PSBR, PFI, Off balance sheet accounting, and Fred Wharton

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My mate David requested I do something on Public Sector Borrowing.  As it happens my daughter Lily is doing A level History at Durham Johnston Comprehensive.  David and I did the same A level at the same school, but 30 years earlier.  I thought it might fun to do a short history of public debt since WW2.   When I say fun, I mean fun for people who like history, and numbers. 

DJ is still teaching exactly the same European History syllabus as it was when Mr Solon taught us all to memorise “L’Etat c’est Moi”. The British History syllabus has moved on, and now covers C20th British History.   A whole generation has grown up ignorant of the Corn Laws, which, as any fool knows,  is crucial to understanding Brexit.  Shocking.

I can still hear Freddie Wharton hissing “Hhhhhooooopeless, Mr Chadwick, hopeless” at me in a British History A level class.

He did that a lot.

Lily asks me about her History A level, which is great, although I am slightly concerned that she apparently believes I was an eye witness to the establishment of the NHS and the Suez Crisis.

Before I go any further I should probably declare an interest, in that I was a very small participant in the events below.  I was responsible for a Hospital PFI scheme while Brown was Chancellor, and gave outsourcers a dead leg for George Osbourne, among other things.  Feel free to boo and hiss if it makes you feel better.

In the style of Fred Wharton I am going to start by dividing the Chancellors up into sets.

There have been 23 Chancellors of the Exchequer since WW2. 15 Conservatives, and 8 Labour – the Conservatives have generally been in power more often, and change their Chancellors more regularly than Labour. The majority of them left the country with less debt not more – this is because at the end of WW2 we had very high debt which declined over time as the economy grew.

The 5 best Chancellors in the top set for managing debt are:

-53.16 Butler

-44.05 Cripps

-18.55 Gaitskell

-16.12 Barber

-15.42 Jenkins

The numbers beside their names are the reductions in debt over their time in office as a a percentage of GDP.  I chose percentage of GDP as a simple way to avoid inflation affects confounding the data.  If you look at cash instead it gives you a similar picture with one exception – Geoffrey Howe left office with very slightly lower debt as a percentage of GDP, but with more debt in cash terms.  He was in fact the first Chancellor since WW2 to leave office with more cash debt than he started.

The 5 Chancellors in the bottom set for managing debt are:

4.28 Lamont

8.69 Darling

10.96 Clark

22.3 Dalton

36.6 Osborne

Dalton is a bit different to the rest because his time as Chancellor included the immediate end of WW2 which isn’t really comparable to the rest of the series.   

If we exclude Dalton the average Labour Chancellor since the war has reduced debt by 12.16% of GDP. The average Conservative reduced it by 7.5%.   I excluded MacLeod and Thorneycroft from the Conservative numbers as each was only Chancellor for a brief period and would have distorted the average.  For stats fans if we include Dalton, MacLeod and Thorneycroft Labour chancellors are still ahead, by 7.3 to 6.4, which starts to question why the Tories tend to be better regarded for managing debt.

Looking at the performance of Chancellors we can split the post war period up neatly into 3 periods.   

From Sir Stafford Crips through to Denis Healey every Chancellor of the Exchequer left office with less debt than they started.  None of them particularly ran a campaign of fiscal austerity – instead they focussed on growing the economy and paying down debt gradually.  Fans of Bustkillism – the period where Labour and Conservative politicians converged on a centrist consensus  – should feel particularly pleased with themselves.

There is a second clear period starting in the 1990s. From Lamont onwards all Chancellors of the Exchequer except for Gordon Brown leave office with more debt than they started.  Of the worst Chancellors for running up debt, 4 of the bottom set are in the last 25 years.

There is a narrative that the UK was doing great for debt until New Labour came along and “Maxed out the Credit Card”.   It looks rather like the deterioration started way before then.

The question is … what happened in the middle period – the 1980s – to change us from an economy where debt fell to an economy where debt rose? Other than spending lots of money on Duran Duran records. 

There were 3 Chancellors of the Exchequer during the 1980s.  Howe reduced debt by only 0.49% during his 4 years, but increased it in cash terms.  If we are looking for a moment when the economy turned from declining debt to increasing debt Howe is a good suspect.   His performance on debt was markedly worse than Denis Healey (-4.26%) even though Healey had to ask the IMF for a bailout.  The UK fiscal position under Howe looks at least as weak as under Healey, the only difference being that Thatcher held her nerve better than Callaghan.

By contrast Nigel Lawson looks much better.  He reduced debt by 13.8% and narrowly missed a place in the top set.  Major had only a brief stint as Chancellor and managed a slim 2.61% reduction in debt.  He continued to push for lower debt as Prime Minister, but only succeeded in pushing the economy into a recession, which was unfortunate as I was leaving University at the time. 

Down the PFI Rabbit Hole

Before we go further there is a further complication we need to consider – off balance sheet debt.

One of the biggest criticisms of Gordon Brown is that he signed up to a lot of PFI deals which increased debt, but were designed so they didn’t show up on the balance sheet. Actually lots of Chancellors from the 1980s onwards used off balance sheet and non-recurring measures which makes it difficult to work out what actually happened to Government debt.

To try and explore this I created a notional charge to the national accounts based on the value of PFI contracts signed per year, including all future payments accruing to these contracts.     

This gives us this table:

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This adds roughly 22% to public sector borrowing.  This is far too much for several reasons:

  1. Not all PFI was off balance sheet – some of it was always counted in the national accounts
  2. Not all off balance sheet transactions were PFI – there were lots of transactions linked to privatisation which moved debt on and off the governments books creating a notional reduction in government borrowing
  3. FM bundling.  Lots of PFI deals in the NHS included the facilities management costs of running the buildings as part of the deal.  For example – when a new hospital was built in Redcar the FM costs were bundled into the PFI deal.  The hospital that it was replacing  – Stead Memorial – already had an FM budget (a very big one).   Including the FM costs in the PFI costs risks double counting. Deciding which FM costs you should include when calculating how much debt the government hid when moving stuff off balance sheet isn’t straight forward

To correct this we can start by taking out PFI’s which were on balance sheet, and adjusting for FM bundling.   I did this crudely, by looking at a long list of contracts and using my skill and judgement to take out the ones I thought were already on balance sheet, then adjusting for FM bundling, where the FM costs would have been incurred anyway.  At this point the numbers are pretty crude, but without a researcher to chase down each contract it is hard to make them more accurate.

This changes the sums for each of the Chancellors from 1995 onwards, but probably doesn’t change the overall conclusion… from Lamont onwards every Chancellor of the Exchequer increased debt except for Gordon Brown, who reduced debt by less than he claimed when we add the PFI costs in. I say probably because it is possible to make a different set of assumptions which would have a radically different set of results.

Even this doesn’t tell us the full picture because it doesn’t show us off balance sheet transactions which weren’t PFI, typically the result of a privatisation deal.  For example when Royal Mail was privatised a chunk of debt left the Government’s books in return for the Government accepting a long term revenue charge.  The flow of funds looks a lot like a PFI off balance sheet transaction, so much so that a couple of years ago RailTracks debt was recategorised so it counted against public debt.

Calculating the impact of privatisation based off balance sheet transactions is difficult.

It is possible to track central Government privatisation receipts during the main phase of nationalisation up to 1997.   Between 1997 and 2010 privatisations still took place but often they weren’t carried out by central Government – for example Airports which had been owned by Local Authority Consortia, or parts of the BBC.  Off set against those receipts for privatisation are the costs of nationalisation – largely the effects of the investments which the Government made into the banking system in 2008.  Post 2010 privatisation receipts increased, closer to the levels seen under Lawson, mainly from the sale of banking shares the Government had acquired in 2008. 

Taking these numbers out crudely shows us the impact of non-recurring privatisation receipts and PFI costs on the performance of each Chancellor:

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Where does this leave us?   Nigel Lawson fairs better than I expected by a long way, and while Gordon Brown’s track record of investment in public services is still excellent, and it is creditable that he achieved this without adding to government debt, it is less credible to regard him as doing much to reduce the deficit. 

One thing is clear- it is hard to actually make sense of the PSBR data from the mid 80s onwards.  Governments increasingly used forms of financial engineering to disguise the true picture of public finances.   

If I were to try and construct a narrative to tie together the numbers from the 1980s and afterwards it would go like this….

Public borrowing starts to deteriorate under Howe.  He is a poor Chancellor who increases debt and unemployment.

Lawson clears up Howe’s mess and manages to grow the economy and reduce debt but only at the cost of high unemployment.  Lawson saves Thatcherism, which is either good or evil depending on your political standpoint. He also introduces a lot of complexity into government finances which starts to make it harder for governments to understand the real debt position.  He uses non-recurring funds to pay for recurring tax cuts, which sets a dangerous trend.

Major isn’t really around long enough to make a difference

Lamont and Clark are a total shambles.  They run up debt on the balance sheet, and loads more off balance sheet. They take Lawson’s already complex toolkit and make it even more complex. I am not even sure if they realised how much debt they were piling up.  Lamont was actually worse than we thought he was after Black Wednesday, which is hard to believe.

Brown does well in terms of investment in public services, and probably does reduce debt, but not by much.  I am no longer sure that I can give an accurate assessment of the state of PSBR under Brown, it is probably better to give a range of values for the likely debt reduction somewhere between 0% and -3%.

Darling is the Chancellor during the Credit Crunch, he increases debt by loads, but lots of this is the costs of nationalising the banks.  I could have picked a range of numbers for the costs of nationalising the banks, and I picked the lowest.  Interesting to note that between Brown and Darling they nationalise a lot more than they privatise.

George Osborne comes into Number 11 in 2010 and is hopeless.  A total clownshoe. No matter how big a mess you think Osborne inherited his performance is unbelievably bad.  He is worse than Lamont and Clark added to together.   

As Fred would say; “errrr… hopeless, Mr Osborne, hopeless”.

If I had to point to an underlying reason for these problems I can find no better explanation that from the late 1980s onwards Government started to give away tax cuts.  These tax cuts eroded the tax base, and drove up Government debt.   Privatisation receipts reduced this amount temporarily, and PFI deals disguised it.  Governments told us that the tax cuts were funded by growth, when in fact they were funded by debt, and hidden by financial engineering.

Whether you agree that underfunded tax cuts were the cause or not, we will all have to accept that if we want to repair the damage we are in for a long period of tax rises. 

Hopeless

Michael Gove was right. Maybe we shouldn’t trust experts?

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I met Paddy MacAloon from Prefab Sprout today, in the food hall at Fenwick. He looks like Gandalf.   

As well as being one for the greatest song writers of the 80s he had a rather cool looking man bob, which as a young man I decided to copy.  The 80s man bob hasn’t aged well, particularly if like me you have a touch of ginger.

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At the time that I was growing my floppy hair I was studying Economics at Warwick as an undergraduate.  I was so good at it that I graduated with a History degree from Liverpool University.

In fact I was a rubbish economics student.  Admittedly some of that may have been lifestyle choices I made at the time, but I just didn’t get it.  I went from being great at Economics A level to being totally lost with undergraduate studies.   

At the time we spent a lot of lectures and seminars studying a set of ideas which would later become lumped together as neo-liberalism, chief of which was the efficient market hypothesis. I am not really sure how much we should regard neo-liberalism as an actual ideology, or really just a way to describe an assortment of techniques used to move resources from poor to rich.

The efficient market hypothesis states markets are inherently more efficient at allocating resources, setting prices and volumes than any other system.  It is based on the assumption that people are inherently rational.  The freer the market, and the more rational the participant, the more efficient it is.

The attraction of the hypothesis is because it is easily understood and you can think of examples from everyday life where it works well… like buying fruit and veg in the market. 

Somewhere along the line the hypothesis bit became forgotten, and despite being really hard to actually prove it became accepted as true by economists and politicians. 

Because it was such an easy to understand idea it was introduced as a fits all solution.   Where markets did exist, like financial markets, they were de-regulated to make them freer and more efficient.   In areas like healthcare markets were introduced, despite the high risk of market failure.   Transaction costs soared, as gangs of contracts managers, outsourcers and commissioners were recruited. 

When Margaret Thatcher came to power management cost in the NHS was about 6% of budget. By the time she had introduced the internal market and Unit General Management they were 12%.   Given how stingy the uplifts to NHS budgets were during her era it is shocking that so much of it went into administration.

I spent 20 years in the public sector most of which was spent as an intermediary – creating and administering markets for public services, most of which would have worked at least as well without me.   That doesn’t mean that my time was wasted, just that the system could have deployed my talents a lot more usefully.  Despite being awful as an Economics student I was naturally gifted at creating and administering markets for public services, mainly because I ignored all of the guff about rationalism and just kept everything brutally simple – do what I tell you and I give you money.

The problem with EHM at it’s core is that people just aren’t as rational as the theory would like us to think. 

Back end of last year I was looking for a new pump for the distillery on Ebay. Ebay is the closest to a perfect free market that we are ever likely to encounter.   I spent ages comparing price, specification and ATEX rating (the ability of the pump to operate in contact with explosive gases like Ethanol with causing an explosion).   

In the end I got bored and bought a new pair of swimming goggles instead. 

I bought my new pump a few days later from Durham Pumps (the North East’s number one pump supplier in my opinion), not because they were particularly cheap, but because they have an old bloke who knows loads about pumps, and has a massive box of old parts so that he can fix pretty much any kind of commercial pump no matter how old. 

Also because I find the name Durham Pumps childishly funny.

We are not rational utility maximising consumers, but a mess of conditioned responses, emotions, and aspirations.  Sometimes we are so predictable that our actions can be guided by Google algorithms.  At times that makes us predictable, other times hard to guess.   Sometimes were act in a way that Economists would never predict, particularly when we act in groups, sharing ideas, debating.  We are easily swayed by arguments that economists regard as irrational, particularly in the internet age.  Predictability and rationality might not be the same thing.

What this means is that predictions based on efficient markets and rational utility maximising participants don’t always work, no matter how prevalent these ideas are among economists.  Rational people wouldn’t have celebrated Brexit by borrowing loads of money to buy brand new, big engined Diesel cars.  But they did, and the boost to consumer spending helped turn a recession into a palid form of growth.

Maybe I am being unfair to economists, after all there are plenty of them who don’t agree with the Efficient Market Hypothesis, and who don’t have a mechanistic version of rationality baked into their thinking.  The problem is that the economists who matter – those who advise Governments, big Companies, and appear on TV, too often do.   This is the consequence of the way business and Academic Economics have blurred.  A relative of ours was lucky enough to graduate recently from Harvard in Economics.  He recognised the right wing bias in what he was being taught but believed that was a natural feature of economics departments because of their close relationships with the big companies who funded their research and hired their graduates.

Free markets in people are the worst of all for unpredictability and market failure.   If people don’t act rationally when they are buyers and sellers then rational action is even harder when you are the commodity being bought and sold.    That’s why markets in people need to be regulated more than markets in products

It is also why free movement of people within the EU has produced so many problems, and so many examples of market failure.   The demands to regulate free movement are really just demands to regulate the market in people to prevent people suffering the consequence of market failure.

For some reason both major political parties are going into the General Election with daft policies; The Conservatives/UKIP want to de-regulate the Labour Market, but tightly regulate entry into the Labour Market from outside the UK.   Labour want to de-regulate entry into the Labour Market from outside the UK, but reintroduce regulation into the Labour Market.   Both are equally preposterous.

Don’t get me wrong – I hate the idea of more government regulation as much as the next small businessman, and I benefit from being able to hire from the widest possible pool of workers.   And I like the idea of free movement, because I am in internationalist.   

But the whole concept of efficient markets is flawed, and nowhere are the consequences of market failure more obvious than in Labour markets.   

The distrust of experts that Michael Gove tapped in to so successfully is a conflation of 2 things.    

The first is the belief that life, not books, is the best teacher.  Clearly this is a dictum of limited value – there are lots of things where  book learning is essential;  brain surgery, building suspension bridges, designing aircraft.   But this does tap into a real truth – that academic learning is far divorced from most people’s ordinary lives, particularly in fields like social sciences.   Middle class economists study the lives of working class people with the same patronising detachment that white anthropologists used to use when studying people with darker skin tones. 

The second is the sense that independent experts aren’t really as objective as they claim. They have their own agenda, often shaped by business and academic norms – pro-market and socially liberal.   To people outside of these institutions these seem less like timeless truths or eternal values, and more like fashionable things to say.

Chancers like Michael Gove are able to tap into popular distrust of experts because people instinctively had worked out that their objective opinions are simply another persons agenda dressed up in fancy language, annunciated by people with no connection with their lives. 

The agendas that lots of economists, both academic and popular, promote was formed in the 1980s. Post Credit Crunch it looks like the intellectual equivalent of my man bob.