"We’ve now cut the deficit not by a quarter, but by a third."
This might surprising to anybody who read my earlier blog here, which pointed out that the deficit had (measured on a rolling twelve- month basis) been rising, not falling, for the last year or so. Nor does it chime very well with the statement made by Robert Chote yesterday, Chair of the independent Office of Budget Responsibility, who stated that deficit reduction "appears to have stalled". How to reconcile these figures?
The problem, as Chris Giles has observed, is that the deficit figures reported by the Treasury have now become so distorted by a variety of special factors and accounting gimmicks - from the Royal Mail Pension Fund transfer, to the winding up of the Special Liquidity Scheme, to the interest payments on the gilts the Bank of England has bought - that it's almost impossible to make sense of them. The best way to do this is to look at this chart from Mr Chote, which excludes the most egregious of these distortions:
This shows, that as a percentage of GDP, the deficit has indeed fallen by about a third; the Chancellor is correct. But the interesting thing is when and how that has happened, and what happens now. As I noted earlier, most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened - between 2009-10 and 2011-12.
But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what's happened since - with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat. As the OBR says:
"we forecast underlying deficits very close to £120 billion in 2011-12, 2012-13 and 2013-14".
After that, assuming that reasonably healthy economic growth returns, as both we and the OBR do indeed forecast, deficit reduction resumes, although this to a large extent depends on what Paul Krugman in the US context describes as "magic asterisks" (that is, future spending reductions that are simply assumed in advance of actually having policies to deliver them). One thing we can be reasonably certain of is that the Budget itself will do little or nothing to boost growth; the OBR has gone through all the significant policy measures in the Budget (Box 3.1) and concluded that while some will have very small positive impacts, and others equally small negative impacts, the overall impact is negligible. That's not to say we won't get a proper, sustainable recovery at some point; the UK's underlying economic strengths remain, as the current health of the labour market illustrates. But it won't be thanks to macroeconomic policy.
Finally, while it is of no economic significance, it is also worth noting that the deficit is projected to fall in cash terms this year and next. Indeed, the OBR projects that it will fall from £121 billion last year to £120.9 billion next. This seemed somewhat suspicious to many, and it has now been widely observed that the explanation lies in paras 4.118 of the OBR's Economic and Financial Outlook, which notes that
"Our overall forecast of under-spending has a number of elements....[including] payments (for example to some international institutions) that were due to be made late in the current financial year, but which are being delayed into 2013-14. In the last of these cases, departments have assumed that these payments will be accrued to 2013-14 rather than 2012-13, although we see some risk that this may not always be the case and some could be accrued to the original date."
Anthony Reuben for the BBC translated this into: "The cheque is in the post". As Paul Johnson, Director of the IFS, put it:
"There is every indication that the numbers have been carefully managed with a close eye on the headline borrowing figures for. It is unlikely that this has led either to an economically optimal allocation of spending across years or to a good use of time by officials and ministers."
Much of that remains valid, but not all. I would now suggest:"We've reduced the deficit by a quarter, in line with the plans we inherited, despite the fact that the misguided policies we and others implemented have made deficit reduction much more difficult. We've done this mostly by massive cuts to public investment, despite the fact that the economic circumstances are more conducive to public investment than at any time in living memory. On the bright side, however, we've learned that during a period of prolonged weak or zero growth, with businesses and households seeking to raise saving and lower investment, it is possible to continue to finance very large deficits at very low interest rates. "
"We reduced the deficit by a third in our first two years in government, mostly by massive cuts to public investment, which we now realise were a big mistake and have damaged the economy. We're trying belatedly to correct this. We've also now realised that trying to reduce the deficit further while the economy isn't growing is self-defeating, so we're not even going to try to get back on track until it does grow. Meanwhile, since we have no actual growth strategy, and we need to be able to say that the deficit is still falling, we've adopted the proven and time-honoured strategy of putting off paying the bills."