GOVERNMENT'S PROFLIGATE FISCAL POLICIES LIKELY TO LEAD TO 1970S-STYLE STAGFLATION

June 17, 2009

Rather than cure Great Britain's economic recession, Gordon Brown's current fiscal policies are more likely to lead to 1970s-style stagflation, says David B. Smith, a professor at the University of Derby.

Furthermore:

  • Using the 2009 Budget forecasts, Smith calculates that next year the ratio of government expenditure to national income will rise to 53.4 percent, the highest ratio since World War II and 6.9 percent above the peak recorded in World War I.
  • The ratio of public expenditure to private spending, which was 92.4 percent in 2008, will rise to 107 percent in 2009 and 114.5 percent in 2010 -- the highest burden since 1945; the private sector will therefore have to carry more than its own weight in government activity.
  • To fund this, public sector net borrowing will increase from 8 percent of national income in 2008-09, to 14.1 percent in 2009-10, and 13.5 percent in 2011-12.

This represents the longest and largest run of fiscal deficits in Britain's peacetime history.  There must be serious doubt whether deficits on this scale can be financed in a non-inflationary manner, without very large capital inflows from abroad.  And it is hard to see why such inflows should be forthcoming now that the British economy has become so highly taxed by international standards, says Smith.

For example:

  • Government borrowing on this scale means that there is a significant risk that the budget deficit and total spending will start feeding on themselves because of rising debt servicing costs leading to a sharp rise in the real returns on gilt-edged securities.
  • Moreover, the rise in non-productive government spending as a share of gross domestic product (GDP) since 2000 is likely to have cut the United Kingdom's sustainable growth rate by some 1 percent to 1.7 percent per annum.
  • Such a drop in productive potential will have reduced investment returns, acting as a huge disincentive for overseas investors considering supplying desperately needed capital to the United Kingdom.

Source: Editorial, "Government's Profligate Fiscal Policies Likely to Lead to 1970s-Style Stagflation," Institute of Economic Affairs, June 10, 2009; based upon: David B. Smith, "How Should Britain's Government Spending and Tax Burdens be Measured? A Historic Perspective on the 2009 Budget Forecasts," IEA Discussion Paper No. 24., June 10, 2009.

 

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