Tis the season?

overseas-aid

You may have seen this graphic, or some similar sentiment, doing the rounds at the moment.

As you may be aware, successive governments have committed to spending 0.7% of GDP on aid to some of the poorest and most needy people around the world. It’s also a tiny amount of money. The plot below makes this clear: it’s a small amount even of the interest the government pays on its national debt, and (not plotted) about a twentieth of what we spend on pensions each year.

Foreign Economic Aid and Interest on National Debt since 1993

So, practically, firstly, stopping this money would make little difference to the government’s overall budget. Bear in mind that the deficit is still much larger than 0.7% of GDP.

Secondly, there are many, many things that the government spends lots of money on that might be better reconsidered if there is a need to cut other things before we spend more money on flood defences (and helping those affected by the floods).

Third, as we’ll learn about this coming term, governments have budget constraints, and if they spend more than they get in tax receipts they run a deficit (as the UK government has done for a long time now), and need to borrow. As such, if something is important (hence has a good rate of return, however measured), and can be financed at a low interest rate (as is the case at the moment), then a better argument is that it should be funded by more borrowing.

Finally:

Government Investment

One common criticism by those sceptical of the role of government is that attempts by governments to influence economic activity suffer from excessive delays. Hence the term “shovel ready” has quickly become part of the political vernacular since the financial crisis and economic downturn in 2008.

Today gives a great example of a project that is anything but “shovel ready”: the expansion of London (and by extension the UK’s) airport capacity. This is basically a decision on whether to build a third runway at Heathrow Airport, and as the BBC article points out, this has been being discussed now for 25 years, and commission after commission have reported on the issue. Nonetheless, the government is about to announce that yet another review is necessary, and a decision that might have been made around about now will instead happen in six months’ time.

Conveniently enough, after the forthcoming London Mayor elections.

Understandably, the Confederation of British Industry (CBI), a group that represents the interests of UK businesses, is highly frustrated by this. Yet further uncertainty on the back of 25 years of uncertainty is something that is unwelcome for business. We’ll cover investment next term, but one thing that is generally cited as a reason for firms choosing to invest is the absence (or otherwise) of uncertainty. Will firms, British or otherwise, choose to invest less in the UK at the moment given there’s still no clarity on whether or not a third runway will be built at Heathrow?

Fiscal Plans and Fiscal Outcomes: The Importance of Forecasting

Next term we’ll learn about the difference between fiscal plans, and fiscal outturns, or outcomes. Fiscal plans are the ones set out today by the Chancellor in his Autumn Statement. Fiscal outturns are what we’ll see over the next four years.

Probably the most spectacular differences between plans and outcomes come when recessions come unexpectedly, like with the 2008 financial crisis which put paid to Gordon Brown’s Golden Rule (not borrowing for current consumption over the “cycle”). The outcomes, as we all know, were very large deficits, up to 10% of GDP.

What is perhaps most striking is that for all the anticipation of where the cuts would fall, instead the news is all about what cuts didn’t happen: tax credit cuts cancelled, police, international development, healthcare and defence budgets all protected, with a list of additional goodies thrown in.

How was all this possible? Without resorting to cynicism about politicians dressing up the good news and hiding the bad news (hint: local government and various tax rises hidden in the small print), this Guardian analysis makes it clear what changed: an upward adjustment in forecasts for growth and hence tax receipts.

The idea is this: as the independent Office for Budget Responsibility provided a very positive forecast for growth and hence tax receipts (we pay more tax when we earn more and spend more), this meant that in order to keep to his fiscal plans to eliminate the deficit, Osborne had to do much less – growth would do the hard work for him.

But the main point is this: all of this is based on economic forecasts, rather than actual events – it’s plans, not outcomes. We have to wait until 2020 to see what the outcomes are like. It shows just how hugely important economic forecasts are, however – and why you should think about taking my forecasting module when you get to your third year 🙂

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.

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…

Saving the Banks, not the Steel Workers?

It’s a difficult time yet again for workers in the North East of England and in Scotland. Jobs at steel plants are being shed in large numbers – the headline numbers sum to 2,400. The calls, while predictable, to the government to protect these jobs, reflect the desperation that losing a livelihood produces. People need jobs to support families, to save their homes from being taken from them (repossessed), and for a general sense of self worth and esteem. It’s not trivial: workers are not just factors of production, they are humans with lives and the emotional content that comes with them.

The protests of those asking government to step in and support the steel workers makes reference, pointedly, to the bailing out of banks back in 2008. This references the reality that the UK government did step in and bail out a number of banks that were in deep trouble as the financial crisis enveloped the economy. This is the problem of bailing out any particular industry: consistency. Can the government really be consistent in prioritising particular jobs and people over other jobs and people?

Of course, justifications can be made: financial services is an industry that is growing and performing well internationally, whereas our steel industry is not. But does this mean that the value of the lives of those that work in the steel industry should be treated less importantly than the lives of those working in the banking industry? If banks needed bailing out, it rather suggests they weren’t being run particularly well, which is a criticism usually levelled at failing industries like the steel industry.

All in all, a complicated mess without simple answers. We’ll discuss fiscal policy and government intervention in weeks 7 and 9 in the Spring term.

“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…

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:

gov-surplus-1700

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:

ukgs_line

 

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 🙂