We're All Economists Now

The British/European/global economic downturn/credit crunch/crisis/recession from 2008, and now making an unwelcome return in 2011/12, seems to have piqued many peoples' interest in all things economic.

You don't need to fully understand what exactly a hedge fund does, or what is meant by derivatives or naked short selling (if only it means what it sounds like it means), or that getting a 'haircut' now has another meaning, to want to know more about the economic reality that exists in the UK at the moment.

And for that, a sound grasp of the basics is more important that being an expert of each and every intricate financial term. But, thank you BBC for this very helpful financial glossary, all the same.

Here is an attempt to makes things a little clearer:

The principal narrative of the coalition ConDem government is that they inherited a huge budget deficit; that is the amount by which government spending in a year exceeds its income, in terms of taxes and receipts.

It is also referred to as Public Sector Net Borrowing (PSNB): the total the government has to borrow each year, resulting in it racking up a deficit, measured as a percentage of GDP.

By GDP, we mean the total economic activity of a country, in terms of all the goods and services it produces. It measures the health of the economy.

The deficit taken on by the coalition was worth £156.1bn, 11.1% of GDP (p.24), which was actually around £11bn lower than the £167bn forecast for the end of the financial year 2009/10, by the then Labour Chancellor, Alistair Darling, in his final budget.

It is important to note that this figure excludes the money spent bailing out UK banks (RBS, Lloyds TSB, HBOS) during the 2008 credit crunch - a total which has fluctuated wildly from a commitment to propping them up to the tune of £1.162 trillion back in 2007, to £612.58bn by March 2010, and then down again to £456.33bn at the end of March 2011.

Then there is the UK's government debt, or its Public Sector Net Debt (PSND), which is the total amount of money the government owes. It is worked out as an aggregate figure, and is the accumulation of all the fiscal deficits, all government borrowing, accrued over previous years, and which is still to be paid off.

Thus, each year's deficit gets added to the existing debt.

The present government inherited debt of £759.5bn or 52.7% of GDP, for the end of the 2009/10 financial year, according to Treasury figures (p.95) released in March's 2011 Budget.

So, who exactly does the government owe this debt to?

In short, most of it is owed to us.

Debt can be divided into internal debt, money owed to lenders within the country, borrowed from those in the private sector, such as pension funds, investment trusts, building societies, and external debt, that owed to foreign lenders.

The UK Debt Management Office (DMO) is charged with managing the government's debt through the sale of gilts (risk-free bonds), Treasury bills, and bonds. The latter act as the government's debt security.

The government issues bonds, which are bought up by various bodies in the form of loans (debt investment), which it then has to pay back at a fixed (maturity) date, with interest.

UK government bonds are seen as relatively secure and risk-free investments as buyers know that they will always be repaid.

Pension funds and insurance companies are the biggest owners of government debt, making up almost a third of it.

The biggest increase in debt since 2007 has been caused by the bank bailouts, and the need for quantitative easing (printing money), in order for these financial interventions to have been possible.

And, about a third of debt is external, owed to overseas investors.

In order to make sense of the UK's debt and deficit figures they need to be put into context.

In historical terms, the UK had the largest budget deficit since 1945, and the biggest since the early 1990s. Its current debt stood at the highest levels since the late 1960s. History tells us that the British Empire was in fact built on debt.

However, over the last 100 years, debt levels have been higher before. A lot higher in fact: at 250% of GDP at the end of the 1940s, and over 100% during the 20s and 30s; the result of having to fund two world wars.

And, as one economics commentator points out, the enormous debt built up during the 1940s also coincided with the creation of universal healthcare and the welfare state. Rather than paralyse Britain, this was followed by three decades of strong economic growth.

How does this compare to other countries?

By the end of 2010, the UK had the third highest budget deficit of all the nations in the EU, with only Greece and Ireland worse off.

For the same period, even though the UK had above average levels of debt, it was still less than France and Germany, and came ninth overall within the EU.

It is important to recognise that the EU, and other bodies such as the OECD, an economic think tank of the world's wealthiest states, measure deficit and debt using a different methodology to the government.

For the EU, stats are compiled using methods prescribed by the 1992 "Maastricht Treaty," which advised member states to avoid excessive debt, equivalent to 60% of GDP, or deficit levels exceeding 3% of GDP.

They therefore found UK deficit levels of 11.6% of GDP, and debt worth 71.2% of GDP, for the end of the 2009/10 financial year.

Globally, the Treasury pointed to OECD stats, which in May 2010, estimated that the UK would have the highest deficit of all its members, as well as IMF forecasts predicting that the UK's 2010 borrowing would eclipse all other countries in the G20.

Final figures released by the IMF (p.121) for 2010 found the UK, pipped only by the US, in having the second highest budget deficit of all G7 and G20 nations, with Britain's excess borrowing way above advanced economies and Eurozone averages.

Yet, the IMF also showed that, when it came to government debt, Britain had the lowest levels of all G7 states (p.127), and close to average levels of the countries in the G20.

So, those are all the necessary facts and figures out of the way. Time for the blame game.

This government's main line of attack against Labour is that the latter left the country's finances in a mess.

They have made political capital out of arguing that Labour borrowed and spent too much, and didn't save during the boom years. Now in office, the coalition has committed itself to tackling and then eliminating the deficit as its main priority.

The main charge, that Labour built up an unnecessarily huge deficit, is of course true if you just look at the raw figures but ignore the context.

Labour themselves inherited a small deficit in 1997, and then achieved a budget surplus for the next five years.

But, in November 2002, Gordon Brown, as Chancellor, admitted that Britain would have to borrow to pay for a huge public spending programme, as laid out in the 2000 Spending Review, investing in services that had been chronically underfunded by the Tories, such as the NHS and education.

He was also responding to an economic downturn, caused by world events, such as the global threat from terrorism.

The real spike in the deficit comes in 2008. Borrowing leapt from 2.38% of GDP in 2007/08, to 6.75% in 2008/09, and then peaking at 11.1% in 2009/10 (p.7). Essentially, rising from £33bn to £156bn in the space of just three years.

Whilst the reckless spending charge is easy to level, it deliberately ignores several crucial factors: 2007/08 saw the beginning of a worldwide economic downturn and then recession, the worst since the 1930s, affecting almost all of the world's major economies.

It resulted in the collapse and then enormous bailout of many of the UK's high street banks, crippling the public finances.

The 2009 budget had forecast a growth in revenue. Instead, the government suffered a spectacular loss, with 2009/10 bringing in about £112bn less than they had expected.

The downturn meant higher unemployment, lower tax receipts, and more people in need of state help. A 100,000 increase in unemployment costs the Treasury about £500m, with the reverse happening when the economy is performing strongly.

This therefore required a surge in public borrowing in order to compensate.

Thus, the bulk of the deficit taken on by the coalition came as a result of events beyond Labour's control.

Once in office, the coalition has decided to run roughshod over the economic reality.

For the last 21 months or so they have pursued a series of tough austerity measures: aggressive cuts combined with huge reductions in public spending, believing that this is the only way to eat into the deficit.

This despite the raft of evidence that a weak and fragile economy requires an increase in government spending as the best way to stimulate the economy, especially as, naturally enough, in hard times, people choose to spend less. If nobody's spending, the economy comes to a standstill, or worse.

The last few years has seen a resurgence in support for Keynesian economics: the view, by the English economist, John Maynard Keynes, that fiscal stimulus (more government spending) is essential in a recession. During the Great Depression in the 1930s, he called for governments to invest in infrastructure.

Advocates of this position have consistently warned that cutting the deficit when the economy is weak is dangerously detrimental, and will only serve to harm it further.

As Robert Skidelsky, the acclaimed biographer of Keynes, explained:

"The reason for the slack [in the economy] is that the private sector is not spending enough to employ all those seeking work – whether because investment prospects are too uncertain, or because it is paying off debt. In these circumstances government spending is not at the expense of private spending: it compensates for its absence. If the government were to economise on its own spending at the same time as the private sector was spending less, the result would be a slide into even greater recession. Keynes called this the "paradox of thrift."

Paul Krugman, the celebrated Nobel Prize winning economist, has been cautioning against rapid spending cuts, both in the US and the UK, for years. He has argued that the coalition are ignoring lessons from history with their severe deficit-reduction strategy, and that such a move will fail to stimulate enough real growth:

"Fiscal austerity will depress the economy further...The sensible thing is to devise a plan for putting the nation's fiscal house in order, while waiting until a solid economic recovery is under way before wielding the axe."

"Why is the British government doing this? The real reason has a lot to do with ideology: the Tories are using the deficit as an excuse to downsize the welfare state. But the official rationale is that there is no alternative."

A stagnating US economy with stubbornly high unemployment has led even staunch Republicans to concede that Krugman may actually have a point.

He is also backed by Carmen Reinhart and Ken Rogoff, authors of the universally-praised book, This Time is Different, in which they documented financial crises in over sixty-six countries, over a period spanning 800 years.

Both agree with Krugman that fiscal adjustment is necessary, just not at the moment, or to the extent that it is being implemented.

Rogoff argued that:

"The important thing to do is structural reform. Make us [the US] grow faster. Improve our tax system, build infrastructure, education, view it as a crisis in that way [but]...I certainly don't think slashing budgets...is the way to go about business."

Instead, 21 months on, whilst sticking steadfastly to Plan A, this is the current economic reality facing Britain:

a stalling economy, unemployment the highest in 17 years, with an average of 23 applicants for each job, record numbers of people 'underemployed,' -those working part-time through lack of choice- the longest ever period of wage stagnation, with analysts warning that the Chancellor's 2011 autumn statement will see, between 2009/10 and 2012/13, real median incomes fall by 7.4%, levels not seen since the mid-1970s.

Noting a lack of any meaningful recovery has led to an increasing number of analysts to publicly question the government's chosen path.

One of Britain's leading economic think tanks told George Osborne to rethink the scale of the cuts, urging something more targeted:

"...fiscal policy is too tight, and a modest loosening would improve prospects for output and employment with little or no negative effect on fiscal credibility."

Another called for spending cuts to be aligned to economic growth, and fiscal consolidation to be less severe in a year where growth is forecast to drop below 1.5%. Cuts should be slowed until the economy was stronger and able to absorb them.

And in recent months, murmurings from various international bodies have got louder, with warnings that austerity drives are in fact harming, rather than healing, sick economies.

This month, the leaders of the IMF, World Bank, and WTO, expressed concern at over-aggressive deficit reduction programmes, and issued a joint plea for governments to:

"...manage fiscal consolidation to promote rather than reduce prospects for growth and employment. It should be applied in a socially responsible manner."

Finally, the public are starting to turn on the government, with a recent poll finding 59% of voters backing a slowdown in spending cuts.

The trouble for Labour is that more people blame them for the state of the economy than the coalition's cuts.

In spite of several months of gloomy economic news, and despite the gathering calls for a Plan B, the government seems more determined than ever to press on, with the downturn used as cover for an irreparable and ideological shrinking of the state.

This article was first published in three parts by Left Futures. Part 1 appeared on Monday 30 January 2012, part 2 on Tuesday 31 January 2012, and part 3 on Wednesday 1 February 2012.

This article was also published in two parts by Left Foot Forward. Part 1 appeared on Saturday 4 February 2012, and part 2 on Sunday 5 February 2012.