The economics of a budget surplus: Something to think about before making rash promises

Left of centre political parties are nearly always faced with the charge, levelled by their right of centre opponents, of fiscal profligacy. Accusations are made that the more socially minded parties cannot be trusted with a nation’s finances.  They will tend to spend too much ‘taxpayers’ money’ on what they consider to be worthy causes. This supposed tendency is often disingenuously linked to the size of the government budget deficit, which in turn is equally disingenuously linked to the size of government itself.  Left unanswered this charge will cost votes. So how should they best respond to the very predictable attacks along these lines which will be only too familiar to Labour Party strategists?

The Australian Labor Party answered this question during the 2010 Australian Federal election campaign by promising, as Julia Gillard put it at the time, “the budget will be in surplus by 2013 if I’m re-elected. No ifs and no buts.” Her deputy Wayne Swan chipped in with “We have nailed our colours to the mast.” You can find lots more similar quotes from both. It didn’t turn out too well. It wasn’t his colours which ended up being nailed to the mast.

As late as 2012 Julia Gillard was claiming to be ‘on track’ but in the end Wayne Swan had to acknowledge ‘it’s unlikely there will be a surplus’ and there wasn’t.  So, even though in many respects the record of the ALP was highly commendable, delivering an economic performance which was better than seemed possible in the aftermath of the 2008 GFC, the economic credentials of the ALP were shredded. The party slumped to a heavy and humiliating defeat in the subsequent 2013 elections. There were of course other factors, such as in-fighting between leading members of the government, but nevertheless the ALP had loudly proclaimed their ability to deliver a surplus. It was far from a minor policy in their 2010 manifesto. Perhaps even worse than the loss of the 2013 election is the long term loss of economic credibility. Their political opponents will remind the Australian electorate of the fiasco at every possible occasion for the foreseeable future.

In reality, the ALP did not come close to ‘achieving’ any surplus, which was just as well. If they had, they would have crashed the Australian economy. It can only be assumed they were unaware of the difficulty of making good their promise. So, what is involved in running a budget or internal surplus? These are, of course, possible. Germany, which has at least as big a government as the UK, proportionately as well as absolutely, and spends at least as much on social programs, runs a balanced budget continuously, sometimes slightly positive other times slightly negative, seemingly without  problem.

Unlike Germany, the UK has been a net importer since the early 80’s when the Thatcher government shifted emphasis away from manufacturing industry. The USA, too, runs a similar style of economy. Imports have to be paid for and these payments drain money from their economies. This is ‘retrieved’ by the sale of the Treasury securities on the international market and recycled back into their economies by government budget deficit spending.

So, whereas the UK runs both an internal deficit of around 6% of GDP and an external (trade or more correctly a current account) deficit of around 3.5%, Germany has an internal balance but an external surplus of 7%. This, incidentally, is considered by many to be excessive and has led to accusations of ‘mercantilism’ and being tantamount to exporting their unemployment to the poorer countries of the Eurozone.  The Germans have a money-go-round which goes in the opposite direction to the UK’s and they have to tax some of those export revenues away to prevent inflation in the domestic market. They would be unable to run a budget deficit of any size even though the interest payments to fund it would be almost zero and maybe even less! German bonds often have negative interest rates. Currently the Germans are prodigious savers, which accounts for the large difference between their external and internal deficits. Their surpluses end up on deposit at their central bank, which then buys securities from the net importers to complete the monetary cycle, enabling the citizens of those countries to carry on buying Audi and BMW motor cars!  A Government budget balance cannot be considered in isolation in any country.

The Government balance is defined as the difference between tax receipts and spending. This leads politicians to think they can easily control it. However, if spending is reduced or taxes are raised in an attempt to reduce the difference, economic activity will also fall, which in turn leads to reduced taxation receipts and increased demands for welfare payments. The gap ends up being much the same as it would have been had spending and taxes been left alone. The Troika are the latest to discover this the hard way in Greece. Their action in bleeding the economy is little short of a collective punishment on the Greek population.

Many economists would argue that imports are a net benefit whereas exports are a net cost. Most economists would argue that a trade deficit of around the 3-4% level is quite sustainable, that there was no need to worry and it shouldn’t make any difference to unemployment levels. They would say a public deficit equated to a private surplus. They would argue that not all countries can be net exporters and that the UK and the USA are offering a useful service by being the world’s banker and should take a free ride when it is offered. That is all true. For my own part, I’m not happy taking a free ride and wonder why developing countries enthusiastically swap real goods and services for what are just the IOUs of the wealthy western world. Will they ever be redeemable for anything close to the value to the goods supplied?  It could be that sooner or later these countries will take the view they’ve been had!  We probably should make preparations before they come to that conclusion.

If the ALP chose a poor option, what would be a better one for the British Labour Party?  It has to start by having a sensible discussion with the electorate on the type of economy they want including an explanation of what is possible. An internal surplus with a substantial external deficit wouldn’t be at all possible except for a very brief time before the economy went into deep recession. Do they want a Thatcherite debt finance based economy, selling government securities to the world; or, do they want to move, in a sensible timescale, maybe a period of a decade or so, towards an economy based on the principle of as close to full employment as possible, selling real goods and services, allowing Britain to contribute its fair share towards world prosperity, and keeping a better balance of both the internal and external deficits?