Cuts: separating fact from fiction (updated)

There is far too much overblown rhetoric both in the mainstream media and in the blogosphere regarding "cuts" (such as this from Plaid Wrecsam and this from Everyone's Favourite Comrade) which is both full of inaccuracies and based on lazy assumptions. Accordingly the Druid Statistical Research Centre © has taken a closer look at the actual figures announced in the June Budget because there is scant little evidence that anybody else has bothered to do so.

However, first of all, lets put what we are about to analyse into context. In order to make the point that government debt is not historically high, several bloggers have been displaying the following chart (for example here):

Its easy to look at this and conclude (as many have done) that actually public debt is fairly minuscule compared to how indebted the country was following the accumulated debt of having fought two world wars. However the problem with this chart is that it represents public debt as a percentage of GDP at the time. As current GDP is approximately four times larger, it is illuminating to view the same figures adjusted for inflation:

This is chart uses exactly the same dataset but with the figures adjusted to represent the real value in 2005 pounds -- and shows very clearly our current national debt is virtually as high in real terms as it was following the devastation wrought on the UK's finances of having fought two world wars. Clearly this is not a good position to be in -- however the common fallacy on seeing this graph is to mistakenly assume that the 2010 peak is a summit like the peak around 1946, and that the 'cuts' which the coalition government are about to implement will see this debt falling rapidly from here on in. Unfortunately, as we will see, that is not the case. The point on the chart with which we should be comparing our current level of indebtedness is in fact around 1940 as, despite the apparent "ferocious cuts", public debt is set to double between now and 2016.

Don't believe me? Lets take a look at the figures.

Here is how much the current coalition government is actual planning to spend each year from now until 2016. (Just in case you don't believe government figures, all the data I am using from here on in comes from this report (pdf) from the quasi-independent Office for Budget Responsibility. In every case, the figures for '08-'09 are actual, those for '09-'10 are estimates, and those thereafter are OBR forecasts).

click to enlarge

So despite the rhetoric of "eye-watering" and "blood-curdling" cuts, the reality is that in nominal terms government spending is actually set to rise each year until 2016. So where are the cuts? Well, these figures are not adjusted for inflation, so in real terms spend is actually going to be remaining pretty static -- but that is still not a cut. Lets look a little closer at these spend figures:

click to enlarge

These are exactly the same spend figures but now broken down to show how much is current expenditure and how much is capital expenditure. Current expenditure represents the day to day costs of running government services and includes things like civil service salaries. Capital expenditure represents the costs of buying fixed assets, like schools or hospitals for instance. Now we can see that planned capital expenditure is being reduced year on year, in order to protect current expenditure -- in other words the government is planning to reduce spend on building things in order to protect public sector jobs. I think we can all agree that protecting front line services and jobs should be the government's first priority - and this appears to be what the coalition is trying to do.

I said earlier that public debt is actually set to double from current levels by 2016 -- why is this? Well, lets compare the above government spend with forecasted receipts (i.e. total government income from taxes, etc) over the same period:

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The blue bars represent the same government spend figures we looked at above, the green bar shows how much revenue the government expects to receive each year over the same period. As you can see there is a considerable gap between spend and receipt -- i.e. the deficit -- all of which needs to be covered by government borrowing. Why is there such a large gap between income and spend? There are several reasons:

• decreased tax income due to companies make less profit, wages being depressed, and more people being unemployed;
• increased social security payments to cover the greater numbers of unemployed;
• increased interest payments as government debt increases;
• the fact that the size of the state has anyway been artificially increased over time beyond the public's willingness to pay for it through taxes (in fact the last time receipts exceeded spend was in 2001, every year since then the government has spent more than it earned).

So what about the costs of bailing out the banks? Indeed just yesterday another blog shortlisted for the "best welsh political blog" category, Everyone's Favourite Comrade, wrote this:

"The only reason that we have a deficit is because all the money was given to the banks"

This, I'm sorry to say, is complete nonsense. The cost of re capitalising the failed British banks came to £117bn and those costs were spread out over the years 2007-09. There is no subsidy to banks included in the current deficit, and indeed Gordon Brown was running a deficit long before the Northern Rock debacle in 2007.

Anyway, here's the forecasted borrowing figures (i.e. deficit) between now and 2016:

click to enlarge

Of course another way of describing the deficit is as the rate at which national debt grows each year -- accordingly lets take a look at what effect this deficit will have on Government debt (and bear in mind that the £771bn figure is the 2010 'peak' in the second chart above):

click to enlarge

So as you can see, even at this pace of 'cuts', government debt will effectively double to £1.3 trillion by the end of the parliament. And remember the government doesn't really have debt -- it is actually our public debt, which we (and our children, and our children's children) will have to pay back. And indeed we are already paying it back -- take a look at the amount the government is forecasted to spend on interest alone as the total debt spirals upwards:

click to enlarge

Yes, thats right, interest payments are going to double too. The figures involved here are so huge it might be difficult to understand them unless we put them in context. Accordingly I have added the amount the government will spend on debt interest this year, and the amount it is forecasted to spend in 2016, into a chart of departmental spending for 2010-11:

click to enlarge

So as you can see, current debt interest is the fourth largest single government expenditure -- more than we spend on defence, police spending, the environment, and twice what we currently spend on transport. By 2016 however, debt interest will have risen to be almost half of what we spend on the NHS! What a tragic waste of money. I can only wholeheartedly agree with Lord Myners, Gordon Brown's City Minister, when he said:

"There is nothing progressive about a government that consistently spends more than it can raise in taxation and certainly nothing progressive that endows generations to come with the liabilities incurred in respect to the current generation."

If only he had said so when he was still in Government.

Anyway moving on, what of the arguments put forward by various Labour (and Plaid) politicians that you "can't cut your way to growth", implying that it is illogical to reduce government spending at a time of limited demand as that will only exacerbate the situation? Well this is what a favourite of this blog, Nouriel Roubini, the professor of economics of NYU, had to say about the cuts versus stimulus debate:

"The policy dilemma is that you are damned if you do and damned if you don't. You have large budget deficits, there has been a large monetisation of these deficits, near zero rates, Quantitative Easing [Ed: printing money to you and me]. On one side if you exit too soon in terms of fiscal stimulus and the recovery is still too weak there is a risk that you fall back into recession and deflation. On the other side, if you don't want to make that mistake, you say "no, lets maintain this stimulus", then deficits and debt are becoming already large - 10% of GDP deficits in most advanced economies, public debt rising towards 100% plus in the next few years, therefore either you have a fiscal trainwreck down the line, or you monetise these debts and eventually youre going to have high inflation and high loan rates are going to begin and crowd out the recovery. So its an extremely delicate trade off in this debate between growth now and fiscal and monetary austerity now."

As he says, its a very delicate trade-off with huge potential pitfalls on both side of the argument. Do you risk borrowing more to stimulate the economy and end up with large increases in debt and interest payments plus probably runaway inflation, or do you start to cut too early and plunge the economy into a double-dip recession and deflation? My own personal opinion based on all the evidence is this:

• Even at the coalition's proposed rate of slowed down public sector spending, the national debt is set to double to £1.3 trillion. This already means that in five years time our public debt in real terms will dwarf the debt the country ran up in fighting two world wars. If the country was to borrow even more now to attempt to stimulate the economy what will be the resultant debt? What will be the annual interest payments on maintaing those levels of debt? How many generations will it take to pay it off? 
• If we were to continue to spend, how much would the government realistically need to spend to adequately stimulate the economy into growing? This is an important question as there is no point in increasing borrowing for no outcome. The US last year implemented a stimulus package worth $800bn -- the equivalent of almost 5% of their $15 trillion GDP -- yet the returns have been meagre, so much so that Obama is now discussing implementing a second stimulus. Are we sure that we want to go down this path with no guarantee of returns?
• What is likely to happen if we decide not to stimulate and also not to reduce public spending? In this case the likely result is that there will have to be either higher taxes and/or higher interest rates, which will lead to a new round of private sector job losses -- i.e. further turmoil in the wealth generating sector of the economy.
• In addition if we continue to spend without any credible plan to pay back our debt, then we are likely to lose our AAA debt rating with untold consequences in terms of debt interest repayments.
• Finally it is by no means certain that there are no more structural economic shocks in the pipeline - therefore it is certainly prudent to attempt to get our financial situation into better shape now in anticipation of further economic troubles.

Accordingly, on balance, I'm afraid that there appears to me to be little realistic alternative paths to that currently being adopted by the coalition government. 

UPDATE: Certain commenters have asked me to clarify how the UK compares to other international governments in terms of accrued debt. I am happy to oblige. Here are the OECD's figures for total government debt as a percentage of GDP for the most recent year available, 2009:

click to enlarge (Japan figure for 2008)

And to demonstrate the trajectory of growth of debt, based on the same OECD figures, the following chart illustrates how much debt has increased over the five year period of 2004-2009:

click to enlarge (Japan figures for 2004-08)

(source: here)

UPDATE 2: As luck would have it, the Economist published just yesterday the below chart comparing the budget deficits of various countries as a percentage of GDP:

So to recap these international comparisons: the UK is running the second highest budget deficit behind Ireland, the UK's debt has grown faster over the past five years than any other country bar Iceland, and the size of our debt is nudging towards that of Italy and Japan. I'm afraid I would find it difficult to argue against a period of prudence if we want to avoid a much more serious economic trainwreck down the line.