New words spell out a new world order

THERE are new words in the economic air. People are now talking about the threat of "deflation" instead of "inflation". In East Asia the word "tiger" has been replaced by "default". And last week, in America, the word "deficit" gave way to "surplus".

Remember all the agonising that took place about America's twin deficits - the deficit on the balance of payments and the deficit of the Federal government? Well, the first continues and may well become a serious worry again next year. But the Federal deficit seems to be disappearing in a puff of smoke. A few days ago President Clinton said that the deficit this fiscal year (which ends on 30 September) would be below $22bn. Now the Congressional Budget Office has forecast that the deficit for the next fiscal year will be only $5bn, well within the rounding error, and that there would be a decade of surpluses totalling as much as $138bn by 2008.

So the US is not struggling to get its budget deficit below 3 per cent; it is trying to stabilise it as a percentage of GDP over the economic cycle. If the projections are right it is effectively in balance, and as a result the US national debt as a proportion of GDP will fall steadily.

Of course, this may not turn out to be the case. The projections are based on a continuing strong economy and at some stage during the next 10 years it would be astounding were there not to be another recession. Remember in the late 1980s when Britain was running a fiscal surplus and people talked of the National Debt disappearing? The last recession soon solved that problem.

Still, the improved US fiscal outlook will have a profound practical impact on the attitudes towards government in general. It will, I think, come to be seen as normal for governments to keep their finances in surplus, or at least in balance, just as it was normal for them to do so in peacetime until the early 1970s. Running a balanced budget is closely associated with stable prices, for in a world of stable prices you cannot rely on inflation to reduce the real value of the debt.

So with the move of the US towards balance, we are catching an early indication of a big, big shift in attitudes. Just as we now no longer believe it appropriate for elected governments to have much influence over interest rates - countries signing up to EMU accept that governments should have no say at all - we are moving to a world where governments may have little influence over their ability to borrow. If they wish to spend more money, they will have to raise it in taxation.

To get a long-term perspective on the size of the national debt relative to an economy, look at the left-hand graph. The general pattern is for debt to fall in peacetime and rise during wars. Thus UK and US debt fell during the second half of the last century (in the US case after the Civil War) while that of Japan rose during its war with Russia. UK debt shot up during both world wars, while the US and Japanese also rose during the Second World War. A "normal" level of debt to GDP in peacetime would perhaps be 50 per cent, and the peaks of above 100 per cent (and above 300 per cent in the case of the UK in 1945) clearly have to be wound down fast.

This rule-of-thumb that anything around 50 per cent is all right seems to suggest that neither the US nor the UK has much of a problem at the moment - both are between 50 and 60 per cent - although Japan has an emerging one. But there are two powerful reasons to question this.

The first, noted above, is that much of the post-1945 cut in debt ratios has been the result of inflation whittling away the real value of debt. That isn't going to happen in the future. So cutting debt levels will have to be done the hard way, by running something close to balanced budgets. Britain spent a century from 1815 to 1914 paying off the cost of the Napoleonic wars.

The second, maybe more important, is that demography is no longer helping the fiscal position. A rapidly expanding population will, in a developed country at least, usually bring rapid economic growth. A young population will mean that there is a relatively small proportion of dependants relative to people of working age. The growing responsibility taken on by the state for underwriting the welfare of the old exacerbates this problem.

Some implications of an ageing population on the fiscal position of different countries is shown in the right-hand graph. These figures were published last summer by the OECD and do not fully pick up the latest US position. But you can see how US national debt stays pretty well constant as a percentage of GDP through to about 2010 without any increase in taxation. Thereafter it climbs away. Here in Britain we need slightly higher taxation, though the small increases put through last year by Gordon Brown may be enough.

Germany, too, does not have too much of a taxation problem until about 2020, but thereafter the tax burden goes through the roof. (The plan for Germany to put up its VAT rate this year is an attempt to take early action to stop its social security deficit getting out of control.) Japan has the gravest problem, with its rapidly ageing population. It already has the largest fiscal deficit of any G7 country and faces catastrophic rises in taxation within the next 10 years just to keep that debt from rising still further.

Of course one should take these figures with a pinch of salt. They are only projections - what might happen if nothing is done. Lots of things can be done: careful trimming of present spending plans, privatisation, user charges for public services, and so on. But I think the big message is that the world will be looking to the US experience of a balanced budget - if it occurs - as a model. The only way a country like Japan can avoid a catastrophic fiscal situation in less than 10 years' time is to start taking action now. If this runs counter to the present conventional wisdom that Japan needs a government-led fiscal reflation programme, then maybe the conventional wisdom is not so wise.

The move of the US towards surplus is not the only fiscal surprise of the last two or three years. There has been another: the relative ease with which European nations have cut their deficits to meet the Maastricht 3 per cent target. That target is far too lax; they will have to cut deficits much further in the next few years. But at least they have shown that things can be pushed in the right direction.

Looking ahead, it seems to me that most of the developed world faces fiscal strains of similar magnitude to those which many countries faced after a war. Instead of the pressure coming from war, it will come from demography. The absolute levels of indebtedness are lower, but they still need to get about 3-5 per cent of GDP into taxation or out of public spending, less in the US, more in Japan. We will have a generation or more when the public sector is short of cash relative to the demands upon it.

That will lead to a whole series of changes in the way politics operates. You can see something of that in the US and UK at the moment: politicians seeking votes not by promises to spend, but rather by promises to not to spend. Politicians are becoming proud to be prudent. I expect that if the US does indeed run a budget surplus, that will become the new norm which other nations will be forced by financial market pressure to adopt. Even small levels of borrowing will be frowned upon, forcing politicians to get as many projects as possible funded by the private sector. That will alter still further the relationship between government and business, while voters will look to business to solve problems, not government.

But first, the US has to get into sustained surplus. The "sustained" bit is the hard part. If UK experience is any guide, staying in a state of virtue is a lot harder than briefly achieving it.

Suggested Topics
The data shows that the number of “unlawfully” large infant classes has doubled in the last 12 months alone
i100Mike Stuchbery, a teacher in Great Yarmouth, said he received abuse
Arts and Entertainment
The starship in Star Wars: The Force Awakens
filmsThe first glimpse of JJ Abrams' new film has been released online
Rio Ferdinand returns for QPR
sportRio Ferdinand returns from his three-game suspension today
The Speaker of the House will takes his turn as guest editor of the Today programme
arts + ents
ebooksNow available in paperback

Watch the spoof Thanksgiving segment filmed for Live!
Billy Twelvetrees will start for England against Australia tomorrow with Owen Farrell dropping to the bench
rugbyEngland need a victory against Australia today
Arts and Entertainment
The cover of The Guest Cat – expect to see it everywhere
Tyson Fury poses outside the Imperial War Museum in south London ahead of his fight against Dereck Chisora
boxingAll British heavyweight clash gets underway on Saturday night
i100 Charity collates series of videos that show acts of kindness to animals
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Austen Lloyd: Company Secretary

Excellent Package: Austen Lloyd: EAST ANGLIA - SENIOR SOLICITOR LEVEL ROLE** -...

Citifocus Ltd: German Speaking Client Specialist

£Attractive Package: Citifocus Ltd: Prestigious asset management house seeks a...

Citifocus Ltd: Performance & Risk Oversight

£Negotiable: Citifocus Ltd: This is a varied role focusing on the firm's mutua...

h2 Recruit Ltd: Sales Director - SaaS (SME/Channel) - £140,000 OTE

£90000 - £140000 per annum + benefits: h2 Recruit Ltd: Are you a high achievin...

Day In a Page

Homeless Veterans Christmas Appeal: ‘We give them hope. They come to us when no one else can help’

Christmas Appeal

Meet the charity giving homeless veterans hope – and who they turn to when no one else can help
Should doctors and patients learn to plan humane, happier endings rather than trying to prolong life?

Is it always right to try to prolong life?

Most of us would prefer to die in our own beds, with our families beside us. But, as a GP, Margaret McCartney sees too many end their days in a medicalised battle
Thomas Cook's outgoing boss Harriet Green got by on four hours sleep a night - is that what it takes for women to get to the top?

What does it take for women to get to the top?

Thomas Cook's outgoing boss Harriet Green got by on four hours sleep a night and told women they had to do more if they wanted to get on
Christmas jumper craze: Inside the UK factory behind this year's multicultural must-have

Knitting pretty: British Christmas Jumpers

Simmy Richman visits Jack Masters, the company behind this year's multicultural must-have
French chefs have launched a campaign to end violence in kitchens - should British restaurants follow suit?

French chefs campaign against bullying

A group of top chefs signed a manifesto against violence in kitchens following the sacking of a chef at a Paris restaurant for scalding his kitchen assistant with a white-hot spoon
Radio 4 to broadcast 10-hour War and Peace on New Year's Day as Controller warns of cuts

Just what you need on a New Year hangover...

Radio 4 to broadcast 10-hour adaptation of War and Peace on first day of 2015
Cuba set to stage its first US musical in 50 years

Cuba to stage first US musical in 50 years

Claire Allfree finds out if the new production of Rent will hit the right note in Havana
Christmas 2014: 10 best educational toys

Learn and play: 10 best educational toys

Of course you want them to have fun, but even better if they can learn at the same time
Paul Scholes column: I like Brendan Rodgers as a manager but Liverpool seem to be going backwards not forwards this season

Paul Scholes column

I like Brendan Rodgers as a manager but Liverpool seem to be going backwards not forwards this season
Lewis Moody column: Stuart Lancaster has made all the right calls – now England must deliver

Lewis Moody: Lancaster has made all the right calls – now England must deliver

So what must the red-rose do differently? They have to take the points on offer 
Cameron, Miliband and Clegg join forces for Homeless Veterans campaign

Cameron, Miliband and Clegg join forces for Homeless Veterans campaign

It's in all our interests to look after servicemen and women who fall on hard times, say party leaders
Millionaire Sol Campbell wades into wealthy backlash against Labour's mansion tax

Sol Campbell cries foul at Labour's mansion tax

The former England defender joins Myleene Klass, Griff Rhys Jones and Melvyn Bragg in criticising proposals
Nicolas Sarkozy returns: The ex-President is preparing to fight for the leadership of France's main opposition party – but will he win big enough?

Sarkozy returns

The ex-President is preparing to fight for the leadership of France's main opposition party – but will he win big enough?
Is the criticism of Ed Miliband a coded form of anti-Semitism?

Is the criticism of Miliband anti-Semitic?

Attacks on the Labour leader have coalesced around a sense that he is different, weird, a man apart. But is the criticism more sinister?
Ouija boards are the must-have gift this Christmas, fuelled by a schlock horror film

Ouija boards are the must-have festive gift

Simon Usborne explores the appeal - and mysteries - of a century-old parlour game