The deficit: much tougher than it looked

A friend asked me, earlier this week, “If you’re saying David Cameron and George Osborne are not dedicated state shrinkers, and they’re not stupid either, why would they commit themselves to such a big reduction in public service spending?”

Because, when the Conservatives first promised to eliminate the deficit, they had no idea how big a task it was going to be.

To be fair, they weren’t alone. In 2010, most people assumed that the economy would eventually grow again in its usual post-recession pattern, starting with a big jump to counteract the big slump, then settling into steady growth. That would have boosted employment, increased wages, raised the tax take and lowered welfare costs.

In the event, that didn’t happen. The government’s growth forecasts in the early years of the Coalition turned out to be way too optimistic. Even after the ONS’s revised GDP estimates (black line on the graph), growth fell well short of expectations. As the OBR points out, the government projections were not that much different from those of most outside forecasters. In 2010, no-one expected the economy to perform so badly.

Screen Shot 2015-05-06 at 18.05.56

Source: OBR Forecast evaluation report, October 2014.

The result of the poor growth was poor tax revenues and stubbornly high welfare costs. At each budget and autumn statement, the forecasts had to be revised, in the wrong direction.

The tax take was disappointing:

Screen Shot 2014-12-01 at 11.14.28

Source: EY Item Club

While the welfare bill stayed high:

Screen Shot 2014-11-19 at 17.59.25

Source: OBR Welfare trends, October 2014

If tax revenues are poor and welfare costs rise, more of the burden of deficit reduction has to fall on public services. As time went on, therefore, the level of public service cuts needed for the elimination of the deficit increased.

Giles Wilkes produced this chart a couple of weeks ago based on public service spending forecasts over the past five years. Each time, public services get squeezed that bit more to compensate for lower than expected taxes and higher than expected social security costs. By the end of 2014, the cuts needed to eliminate the deficit were about £80 billion more than George Osborne envisaged in 2010. Even to achieve Labour’s current (as in day-to-day) spending surplus will require Ed Miliband to spend less on public services than George Osborne originally thought he’d be spending.

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The problem, then, is very straightforward. To get rid of the deficit, if the economy doesn’t grow by as much as you thought, the amount that has to be cut from public services must increase by more than you thought.

David Cameron and George Osborne had no intention of slashing public services by as much as the OBR projections now suggest. Eliminating the deficit looked difficult but do-able in 2010. The problem now is that the weak economy has left them with much more to do than most people predicted five years ago. It implies more public service cuts in the next three years than we saw in the whole of the last parliament.

It may come right, of course. Perhaps the OBR growth forecasts are now too pessimistic and we will see a boost in productivity and GDP. In which case, the deficit may disappear without the need for even bigger public service cuts. At the moment, though, the recovery is looking anaemic and a sudden pick up in growth seems unlikely. Unless a lot more of us start getting paid a lot more, welfare costs will stay high and tax revenues will stay low.  The IMF believes the UK will still have a deficit at the end of the decade. Whatever happens today, the deficit will be as big a headache for the next government as it was for the last one.

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10 Responses to The deficit: much tougher than it looked

  1. Luis Enrique says:

    Hi Rick,

    I wonder what the OBR would make of a massive social housebuilding scheme, if it was accompanied by a policy to move (some) people out of private renting paid for by housing benefits (and if not, just to drive down rents across the board).

  2. Dirk says:

    If they had they guts to solve the housing crisis and bring house prices/rents down, then productivity might improve.
    They dont however. A BTL governemnt does not want to bring house prices down.

  3. John says:

    There was one person who tried to warn us all of the impending financial and economic problems.
    When Alistair Darling did so – as the then Chancellor of the Exchequer – he was forced to shut up.
    The 2010 general election – as the one today – was marked by a policy of avoidance of the truth.
    That is why the outcome then and now was and will be inconclusive.
    The people of Britain are not fools; they know they are being lied to and misled.
    That is why no one party will command an overall majority in the House of Commons tomorrow.

  4. Truth to Power says:

    If you look at something under a microscope it is very difficult to understand what you are looking at – for that reason your graphs are unhelpful.

    You really need to look at the period 1970-2015, use the HM Treasury deflator series to present that data in terms of current values, and then you will start to understand.

    your website does not allow me to post a graph.

  5. AJ Thomas says:

    “The problem, then, is very straightforward. To get rid of the deficit, if the economy doesn’t grow by as much as you thought, to get rid of your deficit, the amount that has to be cut from public services must increase by more than you thought.”

    A self defeating mess. To grow an economy investment is required.

    “Standard macroeconomics said that cutting spending in a depressed economy, with no room to offset these cuts by reducing interest rates that were already near zero, would indeed deepen the slump.” http://www.theguardian.com/business/ng-interactive/2015/apr/29/the-austerity-delusion

  6. sdbast says:

    Reblogged this on sdbast.

  7. DensPW says:

    I believe some of the initial impetus to cut spending was ideologically driven but nevertheless there were man y more options open to government than the cuts the decided to make. They were prepared to print money to keep bankrupt banks going (they probably still are bankrupt), they could have used some to put directly into the real economy (helicopter money) to boost consumption and jobs; the purchase of a lot of new debt was made by the BoE via QE and the very low rates paid meant new debt isn’t that much of a problem if it is used to invest in future output but they talked the markets in to demanding cuts. With all central banks undertaking QE and keeping rates low there are no free markets to tell you the price of anything. Most prices are fixed and printed money given to banks has gone into asset bubbles. We have a form of fascist corporate state sponsored crony capitalism managed in the interests of capital (in very few hands now) not in the interests of workers. This keeps wages low and therefore reduces consumption. A downward spiral is created and we are well into that now.

  8. JCEH says:

    What a lot of black & white thinking. The forecasts are almost amusing, you might as well have a blind-man throwing darts at a dartboard for comparable sophistication. There are many, many interlinked variables that give rise to the effects seen above, like a chain of 3-D interlinked see-saws. Pressing in one point pushes the balance of different sized see-saws to a varying amount and you need to be very careful where you put the pressure and to what extent. Unfortunately there is some truth as to who has the biggest voice and it is less of a finger than a foot that has been stamped with reckless abandon. There are ways to make the public sector WAY more efficient but it would require a massive policy shift away from private ideologies and that isn’t going to happen. Similarly regulation and taxation and even our relationship with other economies such as Europe. Unfortunately in all these areas politics is a hindrance, not a enabling force. Time will tell if the civil servants and private companies can prosper in spite of the current policies.

  9. Pingback: Winging the Constitution | Ken Gibb's 'Brick by Brick'

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