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Running a Government Budget as if it Were a Household Budget Is Bad Economics

06/16/2015 11:31 am 11:31:28 | Updated 15 June 2016

George Osborne's plan to enshrine permanent budget surpluses in law, I expect, will chime favourably with many people. The reason is simple; most of us look at financial matters in terms of our family finances. The argument that as a family: "wouldn't you want to pay your debts and live within your means" is a very appealing proposition. However, there is a fundamental difference between running a household budget and a government budget.

I intend to rely on my engineering and science knowledge to show the difference. In science if you want to study the behaviour of a system under different conditions, you put a boundary around it and examine its interaction with its surroundings. For a household, let us put a boundary around the house (the system). Money flows through the boundary into the house by what the family earns and out of the house by what the family spends.

It is obviously desirable to have these balanced. Most families, however, will still be in debt, primarily in terms of a mortgage to buy their house. No one would suggest that a family should wait until they saved the whole value of the house before they bought it. Student members of the family would also incur debts to finance their higher education. So having debts to invest in the future of the family is necessary and desirable.

If we look at the government budget, our system is now the whole country, and the government is within it. Government money comes from other parts of the system in the form of taxes. The amount it gets depends on the economic activities within the country. Part of that money it then spends on infrastructure and education that make it possible for the economy to flourish. Other spending on the NHS, welfare, police etc. is necessary for a functioning civilized society.

If producing budget surpluses becomes the economic goal enshrined by law to be achieved, come what may, actions taken to achieve that could dampen economic activities within the system (the country) to the extent that government revenues would drop by more than the money it saves through cutting its spending, consequently increasing government debt rather than reducing it. This is in addition to the hardship caused to the poorest and most vulnerable members of our society.

A letter to the Guardian signed by 77 leading economists explains the danger to Britain's economy thus:

"The government's budget position is not independent of the rest of the economy, and if it chooses to try to inflexibly run surpluses, and therefore no longer borrow, the knock-on effect to the rest of the economy will be significant. Households, consumers and businesses may have to borrow more overall, and the risk of a personal debt crisis to rival 2008 could be very real indeed... The plan actually takes away one of the central purposes of modern government: to deliver a stable economy in which all can prosper. It is irresponsible for the chancellor to take such risky experiments with the economy to score political points. This policy requires an urgent rethink."

Running the government budget is fundamentally different from running a household budget. Simplistic dogmatic wheezes, such as enshrining budget surpluses in law, could cause real damage to Britain's economy. Mr.Osborne, please listen to the advice of experts and bin the policy.