The Voice of a Siren

01/08/2012 3 Comments

Do you remember Going for Gold with Henry Kelly? No? Come on, did you never have a school-day off sick in the early 90’s? In case you haven’t watched it, someone has helpfully posted a whole episode on YouTube:

If you don’t want to watch all of it (and I recommend you don’t) – at least watch the opening titles. Probably the worst TV theme song that’s ever been made.

So now we’ve reminisced, we’re going to have a quick quiz now, in the format of Going for Gold. Fingers on buzzers.

WHAT AM I? I am a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards collapse.”

; Only Fools and Horses Christmas Specials?

Incorrect. Knut, you’re out of the rest of the round.

; Steve Martin?

Incorrect. Bjorn, you’re out of the rest of the round.

; An economic depression?

Correct! RedEaredRabbit, you’re through to today’s final!

#Win

The definition wasn’t really Henry Kelly’s. It was that of John Maynard Keynes and he wrote it in 1936. Although written 72 years ago, you could easily mistake it for something written yesterday describing the current state of the UK economy. We haven’t imploded but there’s no growth and the economy continues to operate below potential, with lots of workers available to work but a lack of demand for their services.

A common misconception is that a depression is just a long recession – i.e. the economy has to shrink quarter on quarter for a long time. A much better way of thinking about it is that, following a recession, the economy operates below potential for a long time. So what do I mean by ‘below potential’?

I mean that at the moment our economy:

  • Is much smaller than it used to be
  • Has the potential to a produce a lot more goods and services than it does
  • Does not produce more goods and services because we choose not to produce them

That sounds crazy. If we can produce them then we should, right?

The economy is largely based on supply and demand. At the moment we are all good to go on the supply side but we are have a major problem on the demand side and this is very important in understanding why we are in depression and also important in understanding what we should do about it.

I can explain this a bit better with some examples.

The car manufacturer is producing fewer cars because fewer people want to buy cars. She could easily employ more people and produce more cars but as long as the demand for them is low she won’t do it. Her costs would go up and her revenue would stay the same. She is waiting for the economy to recover before producing more cars.

The garden centre owner is growing fewer plants because fewer people want to buy plants. She could easily employ more people and grow more plants but as long as the demand for them is low she won’t do it. Her costs would go up and her revenue would stay the same. She is waiting for the economy to recover before growing more plants.

The car manufacturer and the garden centre owner can easily ramp up their operations because taking on new employees is easy – their are lots of people who need jobs. They don’t though because demand for their products is low.

The people who don’t get jobs because the car manufacturer isn’t taking on staff don’t buy new plants from the garden centre. The people who don’t get jobs because the garden centre isn’t taking on new staff don’t buy cars from the car manufacturer.

You can see how the whole thing is self-perpetuating. Remember, my spending is your income and your spending is my income. At the moment I am awaiting for you to spend before I can spend and you are waiting for me to spend before you can spend.

We just looked at two examples but this is the case across the whole economy. The demand for goods and services is low, therefore spending is low, therefore income is low, therefore the demand for goods and services is low.

While everyone waits for everyone else we have economic deadlock and the economy is depressed. We need to appreciate this problem in order to know what to do about it.

Suppose that the government took a look at our school buildings and admitted that they probably need investment. Workers are easy to come by when unemployment is high, so they have no trouble in finding available resources to work for the next few years repairing, rebuilding and redecorating old classrooms, school halls and gymnasiums. The newly employed workers have cash in their pockets and so they start to buy other things like plants for their gardens. The garden centre take on more staff and now there are even more people with cash in their pockets. They start to buy cars and so on.

That’s how government spending solves the problem. The government could spend on pretty much anything to solve the problem with demand but it makes a lot of sense to spend it on things like schools and renewable energy because that is money we need to spend soon anyway. We can wait another five years to do it or do it now but we spend pretty much the same amount of money either way.

Not everyone agrees with this solution though. The UK government for example, believes that if they cut spending, rather than increase it, everyone will become more ‘confident’ and they’ll then start spending. How this works is a bit of a mystery but we are continually assured that it does work. Somehow.

So how’s that policy going? The latest figures are out so without further ado… let’s update The Depression Tracker!

(The blue line is the Great Depression of the 1930s and the red line is the current depression.)

Depression tracker

Damn, that doesn’t look very good. Here’s George Osborne’s reaction:

You will hear those arguing that we should abandon our plan and spend and borrow our way out of debt…these are the siren voices luring Britain onto the rock. We won’t go there.

George had clearly been working on that metaphor. Probably for most of the three months since he had to explain the last set of figures.

Here’s David Cameron’s reaction:

My message today is clear and unequivocal. Be in no doubt: we will go on and finish the job.

Finish it? Starting it would be nice. The economy is smaller now than when he took office.

The confidence argument is great for soundbites but do any of its proponents actually bother to look at the data? Do they actually look at figures like those in the graph above and think, “Hold on a moment, if my argument was a good one, that graph would not look like that.”

Not only is it not backed up by evidence, the logic of the theory seems extremely shaky. From where exactly is the car manufacturer suddenly going to gain the confidence to start employing people and building more cars? I can understand a person gaining confidence from seeing sustained economic growth but no one is going to look at that graph, see what the government has done to the economy, get all confident and then go on a massive manufacturing bender.

Referring to people as “sirens” for making a logical, evidence-based argument as opposed to an illogical, fantasy-based one demonstrates the heart of the problem. A problem that started as an economical one is now purely political, and it is two-fold.

  • We have a government whose base political beliefs are centred around a small public sector, so they will try to bring this in irrespective of the economic situation.
  • We have a government who have so publicly trumpeted the economic growth that austerity would bring that they simply cannot go back on it now without committing political suicide.

Remember, the depression definition though. Despite the 0.7% contraction in Q2 we are not falling off a cliff. We will almost certainly do better in Q3 – it is virtually impossible for us to repeat a quarter that bad. And when we get a recovery in Q3, the government will be saying it is advocation of their policy.

It won’t be though. The underlying problems will remain and while we wait around for those problems to be solved by ‘confidence’, our economy will continue to flat-line, and millions of people who want to work will be forced, because of those two political problems, to sit at home, waiting for the demand to return to our economy.

And how long will that take? Well, we know from our economics textbooks that long-term output is determined by the supply side. That is, as long as the depression isn’t so bad that we lose our ability to make things, we will eventually recover anyway but we also know that we have all of the tools available to fix the problem with demand right now, so why not do it? After all, as John Maynard Keynes said, in the long run we are all dead.

With this government though, sitting around waiting for the long-run to sort things out is all the help our unemployed are going to get.

Where’s Going for Gold when you need it?

RedEaredRabbit

Advertisement

Filed under Economics, Politics Tagged with , , , , , ,

Lies, Damned Lies and Austerity

17/05/2012 3 Comments

Today David Cameron once again reiterated his intention to continue down the path of austerity in order to sort out the UK’s economy. David does this a lot and continually comes back to his belief that government spending caused the mess and that only a severe reduction in government spending can restore economic growth. As you probably know, in contrast to David, I am in favour of an economic stimulus.

When I write about that on here I often receive comments along the lines of David’s – that government spending caused the mess in the first place and more of it would just cause an even bigger mess. I have perhaps not addressed this directly in the past so, hold on to your hats, I will do so now.

First of all saying that the cause of the mess was purely the previous government’s spending is at best an extremely simplified view. There were many factors that combined to cause the financial crisis. People who say it was caused by government spending are conveniently forgetting what the banks were up to. That’s another story though and I do need to address the misconceptions about government spending. I am going to try to explain why I think spending is sometimes a good idea and sometimes a bad idea and why at the moment I think it is a very good idea indeed. So here goes…

Over time the economy swings between periods of growth and periods of contraction. Governments (despite often making claims to the contrary) have never been able to stop this happening and perhaps this shouldn’t be too much of a surprise. After all, a government has only simple tools at its disposal and economies are complicated things in which bad things have a habit of finding ways to happen.

Although we should accept that there will always be good and bad periods in the economy we should also appreciate that the government is certainly not powerless to help out. A government can use some of its simple tools to reduce the impact and duration of the bad times when they arrive and bring back the good times as soon as possible.

One of these tools is government spending and to see how this can help we need to first take a look at the private sector. Companies in the private sector have important short-term financial goals. They generally seek to make a profit every year and additionally have certain cash flow considerations (e.g. they need to be able to pay salaries, buy stock, pay rent etc). So if their revenue drops off, they may well look to reduce their spending in line with it. If their revenue increases, they may well look to increase their spending accordingly. For example, if a company is doing badly they may reduce their costs by making redundancies and if a company is doing well they may take on more staff. Simple enough. Let’s look at what happens in economic cycles.

In periods of strong economic growth, lots of companies do well and expand and take on staff. In periods of economic contraction, lots of companies do badly and lots of people lose their jobs.

This means that private sector spending closely follows how well the economy is doing as a whole – when the economy is doing well, private sector spending increases and when the economy is doing badly, private sector spending decreases. These spending swings in the private sector actually amplify the effect of the economic cycle. i.e. the redundancies they make during weak economic times weaken the economy further because unemployed people stop having money to spend and rely on benefits and in weak economic times they cannot easily find new employment.

One way the government (or actually the Bank of England since it is now independent) can influence this is through changes in interest rates. By lowering interest rates, it becomes cheaper for companies to borrow money and therefor encourages them to spend.

There is a problem with this approach though as you can only cut interest rates so far. Once they are down to almost zero (as they have been in the UK for over three years) then there is no way to stimulate the economy by cutting them further.

Another way the government can influence things is by spending money. When spending in the private sector dries up the government can step in and fill the gap. Governments of developed economies (who borrow in their own currency) can borrow very large sums over very long periods of time and don’t have to worry about the same short term profit or cash flow issues that companies face.

When the private sector is expanding, the government can reduce public spending and let the private sector fill the gap. When the private sector is contracting, the government can increase public spending and fill the gap. If the gap is not filled then we end up with unemployment and recession.

That’s what happens if the government does nothing but now imagine an even worse situation. In this situation the government spending tracks that of the private sector. i.e. when things are going well, the government increases spending and when things are going badly the government reduces public spending. Pushing up government spending when the private sector is trying to expand will help boost the economy a bit but it is an inefficient use of funds because the public and private sectors are in effect competing against one another. Essentially we create a strong supply of jobs for which there is weak demand. In contrast, reducing government spending when the private sector is contracting further amplifies the effect of the downturn. In this situation we are reducing the supply of jobs when there is strong demand. In the latter situation the government may cause a full-blown economic depression from which the economy may take many years to recover.

Actually, that sounds familiar.

Anyway. During the years preceding the economic crisis, the UK was experiencing some unspectacular growth. The Labour government at the time coupled this with some unspectacular increases in government spending when they should have, if they were sensible, made some unspectacular reductions in public spending.

So yes, I agree that they got things wrong. Their increase in spending was certainly fairly benign compared with the current government’s version of what happened but yes, they would have been better to reduce spending overall.

Since the crisis hit, however, the economy has contracted hugely and the private sector has shed hundreds of thousands of jobs. Now we have one of those spending gaps I mentioned and it’s a really big one. This is why government spending now would be a good idea – we’re not competing with the private sector, we are simply trying to increase the supply of jobs to help meet the huge demand for them. Let me be very clear – I am not saying that fiscal policy under the previous government was right but just because they got it wrong does not mean that we should be backing a plan now that is even wronger.

If it is this simple though, why is our government backing an austerity plan at all? Given the above argument, isn’t it the exact opposite of what they should be doing? Yes it is. Politicians are people with agendas though.

Let me give an example of an agenda. Suppose you were a politician who very much liked rich people. Your ideal UK might consist of low taxes on rich people but that’s expensive so you might try to fund those tax cuts by severely cutting public spending. Of course, since most people are not rich, you couldn’t just say that’s what you were doing because you need more than just rich people’s votes to stay in power. You might therefore invest significant time and effort trying to convince people that government spending during bad economic times was a terrible thing and the only way to restore economic growth was through reducing spending and cutting taxes on rich people.

The government has managed to get away with it quite well so far because the economy is complicated so it’s very hard for people to know whether they are telling the truth or have a hidden agenda. Additionally, the government is extremely effective at misleading the electorate. For most people the “reduce spending when things are bad” makes a lot of sense because they are able to relate it directly to their personal finances. If I have a big credit card bill and my household income drops I’d better cut back spending and pay off my credit card, right? Yes, that’s right for your household but there is a subtle and very important difference between household finance and the economy as a whole.

In your personal finances you are only concerned about your own personal incomings and outgoings. In the economy though, your spending is my income and visa versa. If we decide to kill off spending in the economy we by definition kill off income too. The government continually draws an analogy with personal debt and never takes the time to explain this distinction.

You might say that you accept the above arguments but it’s too late for us to borrow money because we already have so much debt no one will lend to us. You’d be wrong though – we have people queuing up to lend to the UK at the moment. A developed economy borrowing in their own currency (this importantly excludes the Eurozone) has a truly amazing capacity to borrow money cheaply. If you think we’re anywhere near the limit then have a look at Japan’s government debt in comparison:

And guess what? They can borrow even more cheaply than us!

Also worth pointing out on this graph is how little our debt actually increased during the years preceding the financial crisis. Yes, it should have been reducing but it wasn’t exactly the mad spending spree that everyone seems to think it was. Labour had, on the eve of the financial crisis, more or less the same amount of debt they inherited when they were elected in 1997.

In summary there are three important points in this post that David Cameron doesn’t want you to know because if you know them his argument falls to pieces:

  • Government spending during a period of economic growth and spending during a period of economic contraction are very different things. Just because the former is bad does not mean the latter is, especially when interest rates are at zero.
  • The personal spending analogy does not work when considering the economy as a whole because one person’s spending is another person’s income.
  • There is plenty of scope for the UK to borrow money

I know this post is quite a lot to digest but I have done my best to explain why I think the things that I do. Perhaps you’ve read through the post and think my reasoning is wrong and David Cameron’s is right. Perhaps you think austerity really is the way to restore economic growth. That’s fine, after all David and I each have a theory and at the end of the day that’s all they are – theories.

I suppose though, if I were being really picky, I might point out that the growing evidence strongly supports my one.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

Depression

25/04/2012 4 Comments

Do you remember that time that Alistair Darling did that terribly apolitical thing of trying to tell the truth and said there was a recession coming that would be the worst since the Great Depression? And then Gordon Brown “unleashed the forces of hell” on him? I think in hindsight, there are a couple of interesting points to make about this event.

The first one, which is important to Christians, is that the forces of hell are clearly far weaker than we were taught at school. As we can see from this recent interview, Darling is alive and well, having suffered little more than a minor singeing of the eyebrows.

Secondly, we can say that Alistair was wrong. The Office for National Statistics published their quarterly Economic Review today and conveniently it contained some figures comparing the current economic cow-pat with that of the Great Depression. The below graph shows their results of comparing quarterly GDP against the pre-crisis peaks. The red line shows how GDP has changed since Q1 2008. The blue line shows how GDP changed for the equivalent period in the Great Depression (starting at Q1 1930).

(I have added a green dot to show when David Cameron came to power.)

Darling got it wrong because the current depression is actually worse than the Great Depression. By this stage in the Great Depression, the UK was going through a period of significant economic growth and had already passed the pre-crisis peak. The UK’s current GDP is still 4.3% lower than it was at the start of 2008.

The report said also, as you have probably heard today, that the UK economy has now contracted in two consecutive quarters and therefore, by the government’s definition, we are once more in recession.

If the government had achieved 0% growth as opposed to -0.2% in the first quarter they would have avoided recession and the media would be reporting it as such. The media, I feel, often puts so much weight on whether we are in or out of recession that we are essentially missing the big picture. Look at the red line on the graph above since David Cameron was elected and you see the real picture. We might be technically sometimes in growth and technically sometimes in recession but what we are actually in is a sustained period of economic stagnation.

Predictably, Cameron and Osborne have each made statements today saying that they will be strong in the face of the recession and stick with their current policy of reducing government spending. It makes me want to weep. Recession, stagnation, whatever you want to call it, this situation was caused by them. The government’s fiscal policy since they took office has been the exact opposite of what was needed to create growth in the economy and the effects are there for all to see.

When proposing a stimulus, I am often told that spending more would send us into a recession! Well, without spending more we’re now back in one but nevertheless I will explain my stimulus thoughts in a bit more detail.

Let’s take a look at say, renewable energy. By 2020 we are legally obliged to have 20% of our energy consumption coming from renewable energy. How’s that going to happen? Well it won’t happen without investing a lot of money building wind farms, tidal power stations and the like. This is money we need to spend anyway – we have agreed to be legally bound to the target. Why not bring the investment forward and spend the money now? The difference in government debt between spending the money now or in a couple of years is nigh on nothing and believe me, we won’t even get close to that target if we don’t get our arses in gear.

Or how about schools? I find it hard to believe that there are not thousands of state-funded schools not needing their ailing buildings, classrooms, gymnasiums fixing and rebuilding.

As you can see, I am not promoting the idea of spending money on things we don’t need – we need to do these things anyway so this money has to be spent sooner or later. All I am proposing is spending it now, at a time that we have economic stagnation and lots of people waiting for the jobs that such spending will create.

The government chose to implement a policy that opposed basic macroeconomic theory and that policy has had exactly the effect that basic economic theory predicts – depression. So how could they have got it so wrong? How could they not see that the fiscal policy they were pursuing was not just erroneous, it was completely irresponsible and entirely negligent?

One may as well ask, how could they not see that cutting tax on the rich at the expense of the poor was a terrible idea? Or, how could they not see that selling places at the Prime Minister’s dinner table in return for influence over government policy, was both morally and democratically abhorrent?

The answer is both surprisingly simple and hugely depressing. This government, (as with many other governments throughout history and throughout the world), did not come into power, assess the circumstances and devise the best possible policies to benefit the population and the country as a whole. They came into power with a particular idea of how they wanted the country to be. It involved private health care, lower taxes on the rich and yes, low government spending.

The fact that basic economics said that cutting spending would screw the economy was totally irrelevant. They probably knew it would. Their efforts have not gone into putting good policies into being but have instead gone into trying to make the country into their Etonian Utopia. They have cleverly coupled this with a massive campaign of bad marketing to mislead the electorate into thinking that all of these things are necessary. They know that economics is not a subject that is easily understood by the majority of the public and know they can use this to their advantage.

In forcing through the changes they wanted to make anyway, they have unnecessarily caused a depression on a scale not seen in recent history. As a direct result of these policies, people have lost their jobs and people have lost their houses.

If the 1930s was the Great Depression, then our current day situation will surely be looked on in history as the Even Greater Depression.

And the most depressing thing of all is that this was completely avoidable.

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics, Politics Tagged with , , , , ,

Economic Bloodletting

19/01/2012 7 Comments

In older times bloodletting was a common medical practice. A doctor would treat a poorly patient by pumping out a few glugs of blood in the hope that it would cure them. The patient would then decline a bit and the doctor would say, “It’s more serious than we thought!” And he’d pump out some more blood. The patient would then get even worse and this bizarre cycle would continue, often until the patient died, at which point the doctor would say, “Well we did our best but they were clearly beyond saving.”

In 2010, the coalition government inherited a poorly economy. (Can you see where I am going with this?) They decided that what it needed was less spending. Less spending they claimed, would have the economy back on its feet in no time.

They predicted that with some much needed spending cuts, economic growth in 2011 would be 2.6%. Then a couple of months later with an even more sickly economy they predicted that with some more spending cuts, 2011 would enjoy economic growth of 2.3%.

November 2010 came though and the patient had deteriorated. 2011 economic growth was now predicted at 2.1% – despite economic bloodletting things were looking bleak. What this patient really needed was… bloodletting.

By March 2011 they had downgraded the annual growth from 2.1% to 1.7% but maintained that the patient’s only hope was spending cuts.

By November, the annual growth prediction was downgraded to 0.9%. We’ll soon see what the real figure was but it is clear that like the quacks of ancient times, the government is unwilling to recognise that there is any link between the treatment and the illness.

Some will disagree that this policy had anything to do with the worsening economy. What is indisputable however, is that the government’s policy of austerity has not led to the economic benefits that they predicted it would.

So let’s think about an alternative policy. Another option is that when the economy is weak we should pursue policies that encourage economic growth and employment. When unemployment rises, there are two immediate consequences. Tax revenues drop and government spending on benefits increases. Then public spending decreases because fewer people have money to spend, and those in employment save more because they are worried about rising unemployment. When public spending decreases, the economy weakens further, the whole thing becomes self-perpetuating and if unchecked we end up where we are today in an economic depression.

The government would say that you can’t spend your way out of recession. They say it all they time. It’s entirely incorrect though – government spending increases economic growth. So a better way of doing things might be to increase spending during a recession and then cut it back once the economy had recovered, employment had gone back up and tax revenues had gone back up. You could also supplement this with some taxes on the wealthy. So we have found a policy that is better than the government’s. Great! Let’s get ’em!

Oh, hold on. Where’s the opposition gone?

Oh dear.

The Labour party it seems, have decided not to take a stance against the spending cuts. Well, I think they have decided that. If I’m honest I’m not absolutely sure. For the past 18 months they have sort of said that they oppose them but have never really laid out a clear alternative. Now Ed Balls has decided that they would not commit to reversing spending cuts whilst maintaining that the government is cutting “too fast and too hard”.

Well I am confused. If they think we are cutting “too hard” but wouldn’t change the policy of cutting exactly this hard then what exactly are they proposing? Labour seems to have moved from a bit wishy-washy to some bizarre conflict of agreeing with government policies whilst saying they are bad.

If I were Ed Miliband, every time David Cameron said during PM’s Questions, “you can’t spend your way out of recession!” I would stand up and read bits out of a first year Macroeconomics text book to him.

And it doesn’t stop at economic policy. Opposition to the government’s proposed health care reforms have come more from doctors than they have from the Labour party despite the government’s argument being shown to be based on completely false statistics. We have a Secretary of State for Education who thinks we should fire more teachers for poor performance. If I were in opposition I think my criteria for firing secretaries of state would include trying to spend £60m on a boat for the Queen and £400,000 on personally inscribed bibles.

In my frustrated state, I am quickly running out of parties to vote for:

  • The Conservatives –  Implementing poor policies with no end in sight
  • The Labour Party – Unable to convey an alternative
  • The Lib Dems – Presumably I don’t need to explain
  • UKIP – Xenophobic
  • BNP – Racist
  • Green Party – In no way prepared for government but might have to look at them now

Ed Miliband’s time is running out to provide coherent opposition to what is going on. He was a good politician in government but for whatever reason he has been positively ineffective in opposition. A recent poll said that the UK public trusted the coalition more on economic policy than they did the Labour Party. I am in no way surprised by this. While I think the coalition policy is bad, it is at least coherent and clearly communicated. Rather than think of a better one, Labour seems to have given up and said, “That’s popular, let’s say that too!”

And say it they did. In a completely incoherent way.

The Conservatives might be poor when it comes to forming policies to gain economic growth, put people into jobs, or improve education and the NHS but never underestimate their brilliance when it comes to making a crap policy sound like common sense.

It is a fragile brilliance though and as their dumb marketing machine rolls forward we can see quite a few gaping holes at which to aim our wrath. I really do believe that a few carefully placed, well-argued policies could derail the whole thing but sadly I see no sign of them on the horizon.

And so, I am making one last, desperate, heartfelt plea:

Could the real opposition please stand up?

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics, Politics Tagged with , , , , ,

The Greatest Democracy on Earth

22/09/2011 1 Comment

The United States is often marketed as the Greatest Democracy on Earth. I’m not sure I agree.

A couple of months ago there was a lot of worry in the global markets that the US was about to default on its debt. As I wrote about here, this was a very different situation to that of Greece who is very much in danger of default at the moment.

So, why is it different? After all, both of them need money. Let’s take a look.

The USA

Investors are banging on the door to lend the US more money.

Greece

Finding someone who wants to lend to Greece at the moment is harder than finding a dodo who can simultaneously breakdance, juggle six elephants and recite its seven times table in Welsh.

While both countries need money, investors believe that the US will be able to pay it back and Greece won’t. It is probably not a bad judgment.

So if the US isn’t a risk to lend to, if people are queuing up to lend it money – why was there ever talk of a default?

To understand this we need to look at US politicians. In the US (to all intents and purposes) there are just two parties, the Democrats and the Republicans and things are always very close between the two. With nothing to back this up, I am going to lazily say that 45% of the US public always vote Republican and 45% always vote Democrat. The remaining 10% decide who is in government and even they are often fairly evenly split.

Because of this the US always has a fairly evenly split Senate, which in turn leads to both parties needing to agree in order to pass changes to US policy. There’s nothing wrong with this in theory; in some ways it is quite good but it does require that to get anything done the two parties need to work together in a reasonably constructive manner.

That’s where the problem lies – they can’t. Or at least they don’t.

The President of the United States, is often referred to as the most powerful person in the world. Evidence clearly shows this is far from true. Take that “almost default” example. Without the Senate agreeing, Obama couldn’t even make the decision to take the money that the US needed and not default on their debt repayments.

Instead the decision went to the Senate.

Defaulting on your debt when people want to lend you money very cheaply would be more than a bit daft. In fact it would be so daft that even the Republicans knew it would be much worse for the US than just borrowing the money that people wanted to lend it.

The Republicans also know though, that their votes are needed for the decision to pass so instead of just saying “Fine borrow the money, let’s move on to something important.” They instead said, “You can borrow the money only if you do something totally unrelated that we want.”

(For more on that read my charming, metaphorical story about Obama flying an aeroplane. Or should that be an “airplane”?)

Had the bill not passed, the people who would have lost out would firstly have been the US citizens as their economy went down the pan. Then everyone else in the world would have been in trouble (as the health of the US economy affects us all).

Although there was a lot of posturing and political bravdo thrown around by both sides, that situation can be neatly summarised like this:

The Republican Party held the US government to ransom with the American people as the hostages.

I’m not being theatrical, this is simply what happened. The Republicans wanted some spending cuts and held the country ransome to get them and it was truly shameful. A far better way of doing things (without causing global economic chaos) would have been to say:

“We all agree that we need to borrow some more and while we would like to discuss other fiscal measures we will do so once this is sorted out. After all whatever we agree on those items, paying our bills is essential.”

Unfortunately this isn’t a one off. Obama has recently announced a new bill aimed at boosting the US economy through closing tax loopholes for the wealthy and increasing government spending. It is actually a very sensible bill but it doesn’t matter – it will be shot down by the Republicans and it won’t pass.

Is that stupid? No, it is ludicrous. Republicans, hate taxes on rich people and hate government spending. Their political campaigns are funded by the rich and that is of more interest to them than doing something sensible to actually help sort out the problem.

The US government needs to act decisively but can’t because of their politicians and sadly, their economy will experience far lower growth than it should do and we’ll all be worse off because of it.

Have you ever wondered why the US can’t bring in public health care or cut greenhouse gas emissions? Same reason – any sensible policy can be easily blocked by a few right-wing half-wits with their own agenda.

In light of this, is the US the greatest democracy on Earth or a bit of a fucking mess?

It’s not just the US though. Europe is in a big mess too. Do you see any sign of some decisive action from European politicians to put forward a clear plan to sort their mess out? If you’ve spotted one then let me know, it must have passed me by.

Politicians just don’t seem to realise that part of the remit we gave them when we elected them was to be able to sort this stuff out. In the US, Obama is trying but he’s ultimately powerless in achieving anything. In Europe they’re doing nothing and hoping it blows over. (It won’t.)

So what of the UK? The UK government has favoured spending cuts and austerity over any attempt to boost the economy. With interest rates at the zero lower bound and unable to be cut further to offset the cuts, this is at best a dangerous game. Basic economics shows that spending cuts in such a situation will harm growth but the government crossed their fingers and hoped that the economy would somehow sort itself out on its own. In the long run it probably will but that’s hardly a reason to dismiss opportunities to sort things out now.

The IMF has said that if the UK is not going to meet the government’s 2011 economic growth targets (it doesn’t have a chance by the way) that it should reconsider its policy of spending cuts and look instead at a policy of stimulating the economy.

After the election in 2010 it would have been very difficult for any political party to forsee the future and build the perfect fiscal policy to cope with such unknowns. In such circumstances, the elected government should:

– Have used macroeconomic theory as the foundation for their policies. (They didn’t)

– Absolutely be prepared to adapt their policies to match the continually changing and unpredictable economic climate. (They aren’t.)

The government based their policy of spending cuts on the hope that economic growth would happen anyway. It hasn’t and now is the time for them to understand that blindly pursuing this will only cause further harm to the economy.

When looked at objectively, the ability to assess and adapt seems like common sense but asking a politician to consider changing policy is not so simple. A lot of that is our own fault. When a government changes its policy we all say, “It’s a U-turn! You got it wrong! You’re rubbish!”

That really is missing the point. An effective government will not be made up of fortune tellers. Therefore an effective govrnment needs to be able to continually adapt their policies to fit with a volatile and unpredictable world. If, next week, George Osborne says that he is going to scrap some cuts and instead focus on some policies to stimulate the economy, we should not all be criticising him as a weak policitian for changing his mind. If he does this we should be commending him as a strong politician – someone who is able to adapt their policies to fit the situation in which they find themselves.

Of course this is all wishful thinking. In reality what will happen next week is that:

  • Obama will bang his head against a wall because the Republicans will block his sensible policies
  • Angela Merkel will keep her head in the sand and hope it all goes away
  • George Osborne will fly in the face of logic and stick with spending cuts

The really sad thing is that now, more than any time in the last three years, it is easier to know what a good fiscal policy is.

It just seems harder than ever for a politican to spot one.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , , , ,

The Tax Delusion

09/09/2011 5 Comments

Have you ever met a climate change denier? I wonder why they don’t believe in global warming. Using some fairly basic maths you can calculate the Earth’s surface temperature assuming no greenhouse effect exists – it’s about minus 18°C. The reason we’re not in a permanent ice age is because of the greenhouse effect.

“Rubbish!”  you say, “the greenhouse effect is something new, we didn’t have it before and it wasn’t that cold!”

The greenhouse effect is actually nothing new – it’s been around as long as carbon dioxide, water vapour and other greenhouse gases have existed in our atmosphere. The problem now is that our activities are increasing the concentration of these gases. Basic physics states that this should increase the Earth’s surface temperature and lo and behold that’s exactly what we observe. Of course there are many factors that affect our climate at any one time and while we cannot be 100% sure how much the greenhouse effect will affect the surface temperature in any one given year, we can be sure of these two facts, which are absolutely indisputable:

a) We are increasing the concentration of greenhouse gases in the atmosphere

b) Greenhouse gases increase the surface temperature of the planet

When the temperature starts going up in line with this it is surprising that lots of people choose to put their heads in the sand and deny what theory and evidence shows is very clearly happening. The reason I think, that this denial-phenonmenon exists, is simply that it is much more convenient for people to live in denial than it is for them to accept reality.

Accepting the true scale of the problem means significantly changing our lifestyles and a lot of people don’t want to do that. Pretending that climate-change skepticism has any basis outside cloud-cuckoo land allows people to continue doing what they’re doing and avoiding this massive inconvenience.

This blog isn’t about climate change though.

Have you ever met a supply-sider? Supply-siders have a lot in common with climate change deniers. I should explain what I mean by a supply-sider. It’s about tax though, so grab a coffee before you continue.

Cutting income tax has a positive effect on economic growth because people have more incentive to work and have more disposable income to spend. The problem though is that tax cuts need to be financed by cutting public spending and that has a negative effect on economic growth and a negative effect on people’s quality of life. As an alternative to cutting spending, we could borrow to cover short-term tax cuts but we can’t make permanent tax cuts and still have a functioning NHS, education system, armed forces etc. etc.

That much is, again, basic maths and uncontroversial. Unless you are a supply-sider. Supply-siders believe that the effects of tax cuts is so ridiculously large that they more than pay for themselves – that cutting taxes actually increases government revenue and everyone becomes better off because of it.

Nowhere are supply-siders more prominent and militant than in America. When Bill Clinton took office he took over a large budget deficit. He responded to this by introducing tax rises on the middle-classes and wealthy. Supply-siders went mad – claiming that this would starve the economy and usher in financial disaster! In fact what happened was that the economy grew, unemployment went down and the deficit turned into a surplus.

Enter George W. Bush. As a supply-sider, Bush brought in an era of tax cuts and the richer you were, the more you benefitted. This, he assured everyone would make a massive boost to the economy. The surplus quickly turned back into a massive deficit.

Of course these are just two examples (albeit good ones) and there were many other things going on which would have contributed to these two outcomes. Importantly though, supply-siders said that Clinton’s policy to raise taxes on rich people to pay off the deficit would spectacularly backfire and they said Bush’s policy to cut taxes on rich people would boost the economy. In both cases they were 100% wrong.

Like, climate-change deniers, supply-siders ignore logic and evidence simply because the reality is inconvenient. Supply-siders organise huge campaigns to tell voters that their taxes are harming the economy.  They tell people that if they just paid less tax to the government and kept more money for themselves, we’d all be better off. This is voodoo economics. This is one of the ultimate examples of bad marketing. This is to economics what homeopathy is to medicine.

So we can see that while cutting taxes stimulates economic growth, it does not pay for itself. Cutting taxes will cost money and if it is the rich receiving the benefit, it is everyone else who is receiving the cost of it.

It was therefore, with sadness that I read this week’s story about 20 economists writing to the FT to campaign for a lowering of the top tax rate, stating that it was harming the economy.

I do agree we need something to stimulate the economy. As I’ve discussed before on here – we won’t get rid of the deficit without economic growth and there is precious little of it at the moment. I do though have a big problem with attempting to do this through a tax cut on the 320,000 richest people in the country. Don’t misunderstand me – I am not so much of a liberal that I want to advocate the punishment of rich people, I simply think that if you are in the top 320,000 richest people in the country you should not be at the front of the queue when it comes to government handouts.

The supply-siders’ excuse is that by giving rich people even more money we will boost the economy and it will filter down to the poor people.

So which of these boosts the economy more?

a) Giving 10 rich people £1,000,000 each

b) Giving a million poor people £10 each

The letter to the FT offered nothing more than vague anecdote to say why we should go for a). 24% of income tax, it said, is paid by the richest 1%. This could be because taxes are grossly unfair. It isn’t though.

The income gap between rich and poor has been rising for a long time and is now bigger than it has ever been. When a small number of people earn lots of the income, a small number of people pay lots of the income tax. On its own, that figure of 24% paid by 1% tells us nothing useful at all. (I wrote more about this here.)

I reread the letter a few times and couldn’t really understand how 20 economists (a few of them with senior academic positions) could so strongly advocate such a tax cut and only provide a weak argument of vague anecdote to back it up.

To say the least it was a wish-washy argument: “Some rich people might all move somewhere else with a lower tax rate.” Well they might indeed – we all understand incentives. I would have thought though – no I would absolutely have expected that 20 economists arguing for tax cuts for rich people, between them could have come up with something concrete to show why, in the circumstances, this is a good policy. The US has (and has had for a long time) a far lower top income tax rate compared with the large economies in Europe and they’re doing worse than we are. I haven’t see a huge number of UK companies abandoning ship and moving to the US.

Supply-siders argue that when taxes on top-earners are raised that top-earners find ways to avoid and evade the taxes. That’s also true, but it isn’t necessarily a reason to sort it out through a policy of:

“Damn those rich people, they’re so wiley! We’ll have to recoup that money from the less-wiley poor people!”

If our tax rules are this easily side-stepped by rich people then we should look at the tax rules and make them tighter. We should not be saying that poor people should be picking up the bill because we have loop-holes in our tax law.

A very important point that the letter ignored though is what people do with the extra money they receive through tax cuts. If we go with option a) and give 10 rich people £1,000,000 they might spend a bit of it but most likely a lot will go into their savings – they already have plenty of money to finance their lifestyles.

If we go with option b) and give 1,000,000 poor people £10 each they will spend it. When people are really struggling to get by on what they earn they don’t open a savings account.

This is very important because the key reason that tax cuts help to stimulate an economy is because people have more money to spend and in spending that money they stimulate the economy. If we make a tax cut where the extra money goes straight into people’s bank accounts then no economic growth is realised. These are two very basic and indisputable economic rules:

  • Rich people save a greater proportion of their income than poor people
  • Spending money stimulates the economy
It is therefore absolutely the case that option b) would lead to more of the realised tax benefits being pumped back into the economy. Wouldn’t it be a good idea to have at least mentioned this in the letter? Maybe shown how they could be so sure that the effect of the disappearing, tax avoiding rich people outweighed this effect?

Anyway, as it transpired, the 20 economists’ letter to the FT had been organised by a PR company. I’ve no idea why a PR company decided to set out to find 20 economists to sign their letter but something fishy is definitely going on.

Labour’s alternative is to make a temporary cut in VAT. This might work quite well as an economic boost – everything is cheaper for a year, buy it now! It isn’t a perfect way of targeting the poorest – VAT has a reasonably equal effect on everyone. The Lib Dems (remember them?) are said to favour raising the threshold below which no income tax is paid to £10,000. I like that one the best.

Let’s be clear, though – none of these ideas is going to suddenly pay for itself. Despite the claims of the supply-siders, all tax reduction policies would increase the deficit (or mean additional, unplanned spending cuts.) While increasing the already massive deficit is not ideal, I would be in favour of doing so if it kick-started some growth and simultaneously helped out the poorest people who are struggling the most.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are now considering your position then this post has done its job.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are not now considering your position then don’t worry, you’re not on your own – George W. Bush is on your side too.

RedEaredRabbit

Filed under Economics Tagged with , , ,

Beating Up The Rich

08/01/2011 3 Comments

In amongst the knob gags and poo jokes, someone occasionally writes something serious on Twitter. The other day someone wrote this:

The top 10% of earners pay more than 50% of all income tax. When can we stop beating up on the rich?

It got retweeted and found its way into my timeline. I did try to start a debate with the originator but they didn’t seem to want to take part. Twitter is a fairly clumsy medium for doing so in any case.

I hope I am not doing the originator a disservice but I think the case being made was one I have heard on several occasions – that because such a large proportion of tax is coming from a relatively small proportion of the population they must be more than paying their way and it would be unfair to ask them for even more.

The point I wanted to make was that this statistic on its own doesn’t really tell us enough to know whether we should stop beating up the rich or not.

(I think we are talking about a metaphorical beating up here. I want to make it explicitly clear that I do not condone the beating up of rich people irrespective of the income tax rate for high earners. Except perhaps Duncan Bannatyne and even then no more than a wedgie and a titty twister.)

So why does this statistic not tell us enough on its own?

Reason #1

Let’s look at two fictional economies:

Thatcherland

The country of Thatcherland has 10 residents. Nine of them earn £10,000 per year. One earns £10,000,000 per year.
Income tax is a flat 30% irrespective of salary.

=> In Thatcherland the richest 10% of earners pay 99% of the total income tax.

Getoffmyland

The country of Getoffmyland is populated by 10 farmers. Nine of them earn £10,000 per year. One earns £30,000 per year.
In Getoffmyland, income tax on salaries up to £20,000 pay income tax at 10%. For anything over £20,000 income tax is 40%.

=> In Getoffmyland, the top 10% of earners pay 40% of the total income tax.

If we simply assume that a higher proportion of income tax paid by the rich is equivalent to fairness then Thatcherland comes out as a brilliantly fair economy! Look, that lovely rich person is paying almost all the income tax. The other 90% of residents only have to find 1% between them!

Of course, it isn’t fair though because we just neglected to take into account the income gap between the rich and the poor: If the income is unevenly distributed in the first place then it should not be a big surprise to anyone that the income tax is too.

Reason #2

The statistic tells us only about income tax and we can’t make a valid judgment without taking into account all the other taxes we have to pay. e.g.

  • In Getoffmyland there is another tax which farmers have to pay based on the size of their farmhouse. The bigger it is the more they have to pay.
  • In Thatcherland, this tax has been replaced with a poll tax where all residents pay the same.

Even if the income tax were fair in Thatcherland we would be fairly rash to declare the whole tax system fair without taking the poll tax into account.

Let’s forget about our fictional economies and move to a real one. The UK government is currently in the process of implementing fiscal austerity. At the highest level they have two ways to do this:

  • Decrease Government spending
  • Increase Taxes

It seems to me they are a lot keener on adjusting the former than they are the latter and I do have a big concern about this. In August the IFS published an analysis of the government’s emergency budget and found that contrary to George Osborne’s claims the policies were not progressive. i.e. they proportionally penalised the poor more than the rich. (You can read the post I wrote about that here.)

This shouldn’t be a big surprise. If you hugely reduce the budget of local councils then libraries close, public transport services reduce etc and those services benefit the poor more than the rich who buy their own books and have their own cars. Additionally there have been much publicised cuts to both housing benefit and tax credits and despite what the Daily Mail says, people who claim benefits are not all millionaire hoodwinkers.

Strangely though, throughout all of this, no one has seemed to consider for 5 minutes financing any of this through a rise in income tax on the wealthy (metaphorically beating them up) and I really don’t for the life of me understand why. Austerity in the current climate is foolhardy but if you are dumb enough to want to implement it, why not start with the people who aren’t going to starve?

Prior to the downturn the UK economy had enjoyed 15 years of sustained growth and a great many people benefited because of this. Now the economy is in a bad way, why is a government hell bent on austerity, not considering going back to those who have benefited the most and asking them to contribute more? It seems especially odd when the alternative is asking the poor to foot the bill.

I must though, be fair to the government and highlight a progressive policy they are implementing – the freezing of the television license fee. It is just a shame that David Cameron had to get in bed with Rupert Murdoch to come up with one.

Leaving the rich untouched and taking it all from the poor just increases the income gap, pushing us still further towards the economy in Thatcherland.

And as we approach Thatcherland, the richest 10% will pay more and more of the income tax.

And things will be more and more unfair.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,