Capital Economics: UK budget surplus goal a double-edged sword

The all-consuming focus Tory and Labour politicians put on engineering a fiscal surplus overplays politicians’ hands  – and could be damaging rather than helpful, according to Capital Economics.

UK economist Martin Beck says the two main UK political parties have been battling to prove their fiscal responsibility with the budget surplus as the battleground.

Last year Chancellor George Osborne laid out a plan to run the first absolute budgetary surplus since 2000/2001 in the next Parliament.

Labour’s shadow chancellor has pledged to hit the same goal, given the chance, albeit with the longer deadline of 2020. 

Goals such as these could have “some undesirable consequences”, including households expanding already excessive indebtedness, Beck warns.

“Ambitions on both sides for a budget surplus exaggerate the influence politicians have over the public finances,” he says.

A budget surplus is not necessary to reduce the ballooning ratio of public debt to GDP.

Office for National Statistics figures show the UK’s £1,386.7bn debt in 2012/13 was 88.3 per cent of GDP, up from 85 per cent the previous year.

If a favourable gap is created between nominal GDP growth and gilt yields, the ratio will drop despite a deficit, Beck explains.

Also, the Government does not fully control its net borrowing position as the financial balances of households, companies, and foreign entities have to equal zero, he explains.

If some parts of the economy are net savers, other parts must be net borrowers.

That means if the private sectors start saving more, it will be difficult for the Government to run a surplus without depressing the economy, he says.

That means talk of “balancing the nation’s books” is wide of the mark, he adds.

“If the Government’s revenues exceed its spending – i.e. it runs a financial surplus – someone else must run a deficit,” he says. 

The UK’s biggest foreign markets are savers – China and Germany a case in point – so the private sector is most likely to post the matching deficit, he says.

“Witness the UK’s sizable current account deficit, which we think is unlikely to disappear over the next few years.  As a matter of arithmetic therefore, a government surplus is likely to be matched by households and/or firms running a deficit,” he concludes.

That would not be a concern on its own, if it was a corporate investment boom leading to longer term benefits to the economy. 

“But the outcome might be less encouraging if the corollary to a government surplus is a fall in saving and rise in borrowing by already indebted households,” he says.