Belated Budget thoughts and ‘the end of austerity’

Belated Budget thoughts and ‘the end of austerity’

Brexit might be the news of the day right now, but last month’s Budget remains an important turning point. I’ve had a few people ask me how there seemed to be more money around in the Budget and where it came from, while there’s been plenty of debate on what the end of austerity really means.

Before we answer those questions; however, which I’ll do by means of a simple analogy, it’s vitally important to make sure we fully understand three core concepts, which will be coming up a lot.

  • The deficit is the difference between the amount of money the government takes in each year, mainly through taxes, and the amount it spends. Each year we run a deficit, our debt gets bigger.
  • Our debt is the total amount of money the government owes.

Importantly, the debt can still be going up while the deficit is going down.

  • Deficit/GDP and Debt/GDP are simply the above two terms, expressed as a proportion of GDP, which is broadly speaking the amount of wealth that the country produces each year. In the same way that a £10,000 debt will be more significant to someone on minimum wage than to someone earning a million a year, looking at deficit/GDP and debt/GDP is more meaningful than looking at the raw figures, as it shows us how affordable each is.

 

In 2010

Imagine that your take home pay after tax is £2000 a month(1). Out of this you’re paying a mortgage, which is large but theoretically manageable, food, transport, heating and all the other necessities, plus a small number of luxuries. Oh, and every year you get a pay rise – not as much as you’d like it to be, maybe only 1% some years, but something.

Unfortunately, added together your monthly outgoings total £2200 – so every month you’re adding £200 to your overdraft. Though your mortgage by itself might be manageable, the monthly overspend is running up your overdraft, putting you more and more in debt every month.

This is like the UK’s position in 2010. Our debt/GDP in 2010 was about 75%; much higher than ideal but theoretically manageable if it stayed there. The real problem was the deficit – at almost 10% of GDP, the overspending was pushing up our debt at a rapid rate, just like the person racking up £200 of extra debt each month on an income of £2000.

 

Moving on from 2010

Well, you know you have to stop overspending. The first thing you think is that your annual pay rise might help – but that’s too small to make a difference for several years. You’re going to have to cut back.

But that’s easier said than done. You can’t reduce your mortgage or your commuting costs and even some of the luxuries, like an expensive phone contract, are on long-term contracts that can’t be cancelled easily. £200 maybe ‘only’ 10% of your monthly income, but it’s a much higher fraction of your disposable income.

So you do what you can. You switch to a cheaper supermarket and turn the heating down. As time goes on, you switch out of expensive contracts and start to adjust your lifestyle – though that’s not easy and sometimes you don’t manage to make all the changes at once, or to stick to them after you’ve decided to make them. And of course, all of your meagre pay rise each year goes into reducing your deficit, rather than in being able to buy more of the nice things you might like.

It doesn’t go smoothly: sometimes there are unexpected expenses, like car repairs or a new boiler; one year your employer made a loss so you didn’t get any pay rise at all. And what’s worse, even whilst your reducing your monthly deficit, to £150 a month and then £100 a month, your debt is still rising – because whilst overspending by £100 a month is better than by £200 a month, it’s still overspending. But eventually, after a number of years, you manage to get to a place where your debt isn’t going up any more.

This is the UK’s position from 2010 to 2018. Although we wanted to cut our deficit, we couldn’t do it straight away. Some of the reasons were similar to the household’s: long-term commitments; things we had to spend money on or weren’t prepared to cut (the NHS, pensions); things we simply weren’t prepared to cut back all at once. Other reasons are different: because a country’s economy is more complex than a household budget – government spending has a role in stimulating demand and there are multiplier effects: we really couldn’t have cut almost 1/5 of government spending – or raised taxes by an equivalent amount – all in one go without plunging us into recession.

The small pay rise is our GDP growth, which has had to go into reducing the deficit instead of going on the things we’d really like. And of course, the whole time even though it’s been painful, the debt has till been going up (albeit more and more slowly) because we still had a deficit.

 

Budget 2018: The end of austerity

You’ve finally done it. Your debt isn’t going up anymore; it’s peaked at a level higher than it was, and far from ideal – but manageable. So what does that mean?

It doesn’t mean that your lifestyle suddenly goes back to what it was before: that, after all, was based on unsustainable borrowing, which you’ve now cut back. It doesn’t mean you’re not in debt: you are, both the original mortgage and the additional debt you’ve racked up from the years of deficit spending. And it doesn’t mean there’s lots of money floating around.

What it does mean is that you’ve turned the corner. Now, each year, when you get your pay rise, you can choose how to spend it. You could spend it on things you want to have, rebuilding your lifestyle. You could invest it, building up savings for the future. You could overpay on your mortgage, paying down your debt faster. Or, like many people would in this circumstance, you might choose to do a bit of all three. After the years when any additional income had to go on deficit reduction, this is a game-changer, and marks the end of austerity.

At the 2018 Budget, our debt/GDP has peaked at 88% (just 13 percentage points higher than in 2010) and has at long last started going down(2). It doesn’t mean we suddenly leap back to our 2010 levels of spending, built on unsustainable debt, or that there’s a huge amount of money floating around. For the first time since the financial crisis, the proceeds of our GDP growth can go on things we’d really like to spend it on, rather than the necessary but thankless task of reducing the deficit.

Like the householder, there’s a choice on what to spend it on. There’s a good case for spending more on public services such as health and education, which could do with some more money. There’s a good case for tax cuts, with the proportion of GDP taken in tax standing at one of the highest levels in decades. And, with our debt/GDP ratio at a post-war high, there’s a good case for putting a bit extra into paying that down.

We’ll all have different views on what should be the priority. At the recent Budget, the Chancellor chose to put most of the proceeds of growth into services, principally to fund the extra £20bn for the NHS. He also put a small amount into some modest tax cuts by lifting the thresholds, and enough into debt reduction to keep our debt/GDP ratio going down. Personally, I’m pretty happy with that prioritisation, especially putting most of it into the NHS. But even if you disagree, the crucial thing is that we now have that choice, and are able to start moving forward.

It is the end of austerity.

 

(1) Close to the UK median.

(2) There is a subtlety here. We still actually have a small deficit; however, due to a combination of growth and inflation, debt/GDP – the figure that really matters – is going down. It still marks the point where we have turned the corner.

3 thoughts on “Belated Budget thoughts and ‘the end of austerity’

  1. This is helpful, although the dependence on household budgets is obviously often criticised by economists: deficits by government can be productive, unlike spending on lattes! (I suppose an analogy might be if you saved money by no longer buying train tickets and so couldn’t get to your job and lost your income)

    More generally, I think the ‘turned the corner’ language is dangerous both at personal/national level if it falsely assumes the income/costs are broadly steady. I’ve come up with an idea of what could happen to the householder (there are probably national-level analogues)

    “Then your spouse remind you that you agreed you’d both move out of your flat – some things about it have been annoying you for awhile. But after you’ve sold it, it turns out that your spouse actually wants to move to Singapore and change your entire lifestyles, while you just wanted to move to a smaller flat down the road. Your spouse hates the idea of the smaller flat, possibly even more than your last place, especially when you say that reading the surveyor’s report you had done would just give him/her the wrong ideas and you’d rather keep it to yourself.

    You start thinking it might actually be best to just move back in to the flat you left: but you’ve already spent lots on legal fees, and you might have to pay a premium to get it back. Plus it’s a bit embarassing after all your facebook posts about being glad to leave it behind and how you didn’t like some of the neighbours.

    So you end up arguing in your short-term rental, with additional costs for marriage counselling, sinking deeper into your overdraft despite all of the savings you’d worked hard to make, wondering why on earth you decided to leave your old house until you’d actually decided what to do next.”

  2. To continue with the analogy, you’ve balanced the books, but at a price. Your kids haven’t had Christmas presents for three years, and are two years behind in school because you couldn’t afford pencils for their homework. Your father has lost his sight due because you couldn’t pay for the required medical care. The back bedroom is out of action due to subsidence which hasn’t been repaired. And the only way your youngest child can eat is if they go next door for their dinner.

    The alternative would have been to cut spending at a lower rate than this. While that increases the overdraft, your bank manager within this analogy isnt quite like a real-life bank manager. They understand that extra investment means that your income increases faster.

    Your kids can gradually start to help out with the family business (they’re on top of their homework, and in track at school), and your father can learn to help with the book-keeping, reducing the costs on accountants. Plus, you can fix the back bedroom and get a lodger. Spending a little on travel means that you can promote your business further afield, and increase your customer base.

    All this means that your income increases slightly faster than if you’d made the larger cuts. It’s not fast, but eventually you are balancing the books again, without the sacrifices.

  3. Lafayette, yes you’re right that Brexit could alter things, potentially. I’m not going to try to predict what could happen there (either the specifics or the economic impact of the specifics!), but certainly the analogy only holds if there are no major disruptions.

    Chris, I don’t think anyone can know for certain what would have happened if we’d reduced the deficit more slowly. Multiplier effects, impacts on the economy and how investors would have reacted are all unknowns (and each situation is unique). Certainly it could have ended up with us balancing the books more rapidly / with fewer cuts, but it could have equally not done so, or even precipitated an investor confidence crisis, with higher interest payments wiping out any multiplier effects. We really can’t know.

    Whatever speed we did it at though, at some point we’d have ended up at the ‘turning the corner’ point which is where we are today.

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