Deregulation and deficit disorders

In PRIME, we think that far too much attention has been paid to the annual government budget “deficit” in isolation, and far too little to the fact that it is by growing economic activity – not by austerity – that deficits fall, at a time when there is obvious spare capacity in the economy.  And with unemployment still over 7%, historically a high figure, and inflation falling to levels that make deflation the greater concern, it is nonsense to claim that we are near the limits of spare capacity.

But given the political attention given to budget deficits as such, we feel it is worth looking more closely at the historical record.  And lo and behold, we find that the worst record by far – until the financial crisis of 2008 – was under Conservative governments. We also find that the principal driver of high deficits is deregulation of the finance sector. 

Our reflection was stimulated by a dataset from the Office for National Statistics, drily entitled “Government Deficit and Debt Return – March 2014” on 3rd April, whose Table M1 includes a table on government net borrowing as a percentage of GDP, beginning in 1992.  This uses the same statistics as Eurostat for government deficits. The first years – during the Major government – show 6.4%, 7.8% and 6.7%, whilst under the Labour government, it never went above 3.5% until 2008.

Here are two charts which show the post-war history of the good old budget deficit. The first is from a 2002 Institute for Fiscal Studies briefing note by Tom Clark and Andrew Dilmot (“Measuring the UK fiscal stance since the 2nd World War”), and covers the period from 1946 to 2000.

You will see that both of the great pre-2008 deficit peaks (at or near 8%) come during Conservative governments, and especially the boom-bust periods of Chancellors Anthony Barber (early 1970s) and Nigel Lawson (late 1980s).  Each was responsible for unleashing a wave of financial and credit deregulation – Barber with the Competition and Credit Control (or rather, lack of credit control) policy in the 1970-74 Heath government, and Lawson with the “Big Bang” deregulation of the City of London in the late 1980s under the Thatcher government.

Since the third great crash, of 2008/9, was also caused by the actions of a deregulated finance and banking sector, we may surely conclude that there is a direct causal relationship, as well as correlation, between financial deregulation and high peak deficits.

The second chart covers a shorter period, from 1992 to 2012, and here we have also shown the real GDP annual % growth alongside the annual deficit as % of GDP.

In the case of deficits, please note, the figures are for nominal borrowing and GDP.  However, the relationship is an interesting one.  In 1992, government borrowing grew (as a % of GDP) and so did real GDP, as the country clawed its way out of the deep recession.  Then, as the economy recovered, net borrowing fell each year until, under the Labour government, there was a surplus for 3 years.  When net borrowing started again in 2002, it reached 3.5% in 2003 and 2004, but then fell again until the crisis.  That is, the average deficit figure for the pre-2008 period of the Labour government was about the same as under the Conservative governments of the 1950s.

Note too that the annual increase in GDP up to 2008 remained relatively constant, and ran in tandem with the deficit.  Then came the financial crisis which – as in each major crisis, of which this was the worst since the 1930s – caused borrowing to leap upwards as receipts fell and unemployment-related benefits grew rapidly.

At the same time, a fiscal stimulus was attempted by the Labour government, which increased short-term borrowing while also helping to kick-start the economy again.  This had a positive effect, as can be seen by the fact that GDP grew by 1.7% in 2010, the same as in 2013.  In between, the government’s and Chancellor’s austerity policies started to bite and while the deficit was forced down somewhat – so was economic activity.

GDP in 2011 was just 1.1% higher than 2010, and this fell back to the vanishingly small 0.3% in 2012. Over the period 2010 to 2013, the increase in GDP was lower than the increase in population.

Finally, we see that in 2013 several things happen – GDP increases by 1.7% while the rate of reduction in the “deficit” slows as a % of GDP.  For as we know, for all the pain imposed, the rate of reduction of the deficit year by year is far slower than had been planned by the government in 2010, and in fact slower than the Labour Party had proposed!

The failure of government to invest

PRIME’s view is different still.  The biggest failing of this government – and of the Labour proposal for dealing with the deficit – was to cut back on government investment in good long-term projects.  Of course an investment-led strategy would have increased borrowing in the short term, but the pay-back would have been far quicker in terms of growing economic activity and tax receipts, as well as providing long-term benefits to the country.  It would have greatly increased private sector activity, through government contracts, at a time when the private sector was unable or refusing to invest.

On a slightly different point, Chart 3 shows the (non-causal) relationship between changes in UK gross public debt and changes in public spending as a percentage of GDP.