Fiscal austerity is self-defeating

The British Office of National Statistics published the latest National Accounts data for the third-quarter 2012 yesterday, which showed a modest burst of growth, consumer driven via the Olympic Games. It is a temporary spike in a downward trend. I will consider the growth data another day. It follows the release last week (November 21, 2012) of the latest – Public Sector Finances – for October 2012, which demonstrates why fiscal austerity is self-defeating. By failing to acknowledge that when non-government sector spending is insufficient to drive economic growth at levels sufficient to reduce unemployment there is a need for increased discretionary government net spending to support growth, the British government not only is creating an increasing economic malaise but failing to achieve its own (mindless) targets – a reduction in the deficit and outstanding public debt. The lesson is that fiscal austerity is self-defeating on all counts – the things that matter (the real economy including unemployment) and the things that don’t matter (financial ratios).

The October Public Finances Data tells us that:

  • Public sector net borrowing was £8.6 billion in October 2012, a rise of £2.7 billion over the year (compared to October 2011).
  • The Public sector current budget deficit was £6.7 billion in October 2012. The deficit was £2.3 billion higher than the outcome recorded in October 2011.
  • ONS say that for the “period April to October 2012, public sector net borrowing (excluding the capital payment recorded as part of the Royal Mail Pension Plan transfer in April 2012) was £73.3 billion; this is £5.0 billion higher net borrowing than in the same period the previous year, when net borrowing was £68.3 billion”.
  • “Public sector net debt was £1,068.8 billion at the end of October 2012” or 67.9 per cent of GDP, a rise of 4.5 per cent over the 12 months.

Now the point of quoting those figures is not to give them any credence in their own right. They can only be interpreted with reference to a meaningful context – which in this case is the state of the real economy. Public deficit and debt ratios have no meaning in their own right, in isolation, when we are discussing a sovereign currency nation such as the UK.

Remember a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.

Also note that the October 2012 outcomes are actually highly misleading because they include the impacts of some monumental fudging from the Government, aimed at misrepresenting the data to all those who do not take the time to read the publications in full.

Refer to dot-point three above – the reference to the “Royal Mail Pension Plan transfer”. What is that about? Sleaze is the answer, but I better explain.

The ONS publication (linked above) contains a section entitled (euphemistically) – “Recent events and methodological changes” (starting page 6). On Page 8 you encounter the explanation for the “Royal Mail Pension PLan” transfer.

The nub is that the Government is preparing the Royal Mail for privatisation. As part of this process it transferred all the assets of the Royal Mail to the public accounts (£28 billion) but not its liabilities, which were much larger (£38 billion). As a result net borrowing didn’t rise by as much as is indicated by the true state of public finances in the UK.

We read that:

Following Royal Assent for the Postal Services Act, on 13 June 2011 the Department for Business, Innovation and Skills (BIS) has transferred assets and liabilities from the Royal Mail Pension Plan (RMPP) to a new government run unfunded public sector pension scheme. Under the terms of the Act, the Government assumes both the RMPP pension liabilities, accrued up to March 2012, and the bulk of the RMPP’s assets. These transactions took place in April 2012 …

The value of the RMPP assets transferred was £28.0 billion and the value of the transferred liabilities was approximately £38 billion. Under National Accounts rules, the pension liabilities of unfunded pension plans, like those for the Civil Service, are contingent liabilities and are therefore not recorded as liabilities in the National Accounts or Public Sector Finances. However, the transfer of the assets will provide the government finances with a one off boost in the short term, though government expenditure rises over the longer term as it pays out the pensions to retired Royal Mail workers.

So fudge of the best variety. Without it, the Public Finances data would reveal a much bigger rise in the deficit and public debt outstanding.

Closer examination of the data reveals that the “activity”-based components are moving in ways that tell you economic activity is waning, notwithstanding the Olympics-blip.

For example, corporate tax revenue fell from £8.9 billion in October 2011 to £8.1 billion in October 2012, a decline of 9.5 per cent over the 12 months. Of significance, is that the rate at which company tax receipts is falling is accelerating. Institutional arrangements also dictate that October is usually a stronger than normal month for company tax receipts.

Overall, tax revenue is slightly up (1.8 per cent over the 12 months) but so is government spending (up 9 per cent), which is why the deficit has increased. Despite its intended austerity, government departments are still increasing spending.

The tax revenue rose on the back of the 2.5 per cent increase in the VAT, which is a deflationary measure overall. But the rising deficit means that the public contribution to aggregate demand is still rising despite its intentions.

That is the point that people do not typically understand. As fiscal austerity impacts negatively on the economic cycle, the damage is attenuated by the cyclical effects that a manifest in the final budget outcome.

I have explained previously how we can decompose a budget outcome into two components – that which reflects the discretionary spending and taxing decisions of the government (so the policy choices) and that which reflects the state of the economic cycle (the so-called automatic stabilisers).

To summarise, a budget balance is the difference between total revenue and total outlays. If total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved.

If the budget is in surplus then the fiscal impact of government is contractionary (withdrawing net spending) and if the budget is in deficit the fiscal impact expansionary (adding net spending).

But the complication is that we cannot then conclude that changes in the fiscal impact reflect discretionary policy changes. To see this, the most simple model of the budget balance we might think of can be written as:

Budget Balance = Revenue – Spending

Budget Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)

Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These components of the Budget Balance are the automatic stabilisers.

Therefore, without any discretionary policy changes, the Budget Balance will vary over the course of the economic cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the Budget Balance moves towards deficit (or an increasing deficit). When the economy is stronger – tax revenue rises and welfare payments fall and the Budget Balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom.

So a rising budget deficit doesn’t allow us to conclude that the Government has suddenly become of an expansionary mind or vice versa.

What this also means is that fiscal austerity policies that damage economic growth will also likely result in a rising budget deficit and via the voluntary (but unnecessary) institutional arrangements that dictate that the state issue debt to the private markets on matching ($-for-$) basis with the recorded deficit, a rising public debt.

The point is that it is easier to bring a deficit down by using deficit spending to promote robust economic activity, which has the side-effect of flooding the government sector with tax revenue (without altering the tax structure at all).

Overall, Modern Monetary Theory (MMT) tells us that an obsession with these financial outcomes are likely to lead to poor fiscal interventions, exemplified by pro-cyclical fiscal shifts, and be self-defeating in terms of their own mis-guided logic.

Please read my blogs – Structural deficits and automatic stabilisers and Structural deficits – the great con job! – for more discussion on this point.

I was most interested in the reaction of the corporate elites to the Public Finance data release.

As an example, the CEO of the British Chambers of Commerce reacted to the data in the predictable (and pathetic) way saying in their Press Release that:

To maintain credibility, the government must persevere with a realistic plan to reduce the deficit over the medium term. But there is also a risk that if weak growth continues, borrowing could overshoot even further, which could in turn threaten the UK’s credit rating. The government should look to make cuts in areas such as welfare reform, pensions and the size of the civil service to ensure that the structural deficit is gradually reduced. We will also be looking to the Chancellor to announce measures in his Autumn Statement that will boost growth and enhance the productive capacity of the UK.

Contradiction personified. What this is really saying is that they want the Government to cut the income support to those who are the least advantaged (and have marginal propensities to spend of 1 – that is, they spend every cent they get) and increase the dose of corporate welfare that these parasitic business groups expect from government as their right.

Hypocrisy has no limits when it comes to these characters.

Corporate welfare is not just about direct government handouts to private businesses in the guise of industry policy and tax breaks. Firms have long enjoyed government support for credit guarantees, cheap labour (via wage and training subsidies), export promotion and other handouts.

But now, whole slabs of legitimate public service delivery in what we consider essential services (health, law and order etc) have been packaged up and handed over the private sector under very lucrative contracts.

The rhetoric that supports these developments talks about “risk-shifting” whereby the private firm has to be rewarded handsomely for taking the risk from the public sector. The lie, of-course, is that no effective risk is transferred. When a local cafe goes broke, patrons sigh and its workforce are distressed, but we just go for lunch at the next cafe. The owners of the cafe lose and life moves on.

But when a public hospital operator goes broke after creaming large returns from these government contracts, the risk is not borne by the operator. The public sector just takes the service back.

Moreover, many of these Public-Private Partnerships (PPP) attract investment from superannuation funds. When the private operator goes broke and the fund takes a hit the implications are obvious. The public pension liability rises, adding to the demand on the public purse. Remember, many of these deals are at the sub-national level where the government is revenue-constrained.

In the UK, the 2011 announcement by the Chancellor of the Private Finance Initiative (PFI) essentially guaranteed massive profits to private companies with zero risk being transferred from the public sector.

I recall being on a panel a few years ago as the critic of PPPs and also on the panel was a leading union official now a leading Labor politician. I challenged his support of PPPs noting that the workers’ superfund of which he was a board member and trustee (by dint of his union leader status) was investing in these neo-liberal contrivances, which then reduced the employment and pay and conditions of his own membership relative to what would have happened under 100 per cent public sector provision. It was an embarrassing moment for him and exemplified the untenable and inconsistent bind that these progressive officials and politicians have got themselves in by playing with the neo-liberals.

George Monbiot summarised this in his article (November 21, 2011) – For corporate welfare queens and their crystal baths, there is no benefit cap:

Socialism for the rich, capitalism for the poor: that is how our economies work. Those at the bottom are subject to the rigours of the free market. Those at the top are as pampered and protected as Tamara Ecclestone’s dogs.

The reference to Ms Ecclestone was in relation to a TV documentary on the F1 heiress who was shown “supervising the refurbishment of her £45m homein London, in which she commissioned a £1m bathtub carved from Mexican crystal, an underground swimming pool complex, her own nightclub, a lift for her Ferrari, a bowling alley with crystal-studded balls and a spa and massage parlour for her five dogs, to save her the trouble of taking them to Harrods to have their hair sprayed and their nails painted”. What the documentary didn’t report was how much public money had gone into the project courtesy of all sorts of dirty corporate welfare deals.

The hypocrisy of these private elites is stunning and is in the “let them eat cake” province.

Remember Northern Rock which was essentially sold by the Government to the Virgin group with all its considerable assets intact but all the liabilities retained in the public sector – and adding to the deficit that is then held out as the object of austerity, which means those damaged by the austerity the most – the poorest British citizens- pick up the tab in one way or another.

George Monbiot traced the fortunes of the CEO of the failed Northern Rock – one Matt Ridley – in all the transactions. The Government enquiry into the failure of the bank noted he oversaw a “high-risk, reckless business strategy”, which was the cause of the bank failure. Ridley is known as “one of this country’s fiercest exponents of laissez-faire capitalism”. The government enquiry into the failure also noted he was able to get away with this poorly conceived business strategy because of the financial watchdog had “systematically failed in its regulatory duty”. That failure is another form of corporate welfare, of-course.

For those who have forgotten about all this – please remind yourself that Mr Ridley authored the book The Rational Optimist: How Prosperity Evolves (published May 2010) – and the promotional material claimed that the book will “do for economics what Genome did for genomics”. Mr Ridley is not a man to feign modesty.

In the book you will learn how the government is a:

… self-seeking flea on the backs of the more productive people of this world … governments do not run countries, they parasitise them …

He outlined how “(t)axes, bailouts, regulations, subsidies, intervention of any kind … are an unwarranted restraint on market freedom”.

That didn’t stop him getting on the blower when his high salary was in risk of collapsing. He sought from those “fleas” bailout money, which eventually amounted to a cool £27 billion.

Then things got worse and the depositors started running on the bank. What did the advocate of free enterprise then do? Ring the fleas again and demanded a deposit guarantee. That state support turned into full-scale nationalisation.

George Monbiot concluded that Mr Ridley had learnt “the square root of nothing” from all this and after his book launch he “returned to his family seat at Blagdon Hall, set in 15 square miles of farmland, where the Ridleys live – non-parastically of course – on rents from their tenants, handouts from the common agricultural policy and fees from the estate’s opencast coal mines”. Not a lot of productive entrepreneurial, risk-seeking behaviour going on there!

George Monbiot’s article (May 31, 2010) – This state-hating free marketeer ignores his own failed experiment – tracks Mr Ridley’s inconsistencies.


The problem is that in its upcoming Autumn statement, the British government is likely to react to the Public Sector data trend by announcing more cutbacks. They should learn that chasing their tail will get them no-where. Just a more deeply-recessed economy, more unemployment (or numbers of people not officially unemployed but shifted of income support in one dirty way or another), and increased rates of poverty.

My trip to Timor-Leste tomorrow has been postponed. The T-L government called a hasty national holiday it seems and all appointments were cancelled. So the delegation I was part of wisely decided not to turn up to empty government offices. We are going in January I believe.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.

This Post Has 13 Comments

  1. Great commentary Bill and a good backgrounder as to what our Governor of the Bank of Canada will have to contend with when he takes up his new appointment as Governor of the Bank of England next July 1st ( Canada Day here in Canada)

  2. Always wondered what Matt Ridley was doing as Non executive director at Northern Rock.
    I remember his book Nature vs Nurture was one of the first books I read on the subject of evolution. It led me on to Dawkins et al. I had no idea he was such a rabid neo-liberal and thought he was just some patsy stuck on the board to make up the numbers or maybe provide a bit of behavioural bollocks.
    Live and learn.

  3. Neil: want to comment on this:

    Why the British elite insist on more austerity (it’s not that they’re stupid)

    From the article:

    ‘This is not a short-term deficit-reduction programme. As in previous crises, such as the prolonged malaise afflicting the British economy until 1982, the government is intent on restoring capitalist dynamism by means of a long-term transfer of wealth away from consumption and towards investment. Bank of England governor Mervyn King has been consistently clear about this: the economy must be rebalanced “away from private and public consumption towards exports and import substitution in the longer run”.’

  4. @stevek9
    That is a good idea, but the way they are going about it is irrelevant to this goal. Screwing the poor is more than about re-balancing the economy. Talking about re-balancing via getting rid of benefits looks more like a smokescreen than anything else.

  5. @stevek9
    Addendum: The way in which the government is ‘re-balancing’ the system is not short term. Cutting benefits is a long term goal for this government. I haven’t read the Guardian piece, but your quote suggests that the journalist hasn’t quite grasped what this Tory led coalition government is up to.

  6. I would be little bit careful predicting future of UK economy. House prices have not fallen much (, and as a consequence, households have not done that much saving. Saving has been done primarily by corporate sector which is notoriously short sighted. It might be that they have now accumulated enough cash reserves/paid down debt that existing deficits would start to flow trough corporate sector into the households where it would boost consumption.

    So it all depends on house prices IMHO. If they keep slumping it could prolong this recession to 20 year slump like Japanise. If not, growth could be around the corner.

  7. I envy your optimism. PZ

    The nationwide document doesn’t seem to make any mention of turnover. Here in Scotland that is at 51% of the 2007 peak. With a chancellor keen on individual departments running surpluses a prolonged slump is probably the best you could hope for.

    They seem to be aiming for the stability of the graveyard.

    It might be that they have now accumulated enough cash reserves/paid down debt that existing deficits would start to flow trough corporate sector into the households where it would boost consumption.

    How would it do that?

  8. By dividents and share buy-backs. If they are not going to save their profits they are going to have to either invest their profits or them back to the shareholders. But it is difficult to predict when savings desires are going to be fulfilled.

  9. By dividents and share buy-backs.
    how does moving around money this way benefit the vast majority who are not shareholders or those whose fortunes are not tied to share values?

    Actual capital investment in the UK seems to be heading downwards

    If Larry Elliot is to be believed, and he usually is;

    There is, however, no evidence that the squeeze on labour’s share of national income has led to higher investment. While the profit share rose from 25% to 30% of GDP between 1980 and 2010, investment fell from 20% to 15% and is still falling. It is a similar picture for spending on business research development, which has been dropping steadily since the mid-1980s.

    I do not understand ‘savings desires’.

  10. “how does moving around money this way benefit the vast majority who are not shareholders”

    They spend the money. Money doesn’t stop at its first use.

    One of the most successful textile manufacturers in England has targeted a niche of the very wealthy selling them classic English tailoring of the finest quality. They have expanded their operation tenfold in a recession hiring an awful lot of tailors in the process. The dividends paid become the wages of the tailors and the weavers in return for posh clothes.

  11. How much is an ‘awful lot of tailors’?
    Reminds me of Ralph Gomory’s question, “What if you’re comparative advantage is in opera singers?”
    Sunrise industries and trickle down economics haven’t lived up to its promises so far.
    Wages down, investment down, employment down and a public sector flogged off as buy to let opportunity.
    That is the situation, that is the policy.
    I don’t blame anyone for looking for a bright side, but this sounds like clutching at straws.

  12. “What if you’re comparative advantage is in opera singers”

    Comparative advantage is a load of rubbish anyway. A moments thought about capital destruction and the resulting system fragility would cause you to reject it.

    “How much is an ‘awful lot of tailors’?”

    That’s an example of ‘trickle down’ in action. I’m not saying it works well, just that there is an effect. UK industry is about servicing the rich and the retired at the moment. Get into that business and you’re likely to be able to weather the storm.

Leave a Reply

Your email address will not be published. Required fields are marked *

Back To Top