IFS
The UK public finances: ready for
recession?
Robert Chote
Carl Emmerson
Gemma Tetlow
The Institute for Fiscal Studies
IFS Briefing Note No. 79
The UK public finances: ready for recession?*
Robert Chote, Carl Emmerson and Gemma Tetlow
Institute for Fiscal Studies
Summary
Neither the current Labour government nor the previous Conservative one can
look back over their respective terms of office as periods of great success in
fiscal management. Both started by strengthening their underlying budget
balances for three years after taking office, but both then allowed them to drift
steadily back into the red. This meant that they were already borrowing
significant amounts when the onset of recession required them to borrow more.
Labour is entering this recession with a similar structural budget deficit to the
one that it inherited from the Conservatives, but with a smaller underlying debt.
It remains to be seen whether the structural budget deficit will deteriorate as far
under Labour as it did under the Conservatives, but debt is very likely to rise
above the peak it recorded under the Conservatives (even without the impact of
recent bank nationalisations and recapitalisations).
Labour recorded a similar structural budget deficit in the year before this
recession to that which the Conservatives recorded in the year before the last.
However, the structural deficit appears to have deteriorated more sharply in the
early phase of the downturn than it did under the Conservatives and as a result
is set to be higher in the first year of recession than it was under the
Conservatives. This largely reflects the particular impact of the credit crunch
and falls in the stock market and housing market, rather than budget decisions.
Labour is also going into the recession with a significantly higher level of debt
than the Conservatives did.
Turning to the international context, we are entering the current recession with
one of the largest structural budget deficits in the industrial world and a debt
level that may be among the smallest in the G7 but which is larger than that of
most industrial countries. We have done less to reduce our structural budget
deficit and less to reduce our debt than most other industrial countries since
Labour came to office.
*
The authors are grateful to the ESRC-funded Centre for the Microeconomic Analysis of
Public Policy at IFS (grant number RES-544-28-5001) for funding this project. Any errors are
the responsibility of the authors alone.
© Institute for Fiscal Studies, 2008
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The public finances: ready for recession?
As the UK economy begins to shrink for the first time in 16 years, the two
main political parties have been arguing over whether the public finances are
stronger or weaker now than they were at the outset of the last recession in
1990 and when Labour came to power in 1997. This Briefing Note looks at a
couple of key indicators of the health of the public finances in historical and
international perspective to assess this.
Claim and counterclaim
Gordon Brown and David Cameron set out contrasting views of the state of the
public finances in a debate in the House of Commons on 20 October.1
• Mr Brown said: ‘The United Kingdom cannot insulate itself from this
global downturn, but with interest rates low and falling and inflation
expected to come down over the next year, these underlying economic
indicators, particularly interest rates, make us stronger than at any other
previous downturn. Debt has been considerably lower than a decade ago,
and lower than that of all G7 countries except Canada, enabling the
Government to increase borrowing at the right time to support the
economy.’
• Mr Cameron responded: ‘Is it not the case that Britain is heading for a
record budget deficit, contrary to what he said, put by some independent
forecasters as high as £64 billion? Will he confirm that that has happened
after 14 years of economic growth and when half the OECD countries are
entering the downturn with a budget surplus? Is not the £64 billion question
this: why, when business and families need more help, has he left the
cupboard so bare?’
Perhaps not surprisingly, both are selective in the picture they draw.
Indicators of the health of the public finances
There are a wide range of indicators that can be used to assess the strength of
the public finances. For simplicity here we focus on two:
• Government borrowing: The government borrows when it spends more
than it raises in tax and other revenues. In comparing the evolution of
borrowing under Labour and the Conservatives, we use the Treasury’s
estimate of cyclically adjusted public sector net borrowing as a share of
national income – the so-called structural budget deficit. This is the amount
1
http://www.publications.parliament.uk/pa/cm200708/cmhansrd/cm081020/debtext/810200004.htm#0810203000512.
© Institute for Fiscal Studies, 2008
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that the Treasury estimates it would have had to borrow if activity in the
economy had remained at a sustainable level consistent with stable
inflation. Adjusting the figures for the ups and downs of the economic cycle
ensures that we do not overstate the health of the public finances when
economic activity is strong and understate it when economic activity is
weak. For international comparisons, we use the OECD’s cyclically
adjusted measure of the general government balance. This measure differs
from the Treasury’s for at least two reasons. First, the OECD looks only at
general government, whereas the Treasury looks at the whole public sector
(which, for example, also includes public corporations). Second, the OECD
and Treasury differ in their estimates of the output gap, which is used to
decompose borrowing into its structural and cyclical components.
• Government debt: As well as looking at the amount of borrowing the
government undertakes in any one year, we look at the amount of debt it
accumulates over time. In comparing performance under the current Labour
and previous Conservative governments on this dimension, we use the
Treasury’s measure of public sector net debt (excluding the impact of
Northern Rock) as a share of national income. For international
comparisons, we use the OECD’s measure of general government net
financial liabilities as a share of national income. The OECD figures differ
considerably from the Treasury figures. Whilst this is to be expected given
the different definitions used by the two organisations, this difference is not
constant over time. In particular, the OECD estimates are significantly
lower than the Treasury estimates in 1990 and 2007, whereas the two sets of
figures are similar in 1996. Unlike the structural budget deficit, the debt
figures are not adjusted for where we stand in the economic cycle.
Figure 1.1 shows how the structural budget deficit and public sector net debt
have evolved over the course of the Conservative and Labour governments.
Labour is entering a recession in its 12th year in office; the Conservatives also
entered one in their 12th (having already suffered a recession in their 1st and 2nd
years in office).
Figures 2.1 to 2.3 and 3.1 to 3.3 show the OECD measures of borrowing and
debt for 2007 (the year before the current presumed recession got under way),
1996 (the year before Labour came to office) and 1990 (the year the last
recession began).
Figures 2.4 and 3.4 show the change in the OECD structural budget deficit and
debt measures between 1990 and 1996 and between 1996 and 2007.
© Institute for Fiscal Studies, 2008
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Key comparisons
The main facts that emerge from the graphs are as follows:
• The structural budget deficit has evolved in a remarkably similar way under
Labour since 1997 to the way in which it evolved over the first 11 years of
Conservative government from 1979.
o Both parties inherited large structural budget deficits from their
predecessors: 4.8% of national income in 1978–79 and 2.9% of national
income in 1996–97. If left unchecked, structural borrowing of these
levels would have left debt increasing rapidly for some time.
o Both then oversaw a significant tightening in fiscal policy, achieving
structural budget surpluses that peaked in their 3rd years in office: 1.5%
of national income in 1981–82 and 1.3% of national income in 1999–
2000.
o Thereafter, both governments presided over a steady drift back into the
red. By year 11 of their terms in office, both governments were
recording very similar structural deficits: 2.6% of national income in
1989–90 and 2.7% of national income in 2007–08.
o To summarise, both governments presided over a fiscal strengthening in
their first three years in office followed by a weakening over the
following eight. But we should note that Labour has used more of its
borrowing to finance capital investment rather than current spending
than the Conservatives did. Under the Conservatives, the structural
budget deficit continued to deteriorate until year 14 (1992–93). It
remains to be seen when it will reach its trough under Labour.
• If we compare the structural budget deficits in the years immediately before
the latest two recessions started, then Labour and the Conservatives faced
the downturn in similar fiscal positions – with a deficit of 2.6% of national
income in 1989–90 compared to 2.7% of national income in 2007–08.
However, the structural deficit appears to have deteriorated more sharply in
the early phase of this downturn than it did under the Conservatives and as a
result is set to be higher in the first year of recession than it was under the
Conservatives. On current trends, the deficit is likely to be 3.6% of national
income this year2 compared with 2.6% of national income under the
2
Extrapolating the first six months’ borrowing figures to the whole year suggests borrowing
will be £62.7 billion in 2008–09. In addition to this, the fuel duty freeze and stamp duty
suspension are expected by HM Treasury to cost £0.85 billion in 2008–09. This gives total
borrowing in 2008–09 of £63.6 billion. Under the assumption that quarter-on-quarter growth
in non-oil GVA (gross value added) is –0.5% in 2008Q3 and thereafter follows the Bank of
England August forecast for the remainder of 2008–09, the output gap in 2008–09 will be
–1.8%, while that in 2007–08 was +0.3%. The cyclical component of borrowing this year is
therefore £10.0 billion, which leaves structural borrowing at £53.5 billion (or 3.6% of GDP).
© Institute for Fiscal Studies, 2008
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Conservatives in 1990–91. This largely reflects the impact of the credit
crunch and the falls in the stock and housing markets, rather than budget
decisions.
• The evolution of public sector net debt differs rather more between the
parties than the evolution of the structural budget deficit, because of
movements in non-structural (i.e. cyclical) borrowing.
o Labour’s move from structural budget deficit to surplus and back again
is mirrored by a fall in public sector net debt – from the 42.5% of
national income that it inherited in 1996–97 to a low of 29.7% in its 5th
year (2001–02), since when debt has risen again to 36.3% of national
income in year 11 (2007–08). On current trends, net debt will reach
39.7% of national income this year.3
o By contrast, the Conservatives inherited a higher level of net debt than
Labour in 1978–79 (47.1% of national income), but this did not fall as
fiscal policy tightened in the early 1980s because the strengthening of
the structural balance was offset by higher cyclical borrowing during the
first Conservative recession. Net debt remained around 45% of national
income until 1984–85, then fell sharply to a low of 26.2% of national
income over the following six years (despite higher structural
borrowing) as the boom of the mid-1980s generated an unsustainable
cyclical surplus and an unsustainably high level of GDP (both of which
artificially depressed the debt-to-GDP ratio).
o So Labour is beginning the current recession with a considerably higher
level of public sector net debt than the one with which the Conservatives
entered the 1990 to 1991 recession. The Conservative figures are clearly
flattered by the Lawson boom. But under Labour it appears likely that
over the next couple of years, net debt will rise significantly higher than
the peak of 46.2% of national income recorded by the last Conservative
government.
• On the OECD measure, the UK had a structural budget deficit of 3.1% of
national income in 2007. This is the 2nd biggest structural budget deficit
among the G7 large economies (after the US) and the 4th highest of the 26
industrial countries for which the OECD has data. As Mr Cameron
highlighted, half these OECD countries are facing the current economic
slowdown with structural budget surpluses.
3
Adding the total extra borrowing projected this year (as explained in footnote 2) to the level
of underlying debt (i.e. excluding Northern Rock) as at end March 2008 brings the level of
underlying debt at end March 2009 up to £592 billion (or 39.7% of estimated year-end GDP).
© Institute for Fiscal Studies, 2008
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o Although the structural budget deficit is slightly smaller than the one
Labour inherited on taking office, the UK has slipped down the
international league table as 19 of the other 24 industrial countries for
which we have comparable data have done more to reduce their
structural deficit (or increase their surplus) than the UK since 1996. In
1996, the UK had the 3rd biggest structural deficit in the G7 and the 8th
biggest of the 25 countries for which the OECD has data for that year.
o Our borrowing position looks even weaker in international perspective
when we compare it with the position when the last recession began in
1990. Although the deficit was still slightly larger in 1990 than it is
today, it was the 2nd lowest in the G7 and only the 13th largest of the 23
industrial countries for which the OECD has data for that year.
• Turning to debt, in 2007 the UK had the 2nd lowest debt ratio in the G7 after
Canada, as Mr Brown told the House of Commons. But our position in the
broader industrial country league table looks less favourable – we have the
11th highest debt ratio of the 28 countries for which the OECD has data for
this year. Although the indebtedness of the larger economies matters more
than that of the smaller ones in determining the total volume of government
debt globally, it is not clear why we should compare ourselves with the G7
economies rather than the broader range of OECD countries in judging how
prudently we manage our public finances. One-third of these OECD
countries now have net financial assets rather than net debts.
o In 1996, we had the 3rd lowest debt in the G7 and the 10th highest of 25
OECD countries. So we have moved slightly higher up the G7 league
and slightly lower down the broader OECD league under Labour.
o Our debt level is markedly higher now than at the outbreak of the last
recession on this measure – at that point, our debt was also lower than
that of most other OECD countries as well as most of the other G7
countries. So in that sense we do appear to have moved down the
international league table since the last recession, although it should be
borne in mind that – unlike the structural budget deficit figures –
comparing debt levels internationally is hampered by the fact that
different countries will be at different points in their economic cycles.
© Institute for Fiscal Studies, 2008
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Figure 1.1. Borrowing and debt: Labour versus Conservatives
Percentage of national income
-2.0
Structural budget deficit (PSNB)
-1.0
0.0
1.0
2.0
3.0
4.0
Brown / Darling
Howe / Lawson / Major / Lamont / Clarke
IFS projection
5.0
6.0
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
50
Percentage of national income
Public sector net debt
45
40
35
30
Brown / Darling
Howe / Lawson / Major / Lamont / Clarke
IFS projection
25
20
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
Years since 1978-79 and 1996-97 respectively
Note: IFS projection based on central government receipts and spending for April–September
2008, Bank of England estimated GDP growth rates from August Inflation Report and HM
Treasury costings of tax policies announced since Budget 2008.
Source: HM Treasury Public Finances Databank, October 2008 (http://www.hmtreasury.gov.uk/5552.htm).
© Institute for Fiscal Studies, 2008
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Figure 2.1. Cyclically adjusted general government balance in OECD countries in 2007
4.6 Finland
4.5 Iceland
United Kingdom
Other G7 economies
Other OECD countries
3.5
New Zealand
3.4
Luxembourg
3.3
Denmark
3.0
Sweden
2.1
Spain
1.9
Norway
0.8
Canada
0.3
Netherlands
0.3
Australia
0.3
Ireland
0.2
Switzerland
-0.2
Germany
-0.3
Belgium
-0.7
Austria
-1.3
Italy
-1.6
Portugal
-2.4
Czech Republic
-2.6
Japan
-2.8
Poland
-2.9
France
-3.1
United Kingdom
-3.2
United States
-3.5
Greece
-5.5
-16
-14
-12
-10
-8
-6
Hungary
-4
-2
0
2
4
6
Percentage of national income in 2007
Source: Annex table 28 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 2.2. Cyclically adjusted general government balance in OECD countries in 1996
Luxembourg
2.9
New Zealand
2.3
United Kingdom
Other G7 economies
Other OECD countries
Ireland
0.7
-0.4
Iceland
-0.6
Finland
-1.0
Netherlands
-1.1
Norway
-1.5
Canada
-1.6
Switzerland
-1.6
United States
-1.7
Denmark
-1.8
Sweden
-2.0
Australia
-2.8
Belgium
-2.8
Germany
-2.9
Spain
France
-3.3
-3.7
United Kingdom
-3.8
Austria
-4.0
Portugal
Poland
-4.8
Hungary
-5.3
Japan
-5.7
-16
-14
-6.0
Greece
-6.2
Italy
-12 -10
-8
-6
-4
-2
0
Percentage of national income in 1996
2
4
6
Source: Annex table 28 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 2.3. Cyclically adjusted general government balance in OECD countries in 1990
3.2
Finland
2.6
United Kingdom
Other G7 economies
Other OECD countries
Sweden
2.4
Luxembourg
1.0
Japan
-0.8
Norway
-0.8
Denmark
-2.6
Australia
-2.9
Austria
-2.9
Switzerland
-2.9
Iceland
-3.4
United Kingdom
-3.6
France
-3.8
Germany
-3.9
Ireland
-4.1
New Zealand
-4.8
United States
-5.8
Netherlands
-6.1
Spain
-6.6
Canada
-7.8
Belgium
-7.9
Portugal
-12.6
Italy
-14.1
-16
-14
Greece
-12
-10
-8
-6
-4
-2
0
2
4
6
Percentage of national income in 1990
Source: Annex table 28 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 2.4. Change in cyclically adjusted general government balance in OECD
countries over 1990 to 1996 and 1996 to 2007
Finland
Spain
Denmark
Iceland
Italy
Sweden
Japan
Austria
Norway
Germany
Belgium
Greece
Canada
1996 to 2007
Portugal
1990 to 1996
Australia
Poland
n/a
Switzerland
Netherlands
New Zealand
United Kingdom
Luxembourg
France
Hungary
n/a
Ireland
United States
-8
-6
-4
-2
0
2
4
6
8
10
Percentage of national income
Source: Annex table 28 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 3.1. General government net debt in OECD countries in 2007
90.7
85.9
73.7
United Kingdom
Other G7 economies
Other OECD countries
68.6
Japan
Belgium
Greece
Hungary
53.1
44.5
Germany
43.8
United States
43.3
Portugal
35.1
Austria
34.0
France
30.4
United Kingdom
29.1
Netherlands
23.3
Canada
21.0
Spain
20.9
Poland
Switzerland
13.7
Slovak Republic
5.7
1.9
Iceland
1.3
Ireland
Denmark
-2.5
Australia
-6.0
-12.1
New Zealand
-13.2
Czech Republic
Sweden
-20.9
Korea
-37.8
Luxembourg
-44.9
Finland
-71.1
Norway
-150.0
-150
Italy
-100
-50
0
50
100
150
Percentage of national income in 2007
Source: Annex table 33 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 3.2. General government net debt in OECD countries in 1996
115.2
104.3
81.8
United Kingdom
Other G7 economies
Other OECD countries
70.0
Italy
Greece
Canada
54.7
Spain
52.9
United States
52.8
Netherlands
47.2
Austria
41.8
France
40.4
United Kingdom
39.3
Iceland
36.2
Denmark
33.2
Germany
32.8
New Zealand
29.3
Japan
27.3
Portugal
26.6
Sweden
25.3
Hungary
20.9
-150
Belgium
Australia
-5.7
Poland
-6.7
Finland
-18.3
Slovak Republic
-19.0
Korea
-41.0
Luxembourg
-41.5
Norway
-100
-50
0
50
Percentage of national income in 1996
100
150
Source: Annex table 33 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 3.3. General government net debt in OECD countries in 1990
107.0
82.2
United Kingdom
Other G7 economies
Other OECD countries
United States
43.7
Canada
33.7
Spain
33.7
Austria
33.4
Netherlands
22.5
Denmark
20.5
Germany
19.0
Iceland
17.1
France
14.5
United Kingdom
14.4
Japan
Australia
-7.9
Sweden
-16.5
Korea
-34.8
Finland
-41.0
-100
-50
Italy
45.2
10.3
-150
Belgium
Norway
0
50
100
150
Percentage of national income in 1990
Source: Annex table 33 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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Figure 3.4. Change in general government net debt in OECD countries over 1990 to
1996 and 1996 to 2007
Japan
1996 to 2007
Hungary
n/a
1990 to 1996
Poland
n/a
Slovak Republic
n/a
Portugal
n/a
Germany
Luxembourg
n/a
France
United States
United Kingdom
Austria
Greece
n/a
Italy
Korea
Netherlands
Australia
Spain
Iceland
Denmark
Belgium
New Zealand
n/a
Canada
Sweden
Finland
Norway
-150
-100
-50
0
50
100
Percentage of national income
Source: Annex table 33 of OECD, Economic Outlook No. 83, June 2008
(http://www.oecd.org/document/61/0,3343,en_2649_201185_2483901_1_1_1_1,00.html).
© Institute for Fiscal Studies, 2008
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