Seems like we’re “generation debt”: all we hear is student loans, overdraft and stuff about UK’s budget deficit – which is apparently around £90 billion… but what does this actually mean?
The deficit is the gap between the amount the government spends and what it receives in taxes. It’s different to the national debt which is the total £££ the UK owes to investors from the UK and other countries.* (FYI we owe a lot to America).
Each year the government spends money on things like schools, the NHS, the army and benefits. This money mostly comes from taxes collected by HM Revenue and Customs.
The Chancellor of the Exchequer (currently George Osborne) is in charge of the country’s finances. They set the budget each year which outlines how much we pay in tax, and what gets spent where (we explained how the budget works here).
If one year the government collects £100 in tax but spends £150, then the deficit would be £50.
Alternatively if £100 is collected but only £80 is spent then the government would have £20 left over at the end. This is called running a budget surplus.
In real life we’re talking a lot more money than this. The UK deficit is currently around £90 billion.
Since the global financial crisis of 2008, “deficit” and “borrowing” have become dirty words. Understandably, the public don’t seem to like the idea of irresponsible governments overspending.
How the financial crisis happened;
Financial crisis in a nutshell; the banks ran out of money – the government had to lend them money.
The Conservatives claim that the current deficit is all Labour’s fault, as the previous Labour government was running a deficit at the time of the financial crisis. Expect to hear this a lot around election time.
Considering all this, it may surprise you that running a deficit is the norm for a lot of countries.
Whilst it is true that Labour was running a deficit before the crash, they had previously ran a budget surplus between 1998 and 2001. Before that point the UK (under Conservative rule) had run deficits each year since 1975 (with the exception of three years between 1988 and 1990 where there was a small surplus).
Many well-respected economic experts like former Bank of England governor Mervyn King and senior Treasury official Nicholas Macpherson suggest that the banks are more to blame for the current situation, rather than Labour overspending.
However, increased government borrowing during the crisis (partly to save the banks, partly to pay for benefits as more people lost their jobs) meant the UK deficit shot up from around £34.5 billion to £90 billion and continued to climb. Ouch.
The Conservatives promise to cut the deficit and deliver a budget surplus by 2020.
Chancellor George Osborne’s austerity programme was supposed to bring the deficit down. In simple English: lowering government spending. Some of the austerity measures have proved controversial; such as cutting tax credits.
Rather than making cuts, some argue there are other methods to reduce the deficit. This include closing loopholes so that big businesses and non-doms pay the right amount of tax, and investing in public services.
The economist JM Keynes suggested something similar during the Great Depression of the 1920s. The idea was use unemployed workers to work on public projects. The workers would start spending their wages, which would get the economy moving again.
Is the Conservative 2020 deadline achievable? George Osborne’s original plan was to eliminate the deficit by 2015, but missed this target; managing to reduce the deficit by half.
This means that although public spending is coming down, the UK is still overspending and doing nothing about our national debt. Are you sitting down? The UK national debt is currently around £1.5 trillion. Wowzers.
Don’t panic though – the International Monetary Fund thinks the UK can survive with high levels of debt forever. Phew.
Current Chancellor George Osborne has created the Fiscal Charter. It’s a proposed new law which bans the government from creating a deficit in “normal” circumstances. This is defined as when the economy is growing healthily.
On paper this sounds like a sensible idea, no?
However, if the charter is passed it would make it harder for governments to borrow money for public investment. Why is this bad? Labour List explains in language we can understand:
“No one thinks it is wise to max out the credit card to pay for the weekly grocery bill, but just as families have a mortgage to pay for their home, so it makes sense to borrow for the infrastructure – like broadband, transport, scientific facilities for universities – which will increase our economic productivity and growth.”
However, perhaps it’s not a good idea to compare economics to your household budget;
So, what’s the answer? Suggestions on a postcard, please.
It’s hard to know who to believe. It’s even more confusing when politicians disagree over whether spending more than your income is good or bad.
What we do know: lending and borrowing is risky, so you had better be sure people can pay it back.
Will the Fiscal Charter work? Think we’ve missed something? Let us know in the comments below or email email@example.com
China’s economy is slowing down and the Chinese Stock Market is about to crash. What does this mean for the rest of the world?
Economy; “the state of a country in terms of the production and consumption of goods and services and the supply of money within the country”
So a strong economy is one which grows at a stable rate, increasing the amount of money in the country. A weak economy is one that is unstable and may shrink, decreasing the amount of money in the country.
The Chinese economy is made up of a vast amount of goods and services – just think how many technological goods, clothing and cars are produced in China. China has a population of around 1.3 billion people and Chinese labour costs are exceedingly low. These factors make China’s economy the second largest in the world (the USA is the largest).
For the past few decades the Chinese economy has been steadily growing by around 10% each year. That all changed this summer. Economic growth slowed down and the Chinese Stock Market saw a massive drop in value.
The Chinese economy relies on investment from other countries. This is because it’s economic model is based on exports. This means selling goods and services to other countries.
China is the largest exporter of goods in the world. The export model means the majority of Chinese goods are exported to other countries, rather than being consumed and used within China itself.
This doesn’t mean that goods made in the country can’t be sold to the Chinese people, but for the moment most companies are focusing on selling abroad. China’s top export products include computers, telephones and office equipment. Last year China’s exports were valued at $2.34 trillion. Wowzers.
Like China, other Asian countries like Japan, Thailand, Indonesia and South Korea use the export model to make money and increase living standards. Nevertheless there is and was a catch: the model is not sustainable.
The Export model made China one of the leading economies in the world. It aims to bring money into the country by industrialising. For China this meant encouraging investors to build factories and transport links in order to build and sell even more products.
China encouraged foreign investment from other countries by establishing “special economic zones” in the 1980s. These zones are areas in the country with special tax benefits for foreign investors. Offering lower tax rates to companies means they are more likely to set up shop in the country.
Foreign investment means more money coming into the country. China’s low wages means manufacturing costs are kept low, meaning more profit for businesses. However, as the China Business Review notes, it didn’t matter how cheaply China could make things as “developed economy demand for manufactured products cannot increase without limit”
In plain English: eventually there will be a limit to what other countries can afford to buy from China.
The Economist agrees that the model is “only a part of the answer to establishing a sustainable economy”.
Economic strategist Patrick Chovanec explained to the Washington Post how “after the financial crisis in 2008, there were signs that… other countries could not afford to go deeper into debt to consume that much. So you started to see a significant falloff in Chinese exports”.
Meaning: China’s exports were dropping, as countries couldn’t afford to buy as many Chinese goods. Given the Chinese economy depends on exporting to other countries; this was a big problem.
To understand Chinese government’s plan to boost the economy we need get our heads around the Stock Market. Don’t panic if you didn’t study business (we didn’t either).
Businesses need money in order to expand and grow. To raise this money quickly the bosses sell off part of the company.
One way of doing this is to sell shares in the company. A share is literally a share in the ownership of the said company. The more shares you have, the more of the company you own.
Think: Dragon’s Den (Shark Tank if you’re American).
Investors buy into the company by purchasing shares. The company uses the cash they receive to grow and expand. Investors hope that the value of the company will increase. If it does their shares (the part of the company they own) also become more valuable.
This is sometimes called owning Equity or Stock in a company.
Shares are bought and sold on Stock Markets. Some, like the New York Stock Exchange, are actual locations where stock traders meet to buy and sell. Others, like the Nasdaq, are virtual market-places where traders complete deals via computer.
After the Global Financial Crisis China’s economic growth began to slow. Within a few years the growth had dropped from 10% to around 7%. This seems like a small change but it was not good news for China.
The Chinese government wanted to boost economic growth. One of their ideas was to change the rules of the Chinese Stock Market. For the first time many ordinary Chinese citizens could buy shares in companies.
Chinese government thinks: more local investment = bigger economic growth.
Government-owned media (newspapers, TV, radio) encouraged people to invest. Many Chinese families borrowed money to buy shares, or invested their savings. They hoped that their shares would eventually grow in value. Between 2014 and 2015 more than 40 million new stock market accounts were opened. However, many of these new investors had no understanding of the financial market. Doesn’t exactly sound like a recipe for success.
As millions of new investors started placing borrowed money into the stock market, share prices were pushed up to inflated levels. The Chinese government realised that allowing people to buy all these shares with borrowed money was a bad idea.
First, if people ended up losing money by making a bad investment then they would then owe a lot of money. Second, these inflated prices were bound to drop at some point.
When they eventually did, investors panicked and sold off their shares to pay back the money they had borrowed.
This mass selling pushed share prices down even further and in June 2015 the market crashed downwards. The equivalent of $3 trillion was lost as a result of the drop in share prices. Not a good day to be in finance.
The government tried to encourage business by reducing the value of the Chinese currency, the Yuan. This was meant to make Chinese goods cheaper, encouraging other countries to buy them. So far it hasn’t worked. Investors around the world still fear the problems in the Chinese economy will spread abroad. This isn’t just paranoia BTW; it could actually happen.
At the moment only 1.5% of Chinese shares belong to foreigners. Despite this fact, the slowing of growth in the Chinese economy and their recent stock market crashes are affecting financial markets in the UK, Europe and America. Put simply: when the Chinese economy goes a bit wobbly, we all feel the effects. Yes, “wobbly” is a technical term.
The BBC reports how stock markets in London, New York and Paris are also seeing drops in value. The value of the FTSE 100 (the UK’s top 100 companies) dropped by around 5% – the largest fall in value this year. These British companies lost the equivalent of £60 billion as a direct result of China’s economic problems.
To recap: there is strong evidence to suggest that China’s export model isn’t working. Economists argue China needs to switch to an economic model called Domestic Consumption (whoever said economics wasn’t sexy?!). In this model goods and services created in the country are bought and used within China.
To achieve this the Chinese government needs to encourage Chinese people to consume more. For example; they attempted to increase the number of washing machines sold to Chinese people in rural communities by distributing coupons and offering a discount.
We’ll have to wait to see if the issues in the Chinese economy lead to trouble around the world. But things don’t look good.
RBS Sale Explained; Why is the government selling Royal Bank of Scotland?
Bankers like risk.
Financial Crisis in a Nutshell: The US market had lent BIG amounts of dollar to people in risky subprime mortgages (given to people with bad credit ratings). Basically, they shouldn’t have risked so much.
When people started defaulting (failing to pay back money owed) on their mortgages, the banks, like Royal Bank of Scotland, should have been able to cover the losses with their capital (AKA savings). But they didn’t have enough saved. Bummer.
The Labour government decided to save Royal Bank of Scotland by buying up shares in the bank. This meant RBS was declared solvent (able to pay your own way) and was able to get emergency funding from the Bank of England to keep going.
RBS was now essentially publicly owned; the UK government owns around 80% of RBS shares. By pouring money into a bank bailout, they hoped to prevent the bank from failing; which would have led to job losses and depositors losing money. In total around £107.6 billion of taxpayer’s money was spent on sorting the banks out.
The government spent £46 billion buying shares in Royal Bank of Scotland. Now a report by independent financial advisers, Rothschild, states that now is the best time to have an RBS sale to start selling the shares.
The small print: because the values of the RBS shares have dropped since they were bought, the government is set to make a loss of £7 billion on the RBS sale.
But because the other banks the government have bailed out have done better; the government is actually set to make a profit of £14 billion. Eventually.
Even though the government is making a profit, they will still be £7 billion down after the RBS sale. So they’ve lost money from bailing out a bank which didn’t do the best job of keeping our money safe. That’s £7 billion which could have been spent on other things.
But as we said, the government is estimated to make a profit overall. So it could be a lot worse.
People have blamed the bankers for the financial crash, others have blamed the government for not putting enough regulation in place to stop this from happening.
Change is coming; we explored how the new rules mean HSBC is separating its high street branches from the investment side of the bank.