By Neil O'Brien
Britain’s budget deficit is soaring to record levels. The Government is spending four pounds for every three that it raises in tax. The national debt is set to double. Britain is running up twice as much debt as the G20 average. The CBI, the IMF, the OECD and the credit ratings agencies have all raised concerns about the spiralling debt. And as you can see from the chart below, the public finances are now in a worse state than when Britain was forced to go “cap in hand” to the IMF in 1976. The red line is the projection from Budget 2009.
Public sector net borrowing (%GDP)
Nonetheless, some people want to run an even bigger deficit.
Today the Guardian carries a piece attacking "debt hysteria" and arguing that "we can spend our way out of recession."
Over at Left Foot Forward, a group of left-leaning luminaries are calling on Gordon Brown to spend even more and to “make the Keynesian case for budget deficits.” They argue that reducing public spending will lead to a double dip recession.
Last week the Guardian leader claimed that “it is hard to find any economists of standing” in favour of cutting the deficit - and that any attempt to do so would lead to a repeat of the mistakes of the 1930s.
These are strong claims. But the evidence doesn’t seem to bear them out.
We recently published a report looking at other countries that had undergone major spending cuts. On average in the 12 case studies we looked at, governments cut spending by over 6% of GDP – equivalent to about £90 billion in Britain today. But on average they grew 3% a year over the four years following the cuts, suggesting that getting debt under control helps recovery and growth. In particular, we found that a number of countries which cut their deficits benefited from lower long term interest rates and higher confidence, leading to faster growth as a result.
We aren't the only ones to find this. There's lots of economic evidence that ever more borrowing doesn’t necessarily stimulate the economy, and that stabilising the public finances can help recovery.
Here are the conclusions of some academic studies:
“The study finds that ambitious expenditure retrenchment and reform coincides with large improvements in fiscal and economic growth indicators.”
Giudice et al (2004)
“Cross-country analysis shows that roughly half of the episodes of fiscal consolidations that have been undertaken in the EU in the last 30 years have been followed by an acceleration in growth. The consolidations that turned out to be expansionary were, in general, based on expenditure cuts rather than on revenue increases.”
Perotti (1999)
“In the 1980s several countries with large government debt or deficit implemented substantial, and in some cases drastic, deficit cuts. Contrary to widespread expectations, in many cases private consumption boomed rather than contracted.”
Alesina et al. (1999)
“Expansionary fiscal consolidations are on average implemented mostly by spending cuts, whereas contractionary ones are characterized by tax increases.”
Alesina and Ardagna (1998)
“One interpretation is that a serious fiscal tightening increases demand… For this effect to produce an expansion, the tightening must be sizeable and occur after a period of stress when the budget is quickly deteriorating and public debt is building up. Another interpretation emphasizes the supply side… Based both on statistical evidence and on a detailed analysis of ten cases of major fiscal adjustment, this article provides cautious support to the supply-side view.”
Alesina and Perotti (1996)
“We find that fiscal adjustments which rely primarily on spending cuts on transfers and the government wage bill have a better chance of being successful and are expansionary”
So running huge deficits won't necessarily stimulate the economy. And the risks involved in running up so much debt are considerable.
As Ed Balls pointed out in 1997: “Governments which pursue monetary and fiscal policies which are not seen to be sustainable in the long term, and, worse, attempt to conceal the fact through short-term diversion or deceit while delaying the necessary corrective action, are punished hard these days - and much more rapidly then thirty or forty years ago.”
