High deficit countries aren't having a good recovery

Financial markets across Europe and the United States have been in turmoil this week as fears have grown about the ability of the Spanish and Italian governments to repay their debt and the prospect of a double-dip recession in America. The London Stock Exchange’s FTSE100 index closed at 5,393 on Thursday 4th August, down from a high of 5,912 on Monday – a fall of 8.8 per cent. Mr Knapp of Barclays Capital highlighted the impact of worries about the American economy:

When the outlook for the US is good or OK, people find it much easier to deal with the problems in Europe

The problem is that lenders are losing confidence in the likelihood that their money will be repaid. The reason governments need to borrow so much money in the first place and that lenders are nervous about lending further vast sums is, of course, because governments have failed to get a grip on spending. Instead of keeping spending prudent during the expansionary years of the credit cycle, the governments now in trouble are those which ran deficits instead. When the financial crisis of 2008 hit, unemployment rose, meaning spending forcing spending to follow suit, while profits and incomes fell bringing taxation revenues down with them. The strength of these factors varied between countries but so did the starting points.

Germany, Australia and Sweden ran budget surpluses in 2007; Greece, Italy and the United States all ran significant deficits. In 2010, the US and Greece ran deficits of approximately 10 per cent of GDP. Italy, with its huge existing debt, retained a deficit that by today’s standards counts as moderate (but would have been seen as dangerous before 2008).

Germany, Australia and Sweden had swung into deficits by 2010, too, but their borrowing was at a much lower rate. This has affected growth rates. Those three countries grew by 3.4, 2.9 and 4.5 per cent in 2011 but Greece’s economic output shrivelled by further 2.9 as Italy and the US grew by just 1.1 and 2.6 per cent. The correlation between large budget deficits and low growth is stark.

Sadly, Britain is in the high deficit, low growth group. As Sean O’Grady reports in the Independent, the head of the Office for Budget Responsibility has warned that the economy is unlikely to meet its already weak existing forecast of 1.7 per cent:

As a simple matter of arithmetic, in order to get to 1.7 per cent now you'd be looking for quarter-on-quarter growth rates of 1 per cent in the second and third quarters of 2011, and there aren't many people out there expecting that.

If the Government want to revitalise the economy, they need to start implementing the cuts that have been talked about so much. Simpler, lower taxes. Lighter, smarter regulation. Reliable, stable money. These are the things an economy needs to grow, not ‘stimulus’, borrowing and taxes.

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