Saturday, April 2, 2011

Debt, Deficit, and the Catastrophic mess Labour left us

There was a literally incredible letter from Paul Holmes in yesterday's CEN. It starts:

"Edward Turnham in recent letters continues to try to blame the last Labour administration for the UK's economic situation"

You don't say... He continues: "Labour wasn't to blame for the deficit" - and then finishes questioning Mr Turnham's credibility! You couldn't make this stuff up.

My understanding is that Paul Holmes is the brains behind the brawn in the Cherry Hinton Labour party, so CEN letter spats between Paul Holmes and Conservative Cherry Hinton candidate Ed Turnham are the initial skirmishes of the local election campaign.

I have watched with increasing incredulity Labour's position on public spending - I even got invited to Labour's 'new politics, fresh ideas' event in Cambridge with shadow chancellor Ed Balls MP. Would have loved to have gone to give him a piece of my mind, but unfortunately I was tied up at work all day...

Labour should apologise for the state they left the country, and stop treating people like fools with their suggestion that we can just carry on spending and borrowing without risk. So for Paul Holmes, and all those struggling to see through Labour's plans, a primer on Labour's economic mess.

First, don't confuse the debt and the deficit.

The debt - that is governments total accumulated outstanding borrowings - is now over £900,000,000,000 and in 2010 cost taxpayers £42,900,000,000 a year in interest costs - over £2,000 for every household in the country. If we followed Labour's plans, then that interest cost would rocket, as there would be even more debt to service, and the money markets that lend to government would demand higher rates, to reflect the increased risk of a Labour economy following the path of Ireland, Greece or Portugal into fiscal oblivion.

A point worth mentioning about this national debt, including in 2007, when Paul Holmes claims everything was fine and dandy with Labour's management of the economy, was the actual debt was far worse than his 'official' figure suggests. With dodgy Enron style accounting, a lot of government debt is now hidden from the official figures in expensive private finance initiative (PFI) deals (the main purpose of which seems to be to hide some of Labour's massive borrowing, with taxpayers picking up higher bills for hospitals, schools and the like for years to come), and in the hidden but ballooning liabilities involved in pension promises made to public sector workers - promises made on the never never, and unlike in private sector pension schemes, promises that have not been significantly changed even though people are now living a lot longer.

But the key point about the debt in 2007 is which direction it was going - this being the much talked about [annual] deficit (or in more sensible times, the deficit was sometimes actually a suplus). The deficit is the difference between what government spends and the amount it collects in tax over a fiscal year - each year this deficit adds to the total debt.

Total debt as a proportion of the economy may have been higher in the past than it was in 2007 - but only after temporary events like a major war, or whilst recovering from a recession and the relative debt level returned to normal over a period of time afterwards. What was incredible about the national debt in 2007 was not necessarily its relative size, or even is large absolute size, but the fact that even after years of uninterrupted economic growth, Government was still running a deficit, so the debt was still growing. What that means is that when the boom turns to bust, a modest deficit immediately turns into a large and unmanageable deficit. If you can't run a surplus after years of economic growth, (which is what people mean when they say there is a large structural deficit) you are in real trouble in a downturn - such was the frankly moronic way in which Gordon Brown destroyed the UK Government finances, who governed as if he really believed his delusional claim to have 'abolished boom and bust'.

Here is the predicted graph of the predicted national debt (from OECD predictions via here) :


Yes, despite the cuts, the total debt will keep rising rapidly, because we are still running a huge annual deficit, and under coalition plans we will have a deficit in every year of this parliament. Under Labour's plan for the economy, such as they have a plan, all cuts are opposed, and the debt would be allowed to grow at an ever faster rate, until the money markets call time and we join the ranks of basket case countries like Ireland, Greece and Portugal, being bailed out, and forced to slash spending. How anyone can march through the streets of London demanding government goes down this path is beyond me.

How did Labour get us into this mess?

The economy had been doing well and growing since the Conservatives left the exchange rate mechanism in 1992, through into Labour's boom in the mid-2000s, until it ended spectacularly in the inevitable debt-fuelled crash in 2008. Labour kept to Conservative spending plans for the first couple of years when it came into power in 1997, but then under Gordon Brown, prudence went out the window, and government spending increased massively. Unreformed public services were showered with cash. Much of this extra cash did not result in commensurate improvements in performance - often, for example in schools - our performance on the international stage actually got worse, despite the extra cash.

Labour increased taxes massively, with dozens of new stealth taxes. But between 2000 and 2008, whilst the economy grew, government spending grew even more rapidly - with government spending as a % of the Countrys entire production increasing from 34.75% in 2000 to 39.75% in 2008. This meant that when the bust came, and the economy fell back, government spending rocketed to 45% of the country's income. This level is totally unsustainable - it either requires massive borrowing, or taxation on people working in the private sector to rocket. Neither of these scenarios will work, as we are already at the point where we are borrowing at the limits of what the money markets will lend without charging large risk premiums, and beyond the point, particularly for high earners and companies, where increasing tax rates will start to lower revenues as people rearrange their lives to avoid the high tax burden. Already many working people, in one cycle between their employers paying them, and them spending the money will see the vast majority of their income being confiscated by the government to pay for its reckless spending, when you consider employers and employees national insurance, income tax, council tax, VAT, fuel duty and all the other taxes used by government to part working people from the money they have earned. We can't go on like this.

One of Labour's more ludicrous suggestions is that if government keeps spending and borrowing ever greater amounts, the economy will grow and the deficit will mysteriously disappear in the rush of new tax revenue. That such an obviously absurd argument has such a lot of support amongst Labour supporters in the unions has more to do with their own self interest than any grounding in economic reality on planet earth. If there was any truth in this suggestion, then by 2008, when public spending had rocketed for several years, Government should have been running the largest budget surpluses in history. But as noted above, it wasn't running a surplus at all. The lesson from these times is that growth built on public sector expansion, funded by borrowing is illusory - and can only end in very painful collapse that would make current cutbacks in public spending look trivial.

Another ludicrous suggestion from Labour is that the cuts are all the Coalitions fault, nothing to do with them, and they wouldn't have had to make them. I have to question whether the likes of Paul Holmes and Ed Balls even slightly believe their own propaganda on this, or whether this is just shameless and cynical dishonesty on Labour's part.

The Conservatives could have done more in opposition to stop the current mess. At the time, I didn't think it was wise for the Conservatives view on spending to be 'share the proceeds of growth' - make no mistake, this was a plan to reduce government spending as a % of gdp, but this approach failed to argue strongly enough at the time that government spending was unsustainably high, and failed if there was no growth proceeds to share. We needed more people arguing that unless public spending was kept within reasonable levels, the long term tax burden on private enterprise would bring down the economy.

Now, I would query whether the coallition is always cutting the right areas - for example, I would support cutting our contribution to the EU to zero, rather than asking local governments, who run key local services like libraries and local transport to make a lot of the cuts. But getting the public finances back in order is vital, and that means cutting back on government spending - there is no other way.

Current savings planned by the Coalition will mean the Government is still adding to its mountain of debt each and every year of this parliament, and will take spending only back to the levels seen in 2007. If anything, the cuts don't go far enough to avoid the worst of the terrible legacy the next generation will face in repaying debt for years to come. Labour had a golden economic inheritance in 1997 - a sustainably growing economy, and public finances rapidly improving. They left a catastrophic mess, built on years of overspending - their only solution now being even more of the same failed policy.