I would be amused at reaction to the news that George Osborne is going to miss his borrowing targets, yet again, as became obvious this morning when much higher than expected October borrowing was announced. The reaction, according to the Guardian, amongst many so-called expert commentators is to suggest that George Osborne now has to impose yet more austerity.
This, very politely is absurd. As I say in a new City University paper co-authored with Prof Ronen Palan to be published early next week:
The core argument for austerity economics as the harbinger of economic growth harks back to highly controversial proposals that originated in the 1990s known as 'expansionary fiscal contraction.' The idea behind these proposals is that the public and private sectors compete over the same pool of capital. It follows that if a policy of deliberate deflation in wages, prices and public spending through reduction in the state's budgets, deficits and debts was pursued, then business confidence would be created as the foundation for growth. The state would no longer be ‘crowding out' the private sector in a race to command scarce capital, resources or labour. The assumption is that private sector's use of these resources (lower cost of capital, resources or labour) would result in higher growth than if they were used by the state (for discussion see: Barry & Devereux, 1995; Blyth, 2013).
Expansionary fiscal contraction theory is predicated, in other words, on three linked, but highly controversial assumptions: first, that there is a finite pool of available capital at a national level; second, that interest rates at national level are determined by a simple demand and supply curve; and third, that private sector investment (and correspondingly, debt) is always preferable to the public sector investment (and hence also debt).
This belief in the superior performance of the private sector has been implicit in the forecasting methodology adopted by the UK Office for Budget Responsibility (OBR), which George Osborne established in 2010 to audit the Treasury's economic forecasts (a task previously undertaken for Labour by the National Audit Office). The OBR has worked on the assumption since 2010 that the multiplier to be applied to government revenue spending has been around 0.6 on average. The OBR has been a little more generous with the multiplier impact of government investment spending, where it has assumed the multiplier to be 1 (Office for Budget Responsibility, 2015, 39). The implications of the OBR's methodology are far reaching: Controversially, as we will discuss below, the OBR's forecasting methodology assumes that government revenue spending actually reduces GDP, whilst government investment could at best just recover cost. It follows from this methodology that any transfer of resources to the private sector — whether by tax cuts or reduction in spending — is bound to increase the growth rate in the economy.
Those who are now arguing for more austerity must share this view that government spending harms the economy, and that shrinking it delivers growth and so more tax revenue and so balanced budgets.
But the reality should, by now have dawned on the Office for Budget Responsibility, whose forecasts have been consistently wrong. If the multipliers are above 1, as the IMF argue is nigh on inevitable, cuts shrink the economy, and so shrink tax revenues by more in many cases than the value of the cuts, meaning that austerity is in fact self defeating: you have slower growth, more unemployment and deficits still.
When will the Treasury admit they've just got this wrong? And will it be too late when they do?
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Well from what a “treasury spokesperson” says in that same report in The Guardian they won’t be admitting they’ve got it wrong anytime soon, Richard, and I don’t see the OBR changing their methodology, despite your withering critique of it (which by implication the IMF also support). But hey-ho why should Osborne care. This is just grist to the mill for more austerity.
Then again, I wonder how this super deficit destroyer, this man whose committing his political life to deficit reduction, will explain away this (also from the report in The Guardian):
“With the government still running deficits each month, the UK’s total debt pile is still increasing, according to the ONS. In total, the UK now owes more than £1.5tn, equivalent to 80.5% of GDP. That compares with 69% in 2010/11, Osborne’s first year as chancellor under the Conservative-Liberal Democrat coalition government.’
Sorry, but I’ve got myself a wee bit confused. I know that Osborne is a useless article, but is that because he has got the deficit down or because he hasn’t got the deficit down? Or both at the same time? I can’t seem to get my mind clear on this.
He has cut spending to try to keep the deficit down
Actually he had to spend to keep the deficit down
So the deficit is higher than it should be if he had spent more
It’s pseudo-science, just like the theories used against ME sufferers to produce the PACE results now thankfully being broadly discredited, and similarly the so-called ‘biopsychosocial model’ the airy-fairy nonsense behind the WCA used to deny the genuinely ill and disabled their lifeline social security support. It’s everywhere! 🙂
Bill, you might enjoy this destruction of the WCA by John Robbins on The Now Show on Radio 4 last night, at 20:10 into the show
http://www.bbc.co.uk/programmes/b06pdjhc
Great post as always. Well, great in the sense that it’s an interesting read; austerity is far from great.
On the subject of deficits, is there ever a reason to run a budget surplus? Could you always run a surplus so long as that money was put into a sovereign wealth fund?
We should have run a surplus throughout the eighties and nineties in the oil boom
Thereafter – why impose saving on a country for no good reason?
I agree, although if you were to say that surplus was reached without spending cuts, but through increased tax receipts from employment and business activity, would it be best to simply spend/invest more to induce a deficit, or reinvest the budget surplus into the economy through a wealth fund? Or should we always be looking to expand our national debt, as it allows us to increase our economic capacity? (I’m no economics expert, pardon me if the conjecture of my question is rubbish 😉 )
The need is for investment to kick start the economy paid for by borrowing or PQE if the markets show even the slightest hint of not playing ball – which is unlikely
An oxymoron ‘expansionary contraction’, words designed to confuse.
So if we spend more the deficit will decrease?
Yes
If the multiplier is more than one – and the IMF says it is – especially for investment – then spending raises more than it costs
That is it
You have worked it out
So why are there ever deficits?
Because the economy is dynamic and governments want to promote growth by deficit spending
Next easy question?
So ‘deficit’ spending does increase the deficit. Other spending decreases it. So if the government cuts back on ‘deficit’ spending it could reduce the deficit?
In the short term deficit spending increases the deficit because revenues always follow spending
But a programme of high multiplier spending – Investment in particular – fuels growth , and so increased revenue and so a reduced deficit
It’s really not hard understand
But I am aware you are not seeking to do so
So the deficit will disappear automatically once the revenues come through? When will that be?
No it won’t disappear
Because then the next round of growth is already underway
There is no such thing as static equilibrium
And even there as no one with any sense would aspire to it
If spending creates a net tax return, then over time the deficit will reduce. In the same way if I invest at a profit although I keep on incurring costs I build up retained profit. So where is this phenomenon if it exists? Why do we have such a large deficit? The only logical explanation is that a hell of a lot of spending does not do this, and if not covered by tax receipts will create a deficit. QED reducing such spending will reduce the deficit.
The deficit for many years (let’s call it the Labour years) was simply the previous year’s difference between income and spend, was less than 3% of GDP and represented the essential funding for growth in a period of appropriate inflation
Call it additional working capital for the economy
After all, aren’t you aware that the economy needs government debt to function? It is the ultimate source of money, after all
The deficit is created by spending more than you receive in tax receipts. Spending even more does not create more tax receipts than the additional spending. If it did, then Labour would have left us with a surplus to come. The exact opposite happened. Tax receipts plummeted.
This is wholly untrue
Paper out on this on Monday – but tax income rose dramatically under Labour – until US banks trashed the world economy
Tax incomes increased because of a credit boom. Not because spending increased.
The data simply contradicts you
How come in Japan the opposite has happened? Spending has been increasing, the deficit increasing too, and tax receipts falling? Why hasn’t spending more in Japan, especially on investment, not resulted in a falling deficit? They’ve been doing this approach for over 20 years.
Because the Japanese insist on saving and so shrink the economy. Continually
This is cultural meaning stimulus does not work in Japan
It has here
“Why hasn’t spending more in Japan, especially on investment, not resulted in a falling deficit?”
Richard is right in his comments to you. The deficit of the government sector is equal , to the penny, of the savings of the non-Government sector. If the non-Government sector is saving ie in surplus then the Government sector has to be in deficit. That’s always true. Austerity or no austerity. So I do question the phrase “austerity is causing our deficit”. It’s not making it any less, sure, but I’d say the word ‘causing’ is taking the argument too far.
We’ll have to agree to differ
If the government decides to deliberately reduce our income (which is what austerity does) how can it not be that our income is not reduced unless (as they incorrectly assume) we spend more elsewhere as a consequence? If austerity instead induces us to save more – as logically it will (we are risk averse) of course austerity induces a deficit
It sounds as if negative interest rates are what’s needed in Japan. Or, I suppose, demurrage.
James G
You might’ve noticed that what you claim to be an impossibility- Govt spending reducing the deficit-has actually happened in Obama’s USA.
Obviously, you’re right to say that there are occasions when a Govt should run a surplus. The classic example was the early 90s when the UK economy was ‘overheating’ & Lawson cut taxes when he should’ve raised them.
I often think Lawson is unfairly unvilified when he really was one of the most disastrous chancellors ever. Norman LaMont was, rightly, vilified, but he was given a truly rancid position to start with.
Eriugenus, I can’t see that correlation at all. Spending has decreased as tax revenues have increased in the US. Also look at what happened in the 1990s – spending decreased and revenues increased.
The states has run declining deficits and got growth is the point
Seeing as I like you today James G, this might help with the basic concepts being applied:
https://medium.com/@girlzplocked/why-amazon-isn-t-a-fucking-idiot-and-runs-a-deficit-f9d5734b68ec#.wmvc22kfo
James G
“In early 2009, President Obama took over, amid the worst recession since the Great Depression. President Obama signed an $800 billion spending increase at the same time that GDP and tax collections tanked. The combination of these two factors–growth in spending and a drop in revenue–exploded the deficit to $1.4 trillion. In 2010, the economy and tax collections improved modestly, and the deficit shrank to $1.3 trillion annualised.”
Now look at the situation as described by that arch-socialist publication, Forbes; The Shrinking Budget Deficit And The Slowing Growth of Federal Debt by Bob McAteer on 11/10/15
Osborne, meanwhile, is adamant that we must “save money” by reducing Govt spending in all areas, including the Police.
Erm, George, you might not’ve been paying careful attention to what has been happening in Paris & Bruxelles, but now is a seriously bad time to be reducing the number of police officers. And if you say you’ll replace trained law enforcement officers with Special Constables I shall know you’re SO taking the p.
“This, very politely is absurd.”
Of course it is. Why in primary school would you ever think the government could expand the economy by spending less?
But apparently they think that in some universities…
And, with luck, the wheels are coming off Osborne’s wagon with the immediate help of his own increase of the minimum wage, Junior Doctors, French Arab terrorists and the House of Lords.
We must hope he gets the change message before the wheels come off the wagon for even more of the rest of us.
Guess what?-despite EU ‘stability pacts’ Hollande has suddenly discovered he can create thousand of new jobs in the Judiciary and security forces-but not with regards to the 24% unemployment.
Is there a clause in Maastricht/Lisbon which says ” fiscal tightening may be loosened in the case of large scale murder but a generation can have their life chances wasted”?
“Hollande says there will be 5,000 new jobs created in the police force and the military police known as the gendarmes. He says there will also be 2,500 more administrative posts created in the judicial system to help manage prisons. Another 1,000 jobs will be created in French customs” http://www.thelocal.fr/20151116/live-france-carries-out-anti-terror-raids-across-country
I too find the available loopholes sickening
I do not dispute the need for security
I dispute the definition of an emergency
Question is what exactly does “the wheels coming off the wagon” actually entail?
For sure, there are any number of imaginable economic scenarios but what implications are there politically? Can anyone seriously see the Eton Trifles running the show experiencing a Paul’ine moment of conversion and ditching this neo liberal nonsense?
Will this run until 2020 until there is another planned election, particularly when at present there is no “safe” neo liberal loyal opposition waiting in the wings to give the illusion of choice and alternative change?
And what will things look like by then? With the strong possibility of TTIP and it’s secret Corporate Kangaroo Courts being in place would an election in 2020 actually be meaningful in the “traditional” democratic sense?
Richard,
“Austerity is causing our deficit”
It may be politically convenient to push this line of argument but we both know it’s incorrect, and as such, doesn’t lead to an increased level of understanding (which is what is really needed) of how our economy functions.
We can easily see how it does by considering the case of a country starting a new currency
Yr1 Govt Spending = 100 Tax revenue = 80 So: Deficit = 20 Debt =20 Non Govt surplus =20
Yr2 Govt Spending = 90 Tax revenue = 60 So: Deficit = 30 Debt =50 Non Govt surplus =50
So we have a situation in which the Govt has cut its spending and its revenue has fallen faster than its cut, leading to a higher deficit.
So is it correct to say that the deficit has risen because spending has been cut? Well no it isn’t. The deficit has risen because the non-government sector has chosen to save more. The non-Govt surplus has always got to be equal to the government sector’s deficit. The govt can’t control that surplus or that desire to save therefore it must follow that it cannot control it’s own deficit. In the UK now, the non-Govt surplus is totally (and bit more besides) in the hands of the overseas sector. The domestic economy is in deficit too.
So, the correct line of argument is to say that austerity, at its present level, isn’t helping to cut the deficit. Spending cuts are translating to reduced levels of taxation revenue as you say.
Of course, if the government applied enough austerity the deficit would certainly be reduced. In that case we’d all end up much too poor to save anything or buy quite so many imports. That’s how the budget deficit in the poorer regions of the EZ has been “fixed”. But that is obviously not quite the correct word for it!
No – sorry – that’s not true Peter
Accounting identities in two periods do not explain the causal reason for the change
You know I agree re the identities but the reasons for change are much more complex than the likes of Bill Mitchell suggest
Richard,
I don’t think either myself or Bill would attribute causality in the way you suggest. The point I would make is that Governments have reasonable control over their spending but they don’t have much control over their taxation revenue. So they aren’t in control of their overall deficit. Any attempt to reduce their deficit by raising taxes and reducing spending is likely to fail for reasons I’m sure we’d agree on.
The point at issue would be whether the deficit would close if the government ignored it and simply based their spending and taxation policies on the need to achieve a reasonable compromise between having too much inflation on the one hand too much recession and unemployment on the other.
There’s no way of knowing for sure because , as you say, we can’t attribute causality. But it’s quite likely that a healthy UK economy will attract buyers for govt bonds which will increase the value of the pound . Demand for imported products will increase and an increased external deficit will translate into an increased internal govt deficit too.
In other words, its quite possible to have a healthy economy, ie austerity free, with significant deficits – both internally and externally.
You miss my point: there is a link, I think, between the size of the deficit and the change in national balance sheet composition
That is the multiplier
It is too simplistic to say a government has no control over its revenue
A mass of evidence says otherwise. This is an area where MMT is insufficient explanation. An accounting identity at a moment gives no indication of a trajectory of travel or reasons for change and I think such explanations are possible
Er, we must hope he doesn’t.
As I, & I’m sure many others, commented, the campaign of Liz Kendall required one thing: that Osborne would succeed & Labour would have to follow at heel.
Osborne isn’t going to succeed. His economic policies require misery for 95% of the population.
This scares me. 20 years ago I would’ve considered myself a “soft” Conservative. Now holding, ino, the same economic opinions I’m branded a “trot”.
I know the feeling. From being quite centrist to now being a left winger in 35 or so years without changing my views
One thing I know is this. If you had said to Govt ministers, senior civil servants, Bank Governors 50 years ago that the best way the Government could respond to unemployment, a housing shortage, a lack of skilled labour & an excess of worthless arbitrage was to do nothing because the market would sort everything out, they would’ve said you were mad.
One thing I also know is . If you say to Govt ministers, senior civil servants, Bank Governors 50 years in the future that the best way the Government could respond to unemployment, a housing shortage, a lack of skilled labour & an excess of worthless arbitrage is to do nothing because the market will sort everything out, they will say you are mad.
Regrettably, we’re in that period where in art, economics & psychiatry madness is orthodoxy.
Interesting comment by an economist on the World Service. He pointed out that provision for the Syrian refugees, extra border controls and increased spending on security would provide a much needed fiscal stimulus – and that is over and above the ‘Military Keynesianism’ of going to war against ISIS.
Sadly, he is right
We can always find money for war, The peculiar genius of Atlee et al was to find money to invest in peace.
Don’t think that’ll be happening again any time soon.
Deficit reduction produces some strange thinking. Some, e.g. the RCN, have projected a huge overspend on agency nursing in the NHS to cover the shortages of trained nurses. Yesterday I heard a news item that suggested one of the responses to cutting the NHS deficit should be to introduce charges for nurse training in line with university fees.
Where is the logic in making a career that is already failing to attract sufficient recruits more difficult to get into? What about suggesting that the agencies have to train their own staff covering the cost from their profits? Or, perhaps they could reduce their 45% commission charges. Perhaps an agency taking on a nurse trained by the NHS should pay a fee.
As the stresses of constantly working at close to absolute capacity increase there is a corresponding increase in the downtime of staff due to illness. It would seem to me that flexibility needs to be built into the system and that would begin with ensuring there are sufficient nurses to offer a contingency quota. When there are sufficient NHS nurses the demand for agency nurses reduces. That would impact on the charges agencies could command.
https://www.rcn.org.uk/__data/assets/pdf_file/0005/608684/FF-report-Agency-spending_final_2.pdf
The contingency suggestion is a sensible one Bill. After all, it is standard practice (at least to date) to have “spare” capacity for electricity generating and we don’t run a just in time system to deliver water to taps.
Unfortunately the lunatic thinking which is currently making the decisions are psycologically incapable of applying the same sensible approach to human beings as applied to inanimate machines and machine systems. They would not drive a car the same way they drive people, which reveals a great deal about the mindset of the zealots who support this nonsense.
I’ve always been struck by the fact that a public sector nurse represents an unproductive drain on the hard-working taxpayer while the minute she goes to work for an agency at twice the cost to the taxpayer then she’s a productive ‘wealth creator’.
The point being that ‘productive’ actually means productive of a claim over value (created ex nihilo by banks), rather than productive of value.
Oh yes! The dichotomy is an indication of the madness that underpins much thinking
The same that a consultant to the government is productive and in their previous role as a civil servant they were not…
In a free society it is good to see debates going on..such as this one. But we should also at the same time try, and develop a far more advanced, and “objective” way of improving our thinking on any issue. Hence, the possible future emergence of the Universal Debating Project.
See http://www.p2pfoundation.net/Universal_Debating_Project
Looking through the write up on this link I see two issues which would impact on the efficacy of such a project.
The first issue relates to the potential impact or otherwise found in the worthy statement in italics at the end of the introduction which states “It SHOULD become of great practical value for educators, citizens, governments, NGO’s, businesses et al.”
As with everything concerning human interaction, no matter how “objective” the presentation of any particular issue the key point is not the “objective” facts (whatever they are) but what they mean to different actors and, more important, different contexts. It does not take much imagination to see that different interests will still interpret anything produced to suit their case.
Moreover, the observation attributed to Karl Rove kicks in, in which such a project, grounded in the “reality based community”, ends up merely as a discussion shop reacting to the decisions made by elite power groups who merely ignore it or interpret what it produces according to the dictates of their own interests, at best distorting the projects purpose, at worst making it effectively redundant.
Secondly, and more problematically, the methodology is fundamentally flawed. It’s not as if reducing complexities to simplicities has never ever been standard practice in the way human beings think and try to deal with the world. The problem with this simplifying everything with a power point presentation, reducing complex ideas, processes, phenomena etc to a three bullet point package is that it simply results in using brain puns as a substitute for thinking, missing Key features of the world such as context, meaning higher level features etc.
The mathematician Ian Stewart and the reproductive biologist Jack Cohen covered this ground, identifying the limitations of reductionist thinking and methodologies, over twenty years ago in their book “The Collapse of Chaos.” Still relevant agony well worth a gone read, particularly when designing agony worthwhile new initiative.
The UDP has some resemblances with Bernard Lonergan’s notion of a universal viewpoint.
https://books.google.co.uk/books?id=5Q1VpNwaPhcC&pg=PA270&lpg=PA270&dq=Lonergan+universal+viewpoint&source=bl&ots=UvFAMmJcwC&sig=eXA5pmvEUCxGWxH1klqCQnoS8RI&hl=en&sa=X&ved=0ahUKEwjJkvWIp6LJAhUGuhoKHaO4DjMQ6AEIJTAE#v=onepage&q=Lonergan%20universal%20viewpoint&f=false
In defence to the aforementioned critisms of this project:
1. There is a criterion of objectivity. Differences of interpretation can be handled by the universal viewpoint by keeping all such differences of opinion in view.
2. The process of reducing all arguments to two or three bullet points is like mapping it to human cognitional activity. Since nobody can deny their use of cognitional activity when framing an argument, this is the correct context.
Lonergan envisaged such a project in his conception of unified metaphysics, but realised there would be stages in its implementation. The first is implicit, because everyone uses their minds when engaged in debate, or they are not worth engaging with. The second stage is problematic, when we try to reconcile the multitude of departments of knowledge with their corresponding cognitional activity. The third and final stage is an explicit metaphysics, when our mental processes are known, understood and acknowledged.
It is indeed an ambitious project, and may be difficult to persuade people we can move beyond stage 2.
The fiscal multiplier was first proposed by a student of Keynes in 1930. It is a simple one dimensional measure of the proportion of government spending that contributes to national income.
A more refined analysis is offered by Bernard Lonergan in his writings “For a New Political Economy”. He focuses on production rather than profit as the goal of economic activity, and distinguishes two kinds of consumption and spending. Consumer spending is on products that enter into the standard of living of an economy. Investment spending is on the tools, machines, factories etc. that are used to produce a steady stream of those products. (See Prof. de Neeve’s paper for more details: http://eileendeneeve.com/Lonergans%20Economic%20Ideas%20Today%20complete.pdf)
Such a distinction may be highly relevant when trying to understand the effect of government deficit spending and taxation. Such spending should always be done to reinforce the needs of the economy, and support the continual growth of both consumer and producer goods. The private sector will fail systematically to deliver the goods and services that the economy needs, because the profit motive by itself is insufficient. Therefore the government should step in to spend when private investment is too low (and inevitably there will be a deficit), and recover the money by taxation when basic consumption is heating up the economy.
The economy goes through natural phases of production and consumption, because of the time lag between the extraction of raw materials and finished goods being sold on the market. (This is different to the former trade cycles of boom and bust – sustained growth is a theoretical possibility provided the existence of a static phase of zero growth is acknowledged.) By looking at the income crossover ratio between the different kinds of consumers and producers, it is possible to identify the present state of affairs, which will enable the government to take the appropriate form of action by either increasing or decreasing the money supply through deficit spending or taxation.
Austerity results from a simplistic attempt to use a single number (i.e. the multiplier) to represent the complex nature of the economy. There are reasons to choose austerity, e.g. lack of knowledge on the alternative courses of action. Conservatism is the consequence of incomplete understanding.