The 5 myths about the UK economy which it suits everyone to perpetuate

by Stephen Tall on June 18, 2012

The economy is the big issue: it was at the last general election, it has dominated and will dominate this parliament, and it will be the big issue at the 2015 general election. Yet trying to get behind the political rhetoric to discover the economic reality is surprisingly tricky. The purpose of this post is to look at what I see as the top five myths currently being perpetuated about the economy, and to explain why I think our current debate is misleading the public and diverting us from finding proper answers.

Myth 1: UK public spending is reducing

So keen has been the Coalition and Labour (for their own different reasons) to talk up the extent of the Government’s spending cuts that the reality has been forgotten. Public spending is going up year-on-year under the Coalition, rising from £690bn in 2010-11 to £744bn (+8%) by 2014-15. If we allow for inflation, there will be a modest reduction: from £690bn to £668bn (-3%) by 2014-15.

That figure of £668bn public spending in the final year of this parliament will be higher than in every single year of the last Labour Government’s 13 years in office, bar its final one. Indeed, Coalition spending in 2014-15 would be higher even than that final Labour year (2009-10) if it were not for the increased cost in servicing the national debt.


(Graph from Burning our Money blog; data from Tullett Prebon economic and fiscal database.)

Myth 2: The Coalition is bringing UK debt down

Not surprisingly, given 1) the economy isn’t currently growing and any recovery is forecast to be weak, and 2) the Government is continuing to maintain historically near-record levels of public spending, the national debt is forecast to continue rising throughout the lifetime of this Parliament. Yet politicians, including Nick Clegg as well as the media, persist in confusing the different concepts of deficit (at its simplest, the excess gap between what we earn and what we spend as a nation in a year) and debt (the accumulation over years of all our borrowing).

So, for the record, here are the public debt figures for the UK. The UK’s debt is increasing throughout this Parliament on the following three measures:

  • Nominal figures: from £903bn (2010-11) to £1,251bn (2014-15);
  • As %-age of GDP: from 61% (2010-11) to 69% (2014-15);
  • At 2010-11 values: from £903bn (2010-11) to £1,125bn (2014-15).


(Graph from The Spectator; data from Tullett Prebon economic and fiscal database.

Myth 3: Ed Balls’ ‘too far, too fast’ claim has been justified

The present dire state of the UK economy has led many to argue that Ed Balls’ repeated warnings, originally delivered in his Bloomberg speech in August 2010, that the Coalition Government is cutting ‘too far, too fast, have been justified. As we’ve seen, however, the reality is somewhat different: public spending in real terms does not even start to reduce until next year (2012-13), and even then it shrinks by just 1% of GDP.

It is true, though, that Labour’s publicly declared plans for the deficit at the 2010 general election were more modest in scope than those adopted by the Coalition. It is quite another question whether they would have stuck to them: after all, it was Labour’s Alistair Darling who warned of ‘cuts deeper than Thatcher’, and Liam Byrne who admitted there was no money left. But let us assume Labour would have done what they said they would: what then would have been the result for the British economy?

This is a counter-factual question which has been assessed by the Ernst&Young ITEM team using a model identical to the Treasury’s to work out the macroeconomic impact of sticking to Labour’s fiscal plans between 2010 and 2012.

The results? Well, under the most likely scenario of Labour’s looser fiscal policy (identified in the graph below as Labour 2), economic growth would have been fractionally lower (2.0%) than under the Coalition (2.1%) in 2010, identical in 2011 (0.7%) and slightly higher in 2012 (0.7% cf 0.4%):


(Graph from Centre for Policy Studies; data from Ernst&Young ITEM club.)

Overall, the marginally higher growth of Labour’s looser fiscal policy would have resulted in 70,000 fewer unemployed. However, that reduction would have been obtained with an increase in debt across the three years of £26 billion — the equivalent of £370,000 per job — to be repaid by the nation later.

In any case, Labour’s ‘too far, too fast’ mantra is built on sand. The reality is the Coalition has so slowed down its original deficit reduction programme that it is now less stringent than Alistair Darling’s. Yes, that’s right — the Coalition’s fiscal plans under David Cameron are looser than Labour’s fiscal plans were under Gordon Brown:


(Graph from The Spectator.)

Myth 4: Obama’s approach is the reverse of the Coalition’s

Trying directly to compare and contrast two different economies such as the UK’s and US’s is tricky. Nonetheless, many, especially on the left, have pointed to Obama’s policies — and the relative success of the US economic recovery — as evidence that the Coalition’s supposedly more extreme austerity policies are therefore flawed.

Yet it’s hard to square this direct comparison with reality. In fact, Obama cut federal spending by 0.9 per cent in real terms from 2010/11 to 2011/12, identical to the UK’s average real term cuts across this parliament. And, as this graph shows, the US deficit reduction plan is forecast to be ‘faster and almost as far’ as the UK’s:


(Graph from The Spectator; no live web-link.)

Fiscally, then, there is more similarity between the US approach and the UK’s. If you want to look for an Obama comparison that holds, you’d be better placed looking at the similarities between his taxation policies and those of the Lib Dems.

Myth 5: There’s an easy, immediate solution to all this

There is something rather ‘Alice in Wonderland’ about the current UK economic debate. The Coalition argues that it is taking historically tough action to bring down the deficit and curb the national debt. The evidence just does not support this assertion. Labour meanwhile asserts that it is the Coalition’s fiscal toughness which has driven the UK back into recession, even though the differences between the Coalition’s approach and Labour’s are minimal.

In short, it suits both sides in this argument to pretend that the dividing lines between their two economic approaches are wider than they are: it maintains the pretence that the electorate faces a great ideological choice between the Coalition and Labour. This illusion is promoted by a media which is also much happier to portray imagined conflict than it is to present the messy reality.

The closer reality is that neither the Coalition nor Labour is at all sure how to respond to the current economic slowdown. The growth of the Blair/Brown years was driven by a massive expansion of personal and government debt, as Tim Morgan has noted here in his pamphlet The Quest for Change and Renewal:

Between 2000 and 2009, the big drivers of the economy were private borrowing and public spending. Reflecting this, the CREF (construction, real estate and finance) sectors expanded rapidly on the back of private borrowing while big increases in real public spending drove up output from HEPA (health, education and public administration) … the rapid growth between 2000 and 2009 in both CREF (+42%) and HEPA (+28%) masked a languishing in the rest of the economy (–5%), with real output from manufacturing plunging by 26%.

These differential rates of growth left a huge proportion of the economy incapable of growth. In 2009, the public spending driven HEPA sector accounted for 19% of all economic output, whilst borrowing-dependent CREF activities represented a further 40%. Add in a retail sector beleaguered by the squeeze on real disposable incomes and almost 70% of the economy is incapable of growth. Thus seen, Britain’s growth prospects are grim, because a huge proportion of the economy is skewed towards, and dependent upon, the dead-and-buried drivers of private borrowing and public spending. And growth is critical to the Coalition’s fiscal plan, because that plan cannot work unless revenues increase in response to a brisk expansion in output.

The usual attempts at an economic fix have failed, as consumers, companies and government de-leverage after a decade or more of maxing out their debt. The Government (both Coalition and then Labour) has tried to boost private spending by keeping interest rates at close to zero, while the Government (both Coalition and then Labour) has injected huge sums of public money into the economy — some £825bn through a combination of deficit spending and quantitative easing. So far none of this has worked, though it may of course have prevented the situation from becoming even worse.

Conclusion

The first step toward a diagnosis is to acknowledge the extent of the problem. Yet that isn’t currently happening in our debates on the economy. Political debate instead turns on the minute differences which separate the Coalition’s and Labour’s remarkably similar economic approach.

It suits the political parties, and it suits the media. But as a result myths are taking hold — that the Coalition is embarking on ‘slash and burn’ austerity, or that the national debt is being wiped clear — which distort the reality of the situation. And this only makes it harder to begin grappling with our problems.

* Stephen Tall is Co-Editor of Liberal Democrat Voice, a Research Associate for the liberal CentreForum think-tank, and also writes at his own site, The Collected Stephen Tall.