Spending Review

As discussed in the Conversations session recently, today is the Spending Review. As this article suggests, the Chancellor is going to indicate spending on housing.

It’s a curious aspect of the political climate that at the same time that huge amounts of cuts need to happen (including to infrastructure investment since the Fiscal Charter doesn’t exempt that), still the headline is about a pledge to spend more on housing.

In addition, there’ll apparently be £3.8bn more for the NHS, and more on defence given the recent crises, while schools and international development can’t be touched. Which leaves a lot of cuts to fall in other areas. The BBC states that “These include local government, the Ministry of Justice and the Home Office, with police forces expected to face more cost-cutting.” Which will surely lead to protests by police officers – perhaps exemplifying why it is incredibly difficult to cut government spending…

We’ll come back to this in fiscal policy later in the Autumn Term…

Borrowing… again

News today is that government borrowing for the month of October was the highest it has been for six years.

Borrowing like this contributes throughout the whole year to the deficit – the gap between government receipts (taxes, mainly) and government spending.

As you’ll be well aware given the recent passing of the Fiscal Charter, the government is set on austerity and on running a budget surplus – by 2019/20. So it’s not too much of a problem with regard the Charter that borrowing is up, but it nonetheless shows the difficulty of getting government spending under control.

Not least, various parts of the NHS are running large deficits, Network Rail projects (in and around Reading) are showing eye-watering overspends, and probably biggest of all, pensions continue to rise at 2.5% even while inflation is at -0.1%. The first two are symptomatic of the difference between fiscal plans, and fiscal outturns – things don’t always happen as expected and can impact government finances as a result.

Back to that fiscal charter…

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Last night Vince Cable gave a very interesting and insightful talk on his time in government, most notably many discussions with George Osborne where he disagreed with the Chancellor. One of those areas has manifested itself in the fiscal charter, passed recently, and already causing the government great trouble when it comes to meeting it.

Yesterday this appeared on the Guardian website; a commentary piece by David Graeber with an apocalyptic warning: we’re heading for another crash. Cable asked as much last night. The level of house prices reached a new high relative to income levels in the years before the crisis, rising from a historical 3 to nearer 6 (as a multiple of average income levels). This led to a lot of unpayable debt being taken on by home owners. That level never really dropped during the crisis, and is starting to rise again – house prices are rising faster than average incomes. Probably the only difference at the moment is it remains harder to get a mortgage than it was pre-crisis, but the government’s many FirstBuy/HomeBuy schemes, where it provides a sizeable chunk of the deposit for willing mortgage takers.

Graeber makes another important point about the fiscal charter and tax credits (and general austerity): national accounting identities (relationships that must hold true at the national economy level, like 1+1=2 must hold true) tell us that the sum of all debt must be zero. Hence if the government reduces its debt level, the private sector, or households, must increase their debt levels. This manifests itself practically in measures like the recent tax credit cuts. If tax credits are cut, many families will be worse off, and will find themselves more indebted. The mechanism the government optimistically claims will make them better off is that all firms will be able to pay them the “living wage” that they’re mandating. Even if that happens, it’s a shift from government indebtedness to private sector indebtedness: either firms incur losses to pay workers more, or they don’t pay those workers more and households incur more debt.

Of course, a follow on question is: should the government take on debt just so that we don’t have to? That’s a blog post for another time. Or the subject of a lecture or two next term…

Tax Credits?

Today’s headline news is not tax credits, but they’ve been dominating the news of late. The government plans to cut tax credits, which many see as unfair.

Tax credits are essentially in-work benefits, paid to people working but earning below a certain threshold (£14k). The motivation for them is to reduce the disincentive to take work that many on benefits face: by taking a job, many can find themselves worse off than they would be if they remained on benefits and out of work – the poverty trap.

One criticism of tax credits is that they amount to a subsidy to for firms unwilling to pay a sufficiently live-able wage to workers, and as a result sustain a low pay culture. This criticism assumes all firms do this out of choice rather than because it is all they can afford to pay. This analysis from the Institute of Economic Affairs makes the same point. It’s possibly a little simplistic in that it assumes all firms are price takers and have no bargaining power, which is probably unrealistic in at least some cases (and probably most likely in low pay cases).

The main reason the government is pushing through cuts to tax credits is that they need to satisfy the fiscal charter they introduced recently, and many other parts of the benefits bill are protected (such as pensions). The political criticism of the move derives from the fact that, pre-election, David Cameron said that he wouldn’t cut tax credits in one of the live TV debates.

On purely economic grounds, a government policy that reduces the poverty trap (or at least shifts it to in-work decisions about how many hours to take), ought to be a good thing – and should be on political grounds too, given that strivers (those in work) are to be encouraged, and shirkers (those out of work) are the ones to be penalised. This raises deeper questions about what function a welfare state serves (insurance mechanism?) if we are to analyse it properly, which we won’t.

But either way, given the fiscal charter the government has a lot of cutting to do, which is going to be very unpopular…

“Living within means”

Last night, the Fiscal Charter, blogged about yesterday and the day before, passed in Parliament. Aside from the politics of Labour’s stance on it, the essence of this charter is that governments must run budget surpluses (so tax receipts must be higher than government spending) in the economic “good times” (defined as real GDP growth of less than 1% a year, as measured on a rolling four-quarter basis).

This is far from the first set of fiscal rules devised by a government or governments; Gordon Brown famously had his golden rule of only borrowing to invest over “the cycle” – so balance the current budget (spending on current consumption like on benefits), but allow borrowing for public infrastructure projects, while the eurozone has the Stability and Growth Pact, which limits deficits and debt levels of eurozone members. Brown’s rule was never enshrined in law, of course, but this need not make a particularly large difference since it’s not at all clear how any deviation from the fiscal charter would be punished, should it happen.

However, the main thing I want to write about this morning is a message we often hear, namely that Britain must “live within its means”. It is simply another way of implying that governments have to be like households, but yesterday I talked about why, outside the eurozone and provided a government can borrow in its own currency, that’s not a useful comparison.

One’s own means include its credibility as a debtor; are we expected to repay debts we incur? Because the vast majority of households in the UK take on gigantic mortgages at some point in their lives, many multiples of the size of their income, but do so on the basis that they will be able to pay off that large loan over a long period of time: they are credit-worthy. If a government can print its own money and borrow in that currency, then it is creditworthy – it will be able to pay back, even if the resulting money is worth less due to inflation.

Hence living within one’s means need not mean running a surplus and never borrowing, just as it doesn’t mean that for a household. More next term…

Fiscal Charter: Vote today

Yesterday I blogged on the Fiscal Charter the Chancellor, George Osborne, is proposing. Today it goes to vote in Parliament, and Osborne is calling on Labour voters to defy their leader and vote for the charter. Again, that’s politics, but what about the economics of it?

Is supporting the charter good economically, or is opposing it? To avoid being political we need to avoid the kinds of responses politicians might make; for example:

Mr Osborne said Labour’s U-turn “confirmed they want to go on borrowing forever – loading debts onto our children that they can never hope to repay”.

As mentioned yesterday, British governments have managed to run surpluses in just 83 of the last 315 years, suggesting they aren’t very good at doing so. And despite running so many deficits, the UK national debt (crudely: cumulated deficits) is far from large by international, or historical standards.

This is, in part, because government borrowing and spending is different from individual borrowing and spending in a way that the simple comparison of government to household, which politicians often make, doesn’t reflect: The UK government prints its own money and legislates that we must all accept that money as “legal tender”.

I can’t print my own money and keep spending when I want more things, but the UK government can. Now, of course, if the UK government does too much of that, we may get high levels of inflation and economic instability. Much of monetary policy is attempting to restrain the government from doing that, one way or another. But because the government can always print money, it can always repay its debts, and hence it can borrow at lower interest rates than the rest of us.

Hence large scale public projects (upgrading our telecommunications or transport networks, for example) can be financed much more cheaply via government and public investment than they would be in the private sector.

The fiscal charter rules out any such public investment projects by requiring that in “good economic times” the government run a surplus. It is, of course, a fine line. Nobody wants a fiscally irresponsible government in place prepared to “go on borrowing forever – loading debts onto our children they can never hope to repay”. But if instead we want a government that borrows to invest in public infrastructure that makes our country a better, more efficient, more pleasant place to be, then our children will certainly be able to repay those debts with interest because of the extra economic growth they have produced.

We’ll learn a lot more about fiscal and monetary policy towards the end of the Spring term. In the meantime, you can look up chapters 13 and 14 in the course textbook.

What is this “Fiscal Charter”?

The main news this morning is overtly political: Labour have apparently performed a U-turn and now oppose the Fiscal Charter than the Chancellor, George Osborne, has proposed. While the U-turn is obviously a political story, and Labour is a political party with plenty of problems at the moment, the Fiscal Charter is something that very much invokes economics, and economic analysis.

What is this Fiscal Charter? Here’s what George Osborne said in his Summer Budget Speech back on July 8 2015:

Today I publish the new Fiscal Charter that commits our country to that path of budget responsibility.

While we move from deficit to surplus, this Charter commits us to keeping debt falling as a share of GDP [Gross Domestic Product] each and every year– and to achieving that budget surplus by 2019-20.

Thereafter, governments will be required to maintain that surplus in normal times – in other words, when there isn’t a recession or a marked slowdown.

Only when the OBR [Office for Budget Responsibility] judge that we have real GDP growth of less than 1% a year, as measured on a rolling four-quarter basis, will that surplus no longer be required.

So in “normal” economic times, governments must run a budget surplus – something that will be enshrined in law should it be passed through parliament this Autumn.

The budget surplus is the difference between government receipts and government spending: T-G, in econ-maths-speak. It is different from government debt, which can crudely be thought of as the cumulation of previous budget deficits – when (T-G)<0.

It seems eminently sensible that when the economy is growing, governments should not be running deficits: in the good times, governments do not need to stimulate economic activity via tax cuts and extra spending projects, and indeed they collect more in various taxes: income tax, corporation tax, VAT, and so on.

However, this next graph suggests that UK governments for centuries have not been very good at this:


Going back to 1700, looking at 315 years of data, in only 83 of those has the UK government run a surplus; less than a third of the time. A casual glance also shows that the positive/negative split bears no resemblance to which party, left or right, has been in power; for almost all of the 1960s and 1970s, when both major parties had spells in power, the government almost exclusively ran deficits.

Of course, this doesn’t mean that Osborne’s charter is a bad thing: if it forces governments to run surpluses, this must be a good thing for the national debt? There’s loads to say about this, and we’ll say a lot more come the Spring in EC114, but for now it’s worth pointing out that the national debt (the cumulated overspends of UK governments) is not only reduced by running a surplus; despite the UK running deficits for much of the post-WW2 period, the following graph shows that UK national debt fell from 238% of GDP in 1948 to 42% by 1980:



So a budget surplus is not essential for reducing the national debt burden. Indeed, many argue it may even hinder this; after all, the UK economy has performed well over the last 315 years despite predominantly having a government operating a deficit. In part, this is because governments invest in public infrastructure projects that can facilitate growth: transport and telecommunications networks, for example.

And this is where Labour appears to be in a muddle about the Fiscal Charter. The Fiscal Charter as Osborne outlined makes no room even for investing in public projects, focussing only on the budget as a whole. Often we split the budget into that for current consumption and that for investment: the part for current consumption (things we spend now: benefits mainly) is referred to often as the structural balance. Labour wants to still be able to spend on infrastructure projects in the good times, whereas Osborne’s Fiscal Charter rules even that out.

More in the Spring 🙂