Cutting Deficits

The British Government is pledged to cut the deficit in its expenditure over income, the worst in peacetime history it says. This is essential, so the narrative goes, to avoid national economic disaster. "We have to borrow £1 in every £4 spent just to keep the lights on," claimed Francis Maude, Tory frontbencher. The Chancellor, George Osborne, warns gravely that Britain is merely a few steps from "the edge of the economic abyss."

So, how bad is the deficit? And are deficits by default bad?

"An Act for granting to theire Majesties severall Rates and Duties upon Tunnage of Shipps and Vessells and upon Beere Ale and other Liquors for secureing certaine Recompenses and Advantages in the said Act mentioned to such Persons as shall voluntarily advance the summe of [£1,500,000] towards the carrying on the Warr against France."

King William and Queen Mary began the national
 debt to pay for their war against France in 1694.
 It has never been redeemed.
With this law of February 1694, the British Government raised its first loan of £1.5 million from the newly founded Bank of England. It was never repaid - in the intervening three centuries, the National Debt has never been paid off. Rather, over time and inflation, it has grown to its present total of around £900 billions - about 60% of the Gross Domestic Product (very roughly, the value of the nation's annual economic activity). Newspaper headlines scream about Britain going broke; debt interest of £42 billion p.a. and the wost deficit in history. It seems we are in truly record breaking times.

Or are we? And how bad would it be if we were?

The national debt is the total accumulated amount owed by the Government. It has been with us for three centuries and it has yet to bankrupt Britain. In that time, the British Empire made the UK the major world superpower for the best part of a century and a half; and as that faded into history, we fought two world wars, founded the Welfare State, developed social housing and set up the National Health Service. And the debt came along with us all the way.

In terms of national wealth as measured by GDP, national debt has been much higher than it currently is for much of its history. Its absolute peak was in 1815 at the end of the Napoleonic Wars when it reached just over 260%. In more recent times, its hit at 238% in 1947, just after the Second World War, but also notably the year before the creation of the National Health Service, which was to transform health care and living standards. In 2011, by current Government estimates, it will stand at just 54%, far from a national bankruptcy-inducing record.

The national debt is sometimes confused with the Government's deficit. This is an annual figure and is the deficit or surplus of spending over income: so the amount spent on all government activities, from defence to welfare, minus the amount raised in all forms of taxation. In the 65 years since the war, governments have achieved surpluses in only 14 years - notably, 10 of them under Labour governments compared to just 4 under the Conservatives. On the whole, the story has been one of deficits - more expenditure than revenue and adding gradually to the overall national debt. Now, in the last three years, the annual deficit has risen sharply from about 4% to nearly 12% of GDP. This is the highest in peacetime history, but should be set in the context of nearly 8% of government spending - some £60 billions - being used to prop up the failed private sector banks.

So carrying a fairly substantial national debt is not necessarily a barrier to wealth creation. Indeed, under the economic theory of Keynesianism, it is often essential to economic success - a proposition ridiculed by many on the right-wing now but for much of the post-war period accepted as economic orthodoxy by all the mainstream parties.

FDR Roosevelt, President 1932 -1945 established the "New Deal"
to put America back to work following the Wall Street
Crash and the Depression. This involved standing
contemporary economics on its head and
investing in public programmes to restart the economy.
It was accompanied by a far more progressive system of tax.
Broadly speaking, John Maynard Keynes developed the theory first put into practice by the US President F D Roosevelt in the Depression Era "New Deal". This contends that, when the "natural" cycle of economic activity slows down or goes into reverse because of lack of demand for goods and services, the most effective way to turn this around is for the government to act as a catalyst by printing or borrowing money to inject into the economy. This can be by means such as tax cuts, but the most powerful approach seems to be investment in public services - while tax cuts can be diverted by individuals into savings, public services mean the money is active in the economy, employing people and driving activity forward. If this goes too far and demand outstrips supply, an inflationary spiral can result if left unchecked, but up to that point it can keep people in work and economies functioning to the benefit of society.

For much of the 1950s and 1960s, the British Government, under both Labour and Conservative Cabinets, adopted a Keynesian policy of fine-tuning the economy - managing the money supply to keep unemployment low but also to put the brakes on when inflationary pressures began to show. Nicknamed "Butskellism" after the Chancellors Rab Butler, a Conservative, and Labour's Hugh Gaitskell, this cross-party consensus generally held until the 1970s when the tripling of crude oil prices following the Yom Kippur Arab-Israeli war led to a new phenomenon of "stagflation" - simultaneous high unemployment and high inflation.

In this climate, the minority Labour Government of Jim Callaghan floundered amidst political and economic problems unprecedented since the 1930s. A loan package from the International Monetary Fund led to the abandonment of Keynesianism by Labour, albeit foisted on them by the banking community, and was grist to the mill for the emerging monetarists in the Conservative Party. With their guru the right-wing maverick Keith Joseph, the monetarists followed the school of thought advocated by Milton Friedman, a US economist, that held that state intervention in the economy was ideologically unwelcome. Instead, Governments should minimise tax, restrict the money supply to avoid inflation and leave the rest to the "free market" which would, in the long run at any rate, find an equilibrium where sufficient goods and services would be provided to satisfy demand.
Milton Friedman (right) developed the monetarist doctrine of minimising
government involvement in the economy, regardless of the social costs.

This justification was used by the incoming Conservatives in 1979 under Margaret Thatcher (and in 1980 in the USA, the Republicans under Ronald Reagan) to slash public spending and be content to countenance mass unemployment on a scale unknown for 50 years as an acceptable tonic to cure inflation and set the scene for economic recovery of a minimally managed, free market. National debt was reduced - down to 25% by 1992 - though at a high social cost. Unemployment remained stuck above 3 million for nearly two decades while inequality in incomes among those in work rose sharply. Where new jobs were created in the private sector, these were frequently part-time, temporary and low paid. But from the monetarists point of view, low inflation and low debt was an ideological triumph. As the Soviet block collapsed, neoliberals proclaimed the final victory of market capitalism over socialism. Fukayama famously declared "the end of history". A new economic orthodoxy was cemented in place.

By the time he defeated the exhausted Tory Government of John Major, Tony Blair had "modernised" New Labour and largely adopted the norm of tight money. His then-ally Gordon Brown's nomenclature of "Iron Chancellor" was an echo of Thatcher's "Iron Lady". Throughout the first decade of Labour's rule, tight money was largely adhered to and, as noted earlier, for four years (1998 to 2002) Brown  generated a surplus in government spending, repaying significant amounts of national debt for the first time in over 30 years.

But the domino effect of the collapse of bank after bank, nationally and internationally, and the need to intervene to protect depositors, saw the massive rise in Government borrowing to guarantee the viability of the financial sector. In addition, as confidence in the economy wavered, Labour undertook a death-bed return to Keynesianism with "quantitative easing" -borrowing to spend on public projects and also providing a modest increase in consumer spending by a temporary 2.5% reduction in Value Added Tax. As a result, although unemployment increased, Britain was spared the worst of the recession. By early 2010, although the annual deficit had risen to 12% of GDP (or £155 billions) in the current year, it was starting to reduce and the worst seemed to be over.

Yet in May 2010, as noted above, a new Conservative-led government came to office, helped in no small way by Labour continuing to espouse essentially monetarist values "but just not yet". The media happily willed this on, eagerly embracing Tory propaganda as fact and talking as if the national debt had suddenly been created from nothing in the last 30 months or so. Hence, so far at any rate, the opinion polls show a very high consensus that massive cuts in public spending are unavoidable. Terrified by figures of hundreds of billions of pounds of debt and references to record deficits, the consensus is that the deficit must be slashed and quickly, and state assets such as the post office and national forests should be sold off.

However, the real worry now should be of a "double-dip" recession - as demand is sucked out of the economy by the Coalition's cuts, undoing Labour's previous reflationary efforts, a new recession may be triggered. From a monetarist perspective, this is essential and even welcome - national debt has risen, doubling over the last three years to slightly under 60% of GDP. Like the 1980s, high unemployment and the impoverishment of people on benefits are prices worth paying for a reduced debt.

The huge spending cuts announced in the Comprehensive Spending Review - £82 billions over 4 years - will superficially reduce the deficit, though forecasts vary as to by how much. The Government's own estimates will mean a continuing annual deficit of £20 billions by 2015, while some forecasters think it will be as high as £70 billions - a little under half its current level.

However, by adding as many as a million people to the dole, it will also reduce Government tax revenue and increase social security costs. So consequently there is a very high potential for creation of a downwards spiral, an ever-decreasing circle of lower levels of economic activity alongside a persisting (or even increasing) deficit. The private sector, stymied by the consequent reduction in consumer spending, will be unable to provide new jobs or create economic activity by itself, even if it manages to squeeze down its costs by paying lower wages - a further blow to recovery as people have even less to spend.

So this Government is not embarked on a crusade to rescue Britain from economic oblivion. Rather it is set on an ideological mission to reduce the size of the State, paving the way in time for tax cuts for the rich and an ever more big profiteer-friendly environment. If millions of people, families, small businesses and local economies have to suffer in the meantime, so be it.

If this seems far-fetched, you only have to look at the track record of the monetarists' poster boy, Milton Friedman, to see that it is in fact grim reality. And also to see the fundamental inhumanity that drives the people who advocate this approach.

In 1973, backed by the CIA, General Augusto Pinochet overthrew the elected socialist government of Chile, killing President Allende. Pinochet invited Friedman and his appropriately named "Chicago Boys" to come and restructure the economy to the benefit of his rich backers. Over the next decade, Chile became an early, brutal laboratory for monetarist experimentation. Some of the best health, education and welfare systems in the Americas at that time were shut down to permit taxes to be reduced. Again and again, Friedman urged the willing Dictator to cut more and more, sparing only the armed forces (no surprise there!). Financial institutions were deregulated, exposing small investors and savers to the reckless gambling that would later on become features of our own financial system. Wages were driven relentlessly down. And, of course, the rich grew richer - much richer.

Salvador Allende (centre), the elected President, flees as
the Chilean army begins its CIA-sponsored coup in 1973.
Within hours of this photograph being taken,
he was dead - by his own hands or others is not certain.
But Chilean unemployment rocketed by 1000% over ten years. Shanty towns emerged for the first time in decades and major industries closed as the deflationary spiral spun ever faster. In a totally deregulated environment, corruption became rife - so much so that by 1982 even Pinochet had had enough and sacked Friedman and his gang. No worry for Milton though, as by then much bigger fish in the form of Britain and the ultimate prize of the USA had adopted his values.

Keynesianism by contrast embraces a very different set of ethics. By this thinking, the economy is a servant of society, rather than the other way round. Intervention and manipulation of markets in order to protect and advance social goals are a given - and why ever not? Humans should value themselves and their brothers and sisters, not submit themselves as willing slaves to some economic theory which embraces private profit as its objective rather than human or environmental well being.

Of course, Keynesianism is not perfect - too much stimulus can create inflationary cycles that start to feed themselves upwards and corrective action can take time to kick in. Likewise, growth in itself is not a panacea - it needs to be sustainable and directed, and possibly even pitched towards a "steady state" where the emphasis is on fair distribution rather than endlessly increasing consumption. But ultimately isn't this approach preferable to waiting for the market to correct itself, with no reference to genuine human needs or planetary stewardship? And as we face a world of rapidly diminishing resources and environmental degradation, surely only the deluded can think that it is in any way safe let alone workable to do anything but seek Government intervention in the economy?

Monetarists will of course claim that it is the Keynesians who are deluded. They will deploy arguments from State-led economies being dreadfully inefficient through to characterising the most modest social protection as the class war weapons of choice of foaming Marxists. Better to leave the economy to business, which will ultimately produce the "fittest" profit-generating winners. They will miraculously create a virtuous circle of prosperity, offering employment and trickling down their wealth on the basis of real, hard earned cash.
Free market economics: anything (and everything) goes.

This is correct after a fashion - the market moves in cycles and does eventually find equilibrium after each disruption. Jobs will ultimately be created, albeit often insecure or low paid. Yet at what cost?

If Chile was the monetarists' laboratory, Britain in 1980 - 1985 was the global pilot. But the rape and pillage of eastern Europe by venture capitalists and mafiosi following the Soviet collapse was its apotheosis. There it was responsible for levelling national economies to the ground, auctioning off state assets and re-building their crushed societies on a basis of authoritarian regimes, rampant corruption and an elitism worthy of the old Czarist Empire.

Is this what we want for our futures? Is this what we want for our societies? For our neighbours - or ourselves?

The monetarist will argue that it is best to suffer in the short to medium term for long term gain. Yet all the evidence is that such gains are limited, unequally distributed and ultimately elusive - our current crisis, the culmination of years of "tight money" is proof enough of this.

But even if it could somehow be shown to work out in the end, as Keynes said, reflecting on the devastation of human lives by the Depression and the global conflict that was its bastard child, "The long run is a misleading guide to current affairs. In the long run, we are all dead."
John Maynard Keynes (1883 to 1946).