The Government Deficit
We often hear politicians talk about “the deficit”. What is it? Why do they seem so keen to blame it on other people and to talk about reducing it? Does it actually matter? It is actually very simple, so I will explain it using a children’s story:
Our story is set in Toytown, home to Noddy and Big Ears. Once upon a time, Noddy was put in charge of all of Toytown’s money. Every year he was given fifty gold coins and he could decide how he spent it. This worried Big Ears, could Noddy be sensible? He gave him a lecture about behaving responsibly, not having wild parties with the Barbie dolls when he needed the money to run the Toytown school and to pay the Toymaker to repair the broken toys and to make new ones. They all needed some new doll houses and some faster toy cars. Noddy nodded his head wildly in agreement, he was terribly excited.
All the gold was put into the money pot at the beginning of the year and every time Noddy needed to pay the Toymaker, or to build a new road, he took some out. For a while, all went smoothly. Then one day, Noddy had an idea. The summer was very hot and he wanted to build a swimming pool. All the toys could swim and enjoy the pool, it would be a place for toys to meet and chat and, best of all, he could invite all the Barbie dolls. But a swimming pool would use up all the money from the money pot and there would be nothing left to pay the Toymaker. He went to see Big Ears.
Big Ears listened to Noddy’s plan and thought about it. He agreed that all of Toytown would enjoy a swimming pool, it was not a bad idea. But they must continue to pay the Toymaker each year. He told Noddy that he could borrow the money to build the swimming pool. So, Noddy went to the Toytown bank. He explained that he wanted to build a swimming pool and needed the bank to give him some money. He would pay back the loan, giving the bank eight golden coins every year. The golden coins would come from the money pot. It would mean that for the next twenty years they would not be able to pay the Toymaker so much money, but all the toys would enjoy the pool, so they would not mind too much.
Noddy built the swimming pool and everyone was happy. For the next twenty years the toys had fewer new houses and fast cars but they did not mind. Everyone enjoyed swimming and they all lived happily ever after.
This shows how borrowing arises. It is when a government has a deficit one year by spending more than it receives. If it spends the money on something everyone needs in the long term, no one minds that it means a bit less money for other things for a few years.
Now, our government does not have a pot of golden coins. It receives money through tax. That income goes up and down depending on the economy. When the economy is going well, there is more money and therefore more tax, so the government has more income. When there is a dip in the economy, people earn less money and pay less tax and so the government receives less income. Now, although their income goes up and down, we do not want everything they spend money on to reflect that. We do not want them to open a new school one year, when the economy is going well, then close it the following year when there is a dip, then reopen it the next year when things improve again. We like stability. This is another reason why governments might borrow money. The economy might be bad for a while but they know it is likely to improve, so they borrow money to keep things going.
We therefore work on the principle that government borrowing is allowed. A government can borrow money to spend now and they pay it back later. The problem is that governments are made up of people and people are not always wise. Politicians like to be popular. They therefore like to promise people lots of nice stuff. Nice stuff makes people happy. Happy people vote for politicians. If the government does not have the money to pay for nice stuff, they promise it anyway, figuring that the future generation can pay back the debt in about twenty years (when they are too old to be in government, so who cares?) This is how borrowing grows. And grows. And grows. This is why future generations inherit huge debt from previous ones.
Where does the borrowed money come from? It is borrowed from institutions (banks) and individuals (for example National Savings Bonds) and from selling Government Bonds.
Let’s have another story. This one is a true story.
Our story begins years and years ago, when Egypt was run by Pharaohs. One night, when most of the world was asleep, Pharaoh stood next to the river Nile. He watched the black water lapping against the bank and listened to the frogs chirrup peacefully. Suddenly, the water began to swirl. Pharaoh watched carefully, was a crocodile about to emerge? He watched the water part as a nose appeared. It was a pink nose.
Feeling confused, Pharaoh leaned closer. The water was bubbling and swirling and the nose began to be joined by others. There were seven and they all began to emerge from the water. First there were nostrils, huffing and puffing droplets of water, then long furry faces with long lashed eyes. Then strong necks and heavy shoulders, then backs and tails and legs. They were cows! With much splashing and mooing, the cows fought their way to the bank. When their hooves were safely on dry land, calm descended and they began to graze, nosing amongst the reeds for food. Pharaoh watched in amazement. The cows were fat, with great pink udders bursting with milk. Their damp coats shone in the moonlight, their stocky legs bearing the weight of wide flanks as they wandered along the river bank.
Then the water began to swirl once more, to bubble and boil. Seven more noses appeared, followed by snouts and eyes and bodies. Pharaoh watched as seven new cows heaved themselves onto land. But these cows were not lush and fat and brimming with health. They climbed weakly from the river, emitting only the thinnest of moo. They were skinny beasts, with shrunken udders and sharp bones protruding from their flesh.
The thin cows approached the fat cows. At first, pharaoh thought that they too were going to eat the lush grass that grew beside the river. But, in horror, he watched as they opened their mouths, showing great pointed teeth and they bit into the flesh of the fat cows. The night filled with screams and wails as the thin cows crunched through bone and flesh, lapping blood and chewing muscle. Pharaoh dropped, sickened to his knees. The thin cows had completely consumed the fat cows, yet they looked just as gaunt as before.
With a great heaving sigh, Pharaoh awoke. It had been a dream, disturbing and vivid. He got up from his bed, drank some wine and emptied his bladder. Then, feeling tiredness seeping back he sank back into the comfortable warmth of his bed. His mind began to wander.
This time he dreamed not of cows, but of wheat. He stood in a cornfield, feeling the golden sun warm his back and he saw that one stalk had seven ears of corn. They were plump and good. Then seven thin ears grew next to them, straggly and full of blight. The thin ears swallowed up the fat ears.
When Pharaoh awoke, he was very uneasy. His dreams had been vivid and he was unable to forget them. What could they mean? He was Pharaoh, a powerful man, so he began to tell everyone he knew about the dreams, asking what they might mean.
Eventually, one of his servants told him about a man who he had met years ago, when serving time in prison. The man was called Joseph and he could interpret dreams. Pharaoh had Joseph hauled from prison and told him his dreams.
Joseph said that God would tell him the meaning. He told Pharaoh that both dreams had the same meaning. There would be seven good years, when the harvest would flourish and everyone would have plenty of food. This would be followed by seven bad years, when there would be a famine on the whole land. He said that God had sent the dreams, so that Pharaoh could appoint a wise man to organise the food. During the good years, they could put some of the extra food into storage, so that during the famine they had a supply of food to survive on. Pharaoh was very glad to know the meaning of his strange dreams, and being a wise leader, he appointed Joseph to be in charge of all the food.
And that is the end of the story. (Actually, it isn’t – you can read more in Genesis 41!)
Let’s look at another true story. From 2002 to 2007, the British economy was doing well. Remember, this means more tax (income for the government.) So, were they wise like Pharaoh? Did they pay off some of their debt? Er, no. Actually, they increased the borrowing by having a deficit. They still spent more than they were earning.
Then, in 2008 there was a financial crisis. They had to borrow even more because they now were receiving less in tax plus they had to bail out some banks. Oh dear, sad story.
Now, what happens if this continues? “Does it matter?” I hear you ask, “What happens if a government goes bust?” Well, we can look at countries where exactly that has happened to find out the answer. Greece is one example. Other countries stepped in to help. They decided that some of the debt could be ignored and never paid back (so institutions and individuals who were owed money would never be paid back.) They also loaned them some money (from the International Monetary Fund.) They gave the loan in chunks, with lots of conditions, refusing to pay the next installment if Greece did not conform. They set tough conditions on how Greece was to be run.
Now, because Greece was part of the European community, it was saved from the worst consequences of going bust. If we look at Russia and Brazil, we can see how awful life could become. One of the first things to change is the exchange rate (how much your currency is worth compared to other countries currencies.) This makes all imported goods very expensive. Too expensive to buy. So, if you were Russian, you could only afford Russian cars, Russian petrol, even (horrors) Russian chocolate. Anything that is imported becomes way too expensive to buy. This would not be good for Britain….
At the moment, all politicians are discussing “deficit reduction”. It should be noted that what they mean is that at some point in the future, they will stop spending more than they earn. No one is suggesting that they should only spend what they earn now. The borrowing continues to grow……..
Thank you for reading.
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