Sunday, May 02, 2010

The scale of the crisis

"We’re trying to keep a fire going by throwing on £50 notes with one hand, and buckets of water with the other."


The ever excellent Charlotte Gore (who I was most pleased to meet in the flesh at the ASI's Blogger Bash) has a post up about the scale of the debt that this country has established—and which it is still racking up.
The Government, you see, is currently overspending above and beyond what it takes in tax on an epic scale, and all three leaders say they want to sort that bit out. All well and good, but none will address the perversion of Keynesian thought that got us into this mess in the first place. Even Keynes thought the absolute maximum tolerable proportion of Gross National Product to be spent by the state was 25%… and we’re approaching 47%. In parts of Britain the public sector is 70% of the local economy which puts Soviet Russia to shame. We’re trying to keep a fire going by throwing on £50 notes with one hand, and buckets of water with the other.

Quite so.

And no one really really seems to understand just how much trouble we are in.
Just because all three parties are talking about cutting the deficit doesn’t mean economic liberalism is experiencing some kind of renaissance. It just means things are probably much, much, worse than we fear.

I'll raise you a "much" there, Charlotte: things are much, much, much worse than we fear.

The scale of the debt


There are a number of contributing factors here...
  • NuLabour's spending splurge has racked up colossal amounts of debt already—near to 70% of GDP. Or, to put it in easier to understand terms...

    The government is currently borrowing about £0.5 billion per day. To put it in perspective, that is about what it costs to run Parliament for an entire year.

  • Our structural deficit is just less than 10% of GDP—or about £150 billion.

    As we know, for the last couple of years, the government has been borrowing more like £170 billion per year. The structural deficit is, basically, the difference between what the government is spending and what it takes in tax that will still be with us when the recession is over.

  • Currently, simply paying the interest (at about 4.5%) on this colossal amount of money is about £40 billion per year—more than the Defence Budget.

    If the market thinks that there is a high chance that the government might default on its debt or try to inflate it away, then investors will demand higher Gilt Yields (effectively, a higher interest rate).

    The higher the debt gets, the more likely it is that the government will try one or both of these strategies, driving interest rates higher. They are currently hovering around the 6.5% mark. In the 1970s, the rate reached close to 18%!

  • Not one of the Big Three parties is proposing any plan to seriously mitigate any of this—all of them are proposing cuts of about £50 billion but none of them has set out in concrete terms how they are going to achieve this.

    And even if they had, £50 billion is only about one third of the structural deficit. In other words, even if the government makes £50 billion of cuts, it will still be borrowing £100 billion per year.

    Which means that not only will it not even be paying off any of the National Debt, it will be adding to it at the rate of £100 billion per year.

    As a result, the interest rate on Gilts is going to continue rising unless there are some serious cuts. (And if Labour get in, we going to be seriously screwed.)

"OK. Yeah, sure, Devil," I hear you cry. "But we're pretty big, economically: surely we aren't going to end up like Greece, are we?"
Hmmmm.

Total Fiscal Collapse


A couple of weeks ago, I was talking to the Taxpayer's Alliance's Research Director, Matt Sinclair, who is a very worried man. Matt pointed me towards a post summing up one projection of just how comprehensively screwed we are if something isn't done urgently.
Now a new report shows that the long term problem is even more serious. The Bank for International Settlements has looked at the picture in the longer term and the projections in its new report [PDF] suggest Britain faces the worst long term fiscal position of any of the countries it has looked at.

First, look at their projections for debt as a percentage of GDP. There are three lines on these graphs. The first - in red - is what they expect with present policies. The second - in green - is with a gradual fiscal adjustment, the BIS have worked on 1% of GDP a year for five years. The third - in blue - is with that gradual fiscal adjustment and a freeze in age-related spending as a share of GDP, which would be incredibly difficult given an ageing population.
...

Without policy change debt rises towards 550% of GDP in 2040 and even with the kind of fiscal adjustment the Government is planning (but not setting out a credible plan to achieve) debt will be rising towards 400% of GDP. Even freezing age-related expenditures won't get us off the hook:



The only country projected to run up bigger debts is Japan. But it gets worse when you look at how affordable those debts will be, which comes down to debt interest payments. It's just like a mortgage, people don't have their homes repossessed because they owe too much but because they can't make the payments.

Thanks in part to quantitative easing, we've had a relatively easy ride on that front so far. But this year the Government expect to spend more paying debt interest than they will on public order and safety. And I wrote yesterday about how that could get much worse quite quickly. The BIS present estimates of how debt interest costs could increase. On that score Britain faces the worst position of any country they looked at with debt interest rising in the baseline scenario to an incredible 27% of GDP:



Wat Tyler puts that in more tangible numbers, setting out the scenario we'll face if politicians don't get the deficits under control:
"Or to put it another way, by 2040 the average family would be paying (in today's money) over £10 grand every year just to pay the government's debt interest bill."

To do a quick back of the envelope calculation, our GDP is currently nearly £1.5 trillion. 27% of that is just over £400 billion. There are under 26 million families in Britain, which means the bill will be equivalent to over £15,000 per family today. And of course you would expect GDP to be a lot higher in 2040 which will inflate those numbers further.


The very important point to emphasise is that under the current plans of all parties, we are still heading for a debt of 400% of GDP. And if that happens, by 2040 we would be paying 27% of our GDP every year—some £400 billion at today's figures—just to pay the interest on our national debt.

Of course, as Matt pointed out, this figure is reasonably irrelevant since we would face total fiscal collapse long before that happened.

Whoever gets in at the next election—whether by a majority or in a coalition—desperately needs to get a grip on the nation's finances. And that is going to mean massive spending cuts in all areas of government; if this does not happen, the alternative is stark.
If that isn't done, we are heading for a prolonged and devastating economic crisis.

And simply raising taxes is not going to help either.
Think you can deal with that deficit through tax rises? The BIS agree with us that isn't a sensible way forward:
"Taxes distort resource allocation, and can lead to lower levels of growth. Given the level of taxes in some countries, one has to wonder if further increases will actually raise revenue."

Tax rises might increase revenue in the short term by taking more money out of people's pockets, but by undermining growth high taxation and spending will mean less revenue over time.

The argument is stronger even than that. BIS projections assume a 1% per annum growth in the economy up to 2040. Although savage cuts will still need to be made, one way in which the effect of these might be mitigated is through allowing the economy to grow considerably faster than this.

Going for broke growth


And the single best way to allow an economy to grow is to lower taxes. Via Burning Our Money, a November 2009 report from the New Policy Exchange featured a chart that showed this very neatly.



And to emphasise the point, let's return to Charlotte Gore's post, which spells out the issue very clearly.
No matter which party forms a Government, we’re going to get a very, very similar Government to the one we currently have.
It’ll be largely social democratic in nature, with a huge public sector that’s desperately trying to compensate for the weak private sector to give the illusion of a healthy economy.

Libertarians like me argue that the weakness of the private sector is in no small part due to the overwhelming redirection of national product into the public sector, and so waiting until the private sector sorts itself out before rolling back the public sector is a) Mental b) Wrong and c) Going To End In Tears.

The Government, you see, is currently overspending above and beyond what it takes in tax on an epic scale, and all three leaders say they want to sort that bit out. All well and good, but none will address the perversion of Keynesian thought that got us into this mess in the first place. Even Keynes thought the absolute maximum tolerable proportion of Gross National Product to be spent by the state was 25%… and we’re approaching 47%. In parts of Britain the public sector is 70% of the local economy which puts Soviet Russia to shame. We’re trying to keep a fire going by throwing on £50 notes with one hand, and buckets of water with the other.

And, in short, this is why there’s not enough jobs. There’s simply not enough stuff going on, so we have millions upon millions economically inactive, and an ever smaller number of businesses and people to pay for the ever growing public sector. This isn’t sustainable, or desirable, and truth is that the only choice is stop doing it or be stopped. That’s the choice.
...

The challenge for the next Government (as set by the three leaders) is simply to get public spending down from “let’s just hand the keys to the IMF” to “catastrophically expensive.” But even if the deficit could be reduced to zero overnight, the Government would STILL be consuming too much of the National wealth.

Quite. The more costs that you impose on business, the less business there will be—it's not a difficult concept to grasp.

And it's a concept that the government does understand—after all, why else tax cigarettes? The government (theoretically) wants people to give up smoking, so it taxes cigarettes so that you have fewer smokers. If you tax businesses, you will get less business.

The Solution


In the end, the solution must be something along the lines of that enacted by the New Zealand government of 1984 (the post on which is recreated from the DK archives below): not only a massive cut in government spending and a consequent consciousness of how—not how much—money is spent, but also a massive cut in taxes (and regulatory burdens).

But I fear that only the total fiscal collapse predicted will force the British public to face up to all of this.

2 comments:

Lola said...

Seriously, Brown needs to be arrested, now.

Personally, I'd just cut out the middle bit and string the bastard up.

Anonymous said...

Will someone remind me why we'd want to save the state from collapse? I'd say this would be quite a welcome development.