The Crazy Right

I note that the US is again leading the way in showing the world how great democracies work.

Yes, the Republicans are once more holding the country to ransom, this time blocking the passing of a new government budget unless the Affordable Care Act (ACA) is postponed/reworked/abolished etc. What this means is that the Republicans are happy for hundreds of thousands of government employees to go on unpaid leave, for markets to panic, for GDP to take a hit and for many public services to be unavailable, if it means a chance of hijacking a law that has nothing whatsoever to do with passing the new government budget.

And the ACA, (or Obamacare as it has become commonly known), is a law. It was passed into law by both houses in 2010. Having failed to prevent it being passed into law and having prevented getting it repealed, Republicans have now resorted to using the American people as hostages in an act that is nothing short of shameful.

But what is the ACA? I’ve had a look and on the face of it, it’s hard to understand why someone would hate it so much. Prior to it, if you couldn’t afford private health care in America you were pretty much stuffed. Even if you could do you were by no means safe. The ACA makes it illegal for insurance companies to refuse to continue to insure you if you become sick. It makes it illegal for insurance companies to refuse to insure you if you have a pre-existing condition. It allows sons and daughters to remain on their parents’ insurance policies until they are 26 rather than having to finance the cost of health insurance themselves.

Why would Republican voters hate those things? It’s a good question and guess what? They don’t! When asked about the individual elements of the ACA, Republican voters actually support them. But the Republican Party has spent so much money on convincing people that “Obamacare” is a terrible thing, that their voters still think they don’t want it. Please do watch this short video by Jimmy Kimmel to show how ridiculous this situation is.

Yes, you didn’t imagine it – there was someone in there whose primary reason for not liking Obamacare was that it was “Un-American”, whatever the hell that means.

Moving on from voters though, Republican politicians know that the ACA and Obamacare are the same thing and they do know all of the initiatives that make it up. So why do they hate it?

Firstly, being a politician in America is an expensive business – getting elected means huge campaigns, TV commercials, travel, televised addresses. That money’s got to come from somewhere and health insurance companies donate millions of dollars to political parties and guess who gets the vast majority of it? Yep the Republicans. Why would Health Insurance companies donate lots of money to political campaigns? Well, it could be that they just like a particular politician’s stance on peace in the Middle East. Or perhaps… maybe… just maybe… they expect to get something back. Yeah – democracy my arse.

It’s not just a question of funding though. The Republican Party are what we call “Starve the Beasters” – that is that they believe that the lower the tax revenue the government takes, the better off things will be. By starving “The Beast” the private sector will surely expand to fill its place! The ACA is clearly at odds with this, as health care for those who can’t afford to go private is financed by the government.

The thing that the “Starve the Beast” rhetoric always ignores is that some things do work better when paid for through taxes. I mentioned a few of those towards the end of this post and the idea that everything works better when private than public is as stupid as the opposite scenario. The question is then, is healthcare one of the things that should remain entirely private for the US or could some government intervention help? The fact that 60 million Americans have no private health insurance, plus the fact that even Republican voters actually like all of the individual parts of the ACA probably tell you something about the answer to that question. If you feel that 60 million people shouldn’t have access to health care because they can’t afford it but state intervention would be “Un-American” then you are entitled to that view, but I would counter it by saying that you are a massive twat.

You might wonder why, as a British person, I care so much about what’s going on in the US. After all it doesn’t affect me, does it? Three points on that:

Firstly, 60 million people without access to healthcare in a country, where it could so easily be provided, saddens me greatly. Whether or not it is the country in which I live is irrelevant. Yes, of course there are many poor countries where people have no access to health care but remember folks, this is the largest economy in the world and it is a problem for which the means to solve it are easily understandable and easily available.

Secondly, the world economy is still very much dependent on the health of the US economy. When Republicans decide to screw it up for nothing more than their own nefarious agenda that affects all of us in some way.

Thirdly, when I look at the Republican party, I don’t just see some crazy people at whom to laugh. I see a party whose only concern is to make the rich richer at the expense of everyone else and that just strikes too close to home for comfort. At the moment I’m just watching the Tories going in exactly the same direction. Simon Wren-Lewis is similarly concerned. Could that really be the future to which we have to look forward? It’s not looking good:

Taxes for rich people? Let’s reduce those. Benefits for poor people? Let’s reduce those too. Public healthcare? Well, we can’t just bin it overnight but we can dismantle it bit by bit. Public education? Make schools “Academies” and then make them private. Climate change? Not a priority. Starve the Beast? Absolutely – we’ll cut the public sector throughout our next term too, whatever the state of the economy!

The Conservative party is undoubtedly moving swiftly to the right, but there is a strategy out there to try to hide that. Both they, with their “Red Ed” campaign and their friends in the right-wing press, with their attack on Ed Miliband’s “Britain Hating” dead father, are trying to position the whole thing not as their own move to the right but as the opposition’s move to the left.

It’s not hard to see the reality though and if the present weren’t bad enough, the trend suggests that the future will be worse with the gap between the moderately crazy Conservatives and the thoroughly crazy Republicans narrowing more and more. When I look at the US political right I don’t just see a bunch of nutters – I see our future.

By the way, you might be interested to know that the term, “Obamacare” was coined as a pejorative term by the Republicans – an attempt to debase it without having to directly address all those good things in it. Sadly, as you can see from the Jimmy Kimmel clip, that initiative has been effective. My hope, however, is not that this term will be disbanded. My hope is that with the rare victory over the crazy right that the ACA was, the name “Obamacare” not only replaces ACA in popular use, but remains in popular use for a very long time to come, as a tribute to a man who managed to do something great. Something that, in the face of such opposition from the crazy right, gave millions of poor people access to healthcare that they’d never otherwise have been able to afford.

And what Obamacare shows is this. No matter how crazy they are, no matter how extreme they get, no matter how much private funding they can muster and no matter how strongly they campaign for the interests of the 1%: Good things can still get done.

Perhaps, after the way things have gone recently in the UK, those of us outside the crazy right should take something from that.

RedEaredRabbit

Bubblenomics

If someone asked you to name the country you most associated with tulips, you’d immediately say, “The Netherlands!” Interestingly enough though tulips aren’t in fact an indigenous Dutch flower, having been introduced from Turkey in 1593. The Dutch quickly fell in love with them though and over the following decades they became highly prized as status symbols among the Dutch social elite.

One of the things that helped them achieve such status was the fact that the supply of tulip bulbs was quite limited, (a flowering bulb takes seven years to grow from seed) and so, as demand increased, prices did too. As prices began to take off, flower sellers bought up as many bulbs as they could in order to get them before their prices increased further. This led to a further drop in supply and a further hike in prices. It wasn’t just the flower sellers though – traders had noticed the seemingly ever-increasing price of tulip bulbs and saw a new way to make money. They started buying them, not to plant in their gardens – they were buying them in order to sell them on later at a profit.

Flower sellers and traders alike were buying bulbs now because they expected them to be more expensive later on. That is, they had an expectation that prices would keep rising and that made them want to buy them now.

If you think by talking about tulip bulbs in the 1600s, I have completely lost the plot, then let me tell you what happened next. In the winter of 1636 – 1637, the already inflated price of tulip bulbs increased by one thousand percent in just three months. Bulbs of rare varieties sold for the same price as an average house and many people mortgaged or sold their properties in order to get in on a seemingly guaranteed profit.

But then something happened. There are different theories to what the event was, or if there even was a particular event that triggered it but one day, prices stopped going up. Panicked investors saw that the peak of the market had been reached and started selling. As supply increased and demand decreased the price started to drop. Soon everyone was trying to offload their tulip bulbs before it was too late but… it was already too late. The price of tulip bulbs plummeted spectacularly until soon they were back at the price that someone might want to pay to have a nice flower in their garden. Such was the shock that the entire Dutch economy collapsed and entered a depression.

While it is easy to look back at this event and conclude that the Dutch simply went mental, almost 400 years later we still experience economic “bubbles” and the effects are every bit as severe today as they were to the Dutch people of the 17th century. So what are bubbles? How to do they form? How do they grow? Why do they burst?

We’ll answer all of this and more in my five rules of Bubblenomics.

The 1st Rule of Bubblenomics

In order for a bubble to have a chance of starting you need lots of people to really want to buy something – in fact you need more than that. What you really need is for lots of people to really want to buy something more than they did last month. Bubbles are not formed off the back of high demand, they are formed off the back of increasing demand. As we saw in 17th century Amsterdam, the tulip bubble was built on the demand for tulip bulbs increasing… and increasing… and increasing. If the demand had doubled and then stopped there would have been no bubble (just more expensive tulips) and so the first rule of Bubblenomics is simply:

In order to create a bubble, the asset must experience a sustained increase in demand.

Easy enough. I’ll make it clear now though, a sustained increase in demand is not the definition of a bubble and it is not, on its own, enough to create a bubble. To understand how a bubble forms we need a few more rules, which I’ll come on to next.

The 2nd Rule of Bubblenomics

There are many different examples of bubbles in many different areas of the economy. Recent examples are the dot com bubble, which inflated during the late 1990s and burst in the year 2000 and the recent housing bubble, which caused the current global financial crisis.

As well as a sustained increase in demand, all of these bubbles have something else in common – a limitation on supply. Let me explain what I mean by that.

Suppose Mars Bars suddenly become really trendy and the demand for Mars Bars goes through the roof. Mars would quickly respond to this by making more Mars Bars. The increased demand would be met with increased supply, the price would quickly stabilise and no bubble would ensue.

Bubbles only form on something of which there is some kind of limitation on supply, such as the number of shares in a dot com company, tulip bulbs in 17th Century Amsterdam or houses.

Therefore the second rule of Bubblenomics is:

In order to experience a price bubble, the supply of an asset must have a limitation such that increases in demand cannot be easily met by an equivalent increase in supply.

You might be asking why, given the second rule, housing is a good candidate for bubble creation. If demand goes up, we should just build more houses, right? Sadly is isn’t that easy.

Demand for houses is volatile and increasing the supply of houses takes time. Suppose that one year the demand for houses in central London is 5% higher than it was in the previous year – you can’t just quickly meet supply by suddenly building 5% more houses in central London. There is the lack of space, the planning regulations and of course, the fact that it takes a long time to build a house. Because of those things, that increased demand just translates into an increased price.

The 3rd Rule of Bubblenomics

A price increase alone isn’t a bubble though and to understand how a bubble forms we need to look at the third rule. Basic microeconomics tells us that when the price of something goes up, we should expect demand for that something to drop and in most situations that is true. In bubble situations however, the opposite happens. Let’s stick with housing to explain this.

When house prices start to increase, potential buyers see that prices are going up and start piling in order to buy something before prices go up even more, thereby further reducing demand. More people are buying, not because the current price is low – it isn’t – but because they expect it to be higher in the future and although now is expensive, now is still cheap compared with what they expect next month might be. That means that more people want to buy now and current prices increase.

This is what the third rule covers:

The expectation of future price increases fuels current demand

Another way of putting it would be, “Aaarrgh! House prices are going up and up! I need to buy now, before they’re even more expensive! Aaargrh!”

I did make that sound a bit panicky but how many times during the decade before the financial crisis did you hear people talk about having to get on the property ladder before it became unaffordable? If you hear logic like that, it is a clear sign of a bubble in progress.

If you take the first three laws together you can begin to see how a cycle might form – demand keeps going up and with supply constrained, prices increase and as the price increases become sustained, demand goes up further because buying now is better than buying later. Together those three explain a lot but in order to really understand bubbles there are two more laws we need to cover.

The 4th Rule of Bubblenomics

As I mentioned, there are different theories of what caused the Dutch tulip bubble to pop but I suspect it had something to do with the availability of funds. That is, people simply ran out of things to sell  in order to buy tulip bulbs – after all, once you’ve sold your house, you’re pretty much done.

The equivalent in a housing bubble is how much someone is willing to lend you in order to buy a house. A bubble can only keep inflating when buyers have the access to funds to sustain that inflation. The housing bubble that caused the recent, global financial crisis is a perfect example. As prices increased, banks just responded by lending more money.  If the banks had said, “We’ll only lend 80% of a home’s value and that lending can be at max, three times your income”, the bubble would never have happened. They didn’t though. As prices increased, bank lending just increased to further inflate the bubble.

This is the fourth rule of Bubblenomics:

Inflation of a bubble requires someone to keep providing the air

The 5th Rule of Bubblenomics

Don’t worry, this is the last one and it is the simplest one of the lot. The first four rules dealt with how bubbles form and grow but they don’t explain how they burst. What I am calling the 5th rule of Bubblenomics is known in economic circles as Stein’s Law, after the late American economist, Herbert Stein. It says simply this:

If something can’t go on forever, it will stop.

Bubbles see prices increase dramatically and as we have seen, the price increases are self-sustaining for a while. The reality though, is that the price of something can’t go on increasing faster than people’s income forever. At some point, people either won’t want to buy it, don’t have enough money to buy it or can’t borrow enough money to buy it. That much is inevitable – if something can’t go on forever, it will stop.

As the Dutch saw in 1637 and the world saw in 2008, when a bubble stops the result can be catastrophic. So, it should be obvious to everyone that we want to prevent bubbles, right? Right. It should but clearly it isn’t. Just look at the UK government’s “Help to Buy” scheme, which even Vince Cable pointed out would do little more than create a new housing bubble.

He was of course quickly silenced by George Osborne but let’s remember that Vince is an extremely well-qualified economist and George has an undergraduate degree in history.

Apparently a degree in history that didn’t cover the Dutch Tulip Bubble of 1637.

RedEaredRabbit

The Popularity Paradox

This week I’ve been pondering an apparent paradox: Given the fairly disastrous economic achievements of the current government, how in the world are they able to remain so popular in the polls?

Part of this is surely a lack of confidence in the opposition but even so, I don’t think that is enough of an explanation. The polls are not just saying that a lot of people still prefer the government to the opposition – the polls are saying that a lot of people actually trust the government on economic policy. This is The Popularity Paradox – the fact that the government can be hugely unsuccessful and still retain a surprising level of popularity. This post is my attempt to explain that apparent paradox.

Part I: The First Rule of Politics

The first thing we need to do is break our association between political success and political popularity. Democracy is far from an ideal system – the first rule of politics isn’t “Make things better!” The first rule of politics is “Win the next election!”

Because of this, the popularity of a policy is far more important than its success – the primary goal of government policies is to achieve popularity. You can see this in the way that governments deal with taxes. Sometimes increasing taxes would be sensible but governments know that increasing them is a vote loser, so they don’t get increased or they get increased in strange areas that they hope people won’t notice. Similarly they know that tax cuts are popular so a government might cut income tax before an election, even if it makes no economic sense for it to do so. Popularity is everything.

Do you think the trucks hauling, “Illegal Immigrants Go Home” signs were aimed at illegal immigrants? Was the government really expecting illegal immigrants (who they tell us can’t speak English anyway) would just see these trucks, pack their bags and leave? No. The message on those trucks was not aimed at illegal immigrants at all – it was aimed at voters. It was an attempt to boost popularity for the government by convincing people that illegal immigrants were a huge problem and that the government was implementing a tough solution.

Will this stunt result in fewer illegal immigrants? I can’t see how, but that was never its aim. The aim was popularity and whether or not it actually ends up resulting in fewer illegal immigrants is by the by.

Popularity is not achieved through success. Popularity is achieved by convincing people that there is a problem and then telling them how you’re going to solve it. That brings me nicely on to my next point.

Part II: Partial Problem Solving

Let’s take a look at a generic process for solving a problem. It might look a bit like this:

  • You define the problem you wish to solve
  • You find the underlying causes of the problem
  • You design a solution to address the problem
  • You state clearly how you will measure the solution’s success once it is implemented
  • You implement the solution
  • You measure how well the solution performs against your pre-defined criteria
  • You design and implement improvements to the solution and reassess against your pre-defined criteria (repeat this as necessary)

You might be wondering why I’m boring you with this. Well, one way of looking at a government is as a group of people we put in charge to solve problems in our society. In order for people to have trust in a government, they need to understand both the problems that the government is trying to solve and the solutions they are using to solve them.

Let’s look at an example from the current government:

  • Problem: Immigration is too high and unaffordable in its current state
  • Underlying causes: Immigrants are arriving in huge numbers, taking jobs from British citizens and claiming massive sums in benefits
  • Solution: Clamp down on non-EU immigration. Hold a referendum on EU membership so we might soon be able to clamp down on immigration from within the EU too.

Let’s look at another example:

  • Problem: The UK’s economy is weak because of high government spending
  • Underlying Causes: The previous government went on a spending spree that was unaffordable
  • Solution: We need to immediately reduce government spending.

In both of these cases the government clearly defined the problem and the underlying causes and then clearly set out the solution. Both of these policies were popular with a lot of people. Let’s remember though, the seven steps of problem-solving that I outlined above. The government is only performing four of the seven steps. Let’s look at the list again, this time with the steps the government is doing underlined:

  1. You define the problem you wish to solve
  2. You define the underlying causes of the problem
  3. You design a solution to address the problem
  4. You state clearly how you will measure the solution’s success once it is implemented
  5. You implement the solution
  6. You measure how well the solution performs against your pre-defined criteria
  7. You design and implement improvements to the solution and reassess against your pre-defined criteria (repeat this as necessary)

In the second example I gave, the government has spent three years unwilling to adapt a policy that has not even got close to solving the problem of a weak economy. A much better way of doing things would be to admit that the initial policy wasn’t working and adapt it. After all,  the economy is complicated and it is unreasonable to expect every policy you start off with to be perfect and never require adapting. Willingness to adapt a policy based on how well it performs is essential when trying to solve a complex problem.

Those missing steps might help to explain why the government’s solutions are unsuccessful. To understand why they are popular however, we need to look at something I’m going to call The Ignorance of Crowds*.

Part III: The Ignorance of Crowds

When we vote, we are expected to assess the relative merits of a huge number of different policies across many different areas of government. We need to determine what the best policies are in economics, health, education, foreign policy, crime etc etc etc. An economist might be an expert on monetary and fiscal policy but lack the knowledge to make a good judgment on education policies. A teacher might be an expert in education but lack the knowledge of the relative merits of sanctions vs military intervention in Syria**.

A small number of people are experts in one area. An even smaller number are experts in two. I doubt anyone is an expert in more than three. You can see why this is a problem in a situation where a crowd of people needs to each, individually pass judgment on a wide range of complicated subjects.

But why is this important in understanding why a policy can be simultaneously unsuccessful and popular? Have a look again at the steps of the problem solving process that are highlighted (the ones the government is doing) and those that are not. It is quite easy for a non-expert to understand a clearly defined problem. It is also quite easy for a non-expert to understand a clearly defined solution. However it is much harder for an non-expert to assess whether or not a policy is actually succeeding.

So the government defines a problem that the crowd understands (e.g. debt is too high) and defines a solution that the crowd understands (e.g. spending must be cut) but unless an individual has some level of expertise in that area they are forced to rely on the reports of third parties to know whether or not that policy is working. This would not be such a bad thing if the third parties took time to carefully explain how they had reached their judgments so that they could be understood by non-experts but that’s very rare because the third parties from whom people get this information are of course, the media and the politicians themselves.

The Ignorance of Crowds says that as non-experts we can understand a problem that is presented to us and we can understand a proposed solution but it is very hard for us to know how successful that solution actually turned out to be. That means the definition of the problem and the definition of the solution are far more important factors in determining a policy’s popularity than its success.

This explains why the government only worries about certain steps in the problem solving process. The things that make you popular are clearly stating the problem you wish to solve and clearly stating how you want to solve it. Whether it works or not is almost by the by.

Part IV: Phantom Problems

So we’ve looked at how a problem should be solved and seen how and why the government doesn’t do things like that. We’ve seen that a government can take advantage of The Ignorance of Crowds by giving the appearance of solving problems that they are in fact not solving at all and we have seen that solving problems is not their main concern in any case. There is though, another reason for that gulf between popularity and success and this one is far worse than anything I’ve mentioned so far.

In the set of steps for solving a problem that I outlined, you start by defining the problem, then working out the underlying causes and then defining the solution. The government does not do this. What the government does is nothing less than scary.

The government starts with the solution – that is, the policy that they want to implement. They then work backwards to come up with a “problem” that they can use to justify that solution.

Look at the examples I gave:

  • Problem: Immigration is too high and unaffordable in its current state
  • Underlying causes: Immigrants are arriving in huge numbers, taking jobs from British citizens and claiming massive sums in benefits
  • Solution: Clamp down on non-EU immigration. Hold a referendum on EU membership so we might soon be able to clamp down on immigration from within the EU too.

Now, if you were to start at the problem end you would never even get as far as defining this as a problem. Immigration has a clear net benefit to the UK. Immigrants contribute to economic growth, don’t take jobs away from non-immigrants and take less on average than non-immigrants do in benefits. We are better off with immigration than we would otherwise be. The only way you can arrive at the problem that the government defines is by starting from the solution you want to implement (I don’t like foreigners, let’s get rid of them) and then work backwards to define a problem.

This is an example of what I call, a Phantom Problem – that is, a problem that is scary, doesn’t really exist and has been made up purely to justify the “solution” you want to implement.

Let’s look at the other example:

  • Problem: The UK’s economy is weak because of high government spending
  • Underlying Causes: The previous government went on a spending spree that was unaffordable
  • Solution: We need to immediately reduce government spending.

The government dislikes public spending. Not, because it caused the financial crisis though, (it didn’t) but because government spending is paid for through taxes and they like low taxes. After all, taxes are a key instrument through which wealth is distributed from the rich to the poor. The government doesn’t like taxes.

But, whether or not you support lower taxes is irrelevant. The fact is that the financial crisis wasn’t caused by public spending – it was caused by irresponsible bank lending. “The UK’s economy is weak because of high government spending” is an example of a Phantom Problem.

Summary

Partial Problem Solving explains why government policies are often unsuccessful. The Ignorance of Crowds explains how the government makes unsuccessful policies popular. The phenomenon of Phantom Problems allows a government to arbitrarily create policies around their own ideals that have no real basis for existence. Unsurprisingly, a solution that addresses a Phantom Problem will almost always do more harm than good. We might turn away immigrants that would otherwise have made everyone better off. We might implement spending cuts that further harm an already weak economy rather than strengthening it.

These things together explain how our government can be far more popular than the success of their policies would merit and The First Rule of Politics explains their motivation for doing it. It’s a pretty sad state of affairs but it does at least show that The Popularity Paradox is not really a paradox at all. It’s simply the logical result of a government that is adept at exploiting the weaknesses of the democratic system.

So – benevolent dictatorship, anyone?

RedEaredRabbit

* I Googled “The Ignorance of Crowds” and see that different people have already used this term for different meanings. I am using it purely as the definition I give here and not referring to how anyone else might have used it. As Humpty Dumpty said,  “When I use a word, it means just what I choose it to mean — neither more nor less.”

** I’m not being snooty here –  I count myself among the ignorant. That is the reason I generally avoid education or foreign policy or a whole bunch of other things on this blog. Like anyone else, I am mostly ignorant of most complicated things.

Not Learning From Our Mistakes

Over the last few years on this blog, I have often talked of the importance of understanding the problem. That is you can’t properly solve a problem unless you understand what’s causing it.

For example, what caused the financial crisis? If you want to prevent a reoccurrence, you need to understand what caused it and make sure you put something in place to prevent the same mistakes being made in the future.

The government pedals the story that the financial crisis that affected the whole world was caused by the irresponsible spending of the previous Labour government. I’ve written in detail about why that’s a fallacy here but I’ll summarise it briefly:

The banks started lending higher and higher loan-to-value mortgages to people wanting to buy houses. In older times the banks would have worried about house prices going down but house prices had not gone down for so long that banks forgot about those risks. Borrowers were able to take on bigger and bigger mortgages relative to their wealth, which in turn led to a huge increase in house prices. The huge increase in house prices led banks to lend even more irresponsibly in order to provide the now even more unaffordable mortgages to borrowers. That led to further increases in house prices. Etc. etc.

By the time the banks realised they’d made a bubble and that bubble was about to burst it was too late. Lots of people couldn’t make their mortgage repayments all at once. The banks had started by lending the money they held in savings but as the bubble took off, the money that they held in deposits wasn’t enough to finance the mortgages they wanted to give so they borrowed more and more in order to lend it out again. When the homeowners were unable to make their repayments to the banks, the banks were unable to make their repayments to each other. Like a house of cards everyone became insolvent and the governments of the world had to take on a lot of debt to bail them out. The financial crisis was upon us.

This is how house prices in the UK have compared with the median wage since 1997:

UK house prices vs median wage

UK house prices vs median wage

In the ten years running up to the financial crisis the average house price in the UK almost trebled and wages were not going up anything like that amount. This was the result of irresponsible lending and it was happening all over Europe and the US.

But now forget this for a moment and suppose that you didn’t understand what caused the financial crisis. Put yourself in the shoes of a government minister who has spent the last five years marketing the argument that the crisis had nothing to do with the banks’ private lending. Suppose instead you had put a huge amount of marketing effort into perpetuating the falsehood that the financial crisis was all down to the public spending of the previous government.

I don’t think I’m asking you to make a huge leap of faith by accepting that you that if you’d put everything behind that wrong assertion it’s quite possible you’d have come up with the wrong solutions to the problem.

Throughout his time in government, George Osborne has frequently appeared with a brand new, broken lightbulb taped to his forehead. The latest example is called his “Help to Buy” scheme. In this scheme, the government will encourage banks to offer high loan-to-value mortgages by providing guarantees for them in the case that the borrower defaults.

Yes. Read that last sentence again. That is really what they want to do.

When the financial crisis hit, the banks quickly changed their policy from lending high loan-to-value mortgages to not lending high loan-to-value mortgages, ‘cleverly’ spotting that these had directly caused their insolvency. Our government now wants to bring back this bubble-inflating, crisis-causing system and so much so that it is prepared to offer a tax-payer funded subsidy to the banks to get it going again.

Using public money to subsidise high loan-to-value private mortgage lending is really not a good idea. It is a policy that directly encourages banks to make all of the same mistakes that caused the financial crisis but (and get this) this time the banks won’t be liable and have to ask to be bailed out! This time the taxpayer will just fund the defaults directly! Ace!

When I’ve talked about bad government policy in the past, I’ve often pondered on whether the motivation has been government incompetence or something more sinister. For example, did they cut public spending in an economy suffering from a lack of demand because they didn’t understand that my spending is your income or was it because they saw a chance to evilly create a smaller public sector in order to align it with their own idealisms? Well, who knows?

In the case of the “Help to Buy” scheme though, I can really see no possible motivation, good or evil, for pursuing such a terrible strategy. In the past we could have argued that they were being clever and devious but not any more.

“Help to Buy” simply shows that they have no idea what they’re doing.

RedEaredRabbit

The Importance of Being Lucky

We have been taught that meritocratic institutions and societies are fair. Putting aside the reality that no system, including our own, is really entirely meritocratic, meritocracies may be fairer and more efficient than some alternatives. But fair in an absolute sense? Think about it. A meritocracy is a system in which the people who are the luckiest in their health and genetic endowment; luckiest in terms of family support, encouragement, and, probably, income; luckiest in their educational and career opportunities; and luckiest in so many other ways difficult to enumerate–these are the folks who reap the largest rewards.

Ben Bernanke, 02/06/2013

This is an excerpt from a speech that Ben Bernanke, the Chairman of the US Federal Reserve, gave earlier this month. How fantastically refreshing it is to hear someone, who holds such a senior position in global economic policy-making, expressing an opinion like this. As Bernanke notes, “We have been taught that meritocratic institutions and societies are fair.” We have and nowhere can this be the case more than in the UK in the past three years. Let’s recap on why the government thinks that the poor and vulnerable are where they are today:

Don’t get a job. Sign on. Don’t even need to produce a CV when you do sign on. Get housing benefit. Get a flat. And then don’t ever get a job or you’ll lose a load of housing benefit. David Cameron

…out of work for years, playing computer games all day, living out a fantasy because he hates real life… David Cameron

…it pays not to work. That you are owed something for nothing. David Cameron

…fairness is also about being fair to the person who leaves home every morning to go out to work and sees their neighbour still asleep, living a life on benefits. George Osborne

The Conservative position has long been that those who are doing well have earned it and those who are doing badly have not. The rich are strivers (well done, have a tax cut) and the poor are skivers (must try harder, have a benefits cut). The government perpetuates this myth in order to represent a complicated problem as a simple case of an unfairness in our society, which thankfully they are on hand to address.

Both I and the government agree that things as they stand are not “fair” and we both see unfairness in the way that wealth is distributed. We do though, have opposite views on the direction that this unfairness takes. The government believes that policy has been punishing the rich and rewarding the poor. I believe that policy has had the opposite effect and is a direct cause of the growing gap between rich and poor.

So why do we have such different views? The government’s view assumes that it is a simple problem of incentives. Make being poor less attractive by cutting benefits and being rich more attractive by cutting the top rate of income tax and the problem will resolve itself. The problem with this view is that it assumes that poor people have chosen to be poor. I would like to propose that another factor be included when trying to understand why some people are better off than others. I want to talk about luck.

Like it or not, we are not all born equal. From the moment the sperm fuses with the ovum, a person’s genetic make-up is determined forever. That genetic make-up will have a huge effect on that person’s intelligence, social skills and health. The genes that we are born with, I would argue are entirely down to luck. George Osborne might argue that the sperm that make rich people are striver-sperm. Hardworking sperm who want to “get on”. Not like those other sperm who sit around doing nothing in their teste all day. I don’t buy that though. Before a person is even born, a huge factor in how lucky they might be in life has already been set.

And when that person pops out into the world, the role of luck doesn’t diminish one bit. Those of my generation probably all read the Roald Dahl book, Matilda – a story of a loving, caring, genius child who was born to parents who were the opposite of all of those things. That was just a book though and the social environment in which a child is lucky or unlucky enough to be raised does undoubtedly have a huge bearing on the opportunities they will have in future life.

David Cameron and George Osborne are themselves good examples of being lucky. They were lucky enough to be born into families who were fantastically wealthy and well-educated and who were able to send them to the most prestigious educational institutions in the country. But in spite of this they seem utterly unable to appreciate how luck affects the citizens in the society over which they preside.

I was lucky too. I wasn’t born into a rich family and didn’t go to a posh school but I was lucky in that I was born healthy and with genes that made me want to learn things. Furthermore, I was lucky that my parents had an interest in appeasing my appetite for learning. As an infant I was fascinated by magnets. My mum bought number fridge magnets and every morning the front of our fridge would display new sums for me to do. Before I’d even got to school I’d picked up a lot of maths and being good at maths ultimately got me into university, got me a job out of university, allowed me to be good at the job and allowed me to continue doing something that I’ve (mostly) enjoyed ever since. It would be very convenient for me to believe that this happened purely through my striving. It wasn’t though. If I am honest, I was just lucky.

A government who does nothing to acknowledge the role that luck plays in society will only make things worse. After all, the luckiest are likely to be born into the already lucky families and the unluckiest into the already unlucky ones. If a government did nothing then social polarisation would surely continue. What we have now though is even worse. If you accept that luck plays a major part in this, our current government’s rhetoric around rewarding strivers and punishing skivers actually means further rewarding the lucky and further punishing the unlucky.

I’m not suggesting that the notion of striving is a futile one, I don’t believe it is at all. I do however suggest that if you reduce a complex social problem into a simple debate of “strivers vs skivers” without accepting that we are not all dealt the same cards, it will lead you to implement entirely the wrong policies. The reality is that if you introduce policies that disproportionately benefit the advantaged at the cost of the disadvantaged, the advantaged will become more advantaged and the disadvantaged will be come more disadvantaged.

It really is that stark and any government who actively pushes things in such a direction must be extraordinarily detached from reality.

Unless of course, it was exactly what they were aiming for.

RedEaredRabbit

Losing the Argument

I read Phillip Inman’s piece in The Guardian last weekend entitled, “9 reasons Keynesians aren’t winning the argument”. I always feel a little bit uncomfortable with how the term “Keynesian” is used, as it makes it sound like a bit of a cult rather than a mainstream view but anyway, for now lets go along with it.

So, as someone who falls into the category about which Inman is talking, let’s see how his arguments apply to me.

1. They think policymakers refuse to change course because they don’t understand

I disagree. Inman’s first reason implies that there are two possibilities – either policymakers don’t understand or they do understand and are doing something else anyway. My position is far simpler – whether policymakers “understand” or not is entirely irrelevant. Policymakers’ refusal to change course has nothing to do with the theory or evidence because they are not interested in the theory or the evidence. Policymakers don’t ever consider changing course because changing course is considered political suicide. Their “understanding” has no bearing on this argument.

2. They think that everyone agrees austerity is wrongheaded

I disagree. If that were the case then policymakers would probably have no option but to change course. The fact is that plenty of people still believe (in large part due to policymakers’ propaganda) that the UK’s economy works like that of an indebted household who must pay down their debt immediately in order to recover. Wrong as that is, I don’t think Keynesians believe that that isn’t a commonly held belief.

3. They think Brussels and the IMF have changed their tune

I disagree. Brussels has clearly not changed its tune and I haven’t said otherwise. Mario Draghi (President of the ECB) may not be as bad as Jean-Claude Trichet (his predecessor) but there is still plenty to criticise and I don’t recall too many people holding back. The IMF’s position has clearly moved though. Although they are not now throwing themselves unequivocally behind fiscal stimulus, they have nonetheless, amongst other things, admitted that fiscal multipliers are much higher than they initially thought, that George Osborne is “playing with fire” and most recently their admission that they had hugely underestimated the damage that austerity would do to the Greek economy. It is not in any way a total reversal of their position but to refuse to acknowledge a noted change is a bit silly.

4. They make out that a spending boost with borrowed money is risk-free

Inman doesn’t really explain what the mysterious risks are that I’m ignoring. Austerians say that the risk is that markets would lose confidence and interest rates would soar. I do strongly dispute that but that’s not a risk that Inman mentions. Inman’s risk seems to be that we might be the next Japan and that is pretty lazy journalism to be honest. I haven’t, (and I don’t think any Keynesian has), been singing the praises of Japanese economic policy over the past 20 years. A Keynesian view on Japan would be something like they should pursue higher expected inflation in conjunction with a significant and temporary fiscal stimulus. I don’t recall them doing that at any point in the last 20 years (although it looks like Abe might be starting to do that now.)

5. They think central banks can carry on printing money with no risk

Hold on a moment, why are the argument-losing Keynesians getting the blame for central banks printing money? That’s being done at the moment anyway. My take on QE has always been that the benefits have been and will always be hard to measure and that it’s almost certainly far less effective than fiscal stimulus. Of course a central bank can’t print money forever without consequence – I’ve never said that. I think all I ever said on it was that while we’re in a liquidity trap it wouldn’t be inflationary (and it hasn’t been.)

6. They think quantitative easing can be switched off and normality will return

Hold on again. In point 5 I’m ignoring the risks of carrying on printing money and now I’m ignoring the risks of not carrying on printing money? Ok, I’ll address it anyway.

It would be a bad idea if tomorrow The Bank of England decided to dump all of the debt they have accumulated back into the bond market. I don’t think any Keynesian has ever suggested they should do that though. When things are good again should we drip it back in slowly or should we just let it mature? To be honest I don’t think there is a massive problem either way but irrespective of that I don’t really understand why this is a reason I’m losing the argument – austerians have exactly the same decision to make.

7. They argue that no one should fear inflation

This is just not true. Higher inflation is bad for lots of people. If I’m a wealthy pensioner with lots of savings and inflation is higher than the interest rate I get, then that’s clearly a worry for me. In that situation I would “fear inflation”. What I’m saying is that while higher inflation has problems, it also has benefits and the benefits of higher inflation are often ignored. When interest rates are at the zero lower-bound and the economy remains depressed then what we need is a negative real interest rate and that means higher inflation. No one is saying that it’s going to be better for everyone but we should all be sensible here and understand that a 2% inflation target is not going to be the perfect rate in all economic circumstances.

8. They argue that stock market and house price rises are benign

Really? I seem to recall that I wrote a fairly damning post about the latter’s role in the economic crisis. “The London stock market recently neared its all time high”, warns Inman. Not when you take inflation into account it didn’t, and let’s be clear here – the potentially catastrophic effect of bubbles are well known and well appreciated by Keynesians. Paul Krugman spent five years before the crisis warning that the dotcom bubble had been replaced with a housing bubble.

9. They believe politicians can be trusted to spend stimulus funds in the best way

This really is a load of poo. When have I, or any other proponent of fiscal stimulus ever said, “the government should borrow money and I don’t care what they spend it on because they’ll know best”? I think a more familiar argument is, “the government should borrow money and spend it on those infrastructure projects that will increase employment, boost growth and need to be done anyway”. Rebuilding old schools, investing in renewable energy, replacing old bridges and roads that are falling to bits – that’s money that we need to spend soon anyway – all the Keynesians are saying is let’s spend it now when the economy is suffering from a lack of demand and borrowing is really cheap rather than after a recovery when unemployment is low and borrowing is more expensive.

Conclusion

Inman’s article really isn’t very good. It contains a couple of validish arguments that are badly represented but mostly it’s a list of things that really aren’t important in understanding why the argument is where it is. We can of course faff around, quibbling about what happens when quantitative easing is switched off but do you really think that this is the reason that public opinion has not unanimously fallen behind Keynesian policies? No.

As I mentioned earlier, our politicians have rejected reasoned arguments, economic theory, and the damning evidence that followed because to them, these things just weren’t relevant. Our politicians wanted low public spending and so they cut public spending. They then misrepresented the situation in order to make it look like their policies were good and with their charming little analogy about how we were just like an indebted household, they did a very effective job of perpetuating this fallacy within the masses. That is the important point and it’s one that Inman completely misses. The Keynesians have been trying to fight an economic battle but they are doing so against politicians who, with their weapons of spin, misdirection and misrepresentation, are simply too strong.

Inman doesn’t just misunderstand what the argument is he also misunderstands where the argument is. Keynesians are not losing this argument – Keynesians lost this argument a long time ago.

For three years we have pursued austerity. For three years we have failed to deliver economic growth. We have created the longest depression since the 1800s. We have created a society in which people unnecessarily lost their jobs and their houses. We have created a society in which people who want to work are forced to sit at home because there are no jobs for them to go to. We have created a society in which our school-leavers and university graduates go forth into a job market that has no use for them.

That is what Keynesians predicted that austerity would give us and this is what austerity has given us but winning the argument wasn’t about being able to stand around afterwards saying, “I told you so.” Winning the argument was about preventing this disaster from ever happening and we didn’t and therefore we lost.

To those of you who think I’m being overly defeatist, I ask this – take a good look at the state of our country today and then tell me that austerity hasn’t already won.

RedEaredRabbit

Don’t Be Evil

Do you remember when we had that big scandal surrounding MP’s expenses? And we found out all the crazy things they had been claiming for? And then they said that it was ok because their claims had been within the letter of the law?

I can’t help but spot the irony when, in more recent weeks, companies such as Google, Amazon and eBay have been summoned in front of MP committees to explain why, in spite of lots of sales, they have managed to pay so little tax in the UK.

“We’ve paid every penny according to the letter of the law!” They claim.

“But it wasn’t in the spirit of the law!” Say the MPs (who have presumably found some kind of salvation in the intervening months).

Since their dodgy expense claims were exposed, MPs seem to have had developed a sudden fetish for these televised committees in which they, (the goodies) can heap their new-found morality on the baddies – G4 security, the BBC, the newspapers, tax savvy multinationals etc. But has the fastening of these people in the metaphorical stocks, while our MPs throw their metaphorical rotten vegetables really achieved anything?

I’ll be clear – I don’t think Google et al should get away with paying so little in tax but this mock outrage from MPs gets my goat. Should we really be that surprised that a company turns out to be a bit of a shit just because their motto says, “Don’t be evil”?

It’s a nice thought but in reality it is simply unreasonable to assume that when you have tax loopholes in your system, someone (most likely a big and powerful someone) won’t take advantage of them. Companies will look at what the negative publicity will cost their shareholders and will look at what the reduced taxes will give their shareholders and they will make their decision based on that. If they didn’t they would be being negligent to their shareholders.

There is, of course, one way for our MPs to address this and that is to close those loopholes. These companies sell a lot of stuff here and make an awful lot of profit here. If the laws of the land don’t turn any of these profits into tax revenues then it is time to change the laws of the land and guess who makes them?

It’s up to our government to make sure that the loopholes are closed and it is fairly daft to expect these companies to pay tax that they could legally avoid because of “morality”. Yes, I’m sure our MPs all feel like paragons of virtue when they sit on their committees but let’s all be sensible here – these companies are concerned with profits, not morality and to be honest why shouldn’t they be?

When the UK has exploitable tax laws then it is the duty of our MPs to make them non-exploitable, not to faff around trying to play the morality card. And while we’re on that subject let’s be brutally honest here – given their history, these guys have absolutely no right to play that card.

RedEaredRabbit

The Immigration Fallacy

Immigration has been a hot topic recently. UKIP, (who seem to be founded on nothing more than the principal that British people are the best), did extremely well at the recent local elections. The Conservatives then panicked and decided that UKIP’s popularity showed that they must become even more tough on Europe and immigration themselves.

(Ed Miliband, being as always one headline behind everyone else, proposed a government subsidy for the living wage.)

I don’t think that Ed’s policy has much going for it but that’s not the subject of this blog. Today I’d like to talk about immigration – or more specifically the main arguments against it. They seem to fall into two categories:

  • Immigrants steal our jobs!
  • Immigrants just live on benefits and don’t contribute to the economy!

I’ll take each in turn…

Immigrants steal our jobs!

The arguments goes something like this.

In the UK we have net immigration – that is, we have more people arriving to live here than we have people leaving the UK to live elsewhere. The people who arrive from overseas take jobs away from those who were born here.

It’s understandable how you would draw that conclusion. Imagine a country who has a working-age population of 20 million people of whom 1 million are unemployed. Over the next five years the working age population increases by 500,000 due to immigration. At the end of the five years there will be 1.5 million unemployed people and because people move into and out of work during this time, lots of the immigrants will have jobs and those jobs will have come at the expense of a lot of the people who had jobs before those immigrants arrived.

Simple enough, right?

Wrong. Things are not that simple. It is, in fact, perfectly possible to add people to the working-age population without increasing unemployment. How? Trickery? Sleight of hand? Government statistics? No.

During the 20th Century, the UK population increased by about 21m people. We have, in fact been adding more people without increasing unemployment for a very long time. When we add more people to the economy, more goods are made and more services are provided and this leads to economic growth and to the creation of more jobs. It is easy to think of the economy as having a finite number of jobs and employment as a “one-in, one-out” market but that is not the case.

A much more useful way of looking at it would be this:

For every 100 people I add to the population, by how much does unemployment change?

Or to move the argument back to immigration:

For every 100 immigrants I add to the population, by how much does unemployment change?

It’s an intriguing question. Fortunately, NIESR has done the analysis and guess what they found out?

(UKIP, Tories, Daily Mail – you might want to look away now.)

The results show a very small negative and generally insignificant correlation between the migrant inflow rate and the change in the claimant count rate. A hypothetical example can help give a sense of how small this coefficient really is. A 2 percentage point increase in the migrant inflow rate, akin in magnitude to the large and sudden inflow of A8 migrants in the years 2004-2006, would, according to these estimates, be associated with a fall in the claimant count rate in the order of only 0.02 percentage points.

I don’t think I am doing them a disservice here if I summarise that if we are worried about unemployment, we can quickly exclude immigration as a significant factor. The effect is nigh on nothing.

(UKIP, Tories, Daily Mail – you can look again now, it’s gone.)

Let’s look at the second argument.

Immigrants just live on benefits and don’t contribute to the economy!

Well that would account for the fact that immigrants don’t take people’s jobs. Perhaps they just turn up, don’t attempt to get a job and just claim benefits?

You might believe that if you base your beliefs on what you read in certain newspapers but the reality is clearly going to be more complicated. A better way of looking at this question would be:

Is the overall contribution of immigrants to the economy positive or negative?

Fortunately the Centre for Research and Analysis of Migration have done a comprehensive study that answers this question.

(UKIP, Tories, Daily Mail – you might want to look away now.)

Yes, it’s positive. They found that immigrants on average paid 30% more into the economy via taxes than they took out through public services. But not only was it positive – the analysis found that on average, immigrants contribute more and take away less than non-immigrants. Jonathan Portes discusses it very well here.

Conclusion

So what can we conclude? Firstly, we have very good data that shows that not only does immigration not increase unemployment but also that immigration does boost the UK economy. Although the UK economy is doing badly at the moment it isn’t the fault of immigrants – we would actually be doing even worse if it weren’t for them.

Given this, it’s bizarre that these days we always seem to find ourselves surrounded by politicians wanting to show how “tough” they are on immigration. Given the facts it’s hard to understand – but when were politicians ever concerned by those?

The UK economy is in the longest depression in living memory, longer by far than The Great Depression of the 1930s and throughout it, unemployment has remained stubbornly high.

When such a situation occurs people naturally want to look around for someone to blame and, shameful as it is, politicians have done their upmost to direct that rage onto immigrants (and the recipients of benefits). But why would they do that, given that such a campaign is completely contradicted by the facts?

To win votes by explaining the benefits of immigration takes more time and effort than it does to win votes by saying that immigrants are job-stealers and benefit scroungers.

Politicians care far less about doing the right thing and far more about winning easy votes

Oh, and regarding why they want to blame these easy targets specifically for the depression? Well that one’s easy – the depression was created by the politicians themselves.

RedEaredRabbit

A Problem of Politics

I don’t have children. I’ll be honest – I don’t like them very much. Many of my friends however, hold the opposing view and over the past four or five years, I have seen many of them pair off and then unfortunately, find out what happens when they combine their DNA with one another.

Before Christmas, I was out with a few such couples and their resultant chimera and at some point during the meal, two of the latter had a minor disagreement over toy-ownership and proceeded to attack one another. Their parents quickly broke up the melee and each offspring was separately told that if they behaved in such a way, Father Christmas would not bring them any presents. The threat had the desired effect and good behaviour was quickly restored.

Sometimes I wonder how future generations will look back on how we dealt with the current economic crisis. As I have mentioned on here before, I don’t think we are now dealing with an economic problem – the economics that would have engineered a recovery long ago are well understood – what we are dealing with now is purely a political problem.

At the moment we have a right-wing government whose political ideals are to seek a smaller government sector. In certain economic circumstances that kind of ideal is easier to achieve than it is in others. At the moment, as we have seen, achieving it is very difficult. When the economy has high unemployment, low demand and interest rates at the zero lower bound, cuts to public spending will not be offset, in the short-term by increases in private spending. That is, if the government makes a bunch of civil servants redundant, the private sector won’t immediately expand and give them jobs. The private sector will probably eventually adjust and take them on but that could take (and has already taken) years  to happen. While we wait for that adjustment to occur people remain unnecessarily unemployed and long term damage is done to both the well-being of those people and the economy as a whole.

As I’ve mentioned more than a few times in the past, cutting government spending under such circumstances is nothing other than negligent but if the economics says one thing, how can the government continually get away with doing the opposite? It’s not an easy question but I think I have an answer. My answer is simply the difference between economics and politics:

  • Economics is a discipline that helps us to understand the best policies to pursue in order to improve the economy
  • Politics is a discipline that helps its proponents win the next general election

But surely they would align themselves? Surely the easiest way to get elected at the next election would be to fix the economy? Right?

Wrong.

Let’s take ourselves back to the story with which I started this post. My friends could have dealt with it by explaining to each of their spawn, the importance of sharing and two individuals working together to achieve the best overall outcome for both parties. Or they could just say that Father Christmas wouldn’t turn up.

The former is a harder message to convey. The latter was much less effort to explain and much less effort for their audience to understand.

It’s the same with the economy. Explaining to people why cutting spending leads to more debt is a hard sell because it involves giving the public a basic understanding of macroeconomics and while it is only a basic one they need, it is still far easier to do this:

  • The previous government went on a spending binge that caused all of this!
  • Our country is just like an indebted household!
  • We need to immediately pay off our debts in order to recover!

And that’s an easy sell. None of those things are actually true but the truth is harder for people to understand.

Democracy has a lot going for it but never for a moment believe it’s perfect. Look at the range of subjects over which a voter has to preside. The economy, education, foreign policy, immigration, the environment, health, crime. The list goes on and on. These are not simple things to understand and yet we are all asked to decide on them every time we vote.

Politicians could spend lots of time explaining these things to people and honestly giving the pros and cons of a particular policy but it’s much easier to just go ahead and do what they want and then give us a few simple, misleading soundbites as to why it is right. When you look at it in these terms it isn’t hard to understand why politics continually fails us so badly.

It’s not just the government though. A big part of UKIP’s recent successes is because they understand this and do it better than anyone else. They say that climate change is all made up. That’s much easier than explaining that driving an SUV burns a lot of petrol and that when petrol is burnt one of the consequences is releasing carbon-dioxide into the atmosphere and that carbon dioxide in the atmosphere causes a reduction in the amount of the sun’s energy that is reflected away from the Earth and that such a reduction causes the temperature of the planet to increase. And even if you got that far, you haven’t even started on the consequences of that temperature increase.

Immigration is another example. An easy sell is telling the electorate that the economy is broken because there are hoards of foreigners arriving on our shores every day and stealing our jobs or sitting around claiming benefits. Although that isn’t true, it is much harder to educate the public on all of the very real economic benefits of immigration and so the xenophobic soundbites win and such policies become popular and everyone loses out because of them.

Our politicians owe us more than this. They should appreciate the weaknesses in the democratic system and make it their absolute duty to clearly explain the realities of the situations that we face. They should not, as they do currently, exploit the weaknesses in the democratic system for their own gains.

So anyway, what then became of my friends’ recently-created miscreants? Well they took onboard the threat, behaved as they were told and got their Christmas presents (none from me, I might add). That said, three years after the country chose to go along with the current government’s economic plan, our Christmas presents still haven’t shown up.

And when we look at what politicians are all about, should we really be surprised?

RedEaredRabbit

The Things We Used to Know

Last weekend when discussing the Reinhart-Rogoff mess I wrote this:

We never needed “new cutting edge research” to solve this problem. The problem we have and the solutions to it are all covered in the first year of an undergrad economics degree.

On the following Tuesday (Economics Nobel Laureate) Paul Krugman, on the same subject, wrote this:

Econ 101 macroeconomics, as I often point out, has worked pretty well…The point is that radical new theories haven’t been needed at all; off-the-shelf economics, tools we already had, provided plenty of guidance.

He probably reads my blog.

So what are those things that first-year economics students know that should have stopped the depression happening? Before we look at those, let’s step back in history and remember how we got here:

The Financial Crisis

  • Banks borrowed lots of money and then lent it out, a lot of it to risky borrowers
  • Banks also encouraged individuals to build up debt through cheap loans and credit cards
  • This not only led to a huge increase in private debt, it helped fuel a housing bubble in much of the developed world
  • The banks had no plan-B if the housing bubble burst
  • The housing bubble burst
  • Oops

When people couldn’t make their debt repayments the banks suddenly became insolvent. Governments borrowed huge sums of money to bail them out and prevented a full collapse of the global banking system but were left with weak economies and high debt. Due to high levels of personal debt, rising unemployment and an all round lack of confidence in the economy, people switched very quickly from spending to paying off debt and saving. In the economy, my spending is your income and your spending is my income. Spending disappeared and a severe recession resulted.

Turning a Recession into a Depression

Governments initially responded by cutting interest rates. Low interest rates make saving less attractive and spending more attractive and in a normal recession this is enough to engineer a recovery. This was not an ordinary recession though and governments found that even with interest rates at almost zero, people continued to save and pay down debt rather than go back to spending. Low interest rates were not enough to fix the economy.

As any first-year economics student can tell you though, monetary policy is not the only tool a government has to boost growth. If the people don’t want to spend, the government can increase spending and fill the gap. Many governments, either through incompetence or the blind pursuit of their political ideals did the opposite and cut spending, which had the predictable effect of exacerbating the problem.

Governments likened their situation to that of an indebted household who must pay off their debt as fast as possible but the analogy, although easy for the public to understand, was disingenuous. In the economy spending and income are two sides of the same coin and in an economy suffering from a lack of demand from the private sector, cutting government spending was only ever going to lead to one thing.

A recession, which we had all of the knowledge and tools to turn into a recovery, turned instead into a depression. Here’s what happened in the UK when the current government took over and slashed public spending. The green diamond shows the point when they were elected:

UK Depression

UK Depression

The amazing thing is that this is all basic, textbook macroeconomics. It is hard to comprehend how the government could try the opposite of what this stuff said they should do and then, when the economy entered depression, just sit around scratching their heads wondering why things didn’t work out.

But anyway – the damage is done now and the government would commit political suicide if they ever admitted that their policies, far from creating a recovery, had in fact caused a wholly unnecessary economic depression. From the day they chose austerity in the face of basic economics, they have had only one way forward: Wait until the economy sorts itself out anyway and then market this as absolution. I’ve come to terms with that now but I really hope we could all at least agree on this:

In 20, 30, or 40 years time when then next big recession happens, could we all take a look back on this period in history when our politicians, with their poo-pooing of basic economics, failed us so badly? Could we all take a look back on this period in history and say that we will never again make mistakes such as these? Let’s instead choose those basic economic rules that have, during this depression, continually got things right.

Let’s remember the things we used to know.

RedEaredRabbit