How useful are comparisons of different countries budget deficits?
Definitions of what a budget deficit is and how to calculate it as a proportion of GDP are fairly easy to find. What is confusing however, is when and how to compare the deficits of different countries. This has become a much enjoyed game of politicians engaging in justifying austerity programmes since the ‘Great Recession‘.
An example is the practice of some UK politicians to compare the UK’s deficit to that of Greece or Ireland to justify implementing similar policies of cutting government expenditure.
Are budget deficits alike enough to make direct comparison useful? Or is an approach of greater depth required?
It’s best to start with a brief overview of what budget deficits are and how they are measured.
A budget deficit happens when a government’s expenditure, on such things as health care, defence and interest on debt, exceeds its income through taxation and other earnings. For convenience, the figures are usually quoted as a percentage of GDP. Budget deficits should not be confused with National Debt, which is the total amount of debt owed.
Direct comparisons between the budget deficits of different countries can be misleading. This is especially the case when trying to use the comparisons to argue that a particular deficit is too high however an alarming picture pundits may paint.
When trying to judge the affordability of a deficit it’s worth bearing the following criteria in mind:
- Ability to pay the debt. Can they afford the repayments on the debt?
- The sustainability of the debt levels. How secure are their circumstances over the period of the repayments?
- Robustness to internal or external shocks. How resilient are they to events such as natural disaster and recessions?
When comparing deficits between countries, it’s important to remember that not everything in the universe is an apple. In other words, very few things are exactly alike and comparing deficits carry the danger of comparing apples and pears. The example below uses an analogy to illustrate the point.
Take two workers. One earns £1000 per week with outgoings of £1200, a deficit of 20%. The other worker earns £200.00 per week with out goings of £210, a deficit of 5%. Which one would better sustain payments on a £5000 loan?
Comparisons become even more difficult when looking at economies of different sizes and balance. The UK for instance is biased towards the finance and service sectors with a declining manufacturing sector. Ireland on the other hand, appears better balanced with service and manufacturing sectors of similar proportions but it’s the Irish economy that’s in intensive care.
There is an important difference to remember between individuals, companies and governments when using analogies to discuss budget deficits. Governments can grant themselves binding pay rises at will by raising taxation. They can also switch on the photocopiers and print their own money…