection of the deficit in the mirror, we see that 2017/8 bears an unfortunate resemblance not to the boom years either side of 1997 but to 2002/3, the year when things started going wrong under Labour as the economy came to be sustained by public and household borrowing. 

Third, if this is where austerity gets us, where do we need to go instead? The answer is that we must concentrate as well on the problematic surpluses, both the chronic corporate sector surplus (into its consecutive 16th year by the end of the OBR forecast) and overseas surplus with the UK – better known as ‘our’ balance of payments deficit. To the extent that there is a debate about alternatives to austerity they are for the most part about how to ‘kick start’ the economy. Without a programme for dealing with the twin surpluses, however, kick-start may turn into stop-start before we get anywhere near a sufficient level of economic activity.

And she looked from Tweedledum to Tweedledee, and from Tweedledee to Tweedledum, and from Tweedledum to Tweedledee again; but already it was impossible to say which was which.
Photo: Getty
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Forget planning for no deal. The government isn't really planning for Brexit at all

The British government is simply not in a position to handle life after the EU.

No deal is better than a bad deal? That phrase has essentially vanished from Theresa May’s lips since the loss of her parliamentary majority in June, but it lives on in the minds of her boosters in the commentariat and the most committed parts of the Brexit press. In fact, they have a new meme: criticising the civil service and ministers who backed a Remain vote for “not preparing” for a no deal Brexit.

Leaving without a deal would mean, among other things, dropping out of the Open Skies agreement which allows British aeroplanes to fly to the United States and European Union. It would lead very quickly to food shortages and also mean that radioactive isotopes, used among other things for cancer treatment, wouldn’t be able to cross into the UK anymore. “Planning for no deal” actually means “making a deal”.  (Where the Brexit elite may have a point is that the consequences of no deal are sufficiently disruptive on both sides that the British government shouldn’t  worry too much about the two-year time frame set out in Article 50, as both sides have too big an incentive to always agree to extra time. I don’t think this is likely for political reasons but there is a good economic case for it.)

For the most part, you can’t really plan for no deal. There are however some things the government could prepare for. They could, for instance, start hiring additional staff for customs checks and investing in a bigger IT system to be able to handle the increased volume of work that would need to take place at the British border. It would need to begin issuing compulsory purchases to build new customs posts at ports, particularly along the 300-mile stretch of the Irish border – where Northern Ireland, outside the European Union, would immediately have a hard border with the Republic of Ireland, which would remain inside the bloc. But as Newsnight’s Christopher Cook details, the government is doing none of these things.

Now, in a way, you might say that this is a good decision on the government’s part. Frankly, these measures would only be about as useful as doing your seatbelt up before driving off the Grand Canyon. Buying up land and properties along the Irish border has the potential to cause political headaches that neither the British nor Irish governments need. However, as Cook notes, much of the government’s negotiating strategy seems to be based around convincing the EU27 that the United Kingdom might actually walk away without a deal, so not making even these inadequate plans makes a mockery of their own strategy. 

But the frothing about preparing for “no deal” ignores a far bigger problem: the government isn’t really preparing for any deal, and certainly not the one envisaged in May’s Lancaster House speech, where she set out the terms of Britain’s Brexit negotiations, or in her letter to the EU27 triggering Article 50. Just to reiterate: the government’s proposal is that the United Kingdom will leave both the single market and the customs union. Its regulations will no longer be set or enforced by the European Court of Justice or related bodies.

That means that, when Britain leaves the EU, it will need, at a minimum: to beef up the number of staff, the quality of its computer systems and the amount of physical space given over to customs checks and other assorted border work. It will need to hire its own food and standards inspectors to travel the globe checking the quality of products exported to the United Kingdom. It will need to increase the size of its own regulatory bodies.

The Foreign Office is doing some good and important work on preparing Britain’s re-entry into the World Trade Organisation as a nation with its own set of tariffs. But across the government, the level of preparation is simply not where it should be.

And all that’s assuming that May gets exactly what she wants. It’s not that the government isn’t preparing for no deal, or isn’t preparing for a bad deal. It can’t even be said to be preparing for what it believes is a great deal. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.