Deficit strategy? The cheque’s in the post

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Today’s public finance figures show that public sector net borrowing is a bit less than forecast. But in reality the chancellor’s deficit reduction plan has stalled and he can’t see a way out 

The deficit is falling! Today’s figures show that the budget deficit for 2012-13 (public sector net borrowing, excluding some of the more obvious distortions) was £120.6 billion – £0.3 billion lower than in 2011-12.

So maybe the chancellor’s cunning plan – to reduce last year’s deficit by not paying some of the UK’s bills until this year, also known as ‘the cheque is in the post’ strategy, has worked.  Or, more prosaically, the government has simply cut public investment again – net investment was £2.4 billion lower in March 2013 than in March 2012, while the current deficit was about £1 billion higher.

So is the plan on track? Certainly not against the government’s original intentions.  The chancellor’s first ‘benchmark for Britain’ was to cut the deficit at a faster rate than that set out in his predecessor’s plans. But under those plans the deficit was supposed to be now about 1% of GDP  – £15 billion – lower than today’s figures show. Of course that would never have happened – those plans too were far too optimistic, and would have proved undeliverable. But describing them as insufficiently ambitious – indeed as likely to lead to a debt crisis – and then making even less progress than they implied, can hardly be described as policy success.

But where we are now is more important.  And here the key point is that, as Robert Chote, chair of the independent Office for Budget Responsibility, has pointed out, deficit reduction ‘appears to have stalled’.

So what’s going on? As I noted earlier, most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened – between 2009-10 and 2011-12.

But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what’s happened since – with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat.

As the IFS puts it: ‘The bigger picture is the same: the government has implemented a combination of tax rises, welfare spending cuts and cuts to spending on public services and brought about a reduction in the deficit between 2009–10 and 2011–12. However, while 2012–13 also saw further austerity measures being implemented, weak economic performance has meant that the deficit was largely unchanged from its 2011–12 level. The same is forecast to be true in the current financial year: the OBR’s forecast is that borrowing will fall by just £0.9 billion to £120 billion in 2013–14. This would leave the deficit largely unchanged for three years.’

Of course, contrary to the rhetoric, there was an alternative. In fact there were (at least) three.

The first would have been to listen to the growing economic consensus – now finally joined unequivocally by the IMF, where economic analysis is finally overriding political expediency – that, with borrowing rates at historic lows, ample spare capacity, creaking infrastructure, and a chronic shortage of housing supply, now is the time to borrow and invest. This might raise borrowing in the short term, but at no great short-term cost and with substantial short-term benefits to growth and longer term benefits to the economy.

The second would have been to follow the example of eurozone policymakers, and react to the lower economic growth and hence weaker public finances that have resulted from premature fiscal consolidation with still more, and more damaging, austerity; the death spiral in which several eurozone countries remain trapped. This option has been tested to destruction in Greece and Spain; it would have been a disaster.

The third would have been to listen to what I describe as the neo-Hayekian approach of cutting taxes, but cutting spending even more. This has the merit of intellectual consistency – and of course it is perfectly legitimate to argue, on either political or economic grounds, for a much smaller state over the medium term – but would again, in my view and that of most mainstream economists, be catastrophic in current circumstances.

The government has chosen none of these alternative approaches; instead, it is simply muddling through.  A year ago I described the government’s refusal to change course as the ‘Macbeth’ approach to policy: well, although the blood is still up to his waist, Macbeth has now decided to pause in the middle of the river.  While this is undoubtedly better than pressing on, or adopting the second or third of the approaches set out above, there is no economic rationale, theoretical or empirical, that I can think of to justify the particular – very odd looking – trajectory of deficit reduction set out by the OBR (note that the reduction in the cyclically adjusted current deficit, the government’s notional target variable, also stalled this year).

There’s nothing in economic theory that says you pause a third of the way through a deficit reduction programme which has gone way off track; nor does the fiscal framework, now effectively defunct with the abandonment of the debt target, dictate this approach. As Matt O’Brien puts it, austerity – such as it is – is ‘a policy without a justification.’  We’re here because we’re here because we’re here.

(The Treasury have stated to me that in their view the strategy is clear; it is to stick to the announced plans – nominal DEL totals and tax and benefit rates - and allow the deficit reduction timetable to slip.  My view remains that, as the observed pattern of deficit reduction – both structural and cyclical – shows, this does not represent a coherent fiscal strategy.)

So what happens next? Eventually, assuming that reasonably healthy economic growth returns, as both we and the OBR do indeed forecast, deficit reduction resumes at a fairly rapid pace, although this to a large extent depends on what Paul Krugman in the US context describes as ‘magic asterisks’ (that is, future spending reductions that are simply assumed in advance of actually having policies to deliver them).

One thing we can be reasonably certain of is that the Budget will in itself do little or nothing to boost growth. The OBR has gone through all the significant policy measures in the Budget  and concluded that while some will have very small positive impacts, and others equally small negative impacts, the overall impact is negligible.   That’s not to say we won’t get a proper, sustainable recovery at some point; the UK’s underlying economic strengths remain, as the current health of the labour market illustrates. But it won’t be thanks to macroeconomic policy.

To sum up; an honest and accurate description of the progress on the government’s deficit reduction plan would be to say: ‘We reduced the deficit by a third in our first two years in government, mostly by massive cuts to public investment, which we now understand were a big mistake and have damaged the economy. We’ve also now realised that trying to reduce the deficit further while the economy isn’t growing is self-defeating, so we’re not even going to try to get back on track until it does grow. We won’t miss our fiscal targets, since we no longer really have any. If the IMF understood that we’re not really going anywhere, perhaps they would stop telling us to change course.’

Jonathan Portes is director of the National Institute of Economic and Social Research. He was previously chief economist at the Cabinet Office. This post first appeared on his blog


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