More than the deficit
At more than 10 per cent of GDP, it is not surprising that all political parties accept that the UK’s public sector deficit must be substantially reduced. Based on what a household has to do if its spending exceeds its income, this just looks like common sense. In fact, however, it is highlyunlikely that the public sector deficit can be reduced wholly – or even mainly – by policies that areaimed directly at it alone.
The reason why is that this deficit is part of an interlocking set of deficits and surpluses. If what is the largest among them is indeed to come down, others must adjust accordingly. Yet there is no guarantee that this will happen – nor that the adjustments that do take place will necessarily be benign.
Even as the policies that the government has introduced start to take effect, economic policy must pay attention to this wider set of imbalances. Above all, it must pay attention to the unprecedented surplus recorded by the corporate sector.
Sectors of the economy
The picture of the economy as a series of sectors is rooted in the national accounts. There are slightly different ways of doing it which depend on how corporations are treated. Here, public corporations are put with government to make up the public sector while private financial and nonfinancial corporations are combined together.
The household sector (which, since it includes both not-for-profit institutions and unincorporated businesses, is also a productive sector), completes the UK economy. The rest of the world is then added on as a fourth sector.
The table shows the size of each sector’s surplus or deficit for the latest year for which there is data, that is, up to the third quarter of 2010. The picture presented is clear: while the public sectorwas in deficit by £153bn or 10.6 per cent of GDP, each of the other three sectors was in surplus.
Table 1 - The four sector surpluses (+) or deficits (-) for the year to 2010Q3
Source data (all ONS Economic Accounts updated 22/12/2010). Net lending/borrowing (table A12): RPYN+RQBV (private corporate); RPZT (household); RQBN+RQAJ+RPYH (public); RQCH (rest of the world). GDP (table A1) YBHA.
From an accounting point of view, the surpluses and deficits of the four sectors add up to zero by definition. The reason why they do not quite do so here (a net deficit of £6bn or 0.4 per cent) is because the creation of statistics is not an exact science. Despite the statistical discrepancy at least in very recent data, the fact that the balances always in principle add to zero raises two questions.
First, although accounting guarantees that the change in any one balance will automatically trigger exactly compensating changes elsewhere, it has nothing to say about which balances will change or by how much. Neither does it have anything to say about any secondary effects, including on the sector where the original change took place. Nor can it shed light on what will happen to output and employment. All these require economics – which leads to the key question of how the different sectors and their balances are linked up in economic terms.
Second, if a public sector deficit of more than 10 per cent is a bad thing, it must follow that one or more of the surpluses in the other sectors is a bad thing too. On the grounds of size alone, the obvious candidate is the surplus recorded in the private corporate sector which was running at more than 7½ per cent in the year to 2010Q3.
A graph of the four sector’s surpluses and deficits for each ‘year’ (to each third quarter) back to the start of the century strengthens the sense that the corporate sector surplus deserves to be seen as a problem too. For one thing, it is not just a recent thing but has instead been present since a sharp two year switch from deficit to surplus between 2001 and 2003.
Even more significantly, the three percentage point jump in the surplus between 2007 and 2008 not only coincided with the start of the recession but also took place before the huge rise in the public sector deficit between 2008 and 2009.
Graph 1 - The four sectors' annual surpluses and deficits to 2010
Source: as for table. Years are the four quarters up to the third quarter of the year shown.
The point is this: while accounting requires that the sectoral imbalances always sum to zero, the consequences of any attempt to change any one of them are complex. There is certainly no reason to think that changes aimed directly at the public sector deficit will just be accommodated by the other sectors. Given its size, its long upward path and its behaviour around the start of the recession, the corporate sector surplus deserves no less attention than the public sector deficit.
What is new and what is not
There is nothing new about the idea that the public sector cannot be looked at in isolation. From the late 1940s until about 1980, the public sector deficit was joined in economic and political importance by the balance of payments deficit. In the presentation used here it is the surplus recorded by the Rest of the World.
Balance of payments crises marked the low point of economic management in the 1940s, 1960s and 1970s. With the abolition of capital controls in 1979, the spectre receded. As the graph shows, the Rest of the World’s surplus in the last decade was remarkable for its stability. With this old problem seemingly vanquished, the idea that seems to have taken root is that where there had previously been two sectors to worry about, now there was only one.
It is this belief, which makes the public sector deficit the over-riding focus of economic policy, that is now letting us down, not of course, because the old problem has returned but because a new one, in the shape of the corporate sector’s behaviour, has emerged to take its place.