British economic growth shows that on-going deficits work

In Australia, the Federal Treasurer announced today that they would be making further spending cuts to the fiscal position of the government in the mid-year statement to pay for “an increase in funding for security agencies” and its onslaught against ISIL. So education, health spending, income support etc will get the chop so we can make the world an even more dangerous place than it is currently at a time when unemployment is rising and economic growth falling. Another case of austerity madness combined with the mindless approach to dealing with the external threats from extremist groups. He should take a note from the British Chancellor’s book who is overseeing an expanding fiscal deficit and public debt ratio, despite the rhetoric to the contrary, and that on-going deficit is supporting growth, helping private households increase their saving ratio and is generally a good thing to behold. Austerity in the UK?- not if you consider the current data!

The word austerity has become very fashionable these days. I also bandy it around relentlessly. But like others I rarely actually define what it might exactly mean.

The only sensible meaning is that it depicts a situation where discretionary fiscal decisions taken by the government undermine economic growth through the effect on net public spending.

However, if the government’s fiscal deficit increases and its spending contribution to growth remains positive it is hard to call that an austerity stance.

That is what is happening in Britain despite the forecasts of harsh fiscal austerity by the British Chancellor George Osborne.

While the composition of the growing (real) fiscal deficit might be damaging to some people, the macroeconomics are clear – the UK government deficit remains relatively high in historical terms and is supporting spending growth.

One might say that the UK Chancellor has failed if we compare the actual outcomes to those forecast in previous fiscal statements and the intent of the government to reduce the size and impact of the public sector.

But I would call this ‘failure’ a success because despite the ideology and intent, they have actually maintained a large deficit – and the economic growth is testimony to that.

The UK Guardian economics writer Larry Elliot discussed the state of public finances in the UK in this article last week – Budget deficit: George Osborne has a lot of explaining to do.

He opened with the statement:

Britain’s public finances are in a rotten state. The deficit-reduction plan announced by George Osborne when he came to office more than four years ago is way off track. On current trends, borrowing to fill the gap between taxes and spending will be in the region of £100bn in 2014-15. The shortfall in the first five months of the financial year is higher than it was in 2013-14.

The question that you should ask is this: Why is a rising deficit, which is clearly supporting growth with falling unemployment, evidence of a “rotten state”?

Using this sort of terminology (rotten state) is symptomatic of the neo-liberal era where the assessment of the fiscal position is made within a circular and meaningless logic.

Accordingly, good is low, bad is high and so if the fiscal balance is not low it is bad, and, presumably, if it gets too high, it is rotten.

None of which makes any sense and ignores the basic function of fiscal policy – to ensure that real spending in the economy is sufficient to maintain economic growth at levels commensurate with full employment.

The only meaningful way to appraise the fiscal position of a government at any point in time is to assess the state of the economy in real terms by asking questions like: Is growth sufficient? How close to full employment are we? Are real wages growing in line with productivity? Do we have first-class public infrastructure including education, public transport, health, and environmental protections?

Questions like that do not require you to even consider the size of the fiscal deficit/surplus as a standalone balance.

Instead, if the current fiscal balance is associated with entrenched mass unemployment, low economic growth (and hence low demand for labour), flat real wages growth etc then the conclusion is that the state of public finances is ‘rotten’ because the fiscal deficit is clearly too low given the state of net exports and the saving desires of the private domestic sector.

But the same fiscal balance (as a percent of GDP) might exemplify virtue if it was associated with full employment and adequate real wages growth. The difference between the two situations is that the behaviour of the external sector and the spending patterns of the private domestic sector would be different thus allowing for different real outcomes to be associated with the same fiscal outcome.

This case highlights what I have called the good and bad deficit (or balance).

Now consider what is happening in Britain at present.

The British – Office for Budget Responsibility – recently released (September 23, 2014), its Commentary on the Public Sector Finances release: August 2014 which allows us to assess, in part, the fiscal situation in Britain.

The OBR concluded that:

Public sector net borrowing (PSNB) was £11.6 billion in August, £0.2 billion lower than market expectations and £0.7 billion higher than a year ago. Central government spending was £1.7 billion up on last year, while central government
receipts were up by only £1.4 billion. Borrowing by local authorities and public corporations was also £0.3 billion higher than last year … For the first five months of 2014-15, PSNB was £45.4 billion, £2.6 billion higher than a year ago.

So government fiscal deficit has risen as has the governments borrowing.

The OBR says that the:

PSNB has risen by 6.2 per cent in the year-to-date, whereas we were expecting a fall for 2014-15 as a whole in our March forecast.

It also says that revenue has risen by 2 per cent for the year to August 2014 whereas they had forecast it would rise by 5 per cent.

Further analysis shows that:

1. “income tax receipts have fallen by 0.8 per cent against a full year forecast of a 6.5 per cent rise”.

2. Apart from some caveats about timing of receipts, the OBR concludes that “weaker-than-expected wage growth so far in 2014-15 also appears to be depressing PAYE and NIC receipts. Unexpectedly weak earnings growth and strong employment growth also mean that a greater proportion of wages and salaries will be subject to the £10,000 personal allowance, reducing the effective tax rate on labour income.”

Which means that the UK economy is producing mostly lowly-paid jobs that leave workers below the tax-free threshold.

The Office of National Assessments published statistics and analysis relating to the so-called (but ridiculously so) “zero-hours contracts” in April 2014 – Analysis of Employee Contracts that do not Guarantee a Minimum Number of Hours.

These so-called ‘jobs’ cover situations where the “employer does not guarantee the individual any work and the individual is not obliged to accept any work offered”. That is how ridiculous the neo-liberal era has become.

A job can be created with no guarantee of any hours of work and be counted as as employment in the statistics.

The OBS estimated that in “January to February 2014 there were around 1.4 million employee contracts that do not guarantee a minimum number of hours” and “among those companies using “zero-hours contracts”, the average proportion of the workforce on “zero-hours contracts” is 19%.” So around 4 per cent of the workforce and rising.

3. The sluggish economy has reduced the “growth in stamp duty land tax receipts” below forecast.

The bottom line is that the British government thought they would deliver a fiscal deficit of less than £40 billion in the 2014-15 financial year but the trends in the data tell us that the outcome is already running well above that and will likely come in close to the 2013-14 figure (around £75 billion).

The ONS publication (released September 23, 2014) – Public Sector Finances, August 2014 – tells us that Net Debt as a percent of GDP is now 79.1 per cent as opposed to 77.4 per cent in August 2013. Borrowing is up and the fiscal deficit is barely moving (as a percent of GDP), which is one of the reasons the British economy continues to grow.

Yesterday, the British ONS released the latest – Quarterly National Accounts, Q2 2014 – which show that the British economy grew by 0.9 per cent in the second-quarter 2014, a revision upward of 0.1 percentage points on the earlier estimates.

The annual growth (second-quarter 2013 to second-quarter 2014) was 3.2 per cent, a solid result clearly. Real disposable income rose by 2.2 per cent in the second-quarter 2014, again a good result, notwithstanding the skew away from workers.

The question is whether this is an endorsement of the British government’s much-vaunted austerity program? The answer, given the previous discussion and what follows is a firm No!

To have any meaning, the term austerity must mean that the government is undermining growth. In the case of Britain the national government continues to support growth by running large fiscal deficits.

The highlights of the latest National Accounts release include:

1. Real household consumption declining but still growing at 0.6 per cent in the quarter and by 2.1 per cent over the year to June 2014.

2. Government consumption spending rising by 1.2 per cent over the year in real terms.

3. Declining gross fixed capital formation growth (that is, investment) – four successive quarters of slowdown. The investment data does not allow us to break the data down to sectoral level, but the related publication (released on the same day as the National Accounts – Business Investment statistical bulletin does).

We learn that Capital Formation by General Government is down by 7.4 per cent over the last year but Business Investment, which includes investment by Public Corporations is up 11 per cent.

4. The much talked about export-led growth is also not happening. Exports fell in real terms by 0.4 per cent in the second-quarter 2014 and “With total exports contracting to a greater extent than imports, the net trade balance has worsened slightly compared to Q2 2013.”

So the external sector is draining growth in Britain.

What is driving economic growth in Britain?

The following graph shows the contributions to real GDP growth (percentage points) for the first- and second-quarters of 2014.

The ONS conclude that:

The largest positive contribution came from household final consumption expenditure (0.3 percentage points) while gross fixed capital formation and changes in inventories both made smaller contributions of 0.2 percentage points. With exports falling only slightly more than imports in Q2 2014, net trade made a small negative contribution to GDP for Q2 2014.

What they don’t say is that Government consumption contributed 0.2 percentage points (almost as much as households) and as much as Gross Fixed Capital Formation.

Without the large inventory swing (as firms restocked or could not sell goods and services) and the contribution of government consumption spending, real GDP growth would have been a very moderate 0.5 percentage points or 2 per cent annualised.

A further point to note is that in the second-quarter there was a reversal of wages growth for employees and that added 0.8 percentage points to real GDP growth in the second-quarter 2014, reversing the negative contribution in the first-quarter 2014.

Wages growth in line with productivity growth is an essential element of a stable overall growth scenario.

However, the latest data release shows that while the economy is growing, real household disposable income per capita, which is the accepted broadest indicator of living standards, was still 2.6 per cent below its 2007 peak.

Conclusion

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.