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.

28 Responses

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  1. Liam Murray said, on January 10, 2011 at 12:51 pm

    The type of post that reminds me why I’ve all but stopped blogging – because I can’t do it nearly as well as some people. A couple of minor thoughts / observations:

    Caveat one seems like a semantic quibble – “we didn’t ‘overspend’, we just didn’t raise enough revenue”? I know households metaphors are abused & misused regularly but is the family maxed out on credits cards overspending or is their salary just too low? It doesn’t feel entirely credible to describe it as the latter.

    And there’s a related point on caveats 4 & 5. While it might be true that Blair’s ‘Fundamental Savings Review’ post 2005 would have had little economic impact the political impact might’ve been significant. The narrative caveat 5 is designed to counter might never have taken hold and Labour wouldn’t be quite so ‘on the back foot’ in terms of public confidence re: the economy etc.

    Great post though, thanks.

    • duncanseconomicblog said, on January 10, 2011 at 1:12 pm

      Thanks Liam.

      Caveat one is really more about the related charge of “wasteful spending”. I can see your points on 4 & 5, although disagree!

      D

      • yorksranter said, on January 11, 2011 at 12:04 pm

        The problem is, though, that AME (Annual Managed Expenditure), i.e. the stuff in the budget that the government can practically control, is a relatively small percentage of the total.

        A lot of the budget is either CAPEX on projects that may have started years before, PFI-ised CAPEX which is fixed, things like state pensions and the NHS that are driven by demographic trends, or else it’s the out-of-work and poverty-related benefits – and those are essentially controlled by the macroeconomic cycle. You might be able to shave a % or two off it, but it doesn’t matter a damn if a major recession turns up and increases unemployment 50%.

        On the other hand, the whole of the revenue side is geared to the economic cycle. If there’s a recession, the revenue side will fall substantially and the budget deficit balloon. Always. There aren’t enough line items that are discretionary within the year to follow the revenue up and down. Also, this is probably a good thing – the Treasury has been notorious for buggering things up by insisting that major capital projects be slowed down over more years to save money in-year. The aircraft carrier project, for example, cost almost a billion more overall as a result of slowing down in 2008.

        Blair’s savings review, had he ever done anything about it rather than whining easily in retirement, would just have vanished under the wheels of the recession. It’s a particular case of the general principle that it’s better to get the broad strategy right than to get individual micro-issues perfect. The crack about needing a lot of Harberger triangles to fill an Okun gap comes to mind.

  2. David Ward said, on January 10, 2011 at 12:51 pm

    Some well thought out stuff here Duncan. I put something similar but less cogent on my blog a couple of months ago, http://www.witteringward.com/accept-some-blame-and-move-on/

    To borrow a metaphor from cricket, Labour need to frustrate the Tories by taking away their favourite shots – ie it’s all Labour’s fault. So getting a strong line on this is crucial.

    • duncanseconomicblog said, on January 10, 2011 at 1:12 pm

      Very good post David.

  3. Howard Reed said, on January 10, 2011 at 1:24 pm

    Absolutely spot on Duncan – I couldn’t have put it better myself. I agree with you 100% on this. In a way I find the “I told you so” smugness of Blairite commentators like Rentoul and Kettle even more outrageous than the Tories.

    I have had some exchanges with Alan Beattie on Facebook and he always comes across as a very well-informed guy.

  4. jimthehedgehog said, on January 10, 2011 at 1:38 pm

    Great post Duncan!

    Regarding point 4 I keep thinking “given his amazing gift for knowing the right thing to do it’s such a shame that Blair wasn’t in a position of power back in 2005… oh wait a minute he was the PM wasn’t he?”. If Blair really thought the economic policy was heading the wrong way he could have and should have done something about it!

  5. Agog said, on January 10, 2011 at 1:55 pm

    Caveat 6(?): should we take the supposed ‘structural’ deficit seriously at all? See Chris Giles at the FT for some sharp criticism. One quote: “The simple deficiency of structural budget deficit statistics is that we cannot measure it. It is entirely made-up, based on the an estimate of what the budget deficit would be if the economy was operating at a normal level.” Google for more…

    • duncanseconomicblog said, on January 10, 2011 at 2:04 pm

      Agog,

      I did consider making that number six! And mentioned it in original debate with Alan.

      I agree it’s uncertain and difficult to estimate with an accuracy (and maybe even a poor target for policy).

      But the wider point about a deficit in a boom stands, especially as debt/GDP started rising in 2003.

      • Neil Wilson said, on January 10, 2011 at 5:18 pm

        So you would have been quite content with millions of people still out of work and without a decent income? Brown was unable to get the out of work figure below 1.5 million. That’s still the population of Birmingham and Glasgow combined.

        So Taxes were too high, the government spending was too low or it was so poorly targeted that most of it ended up as someone’s savings somewhere.

        Real people’s lives sacrificed on the altar of a failed economic model. Sickening.

        • duncanseconomicblog said, on January 10, 2011 at 6:27 pm

          Neil,

          As I’ve said many times before – I don’t think govt spending is the answer to all our economic problems. And tempting as it is – I can’t but the MMT line that deficits can solve everything.

  6. Dave Holden said, on January 10, 2011 at 2:33 pm

    When I hear talk of “the debt/GDP ratio fell” I feel the question should be asked – given we were in a cheap money fuelled asset price boom how much of that denominator – GDP – was real?

    Now I could almost forgive Labour for ignoring the boom in malinvestment that was occurring and just “taking the money” (politicians are nothing if not short-term) but the reality is, they didn’t even see it! In fact, they constantly boasted they’d abolished “boom and bust”.

    Of course the Tories would have been the same save for their more natural leanings to a smaller state.

    And the Bank of England’s record? Equally abysmal. Yes they were restricted by their “inflation” target, but they don’t appear to be restricted now it’s on the upside. In fact, they currently seem to have little problem writing letter to the Chancellor about their failure to control inflation (a massive transfer of wealth from savers and low incoming earners to debtors).

    The reality is – this has been both a failure of Economics and a triumph for vested interests.

    • charlesbarry said, on January 10, 2011 at 3:27 pm

      This is the thing about bubbles – you only know they’re a bubble once they’ve popped. Otherwise what’s the difference between an increase in prices and a bubble?

      As for the idea that the Tories would have done better, I am sceptical. After all, if malinvestment was occurring, it was occurring in the private sector. So an increased reliance on the wisdom of the private sector is dubious.

      I’d be interested to know if you have any specifics around which bits of economics failed or have proven to be wrong.

      Rather than a failure of economics, it seems to me to be a failure of public policy.

      • Dave Holden said, on January 10, 2011 at 3:47 pm

        To the lay man the bubble was easy to spot even if difficult to avoid – the fact that house prices were going exponential and buying a home only made economic sense to both the lender and borrower given the premise that prices could never fall was a pretty good indicator.

        With regards to the failure of Economics – Bernanke saying to congress in 2006 – there was no bubble in housing, well that was a pretty big failure.

        In fact very few Economist predicted the GFC – some notable exceptions http://rwer.wordpress.com/2010/05/13/keen-roubini-and-baker-win-revere-award-for-economics-2/

        With regard to the Tories – I said they’d have been the same, safe for a small chance they’d have run up less debt because of their natural leaning toward a smaller state.

  7. charlesbarry said, on January 10, 2011 at 2:52 pm

    Good post. I would just add to your point “if we want decent public services we have to pay for them” that Labour has to realise (and only started to do so in government from 2004 onwards) that throwing cash at public services doesn’t necessarily make things better.

    Improved public services once adequate funding has been established requires change to structures and working practices amongst others, and a constant reappraisal of the way these services are run.

  8. Steve Jones said, on January 10, 2011 at 2:53 pm

    The main reason the debt/GDP ratio fell between 1979 and 1997 was due to the effects if inflation. As has been pointed out before, the

    As far as structural deficits go, it’s also important to take into account future liabilities, and the use of PFI and increases in the size of the public sector were bound to increase those. Of course there were other such future liabilities that the government cannot be held responsible for, like the aging population, increasing demands on health systems and so on, but it’s still important that these are accounted for.

    However, the big lesson here is we need independent auditing of the state finances as the system is far too open to manipulation by politicians.

  9. Greg Lovell said, on January 10, 2011 at 3:02 pm

    Duncan

    Some excellent points, but there is a wider point on the sense (or otherwise) of running a deficit. It’s certainly arguable, as many economists would, that a deficit is a sensible way to manage government spending, since the costs of borrowing for government debt are incredibly low. Government debt in the market also serves a purpose in terms of redistributing income into pension funds etc (as is the case which much of our debt). There is very little to be said for running a surplus, since countries don’t really benefit from having spare money. The money isn’t the “government’s” in any meaningful sense, and certainly not in the same way that an individual owns money.

    So for me, the issue is not whether a government should or shouldn’t run a deficit, but the manageability of that deficit. Of course it can’t grow exponentially, but there is a strong argument to say a small deficit, which rolls over in time, is a perfectly prudent way to run an economy. It just doesn’t sound logical to the layman and so is a difficult message to propogate.

  10. Alan B said, on January 10, 2011 at 3:37 pm

    No doubt that structural deficits are very hard to measure, but what’s the alternative when planning medium-term fiscal policy? Live hand-to-mouth and balance the budget every year? Keep spending until there is a gilts strike? The wide confidence intervals argue for erring on the side of caution (exactly what Labour didn’t do after 2003) but not for ignoring the concept altogether.

  11. BenM said, on January 10, 2011 at 5:13 pm

    What did that rogue Karl Rove say?

    “When you’re explaining, you’re losing.”

    Difficult to see anything other than a Political quagmire and massive collateral damage if Labour starts holding its hands up on the deficit pre 2008. The rightwing press would have a field day. Like Liam Byrne’s note, you wouldn’t hear the end of it.

  12. Andreas Paterson said, on January 11, 2011 at 1:07 pm

    Hi Duncan, firstly apologies for my late reply on this, second excellent post. Your five caveats cover very nicely the objections that I’ve got to the overall Tory narrative regarding Labour’s handling of the economy. I do also accept your point that Labour did run a structural deficit.

    Where I disagree with Alan is whether Labour should offer a Mea Culpa as a way of gaining credibility. I feel that this is the wrong approach to take. The key point I feel is your caveat five, that the public finances were not in a huge mess. In 2006/2007 Labour were aware that the deficit needed to be addressed and did put measures in place (the NI changes I mentioned on Twitter in particular brought in an extra £12-13bn). In addition much of the rhetoric at around this point was about future years of tight spending, this is apparent from some of the IFS publications at the time.

    While Labour were running a structural deficit in 2007 it was far from obvious that this was a major problem, the view at the time that it could be addressed through a combination of taxation as well as holding back public spending growth. I don’t think it’s really true that it was obvious that we were at the top of a boom at the time, take for example this infamous Anatole Kaletsky column, or the very mild concerns of the IMF. The point is that it seems to me that judged without the benefit of hindsight the fiscal mistakes of the Labour government don’t really go much beyond “Ideally we should have been more cautious.”

    I have a problem with this because I don’t think any kind of apology from Labour will be viewed in that context. An apology will be siezed upon by the Tories and the right leaning press as an admission that they were right and that, to me seems like the message that is going to hit home with the public. Given that the vast majority of the public don’t really understand ideas like deficit and GDP, I think they’ll struggle to understand the complex caveats that you outline.

    • duncanseconomicblog said, on January 11, 2011 at 3:00 pm

      Thanks for the comment.

      2007 is obviously the top in hindsight – agree harder to spot at the time. But the wider point is a 15 yr boom had to end at some point…

      I agree the right wing press would try and have a field day with any hint of appology. That’s the worry. You can do five caveats in a blog post, harder in an interview.

  13. Dominic Minghella said, on January 13, 2011 at 4:56 pm

    Excellent read, thank you. However I’m with Andreas. Studying the numbers, I don’t think there’s anything to apologise for and to have expected more surpluses (or smaller deficits) from any government in power from 97-07 would be to deny reason and history. And it would have made no difference to the effects of the crisis now.

    The real question is whether taking a punch on the economy might be strategically clever, in defusing the relentless Tory assault. As others have written, they had the microphone unchallenged for most of last year, and the damage done is serious. The public has bought the Tory version of history. Perhaps a modest acknowledgment of erroneous judgment would draw the sting and open the door to informed debate?

    But how? Acknowledging a major error would be both false and suicidal. Acknowledging some (real or invented) minor misjudgment would require so much in the way of caveat and qualification as to appear weasly.

    Worse, our media has also bought the Tory script and would not be forgiving.

    Reports suggest Miliband is preparing to acknowledge errors. I really hope the reports are unfounded.

    In chess they say the best line of defence is attack. The Labour Party needs a script of its own. It needs the soundbites. It needs the disciplined and relentless on-message delivery of the Tory machine.

    Sure, it makes sense to sacrifice a pawn here and there. But the economy ain’t no pawn. It’s the whole deal.

  14. […] only complaint about this post from Duncan Weldon is that his caveats are better than the ostensible point. The problem with arguments about the […]

  15. Alan Saunders said, on March 6, 2011 at 10:04 am

    Bunkum and you know it Duncan or else you are self dellusioned. Brown overspent, as Liam Byrne seaid, ‘There is no money left’.

    • Kelvin said, on March 13, 2011 at 3:41 pm

      Is your point for real, Alan Saunders? You come into a blog where the comments are uniformly excellent, thoughtful and nuanced, and drop that? Do you do this elsewhere? Amble into debates that you’re singularly intellectually ill-equipped for, shout something that you think makes you sound like the “voice of reason”, then fuck off?

      “Well, Professor Dawkins, what about the transitional fossils, eh? BYE.”

  16. […] may surprise some readers to learn that I can be something of a ‘fiscal hawk’ at times. I’ve argued here before that Labour shouldn’t have been running a structural deficit in 2003-2007 (although not because […]

  17. Grant Shapps is an idiot | PatoBlog said, on April 18, 2011 at 11:20 am

    […] agree with Duncan Weldon that it was imprudent and needless of Brown to run a deficit at the height of a protracted boom.  […]

  18. david said, on April 21, 2011 at 8:40 am

    It is often not realised that the structural defict (est 8% now) was only est 2-3% before the crisis. The sudden increase is beacuse we have had an L-shaped recession in effect which permanently effects our tax base. Having a surupls would have made little difference to the recession nor to the structural deficit we now have. We would still have had the largest strucutral defcit in the last 40 years or so and the higehest budget deficit since the 1940s and the wrost recession sinc the 1930s.
    The debate other the defict before the crisis hangs really on whether it was wise. On the one hand no because it is best to run a surplus during a boom on the other hand our services were underfunded and as some on the right who seem to suggest we could have carried on with 1990s style funding are wrong…our services would have collapsed and we would have much lower long term growth as a result. Even if the conservatives had won in 1997 i seriously think they would have increased spending too, though perhaps not as much. The question is should the resources have come from taxation (which may have depressed grwoth) or from borrowing (which could be paid back later) and higher growth in years to come as a result of a better infrastructure. Brown probably though the latter. (borrowing to invest as it were). He didnt realise that either A. the results on growth from higher spending would probably take a decade to appear and B. that alot of the money was wasted………


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