I am not sure who it was who said "All models are wrong but some of them are useful", but they had a point. I just made up the version that says "All models are wrong and some of them are harmful." I am thinking of austerity.
The model has always been wrong because it embraces the government as a household fallacy. It is true that if a household that is in debt cuts its spending it increases its chances of balancing its books. That is not true of a government for two reasons. First, government spending is national income. Cutting it does then only increase the chance of balancing the books if the spending adds less to income than it incurs in costs (meaning in economists' terms that the 'multiplier' is less than one). This is what the Office for Budget Responsibility has always assumed, except for investment. They are however wrong; when there is underemployment there is now a mass of evidence, from the IMF and others, that the multiplier is well over one. In other words, spending more than pays for itself and cuts impose more harm than the initial sum supposedly saved reduces spending by. Second, unlike a household a government with its own currency cannot have a debt crisis. It can always pay because it creates the currency required to make the payment and households can't do that.
What is the harm? This is becoming apparent. Data on dramatic increases in crime rates are clear indication that the police have now had resources cut beyond the point where their operations remain effective. They just add to the long list of services where this is apparent. From health, to education, to the rest of the justice system, to social care, and more, cuts are destroying much of what we value and leaving our society at risk. And all this to supposedly balance the books, which has never happened because cuts actually make the achievement of that goal harder, and not easier for reasons already noted.
This we knew though. Let me now add in something many are less familiar with. This is Baumol's law. What William Baumol suggested in the 1960s was that salaries in jobs that have not experienced growth in productivity increase in response to rising salaries in jobs where there has been productivity growth. So, for example, automation in manufacturing might increase productivity, and wages rise with it, but the salaries of string quartet players also rise as a result and there is no productivity gain to be had from playing a string quartet movement written to be played in six minutes in four minutes: in fact, you ruin it if you do. The example is of course contrived: the reality is that string quartet players have increased productivity through better transport, distribution methods and recording techniques. But the fact remains that their core product can't be compressed in time scale.
Nor, once admin gains are won, can policing, education, nursing, social care, social work, the justice system and many other services be compressed and still function. In fact, because they require face to face contact you ruin them if you do that. But the government, dedicated to an austerity programme that demands increasing productivity, demands that we do crush the time spent on these services, which undermines their value, and that the wages of those undertaking them be cut to break the relationship Baumol observed. But there's a problem with that too, because those who enjoy the higher pay set the cost of living e.g. by forcing the price of housing up. In that case those in the services where productivity gains have reached their limit suffer real pay cuts, a loss of job satisfaction as they're not allowed to do the job properly, and quit as a result. The exodus of teaching staff and the declining number of nurses is evidence of that.
And this matters. It matters because we literally cannot do without these people but apparently we can't afford them. I don't blame Baumol for this. Describing the phenomenon does not make him responsible for it. I blame governments, economists and politicians, none of whom have apparently appreciated that technology can only take us so far in many public services and then we reach the crunch point where dealing with people requires real time and irreducible interaction and there is nothing that can be done about this barring supplying a poor service, or none at all.
That's the conundrum at the real heart of modern government. We're phenomenally more productive than we ever have been. And apparently, as a result, we can't afford large numbers of things that were possible in the past. Unless, of course, we change the model. Remember all models are wrong. And what is now clear is that model we're using is not helping.
The model we're using is one that says the state has a limit to the size it can be in proportion to the private sector. And it says the state can supply all the services we need despite this constraint, even if Baumol's law applies. And that model is wrong. We cannot do that. What Baumol's law actually implies is that as we get richer in terms of the productivity of some labour (which, because of robotics, is likely to continue to grow even as total employment falls) the price of public services will rise and that we must accept the growth in the size of the state sector that follows if we are to still enjoy those services we once thought of as basic.
And of course, that means we will pay more tax too. But that tax will be paid out of the proceeds of the spending, because as I argued yesterday, spend comes first and tax comes second, and unless there is full employment at fair pay (which there clearly is not in the UK) the spend does not result in inflation. In fact, the tax ensures that is true. Indeed, because of the multiplier effect, we might even, perchance, balance the books.
But that's not the goal. The goal is to have the services that we are told, despite our apparent riches, that we cannot now afford but which we could have when we were much worse off. And of course we can have those services: it is glaringly obviously absurd to say that because we are richer we can no longer afford to teach people, have police or provide care. It's just that the economic model we are using is wrong. And that's the bit we have to change as a result, which is, unfortunately, the hard bit. Although heaven knows why.
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I think we know why. “Forget what they told you. You want the truth, follow the money.” (Roxanne Bland)
I can never get my head around how the multiplier works. If government spending = private income and both sum out to zero, where does the extra money generated by the multiplier come from?
The government spends
People pay tax
And then spend
And so on
And if it is clear the government will keep spending and so others will keep spending business notices, and borrows, and invests
And so the government spending stimulates growth
But if you say you’re going to cut and then cut some more business retracts and the economy shrinks
As has happened
rather than a `multiplier` – which sounds a bit magical – maybe think of it as a recycler: money can be used, and used again, like a plastic bag, slightly less effective each time but giving a much greater life than the `one use` model.
That’s actually quite nice except for the fact that the recycled bag can be no more than it was and the multiplier can be
I’d never heard of Baumol’s law before, but I’m sure you’ve got the hypothesis and the explanation for it spot on.
“Austerity: the History of a Dangerous Idea” by Mark Blyth demolished the “Idea” a few years ago. You’ve probably read it. It’s reassuring to see many of the more enlightened coming to accept that the current model is a disaster – except politicians of course who have to ensure that the rich get the rewards they’ve been accustomed to.
A question: does the so-called “pensions time bomb” fit this scenario? Is it a chimera? or is it real?
I’ll try to do pensions tomorrow
On the button Richard, as ever.
The toffs might get it easier with a cricket analogy.
With some 82% of the batting side sitting on their bums and 70% of the others just standing around, the game is ripe for productivity improvement.
I do , after repeated reading, begin to see the logic of your argument in a world where fiat money has ruled since the US abandoned the dolar link to the gold price under Nixon and most if not all other jurisdictions eventually followed suit. Not to mention but I will — their permissible evolution of the eurodollar and petrodollar markets to facilitate
the greenback’s continuing world currency hegemony until possibly 2020 circa.
However methinks you will have an uphill task convincing the UK political mainstream of your narrative as
long as persons like this young lady expound the views she does in her recent ( 2017) maiden HoC soeech…….
https://youtu.be/CvzyyBJVNGA
That’s desperate, she is so wrong
it is amazing how the household fallacy has gripped the entire nation, pretty much – to the point where labour politicians have to go on TV and respond to questions on how they will ‘balance the books’ (Andrew Marr etc.) and ‘where will the money come from’.
The entire discourse on this issue is so far off the spectrum of reality, but it’s become the excepted norm. I don’t understand why Labour or Mcdonnell can’t make a stand on this, and when asked on the average BBC interview, turn around and go “that’s not how it works mate”.
It is the single biggest issue which blighted their campaign – Magic money tree was a hugely effective way to disregard practically all of Labour’s manifesto, and for the most part, it did work.
Yup.
Spending must precede taxation because spending precedes growth, the production of goods and services.
And spending means the production of fiat money by licenced money producers. The production of goods and services in a modern economy cannot be limited by relation to a finite value or quantity as it was, say, in the middle ages.
So banks create the money which creates commercial outputs.
Why, on the same basis, can money not be created by a public bank which then produces non commercial, public good, outputs?
Demand pull inflation?; as the money passed to public sector workers and entities competes with the money passed to private sector workers for the goods and services produced. Public sector outputs being provided without financial consideration.Demand for public serices increases exponentially but there is no inflation percentage equivalent.
So, in reality, the control of inflation becomes the primary purpose of monetary and fiscal policy.
Taxation reduces demand. Taxation – a fiscal tool- may be the key control and not interest rates.
What about cost push (Brexit)inflation. Need to think about this.
Why was everything that I was taught about economics, and why is the current MSM debate, so unhelpful in terms of understanding our current precicament?
Because all you were taught was probably wrong
Why doesn’t the Labour economics team get this!!
I do not know
“Why doesn’t the Labour economics team get this!!”
The sad conclusion I have reached is that, whilst their hearts may in the right place, they are not really very bright.
It’s not even that they are poorly economically educated – that’s probably an advantage given the prevailing bias in the academy.
A bit more intellect and curiosity is what’s needed, and that’s conspicuously absent in politicians of all parties these days.
I get more interest in Scoitland, I admit
My view is that there is a culture in the UK where politicians must not argue with the voter (even if the latter are factually wrong) because:
(1) the lies and myths that have been inducted by the voter are so deeply inducted and entrenched so that to take these on will not get you a vote because the voter (or many of them) does not like to be told that they are wrong and;
(2) there is a pernicious culture of ‘customer service’ in public life these days that says that the customer is always right because by adopting this stance public services will improve. This is also on the assumption therefore that the customer is the taxpayer and the money is ‘their money’.
(3) When a politician goes along with the great lie or voter sentiment, this makes the voter more malleable to that politician as the voter feels that the politician ‘understands me’ and a connection is made.
The desire for power ensures that the politicians go along and even reinforce the myths and lies amongst the electorate. This contributes to the death spiral in public services and to the one in the economy that we are still in.
It is a shocking state of affairs really.
Agreed
@PSR, I’m not sure that I agree.
Tory (and LibDem politicians when in coalition) have delivered slap after slap on the face to voters for over seven years now, and in many cases, with visible relish.
Customer friendly they are most certainly not!
Perhaps it’s Stockholm Syndrome or something similar going on?
I think they do get it. But they seem to have decided that saying so would play to the worst Tory/tabloid prejudices about Labour: they wouldn’t get a hearing. There’s no way that they could explain the “household” myth in a couple of soundbites, which is all that is available, so they go for “tax the rich & corporations a bit more to pay for services”. And to be clear, Labour’s tax policy is correct, from the point of view of redistribution, as well as popular. So not much harm done, really.
Labour also attack the issue from the margins, with the “fiscal rule” that can be suspended when at the zero lower bound of interest rates (i.e. right now!). And also with their policies of investment/nationalisation not “funded” out of tax.
They’ve decided this is a far as they can go, at the moment. When they get into government, if they do it right, they can start the long process of economic re-education through their actions. Especially if they come to power shortly after Brexit: that would be a laboratory case for the need/benefits of deficit spending to employ the economic resources left idle by Brexit.
I know it’s frustrating, it frustrates me, especially on the issue of student debt, which is an open and shut case for “People’s QE”, if you ask me.
Of course the labour economics team gets it.
The majority of the population don’t – so they have to be seen as being ‘in control’ and ‘fiscally conservative’ and not ‘spending now to put future generations in debt’ and a whole host of countless slogans that get trotted out, a mixture of about 10 which get repeated over and over, in questions asked in interviews, in opposition to the Tories, practically in any scenario.
Mcdonnell specifically held economics workshops and got some of the best and brightest anti-austerity academics together to come up with a new industrial plan. I’m sure at some point in these discussions they would have inevitably been schooled on everything Richard Murphy has mentioned in his blog. They won’t be complete idiots.
ANd neither are the Tories – they know that repeating the mantras will keep them in power, because the electorate themselves are totally uneducated on the topic and the majority media bend to that narrative without even remotely questioning it.
I can assure you that most of what I say here was not said at most of those workshops
Some, maybe; partly because I did one. Also because Ann Pettifor has. But let’s be clear. They were show pierces and the council of advisers has never been reconvened.
Stephanie Kelton, MMT economist, was hired as advisor to Bernie Saunders presidential campaign. It’s inconceivable that anyone in McDonnell’s position won’t be familiar with at least the basic ‘spend and tax’ tenets of MMT. I think such ideas are largely in the bubbling under phase right now, waiting for the right moment to burst forth and become mainstream.
I very strongly suspect he does not know this
It is very little taught in UK universities
wow, ok – well that is just incredible to me. Not incredible in the sense that I don’t believe it of course – just astonishing to hear, as to me this whole issue of spending = income seems so basic, a fundamental part of economics. Even Y = C+I+G+(X-M) is learnt in the 1st year on the undergrad course!
I remember literally having to rearrange the equation to get the multiplier, and be able to explain what it all meant etc… we had to do it in a group project!
thanks for this info of yours, it reveals a lot in itself.
I teach it
But it does not mean that people then realise that the household fallacy is wrong
It’s in every economics course, I suspect, but many economists still prescribe the household fallacy and won’t see the link
Great post Richard. Thanks.
There is obviously also a further knock on effect of not paying enough to public sector service workers, in addition to all the direct impacts you mention above. That is our now more productive economy can’t actually run at full capacity because there aren’t enough customers with enough money to buy the products and services.
Surely this must affect the profitability of companies in the real economy (rather than financialised companies gambling in the money markets)?
Surely the owners and managers of so affected real economy service and manufacturing companies can be persuaded of the harm caused by this faulty model?
Surely they can be motivated to come out against it if they can see the alternative bringing them greater turn-over and profits?
Do you think most small and medium sized businesses (and even some bigger corporations) are being conned by the bankers and land owners just as badly as the general public have been?
I agree with you
This bizarre approach harms business
Just as business’ appraoch to tax transparency harms business by encouraging cheating and monopoly
Anyone would think business is its own worst enemy
Presumably the finance industry is the one part of the economy that is content (for now) with this model, because they are the ones that can flood the country with chesp (but ultimately unaffordable) credit.
I think this is why outsourcing of public services has become such a prevalent industry – why bother to take the risk of bringing new products and services to market, when you can suck at the Government teat like the worst caricature of a welfare queen?
No need to innovate, no business risk, no competition, no danger of declining demand (on the contrary!), and you’re laughing all the way to the bank. Whack a couple of ex-ministers on the board, make a few political contributions and … Kerchinggggg!!
Agreed
That was a key argument in The Courageous State
I haven’t read it (yet…!), but glad we agree.
The string quartet of Baumol fame is a good example of a multiplier less than one, with it being a subsidised activity in the UK at least. The OECD Fournier and Johansson paper in 2016 suggested a multiplier of 1/6th for subsidies.
Multipliers greater than two have been suggested for repairing our awful roads.
It’s the quality of extra spending, not the quantity that counts.
So the arts have no quality?
Not at all, there’ a market system for deciding the quality of arts. Some people like them a lot, most don’t care. The hand outs are a case of ‘for the few who appreciate it, not the many who don’t ‘. What the OECD are saying is that subsidies to things like the arts have multipliers of around 1/6th and are a very bad use of government spending.
I guess you’ve got a citation that says otherwise?
No, there is no market system that decides the quality of art
Three words prove that: Vincent Van Gogh. Quite clearly the market system for art failed him.
If you think markets answer all questions you are hopelessly deluded. The e plantation is simple. Markets work when we have perfect knowledge and equal access to caoutal and mass market participation. The art market we have enjoys none of these things and so intervention is needed to correct its failures.
A final point, if you’ve come here to write nonsense of this sort please don’t bother. Repetitive neoliberal nonsense from a person is always deleted.
“a multiplier of 1/6th for subsidies.”
Now this is where my lack of an economics education will show – but how can any public spending produce a multiplier of less than 1?
Does taxation on the initial (and consequent) spend count as reducing the input into the economy? If so, why?
The only way I could see the multiplying effect being below 1 was if taxation is included and money was saved not spent.
Pls explain, for dummies!!
The argument is – and it is hard wired into the Treasury and Office for Budget Respoinsibility DNA – that when the government spends income goes up by less than the sums spent
The logic is that tax pays for the spend and the tax raised to pay for the spend reduces income by more than the spending increases income so that overall well being is reduced as a consequence
The OBR and Treasury assume this is true of all government spending bar that invested in infrastructure
To put it another way, they assume that individuals would always spend more wisely than government and that all government spending reduces well being as a result, barring infrastructure
Of course they don’t put it like that, but that’s what their assumtoiuon implies. It says about all you need to know about their deeply ingrained political thinking
Rich Warnes:
Markets do some things well and others really badly. The arts is one such market failure.
While some rich people buy up trendy stuff for millions of pounds as “investments” funding for grass roots arts is woefully lacking. Look at music and art teaching in primary schools, or rather the lack of it.
Meanwhile commercialised “art” pervades our mainstream media in all its banal and pointless glory. Advertising executives are awarded trophies for the art that manages to dupe the most people into parting with their cash for crap they don’t need. Mainstream pop-stars sing about dating and the acquisition of pointless trinkets. Popular novels focus in crime or romance.
Art is a language, a store of cutural knowledge and feelings that can’t easily be expressed in words alone. Without real art a society forgets its past and remains unaware of its present existing in a perpetual state of childish ignorance of anything and everything that really matters.
Of course neoliberals don’t want well funded grassroots art. They don’t want the masses to think, express themselves or organise around overarching cultural beliefs that art can express so clearly.
should also note that cutting back in the extreme leads to more bills in the long run.
lack of investment in infrastructure and productivity = higher bills and inability to cope in the long run. cutting off your nose to spite your face.
prime example being roads. if you don’t spend enough on preventative maintenance when roads are mid life cycle, you shorten the life cycle of the road and in the end it needs to be totally rebuilt at massive cost. a smaller amount of money invested at the right stage would be cheaper in the long run.
Thanks Richard. You are teaching us something that is very powerful. We just have to pass the information on to others. Just like after WWII we can have government investing in public services and the National Debt will come right down.
Ron
Models: It was George Box who said it. Dr W Edwards Deming endorses it in his writing. His book,The New Economics’ full title is for Industry, Government, Education. The golden rules for running ANY organisation economically and fruitfully are all there. My fellow researchers and I estimate that there is at least 30% waste in most of the public sector – caused mainly by a really bad (NPM) model of management, cost-cutting which leads to increased aggregate cost, and valueless compliance structures egged on by HR as it gives them power.
But, try telling that to Hunt et al.
A couple of points.
First, it does matter how government chooses to spend (or cut tax)….
Spending on infrastructure, a rise in benefits for those on low incomes (or tax cuts to low and middle income earners) all will have a positive impact. Tax cuts to the rich (the trickle down effect beloved by some) do not work because they do not increase spending.
Give a rich man a tenner and his spending will not change; give a poor person a tenner and they will spend it.
Second, I would go further than Baumol’s law. Imagine a world with no state provision – as I grow wealthier I will eat better and live in a nicer house. But once a certain level is achieved my extra wealth will go on educating my children and on improving my health. What holds for the individual also holds for society. So, even with Baumol’s observations about differential rates of productivity growth we should still spend an ever increasing share of our wealth on health and education…. and if that is delivered mainly by the state then the state will grow as a proportion of the economy.
sorry – a typo. Last para should read….
“So, even WITHOUT Baumol’s observations about differential rates of productivity growth we should still spend an ever increasing share of our wealth on health and education…. and if that is delivered mainly by the state then the state will grow as a proportion of the economy.”
Clive:
Indeed. The more I think about this stuff the more absurd I find it.
We have a productive system that is actually so efficient and productive that only a minority of the working population are required to produce all the food, shelter, infrastructure and manufactured goods we need. Everyone else has the time and resources to care for each other, entertain each other, discover new technologies, make scientific breakthroughs, create beautiful and meaningful art, engage in sport and adventure, care for the planet and its ecosystems, educate our children and ourselves.
Instead we’re either unemployed or worked to death in marketing, sales, PR, lawyering, or part of a public or private bureaucratic machine focussed on maintaining and facilitating a few peoples’ enormous power.
It would be hilarious if it weren’t such a boring waste of so much human talent.
Sounds a lot like Modern Monetary Theory, which describes how currency works in most countries outside the euro zone. Currency is created by government spending and destroyed by taxation.
Their is no need for continuously balanced budgets or government surpluses.
A government sector surplus usually equates to a private sector deficit ie shrinkage.
All government spending should be seen as investment in or for it’s people – the trick is to make it effective.
Problem is, no political party want to blow the whistle, because they believe it will mean political oblivion in today’s political climate. They may be right, or it could be a chance for a complete rebuild of how our economies and societies work.
It is MMT mixed with what I call MTT – modern taxation theory
Richard, I know a whole load of people who would like to know more about MTT.
They are already well versed in MMT, and passionate about it’s application to government policy.
Would you prefer Facebook, Twitter or email contact?
What are you proposing?
BTW could be a lively debate – MMT holds that taxation just destroys currency.
Anyway it’s a debate to be had. Those who see the current system as wrong should debate to arrive at an overall consensus position. So many people united will, I hope, make continued adherence to the status quo untenable.
It’s always been strange to me that a party so married to the concept of business should opt for an entirely non business metaphor. Ie, the household budget where the metaphorical family depends typically on one or two paymasters for their economic well being. Surely a much better analogy is, and I know it well as I grew up in one, the family farm. When prices fell for a time we looked towards trying to improve our products, the way we produced them, our diversity, our knowledge of how to do things differently and better. If it was easy to get help, ie if interest rates were low, we borrowed money and sent the next generation to college to learn new techniques
What we didn’t do was draw up the drawbridge, sell the cows, take the children out of college and give any cash we did have to the dodgy financial advisor that assured us he was the future and all that hard graft was a thing of the past. We could although we didn’t ever have to have grown our own food. The point is, it’s about strengthening your business through education, through infrastructural development, through using your resources, all your resources well. With 4 sons to work on the farm dad knew that we’ll
He didn’t cut the budget by denying us the little bit of cash incentive we needed to get us to milk the cows
In any case, it was obvious to us all that we all benefitedo.