Duncan’s Economic Blog

The Structural Deficit: Time to Stop Defending It

Posted in Uncategorized by duncanseconomicblog on January 10, 2011

(A long-ish post that will probably manage to annoy every wing of the party in a different way).

On Friday evening, via the medium of twitter, I got into a fairly long debate with the FT’s Alan Beattie about Labour’s record on the public finances. It started with me making the point that between 1979 and 1997 the Tories ran 2 budget surpluses and 16 deficits – the wider points I was trying to make were firstly that those who live in glass houses shouldn’t be so quick to throw stones and secondly that despite this, the debt/GDP ratio fell – in other words small deficits are fine and it’s growth, not running a surplus, that controls debt.

But the debate quickly turned to the question of Labour running “the largest structural deficit in the industrial world” on the eve of the crisis. Occasional commentator here and blogger Andreas joined the argument defending our record – I feel, in this case, he may have been too quick to leap to Gordon Brown’s defence.

I think I better serve my readers by being honest about Labour’s faults as well as trumpeting its virtues. And I feel the Party would better serve the public, not to mention increase its own credibility, by adopting the same approach.

So let’s be clear then – Labour was wrong to run a structural deficit, of the size and duration it did, from 2003 onwards. What’s more, Labour should be prepared to say this publicly.

Before proceeding there are five important caveats to note. The fact I have to explicitly write these caveats perhaps explains why the leadership finds it so difficult to admit to past mistakes – our political culture isn’t suited to debating complex issues and the news media would no doubt be quick to label any comments on Labour’s past record as a “U-turn” or a “retreat”.

Caveat One – We didn’t “overspend”.

Saying we shouldn’t have run a deficit of the size we did is not accepting that Labour “overspent”. We didn’t – welfare spending (as I’ve noted previously) was not high, the increase in net investment (new schools, hospitals, etc) from a miserly 0.6% of GDP in 1997/98 to 2% in 2007/08 was welcome, the increases in spending on health and education were much needed (respectively from 4.6% and 5% of GDP in 1997/98 to 5.5% and 7.2% in 2007/08).

Labour was not reckless with the public’s money. Total managed public expenditure rose from 38.2% of GDP in 1997/98 to 40.9% in 2007/08.

The problem was the revenue side, not the spending side – in terms of both not taxing enough and being too reliant on what turned out to be bubble-inflated forth rather than sustainable funding.

Caveat Two – Labour/Big Government did not cause the recession/large deficit

Even if Labour had been running a surplus in 2007/08 we’d still have a large deficit now. The global recession did start in the financial sector and it caused a large deficit by depressing tax revenues and causing welfare related spending to increase.

Whilst the existence of a structural deficit did hamper out ability to respond to the recession (it meant for example we had a smaller stimulus than other countries) it did not cause it. Ed Miliband is right here to argue that the Tories are rewriting history.

Caveat Three – The Tories are still wrong

For a start, despite latter shameless opportunism, the Tories supported Labour’s public spending plans until late 2008. I also didn’t hear them arguing for higher taxes to close the deficit.

What’s more, launching a stimulus in 2008 was exactly the right response to a global collapse in demand.

Right now, the pace and size of Tory spending cuts risks being self-defeating and damaging a still fragile economy further.

Caveat Four – The Blairites aren’t right here either

Over the past week various Blairite commentators have been quick to point out that in Blair’s memoirs he claims he argued for a “Fundamental Savings Review” in order to crimp public spending in 2005.

Now, leaving aside that this would be the same memoirs where Blair claims responsibility for Bank of England independence, this isn’t the issue. Lower public spending in 2005-08 (as noted above) wouldn’t mean no large deficit now and it won’t have meant no recession. It simply would have meant less money going into the public services in those three pre-recession years. Had Blair argued for marginally higher taxation in 2005-08 I’d be happy to give him credit. He didn’t.

Caveat Five – Despite what I am saying – the public finances were not a huge mess

Britain was nowhere near the brink of bankruptcy. What’s more, debt as a percentage of GDP was lower in 2007 than in 1997 -although it had been increasing on this measure since 2002/03.

Most importantly, and little remarked on in the political debate, the average maturity of UK government debt was 14 years – the longest in the developed world and providing strong insulation against any crisis in the bond market as debt did not have to be rolled over as quickly.

But, but, but and caveats aside….

Running a structural deficit after a 15 year economic boom is not sound policy making. Nor is assuming that bubble-inflated tax revenues will continue to rise at a rapid pace and nor is proclaiming the end of the boom and bust. That’s simple hubris.

For me, Brown’s major achievement in the field of economic policy making (alongside his role in 2008-2010 which future historians will lavish praise on) was the increase in National Insurance to pay for NHS spending in 2002.

A rise in direct tax to pay for service – done explicitly and a move that proved to be popular.

So I won’t attack the level of public spending in 2007/08, I won’t say it’s simply “another case of Blair right, Brown wrong”, I won’t take let Labour take the blame for the recession and I won’t say “maybe the Tories have a point” but I will say there is a simple principle here – if we want decent public services we have to pay for them.

Running a deficit in the face of a recession is simple economic common sense, running one after the longest boom Britain had ever experienced wasn’t quite so clever.

The thing is – this should be easy for Ed Miliband to say. He began his campaign by noting that Labour seemed to have forgotten its critique of capitalism, and he was right.

The best demonstration of this is the growth in the structural deficit from 2003 onwards – the belief that the market had been entirely tamed, recessions were a thing of the past and that the bonus-relate- income-tax, the banking-related-corporation-tax and the property-related-stamp-duty pouring into the Treasury would never stop.

The markets weren’t tamed, the recession did come and those revenues simply stopped.

Labour are entirely right to lambaste the government for the speed and severity of their cuts and entirely right to defend many of the things achieved between 1997 and 2010. But defending that structural deficit does us no favours.

Some Links

Posted in Uncategorized by duncanseconomicblog on January 10, 2011

On Friday evening I had quite an interesting debate (via twitter) with the FT’s Alan Beattie (author of this – which is an excellent read and proves very useful if you find yourself in a long chat about Argentinean economic history at a New Year’s Party, I’m aware this may only be something that happens to me).

I promised a blog post – on Labour’s record on the public finances and where we went wrong.  It’s taking longer than I anticipated – but should be up tomorrow (EDIT: :later today).

In the meantime four things worth reading:

Paul Mason’s “interviews” with Karl Marx and Maynard Keynes. Superb writing.

Mark Blyth’s Huffington Post article on the bailouts and banks business models. (And if you haven’t seen it, his video on False Economy about austerity economics).

Chris Dillow on Labour, the deficit and investment.

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