Here in the UK, there has been a flutter in political dovecotes over the Treasury’s announcement yesterday, that the public finances had posted a surplus in January. That the deficit is falling. Now some readers might feel that this contradicts my (or our – PRIME economics) frequent assertion that cuts in public spending will likely increase the deficit….Why should the deficit be falling, if cuts are being enforced?
The answer lies, in part, in the difference between stocks and flows …The Tory government prefers to focus on flows – the deficit – implying that the deficit is the be-all and end-all of economic policy. But the deficit is just a flow, not the stock of debt, and for the public finances the stock is what is ultimately important. To reduce the stock, government has to cut the outflow of e.g. unemployment benefits, and increase the income of e.g. tax revenues, derived from sound economic activity…..
Yesterday’s announcement reminded me of a question that arose at an excellent seminar with the London Feminist Network last Saturday, when someone told the story of a radio phone-in programme during which the public were invited to question a government minister on ‘the deficit’. A member of the public rang in and cited our by-now famous chart of the UK’s public debt levels, which I will paste in below. This shows that in 1946 UK public debt hit about 250% of GDP, whereas today it is only 57.6% of GDP.
The Minister dismissed the comparison – arguing they were quite different numbers. I’d take a bet he uttered some cliché, like “comparing apples and pears…”
In 1946 the Labour government reacted to this war-induced level of debt, not by cutting expenditure as Right are doing, but by spending. Labour built the NHS, public housing, public schools and other important infrastructure, at a time of exceptionally high public indebtedness. The result? Government debt steadily but surely fell – until reaching a very low level of 20% of GDP in the 1950s. Why? Because government finances recover, ONLY when the economy recovers – and not before. And the economy recovered then, because the Labour government gave the private sector a kick-start – by spending on valuable, productive public infrastructure (as opposed to unproductive, even if necessary, bank bail-outs!).
So when our heroic radio listener phoned in to remind the Tory government minister of our chart, and these facts, the Minister tritely responded that there was a difference between the Government deficit and Government debt-to-GDP numbers cited by the caller. The caller, nonplussed was, it appears, thereby dismissed.
Of course there is a difference between the deficit and total debt. It’s the difference between flows and stocks. And while I am loathe to draw a comparison between your circumstances and the government’s, it may help to argue this: the difference between the deficit and the government’s debt, is the difference between say, your overdraft at the bank and your mortgage.
The overdraft is a flow, and your mortgage a stock.
Your rising overdraft reflects an outflow of cash. Your falling overdraft reflects an inflow. But while the monthly rise and fall of your overdraft/income is important to the monthly payments on e.g. your mortgage – that mortgage, is, say a £300,000 stock of debt that nevertheless hangs over your head…like the sword of Damocles. (“The value of the sword is not that it falls, but rather, that it hangs.”) Often the monthly payments or flows, which are very important, do little to reduce the stock.
It is important to keep the flows flowing, and in the case of an individual to increase income and cut spending. (Government’s finances are different from yours: for one thing, government has recourse to the multiplier and to QE. You don’t.) However, if you were to focus entirely on the flows – and dismiss the mortgage as unimportant – you would be in trouble.
And if you were a government minister and did not understand the difference – you would be in BIG trouble.
Yesterday’s monthly account of the government’s inflows and outflows, reveal that there was a large inflow of tax revenues because people like yours truly submitted self-assessment tax returns, and companies corporation and capital gains returns – and paid up. And of course, government and more importantly, local government are cutting spending like there’s no tomorrow…..So the deficit gap narrowed.
But flows do not a stock make. And the stock is what matters – to bond markets in particular. Keep watching the public debt space, and don’t be distracted by monthly deficit numbers.