“The government has cut it’s borrowing by 11 billion pounds!” the BBC news presenter proudly announced.
I was so incensed by this comment that I heard on BBC radio last week that I had to write this blog to correct it. So forgive me for not talking about the 80mm of rain we have had since the drought was announced (!), or show you pictures of our new post basher at work or even show you pictures of some of the winery equipment we have been looking at. Instead I thought I’d give a little lesson in government accounts and explain what George Osbourne means by cutting the deficit.
The other reason is that I was shocked when I recently went into my eldest son’s old school to address the lower sixth and asked them this question, “how many of you believe that when George Osbourne says ‘we are cutting the deficit’ we are reducing the amount of debt?” Nearly half the hands went up, so here goes.
The fact is that we haven’t cut our borrowing by £11bn. We actually had to borrow a further £126 billion in the financial year 2011/12, which is £11billion less than we had to borrow in same period in 2010/11. So the government has reduced the deficit, which is the difference between what the government spends and what they raise in taxes to cover that spending but they still had to borrow a huge amount of money to cover that shortfall or deficit (see the chart below).
Last year, total government spending actually grew by more that £20 billion to £703 billion, against revenues of about £580 billion, and the forecast is that government spending will rise by a further £20bn, every year, for the next three years. However, the hope is that revenues will grow at a faster pace so our deficit will fall.
So government borrowing has not fallen but risen to over £1022 billion, which is the equivalent of 66% of Gross Domestic Product (GDP) or the total size of the UK economy. GDP gives a measure for how we, in the UK, can repay that debt. When you go to get a mortgage you can normally borrow about four times your income. When you look at a whole economy a Debt to GDP level of more than 60% has historically been seen as risky, but that depends on various factors including: The state of the economy – is it growing or contracting? Do we the consumers save a lot of our earnings? What rate of interest we pay on that debt?
The last of these is the most important factor and the most difficult to predict. Interest rates are set by the lender and in the case of a government that is the international money markets. If those lenders see greater risk to lending more money to the UK because they can’t see a coherent strategy to bring down the deficit whilst maintaining the economy, then they might demand a higher rate of interest on government debt to compensate for the risk that they may not get paid back on time. If the interest rate that the government pays rises then mortgage rates will rise and that can set off a vicious cycle, where higher mortgage rates may slow the economy and force house prices down. So we end up with lower tax revenues, so more debt will be needed to cover the short fall between government spending and revenue i.e. the deficit.
So it’s a confidence game. Showing the international money markets that you can and are aiming to reduce your debt but at the same time maintaining spending and government services. It’s like negotiating with the bank manager for an overdraft.
Don’t be fooled by those who say we can spend our way out of this. We are already spending way beyond our means. Government expenditure has more than doubled over the last twelve years from £338bn to £703bn and will rise further. We have to tackle the deficit before we lose the confidence of our lenders and interest rates rise as they have done in Greece, Ireland, Portugal, Italy and more recently Spain.
So don’t panic, keep calm and carry on…
We are busy putting in our trellising posts, I’ll post some pictures soon. I’m off to write up a project for Plumpton College.