Prof Charles Adams of Durham University posted this on Progressive Pulse on Saturday. It is well worth sharing here. I have already tackled one of the falsehoods perpetuated about the UK economy this morning, which is that the UK has debt of £1.8 trillion when the real figure is less than £1.4 trillion. Charles slays another one of the gross misunderstandings that election economic debate suffers from:
The household fallacy
It’s election time and the household fallacy is back in vogue.
On Radio 4s “Any Questions” this week a lady asked (more eloquently then my version, go to 14.45 minutes in), how are we supposed to teach our children about counting their pennies when politicians are promising to spend on this, that, and t’other? The answers given by the panellists were uniformly disappointing. Here’s what I might have said.
We need to teach our children and everyone else, including politicians, that goverment spending and our spending do not work in the same way.
When the goverment spends, that spending is someones income and that someone pays some tax so the government immediately gets some of their money back. And then that someone spends most of their money which becomes other peoples income. And these other people also pay tax, so the government gets another fraction back. And these other people also spend which becomes the income of even more people who also give a fraction back to the goverment. And so on. If everyone spends then the government gets all its money back. Whereas when you or I spend we do not get anything back. That is a big difference. The only way the goverment can be in deficit is if the people decide to save. The goverment debt is simply the peoples savings. If at any point the people go out and spend their savings, then the goverment debt will be cleared.
Now if that all seems too difficult, and I am allowed a bit more time, lets try to think about things another way.
Imagine your household were like a country. In your household there are people that can provide everything you need. There is a lady who builds windmills that provide power, there is man that looks after the pigs, there is someone who grows vegetables and a wise person who teaches the children. In this utopian self-sufficient household there is no need for money. Everything you need is provided by the labour of the occupants. Everything works fine until someone decides to spend their days drinking beer rather than working. To prevent this, the elders introduce a system of credit based on post-it notes. The credit notes record how much work each person contributes and can be exchanged for beer, wooden toys or whatever they desire (you can try this at home, if someone does the dishes they get a post-it note which can be exchanged for chocolate or saved for a future purchase). When the elders need someone to mend the roof they reward them with post-it notes (of which they have an unlimited supply). But as the number of notes in circulation gradually increases, the makers of wooden toys realise that they can demand double and buy more beer, but then the brewers want more notes for each beer and people start to get upset. To stop this runaway inflation the elders need to prevent the quantity of credit notes growing faster than the amount of work getting done which they do by taking back a fraction of the notes each time they are exchanged. This we call tax.
The elders, via issuing credit, have enormous power to decide what gets done. Whether the roof gets mended or not, or whether we need another windmill. For this reason the other members of the household need some way of replacing them if they misuse their power. And lo, the household invents representative democracy!
Is this too hard for children (and politicians) to understand?
There is one good question a child might ask. “Why can’t I create my own post-it notes like the elders do? Then I can buy everything I want without working.” The answer is. “Well you could, but others will not accept your notes. They have no value. The value of credit comes from the work that is done or promised to be done in exchange. That is why the elders have to be careful to only create credit on the promise of work and if they get that right everyone prospers.”