Labour has promised to reduce UK government borrowing in its manifesto, to be formally published tomorrow. The aim is, of course, to appear to be fiscally prudent and most people will accept that claim at face value, or not, depending on their prejudices and not on the basis of economic reasoning.
If economic reasoning is applied to the claim, however, the reality is that Labour cannot make such a promise. They can certainly state a desire. And it can state it will try to achieve it. But the fact is that as I have explained elsewhere, no government has any real control over the deficit it runs because how much a government borrows is largely dictated to it, and is not within its own control. That comes from holding the position of lender of last resort.
The reason is that there are, in macroeconomic terms four sectors in the economy and they must balance. The first is consumer spending. If consumers borrow more to increase spending then someone must lend it to them, or borrow less, as a matter of fact. That person who must borrow less might be business, who might invest less as they borrow less to compensate for more consumer borrowing, or it might be net overseas trade, or it can be the government. But the point is that the net lending and borrowing of these four sectors, consumers, business, overseas and government, will always balance, as a matter of fact.
So, frustrating as this might be to a politician who wants to appear to be in control of the destiny of their government and the state, the fact is that they have remarkably little control over how much they will borrow. If consumers insist on saving, as does business, and trade is running a deficit, (which in effect means foreigners are saving in Britain) then as a matter of fact the government will run a deficit whether it likes it or not. And there is nothing, bar stimulating business investment, exports, or consumer borrowing that they can do to change this.
So Labour can promise to reduce the deficit. But it's promise to do this through carefully costing its programmes does not, I am afraid, make complete sense because that is not what defines whether or not the government will run a deficit or not - because spending is only a part of the explanation of the deficit and this calculation ignores the revenue side of the equation, which is what these other factors impact. The promise has to therefore instead be matched by a macroeconomic explanation of what Labour will do to make consumers borrow more, business invest more or exports increase. Otherwise no such promise can be delivered without a counter-productive policy of raising tax if there is a decline in economic activity in the future, which no one would make.
That then inevitably leads to the question of what is the best way to stimulate all these activities that are necessary if the government is to spend less. The answer is, perversely for most people but accurately nonetheless, that the government must spend more - because that increase in spending increases consumer spending power, which encourages them to borrow, and that in turn promotes business investment and that in turn stimulates the innovation required to deliver exports. Which means the best way to cut the deficit is, literally, to spend. It is the only way to achieve the goal, and that is precisely why austerity has not worked because the process also works in reverse.
Fiscal prudence may be electorally popular; a fact that I do not doubt. Unfortunately though it is not what we need. I just hope Ed Balls fiscal rule on investment does allow the wriggle room to allow for the spending that is really needed despite the rhetoric, because that is essential.
And green QE does, of course, break all those rules, successfully by printing money and not borrowing it. But that's another story.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
I have to say that after becoming slightly more optimistic about Labour after the non-doms announcement last week, this new “budget responsibility lock” announcement has plunged me back into depression about the prospects for a Labour govt. I think it’s economically incoherent and will straitjacket Labour on economic policy. If there is another crash (which is likely) this rule means that they will have to *cut* spending – accentuating the cyclical impact of the crash! Crazy! And to think that Ed Balls started out as some kind of Keynesian. When I see Labour coming out with stuff like this I’m v pleased to be backing the Green Party in the election.
Howard
I have sympathy
Unsurprisingly I was on a bit of a high last week – things were going well
This is, as you say, a hostage to fortune and an impossible target to set
I don’t know why politicians are so good at setting bear-traps
Best
Richard
I’m very disappointed to see this this morning too. I had begun to feel more positive about Labour last week but this points to a very short sighted outlook. I doubt the SNP will be able to have much influence on them in this area since they are clearly desperate to prove they are fiscally ‘tough’ despite what the country may actually need. I am going to vote Green (for all the good that will do).
Maybe when the economic model produces outlandish conclusions such as the government has no control over what it taxes and spends, and the way to balance the books is to spend more, it’s time to question the assumptions in the model?
No, the model is right
It’s just people don’t realise government spending more raises more tax too – and that balances the books
I think it is very difficult for Labour to be seen to be borrowing as a large section of the electorate and the press do not understand the macroeconomics you are talking about or in some cases may not want to
In the recent leaders debate the three women leaders won the argument with regard to austerity comprehensively
It is a shame that the Greens have a few policies which appear slightly of a crackpot nature otherwise they would be a force to reckon with and could get my support
I had a ridiculous conversation with a a Tory voter yesterday who would not accept the points you are making only whingeing about leaving debts for our children I am proud of the new secondary school our new college and new walk in NHS centre in our town built between 2000 and 2009 which will benefit all our children and their children too.
I fully expect Labour to carry out much needed infrastructure enhancement it would be stupid not to do so with interest rates so low
I very much hope you are right – for all our sakes
Since the end of Bretton Woods and the rise of financialisation there has been a concomitant gnawing away of Government so that we have reached a point where they are largely puppets of the City in a way that is rather similar to the mid Nineteenth Century.
When the financial system crashes down again whoever is in power will ‘have to do something different’. But it looks like it will be that nice Mr Osborne again, when Mr Balls’ pronouncements will be irrelevant.
I too baulked at this – in this case Labour are trying to satisfy the so-called ‘wisdom of crowds’ being in this case that people see macro economics in the same terms as household economics.
Labour cannot have two masters surely? Beasts born with two heads usually die. I want to see real economics at work and see them print some money that circumnavigates the financial sector – like as you say – Green QE.
When will Labour understand that when it does things like this it’s sending out mixed messages and adding to people’s confusion as to where they stand.
Maddening. More than anything else, by sticking to a no-borrowing mantra they are bascially implementing Tory policy which as well as being absurd makes the voter think that politicians are all the same.
There never seems to be any consideration why a government has to run a deficit or what would happen if the government did not run one.
Tax money is never enough to run government services. Without borrowing to supplement taxation, in a debt-based system, taxation would either have to be prohibitively high or else services we all rely on will be unaffordable and grind to a shuddering halt.
As said before, cutbacks and privatisations generally mean a large loss of jobs and a loss of income streams, leading to a drop in tax contributions and the paying out of benefits, leading to an inability to balance the books without the government having to borrow more to make up the difference.
While acknowledging the fact that there is no need for governments to borrow from pension funds, insurance companies and banks, the interest rate at the moment is at its lowest point in history, and hence borrowing costs for the government will be the lowest in history, allowing it to safely raise significant funds to pay for infrastructure, housing and rebalancing the economy towards actually making things again.
Ed Balls has he would like to have a surplus of tax money over borrowings, essentially a zero deficit, a dangerous, economically illiterate proposal that is unlikely ever to be achieved without risking the total collapse of the economy.
Neoliberal economics is only ever good for one thing; making the very rich even richer. They are the kiss of death for the real economy and need to be consigned to the dustbin of history.