This is the start of a simple FAQ guide to the current economic debate for people who want simple answers and stats on what is going on and why it is wrong.
I appreciate a lot of people are starting from scratch on economic issues but are still interested in the ongoing debates. So I’ve tried to be simple and straightforward, with links that explain more.
This is just a starting point: I hope to expand this and add more information (feel free to write suggestions below). Parts of this will also be used for a new website some of us are building, to defend public services.
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What is the Deficit?
The deficit is the difference between government income and spending in a financial year. In the financial year 2009/10, the UK government had to borrow £159.8 billion to cover the shortfall, which was equivalent to 11.4% of our Gross Domestic Product (GDP: the size of the economy). That figure is the deficit.
How is that different to Debt?
Government debt is the total amount of money the government owes to lenders. Most countries around the world have debt, and this is considered fine as long as the debt ratio (to GDP) is at a manageable level. At the end of March 2010, government debt stood at £1000.4 billion, equivalent to 71.3% of GDP. The deficit contributes to overall government debt.
As you can see from the graph below, UK deficit and debt was very manageable before the recession that started in 2008. Then it took off.
Why did the deficit suddenly explode?
Some parts of government spending is difficult to control because ‘automatic stabilisers’ (e.g. welfare benefits) kick in automatically when people become unemployed. As a result, governments usually run deficits during a recession because tax revenue falls and its spending rises.
After the crash, tax revenues plummeted and unemployment rose faster than expected. As a result the deficit ballooned. The Labour government decided that it had to temporarily maintain spending in order to keep the economy afloat. Cutting spending when the economy was in the deepest post-war recession could make the recession even worse.
But as the financial crisis wore on, the deficit became a problem because tax revenues still have not recovered.
Do we need to reduce the deficit?
In short, yes. We are not in dire financial straits but we need to bring it down to a manageable level. Our national debt is also lower compared to other developed countries.
But isn’t the situation dire??
No. The debt, as a percentage of our national income (GDP) is at a historic low. Both indicators are within limits we can manage for now without bankrupting the economy. But tackling the budget deficit is more of a medium term priority than the national debt.
This graph shows that debt (as a % of GDP) was much higher in earlier decades.
This article explains that interest payments on our debt (as a % of GDP) were higher during Thatcher years.
How we do reduce the deficit?
There are two main ways of reducing the deficit: cutting spending and increasing tax revenues. Cutting spending does not necessarily reduce the deficit and can actually make it worse! More on this below.
A government can otherwise seek to increase tax revenues. This can be done by raising taxes or stimulating economic growth, or both. Economic growth can be stimulated through temporary spending, reducing interest rates (makes it cheaper for companies to borrow and invest), devaluing the currency (usually leads to more exports of goods) and cutting taxes on consumption (to stimulate more consumption spending).
Why are Coalition cuts so bad?
The Coalition is planning a ration of 80:20 – 80% cuts to 20% tax rises, over four years, to plug the deficit by 2014.
If you cut spending that drastically (as the Coalition is proposing to do) then it can lead to a rise in unemployment and a fall in consumer spending. A rise in unemployment would mean more spending as benefits are paid out, while a fall in spending depresses the economy even more. Furthermore, a drastic fall in government spending leads to knock-on effects in the private sector because many private companies also rely on the public sector or are dependent on consumer spending.
This is what happened in the 1930s – the last time the government tried to cut spending so drastically.
Do we need to reduce the debt?
We need to eventually bring debt back to less than 60% of GDP. That is the limit the EU applies to member countries and is considered a safe limit. But it’s worth noting that other countries have much higher debt ratios.
Is there evidence the cut are making things worse?
Yes, lots. These are just from the last few months:
- Warning that up to 50,000 firms could go bust as a result of cuts.
- Pessimism about future ‘highest on record’ (will lead to lower spending)
- Osborne’s cuts causing ‘double dip’ in housing
- Employers say cuts ‘arriving at wrong time’
- IMF admits: West stuck in ‘near depression’
- IMF fears government cuts will damage growth
- Budget cuts depress confidence in housing
- ‘Toughest economic environment for 30yrs’
- Boris says Ed Balls could be right on economy!
- Figures show markets don’t reward big cuts
- New report predicts more job losses
So why are the cuts taking place?
The cuts are ideologically driven. The government wants to permanently reduce the level of public services: from the NHS and public transport to spending on developing alternative energy sources, housing an education.