Budget deficit

I listened – last night – to the House of Lords Science and Technology Select Committee session with David Willetts. In general I was impressed, both with those on the committee and with David Willetts himself. Phil Willis (the ex Chairman of the House of Commons Science and Technology Committee) was a member of the committee and he was, as usual, well informed and articulate. He asked a very interesting question about why we are planning to cut research budgets while many other countries (Germany, France, Spain, Japan, China, USA) are ring-fencing or increasing their research budgets. He also pointed out that our total public debt is comparable to or less than that of many of these countries. David Willetts’s response was that the problem is not necessarily the total debt, it’s our current deficit – the amount we need to borrow in order to cover the difference between expenditure and receipts. This is illustrated in the figure below that I have taken from the treasury website. It shows total public sector spending (blue bars) and total public sector spending (yellow bars). The deficit is the difference between these two values.

As can be seen in the above figure, there was actually a surplus in the late 1990s. In about 2001 we started running a budget deficit, but it remained at less than 3% of GDP until 2007-2008 when it suddenly ballooned to about 10% of GDP. This is a big number and does mean that we are borrowing a large amount of money at the moment. This is what confuses me though. If the economy recovers, then the deficit should return to 2007-2008 levels within a couple (maybe a few) years. If we were to do nothing, we would need to borrow a large amount of money and although this may make the city a little nervous, it’s hard to see how the economy itself would suffer. People would remain in employment, education and healthcare would still be well funded, and research budgets would not need to be slashed. What is more, the small print on the above figure says that the public sector spending is the “Total managed expenditure, including the temporary effects of financial interventions.” Maybe I don’t know what this means, but I assume it means that one of the reasons for the large deficit is that we’ve been bailing out the banking sector. If right, we’re facing massive cuts entirely because we’ve had to bail out the banking sectors who already are making profits of billions of pounds a year.

This again seems to indicate that the deficit should reduce, fairly quickly. Again, I understand that our debt will grow if we don’t cut it quickly. Currently we pay 43 billion in interest on our debt. If we increased our debt by one-third, we would be paying about 60 billion a year. It is a lot of money and I’m all in favour of reducing our deficit and, over time, reducing our debt. Given that our deficit is likely to return to pre-financial crisis levels of about 3% of GDP, a reduction of about 9% in public spending (given that public spending makes up about one-third of our economy) could remove the structural deficit and – in the short term – essentially cover the interest payments. What is more, a modest increase in taxation together with a modest reduction in public spending could produce the same result without the carnage that the proposed cuts are likely to produce.

My gut feeling is that this is largely idealogical. It is an opportunity for an essentially conservative government to reduce the size of the public sector. Today’s proposal that students fees could be uncapped and could double in the next year or so, seems to be first step in this direction. Furthermore, it is very difficult to see how removing this amount of money from our economy on such a short timescale won’t do some damage. I accept that not cutting the budget will result in an increase in public debt, but at least we could be reasonably confident that the economy should continue to recover. A goal to cut an amount comparable to the 2007-2008 deficit so that within a few years we’re running a balanced budget and can work towards reducing our debt would seem to be a much more sensible option. It’s quite possible that I misunderstand this competely and I’m pretty sure some people will think this to be the case (probably fairly safe from actually being attacked for this as not many people are reading this). Essentially my view is that we are facing ideologically driven cuts that are justified on the basis of a large deficit resulting from us bailing out the banking sector. If we can convince the right people that cuts of this magnitude are suicide, maybe we can also convince them that cutting the science budget will also do much more damage than good.

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