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The truth behind Britain’s incredible shrinking economy

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Michael Burke explains why the UK’s budget deficit is rising, not falling.

Images of money under a CC Licence

The latest public sector borrowing data shows that the UK budget deficit is widening once more. Indeed, despite a series of accounting adjustments which obscure the true picture, it is clear that the underlying trend is also towards rising, not falling deficits.

The Office for National Statistics reports that the June public-sector borrowing total was £14.4 billion ($22.3 billion), £500 million ($776 million) higher than in the corresponding month in 2011. However, monthly data are erratic and subject to significant revision. Taking the data for the first six months of this year as a whole is more meaningful and shows that the deficit over that period is £37.3 billion ($57.9 billion).

It is widely known that government policies have led to economic stagnation

But this total is flattered by the strange decision relating to the acquisition of the Royal Mail Pension funds ahead of planned privatization. In effect, the government has decided to include the assets of this fund, but not its much greater pension liabilities in its own accounts. This and another smaller transaction lowered government borrowing by £30.3 billion ($47 billion). The underlying deficit, excluding these transactions is therefore £67.6 billion ($105 billion) in the first six months of this year.

This compares to a deficit of £60.5 billion ($93.9 billion) the first six months of 2011. The deficit is rising, not falling.

Factors affecting borrowing

This deterioration in the deficit places British government finances in a growing band of European economies where sharp cuts in government spending are leading to economic contraction, which in turn produces widening deficits.

This should come as no surprise. As the crisis is effectively an investment strike by capital, spending cuts by government will only lead to a further decline in private investment. The reason this logic has taken some time to work through in Britain is due to a number of factors. These are primarily the zig-zag in government policy, which initially saw a very modest increase in government investment under Labour and so produced a reduction in the deficit. This was compounded by the uniquely high level of inflation during the British slump, which eroded the real value of all government spending.

Socialist Economic Bulletin has previously shown that the very moderate increase in government investment from the 2009 Budget under Labour was the catalyst for a modest economic recovery. Because of the increase in government spending (including allowing welfare payments to rise automatically as unemployment and poverty increased) the Treasury forecast that the deficit would rise to £178 billion ($276 billion) in the following financial year. In the event, the deficit began to decline and was £158 billion ($245 billion) for the financial year.

In addition, the effects of economic growth are felt on both sides of government accounts. Expenditure is lower than it would have been because more are in work and the benefits’ bill falls. Revenues are higher because incomes, profits and consumption all raise the level of tax revenues.

Spending cuts have the effect of weakening economic activity and so drive up government expenditures

It is widely known that government policies have led to economic stagnation. Yet it is only now that the deficit has started to rise. The British economy has grown by just 0.5 per cent in the two years since the Coalition came to office. But in nominal terms, before taking account of inflation, the GDP has increased by 6.1 per cent. This surge in inflation during the slump is highly unusual, placing Britain on a par with countries such as Iceland. Britain has an incredible shrinking economy when measured in international currency terms.

Domestically, this is reflected in a surge in inflation. While severely denting the purchasing power of all those on fixed or low-growth incomes, the fiscal effect was to increase nominal government revenues by £56 billion ($86.9 billion) over the last two years. This compares to annualised nominal growth in GDP of £88 billion ($136 billion).

The Treasury’s estimate is that every £1 increase in economic activity will lead to a 50p increase in government revenues. In fact the increase over the last two years has been 64p (£56 billion of revenues of £88 billion increased output). However, government current spending has also risen by £42.3 billion ($65.7 billion) over the same period. This is an inevitable consequence of the savings (i.e refusal to invest) by firms.

This points to the essential fallacy of all ‘austerity’ measures, whether from the Coalition’s frontal assault, or the slightly shallower, slower cuts favoured by current Labour policy. Even nominal growth will largely be reflected in increased government revenues. But spending cuts have the effect of weakening economic activity and so drive up government expenditures.

Even in the narrow terms of reducing the deficit, the only effective prescription is growth. The most effective means of promoting growth, as even the cautious 2009 Labour Budget shows, is for the government to increase investment.

This article first appeared on the Socialist Economic Bulletin website. Crossposted with permission of the author.

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  1. #1 embe 29 Jul 12

    Please forgive my ignorance, I do not understand inflation, GDP or much about economics at all. I'd like to but I just don't know where or how to begin! Bearing that in mind please could someone explain why 'The most effective means of promoting for the government to increase investment.' and futhermore, why isn't the government increasing investment? Thank you

  2. #2 commie 08 Aug 12

    it's because of different core ideas how state's economy and society should function.
    Current Coalition government in Britain consists of Conservatives and Liberal Democrats who think that government shouldn't participate in economic activities, have low taxes, cut the budget and leave people alone, allow them to handle things on their own, so there would be this thing called 'free market'.
    On the other hand, Labour party thinks that the Government need to participate in economic activities, own big companies, have higher taxes, support people with different benefits etc., however usually in this case rich people yell 'leave us alone, we don't want high taxes, it's our money'.

  3. #3 commie 08 Aug 12

    or in other words, Conservative approach: cut the budget, change the laws, make people to sustain themselves by finding jobs or founding companies, not relying on the welfare system all the time -> in the result economy grows because people become more active, sell and buy more. Lower benefits, so more people can't find jobs and start to steal.

    Labour approach: increase the spending, make jobs, pay more unemployment benefits, so these people later can find jobs. However, in this productivity and efficiency decreases because these jobs are 'manually' created and usually would be more efficient if done by private companies. -> in the result economy also grows but because the government artificially invested money. Unfortunately, such system is also used by 'lazy' people who just live on unemployment benefits all the time..something like parasites

    hope I made it clearer

  4. #4 Tim 02 Apr 13

    the welfare state is to blame, starting with pensions back in 1940ish. None of the benefits took into account the future and have become an uncontrollable monster which successive governments have failed to kill.
    The huge debt we face will burgeon onwards and upwards particularly when interest rates start rising.
    I have three teenage children and the old sex pistol lyrics are ringing in my ears 'no future, no future....'

  5. #5 tim 03 Apr 13

    Just like to edit my comment, I said the welfare began in 1940ish it was 1st Jan 1909.

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