The future of public expenditure.
| Author | Arestis, Philip |
| Position | Essay |
The fiscal policy responses to the financial crisis and the onset of recession, starting with the Pre-Budget report in late November 2008, have so far been broadly in the right direction.
The responses can be criticised for being a little late in starting, as the storm clouds had been gathering since at least September 2007, and the recession started in the second quarter of 2008. They can also be criticised for not being large enough in the tax reductions, or more importantly in increases in expenditure, and not focused on raising incomes of the poorest. There has been insufficient discretionary increase in public expenditure, with much of the rise in the budget deficit coming from operations of the 'automatic stabilisers' in that tax revenues fall with recession. (For example, comparing the estimates of the 2008 Budget and the 2009 Budget for the budget deficit for 2009/10, around 82 per cent of the increase in the estimated budget deficit of [pounds sterling]137 billion could be ascribed to the economic slowdown and 18 per cent to discretionary changes.) The responses can also be criticised for the precise form which they took--for example, whether a temporary cut in Value Added Tax (VAT) is the most effective means of stimulating consumer demand is questionable.
But the Chancellor should be congratulated for having suspended the Code for Fiscal Stability and the operation of the 'Golden Rule', under which the government would limit borrowing over the cycle to cover investment and the public debt would be kept below 40 per cent of GDP. The avoidance of any knee-jerk reaction to try to reduce the budget deficit in the face of recession is much to be welcomed. It is though to be regretted that he did not take the further step and announce the scrapping of the 'Golden Rule' and the development of more sensible fiscal rules, which would recognise the role of fiscal policy in addressing problems of unemployment.
Maurice Chevalier once said: 'Old age is not so bad when you consider the alternatives'. The current and prospective budget deficits should be seen as 'not so bad' when the alternatives are considered. Those alternatives would be attempts to balance the budget with increases in tax rates and cuts in public expenditure, resulting in a deeper recession.
Paying the cost
The scale of the budget deficits should be seen as a measure of the extent of the recession and its effects: any regrets over the size of the budget deficit should be regrets over the scale of the recession, which has made the deficit necessary. The government should not be criticised for allowing the 'automatic stabilisers' to come into effect and for taking steps which increased the budget deficit in the face of the worst recession of the post-war era. Any criticism of the scale of the deficit should be that it is not large enough--in the face of sharp drops in output and rising unemployment, more should have been done to increase public expenditure and hence a larger budget deficit.
The basic criticism of government policy should instead be directed at its role in aiding and abetting the conditions and behaviour in the financial sector, which brought on the financial crisis and the subsequent recession. Although there is a financial crisis in many countries and a global recession, the difficulties in the UK are largely homemade. The financial institutions, which have had to be bailed out in various ways, got into difficulties through their own ill-judged decisions. The loose regulatory framework of the financial system, the splurge of borrowing secured against rising house prices, and so on, happened in the UK, though similar events were happening in USA and elsewhere.
The financial crisis has imposed many costs on the rest of the economy in terms of higher unemployment and lost output. The financial sector has itself borne few of those costs; and now there is the prospect of the rest of us being asked to bear more costs through higher taxation and lower public expenditure.
Here our focus is on the implications of the financial recession for the future of public expenditure and the budget position. Our arguments are that restraints on public expenditure would be political not economic, and that the appropriate policies are those to sustain and expand public expenditure as a means of providing more and better public services and more employment. There is a need for more, not less, public expenditure and public sector employment.
The pressure for spending cuts
There is much political talk of the need to make reductions in public expenditure in the years ahead. The pressures for strong constraints on public expenditure following the recession seem to come through three main routes.
First, there is the prospect that the public debt will to be much higher in the next few years than it has been recently, rising from the order of 40 per cent of GDP to around 100 per cent of GDP. The Budget foresees public debt rising to over 75 per cent of GDP (HM Treasury, 2009a) whereas other estimates put it closer to 100 per cent (see, for example, OECD, 2009). The projected increase in public debt arises mainly from the cumulative budget deficits incurred as tax revenues decline. There is also a significant addition to the public debt as a result of (partial or full) inclusion of rescued financial institutions--in June 2009, the public debt was [pounds sterling]798.8 billion when financial sector interventions are included, and [pounds sterling]657.5 billion when excluded (see ONS, 2009).
Secondly, the scale of budget deficits (likely to be 12 per cent of GDP in the current financial year) has already brought arguments that budget deficits have to be reduced, through tax increases and public expenditure reductions. Although it is the norm that governments run budget deficits, in that in the vast majority of years in the post-war period there has been a deficit, there is a constant whipping up of fears over budget deficits.
Thirdly, private sector output is likely to be lower in the future than had previously been thought. The 2009 Budget Report (HM Treasury, 2009a) suggests that the effects of financial crisis have lead to potential output (that is deemed to be the output which the economy is capable of producing without inflationary effects) being 5 per cent lower than it would have been. If that is anywhere near right, then the ratio of public expenditure to national output will tend to be higher, simply because the capacity of the private sector has shrunk. This also tends to bring calls for public expenditure to be cut.
We now want to examine these three sources of pressure to heavily constrain public expenditure.
Is the public debt unsustainable?
Does the size of public debt really matter? The discussion sometimes proceeds as though public debt above a certain level (relative to GDP) will lead to the economy falling into the abyss. When it is reported that public debt may reach 100 per cent of GDP it begins to sound as though all our income has to go to pay the debt.
Let us make some preliminary points about the debt ratio. First, it is a comparison between a stock (debt) and a flow (income). The precise number can be readily manipulated with use of monthly GDP or decade GDP: using the former the ratio become twelve times larger and with the latter one tenth of the size--a number which sounds frightening or reassuring. A figure close to 100 per cent may suggest all income needed to repay debt--but the debt is rarely repaid, and what might be of concern is the interest payments on the debt which would have to be paid for in some way. An alternative measure would be debt relative to...
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