Government Expenditure and the Long recession

This is a very interesting chart from the IMF's World Economic Output Report (April 2013).

What is shows is that in most cases, and certainly in the UK, government expenditure was only slightly above average leading up to the recession (USA being the exception and they were fighting two major overseas wars). Government expenditure seems not to be tightly correlated with the recession. Which is not what we'd expect if the government's rhetoric were true. Instead the figures contradict all the rhetoric about profligacy in the previous government - and yet the opposition seem unable to capitalise on this, but that's another story. These figures are what we'd expect if private debt were the driver of the recession, and in the years leading up to the recession various governments had begun to believe that their economies were now literally exempt from boom and bust (what we might call the Greenspan fallacy).

The thing to note however is that this recession is lasting a long time. And correlated with this is post-recession expenditure well below averages. That is to say that cuts in government spending are correlated with an extended recession. Of course correlation is not causation, but it would be very interesting to look more closely at this.

In the past governments generally continued to steadily increase their spending post-recession. In the world's advanced economies government spending is considerably below the average at present. In emerging market economies (the economies that are still growing at an appreciable rate) government expenditure is presently above average.

One of the factors is that government revenues have collapsed in this recession in a way that is almost unprecedented. With the debt fuelled economic bubble, government tax takes were high for a lengthy period and governments, especially the UK government, became complaisant about spending at boom levels. When the banks collapsed it was necessary to borrow a lot of money to prop them up, raising interest costs and decreasing the amount available to spend.

IMF on UK Debt

There's a very nice little blog on an IMF report from 2011 on the Touchstone website. And it illustrates a good point about where we get our information from and to what extent we can trust the government and the media to keep us well informed.

Back in Oct 2011 the IMF were saying that if growth slows that austerity cuts would need to slow down. The said the same thing in their most recent report: the BBC reported it like this: "The government should slow the pace of budget cuts next year if UK growth does not recover, the International Monetary Fund (IMF) has said." So it seems the IMF is consistently telling the government to on cut public spending if there is sufficient growth. This is the lesson that Japan learned the hard way in the 1990s. The government on the other hand take the IMF report as a confirmation that austerity is the right thing to do.

Back to Oct 2011 there is another story in the IMF report which was not picked up on by the media and flatly contradicted by the government. And it relates to a graph.

All credit to Duncan Weldon for spotting this and telling us what it means. As the title says this graphs shows us what caused public debt increases post 2007 when the credit crunch hit - 5 years ago this week. All the figures are as a percentage of GDP. I won't talk about Italy because Italy is clearly in a class of it's own.

The red block is fiscal stimulus and the graph shows that compared to France and Germany the UK spend less on fiscal stimulus. Note that Germany spent much more on fiscal stimulus and now has a much healthier economy than most of the rest of Europe. These two facts are intimately connected.

The yellow line is amount spent supporting the financial sector, and here again Germany spend a great deal more.

The grey line is basically interest payments which went up either because of more debt or higher interest rates, or both in Italy's case. Clearly this is the primary driver for Italy.

Finally the blue line is revenue loss attributable to the economic downturn - the loss of production. Note that Germany which proportionally spent a great deal more bailing it's economy out, now has a negative contribution from loss of production - i.e. they gained revenue over this period. In France and Germany revenue loss was the major driver of borrowing.

As we know the government's austerity plan is resulting in increased borrowing, and projections are that it will continue to increase. And the IMF are telling us that the main driver of this is revenue loss. As we've heard this week the UK economy is still shrinking: growth was -1% for H1. While the Bank of England are forecasting +1% for H2, we also saw this week that construction is down 6% for the ytd, and "The main driver in this decline was the fall in new public works, which fell by 22% across the three months, reflecting the impact of government spending cuts." BBC. [my italics]

So, as Duncan Weldon points out, the major driver of government borrowing since 2007 has been revenue loss, not profligacy. And the reason the IMF have warned the UK government two years running to beware of cutting while growth is weak would seem to be because without growth the cuts will set up a vicious cycle: