Monday, March 24, 2014

What Is ... the difference between a Debt and a Deficit?

Sometimes it is easy for me to take my understanding of basic economics for granted. Having written articles explaining things like Credit Default Swaps, Information Asymmetry and Fiscal Multipliers in this series, it is a bit of a step down to explain the difference between simple economic concepts like debt and deficit, but I have two good reasons for doing so.

Reasons for writing this

Firstly, the education system in the UK has denied the vast majority of state schooled children an education in the economic fundamentals. The 7% of kids that attend private fee paying schools are much more likely to receive a basic education in economics at a young age, then to attend Oxford University universities in order to study Politics, Philosophy and Economics (which has represented an open door to political power to countless politicians ranging from honourable politicians like Tony Benn, all the way down to untrustworthy spivs like David Cameron).

Without the basic grounding in economics that the children of the wealthy tend to receive, many ordinary people go though life, by no fault of their own, as functional economic illiterates.

The second reason is that even people in positions of power that should know this absolutely foundational economic stuff get deficits and debts confused. One of the prime examples being the Tory MP Claire Perry, who proclaimed debts and deficits to be "the same thing" during a Radio 4 interview in 2012.

The ordinary man or woman in the street has an excuse for this kind of confusion (having never received an education in the economic fundamentals). Claire Perry MP has no such excuse having worked for two banks (Bank of America, Credit Suisse) a major management consultancy firm (McKinsey), an advisor to George Osborne (2006-2009) and an economic spokesperson for the Coalition government. It is no wonder that the economic system failed so spectacularly in 2008-09, and that George Osborne's economic plans have been so ruinous if a person can have a career like that without apparently knowing the fundamentally basics of economics.


I find that the best way to explain the difference between a debt and a deficit is through the use of a simple driving analogy.

Lets imagine that the speed of the car is the debt and the rate of acceleration is the deficit (the rate at which the debt grows).

If you put your foot hard to the floor (run a high deficit) the speed of the car (the size of the overall debt) increases rapidly. If you apply the accelerator gently (run a small deficit) the speed of the car (size of overall debt) still increases, but at a slower pace.

Once you are aware of this, the true meaning of the Tory bluster about how they've "cut the deficit by a third" becomes clear. It is an open admission that they are still borrowing ever more money, and they've not even halved the rate of borrowing that was going on during the incredible fallout from the biggest financial sector insolvency crisis in human history (2009-10). They just seem to be hoping that people are too economically uneducated to read between the lines of their bluster about the cuts they've made.

Returning to the car analogy, the Coalition government still have their foot on the accelerator quite hard, but they're trying to convince their passengers (the public) that the car is getting slower with misleading narratives about how they are "paying down Britain's debts" to quote David Cameron verbatim

Anyone who claims (as Claire Perry did) that a debt and a deficit are "the same thing" is essentially saying that the speed of our hypothetical car and its rate of acceleration are "the same thing". For someone actually working in the field of economics to make such a ludicrous claim is akin to a physicist (lets say a NASA engineer) not knowing the difference between the speed and acceleration of the space flight he's supposed to be plotting the trajectory for.

When George Osborne came to power in 2010 he made two claims repetitively. That he would eliminate the budget deficit via his ideological austerity experiment, and that he would protect the AAA credit rating of the UK economy. He has failed dismally to achieve either of those objectives. According to his latest (still fantastical) projections, the deficit won't be eliminated until 2018-19 (well into the next parliament) and under George Osborne's watch the UK has been stripped of its AAA credit rating for the first time since the 1970s.
The fact is that George Osborne has already borrowed more money in under four years than New Labour did in the preceding 13. Another fact is that by 2015 Osborne will have racked up a mind boggling £207 billion more in debt than he projected he was going to back in 2010.
  It is absolutely no surprise at all that "Osbornomics" has failed so demonstrably, given that he himself has no formal economics qualifications, and his economics adviser between 2006-09 is apparently so economically illiterate that she thinks a debt and a deficit are the "same thing".

To illustrate exactly how clueless the Tory shadow treasury were at the time Claire Perry was Osborne's economics adviser, it is worth noting that George Osborne was still describing the Irish economy as "a shining example of the art of the possible in policy-making" and explaining how the UK should emulate them in 2006. Osborne's Irish eulogy came just 2 years before the Irish economy imploded catastrophically, and just 4 years before Osborne himself had to sign off on a £7 billion bailout for Ireland because their "shining example of the possible" had revealed itself to be a classic illustration of a crony capitalist Ponzi scheme scaled up to the national level.


I hope that after this explanation you have a better understanding of the basic difference between a debt and a deficit (and a handy little analogy to remember it by). I hope you also appreciate how utterly scandalous it is that a Tory party economics adviser could be so clueless as to confuse these two very basic economic concepts, and even claim that they are "the same thing". 

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Explaining the failure of "Osbornomics"
What is ... Capital Flight?
What is... Fiscal Multiplication?
The economic case against tax-dodging

Who is to blame for the economic crisis?
George Osborne's economic extremism
The Tory ideological mission
What is a ... Credit Default Swap?

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