The Alternative is Silly

March 28, 2011

Numbers, numbers, numbers. Lots of them were banded about Saturday’s march – 250,000 being the most important one, at least if you agreed with the march’s aims. However, it’s quite clear that those who agreed were united by more than their opposition to cuts – they were united by a peculiar aversion to expressing the alternative in anything but the most vague terms, eschewing numbers – tax hikes, reallocations of funding, timescales for deficit reduction – in favour of saying why their cause was the most important, and clearly deserving of other peoples’ money.

Indeed, the other clear strand of Saturday’s march was its conservatism: a united stand for every marcher’s piece of the status quo; a fiscal NIMBYism. But perhaps I’m being unfair; the main argument of those who venture into the realm of numbers, however incidentally, is that of a form of Keynesianism. Broadly, activity to cut the deficit is counter-productive as it removes demand from the economy, thus reducing one of the factors required for growth. Instead of cutting the deficit, this additional demand should be left in the economy, allowing growth to raise tax receipts to the point where the deficit is eliminated.

Theoretically, this all sounds very good. However, I’ve yet to see anyone actually put numbers to this thesis: how much growth is required over what period of time in order to eliminate the deficit? I’m going to try to put together a very basic model of the economy to try to figure this out, in order to see if this argument works.

Warning: the following should be taken with a pinch of salt, as I am not an economist and liable to get my numbers wrong

Let’s use statistics from 2009, as they’re the most recent for which a complete set is readily available, and they stand outwith any actions taken by the Coalition Government. The UK’s GDP stood at £1,395,872m, our deficit at £86,302m and our debt at £617,100m. Tax receipts were £530,971m, and inflation (CPI) was 2.2%. Total government expenditure stood at £619,307m (including investment and depreciation), of which £31,570m went on interest payments*.

What we’re going to do is plug these top-level figures into a very simple model, to find out what level of growth we’d require to eliminate the deficit without taking any positive action, including tax rises or spending cuts. We’re going to assume that inflation remains constant (and that Government expenditure rises at the same rate), that tax receipts rise at the same rate as GDP, and that the interest payments on our debt will remain at around 5%. It’ll be a question of what level of growth is sufficient over what period of time. These are all enormous assumptions (e.g. inflation in various areas of Government expenditure, like the NHS, is higher than the CPI), as real life bears out, but they are assumptions which are highly favourable to people pushing the ‘alternative’. An assumption that may be open to challenge is my rolling of investment into general Government expenditure; investment may decrease in response to increased growth. Investment at this particular time represented about 5.9% of GDP.

Let’s start with our base case, in which Britain experiences no growth over the next ten years:

As you can see, if everything goes a bit wrong and we don’t have any growth at all, we’ll be well on our way to bankruptcy by 2020. But this is rather negative. What happens if we grow at the entirely respectable rate of 1%?

Not much. A minimal growth rate just slows down our inevitable decline. To actually eliminate the deficit with growth alone, we need to be growing at a rate of at least 4% every year:

All well and good, I hear you say: as long as we grow rapidly enough, we can ignore cutting the deficit. However, there’s a problem, and it comes in the form of this chart:

Growing at 4% for ten years would be historically unprecedented. In order to eliminate the deficit by growth alone, we’d need to enter a boom period almost unheard of in the history of the UK. This seems somewhat unlikely.

However, it’s worse than that. Assuming the worst predictions of those in fear of the bond markets came true, and the interest rates on our debate accelerated to Irish levels of 9%, we would never eliminate the deficit by 2020 even with growth rates of 4%.

Without that level of growth, the deficit would exceed our tax receipts before the end of the decade. Of course, a lot of our debt still has a good while before it needs to be refinanced, but that would merely prolong the inevitable downward spiral.

We need a strategy to tackle the deficit. If you’re a major political party without one – not mentioning any names – you’re de facto signed up the approach above. If you’re protesting the cuts without a clear alternative yourself, you’re guilty of what my Lib Dem colleague Ian Gaskin rightly called ‘a fear of change to an unsustainable status quo’. And you’re doing it unnecessarily – consider a different pace of deficit reduction, or a different mix of tax rises and spending cuts, there’s plenty of options for a preferred strategy. The question is which allows us to repair our economy in the most effective way while minimising the impact on our standard of living. There will be pain – pain for everyone, whatever option we take – but pretending that there’s some way to avoid is tantamount to ignoring reality.

*Do let me know if I’ve made any mistakes; I find economics intriguing but statistical releases very confusing.

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4 Responses to “The Alternative is Silly”

  1. Dave said

    woohoo, a straw man with numbers!!! Although the numbers are so generalised its a worthless exercise.

    “We need a strategy to tackle the deficit. If you’re a major political party without one – not mentioning any names – you’re de facto signed up the approach above.”

    No, really who do you mean? Labour have set out a strategy to tackle the deficit, it involves spending cuts (pub sector pay freeze, 12% cuts to police budgets, re-rating of welfare benefits for period of 3 years) and tax increases (employers NI, increase CGT, reductions in pension allowances) with a ratio of 56:44.

    Expecting a marcher or even the opposition to come up with a fully worked out plan is frankly ludicrous. You need an army of civil servants and several months to do it and even then you make big cock ups as the tory-libs have done.

    • declineofthelogos said

      Perhaps, in that case, you’d like to point me to the exact part of the Labour Party website which sets out this strategy. I would presume you’re referring to Darling’s pre-election strategy, in which case you’ll also need to point out where both Milliband and Balls have endorsed it since the election.

      You’ll note that I didn’t actually say ‘fully worked-out plan’. I said ‘strategy’. Even if this is as broad as ‘20% off everything’ – which I would agree is inadequate – it counts.

      Claiming that numbers are ‘too general’ is meaningless, by the way. You’ll need to be more specific in your criticism for it to work.

  2. Francis said

    Fantastic analysis, and nice graphs.

    The assumption “that tax receipts rise at the same rate as GDP” is probably a bit off, as different areas of economic activity attract different levels of taxation.

    In the boom years, Labour encouraged the growth of those sectors of the economy that brought in disproportionately high tax receipts in relation to, say, the levels of employment they provided or their social use. Encouraging property speculation was socially useless- actively harmful to society in fact- but raised a lot of revenue for the treasury. You’ve written compellingly on this blog in the past about why Labour did this.

    So when Labour call for the deficit reduction strategy to be entirely based on growth, it’s always unavoidably implicit that what they require- what they really mean by ‘growth’- is a return to high finance and property speculation. Real sustainable economic growth is even more highly unlikely to replace the tax receipts we were getting from socially harmful economic activity at the height of the boom.

    Yet another reason why we must not let Labour back into power!

  3. Excellent article, my thanks.

    The impact of the UK failing to deal with the deficit is fairly starkly laid out here:

    http://www.bis.org/publ/work300.pdf

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