Why are Gordon Brown and Ed Balls denying that public spending will have to fall after the election?
Here’s a possibility. It’s because they don’t believe the Budget forecasts. They think public sector borrowing might fall more sharply than the Red Book projects (pdf), with the result that the spending cuts contained in the Red Book won’t be necessary*.
To see why they mightn’t believe those forecasts, start with my chart, which is taken from various parts of the economic accounts released today. This shows the financial balances - savings minus investment, or net lending - of the public and domestic private sector.
You can see that these two are almost mirror images of each other: the correlation between the two since 1988 has been -0.94**.
Here’s the link between the two. The private sector is now running a surplus because of the credit crunch. Because of this, some people - in fact companies, as that’s where the surplus is - cannot borrow as much as they want. Because others are free to run surpluses, the result is that the private sector as a whole is running a big surplus - equivalent to 4.9 % of GDP over the last four quarters.
The necessary counterpart of this is that the government must run a deficit. I say “necessary” because across all sectors the financial balances must sum to zero - saving must equal lending.
In other words, the public sector is in deficit because the credit crunch has forced the private sector to run a surplus.
The mechanism here is straightforward. As credit-constrained firms cut inventories, capital spending and jobs, economic activity falls. That cuts tax revenue but increases public spending on welfare. (It also causes the government to run a looser fiscal policy, but this is only a small part of the increased budget deficit.)
Now, here’s the reason for optimism. As the credit crunch recedes, the private sector’s financial surplus will shrink as firms become freer to borrow. And the counterpart to this is that the public sector’s deficit will come down - possibly more quickly than the Red Book forecasts, and sufficiently quickly to avoid the need for big spending cuts.
This raises the question. If this is what the government believes, why doesn’t it say so in its Budget forecasts?
In a sense, it does. It forecasts that GDP will grow 3.25 per cent after 2010. Such strong growth is, I suspect, only possible if banks are lending again and firms are borrowing to invest - that is, if the private sector‘s financial balance is falling.
Where the mystery comes is in why this optimism is not embodied in the borrowing forecasts.
It might be because it is politically awkward to do so. Forecasting a big fall in the deficit requires one to forecast either that taxes will rise relative to GDP, and/or that spending (on welfare benefits) will fall even more than is currently pencilled in. Even the former would be politically embarrassing. Perhaps, they think, it’s better to forecast only small changes in spending and taxes and to project a pessimistic scenario for borrowing.
Now, I’m not making forecasts here. I’m not saying that the credit crunch will end swiftly and that public borrowing will fall.
What I am saying is that, insofar as there is an intelligent reason for Brown and Balls to deny the necessity for spending cuts, it’s because they believe a story like this.
Perhaps, then, the "lie" is not in the denial of the need for spending cuts, but in the Budget projections themselves.
* Perhaps what I mean is that they believe that there's a good chance that the deficit will come in below forecast. There is something utterly absurd about the Red Book projections in that these are point forecasts subject to humungous (but unacknowledged!) uncertainty. It would be better if Chancellors follwed the Bank of England's polciy of making forecasts as fan charts of probabilities, but I fear the meeja are too simple to accept such a device.
** It’s not minus one because of movements in the current account deficit - foreigners’ financial surplus. However, as these are small, I can ignore them for the sake of simplicity.
Here’s a possibility. It’s because they don’t believe the Budget forecasts. They think public sector borrowing might fall more sharply than the Red Book projects (pdf), with the result that the spending cuts contained in the Red Book won’t be necessary*.
To see why they mightn’t believe those forecasts, start with my chart, which is taken from various parts of the economic accounts released today. This shows the financial balances - savings minus investment, or net lending - of the public and domestic private sector.
You can see that these two are almost mirror images of each other: the correlation between the two since 1988 has been -0.94**.
Here’s the link between the two. The private sector is now running a surplus because of the credit crunch. Because of this, some people - in fact companies, as that’s where the surplus is - cannot borrow as much as they want. Because others are free to run surpluses, the result is that the private sector as a whole is running a big surplus - equivalent to 4.9 % of GDP over the last four quarters.
The necessary counterpart of this is that the government must run a deficit. I say “necessary” because across all sectors the financial balances must sum to zero - saving must equal lending.
In other words, the public sector is in deficit because the credit crunch has forced the private sector to run a surplus.
The mechanism here is straightforward. As credit-constrained firms cut inventories, capital spending and jobs, economic activity falls. That cuts tax revenue but increases public spending on welfare. (It also causes the government to run a looser fiscal policy, but this is only a small part of the increased budget deficit.)
Now, here’s the reason for optimism. As the credit crunch recedes, the private sector’s financial surplus will shrink as firms become freer to borrow. And the counterpart to this is that the public sector’s deficit will come down - possibly more quickly than the Red Book forecasts, and sufficiently quickly to avoid the need for big spending cuts.
This raises the question. If this is what the government believes, why doesn’t it say so in its Budget forecasts?
In a sense, it does. It forecasts that GDP will grow 3.25 per cent after 2010. Such strong growth is, I suspect, only possible if banks are lending again and firms are borrowing to invest - that is, if the private sector‘s financial balance is falling.
Where the mystery comes is in why this optimism is not embodied in the borrowing forecasts.
It might be because it is politically awkward to do so. Forecasting a big fall in the deficit requires one to forecast either that taxes will rise relative to GDP, and/or that spending (on welfare benefits) will fall even more than is currently pencilled in. Even the former would be politically embarrassing. Perhaps, they think, it’s better to forecast only small changes in spending and taxes and to project a pessimistic scenario for borrowing.
Now, I’m not making forecasts here. I’m not saying that the credit crunch will end swiftly and that public borrowing will fall.
What I am saying is that, insofar as there is an intelligent reason for Brown and Balls to deny the necessity for spending cuts, it’s because they believe a story like this.
Perhaps, then, the "lie" is not in the denial of the need for spending cuts, but in the Budget projections themselves.
* Perhaps what I mean is that they believe that there's a good chance that the deficit will come in below forecast. There is something utterly absurd about the Red Book projections in that these are point forecasts subject to humungous (but unacknowledged!) uncertainty. It would be better if Chancellors follwed the Bank of England's polciy of making forecasts as fan charts of probabilities, but I fear the meeja are too simple to accept such a device.
** It’s not minus one because of movements in the current account deficit - foreigners’ financial surplus. However, as these are small, I can ignore them for the sake of simplicity.
So if I have this right, brown and balls (notably not Darling, who's books they are) are so clever they are possesed of the wisdom to see past mere predictions and into the future.
They wish to believe in an alternate utopia, which just so happens to match their political aims.
it is a very elegant try Chris, but it does not wash at all.
The biggest hole is that they are not taking seriously at all the issue that they may in fact be completely wrong. In which case the markets will serve unto us a currency event in pretty short order.
Posted by: Cityunslicker | June 30, 2009 at 04:42 PM
Hm, so Brown and Balls may have something right? Extremely unlikely as they have managed to get every single forecast wrong since 2000.And they only got the ones before that right because the Tories had done it for them...
Posted by: kinglear | June 30, 2009 at 05:05 PM
"Why is Brown lying?"
I've always assumed he has some sort of congenital defect.
Posted by: Falco | June 30, 2009 at 06:00 PM
"the public sector’s deficit will come down - possibly more quickly than the Red Book forecasts, and sufficiently quickly to avoid the need for big spending cuts."
Things could indeed be better than the Red Book forecasts. Thay could also be a damn sight worse.
Call me cynical if you will, but I find it difficult to believe that the Governments projections will tend to error on the side of pessimism.
Posted by: ad | June 30, 2009 at 06:44 PM
"In other words, the public sector is in deficit because the credit crunch has forced the private sector to run a surplus."
Well, yea and nay.
"** It’s not minus one because of movements in the current account deficit - foreigners’ financial surplus. However, as these are small, I can ignore them for the sake of simplicity. "
For of course that could change.
Posted by: Tim Worstall | July 01, 2009 at 01:12 PM
I think you might find that the reason they are lying is because they are liars.
Posted by: kardinal birkutzki | July 01, 2009 at 06:16 PM
I have real reservations about the validity and relevance of these figures. Firstly over the last year the private sector (principally banks) has written off more bad debt than any time in history. There has been a modest increase in the savings rate among the general population partly as a result of credit restrictions but the chart seems incomprehensible. One possible explanation is that a major new "asset" of the private sector is all the new gilts the Government is churning out but even that does not explain these figures. Secondly, I don't agree the international trade situation is too small to affect the picture. We have been running a deficit for a long time now and it is cumulative in its effect. Thirdly, what about quantative easing? Over £100bn of new money has been issued which clearly should affect balances.
Obviously CSRs are fairly speculative in later years and may be based upon pessimistic assumptions but a Government should be prudent (remember her?). We are so far off the fan charts produced in 2007 by the Bank that they have been discredited. Brown and Balls have no basis for assuming things might turn out better and these are the figures. They are therefore lying.
Posted by: David Logan | July 02, 2009 at 02:41 PM
hmm I can't see the difficulties in sustaining higher levels of public sector borrowing over the medium to long term. In the great depression, it was the inability of governments act sooner and spend which made it drag on so long.
so what if debt is at 100% of GDP? its not unprecedented, and many more OECD countries are in that situation. If it means we survive with more of our jobs, infrastructure and businesses intact then it might be worth it. If we reduce public spending now and see entire industries and localities hollow out, we'll be paying for that in the future anyway...
Posted by: Glenn | July 07, 2009 at 01:58 PM
Can't argue with the logic but maybe an economic historian can help you out. It's true that the surplus in the private sector is a function of an inability to lend and this is how all credit crunches start. The problem is that as the recession continues, can't lend is replaced by don't want to lend. This is exactly what happened in Japan in the 1990s. The lost decade there is all about households and companies continuing to run large surpluses well after the banking system has been fixed. State spending keeps ratching up to try to support growth but it becomes harder and harder to generate a return on this investment. Generating inflation becomes the only way to get the private sector to stop saving but as the Japanese have shown, that's a very hard thing to do when you trying to work off a massive borrwoing binge. Conclusion: Brown and Balls are incompetent liars.
Posted by: AB | July 08, 2009 at 11:45 AM