A2: Assess the view that a structural deficit is a more serious issue for a country than a cyclical deficit. 20 MARKS

A2: Assess the view that a structural deficit is a more serios issue for a country than a cyclical deficit . 20 Marks

It has been said that the UK is suffering a large structural deficit as before the great recession when the UK was at trend growth of 2 per cent per year tax revenue raised was insufficient to meet Government infrastructure (social capital) spending on Health, Education and transport. So even if the UK returns to trend growth there will be a permanent need for the government to borrow which may crowd out the private sector. By crowding out the private sector private companies may struggle to borrow money at low rates so this will damage UK levels of Investment and lower UK trend growth. In addition private health care may not be able to replace NHS provision for those that can afford to pay. The permanent nature of this problem means that a structural deficit is more significant than a short-term cyclical deficit.

However given low business confidence there is no private sector Investment to crowd out. Also the Bank of England’sQuantitative easing programme has provided more loanablefunds boosting the money supply availavle to private firms to borrow at low rates of interest in theory.

A cyclical deficit is when government is forced to borrow during a recession due to government spending on benefits automatically increasing and tax revenue declining as unemployment increases, wages fall and firms make a lower profit. This may not be a problem for the UK as a cyclical deficit acts as an automatic stabiliser – preventing a collapse in consumption and thereby stopping a deep recession, as in the case with Germany where benefits represent 2/3rds of average wages. By its nature a cyclical deficit will be followed by a cyclical surplus as the economy recovers and booms. As more people get a job tax revenues should automatically rise and government current spending on benefits fall. So a cyclical deficit means that businesses should not fear a tax rise in the future; however a structural deficit by its permanent nature may mean that businesses are put off increasing spending on new capital (Investment) as they fear a future government increasing business taxes to reduce the structural deficit.

However businesses may acknowledge that the structural deficit is needed to spend more on health, education and transport to lift UK’s trend growth through increased productivity and thereby National Income. Once these improvements have been made Government may no longer need to continue spending on building new roads, high speed 2 or hospitals/Schools. Also FDI may only be interested in short term profits and not fear future tax rises. Furthermore tax rises do not guarantee a rise in tax revenue according to the Laffer Curve – so firms may not need to fear a rise in business tax rates.

Finally a Cyclical deficit may be more serious than a structural deficit for the UK as we continue to live through the great recession. Even though the UK economy grew at 3% last year the UK economy has only recovered the position it was in terms of Real GDP in 2007 – we are nowhere near where we should be as an economy if trend growth had been maintained over those years. Furthermore there is still evidence that short term growth in the UK is weak with recession in our major export market. This means that the UK continues to have a cyclical deficit of £100 billion a year as tax revenue raised is low with firms making little profits , wages frozen and many workers on zero hour contracts. To achieve the golden rule that the budget should balance over the economic cycle would means that the UK may have to grow at over 3% for the next decade something very unlikely.

However it is very difficult to separate out a cyclical deficit and a structural deficit  or to define precisely what is the structural deficit e.g what if UK’s trend growth was now 2% rather than 1%. Also from 97-07 the UK did experience decade long growth (the NICE decade) so it could have run a cyclical budgget surplus then; the fact it did not perhaps does suggest the strructural deficit is a more serious issue. The Labour Government did though  see its spending on building more

Hospitals and Schools coming to an end in 2010 so again the issue of what is a structural deficit is debatable.