Or, 'I am an Economist and I am here to help'.
This week I was pleased to hear Labour leadership contender, Yvette Cooper, cautioning some members of the Party against ‘swallowing the Tory manifesto’. This is being interpreted as a criticism of rivals Andy Burnham and Liz Kendall, who appear to be keen to admit to Labour’s past mistakes in office in an attempt to capture the electoral centre ground away from which Ed Miliband moved the Party.
I have written before about how disappointed I have been by Labour’s unwillingness to defend its record on managing the economy and the public finances during the Blair-Brown administration against Coalition charges of profligacy (‘failing to fix the roof when the sun was shining’, etc). I was consequently shocked when potential leadership candidates appeared to be falling over each other to criticise Labour’s poor economic management and embrace the new Tory fiscal orthodoxy. Here’s Andy Burnham saying that Labour ran deficits that were too high. And here’s Liz Kendall going even further, declaring that Labour should run a budget surplus in future. There can be little doubt that if Chuka Umunna was still in the contest he would be saying much the same, as he was reported to have received the ‘hairdryer’ treatment from Gordon Brown when he criticised Labour’s economic record in office and accused the Party of being in ‘deficit denial’ in September last year.
Perhaps Cooper wasn’t focussing on this when she made her ‘swallowing the Tory manifesto’ jibe, but had in mind the calls from some in the Party for an EU referendum, more talk of aspiration and less defence of those at the bottom on benefits. Maybe I will be confounded when she comes out and says we need to run a budget surplus to keep the public piggy bank topped up for a rainy day. I say confounded because, unlike her leadership rivals, she did study Economics. In her case it was PPE at Oxford. This is in contrast to Andy Burnham, who read English at Cambridge, Liz Kendall, who read History, again at Cambridge, and Mary Creagh who read Modern Languages at Oxford (Chuka Umunna studied Law, not at Oxbridge, so I don’t think he would have been allowed to be Prime Minister anyway).
Sadly, it now seems that you can’t say you studied Economics, like I did, and expect people to think you know anything that they do not. This is in contrast with people who studied sciences, Law, Medicine, Accountancy or Engineering. People may have a low opinion of English and History but they would expect Andy Burnham to know about some books that they hadn’t read and Liz Kendall to know some stuff about a particular bit of the past that they didn’t. What’s worse is that most people seem to think that what Economics teaches you is wrong and should be ignored. Which is not surprising, because so much of what you learn is counter-intuitive and appears to contradict common sense. Moreover, it can be an affront to what people believe to be morally right. For example, Economics teaches you can generate a better outcome for society if polluters pay for the right to pollute, rather than if they are fined when they do, providing the money goes to compensate those who suffer the harm.
The debate on economic policy has been almost entirely captured by those who advocate the paradigm that the public finances are just like that of a household. You can’t spend more than you earn indefinitely. You cannot keep on borrowing. You will have to pay your debts back eventually or you will go bankrupt. If you spend more than you earn, then you need to cut your spending. This was the orthodoxy that prevailed before WWII and prolonged the economic crisis after the Wall St Crash in 1929, creating the Great Depression of the 1930s and brought Hitler to power in Germany. The great triumph of the economist John Maynard Keynes was to get the Very Serious People to accept that this household pocket book approach to running the public finances was wrong. To do this, he identified the concept of the ‘Paradox of Thrift’. He demonstrated that although thriftiness, or saving, was generally accepted as being a good thing, in certain circumstances it could have bad consequences. This was because if the economy was depressed, then savings wouldn’t get spent on investment so the more savings rose, the less people would spend. This meant that as one person’s spending is another person’s income, the economy would just get more depressed. He argued that in these circumstances, that is, in recessions, Governments needed to keep their spending up to take up the slack in the economy until such time as private sector confidence returns and people start spending and investing again. This ‘counter-cyclical’ view of Government fiscal policy held sway from after WWII until about 1980, when it was supplemented by free-market monetarism. The triumph of this new free-market credo which, incidentally, ushered in a period of slower growth and rising inequality, culminated in the private sector banking crisis that led to the Great Recession in 2008.
It should be said that Keynes thought that Governments should generate budget surpluses when times were good to offset the deficits it needed to run when times were bad. Perhaps he was being too cautious. The ratio of UK Government debt to GDP stood at around 240% in the late 1940s as a result of the costs of the war and then the setting up of the Welfare State by the post 1945 Labour Government. This ratio was brought down to less than 50% by the mid-1970s, not by successive Governments running budget surpluses, but by the eroding properties of inflation and economic growth.
In fact, despite what common sense may suggest and moral outrage demand, it is possible for the Government to run a Budget deficit indefinitely whilst at the same time reducing overall Government debt as a percentage of the economy. Here’s an example:
Year 1 GDP = 100 Govt Debt = 50 so Debt to GDP ratio is 50%. Govt is running a deficit of 1.
If we assume that inflation is running at 2% and real GDP growth is 3%, then the economy will grow in money terms by 5%. If the Government continues to run a budget deficit of 1, then:
Year 2 GDP = 105 Govt Debt = 51 so Debt to GDP ratio has fallen to 51/105 = 48.6%.
If this trend continues, then
Year 3 GDP = 110.25 Govt Debt = 52 so Debt to GDP ratio has fallen to 52/110.25 = 47.2%.
If this continues, then by
Year 10 GDP = 155.13 Govt Debt = 59 so Debt to GDP ratio has fallen to 59/155.13 = 38%
If these deficits are going to finance much needed public investment in infrastructure that expands our productive capacity thereby enabling the economy to keep growing at a healthy rate, 3% in the example above, what is there not to like?
I fear that the current obsession of seeing the running of the public finances as an extension of managing household budgets will, rather than protect our children from being saddled with our debts, burden them with a colossal bill for rectifying the problems caused by years of lack of investment.
I have written before about how disappointed I have been by Labour’s unwillingness to defend its record on managing the economy and the public finances during the Blair-Brown administration against Coalition charges of profligacy (‘failing to fix the roof when the sun was shining’, etc). I was consequently shocked when potential leadership candidates appeared to be falling over each other to criticise Labour’s poor economic management and embrace the new Tory fiscal orthodoxy. Here’s Andy Burnham saying that Labour ran deficits that were too high. And here’s Liz Kendall going even further, declaring that Labour should run a budget surplus in future. There can be little doubt that if Chuka Umunna was still in the contest he would be saying much the same, as he was reported to have received the ‘hairdryer’ treatment from Gordon Brown when he criticised Labour’s economic record in office and accused the Party of being in ‘deficit denial’ in September last year.
Perhaps Cooper wasn’t focussing on this when she made her ‘swallowing the Tory manifesto’ jibe, but had in mind the calls from some in the Party for an EU referendum, more talk of aspiration and less defence of those at the bottom on benefits. Maybe I will be confounded when she comes out and says we need to run a budget surplus to keep the public piggy bank topped up for a rainy day. I say confounded because, unlike her leadership rivals, she did study Economics. In her case it was PPE at Oxford. This is in contrast to Andy Burnham, who read English at Cambridge, Liz Kendall, who read History, again at Cambridge, and Mary Creagh who read Modern Languages at Oxford (Chuka Umunna studied Law, not at Oxbridge, so I don’t think he would have been allowed to be Prime Minister anyway).
Sadly, it now seems that you can’t say you studied Economics, like I did, and expect people to think you know anything that they do not. This is in contrast with people who studied sciences, Law, Medicine, Accountancy or Engineering. People may have a low opinion of English and History but they would expect Andy Burnham to know about some books that they hadn’t read and Liz Kendall to know some stuff about a particular bit of the past that they didn’t. What’s worse is that most people seem to think that what Economics teaches you is wrong and should be ignored. Which is not surprising, because so much of what you learn is counter-intuitive and appears to contradict common sense. Moreover, it can be an affront to what people believe to be morally right. For example, Economics teaches you can generate a better outcome for society if polluters pay for the right to pollute, rather than if they are fined when they do, providing the money goes to compensate those who suffer the harm.
The debate on economic policy has been almost entirely captured by those who advocate the paradigm that the public finances are just like that of a household. You can’t spend more than you earn indefinitely. You cannot keep on borrowing. You will have to pay your debts back eventually or you will go bankrupt. If you spend more than you earn, then you need to cut your spending. This was the orthodoxy that prevailed before WWII and prolonged the economic crisis after the Wall St Crash in 1929, creating the Great Depression of the 1930s and brought Hitler to power in Germany. The great triumph of the economist John Maynard Keynes was to get the Very Serious People to accept that this household pocket book approach to running the public finances was wrong. To do this, he identified the concept of the ‘Paradox of Thrift’. He demonstrated that although thriftiness, or saving, was generally accepted as being a good thing, in certain circumstances it could have bad consequences. This was because if the economy was depressed, then savings wouldn’t get spent on investment so the more savings rose, the less people would spend. This meant that as one person’s spending is another person’s income, the economy would just get more depressed. He argued that in these circumstances, that is, in recessions, Governments needed to keep their spending up to take up the slack in the economy until such time as private sector confidence returns and people start spending and investing again. This ‘counter-cyclical’ view of Government fiscal policy held sway from after WWII until about 1980, when it was supplemented by free-market monetarism. The triumph of this new free-market credo which, incidentally, ushered in a period of slower growth and rising inequality, culminated in the private sector banking crisis that led to the Great Recession in 2008.
It should be said that Keynes thought that Governments should generate budget surpluses when times were good to offset the deficits it needed to run when times were bad. Perhaps he was being too cautious. The ratio of UK Government debt to GDP stood at around 240% in the late 1940s as a result of the costs of the war and then the setting up of the Welfare State by the post 1945 Labour Government. This ratio was brought down to less than 50% by the mid-1970s, not by successive Governments running budget surpluses, but by the eroding properties of inflation and economic growth.
In fact, despite what common sense may suggest and moral outrage demand, it is possible for the Government to run a Budget deficit indefinitely whilst at the same time reducing overall Government debt as a percentage of the economy. Here’s an example:
Year 1 GDP = 100 Govt Debt = 50 so Debt to GDP ratio is 50%. Govt is running a deficit of 1.
If we assume that inflation is running at 2% and real GDP growth is 3%, then the economy will grow in money terms by 5%. If the Government continues to run a budget deficit of 1, then:
Year 2 GDP = 105 Govt Debt = 51 so Debt to GDP ratio has fallen to 51/105 = 48.6%.
If this trend continues, then
Year 3 GDP = 110.25 Govt Debt = 52 so Debt to GDP ratio has fallen to 52/110.25 = 47.2%.
If this continues, then by
Year 10 GDP = 155.13 Govt Debt = 59 so Debt to GDP ratio has fallen to 59/155.13 = 38%
If these deficits are going to finance much needed public investment in infrastructure that expands our productive capacity thereby enabling the economy to keep growing at a healthy rate, 3% in the example above, what is there not to like?
I fear that the current obsession of seeing the running of the public finances as an extension of managing household budgets will, rather than protect our children from being saddled with our debts, burden them with a colossal bill for rectifying the problems caused by years of lack of investment.
