Category: Essential Economics for Business 7e and 6e

The issue of the state of the public finances has dominated much economic-thinking in 2010. This is not just a UK issue, it is a global issue; deteriorating public finances have led to governments around the world making some often very difficult fiscal policy choices. For instance, here in the UK we are continuing to debate the issues arising from the Comprehensive Spending Review which presents the government’s spending plans for the next few financial years. Over in Ireland concerns have resurfaced about the ability of the Irish to finance its burgeoning stock of public debt (see articles below). The fragility of the Irish banking system has meant that interventions by government have been needed to support financial institutions which, some estimate, will see net borrowing by the Irish government this year rise to the equivalent of over 30% of Ireland’s Gross Domestic Product.

The International Monetary Fund’s World Economic Outlook Database is a rich source of information for anybody looking to make international comparisons of public finances. Being able to extract key messages from data and to make economic sense of them is a crucial skill for an economist. But, in doing so it is important that we have an understanding of some of the terms being used by those presenting the data. In this case, to help you undertake your own study of the size of government expenditures, revenues, deficits and debt for countries around the world, we provide a short overview of some of the terms relevant to understanding public finances and illustrate them with reference to a sample of countries.

The IMF’s public finance figures relate not to the whole of the public sector but to general government and thereby exclude public corporations. The general government’s budget balance is presented in both national currency and relative to its Gross Domestic Product. The latter is very useful when making comparisons across countries. A negative figure indicates net borrowing, i.e. expenditures exceed receipts, while a positive figure means that government is a net lender, i.e. receipts exceed expenditures. Forecasts are available for 2010, but, naturally, can be rather unreliable, given that the fluidity of economic events means that they are subject to sizeable revision – Ireland being a case in point.

If we look at the period from 1995–2009 as a whole, the UK was a net borrower with a deficit equivalent to around 2¾ of GDP. Ireland, in contrast, averaged close to a balanced budget with some sizeable surpluses, such as in 2006 when it ran a budget surplus equivalent to 5.2% of GDP. Some countries, such as Australia (0.5% of GDP), averaged budget surpluses over this period. But, the UK’s deficit was not especially large by international standards. From 1995–1999, the USA ran a deficit equivalent to 4.5% of GDP, Greece 5.7% of GDP and in Japan, where several fiscal stimuli have been attempted to reinvigorate the economy, 5.9% of GDP. Nonetheless, the UK’s predicted deficit for 2010 of in excess of 10% of GDP does place it towards the higher end of the deficit-scale, though by no means at the very top!

Another budget balance measure is the structural balance. This attempts to model government expenditures and receipts so as to be able to predict what the budget balance would be if the economy was at its potential output, i.e. that output level when the economy’s resources are being used at normal levels of capacity utilisation. At the moment, for instance, many countries are experiencing a negative output gap, with output below its potential. This puts upward pressure on expenditures, largely welfare expenditures, but also depresses receipts, such as those from taxes on income or spending. The UK is estimated to have run a structural budget deficit equivalent to 2.6% of potential GDP from 1995–2009. With the fiscal measures to support the economy this is forecast to be as high as 7.9% in 2010. Japan is estimated to have run a structural deficit over the period from 1995–2009 equivalent to 5.4% of potential GDP, while in Greece it is estimated at 6.1%.

Another commonly referred to budget balance measure is the primary balance. The primary balance excludes any interest received on financial assets held by government, and, more significantly, interest payments made by the government on its stock of debt. This measure gives us a sense of whether governments are able to afford today’s spending programmes. The UK ran a primary deficit between 1995 and 2009 equivalent to 1% of GDP, while in America and Japan respectively the primary deficit averaged 2.6% and 4.8% of GDP. Interestingly, because of the size of debt stocks in many countries the exclusion of interest makes a notable difference to this fiscal indicator. For instance, Greece typically ran a primary surplus equivalent to 0.9% of GDP.

Budget balances are flows, whereas debt is a stock concept. In other words, budget deficits and surpluses can add to or reduce the stock of debt. Figures are available both on gross debt and net debt. The latter is net of financial assets, including gold and currency reserves. The UK’s average stock of gross debt to GDP between 1995 and 2009 was 45.2% of GDP, but this has risen to over 75% in 2010. In fact, by international standards our public-debt to GDP ratio remains favourable. In Greece, gross public-debt to GDP is predicted to be around 130% of GDP this year, but as high as 225% in Japan.

Finally, consider an interesting case: Sweden. By international standards its public expenditure to GDP share is high, averaging 54% between 1995 and 2009. But, it ‘balances the books’ with a small average budget surplus of 0.2% of GDP and a primary surplus of 0.8% of GDP. Its stock of debt has been falling even in recent times and stands at only a little over 40% of GDP. In 2010, despite the prediction of a small overall budget deficit of 2.2% of GDP, it will continue to run a structural surplus of 0.4% of potential GDP. Hence, Sweden demonstrates nicely the danger of assuming that, in some way, public expenditure necessarily translates into government deficits and, in turn, stocks of public debt.

IMF World Economic Outlook Database
World Economic Outlook Database International Monetary Fund

Articles

Ireland warns jump in borrowing costs very serious Telegraph (12/11/10)
Ireland’s cost of borrowing soars after dramatic sell-off Telegraph, James Hall, (11/11/10)
Imperative Budget is passed – Lenihan RTE News (12/11/10)
Lenihan welcomes EU move to calm markets RTE News (12/11/10)
Irish crisis demands new EU response Financial Times , Mohamed El-Erian (12/11/10)
Britain backs EU rescue missions for debt-ridden Ireland Guardian , Phillip Inman and Patrick Wintour (12/11/10)

Questions