I see that the debate on what John McDonnell and James Meadway claim to be a fiscal rule is not going away. Another iteration appeared on the Socialist Economics Bulletin today.
Someone I have never heard of called Tom O'Leary (I make the point solely to say I have no idea who he is, whether I have ever met him, and whether he has any qualifications to comment, or not) has put forward an argument that revolves around these points:
- I am ignorant (but that goes without saying these days if you don't support Jeremy Corbyn)
- The rule exists
- The rule will never require austerity on current spending
- There is no limit on investment spending under the rule
- Tax revenues can always be raised by closing the tax gap without other economic consequences
- There is 'an identity' which if believed would lead a person to fail economics A level on the relationships between consumption, investment, the government spending and next exports.
Let's take (1) as read: I can't be bothered to argue.
On (2), this is untrue: as James Meadway has said at the zero bound, which today's moves from the Bank of England have confirmed will go on for a very long time, the rule does not apply. It's always been a charade.
(3) remains absurd: the Corbyn plan os for extra investment of maybe £50 billion a year, by no means all funded by government. Total government spend is £700 billion. Deficits exceed £70 billion. Now I concede some of that is existing investment, but the point is that no government has since 2008 balanced current spend with tax revenues despite the economy growing. So prima facie doing so is a) hard and b) quite likely to require that tax revenues exceed current spend sometimes. So to dismiss my argument is wrong is absurd. But it is also an unnecessary constraint: why impose a limit on current spending but none on investment (which brings us to point 4)? The actuakl and undoubted implication is that the McDoinnell rule would let us build hospitals but not staff them, which is absurd.
And as to 4, of course there is a limit to investment: the economy has a capacity. To pretend otherwise is just wrong.
And then to point 5. I suggest O'Leary reads The Joy of Tax and the explanation of what tax is for and how it should be used. O'Leary is still very obviously living in the era where it was thought tax funded government spending when in truth it does not: it is the factor that balances the macro economy to ensure we do not have inflation whilst delivering social purpose. So yes, I definitely want the tax gap closed but to right now to pull the funds in question out of the economy to run a surplus as O'Leary suggests should be done would be recessionary, so beat the tax gap by all means (please) but re-inject the funds to create social worth. The alternative would be very bad news in a recessionary environment.
And then 'that identity' which is dismissed as nonsense. That's called national income accounting. That's no oddity; it's taught (I hope) to just about all economics students and with good reason.
So the claims made are all ridiculous, but the sting is in the tail. take this claim:
But eliminating poverty cannot be achieved by increasing NHS spending (Government Consumption). Poverty could be eliminated by a very substantial increase in investment, led by public investment. This should create high wage, high skill jobs. It reduces the Government's outlays on poverty and increases the Government's tax revenues. This is what McDonnell means by eliminating the deficit on current spending. It is not cuts, but investment.
Just think on that for a moment: no current government spending eases poverty. Scrap benefits then. And the old age pension. And why bother with state education when just building the schools will do to provide all the opportunity people need to break out of their economic situations? And in the NHS no amount of current spending to ensure people can live full lives in the communities of which they are a part helps poverty, just new waiting rooms do?
This opposition to what I have said is all getting rather silly.
But it does suggest that what Danny Blanchflower and I have been saying, that there is no economics policy on display from Jeremy Corbyn is justified. Which is deeply depressing. There was a move in the right direction last summer, and even that;'s been abandoned.
I'm happy to talk to John, James and anyone whenever they want. But for heaven's sake the policy has to be based on:
- Honesty
- Credibility
- Meeting need in accordance with the principles of the left.
If not, why bother?
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I have decided to post a detailed critique because the rule is a disaster that simply cannot work. This Keynes idea appears to come from a time before the Beveridge style welfare state was implemented and certainly before that evolved into a spending side auto-stabiliser system, but that fact change doesn’t appear to have dulled enthusiasm for the concept.
So I thought I’d dig into the numbers to show what it is all about and point out all the issues:
The numbers come from the Public Sector Finance report from the UK’s Office of National Statistics.
For the financial year 2014/15 the current budget deficit stood at £48,876mn. So that is the amount you have to generate from somewhere to get it to zero.
However before we do that it is useful to understand how you get that figure. What actually is the current budget deficit?
It is defined as:
Net Current Expenditure + Interest Paid + Depreciation – Current Receipts
so using the figures from 2014/15 (In £ mns) you get:
634,317 + 47,222 + 37,306 – 669,969
To get the current budget deficit to zero you have to conduct extra investment spending – which then gets taxed away at the tax take percentage (which is 1 – the saving percentage) creating the extra tax receipts to cover the current budget deficit. Effectively you move the deficit from the current budget to the capital budget.
There are a couple of things to note from this calculation.
The first is that the depreciation figure is a transfer from the capital budget and adds to the current deficit. The more investment you do, the bigger the depreciation figure gets which then means you have to do ever more investment spending every year to cover the growing current deficit.
The second is the interest paid figure which similarly adds to the current deficit. The more investment spending you do at interest the bigger this figure gets. The higher interest rate you pay the bigger this figure gets. And the bigger the figure gets, the more investment spending you have to do in subsequent years to clear the current deficit.
You can already see that there are two unfortunate positive feedback loops inherent within the calculations.
Net investment spending (Gross spending less depreciation) for 2014/15 was £30,328mn. If you express receipts as a percentage of total expenditure you find the tax take is 89.4%. So for every £100 spent, £89.40 came back as tax and £10.60 was held as financial savings.
The tax take percentage varies as the tax side auto stabilisers allow people to save. In the post crash era where people are generally saving it has been as low as 82%.
So to clear the current budget deficit at a conservative tax take of 80% you’d need to make £61,095mn of extra investment spending (i.e. the capital net spend needs to be three times what it currently is!) That will vary up and down depending upon the actions of the automatic stabilisers. In 2009/2010 you would have needed £107,684mn of investment spending.
There is of course lots of talk within Corbynomics of closing tax gaps, changing rates and the like. All of that is largely distributional. If you take tax off one person, they can’t then spend it with somebody else and you potentially deprive somebody of an income. Only where you defer or offset saving behaviour, somehow, is there an impact on the total tax take percentage. Really you’re relying on the old balanced budget multiplier to work its magic – which likely isn’t that effective in an open net importing economy like the UK.
There is, of course, no need to balance any budget, and doing so violates ‘Lerner’s Law’. The wisdom in Lerner’s statement is already apparent given the brouhaha over People’s QE. All that is down to the complexity of trying to present a simple overdraft or guarantee in flowery language. The mainstream have misinterpreted it and are now engaged in a campaign of misinformation. The lack of simplicity makes that difficult to counter.
Begin to see the problem?
Besides the complexity issues, balancing the current budget has clear issues.
* You are limited to fixed capital formation and capital transfers. So you *can build universities and hospitals but you can’t staff them!*
* Eventually you run out of stuff to build. This leads to the old Labour problem of building roads to nowhere just to keep ‘investment’ going.
* You neglect items because of the current budget restriction. The only effective investment a government can make is in its people. But that is all current spend and is therefore difficult to do.
* You have to raise taxes to make the books balance. Nobody likes tax rises. Raising taxes is far more unpopular than explaining that budget balances are not really significant. It seems strange to take a political hit on taxation when you don’t need to.
* Fixed capital investment targets a small section of the country’s supply chain. Only a small section of the population is engaged in building things. The UK is 80% service based and people are trained for services. So you are quickly going to run into supply side capacity constraints, and potentially start to limit other capital development in the private economy.
* The action of the auto-stabilisers pulls the current budget out of balance as a matter of design. If the economy contracts social security payments go up and tax take declines. You then have to do more investment spending to counter that. Yes there is more slack at that point, but is it the right sort of slack. Is the supply fungible enough?
* The more investment, the more depreciation and interest paid. That leads to a positive feedback spiral between the current budget deficit and the level of required investment (and is another reason why Gilt Issues are harmful.)
Thank you
May I post it as a blog in its own right?
Richard
I certainly hope “Bob” agrees to that, Richard, as this is a concise deconstruction and demolition of the fiscal rule nonsense. It would also be wise for the people who support such suggestions to stop talking them up as some kind of law as we would see in physics, for example. This has become common practice in economics as we well know, but let’s be honest here: rules are social constructs – period. To reify them, as Brown, Osborne and now McDonnell and his henchmen are tying to do (and the BoE has done with it’s ridiculous and now worthless inflation rule/target) has already proven to be both misguided and stupid. So why repeat that stupidity? I can only think it’s because they are running scared of the Tory press and so this is team Corbyn’s attempt to signal their economic competence, whereas what they are actually doing is creating a mirror image mess on a par with that created by Milliband’s refusal to rebut the Tory myth that Labour and not the banks created 2008-10 crash.
Ivan
Agreed, entirely
From a quick blog break on holiday
R
Bob, Richard, a most informative post that I’ve read for a long while and does settle the issue in my mind! It still doesn’t answer why McDonnell framed Labour’s austerity stance as he did – I assumed McDonnell was politically countering ‘Osborne Fairy Tales’ for the wider public audience. When it was first reported in the media I was alarmed why McDonnell went this way.
I still don’t understand what the left’s economic policy is? A frustration with the left is it seems to want to solve the theory first! Whilst the Tory’s make it up on the hoof, so long as wealth is protected and trickles up. Lets get on with framing the anti-neoliberal agenda and policy — that’s the grand challenge for the left — not internecine war. And by the way can the world survive a “growth based economic model” much longer, particularly such a dysfunctional implementation as witnessed by the socially disastrous Cameron/Osborne variety.
This was not written by Bob but Neil Wilson. http://www.3spoken.co.uk/2015/09/corbynomics-and-current-budget-balance.html
My apologies to Neil then and I hope he is happy with it remaining here
Is there a difference between accounting and economics? And if so, how does using accounting limit an understanding of economics?
It can severely limit it
Understanding both is a massive advantage
Accountants need to look at dynamics more. There is however too great a gap between the simplistic housekeeping public understanding and high level research economics. There is certainly a great need for public understanding of macroeconomics and an accountant’s perspective will be very valuable here. Politicians have ever since Thatcher (or probably long before) been able to get away with simplistic half truths. I hear an other book is in the pipeline after “Dirty Little Secrets”?
Just a rumour as yet between me and my agent
Yes there is a difference but they aren’t incompatible. Just as anyone who runs a business has to understand accounting to know how well they are doing so too does a government.
Except, the accounts aren’t quite the same. It is a mistake to equate a Government’s surplus with a businesses’ profit for example. Different rules apply for macroeconomic considerations. For example if Government starts from scratch and issues a new currency of say 100 million units the Government has that liability. It has to be in debt. If the Government then taxes back 80 billion the assets of the populuation falls to 20 billion and it debt is also 20 billion. If the population runs a trade deficit of 5 million then 5 million is held oustide of the country.
So we can see that Govt Debt = Assets held Domestically + Assets Held Abroad:
Or (in any one time period) Govt Deficit = Savings (Domestically made) + Trade Deficit
That’s quite an importamt result! It’s so simple but most politicians fail to grasp it.
Richard,
I’m generally in agreement with you on Economics questions. But, politically, I’d just question whether Owen Smith is going to be any better than John McDonnell. The quote below suggests he didn’t at all understand the causes of the GFC. Which might be forgivable if he has learned since but has he?
“However, I think there does need to be an acknowledgement that had we [The Brown Labour Govt]spent less in the last few years before the deficit and had we been more mindful of the fact that lax banking regulation meant there was less insight into what the banks were doing and perhaps more risk associated with our economy than we appreciated then we might have run smaller deficits or sought to pay down the deficit faster. And if we had done that, I think we’ve got to be honest and acknowledge we would have been in a better position to withstand the crash…”
I know JC cannot do the job
So too do many who have seem him and John I’m action. One former campaign group MP (retired) shares my view they are shambolic
The policies are very similar
Neither really understand economics
I think one is willing to learn
So, why does Labour need a fiscal rule?
One big reason, I think, is political. Labour must establish economic “credibility”. In the eyes of our asinine media, this credibility requires a plan not for jobs but for the public finances. John McDonnell’s rule does just this without damaging the economy. When you’re faced with a rabid dog, you should throw it a bone
http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2016/08/in-defence-of-labours-fiscal-rule.html
It is what labour has always done
It has never worked
Agreed . Historically this was always simply a class war and the narrative ‘ Labour is incompetent to manage the public finances ‘ put out by the Tory press was believed not just by the electorate, but by the Labour Party itself. Corbyn has just resurrected this
tradition by not embracing your People’s QE . He needs to shrug off this inferiority complex and explain to the public that government is not a household and it spends and taxes and not the other way around. I think he’d be surprised by just how ready people are to hear this because they already suspect it is true ( ‘ there’a always enough money for what the government wants to do etc ‘ ) .
John, Three varieties of politics now “Original”, “Lite” or “Anti” neoliberal. Establishment won’t tolerate the last.
Which is why the way it wins has to be so carefully orchestrated
And thoroughly embrace parliament
Of course all politicians of integrity should tell / explain economic truths. However, the Tory Party know they’re on a vote winner when it come to Labour & the economy and will continue to spin the houshold budget metaphor, even though they know it’s untrue. The conflating of ‘Labour borrowing recklessly’ with the 2007 GFC still resonates positively with most people. It will take at least another major financial crisis under a Tory government for the penny to drop, albeit they will point the finger of blame elsewhere – the EU, gloabl economy, China, Russia, climate change … you name it. Even then (i.e. in 2020) I don’t see the current Labour Party being able to secure a majority. It was very different back in 1997. Tony Blair was seen as an inspiration and an unsullied pair of hands to carry the country forward out of the Tory mire. Ahhh – memories, memories!
My observation (not that distinct from others really) is that the public seems to have swallowed these ‘fiscal rules’ testicular material hook, line and sinker – never mind the media.
Corbyn and McDonnell are just trying to show their ‘credentials’ by being seen to basically accept Tory macro principles which seems predicated on insuring that money is continued to be made out of private debt provision instead of State investment.
Corbyn (Labour actually – most of them – PLP and Corbynistas) just do not want to have a proper debate or argument with the public who they want to vote for them. To disagree with those whom you want to put you in power is seen as a bit suicidal maybe?
As a result we have some sort of ‘tyranny of ignorance’ dominating fiscal policy at present.
One thing this ploy by Labour is not is ‘courageous’.
It shows once again the paucity of self belief in original Labour party values and as well as a lack of belief in people that has eaten away at the Labour party since you know who came on the scene (middle name ‘Hilda’). If the Labour party were a person he/she would be in therapy.
Labour? Sod ’em.
The real question is what is the point of Labour if even Corbyn and McDonnell really want to be Tories, and it seems they do