I’ve written before about the poor quality of the debate over the UK’s budget
deficit, about what actually caused the deficit and about why there is really no alternative economic policy to the one now being pursued.
Unfortunately, the deficit debate remains as facile as ever. What’s clearly needed is a chart. And not just any chart – the one that explains nearly everything about the UK fiscal position.
What this chart represents is the difference between what the government spent and what it took in in tax over a 60-year period up to the last full financial year (2010-2011). So that we can compare like with like, the deficit or surplus is expressed as a percentage of overall economic output – GDP. The data in the chart excludes the cost of financial interventions (ie bailing out the banks).
So, what does the chart show?
Well, it clearly shows that for much of the last half century, the UK government has been spending more than it’s taken in in tax revenues.
What it also shows – though it is not immediately obvious from this chart – is that deficits mirror recessions: when the economy contracts, deficits increase, and when the economy grows, deficits decrease and we (sometimes) get a surplus.
That pattern – of an increasing deficit in recession and a decreasing one during periods of growth – is remarkably consistent until we get to about 2002. Then something odd happens.
If one looked at this chart in the abstract, without knowing the corresponding economic growth figures, and tried to guess the onset of recessions from it, one would almost certainly say that the UK entered recession in 2002. All the evidence is there: we go from a decent budget surplus (of nearly 2 per cent of GDP) to a deficit of over 2 per cent (rising to over 3 per cent in 2004-5) in a very short space of time.
But such an assumption would be wrong: the period highlighted in the red box in the chart was a period of very strong economic growth. The UK did not enter recession until 2007.
So what was going on?
Basically what was happening was that the government at the time – and particularly Gordon Brown, the then chancellor – was making a political choice. That political choice was this: to dramatically increase government spending without the corresponding increase in taxes to pay for that spending.
At this point it’s worth remembering that Labour had just won a second term in office (in 2001), and it doesn’t take a genius to suggest that they had, at a minimum, an eye on winning an historic third term a few years hence.
It also doesn’t take a genius to see how that fact ties in with Gordon Brown’s strategy of increasing spending by borrowing the money to pay for it. All the gain, none of the pain.
I would argue that the correct economic policy would have seen the red highlighted section of this chart reversed, so that the government was running a budget surplus of 2-3 per cent of GDP, which would have been commensurate with the very strong economic growth at the time.
This would have had three positive effects:
First it would have meant being able to reduce the national debt to historically low levels (meaning lower expenditure on debt interest payments).
Secondly it would have left the UK in a strong position to weather the deep recession that struck in 2007, enabling a bigger temporary fiscal stimulus.
And thirdly, it would have left the post-recession UK fiscal position in a much healthier state, making the level of cuts needed now much less drastic and keeping us out of the sights of international financial markets.
One final point to note from this chart is this: the suggestion, made by some, that the current deficit is not high by historical standards is clearly nonsense. The deficit in 2009-10 was much higher than at any other time since the second world war, and almost double the usual level in previous recessions.
While it is true that the national debt is currently not particularly high by historic standards, that would soon be untrue were we to continue borrowing at the current rate.
Political choices made nearly a decade ago are leading to an immense amount of turmoil and pain as services are cut and taxes rise. But such measures aren’t optional, they are essential. The above chart shows why they are necessary, and I know who I blame for the severity of the cuts – and it’s not the coalition.
Nick Thornsby's Blog 
How much are the cuts though and by how much are they actually going to reduce the budget deficit by, in forecast percentage terms (with all the underlying assumptions)?
It’s like trying to take the sprinkles off a trifle.
Page 6 of the 2011 budget (10 in the PDF), look at the biggest item on there, Social Protection, over a quarter (as much as health and education combined), in comparison to the other items which are just tiny – http://cdn.hm-treasury.gov.uk/2011budget_complete.pdf
No, I’m not saying we’re not doing enough.
It is all about perspective and priorities – quick wins versus the long-term game, decisions taken right now are for the next generation.
Not bad research. I thought whenever people refer to record levels of national debt, that’s probably true of the US.
An excellent account of the role of government in the deficit crisis: if only the dailys bothered to report with this kind of integrity.
Great post, you may want to additionally point out if you mean real or nominal GDP, given the timescales.
So, correct me if I am wrong or over-simplifying the situation, Labour spent all the tax revenue that was taken in growth years… sold the gold and spent that… borrowed more money… spent that… and still had to keep the multi-billion pound PFI projects ‘off the books’…
It leaves me with one question: Where the **** did all the money go?!
The chart doesn’t explain all. It is true that in the highlighted area Labour should have raised taxes. Had we not gone to war in Iraq we would have saved money on that as well.
The next increase in debt was caused primarily by the banking crises and the only response to the ensuing recession was to have an economic stimulus, which was the right thing to do, even at the cost of increased sovereign debt.
The problem with the spending cuts taking place now is that it coincides with low economic growth. We need growth to help pay off the sovereign debt but we are not getting anywhere near enough of it. The cuts are depressing growth and not helping it at all.
Geoffrey, the points you make are addressed by me in more detail in the posts on the cause of the deficit and why there is no economic alternative which I link to at the top of this post.
A useful explanation of the past. That doesn’t make it a good prescription for the future. And please can we have more analysis of the type of spending and/or taxes required, not just totals. Some spending is investment (e.g. in renewable energy), other spending produces no asset. Spending on low-middle pay jobs has a high multiplier for Government, bringing money back as taxes as well as reducing benefits, and much of the rest is spent locally. Some taxes (e.g. VAT) are more regressive than others (e.g. income tax). The overall impact at the moment isn’t just to risk stalling the economy but also to make income distribution less balanced.
I have been making this argument since around 2003, when it was clear that in a period of growth our deficit should not be growing. I’m glad that someone has taken the time to put some detail to what I (and anyone that can add up) could see as reverse logic. Gordon Brown’s defense for this at the time was that he believed we would never have a recession again!
Excellent post. Not enough people appreciate that public expenditure was at unsustainable levels before the crisis struck, and that is one of the main reasons for the cuts (the other being unsustainable taxes from the city and property booms).
One point of accuracy though. We did hit a bit of an economic squall in 2001, with the bursting of the tech bubble and 9/11. At the time this was the reason given for the increase in deficit – and it made a degree of sense. The problem was what happen afterwards, 2003-07.
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