What the Tories used to say would happen if the deficit was only halved by 2015

election poster

It’s funny how things change. The Conservatives launched this, their first election poster this week. One of their three boasts is “THE DEFICIT HALVED”. This has now been redefined as a success, but Jonathan Portes has dug up some great quotes from 2011 when they were saying something entirely different:

Mark Lancaster: The Government’s plan to eliminate the deficit by 2015 is in stark contrast to the Darling plan, which was simply to reduce it by half. What assessment has the Minister made of the likely impact of the Darling plan on the level of debt and the cost of servicing it?

Mr Hoban [Mark Hoban, at the time a Minister at the Treasury]: If we had continued with the previous Government’s deficit reduction plan, debt would still be rising in 2015, not falling, meaning that we would have to spend an extra £3 billion in one year on debt interest while still having to make spending cuts. The lack of ambition in the previous Government’s plan put our credit rating at risk, thus threatening the prospect of higher interest rates and putting a brake on the recovery.

Then, only halving the deficit by 2015 as per Labour’s original plans would “put our credit rating at risk, thus threatening the prospect of higher interest rates and putting a brake on the recovery.” Now though, halving the deficit is cause for high-fives all round!

This is not to say that Labour’s plans were better than the Tories, both were stupid to focus on the deficit, which was never a big issue. I just make the point to show how divorced politics and economic reality have become. Failure can be redefined as success at will, and something that once was said could lead to catastrophe is now just a step on a road to long term recovery. It’s rather transparent, so hopefully more people will start to notice.


Osborne says he won’t take us back to square one. We never left

George Osborne has been coming under increasing pressure to change course of his austerity strategy. Even the IMF – who originally backed austerity – have deserted him. Osborne is sticking to his guns however and last night, in a speech at the annual CBI dinner said:

“Now is not the time to lose our nerve. Let’s not listen to those who would take us back to square one. Let’s carry on doing what is right for Britain. Let’s see this through.”

So the message is that doing anything additional to help the economy would “take us back to square one”. But how does “square one” compare to now? Assuming square one would be the situation Osborne inherited in May 2010, have far have we come since then? Here’s a few quick stats and commentary.

1) The Deficit

2009/10: £159bn

2012/13: £121bn

So the deficit down by a quarter. This seems to be the thing Osborne is most proud of, but – putting aside the fact that the deficit on its own is neither good nor bad – this reduction has been achieved primarily by cutting capital expenditure in half. From right to left, almost all commentators believe capital spending is precisely the thing not to cut, so in trying to lower that headline deficit figure, he’s actually setting us up for problems further down the road. Square one with double the capital spending actually sounds quite attractive.

2) Unemployment*

3 months to March 2010: 2.51m

3 months to March 2013: 2.52m

Yes, you read that right. Unemployment is actually higher now than in the comparable quarter in 2010. We are still at square one!

3) Employment*

3 months to March 2010: Employment rate – 72%; Total Employed – 28.83m

3 moths to March 2013: Employment rate – 71.4%; Total Employed – 29.71m

The Coalition like to say it has created 1 million private sector jobs. The net additional jobs since March 2010 though has been just under 1 million, and the working age population has risen faster than that, so the employment rate has actually fallen. Square one would actually be an improvement here.

4) Real Incomes

Median hourly earnings 2010 (constant prices): £11.92

Median Hourly earnings 2012 (constant prices): £11.21

Real incomes then have fallen since 2010, so again, square one doesn’t look too bad.

5) Interest Rates 

10 year bond yield May 2010: c3.6%                                          

10 year bond yield May 2013: c1.9%

Interest rates are another success Osborne likes to trumpet, and they have come down since 2010 (although by May 2010, they were already coming down). Whether this is a good or a bad thing depends on whether you are a borrower or saver, but assuming they are a good thing, how much credit should Osborne take for them? According to Jonathan Portes, not much.

In conclusion then, if Osborne were to change course, taking us back to square one, what would that look like? The deficit would be higher, but so would capital spending. Unemployment would be slightly lower, and a greater proportion of people would be employed. They’d also be paid more for that work. Interest rates would be higher (although on a downward trend). So the overall economic picture has barely changed since May 2010. I haven’t even mentioned the almost complete absence of economic growth since then. It looks like we never left square one. Going back there would actually be a slight improvement, and if we could go back there, but deploy our resources smarter than Gordon Brown in 2009/10, a huge one.

* Labour market figures sourced from ONS here: http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/index.html

Debt, Deficits and Interest Rates – Some More Charts

Following on from the last post on debt and deficits, this post will look at interest rates. This will be a somewhat superficial examination of the data as the reality of the link between debt, deficits and interest rates is a complex one, but I hope to show that the Government line on interest rates is at best simplistic, and at worst wildly misleading.

After the release of last week’s GDP figures, a succession of Ministers gave interviews where they mentioned the UK’s low interest rates as a positive outcome from austerity. The reasoning goes that if debt and deficits get too high, the markets will revolt and start demanding high interest rates on government debt. The Government’s argument is that since austerity began, the markets are now reassured that the Government is dealing with its debts (!!?) and so interest rates have remained low.

I think Jonathan Portes did a pretty good job of debunking this argument last year, but we are still hearing that this story that low interest rates indicate the success of austerity, so here are some charts that suggest something different. The data from all these charts comes from Trading Economics and is the latest available.


This first chart shows the debt-GDP ratios of a cross-section of countries (left hand axis) vs the interest rates they have to pay to borrow for 10 years (right hand axis). The Debt-GDP ratio remember, is the  total amount the government owes, expressed as a % of GDP. In this chart, apart from a couple of outliers, in particular Japan, the blue line does trend downwards, i.e the lower a country’s debt, the lower the interest rate it has to pay. Lets show this chart again though, but with the Eurozone countries excluded.Debt-GDPb2This time, something weird has happened. Whereas before it seemed like highly indebted countries had to pay high rates on their debt, now the opposite seems to be true. The country with far and away the highest government debt is Japan, but Japan also has the cheapest borrowing costs. And Australia, with the lowest debts, pay the highest rate. What’s different? All the five countries in the second chart have their own currencies, while the first chart contained countries that do not. But maybe it’s the size of the deficit rather than the debt that makes the market get anxious?


This is a similar chart, but this time the bars show each country’s deficit as a % of GDP. The UK is in the middle. If you squint a bit, you might be able to discern a slight negative relationship between the deficit and bond yields, but it’s pretty weak. So there doesn’t seem to be a clear link between deficit size and the rate governments pay to borrow money. All that’s left then is some sort of vague notion that markets don’t look at the numbers but at the intentions and credibility of each government. Does this sound convincing to you? It doesn’t to me.

Let’s just look at the Debt-GDP chart once more, but only including the Eurozone countries.


This time, it does seem that higher debts lead to higher interest rates. Why would this be true for Eurozone countries, but not other wealthy nations? Well, by joining the Euro, these countries gave up their right to set short term interest rates, devalue their currencies or to print money. This means when a crisis hits, these countries are unable to pull the usual policy levers. The bailouts of certain Eurozone countries have seen rates fall (Greek rates were aroung 35% a year ago), but ultimately, there is a real default risk on these nations debts, so yields are priced accordingly.

Nations with their own currencies do not have this inherent risk of default because they can always make any payment due in their own currencies. Ultimately, they can print money if needs be. So what does determine long term interest rates in these countries (the UK included)? Lets look at one more chart.


Here we have the 5 country’s central bank base rates next to the rate they pay on 10 year bonds. They are quite closely correlated. That’s because as Portes points out in his post I link to above:

“…theory suggests that the low level of long-term interest rates in the UK reflects low expected future short-term rates.”

Short term rates are low today, and market actors expect them to be low tomorrow, so long term rates are low. Central banks can manage expectations by pre-announcing their intentions on rates, as Ben Bernanke has done in the US. The markets are also crying out for safe assets, so there is a rush into bonds and away from more risky investments.

So to conclude then, the take-away messages from this post are:

  • The link between high deficits/high debts and high bond yields only applies to countries like those in the Eurozone which do not have full control over their own currencies.
  • The Government’s belief that their economic policies have ensured interest rates stayed low is based on magical thinking. The idea does not stand up to scrutiny.
  • The real reason long term rates are so low is partly because short term rates (set by supposedly independent central banks) are so low, as are expectations about future rates, and partly because the world economy is so depressed and so the markets are looking to invest in safe assets.

Government Debt and Deficits in Charts

The recent exchange on Twitter between Jonathan Portes and Tory Party Deputy Chairman Michael Fabricant suggested something quite worrying. A lot of MPs it seems do not know the difference between the debt and the deficit. If they don’t understand this, how can they come to a view about whether the economic situation warrants the imposition of austerity?

With this in mind I thought I’d do a quick post on debt and deficits to clear up a few misconceptions. To help me I’ll be nicking some charts from the excellent ukpublicspending.co.uk. First the national debt.

This first chart shows public net debt* between 1900 and 2011. This is a scary looking chart. Outstanding debt has seemingly exploded from almost zero in the mid 70s to almost £1 trillion in 2011. You will often hear the national debt discussed in these absolute terms, but obviously this lacks context.

When you hear David Cameron say the Government is “dealing with the debt”, or “paying down the debt”, he doesn’t mean the debt pile will shrink, he’s talking about slowing down the rate of increase, which doesn’t sound quite so impressive. The debt pile will probably keep rising in absolute terms for ever.

A more useful chart though is this one, showing debt as a ratio to GDP. This is quite a famous chart and shows that today’s national debt – despite having increased significantly in recent years – is still well below the levels seen in the past. The chart shows that for the entire period from the end of WWI to the early 60s – more than 40 years – debt as a proportion of GDP was higher than today. After WWII, debt reached almost 250% of GDP – more than two and a half times what it is today. Look how quickly it fell from that peak. How did that happen?

Real GDP Growth

The answer is growth.** From 1948 to 1973, the economy grew almost continuously and at an average of 2.9% per annum. But the governments of the day must also have run balanced budgets or surpluses to “pay down the debt” right? Wrong. Lets now move on and look at the deficit.

In simple terms, a deficit (or surplus) is the difference between what a government collects in taxes, and what it spends. While the national debt is a stock measure of how much money the government owes, the deficit (or surplus) is the amount added to (or subtracted from) the national debt in a given year. So a deficit of £100bn increases the debt by £100bn. The only way to reduce the debt in absolute terms is for the government to run surpluses.

Now you will also often hear that governments should save in the good times and spend in the bad, but have past governments actually done this?


This chart*** is from this IFS report. You can see that of the 55 years between 1946 and 2000, the government ran a surplus in just 11 of those. 8 of those surpluses were 2% or less, while the largest budget deficit over that period was almost 8%. So this idea of balanced budgets over the cycle is a fiction. The average deficit has been around the 2-3% range (also roughly the size of Labour’s deficits prior to the crash). It is true to say though that since the financial crash deficits have been at their highest level since the Second World War. You can see that in this chart from here (the chart serves my purposes, but I don’t recommend the source. The strap-line at the top of the site would be correct without the No- at the front):


In a future post I might talk about whether we should be worried about this, and what conclusions we can draw from  observing the size of the deficit alone, but to re-cap, the take-aways from this post should be:

  • The best way to assess the size of the debt is to look at the net debt/GDP ratio;
  • This ratio was larger than today for almost half of the last century;
  • This ratio is brought down when the economy grows, not by balanced budgets or surpluses
  • In the past, budget deficits have been the norm, while surpluses are relatively rare

* Net debt is the total amount of debt owed by the government to its creditors minus the value of financial assets held by the government. This is the measure generally used when discussing government debt.

** The GDP growth chart data comes from here.

*** The first version of this chart I uploaded copied very poorly, but a reader kindly sent me a much clearer version (h/t @sebschmoller)

Countering myths about the reasons for austerity

The idea for this post came to me while watching Question Time last night and seeing the bizarre sight of Lib Dem Ed Davey and ‘celebrity’ MP Nadine Dorries teaming up to roll out the usual reasons why austerity was and is the only course of action available.

A lot of people on the left seem to concede that the economic crisis did mean that urgent action was required to reduce the deficit, and their policy proposals operate within those parameters. Alternative policies generally include raising taxes on the rich and cracking down on tax avoidance. Some even agree that we should get rid of universal benefits to save money. Every proposal seems to be of the form that “we will cut this or raise taxes on that to pay for this.”

This is a very unsuccessful strategy in my view because it implicitly accepts a lot of the myths that have grown up around how the economy works. These myths are repeated ad nauseum by politicians to the point now that they have almost become received wisdom. Unless the counter argument to austerity is altered to reflect the reality of the way the economy actually works, the deficit hawks will win every time.

I’m going to split this post into two parts. Here’s the first three (of six) common talking points you will have heard from those in favour of austerity and how you can counter them.

1) The UK could end up like Greece

On the face of it, this is a scary thought. Greece had a large deficit and the interest rates on its debts soared to the point where it became – to all intents and purposes – bankrupt. In reality though there is zero prospect of the UK ever becoming like Greece. If someone says there is, the appropriate response is to laugh in their face.

Greece joined a currency union with significantly wealthier nations which led to them using an overvalued (for them) currency over which they had no control leading to them having a massive competitive disadvantage. This led to ever increasing deficits and meant when the financial crisis struck, they were unable to pull any of the policy levers available to countries with their own currency like the UK. They couldn’t devalue, couldn’t change interest rates and most importantly couldn’t issue money. The lack of these tools means the ability of Greece to borrow on international markets very much depends upon the markets assessment of their ability to repay, and so bankruptcy becomes a very real risk.

The mere fact that the UK does issue its own currency, doesn’t borrow in others and its exchange rate floats means it could never end up like Greece.

2) The Coalition inherited the worst deficit in the Western world

Answer: No it didn’t. It inherited the largest deficit*. This is not the same thing at all. A deficit, whether large or small is neither a good or a bad thing. It could be either, but at the end of the day, all the deficit is, is an outcome, and all it tells you is that the non-government sector (the private sector here, plus the trade deficit) is running a surplus. The government’s deficit is the mirror image of the non-government surplus. A graphical representation of this can be found here. To a large extent the government has no control over its budget outcome. It depends upon the saving preferences of the private sector.

The appropriate response for the government to take when faced with excess private sector savings would be to either accommodate them by maintaining an expansionary fiscal stance, or to seek to confiscate some of the surplus through taxation (more difficult). Seeking to reduce the Government’s deficit while the private sector are still paying down debt, simply undermines those efforts and prolongs the slump unnecessarily. This is what we see now.

3) If we hadn’t implemented austerity, the markets would have panicked, interest rates would have gone up.

The underlying assumption here is that markets alone set bond rates based upon their view of the ‘credibility’ of the government’s fiscal stance. To a degree this is true for countries in the Eurozone for the reasons cited at point 1, but for a country like the UK, it’s just nonsense. For a start, countries that issue their own currencies like the UK present no involuntary default risk. Zero.

Secondly, even mainstream economic theory doesn’t say that markets set interest rates in the way politicians want us to believe. Jonathan Portes wrote a very good blog post on this topic in September here. Basically, long term interest rates are thought to be based on expectations about future short term rates. Short term rates are set by the Bank of England, and the Bank can make it clear what their thinking on future rates will be. The markets expect future rates to be low, so long term rates now are low. Nothing to do with the markets having ‘confidence’ in the government’s economic policies. Because markets don’t behave the way politicians suggest, there is no reason to believe alternative fiscal policies would place upward pressure on interest rates.

Part 2 will discuss these further common points we often hear related to austerity:

  • Gordon Brown spent all the money and now there’s none left. Just ask Liam Byrne
  • Cutting x will save £y
  • What would you cut?

*EDIT: A reader has pointed out that the US actually had the largest deficit in 2010, and the UK only the 2nd largest (h/t Richard Evans via Twitter), but my point still stands. Many politicians continue to claim the UK’s deficit was the worst, including Ed Davey on Question Time this week . So another counter argument is that the US had a higher deficit in 2010, but took a different path. It’s deficit has now shrunk from around 11.4% of GDP in 2010, to about 7% last year. The US economy grew by 3.1% in Q3 of 2012. Although the US lost its AAA credit rating, the interest rate of US government debt has remained very low.

The Future Jobs Fund: One of the most ineffective job schemes there’s been?

The Future Jobs Fund (FJF) was an employment subsidy brought in by the last Labour Government at the height of the recession to help tackle youth unemployment. It provided sufficient funds to create 100,000 6 month jobs for long term unemployed 18-24 year olds, paying minimum wage for 25 hours per week.

In September 2009, when the first young people started FJF posts, there were 99,000 18-24 years who had been claiming Job Seeker’s Allowance for over 6 months. When applications for the FJF closed in March 2011, this had fallen to 78,000. Today, 18 months later, there are almost 145,000 18-24 year old long term claimants of Job Seeker’s Allowance (source here). One of the Coalition’s first acts was to scrap the FJF. David Cameron had this to say about the decision:

“The Future Jobs Fund has been one of the most ineffective job schemes there’s been… The really damning evidence is that it’s a six-month programme, but one month after the programme [has finished] half the people that were on it are back on the dole. It failed.”

David Cameron, 17 March 2011

At the point he made that statement, no evaluation had been done on the efficacy of the programme, so there was really no basis for the PM’s pronouncement. To their credit though, the DWP did do an evaluation of the FJF and last week it was published (or sneaked out on a Friday with no press release if you are cynical like me). So now the results are in, was the FJF “one of the most ineffective job schemes there’s been”?

Jonathan Portes has written a very good blog post on the evaluation here, and his organisation NIESR peer-reviewed DWP’s work on this. He writes:

The bottom line is that the impact of the Future Jobs Fund (FJF) on the chances of participants being employed and/or off benefit was substantial, significant and positive. 2 years after starting the progamme (so long after the programme itself had ended, so the participants were back in the open labour market), participants were 11 percentage points more likely to be in unsubsidised employment.  

This is a very large impact for an active labour market programme (considerably larger than that found for New Deal for Young People, for example) suggesting that the programme had a large and lasting impact on participants’ attachment to and ability to succeed in the labour market. 

The FJF  programme is estimated to result in:

  • a net benefit to participants of approximately £4,000 per participant; 
  • a net benefit to employers of approximately £6,850 per participant; 
  • a net cost to the Exchequer of  approximately £3,100 per participant; 
  • and a net benefit to society of approximately £7,750 per participant.

…we know now; the Prime Minister was wrong.”

Not for the first time then, David Cameron has said something, based on no evidence, only to be subsequently proved wrong. So much for evidence-based policy. Contrast this with the Mandatory Work Activity. A similar evaluation concluded that this programme generated no impact on employment. How did the Government respond to this finding? It extended the programme! Ideology trumps facts again.

Back to the FJF. I had some peripheral involvement in the programme in my local area. The majority of the job placements were with local community and voluntary organisations. It was win win. The organisations were able to increase their capacity (very Big Society!), and the individuals were given a chance to try something new and get into the workplace (in some cases for the first time). The key benefit of FJF was that participants were actually in a job – they were being paid. They felt that someone had finally given them a chance after months of rejection. The increase in their self-confidence should not be underestimated, and this seems to be reflected in the evaluation results. After the 6 months were up, participants were much more capable of securing further work than would otherwise have been the case. You cannot replicate this feeling of self-worth with unemployed work experience placements at Poundland.

The FJF has been replaced by the Work Programme and the Youth Contract. The fact that long term youth unemployment has doubled since the FJF was scrapped, suggests these new programmes are not working.

The FJF showed that government can create jobs, and when it does the private sector and wider society benefit. The FJF was quite a modest programme. We could, and should be much more ambitious. The intervention I favour is the MMT Job Guarantee, which I have tried to outline here.