Ed Miliband’s claim that government borrowing owes more to the global financial crisis than to Labour’s over-spending has met with a - ahem - sceptical response.
It is certainly true that Labour were running a large deficit even before the crisis. But there is, I think, a defence of this.
It starts from the premise that, in the mid-00s, business investment was low, as there was a dearth of investment opportunities. As McKinseys put it: “The investment rate (investment as a share of GDP) of mature economies has declined significantly since the 1970s.”
This lack of investment, however, coincided with high profits, with the result that companies ran an increasing large financial surplus from 2001 onwards. As a matter of national accounts arithmetic, the counterpart to this is that there had to be government borrowing; my chart shows that the government surplus/deficit is to a large extent the mirror image of the corporate surplus/deficit.
To put this another way, the fact that companies were not spending all their revenue tended to reduce aggregate demand. Government stepped in to fill this gap. Labour’s deficit was, then, a reasonable macroeconomic strategy - a counter-cyclical response to weak private demand.
Now, you might reply to this that I’ve got the correlation ass backwards - it was public spending that crowded out private spending.
One fact refutes this - between 2001 and 2007, long-dated index-linked gilt yields halved, from over 2 per cent to around 1 per cent. This is inconsistent with the notion that government borrowing raised borrowing costs and thus hit private investment. It’s also inconsistent with the notion that high borrowing was freaking out financial markets. It is, however, entirely consistent with the idea that a global savings glut - the flipside of the investment dearth - was depressing interest rates.
What’s more, core CPI inflation (that is, excluding food and energy) was roughly the same level in 2007 as it was in 2001-02 - around 1.5 per cent. This suggests that increased government borrowing was not creating inflationary pressure, but was instead filling the hole in aggregate demand that a lack of private investment was creating.
So, I don't think Labour can be blamed for running an excessive deficit. Of course, you might argue that it was wrong to increase spending rather than to cut taxes. I have some sympathy with this view. But it is a separate argument from the rather feeble claim that Labour was irresponsible to create a large deficit.