What’s not sufficiently appreciated, however, is that this is in large part just an inevitable effect of the credit crunch.
This follows from a basic national accounts identity - that across the whole economy, savings must equal investment.
Now, the credit crunch means that private sector savings are rising, relative to investment. This is not just because folk are paying down debt. It’s also because credit constraints mean that people who would like to borrow cannot do so.
If private sector savings rise relative to their investment - that is, they run a big financial surplus - someone else must run a deficit. There are only two candidates - foreigners or the government. But foreigners, especially those in Asia, are net savers.
As a matter of arithmetic, therefore, the government deficit must increase.
My chart shows this. It shows that for the last 20 years there’s been an inverse relationship between the government’s financial balance and the corporate sector’s. When companies save more than they invest, government runs a deficit. With companies now running the biggest surplus they ever have - partly because those who would like to borrow to invest cannot do so - it’s no surprise that the government is running a big deficit.
This has four implications:
1. Britain’s red ink is not just due to New Labour’s profligacy. The OECD expects government borrowing to rise in most developed economies (though granted, more in the UK and US than elsewhere). This is because the rise in the private sector’s financial balance is a worldwide fact, albeit more so in the UK and US than elsewhere.
2. It explains why gilt yields have stayed low. The same credit crunch that is, by simple arithmetic, responsible for government borrowing is also causing a “flight to quality” and low gilt yields.
3. Your view on how big government borrowing becomes should depend very much upon your view of the credit crunch. If you’re pessimistic about the latter, you should expect big borrowing.
4. It’s possible that the public finances might improve more than expected. If or when the credit crunch does end, companies might have a big backlog of unfilled capital expenditure plans. As these become realizable, the corporate surplus could swing into deficit, causing the public finances to improve quickly.
Seems unlikely? Maybe. But I remember being told both in 1989 and 2000 - when the government was in surplus - that we faced years of surplus. And I remember being told in the mid-90s that we faced years of deficits. It was all bull.
Experience, then, teaches me that long-term forecasts of the public finances aren’t worth a wet fart.