This year’s deficit gets added to all of the previous years’ deficits, which accumulate into an ever-expanding mountain of debt.
As the debt piles up, so too does the interest that has to be paid.
In 2012/13 the UK government’s net borrowing was £119,400 million. In the same year it paid interest of £48,230 million on the accumulated national debt. So more than 40% of the money that the government borrowed was used to pay interest on money that had already been borrowed.
More interest means less money is available to spend on public services.
In 2008/09 interest payments were 5.1% of government expenditure. In 2012/13 that had risen to 7.2%. Analysts at Deloitte are predicting that interest payments will amount to 50% of government spending in 2044 if the trend continues. This is clearly unsustainable and explains why finance ministers are so troubled by their deficits.
There are two opposing views as to how we can solve the deficit problem.
The fashionable solution is austerity: cut government spending until it matches tax revenue.
For that last three and half years the UK government has been slicing what it regards as slabs of fat off the underbelly of public services. Over the first three years the average annual deficit has been around £110,000 million and is forecast to come in at around £100,000 million this year. This is approximately 15% of total government spending and, given that the “easy” cuts have already been made, the idea that the deficit can be eliminated through the policy of austerity isn’t very plausible.
The reasons for austerity’s failure aren’t hard to work out. Less government spending means less money cycling through the economy. If the missing money isn’t replaced by private sector cashflow (investment and borrowing) there will be less economic activity, which means less tax revenue and more people being forced to claim welfare benefits, which increases government spending.
Austerity clearly doesn’t work while the economy is flickering in and out of recession. It might give the impression of success if the economy ever manages to boom again, but as soon as the bust catches up with us (as it surely will) deficits will reappear and we’ll be back where we started. The fashionable solution is no solution at all.
The unfashionable solution to the deficit problem is stimulus: increasing government spending on things that promote economic activity (e.g. infrastructure, education, research), which will generate enough tax revenue to close the fiscal gap.
The theory behind this idea is that every pound spent by government is a catalyst for several pounds of additional economic activity. There is good evidence that this “multiplier effect” is real but none at all that it will ever generate enough tax revenue to permanently eliminate the deficit.
The extra borrowing that’s required to fund the stimulus makes the deficit bigger long before you might hope to see any increase in tax revenue. It’s a bit like digging a hole to fill a hole in the hopes that the second hole will be smaller than the first one.
As with austerity, when the boom comes along it looks like the stimulus strategy is a success but then comes the bust. The extra tax revenue dries up, welfare claims grow, and we’re soon back in deficit.
As with so much in economics, the debate between austerity and stimulus is futile. Neither strategy works during a recession, which means both are useless. In fact they’re worse than useless because they distract us from considering ideas that might actually work.
Fiscal deficits, and the interest that’s payable on the accumulated debt, are symptoms of a cashflow problem. The cyclical flow of money between the private sector and government isn’t enough to pay for everything that we ask government to do for us. Reducing demand to fit the flow doesn’t work in a recession (at least). Neither does trying to increase the flow to meet the demand.
So instead of pretending that twiddling a valve here and fixing a leak there is going to have any significant effect on the deficit problem, why don’t we redesign the system so that money flows where we need it, when we need it?
For an economy to work money has to be available and mobile. For businesses to thrive their customers must have money to spend. For communities to thrive they must have infrastructure and services, which means government must have money to spend. Spending is money on the move. It’s all about cashflow.
Our financial plumbing system encourages linear flows of money, from creation by banks (as debt) to accumulation by everyone who’s lucky enough to capture more than they need to spend. The money might take a couple of turns around the productive economy on the way to the virtual storage tanks where we stash our financial wealth, but the general trajectory is in a line from A to B.
The linear design of the system makes debt unavoidable. Every pound that’s created by the banks and ends up in the storage tanks comes with a pound of debt. Every pound that flows from the storage tanks back into the economy as government borrowing, is debt.
The interest payable on all this debt, private and public, is money that’s created as even more debt by the banks, and most of it flows straight into the storage tanks.
Deficits are the result of insufficient cashflow around the economy. If we’re serious about eliminating deficits we have to reconfigure the plumbing so that enough money flows in cycles, regularly and reliably throughout the economy.
The problem with the current set-up is that the pipes that carry money from the economy into the storage tanks are large and many, but the return pipes are small, few, and little used. If we engineer a solution where these return pipes carry enough money to keep the economy properly lubricated then the deficit problem disappears, and with it, in time, the mountain of government debt.
If we can get enough of the stored money flowing back into the economy then the need to constantly create new money will all but disappear as well, along with the mountain of private debt.
The targets for a redesigned system are fully-funded government and a sustainable thriving productive economy, all free of historical accumulated debt.
But before we can start redesigning the system we have to stop the austerians and the stimulators from bickering over whether to cut or spend and get them to admit that neither strategy has a cat’s chance in hell of permanently eliminating fiscal deficits.