For my first piece I wanted to have a quick look at the notion that the government budget is like a household budget, and that governments in debt need to cut their spending and pay down their debts or they will end up in some sort of economic disaster. It seems that in spite of the metaphor being repeatedly discredited, government debt is repeatedly compared to a household budget: they need to get their affairs in order by stopping profligate spending and thus reduce their reliance on the “national credit card” (a term that seems to get used a lot here in Australia). This seems to be the basis of the austerity programs persisting within parts of the European Union. There’s been a lot written on this and there are a lot of aspects to it (the perpetuity of the government and the lack of necessity of totally paying back debt, the potential role of central banking, etc). Maybe I’ll write more on this later, but for now I’m going to focus on what I think is perhaps the biggest difference between the two, and one that I don’t think is emphasized enough: the relationship between debt, deficit spending, and income.
For a household, income can be treated more or less as a constant. A household’s personal income is largely independent from their debt; the only income affected by a loan to a household is the lender’s. A household’s income is also spent largely on consumption (and the financing of consumption), rather than investment with expectation of a return. Therefore, reducing spending will necessarily allow that household to pay down more of its debt, without any other real consequences. On the other hand, running a deficit – spending more than the household earns – will only ever get the household into more debt.
On the other hand, not only the government’s income but the income of an entire nation is inextricably tied up with government spending, both how much it spends and what it spends it on. When a government cuts spending, it isn’t merely cutting spending on its own consumption. It’s cutting good government jobs, spending on infrastructure, and important programs (unemployment insurance, aged pension, public health, etc) which people – especially the most vulnerable people in society – rely on. This can negatively affect GDP growth and the unemployment rate (and this goes beyond government employees). So not only do people have less income to spend but it also can mean more outlays on the bare minimum social welfare programs which remain. Not only does unemployment increase, but those who are unemployed are then worse off than they otherwise would’ve been. So cutting spending not only is bad for the poor, the vulnerable, and really everyone who relies on the efficient (yes, efficient) services that government can provide, but it can exacerbate or cause economic stagnation, and can proportionally mean ending up with a greater debt burden than the government had before cutting spending. On the other hand, when the government runs a deficit, that money isn’t simply being consumed, it’s being circulated in the economy and being invested in the important services people need.
Consequently, the effects of cutting spending and reducing deficits can be the opposite of what they might be for a household. I like tradingeconomics.com because it’s an easy way of getting comparable data across a range of countries. Take three of the European countries who were told that they needed to undertake a program of “austerity” in order to pay down their big deficits: Portugal, Spain, and Greece. If you check out their government spending, you’ll see that all have cut their government spending since the imposition of austerity: around 2010 or so in Greece’s case and 2011 for the other two. But then you check their government debt to GDP ratio…and it’s more, not less than when they started. Portugal had 94 percent public debt to GDP in 2011: now it’s 129 percent. Spain’s was at 61.7 percent in 2011: that’s now 93.9 percent. Greece had debt of 129.7 percent of GDP in 2010 when it was told it had to cut spending: that’s now skyrocketed to 175.1 percent. All of these countries have also seen declines in per-capita GDP. All have had increases in unemployment compared to 2011 (though some recovery is now underway in Portugal’s case), and in the case of both Spain and Greece this is at Great Depression levels (around 25-27 percent in both cases). They have also all seen declines in per capita GDP. Interestingly, government spending compared to GDP has remained stable or increased in spite of the declines in absolute spending and the cutting of jobs and programs. On all of the indicators, these countries are worse off, and this pattern is generally mirrored in the countries who undergone austerity.
Contrast this with Sweden, whose level of public spending actually increased over the same period, and it ran a net deficit (ie. it spent more than it earned from taxes) over that period…yet its public debt to GDP ratio has been relatively stable: it was 42.6 percent in 2010 and is now at 40.6 percent of GDP. Its GDP per capita growth is healthy, and its unemployment rate, while not exactly low, is nonetheless much better at around 7 percent. Similar stats are evident for Germany (those alleged paragons of fiscal rectitude): higher absolute spending, net deficit spending, and lower public debt to GDP. Switzerland has similar stats on spending and public debt to GDP, though it has run surpluses.
If one were to check out table b-20 of the 2014 Economic Report of the President, one would also see that the United States government has run deficits nearly every year of at least the second half of the 20th century, and had stable or increasing spending as a proportion of GDP from 1950-1981, yet it had a decline in public debt to GDP over the same period.
The debt-to-GDP rise, interestingly enough, began under that well-known left-wing welfarist, friend of the poor, and advocate for bigger government, Ronald Reagan. More recently, one would also see that total outlays as a proportion of GDP declined from 2009-2013 (from 24.4 percent to 20.8 percent), yet debt to GDP rose from 82.4 percent to 100.6 percent over the same period.
My point isn’t to allege that this counter-intuitive relationship between levels of spending and levels of relative debt is inevitable: particularly, it would be total nonsense to suggest that a country will always reduce its relative debt by increasing spending. But the idea of running a deficit, increasing spending, and then having a lower or even stable relative level of debt makes no sense from the household spending/balancing the budget perspective, nor does the notion of cutting spending and deficits and then ending up with more relative debt. It is therefore dangerously simplistic to suggest that when government debt is high or increasing, cutting spending on important welfare programs and infrastructure and the sacking of public servants is necessarily the answer. The effects could be the opposite. Indeed the “cure” these doctors are calling for seems little better than a prescription of leeches.