Home > Uncategorized > Clearing the Deficit Confusion!

Clearing the Deficit Confusion!


I was watching last nights BBC Question Time on iPlayer here. What astounded me was the amount of confusion over the country’s finances.

Mark Serwotka, the General Secretary of the Public & Commercial Services Union was confusing our debt with the deficit. A lady in the audience confused the cyclic deficit with the structural deficit so I thought I would try and explain properly the state of the public finances in the UK & whether its a good idea for the government to be cutting now.

Mark Serwotka was right on one level, the country is heavily in debt, always has been & probably always will be. The government isn’t trying to pay off the debt just to reduce the deficit so that we’re not continually adding to the debt.

In order to understand why we need to cut public spending in order to deal with the deficit, we need to understand the different types of deficit. There are two types of deficit. Not just good & bad but structural & cyclical.

Cyclical deficit is the easiest to explain. The economy has cycles, periods where there are lots of growth & periods where there is little growth or even negative growth or in normal terms, there are good economic times & bad economic times. It is normal for governments when there is negative growth or very little growth to invest in the economy to stimulate it creating a sizeable deficit between income in tax revenues & government expenditure. This kind of deficit is normal & will go away with growth in the economy.

Now the world has just gone through a global financial crisis & recession so nearly every country has this type of deficit at the current time including the UK. The UK’s cyclical deficit includes the money the government used to bail out the banks & Gordon Brown’s stimulus package.

The UK has another type of deficit as well. Its called a structural deficit. This type of deficit won’t go away by just returning to growth, only way to reduce this deficit is to either raise taxes or cut spending. This type of deficit is harder to explain. Imagine, the economy is perfectly healthy, we’re not in a boom or not just come out of a bust but perfectly normal now in an ideal world government spending would equal the tax revenues coming in. There is an idea floating around there by Labour supporters, by Trade Union officials who are economically illiterate that if we don’t cut and just return to growth that this is where we would be. That is wrong. When we return to a full, strong economy we will be spending more than we are bringing in in tax revenues – this is what we mean by a structural deficit.

The structural deficit is Labour’s fault as the graph below shows, Labour was overspending since 2002.

What Labour should have done is to pay off the debt & to build a surplus so when tough times came we had money to invest back into the economy. The best time to deal with a structural deficit is when the economy is booming like it was in 03. As even if you the economy contracts your not going to go into a recession, you just go back to normality.

The current government are taking a huge risk with our economy. If they pull it off, it will be worth it. The government has committed themselves to getting rid of the deficit by 2015.  It is hugely complicated to get rid of two types of deficit quickly. One needs growth, the other needs spending cuts & higher taxes. The problem is if you raise taxes, people have less disposable income to spend in the economy therefore lowering growth but if you cut spending, you will undoubtedly cut jobs, therefore there are more people on benefits & less people paying tax.

I’m in no doubt that there is a way to do it in 5 years but considering the office of budget responsibility has reduced the growth forecasts then it looks like the way he is cutting spending & raising taxes is the wrong way.

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Categories: Uncategorized
  1. John
    April 1, 2011 at 20:49

    Yes but is it the LEAST wrong way?

    • April 1, 2011 at 21:05

      I think it would be safer to deal with the cyclical deficit first by growing the economy & then you can deal with the structural deficit on its own. Its also clearer to the public as to why you are cutting spending, at the moment Trade Unions & Labour can easily say you don’t need cuts, growing the economy is enough & use people’s ignorance of not knowing the difference between cyclical & structural deficit.

      Whats also a problem is that no one really said anything about Labour was overspending from 02-07 so people don’t seem to know there was a deficit before the crash.

      • April 6, 2011 at 03:17

        The problem is that if the deficit shrinks any slower, no-one will lend us money cheaply any more.

        We have been warned by 2 debt collection agencies on this.

      • April 6, 2011 at 09:43

        Should we not be focusing on the cyclic first by getting growth back into the economy coz then we can cut without risking another recession or not worry about increasing the cyclic deficit too much.
        Would people lend to us cheaply if we focused more on getting cyclic deficit down rather than the structural deficit?

  2. Cat
    April 2, 2011 at 00:02

    @Nicola

    It doesn’t help anybody’s understanding if you go around spouting political attack points as economic fact. The reality is nobody knows how much of the deficit is cyclical and how much is structural. The “structural” deficit is guesstimated by economists looking at the modern equivalent of a goats entrails and coming up with a number for how big or small the output gap is. Darling made a guess with one set of optimistic entrails in 2009, Osborne got his old buddy Alan Budd to make a guess with a rather more conservative set of entrails. Hence, Osborne & co. could run around and say the [structural] deficit was bigger than we thought, must cut more, Labour’s fault, etc. Never mind that the whole idea of a “structural deficit” isn’t economics but politics, the deficit structural or otherwise could be wiped out tomorrow by increasing taxation. It is just the political will isn’t there to do so.

    In truth, Osborne’s quicker deficit reduction plan will make the structural part of deficit bigger as his plans will reduce growth more and thus increase the output gap. But that suits him fine, he believes in a small state anyway so having an excuse to cut public spending is a godsend.

    It is total and utter bollocks to suggest that Labour was overspending from 02-07, Keynes said governments should save in the good times which is exactly what Labour did. Between 97 and 02, Labour paid down more of the national debt than any government previously. They then made the judgement that as the debt vs. gdp ratio was at an historic low they would borrow to fund capital spending. It by its very nature can’t be structural because you can just stop spending money on capital projects. Are you really suggesting that Labour should of kept public spending at 97 levels in real terms and just paid down the national debt from 02-07? If so, were you personally advocating it at the time? Your party certainly wasn’t, in 97, 01 and 05 your manifestos contained more spending commitments than Labour’s. Without the necessary tax increases to pay for them.

    Labour’s massive error of judgement was to allow the countries tax base to become over dependent on financial services. And to then allow the financial services industry enough rope to hang themselves. A tiny 2.5% fiscal deficit in 2007 was nothing compared to the huge economic contraction caused by the banking crisis and subsequent recession. It wiped out government tax revenues and increase unemployment by a million.

    • April 2, 2011 at 00:27

      Your right, thats why i think it would be safer to get rid of the cyclical deficit first by growing the economy then deal with whatever is structural. The structural part of the deficit doesn’t do anything with more or less growth. The cyclical part of the deficit will increase with less growth.

      Why is it bollocks to suggest that Labour were overspending when they were overspending. What amount of overspending is acceptable is a debate in the economic & political arena’s especially at the moment. Labour should have continued paying down the debt & to start building a surplus & yes that was my personal view then. I thought we would need a surplus so that when the bad times came we would have the money to invest our way out of it so that we didn’t create a lost generation. At the time, i wasn’t a member of any party & i couldn’t vote until 2007 so I’ve never voted for any increase in spending.

      To borrow money when the economy is booming i.e. when the country is in profit is categorically wrong. I don’t care how much money it is or how its spent but spending more money when the country is effectively making profit is absolutely wrong. Borrowing money at that moment was irresponsible.

    • April 6, 2011 at 03:16

      Darling’s estimates and the OBR’s estimates of the structural deficit were close enough that the difference is irrelevant to the discussion.

      You’ve confused cyclical and structural. Osbourne’s deficit reduction plan will increase the cyclical deficit and decrease the structural deficit.

      Labour started deficit spending in 2001 I believe.

      The 2.5% deficit (haven’t checked your figures but the average was closer to 3%) is what prevented a stimulus from stopping our recession being 3x deeper than most countries.

  3. Cat
    April 3, 2011 at 02:01

    @Nicola

    “thats why i think it would be safer to get rid of the cyclical deficit first by growing the economy then deal with whatever is structural.”

    So, you’re completely against the current tory-lib governments economic policy?

    “Labour should have continued paying down the debt & to start building a surplus & yes that was my personal view then. I thought we would need a surplus so that when the bad times came we would have the money to invest our way out of it so that we didn’t create a lost generation”

    So, you think Labour should have pay down the national debt entirely? What would the point in that? If they’d done that then we wouldn’t have any decent public services and we’d have a whole lot more than a lost generation – child poverty in 97 was 1 in 3.

    We’ve got plenty of money to not have to let 1 million under-24s idle on the dole. Its just Clegg & Cameron have adopted a political strategy to get the big cuts in first and hope they come up smelling of roses in 5 years time. That will generate the collateral damage of higher unemployment.

    “To borrow money when the economy is booming i.e. when the country is in profit is categorically wrong.”

    No it isn’t. And if a business is in profit it is perfectly reasonable to borrow money to expand/upgrade. This is what Labour did, their borrowing was only for capital spending that improves/upgrades the countries infrastructure that will generate returns, in economic and social terms, on that investment many times greater than the cost of the borrowing.

    “Borrowing money at that moment was irresponsible.”

    No it wasn’t. It was perfectly responsible to borrow to invest. Plus, you’re forgetting that from 2000-02 the world was feeling the effects of the dot-com crash and 9/11. Economies around the world were slipping into recession, Labour increased public spending to keep the economy out of recession and all was well until September 2008.

    Your argument is basically incoherent. You seem to want the tory-lib government to ignore a fiscal deficit of 10% and just try and stimulate economic growth. Yet you believe a small deficit of 2.5% of gdp borrowed to invest in better public infrastructure is somehow totally irresponsible.

    • April 6, 2011 at 03:10

      Child poverty is essentially a communist target that never ever otherwise be eliminated. Why? Because it’s not absolute poverty they’re talking about but relative poverty (could just as accurately be called relative wealth).

      Labour wasted money on a scale never before seen. One example is they accidentally overpaid doctors by ~60%. This is costing a (back of envelope) estimated £20bn each year.

      You’re right that Brown and the BoE did a good job keeping Britain out of recession in 2000-2001.

      It is awful business sense to borrow money at variable rates when you have no means and no intention of paying it back. This is what destroyed many businesses in the recession. From 2002, Brown should have been running a surplus. The fact the Tories didn’t from 1992 is no excuse.

      Failing to do this meant there was no money for a proper stimulus. Labour couldn’t spend their way out of recession like they did earlier, so it was much deeper & longer than it needed to be.

  4. April 3, 2011 at 23:08

    The majority of the structural deficit comes from 10% of the economy going out of business. Labour ran something like a 3% deficit from 2001 to 2007.

    According to the ONS, the structural deficit was 8.8% last year. So around 5.8% of that would come from loss of revenue from bankrupt companies.

    Labour rightly argue that the Tories were running the same kind of deficit from 1992 to 1997. Labour got caught out though, first by the credit crunch which make cheap credit harder to get hold of and of course the recession itself.

    This is effectively like getting a pay cut and having your credit card limit reduced at the same time.

    So we couldn’t spend our way out of recession. Not only does this prove that we’re up to the hilt in borrowing, this left devaluation and printing money as our only tools.

    • April 4, 2011 at 02:12

      Surely that would be part of the cyclic deficit – not structural – if you get that 10% back from private enterprise i.e. growing the economy you get eliminate it.

      • April 6, 2011 at 02:54

        That 10% isn’t coming back. It’s gone forever.

        Comments above are right in that it’s an estimate but wrong in other ways I’ll address individual.

  5. David Gould
    April 6, 2011 at 11:17

    Nicola: Should we not be focusing on the cyclic first by getting growth back into the economy coz then we can cut without risking another recession or not worry about increasing the cyclic deficit too much.
    Would people lend to us cheaply if we focused more on getting cyclic deficit down rather than the structural deficit?

    There may be a small amount of wiggle room, certainly less than the ~50% consolidation that Labour are pretending they wouldn’t do. Of course, these agencies are a law unto themselves but what they’re saying is that Britain should already be downgraded. I agree, I would consider British bonds a default risk.

    At the end of the day, it’s finding a balance between these risks:
    The risk of a debt spiral
    The risk of a double dip recession.

    Neither are particularly within the Govt’s control. There is no doubt a drop in GDP would have happened under any govt. But it seems the next quarter will be up – recession stigma avoided.

    Worryingly, a crisis in Europe could cause both as could any shock. As such, the less risky move by far is to get the deficit and debt down asap without causing a double dip. The Tories/coalition seem to be 100% on economic matters so far.

    Labour’s policy doesn’t even make sense. Halve the deficit? So they’ll keep growing the debt at £75bn a year from 2014?

    The problem is they know the country is economically illiterate and are happy to take advantage. Mind you, the LibDems did it enough.

  6. david
    May 1, 2011 at 18:47

    this article is interessting. It says borrowing in a boom is ireesponsible. First, it is true that normally in a boom borrowing should be reduced and debt paid back. But you can argue that if debt is low and services are struggling and infrastructure investment is needed then borrowing can be useful providing it is limited. I think the problem was that although there is nothing wrong with the apporach they took in priniciple, the problem was alot of the money was wasted though this was probably not forseen when brown/blair took the decsion to increase borrowing during the boom. I imagine they thought quite reasonably that any deficit now would be replaced by lower debt due to higher growth as a result of the infrastructure improvments later on. It is worth considering what would the level of growth had been if 1997 levels of spending had continued. Sure in the short term the debt would be lower, but in the long term having schools with no roofs is building up far larger problems. How would the workforce be educated and comptete against places such as asia with a high skilled workforce? It couldnt so growth could have ended up lower and perhaps even lower then the long term growth we have now.

  7. david
    May 1, 2011 at 18:53

    as to the structural deficit it is often beleived wrongly that ALL the structural deficit was caused by “labour overpsend” it wasnt. This has confused most people. Normally in a recession the cyclical deficit rises but the structural deficit remains unchanged. This is how most people see it so if they read the strctural defict is 8% then it must have been before the recession and as labour had deficits in the years proceeding the crash, therefore it must have been caused by labour overspend. Yet many are unaware that we have had not a normal V-shaped recession, but an L-shaped recession, (examples 1929 wall st crash, japan 1990 etc). In these the structural defict itself risies in this case from say 2.5% to over 8%. This means that even if labour had a surplus in the year 2007 there would still be a HUGE structural deficit now and the need for huge spending cuts. It was this sort of thing that caught labour (and the tories cos they signed up to labour’s plan) out. While running deficits i suspect that even brown thought “what if there is a recession?” he would have assumed any recession was V-shaped and so after the recession the deficit would return back to the 2-3% it was before which is actually a similar defict that he inherited in 1997….no reason to painc. But of course he got caught out because we didnt have a “normal” recession.

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