In 2015, controversy existed over whether the UK deficit had been handled by 2015. This matters now because the situation post-COVID will get much worse again. It shows that it was possible to handle the deficit after the global financial crisis of 2008. After COVID has been managed, we can do it again.
The Conservative claim was that the UK deficit had “halved.” The objection was based on the observation that £91bn is not half of £153bn:
As the Conservatives correctly argued, the most natural way of considering the deficit is a proportion of the size of the economy. On this measure, they said it has indeed halved. I will offer a couple of brief arguments as to why the Conservatives were right to say this. They could have gone further and argued that the problem was over. (They may have chosen not to do this because they considered it would be valuable in the election as a way of harming other more spendthrift parties.)
1). The deficit as a proportion of GDP is the way the bond markets look at deficits. This is the correct perspective to take, because it is the bond markets who are funding the deficit. They look at debt to GDP (%) and the deficit is the rate of change of debt to GDP (also %).
2). Relatedly, looking at the absolute number makes no sense. If I ask you whether a £5,000 overdraft is a problem, you will ask me what the person who has the overdraft makes in a year. With no income, it’s a big problem. If they make £80,000 a year, it is no problem at all.
Now I will look at what they could have said.
Now I will look at what they could have said.
The UK budget balance as a % of GDP was -4.5% of GDP. (All of my numbers are going to come from the table on p. 96 of the 13 December 2014 issue of The Economist. They caveat their number as being either from “The Economist poll or an Economist Intelligence Unit estimate/forecast.” We do not need to worry about this as the number is about right. They were just allowing for the fact that they are making an estimate for the whole of 2014 slightly before it ends.
We now need to know the trajectory. The first benchmark is the Maastricht criterion. Although the UK was not looking to join the Euro, that is a relevant benchmark of UK peers. It requires the deficit to be 3% or less of GDP. (Again, note that we state the criterion as a % of GDP because that is the only sensible way to look at it. It’s on that basis that we can conclude that the UK Deficit Had Been Handled by 2015)
I saw estimates before the 2010 election that the previous administration was looking to borrow 15% of GDP p.a. That was terrifying, not least because 1.15^5 = 2.01 i.e. 15% a year doubles debt to GDP in a single parliament. That is a doubling of the national debt before you get another chance to intervene. That’s a reason for COVID caution.
GDP Percentages Show that UK Deficit Had Been Handled by 2015
Now, perhaps that 15% estimate was political. More neutrally, all sides agreed that the deficit had reduced from around 10%. Let us take that number. Now consider this: you can run a deficit at the same level as your nominal GDP growth without changing your debt to GDP number. Since that is what bond markets care about, it should be what you care about as well. GDP growth for 2014 is 3.0%. So imagine we want to get from 10% to 3%, then the distance we want to travel is 7.0%. We have actually moved from 10% to 4.5% i.e. a distance of 5.5%. 5.5% divided by 7.0% = 79% i.e. we really only have another 20% of the distance to go.
Why You Can’t Borrow for any Purpose
Now I was the first to think we should continue to bear down on the deficit. In particular it is a really bad idea to fund OpEx with debt rather that Capex. This means you can borrow to fund actual investments in actual pieces of infrastructure which pay you actual GDP benefits but you cannot sensibly borrow to keep the lights on or to pay benefits. That won’t work. However, a lot of the work was complete. I would at that stage like to have seen the deficit number reduce only slightly but shift spending into sectors which will produce a GDP return.
Two ideas: the Germans lend EUR16bn a year to their famed SME sector. The Israelis generated a globally successful tech start-up industry by `pouring money into elite universities and creating a clever system to attract venture capital’ (The Economist again, p. 76). So you can spend wisely. It just doesn’t happen very often.
Conclusion: UK Deficit Had Been Handled by 2015
The UK Deficit Had Been Handled by 2015 but it is going to be a problem again after 2020.