Friday, 8 April 2016

Deficit — Skin and strawmen

You never really understand a person until you consider things from his point of view . . . until you climb into his skin and walk around in it.
Atticus Finch, To Kill A Mockingbird by Harper Lee

This quote sums up what I've been trying to do with preceding posts:
In this post I'll highlight the flaws in those arguments and examine any entrails that spill out of the strawmen. Here's the graph, one last time:


This graph and all the numbers stated in previous posts are, as far as I know, correct. The problems lie in the interpretation and how various facts are connected together, or omitted from the arguments.

Curiously, both posts use the same trend in the graph to support their cause. The growth of onshore revenue gives hope that Scotland's deficit can be closed in future years for a supporter of independence, but also plays a part in highlighting that North Sea revenue is not a bonus in the pro-union argument. The claims that £15 billion is the smallest deficit excluding North Sea revenue and that the "eye-watering" £22 billion deficit of 2009-10 is the largest are mostly due to the difference in onshore revenue rather than spending.

The pro-independence argument

The question concerning raising revenues to match spending is not an if, but a how.
The most problematic issue with the pro-independence argument is that it never explains "how" growth can be high enough to close the deficit gap in five or six years. According to the IFS a real growth rate of at least 4.5% would need to be sustained for that to happen and the argument does not mention which fiscal levers will be used to promote such growth. No one, certainly no credible economist, can tell us how a developed economy can reliably achieve such growth.

Ireland's high growth rate seems encouraging, but it's unlikely to be sustained because it is mainly attributable to post-recession bounce-back and a weak euro helping to boost Irish exports. Also, it's important to remember that Ireland, being in the Eurozone, was compelled to go through heavy austerity in the wake of the 2008 financial crisis. In contrast, the graph above shows that spending in Scotland did not fall post-2008 but remained flat in real terms whilst the UK coalition government was in power.

Even if we were to accept that Ireland's growth rate could be sustained, it is the only example of a developed country with such a high rate. This highlights that the argument plays the rhetorical trick of referring to critics who say it "cannot be achieved" and then demolishes the over-assertion with a counter example that is exceptional.

If you wish for Scotland to be independent then an economic argument based on rapid growth is unlikely to convince others. There are of course more realistic proposals, such as this one which highlights how Scotland can make different spending choices if outside the UK.

The pro-union argument

The UK's debt is worryingly high right now — £1.6 trillion and will continue growing along with the interest we pay on it while we run deficits. But the UK is well equipped to deal with its deficit...
The pro-union argument's flaw is that it never explains why the UK is "well equipped" compared to an independent Scotland. Worse still, this quote undermines a key argument as to why the UK is well equipped by making a seemingly plausible but demonstrably false statement about the debt, deficit and interest.

When I say "demonstrably", I mean from the historical record. Before reading further look at these three graphs.

Firstly, it is quite possible for debt as a percentage of GDP — and this is what matters, not absolute debt — to fall while running a deficit. This can happen through a mixture of growth and inflation. And it's not only possible, it is in fact exactly what has happened. Look at the first and second graphs in the link above: the huge post-war debt fell while the UK mostly ran deficits. In 54 out of the last 60 years, the UK public sector has been in deficit.

Likewise, despite the UK's debt increasing both in absolute terms and as a percentage of GDP in recent years, more than doubling since the recession, the amount paid in debt interest has not increased. In fact, it has fallen: when debt was at its lowest, at around 30% of GDP, the interest we paid on it was higher than it is now with debt at 80% of GDP. The reason is that the effective interest rate we pay on public debt has fallen to a low.

This seems counter-intuitive. If an individual gets themselves heavily into debt, the amount they can borrow becomes limited and the interest rates on offer go up. But the public debt of the UK is quite different to such private debt. The reason is that in troubled economics times, as we're still experiencing, UK bonds (shares in public debt) are trusted more than many other forms of investment. There is high demand for the UK's bonds from nervous investors and so their price goes up and this means their yields (akin to the interest rate) goes down.

UK bonds are trusted because the UK has its own currency and a central bank. The same is true of the the US and Japan. This is why the UK is well equipped to deal with high debts and deficits that occur in times of economic crisis, and why countries in a flawed monetary union, such as Ireland, Greece or Italy, end up having their fiscal independence curtailed by the wishes of a large, wealthy state like Germany.

Final thoughts

There's little doubt Scotland would have been in deep fiscal trouble had it become independent in March 2016 and this gives the pro-union argument much credence. But it rests too heavily on the current economic situation, and fails to make the case for a key strength of the UK. The pro-independence case is correct in principle, in that deficits are historically the norm, and that they are reduced by growth, but it's unrealistic about timescales and seems to hope for the best and make no plan for the worst.

Perhaps the UK's ability to deal with crises by handling large public debts and deficits can be built into a new case for an independent Scotland? That raises further questions. Technically, can a small country with trade dominated by a much larger neighbour launch its own currency and gain trust in its bonds without its own borrowing history? And, politically, would proponents of such an approach risk highlighting an existing strength of the UK?

The thought experiment I've conducted in these blog posts is limited because the arguments are forced to sprout from one graph. But, both arguments and the commentary above are not based on only the data in that graph. To make an argument you have to bring in other information and, importantly, the weight you will give to various pieces of evidence will depend on your pre-existing views. Like it or not, we are all, myself very much included, susceptible to delusions of objectivity.

In writing my book I was conscious of this problem. My aim was to let the data tell its own story and prevent my own views from polluting it. When reading blogs, articles and books I paid attention to how information gets slanted according to point of view. This helped me avoid some common pitfalls, and led to me to aim for a light touch with the commentary. Similarly, data was processed as little as possible in making tables and graphs and care taken in details such as the scale chosen for axes. There were also some difficult choices to be made in choosing what information to include and what to omit.  But it's impossible to police yourself for bias so I also made sure drafts went to people with a variety of views for comment (there exists a spreadsheet which tracks comments against people's political leanings).

I feel I've done the best I can in letting the data speak for itself in my book, but I'm very interested to know if I've fallen short of my goal. Any feedback on that, preferably constructive, is very welcome.

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