2019: A vanity project

The Resolution Foundation’s Parliament of Pain event last week drew in a big crowd. Its chief economist Matthew Whittaker started off with the caveat that “we are facing a candour deficit as well as a fiscal one”, meaning that none of the major parties has been clear about its plans and what little they have said is confusing and often contradictory. Trying to predict what they might do after 2015 is therefore no easy task.

Nevertheless, the folk at the Resolution Foundation have looked back over the politicians’ recent utterances and made a pretty good guess. Based on the meagre information the parties have given, they have worked out what the implications would be for public spending and deficit reduction over the next parliament.

They haven’t included the Conservatives’ tax cuts in these calculations, though. Here’s why:

The Conservatives also propose £7.2 billion of income tax cuts by 2020 – raising the personal allowance to £12,500 and raising the higher rate threshold to £50,000. It has not been made clear how this would be paid for, though the indication is that it would be via additional spending cuts. However, there is no timetable for delivering these tax cuts within the parliament. They might for instance be delivered in 2019-20 or 2020-21, rather than the years analysed in this report. For that reason, we do not model the implications of these tax cuts in Section 4. It is worth noting however that, were they delivered earlier – in part or in full – the squeeze on departmental and welfare spending that we present would be even tighter and even harder to deliver.

Which is about as close as you can come in a polite think tank report to saying these tax cuts are a fantasy piled on top of a delusion and not really worth more than a passing mention.

Onto the real stuff then. On this handy chart, they have mapped out the likely spending plans of the three main parties.

Screen Shot 2014-11-26 at 18.32.06

It looks about right. The Tories more gung-ho about cuts, Labour much less so and the Lib Dems somewhere in the middle

The analysis takes the £8.5 billion cuts planned for 2015-16 as read. The budgets will have been set by the time of the next election, so the figures on this chart are based on what happens afterwards.

The key difference between the Conservatives and the others is that they are aiming for an absolute surplus by 2019. The other two parties are aiming for a current surplus, which means being able to fund day-to-day spending from revenues, while still borrowing for capital spending. (Incidentally, the report has an excellent appendix explaining government finance and all its terms and acronyms, which is well worth reading.)

Taking longer to reduce the deficit and continuing to borrow for capital spending gives the other parties a lot more room to manoeuvre. For example, by extending the target for a current budget surplus to the end of the decade and borrowing for capital expenditure, a future government would only need to make a further £4 billion in cuts after 2015-16. And that figure includes the increased debt payments brought about by higher borrowing.

Using the OBR’s projections for growth and tax revenues, the Resolution Foundation reckon that this would still enable a government to run a small current surplus by the end of the decade. It would be much a slower reduction than the one the Conservatives are advocating but the overall debt-to-GDP ratio would still start to come down by 2020.

Screen Shot 2014-11-27 at 19.07.31

It is highly likely that the ‘Coalition frontier’ will shift to the right anyway because £37 billion cuts in the 3 years after 2015-16 is nigh on impossible without dismantling large parts of the state and there is no public appetite for doing that. Either the target will shift or some of the deficit reduction will come from tax cuts.

But the Resolution Foundation’s model suggests that a future government could cut spending a lot more slowly and still start to reduce the debt-to-GDP ratio by the end of the decade. Why is it so important to start the process so much earlier?

Simon Wren-Lewis, who spoke at the Resolution Foundation event, reckons it isn’t. We were, he says, bounced into austerity in 2010.

“Debt must be reduced because the markets will punish us otherwise.”

This is a plausible excuse for austerity in 2010, because of what was happening in the Eurozone, but as an IMF evaluation has recently acknowledged, the Eurozone was a false alarm which shifted policy in the wrong direction. There never was a ‘clear and present danger’ that the UK might become like Greece, and there certainly is not that danger now.

The Chancellor must know full well that a more modest pace of debt reduction from 2015 will not lead to any market panic. It might lead to higher long term interest rates, but that will only be because the markets expect additional growth from less fiscal contraction (and therefore an earlier tightening of monetary policy), and that would be a good thing. There is no way markets will react to a more modest pace of debt reduction by starting to think the UK will default! He should know this because he allowed a more modest pace of debt reduction from 2012 (see below), and the markets did not blink an eyelid.

CA UK budget deficit

A deficit of 3 percent of GDP, he says, is sustainable in the short-term and Labour’s (presumed) target is well within that. Why impose £37 billion of spending cuts (or tax increases) which could put the recovery at risk?

It’s not as though government borrowing costs are high at the moment. Although public debt as a percentage of GDP is roughly double what it was in the mid 1990s, the cost of debt repayment is still lower. Borrowing is nowhere near as expensive for the government as it was 20 years ago.


Chart: Via Economics Help

But surely, say the deficit hawks, you should pay your credit card bill off as soon as you can. If we are going to use a household analogy, though, mortgage payments would be a better one.

Let’s say you decide to pay off your mortgage more quickly but to make the payments you have to stop eating for a few days here and there. Over time, this makes you tired and ill, so you take more time off work and start losing pay. The whole exercise then becomes self-defeating. If you’d kept eating and kept earning, you’d have paid your mortgage off eventually anyway.

Taking £48 billion out of public spending over 4 years will certainly make the public sector sick and could well derail the whole recovery. In the current climate, taking a few years longer to reduce the deficit wouldn’t cost us that much more and would save a lot of pain.

As Frances says, the conversation among economists has shifted since the Bankrupt Britain baloney of 2010. They are less worried about debt and more worried about growth:

I am struck by how things have changed. Less than five years ago, economists were convinced that high debt and deficits were disastrous and governments must turn their attention to deficit reduction: growth would magically happen once public finances were “restored”. Now, it seems economists are far less concerned about deficits and debt, and much more worried about growth, than politicians are. In August this year, Nobel laureates at Lindau and central bankers at Jackson Hole called for large-scale public investment, particularly in education and training. Were politicians listening? No. Major public investment is not on the agenda anywhere. Debt reduction and “balancing the books” is fashionable across the political spectrum, even if it means consigning an entire generation of young people to the scrapheap. Older voters, it seems, have not yet understood that their security in retirement depends on having a fully employed, high-earning workforce in the future. Wrecking the prospects of young people in the name of deficit reduction is folly.

So why do it then?

The absolute surplus by 2019 was something George Osborne dreamt up last October. It has the feel of a vanity deadline. Vanity deadlines are a subset of vanity projects. I’m sure many of you will be familiar with them. It’s when your boss tells the board, “We’ll have it sorted by Christmas” or “It’ll be in by the end of the financial year,” with no other rationale than a memorable date that makes him look good. You and your colleagues then spend your evenings and weekends rushing to meet a deadline that has no benefit to the business and might even expose you to considerable risks, just because your boss doesn’t want to go back to the board and admit that he might have been a bit hasty.

Is an absolute surplus by 2019 just such a vanity project? Could we be about to dismantle our public services and put the recovery at risk just to meet an arbitrary deadline? There appears to be no rationale for the 2019 deadline apart from it simply being the date that the Chancellor has picked. As far as I can see, it’s a lot of pain for not a lot of gain. Or, as one of my lecturers used to say, the view isn’t worth the climb.

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12 Responses to 2019: A vanity project

  1. Jeffery Davies says:

    Il say once again who do the ninty nine percent who aint rich owe this money to
    it seems austerity was only for the poor yet the rich just get richer under this
    austerity banner if a bank went bust then it would be the names who had monies
    in these banks the one percent yet we shored these up under austerity isnt it
    strange when the they make you pay for their greed yet if councils builds more houses
    the rents could come down and taking back those privised companies back under the
    government’s rule then instead of monies for the rich you giving jobs to the ninty nine percent who aint rich yet untill you believe thatchers way wasnt the way then perhaps
    we will wake up from this terrible dream jeff3

  2. TickyW says:

    Great post, Rick.

    Have just read Simon Wren-Lewis. piece on the same topic, which is also very good (I think Simon is right, by the way).

    Many companies have debt in their capital structures. In bad times, they may seek to replace their debt capital with equity capital. This is exactly what my former employer (a blue-chip) did in 2010 in response to its forecast of a second downturn. Reducing debt in these circumstances reduces the risk of insolvency.

    As you rightly say, the UK’ finances differ significantly from those of a household. They also differ significantly from a company’s finances. Neither companies nor households have access to the “money printing press”, unlike the UK government. The UK government can, at last resort, “print” more money if it is in danger of missing its interest payments. Households and companies do not have this option

    So concepts of gearing, (the mix between debt and equity capital), make good sense with respect to corporate and household finances – reducing debt in downturns can be wise financial management. But as far as I can tell concepts of gearing have little applicability to the UK government’s finances.

    I wonder if anyone has convincingly applied gearing concepts to government finances. As far as I can tell, governments have no equity capital or anything analagous to it. Governments are financed solely by tax receipts and by borrowing.

  3. John says:

    You could look at Premium Bonds and other forms of national savings as a version of gearing.
    During the two world wars, governments encouraged national forms of savings, which were redeemed some years later. City banks hold Treasury Bonds too at a regular rate of interest.
    The unravelling of quantitative easing will possibly throw up future unintended consequences.
    If the main parties continue with their “candour” deficit, I expect the electoral outcome will be similar to 2010 – no overall control and another coalition government.
    Right now, a Labour-SNP coalition government seems the most likely.

  4. P Hearn says:

    It’s academic really, because it’s odds-on that Labour will either win the next election outright, or will fudge a coalition of Lib Dems, Greens and SNP to [try to] govern/muddle along for the next five years.

    Labour’s economic targets already look very unambitious, so when watered down with a dose of Green/SNP influence, expect to see no reductions in deficit and debt whatsoever. Will the markets benignly accept this? Doubt it.

    Ed Balls may attempt his mansion and bankers’ bonus taxes, and it will be most interesting to see if Balls or Laffer is right on those.

  5. ChrisA says:

    Well maybe interest rates are low despite the deficit, due the credibility that the Government has gained. Its a sort of anti-siren approach, George has tied himself to the mast to assure the lenders he is fiscally responsible. Plus there are other factors, perhaps the Conservatives know they likely will be only in power for one parliament, so they had better force through the necessary structural reforms while they can. The reduction in the deficit is an excuse to force through the necessary reforms – hard decisions are only made sometimes when cash is short. This is something many business have to learn.

    The whole “austerity” causing less growth that Wren-Lewis pushes has pretty much been intellectually demolished by Scott Summer with his monetary offset argument.Note again, Government debt and expenditure grew strongly since 2009. If there is a villain in the piece about the slow growth from 2009 through 2012 (when compared with previous recoveries) it was the BOE and the ECB with their excessively tight NGDP growth due to inflation mania and poor expectations management. George did bring in Carney as a result and since then we seem to be on track there.

    On the impossible deficit reduction targets, of course if state expenditure were to fall back from 37% to around the 33% that is the long term average share of NGDP there would be no problem. There are some short term structural issues that might prevent that in the future (Government subsidies of jobs for instance) but in the longer term there is no reason that this can’t be reached. If we don’t try we definitely won’t get there and what better time to start than with a motivated government and strongly growing economy?

    My recipe for all this is quite simple. Announce a catch up NGDP growth strategy, with debt monetization continuing until NGDP reaches the previous 2009 trend. We would see tax receipts soar and we can make all the cuts we need without too much pain by holding down public sector salaries by less than inflation.

    I definitely sense a pre-Thatcher fatality again in Britain, declinism and nothing can be done all over again. How sad.

    • TickyW says:

      “Well maybe interest rates are low despite the deficit, due the credibility that the Government has gained.”

      Maybe. But probably not.

      Interest rates are low because of:

      1. QE has kept demand for government bonds high. High demand equates to high bond prices. And as every woman and her dog knows, high bond prices means low yields/interest rates.
      2. There is a death of alternative investment opportunities with an acceptable risk/return ratio to investors. Government bonds are safe and are very attractive for those wishing to invest surplus funds. This too pushes up the price of G bonds and lowers yields/interest rates..

      • ChrisA says:

        Ticky – you said interest rates are low because of QE keeping demand for Govt bonds high. This goes against all kinds of common sense. If it were really true that printing money to buy government bonds lowered interest rates, then we have the equivalent of the best free lunch ever. We can safely buy up all the government issued debt without any inflation whatsoever. What great news. Imagine the burden we have just lifted from future generations. All that worrying about the national debt for naught. I suspect that this is too good to be true however.

        I have more sympathy with your second point. Interest rates are low because Government debt is more attractive than other opportunities. Why is that so? Well one reason is almost certainly what I quoted earlier, people are convinced that the Government won’t do irresponsible things like issue too much debt to be paid back. Spiraling interest rates did occur in the 1970’s partly due to that reason so it can happen. Remember the emergency IMF loan? I agree that another reason is dearth of investment opportunities, or what I think of as lowered opportunity cost with low inflation. If you have low inflation, then you don’t need to worry so much about low interest rates on safe government debt. If inflation increased then we would see people worry more about find higher yields leading them to move out of Government debt and hopefully into more promising investments. That’s one reason why I propose a more aggressive NGDP growth target,

        • TickyW says:


          The risk of inflation is low when there is spare capacity (as we have now).
          So QE is not a free lunch – in good times, it may well cause inflation.

  6. John says:

    Interest rates are low because the UK economic “recovery” is completely fragile.
    If interest rates were to be raised, it would send the economy into a downward tail spin.
    The UK is suffering from a global race to the bottom where corporations are concerned.
    We are witnessing the growth of a mega–rich global elite who pay little or no taxes.
    This is why central governments’ expenditures are so high all round the world.
    Until the rich start paying their fair share, all the rest of us will go on getting poorer.

  7. John says:

    There is another reason for low interest rates, which represent the ” cost” of money.
    All the bailed-out (and other) banks are making much more money speculating on global trading markets than they can make paying interest to savers or levying charges on loans to businesses.
    They are in a “perfect” – for them – market situation: they offer nothing to customers (whether lenders or borrowers) and rely on the UK government to provide almost unlimited money to them.
    They bribe politicians with donations to their parties to ensure the policy continues.
    It’s great for them – but not for the rest of us.
    I used to be exercised by the lack of savings’ opportunities.
    No more.
    I have no savings money left after experiencing real income decline over the last 4 years!

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