The entertaining political show where an audience gets to pose questions to a panel of politicians from different parties is normally amusing. Naturally enough these days most editions touch on the subject of the budget deficit. It does amaze me though the apparent total ignorance of the panelists when it comes to finance or the role the government plays in it.
On the most recent show one panelist said she feared that reducing the deficit would cause a double dip recession and anyway the deficit isn’t a problem, we had a higher deficit when we were fighting Napoleon, and no one would worry about it if is wasn’t for Standard & Poors (the ratings agency) threatening to downgrade us despite the fact that the credit crunch was all their fault in the first place. The audience applauded loudly – I considered packing my bags to go to a capitalist country like France.
Another panelist from Scotland agreed that it was foolish to reduce spending although he thought increasing taxes would do the trick. Perhaps he thinks all the rich people have left Scotland and so the burden would fall on the English? Mind you as he is famous for having no restraint with the whiskey bottle either.
The only person who had a grip on the economic situation was an historian, but he was made to look eccentric for clinging to old fashioned beliefs such as that spending without control is like living in Never-Never land and that one day there will be a reckoning.
It is true that all major western countries have large budget deficits thanks to the economic crisis. So for the moment there is safety in numbers, but as economies recover, the countries in the weakest position start to attract unwelcome attention. Greece has managed to have worst financial management of any country in Europe with debt 130% of GDP and a 13% budget deficit, topped off with a government accounting scandal. But UK has managed to squander its financial position in record time. We had a debt of less than 40% of GDP two years ago now it is at 60% and with current projections it will be 80% in 3 years and probably will go over 100%. There is unfortunately an economic death spiral that occurs when creditors worry about your finances. When banks lend you money they increase your interest rate when you default thus compounding your problems in order to minimise their problem with you.
Debt set to rise if AAA status is lost
This is the threat to UK government finances; that interest payments as a percentage of GDP will start to inflate out of control. When debt servicing goes above 5% of GDP creditors worry and UK is at that point (greatly helped to stay below that level by ultra low interest rates). If interest rates rise even by a small amount, the cost can be measured in hundreds of hospitals or new schools or university places or defense projects (we currently pay £35 billion in interest per annum on debt of £848 billion which is roughly an average of 4% interest; with debt set to rise to £1.2 Trillion if we lose our AAA status interest costs could rise to £72 billion or 5% of GDP or 10% of government spending.). We can’t pursue this course of action; we must reduce the deficit to reduce interest payments to a sustainable level.
Governments can increase tax, and the next government will do so regardless of political hue, but the danger is that too many tax increases will choke the economy. Cutting government spending must also be done, and here the scope is much larger. This is because the government does not actually produce wealth, it merely passes it around. After 12 years of Labour government the number of pet projects of dubious necessity, the range of overlapping Quangos created as a reward for political support and the general bloating of employment by the government (more than 1 million jobs) leaves enormous areas of unproductive spending that can be cut. Of course the people affected also represent their vested interest and as they say turkeys do not vote for Christmas.
So telling people that if they are in the firing line it is for the good of the country (and so vote for me anyway) is a tricky sales pitch: hence (probably), the apparent ignorance and wishful thinking of all politicians at the moment when they talk about the budget deficit.