The debate on what spurs economic growth and therefore what policy tools to use is not unique to Britain. As the world economy slows, variations on this debate are taking place in many countries.
A piece on the Irish blog ‘UNITE’s Notes on the Front’ deals with this question from the specific perspective of the current Irish economic and political situation and is written by Michael Burke.
The context is that the general election to the Irish Dáil is less than 12 months away. The current government is a coalition led by the right wing Fine Gael and the Labour Party and has been pursuing austerity policies. But now that an election is in the offing the Coalition has shifted towards boosting consumption in order to get re-elected (much like the coalition government in Britain after 2012). This was the content of the recently announced Budget for 2016.
However, a wide array of forces opposes this agenda. Sinn Féin, some other elected representatives, many in the trade unions and social justice campaigners all argue (with differing emphases) that investment should take precedence. Boosting consumption should be a secondary priority and this should mainly be done by boosting the incomes of the poor and lower paid workers at the expense of the rich and the very highly paid.
There are sound theoretical reasons for this order of priorities, which have been demonstrated by SEB. Moreover, the recent history of the US, which is the Western economic model shows that, as consumption rises as a proportion of GDP economic growth slows and so does the growth rate of consumption. An examination of recent Irish economic history exhibits the same pattern. This is, a high or rising proportion of the economy devoted to investment leads to higher growth, including the growth rate of consumption. A low or falling proportion of investment leads to slower growth, including the growth rate of consumption.
The full piece can be read here.
Friday, 23 October 2015
Thursday, 15 October 2015
Corbynomics: winning with policy clarity
By Michael Burke
Economic policy is central to the survival and eventual victory of the new Labour leadership, even though it is clearly not the only issue. Contrary to the usual Tory media reports, Jeremy Corbyn and his Shadow Chancellor John McDonnell registered an advance with the debate and vote on Osborne’s risible Fiscal Responsibility Charter. That advance came because the correct position of voting against was adopted. As this question will not go away, further advances will require even greater clarity.
The measure of the advance can be summed up in its political aspect with an analysis of the vote. Just 20 Labour MPs rebelled against Labour’s line by abstaining on the Charter. It may be recalled that of the 35 nominations Jeremy Corbyn received from MPs in the leadership contest, only about half of them actually supported him. During that campaign the vast majority of MPs followed the line of abstaining on the Tories massive cuts in the Welfare Bill. Now the overwhelming bulk of the Parliamentary Labour Party has voted against the key Tory legislation of permanently enshrining austerity and ruling out borrowing for investment. This is despite the fact that as recently as May the party’s economic line was ‘fiscal rectitude’, ‘zero-based spending reviews’ and sticking to outlandish Tory spending cuts in the first two years of the Parliament (something the Tories could not do in their own June 2015 Budget).
Politically, the 20 abstainers have isolated themselves within the party (although they will no doubt find regular berths in the BBC studios and lots of column inches in the Murdoch press). Jeremy Corbyn and John McDonnell have led the PLP to a much better economic position by opposing Tory economic policies. As the Tories are committed to austerity and this will be central to the economic debate over the next five years, that leadership will need to keep moving forward.
Exposing Osborne’s fallacies
Labour lost the last election because its economic policies were not credible. There is a concerted effort to distort this factual finding to suggest that Labour was too anti-austerity. Therefore the debate on economic policy is central both to the future direction of Labour policy and its election prospects.
Osborne’s great fallacies, like most distortions of the truth, have some connection to popular understanding otherwise it would be impossible to explain their political power. A central fallacy is to treat all debt as essentially the same, with equally negative consequences. Instead, as Socialist Economic Bulletin (SEB) has repeatedly shown John McDonnell and Jeremy Corbyn have made the correct distinction between borrowing for consumption and borrowing for investment.
In the homely analogies beloved by this Chancellor and by Margaret Thatcher, ordinary households understand very well the difference between different types of borrowing. Borrowing to buy a home, or borrowing to pay for night classes, or a new work-related computer all provide an asset or additional income and so are an investment. But borrowing to pay the electricity or grocery bills is not sustainable. It may ‘circulate more money in the economy’ but can only be done in extremis and not in the long-term.
Likewise, businesses understand cashflow. Business makes an appraisal of investment opportunity on the basis of cost-benefit analysis. If a reasonable expected rate of return exceeds the cost of borrowing then the investment will be made. But if the business is borrowing to meet day to day expenses it will soon face insolvency and possibly bankruptcy.
Government relies on these economic agents for its income. But in truth it is not unique as all three agents, government, business and households rely on each other for their income both directly and indirectly. In that sense government is no different. Government borrowing for investment delivers an economic return, either direct or indirect, will expand the economy and, just like business a key criteria will be whether the rate of return on the investment exceeds the borrowing cost. Contrary to views Keynes did not hold, but which are misleadingly entitled ‘Keynesianism’, borrowing for day to day consumption will not necessarily expand the economy – this depends on whether extra production increases profit, and in a number of situations expansions of demand may not increase profit and may actually reduce it. Consumption should usually be met by current revenues from taxation. If there is a shortfall between desired government current spending and revenue, wasteful spending can be cut (e.g. Trident) and/or taxes can be increased.
SEB has repeatedly demonstrated that investment is the decisive input for growth and consumption cannot lead growth, and from this it follows that government borrowing should be used for investment over the business cycle (running deficits/borrowing for consumption as well as investment may of course be valuable in economic downturns)
Alliances
The clear opposition to the Fiscal Responsibility Charter from the ‘Corbyn/McDonnell’ team on the Labour front bench was supported by strong economic arguments from a number of quarters, not all of them long-standing allies.
In the Commons debate Caroline Lucas said, “The Chancellor is incredibly irresponsible to imply that borrowing is always bad. If we borrow to invest, we increase jobs, stabilise the economy and increase tax revenues. That is good for the economy, not bad for it…... If we are investing in jobs, that gets taxes going back into the Revenue, which is good for the economy.” And, “The Chancellor is deliberately misleading the public by continuing to claim that all borrowing is irresponsible. It is not. What is irresponsible is failing to borrow to invest, providing we are able to sustainably meet the cost of borrowing.”
Jonathan Reynolds, describing the Charter as intellectually moronic said, “It essentially commits this House to never borrowing to invest, even when the cost-benefit analysis of that investment is such that the country would benefit greatly. That is why it has not one serious economist backing it.”
Helen Goodman said, “One of the most pernicious things about the rule that the Chancellor has chosen is that it treats capital and current spending the same. He is ignoring the fact that investing in housing, science, broadband, transport and the university system is a way of strengthening economic productivity and increasing growth in the British economy. Nobody thinks that it is right to max out the credit card to pay the weekly grocery bill—of course not—but families up and down this country take out mortgages to buy their homes. There is a precise parallel here.”
Regarding what John McDonnell himself said, as much of the press will not report it accurately, here are some of his key points “The worst false economy is the failure to invest. This will be a direct result of Government policy embedded in this charter, with its limits on all public sector borrowing. This Chancellor’s strategy has given us investment as a share of GDP lower than all the other G7 countries, falling even further behind the G7 average in recent years. It is incomprehensible for the Chancellor to rule out the Government playing a role in building our future. For him to constrain himself from doing so in the future, no matter what the business case for a project, has no basis in economic theory or experience.”
And, “We will not tackle the deficit on the backs of middle and low earners, and especially not on the backs of the poorest in our society. We will tackle the deficit, but we will do it fairly and to a timescale that does not jeopardise sustainable growth in our economy. We will balance day-to-day spending and invest for future growth, so that the debt to GDP ratio falls, paying down our debts”.
“That is why we will establish a National Investment Bank to invest in innovation across the entire supply chain, from the infrastructure we need to the applied research and early stage financing of companies. To tackle the growing skills shortages we will prioritise education in schools and universities along with a clear strategy for construction, manufacturing, and engineering skills to build and maintain sustainable economic growth. The proceeds of that growth will reach all sections of our society.”
Outside the Chamber, Chi Onwurah had previously written a strong piece deriding Osbornomics’ refusal to invest, “The Osbornomic farmer wouldn’t borrow to buy a tractor unless crop prices were falling. The Osbornomic househunter would not take out a mortgage unless her salary was being cut. The Osbornomic CEO would only invest in a new product line when revenues were falling.”
Long-standing Corbyn/McDonnell ally Diane Abbott made a series of similar points on Twitter, “Osborne's Fiscal Responsibility Charter effectively outlaws the equivalent of taking out a mortgage…..Osborne's Fiscal Responsibility Charter is a con-trick from a charlatan. Outlawing borrowing for investment means long-term stagnation….Every household and firm knows that borrowing for investment boosts incomes. Only Osborne and the austerity fanatics are unaware of this.”
These analogies are extremely useful for popularising the alternative to austerity, which is investment. The new leadership team has shown it can command an overwhelming majority in PLP with clear opposition to Tory austerity. Developing a broader understanding of the distinction between borrowing for investment and borrowing for consumption, and why Labour should support the former will be key in pushing back the Tories in the period ahead.
Economic policy is central to the survival and eventual victory of the new Labour leadership, even though it is clearly not the only issue. Contrary to the usual Tory media reports, Jeremy Corbyn and his Shadow Chancellor John McDonnell registered an advance with the debate and vote on Osborne’s risible Fiscal Responsibility Charter. That advance came because the correct position of voting against was adopted. As this question will not go away, further advances will require even greater clarity.
The measure of the advance can be summed up in its political aspect with an analysis of the vote. Just 20 Labour MPs rebelled against Labour’s line by abstaining on the Charter. It may be recalled that of the 35 nominations Jeremy Corbyn received from MPs in the leadership contest, only about half of them actually supported him. During that campaign the vast majority of MPs followed the line of abstaining on the Tories massive cuts in the Welfare Bill. Now the overwhelming bulk of the Parliamentary Labour Party has voted against the key Tory legislation of permanently enshrining austerity and ruling out borrowing for investment. This is despite the fact that as recently as May the party’s economic line was ‘fiscal rectitude’, ‘zero-based spending reviews’ and sticking to outlandish Tory spending cuts in the first two years of the Parliament (something the Tories could not do in their own June 2015 Budget).
Politically, the 20 abstainers have isolated themselves within the party (although they will no doubt find regular berths in the BBC studios and lots of column inches in the Murdoch press). Jeremy Corbyn and John McDonnell have led the PLP to a much better economic position by opposing Tory economic policies. As the Tories are committed to austerity and this will be central to the economic debate over the next five years, that leadership will need to keep moving forward.
Exposing Osborne’s fallacies
Labour lost the last election because its economic policies were not credible. There is a concerted effort to distort this factual finding to suggest that Labour was too anti-austerity. Therefore the debate on economic policy is central both to the future direction of Labour policy and its election prospects.
Osborne’s great fallacies, like most distortions of the truth, have some connection to popular understanding otherwise it would be impossible to explain their political power. A central fallacy is to treat all debt as essentially the same, with equally negative consequences. Instead, as Socialist Economic Bulletin (SEB) has repeatedly shown John McDonnell and Jeremy Corbyn have made the correct distinction between borrowing for consumption and borrowing for investment.
In the homely analogies beloved by this Chancellor and by Margaret Thatcher, ordinary households understand very well the difference between different types of borrowing. Borrowing to buy a home, or borrowing to pay for night classes, or a new work-related computer all provide an asset or additional income and so are an investment. But borrowing to pay the electricity or grocery bills is not sustainable. It may ‘circulate more money in the economy’ but can only be done in extremis and not in the long-term.
Likewise, businesses understand cashflow. Business makes an appraisal of investment opportunity on the basis of cost-benefit analysis. If a reasonable expected rate of return exceeds the cost of borrowing then the investment will be made. But if the business is borrowing to meet day to day expenses it will soon face insolvency and possibly bankruptcy.
Government relies on these economic agents for its income. But in truth it is not unique as all three agents, government, business and households rely on each other for their income both directly and indirectly. In that sense government is no different. Government borrowing for investment delivers an economic return, either direct or indirect, will expand the economy and, just like business a key criteria will be whether the rate of return on the investment exceeds the borrowing cost. Contrary to views Keynes did not hold, but which are misleadingly entitled ‘Keynesianism’, borrowing for day to day consumption will not necessarily expand the economy – this depends on whether extra production increases profit, and in a number of situations expansions of demand may not increase profit and may actually reduce it. Consumption should usually be met by current revenues from taxation. If there is a shortfall between desired government current spending and revenue, wasteful spending can be cut (e.g. Trident) and/or taxes can be increased.
SEB has repeatedly demonstrated that investment is the decisive input for growth and consumption cannot lead growth, and from this it follows that government borrowing should be used for investment over the business cycle (running deficits/borrowing for consumption as well as investment may of course be valuable in economic downturns)
Alliances
The clear opposition to the Fiscal Responsibility Charter from the ‘Corbyn/McDonnell’ team on the Labour front bench was supported by strong economic arguments from a number of quarters, not all of them long-standing allies.
In the Commons debate Caroline Lucas said, “The Chancellor is incredibly irresponsible to imply that borrowing is always bad. If we borrow to invest, we increase jobs, stabilise the economy and increase tax revenues. That is good for the economy, not bad for it…... If we are investing in jobs, that gets taxes going back into the Revenue, which is good for the economy.” And, “The Chancellor is deliberately misleading the public by continuing to claim that all borrowing is irresponsible. It is not. What is irresponsible is failing to borrow to invest, providing we are able to sustainably meet the cost of borrowing.”
Jonathan Reynolds, describing the Charter as intellectually moronic said, “It essentially commits this House to never borrowing to invest, even when the cost-benefit analysis of that investment is such that the country would benefit greatly. That is why it has not one serious economist backing it.”
Helen Goodman said, “One of the most pernicious things about the rule that the Chancellor has chosen is that it treats capital and current spending the same. He is ignoring the fact that investing in housing, science, broadband, transport and the university system is a way of strengthening economic productivity and increasing growth in the British economy. Nobody thinks that it is right to max out the credit card to pay the weekly grocery bill—of course not—but families up and down this country take out mortgages to buy their homes. There is a precise parallel here.”
Regarding what John McDonnell himself said, as much of the press will not report it accurately, here are some of his key points “The worst false economy is the failure to invest. This will be a direct result of Government policy embedded in this charter, with its limits on all public sector borrowing. This Chancellor’s strategy has given us investment as a share of GDP lower than all the other G7 countries, falling even further behind the G7 average in recent years. It is incomprehensible for the Chancellor to rule out the Government playing a role in building our future. For him to constrain himself from doing so in the future, no matter what the business case for a project, has no basis in economic theory or experience.”
And, “We will not tackle the deficit on the backs of middle and low earners, and especially not on the backs of the poorest in our society. We will tackle the deficit, but we will do it fairly and to a timescale that does not jeopardise sustainable growth in our economy. We will balance day-to-day spending and invest for future growth, so that the debt to GDP ratio falls, paying down our debts”.
“That is why we will establish a National Investment Bank to invest in innovation across the entire supply chain, from the infrastructure we need to the applied research and early stage financing of companies. To tackle the growing skills shortages we will prioritise education in schools and universities along with a clear strategy for construction, manufacturing, and engineering skills to build and maintain sustainable economic growth. The proceeds of that growth will reach all sections of our society.”
Outside the Chamber, Chi Onwurah had previously written a strong piece deriding Osbornomics’ refusal to invest, “The Osbornomic farmer wouldn’t borrow to buy a tractor unless crop prices were falling. The Osbornomic househunter would not take out a mortgage unless her salary was being cut. The Osbornomic CEO would only invest in a new product line when revenues were falling.”
Long-standing Corbyn/McDonnell ally Diane Abbott made a series of similar points on Twitter, “Osborne's Fiscal Responsibility Charter effectively outlaws the equivalent of taking out a mortgage…..Osborne's Fiscal Responsibility Charter is a con-trick from a charlatan. Outlawing borrowing for investment means long-term stagnation….Every household and firm knows that borrowing for investment boosts incomes. Only Osborne and the austerity fanatics are unaware of this.”
These analogies are extremely useful for popularising the alternative to austerity, which is investment. The new leadership team has shown it can command an overwhelming majority in PLP with clear opposition to Tory austerity. Developing a broader understanding of the distinction between borrowing for investment and borrowing for consumption, and why Labour should support the former will be key in pushing back the Tories in the period ahead.
Tuesday, 13 October 2015
Why borrowing for investment is correct – John McDonnell is right & Osborne is wrong
By John Ross
An earlier article ‘Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne’ analysed in the ‘family’ and ‘common sense’ vocabulary Osborne likes to present the distinction between state borrowing for investment and state borrowing for current expenditure – a key economic distinction Osborne’s Fiscal Charter deliberately tries to obscure. It also showed how sections of the media deliberately attempt to aid Osborne in this by talking of budget ‘deficits’ and ‘borrowing’ without distinguishing between borrowing for investment and borrowing for consumption.
The following article, an excerpt from a longer analysis of Western responses to the Great Recession, analyses the issue in more formal economic terms. It shows that John McDonnell is very far from being an ‘extremist radical’ in supporting state borrowing for investment. Among those holding the same logical position are fellow 'extremists' Ben Bernanke. Larry Summer and Martin Wolf!
* * *
An answer that may be immediately rejected in explaining the failure of response to the Great Recession, and the ‘new mediocre’ slow economic growth following it, was that no Western expert understood the situation. To the contrary, eminent Western economic figures well understood that the problem in the US and other Western economies was that the mechanism translating company income into investment was not functioning adequately, and that the solution was for the state to step in and invest these funds - as in Roosevelt’s 1930s response to the Great Depression. Merely a representative few of those arguing for this response will therefore be quoted - to show the accurate, indeed comprehensive, character of their analyses.Ben Bernanke, almost immediately he could speak openly after ceasing to be Chair of the US Federal Reserve, called for:
‘a well-structured program of public infrastructure development, which would support growth in the near term by creating jobs and in the longer term by making our economy more productive.’1
Lawrence Summers, former US Treasury Secretary, argued:
‘We may… be in a period of ‘secular stagnation’ in which sluggish growth and output, and employment levels well below potential, might coincide for some time to come with problematically low real interest rates…
‘The… approach… that holds most promise – is a commitment to raising the level of demand at any given level of interest rates… This means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.’2
Martin Wolf, chief economics commentator of the Financial Times, and one of the world’s most influential economic journalists, argued:
'In brief, the world economy has been generating more savings than businesses wish to use, even at very low interest rates. This is true not just in the US, but also in most significant high-income economies.
‘The glut of savings, then, has become a constraint on current demand. But since it is connected to weak investment, it also implies slow growth of prospective supply…
‘So what is to be done? One response to an excess of desired savings over investment would be even more negative real rates of interest. That is why some economists have argued for higher inflation. But that would be hard to achieve, even if it were politically acceptable….
‘Yet another possibility… supported by many economists (including myself), is to use today’s glut of savings to finance a surge in public investment.
‘The best response… is measures aimed at raising productive private and public investment. Yes, mistakes will be made. But it will be better to risk mistakes than accept the costs of an impoverished future.’3
Wolf analysed this situation in the UK, which faced the same problem as the US, citing similar views by other influential commentators:
‘With real interest rates close to zero… it is impossible to believe that the government cannot find investments to make itself, or investments it can make with the private sector, or private investments whose tail risks it can insure that do not earn more than the real cost of funds. If that were not true, the UK would be finished. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way…
‘This does not even deserve the label primitive. It is simply ridiculous.’
Wolf clearly pointed to the consequences:
‘The results… are not at all ridiculous. They are extremely costly to both the economy and society. Yet, instead of taking advantage of the opportunity of a lifetime to repair and upgrade the capital stock, as Mr Portes [of the UK National Institute for Economic and Social Research] notes: “Public sector net investment – spending on building roads, schools and hospitals – has been cut by about half over the past three years, and will be cut even further over the next two.”’
Wolf concluded, endorsing such analysis:
‘He [Portes] recommends a £30bn investment programme (about 2 per cent of GDP). I would go for far more. Note that the impact on the government’s debt stock would be trivial even if it brought no longer-term gains…
‘the government… is refusing to take advantage of the borrowing opportunities of a lifetime…. It is determined to persist with its course, regardless of the unexpectedly adverse changes in the external environment. The result is likely to be a permanent reduction in the output of the UK.’ 4
Richard Yamarone, of Bloomberg Economics Brief, caustically noted:
‘Instead of adopting an economic solution such as matching idled and unemployed agents (millions of manufacturing and construction workers) with necessary improvements to the electrical grid, dilapidated highways, high-speed trains, outdated bridges, tunnels, ports, and water pipes, America received the political response of extended unemployment benefits and a whopping food stamp programme – safety nets for those who have fallen, not ‘stimulative’ measures.
‘Unlike during the Great Depression, which left a dazzling infrastructure legacy including a swath of bridges, tunnels, highways, art, dams and power generation, the only remnant from the 2007-09 depression is an underemployed labour force, earning a fraction of previous incomes, diminished skill sets and little or no promise for recent college graduates.’5
References
1. Bernanke, B. (2015, April 30). WSJ Editorial Page Watch: The Slow-Growth Fed? Retrieved May 2, 2015, from Brookings: http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/30-wsj-editorial-slow-growth-fed?cid=00900015020089101US0001-05011
2. Summers, L. (2014, January 5). Washington must not settle for secular stagnation. Financial Times.
3. Wolf, M. (2013a, November 19). Why the future looks sluggish. Financial Times.
4. Wolf, M. (2012, May 17). Cameron is consigning the UK to stagnation. Financial Times.
5. Yamarone, R. (2014, January 8). Summers’ remedy is years out of date. Financial Times.
Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne
By John Ross
If Osborne’s Charter for Budget Responsibility, which seeks to ban all government borrowing over the business cycle, was read naively you would assume it was written by an economic ignoramus who does not understand the difference between investment and current expenditure. But of course its economic howlers do not flow from ignorance but from a deliberate attempt to obscure issues which is driven by an ideological agenda to prevent the effective way for the economy to grow – by the state investing when the private sector does not.
In this deliberate attempt to obscure elementary economic realities Osborne is aided by sections of the media, such as the @bbcnickrobinson or @JohnRentoul, who equally talk about the budget ‘deficit’ without distinguishing between investment and current expenditure – although in their cases pure economic ignorance cannot be ruled out. However as other journalists such as @afneil (Andrew Neil) are capable of perfectly correctly understanding and expressing the issue, whatever their differences on other questions, it is more likely that some media comment follows Osborne’s deliberate attempts at confusion. As Osborne claims to explain things in homely ‘family terms,’ and as 'common sense,' we will do so equally – a second article will give a more formal economic statement related to present economic conditions.
The nation’s credit card and the nation’s house purchase mortgage
Virtually every family in the country in fact understands the difference between borrowing for investment and borrowing for current expenditure because that it how they organise their finances. To take Osborne’s analogy of the ‘credit card’ anyone who simply continues to run up debts to buy groceries on their credit card (current expenditure) without being concerned about whether they can repay them is heading for financial trouble. But no rational person decides to buy a house (investment) by first saving up the money and then buying the house – they take out a mortgage to do so.
This difference is even expressed formally in a balance sheet. If money is spent on food or other current expenditure there is an expenditure item and no corresponding asset – the expenditure has just been consumed, both literally and in economic terms. But the expenditure on the house has a corresponding asset – the house. This is a reason the borrowing for the house is entirely rational while ever increasing borrowing for current expenditure is not.
Osborne’s ‘Charter for Fiscal Responsibility’ is an attempt not only to limit expenditure on the credit card but to make it illegal to take out a mortgage to buy a house.
How factory machinery is financed
Another analogy, in this case from business, makes the situation equally clear. A company does not finance purchase of machinery, for example to build cars, out of its cash flow. It borrows the money, buys the machinery, and then repays the loan from the production. If it did not do so, and waited until it had saved the money for the machinery from current cash flow, that company would be totally outcompeted by companies which had borrowed the money, purchased the machinery, could now produce more efficiently, and had therefore gained a competitive advantage. That is why borrowing for investment is not merely economically rational but necessary.
George Osborne tries to obscure these elementary economic truths for his ideological purposes – he prefers the economy not to grow rapidly, and people to be poorer, unless it is done by the private sector. Sections of the media, by talking about the ‘budget deficit’ and borrowing without distinguishing between investment and current expenditure either are economically illiterate or themselves attempt to deliberately obscure elementary economic realities.
John McDonnell’s position has so far been correct. There is a clear economic difference between consumption and investment. The government should not borrow for consumption over the course of the business cycle. The government should borrow for investment. Osborne’s ‘Charter for Budget Responsibility’ should be amended to allow borrowing for investment. If it is not permitted to amend it, the Charter should be voted against. That has become Labour’s position and it is the correct one.
If Osborne’s Charter for Budget Responsibility, which seeks to ban all government borrowing over the business cycle, was read naively you would assume it was written by an economic ignoramus who does not understand the difference between investment and current expenditure. But of course its economic howlers do not flow from ignorance but from a deliberate attempt to obscure issues which is driven by an ideological agenda to prevent the effective way for the economy to grow – by the state investing when the private sector does not.
In this deliberate attempt to obscure elementary economic realities Osborne is aided by sections of the media, such as the @bbcnickrobinson or @JohnRentoul, who equally talk about the budget ‘deficit’ without distinguishing between investment and current expenditure – although in their cases pure economic ignorance cannot be ruled out. However as other journalists such as @afneil (Andrew Neil) are capable of perfectly correctly understanding and expressing the issue, whatever their differences on other questions, it is more likely that some media comment follows Osborne’s deliberate attempts at confusion. As Osborne claims to explain things in homely ‘family terms,’ and as 'common sense,' we will do so equally – a second article will give a more formal economic statement related to present economic conditions.
The nation’s credit card and the nation’s house purchase mortgage
Virtually every family in the country in fact understands the difference between borrowing for investment and borrowing for current expenditure because that it how they organise their finances. To take Osborne’s analogy of the ‘credit card’ anyone who simply continues to run up debts to buy groceries on their credit card (current expenditure) without being concerned about whether they can repay them is heading for financial trouble. But no rational person decides to buy a house (investment) by first saving up the money and then buying the house – they take out a mortgage to do so.
This difference is even expressed formally in a balance sheet. If money is spent on food or other current expenditure there is an expenditure item and no corresponding asset – the expenditure has just been consumed, both literally and in economic terms. But the expenditure on the house has a corresponding asset – the house. This is a reason the borrowing for the house is entirely rational while ever increasing borrowing for current expenditure is not.
Osborne’s ‘Charter for Fiscal Responsibility’ is an attempt not only to limit expenditure on the credit card but to make it illegal to take out a mortgage to buy a house.
How factory machinery is financed
Another analogy, in this case from business, makes the situation equally clear. A company does not finance purchase of machinery, for example to build cars, out of its cash flow. It borrows the money, buys the machinery, and then repays the loan from the production. If it did not do so, and waited until it had saved the money for the machinery from current cash flow, that company would be totally outcompeted by companies which had borrowed the money, purchased the machinery, could now produce more efficiently, and had therefore gained a competitive advantage. That is why borrowing for investment is not merely economically rational but necessary.
George Osborne tries to obscure these elementary economic truths for his ideological purposes – he prefers the economy not to grow rapidly, and people to be poorer, unless it is done by the private sector. Sections of the media, by talking about the ‘budget deficit’ and borrowing without distinguishing between investment and current expenditure either are economically illiterate or themselves attempt to deliberately obscure elementary economic realities.
John McDonnell’s position has so far been correct. There is a clear economic difference between consumption and investment. The government should not borrow for consumption over the course of the business cycle. The government should borrow for investment. Osborne’s ‘Charter for Budget Responsibility’ should be amended to allow borrowing for investment. If it is not permitted to amend it, the Charter should be voted against. That has become Labour’s position and it is the correct one.
Wednesday, 7 October 2015
‘Butskellism’ versus Keynes and Marx
By Michael Burke
Economics of budget deficits
The debate is continuing on the purpose of government borrowing and the role of ‘balanced budgets’ - which was started by John McDonnell’s position of balancing the budget on current expenditure but borrowing for investment. This is not surprising given that economic policy has to be the core of the programme for a Labour government.
A thoughtful addition to the debate is this piece by Jo Michell in the Guardian, who asks for a real alternative to Osborne, which SEB has provided in relation to the Fiscal Responsibility Act. But an important misunderstanding should be clarified. That article argues that advocacy of a balanced current budget over the business cycle would be to 'emulate Ed Balls and austerity lite.' That is incorrect. It would only be the case if the level of government investment were maintained at current miserably low levels. Instead what is proposed here is a transformational increase in public investment, sufficient to foster a sustained recovery led by public investment. Far from this being ‘austerity lite’ it makes state driven investment a key to economic policy – entirely unlike the policy of Ed Balls.
The piece below examines this attachment to persistent government budget deficits, which have been combined with a simultaneous long-run decline in public investment.
The position on Osborne’s proposals that a Labour government should balance the budget on current expenditure over the business cycle but borrow for investment is set out in an earlier article here. It follows from the fact that the purpose of economic policy is, or should be, to optimise the growth in the sustainable living standards of the population. Increasing living standards requires growth – internationally over 80% of increases in consumption are due to economic growth. Since it is not possible to increase the fundamental productive capacity of the economy without investment, investment is the decisive factor in producing growth (in an overall framework of increasing the division/socialisation of labour). Therefore economic policy, including fiscal policy, should aim at increasing investment and gradually enhancing the proportion of output devoted to investment. This is the precondition for more rapid growth – ‘growing the economy out of the crisis’ as John McDonnell and Jeremy Corbyn put it. Borrowing should primarily be confined to investment, only resorting to support consumption in specific exceptional circumstances – such as to maintain living standards of the least well off sections of the population during economic downturns. Social protection should be financed via taxation – levied in a disproportionate way on the richer sections of the population.
However, permanent or structural budget deficits have become a shibboleth for many ‘Keynesians’. This has almost nothing to do with Keynes, who himself responded to critics by arguing that the General Theory was primarily focused on the ‘regulation of the investment function’ (and barely mentioned budget deficits)*. Instead, the attachment to budget deficits is a product of the post-World War II economic consensus. In Britain this was known as Butskellism, the Tory/Labour bipartisan approach to policy which ended in spectacular economic failure by the early 1970s.
This consensus failed because it was based on a myth. The reality is that at the beginning of ‘Butskellism’ Britain and the US had experienced war-related booms. In four years of World War II the US economy doubled in real terms, and was to take another 22 years before it doubled again. In Britain the economy expanded by 55% in 10 years to 1943 and it was to take another 25 years before it increased by another 55%.
The false economic consensus was that the ‘post-WWII boom’, which some even dubbed the Golden Age of capitalism simply required expert ‘demand management’, where every sign of downturn was met with more government borrowing to finance day-to-day spending (and government-run industries were starved of investment). The true position is that this was the dwindling of the war boom, when government investment and direction of the dominant sectors of the economy had predominated. The attachment to persistent or structural budget deficits, on current expenditure and not for investment, arises from this post-WWII economic failure. The success was state-led and directed investment of the war and war preparation years.
It is a rather strange feature of the debate that many ‘Keynesians’ also regard themselves as scourges of the finance sector in general and its dominance in British society in particular. Yet as both Adam Smith and Karl Marx noted, the material power of the finance sector derives largely from its parasitic relationship to government. The interest which fattens the finance sector comes significantly in the first instance from the government, and the taxes it levies on the productive economy. As for Keynes, it is the opposite of his ‘euthanasia of the rentier’, to continually hand state assets to the finance sector. When, briefly, the Thatcher and Blair governments each had budget surpluses, there were howls of protest form the City about the ‘death of the gilts market’.
If there are deficits on current expenditure, including all the very valuable functions that can or should be performed by government, these should be met with progressive taxation. As the burden of taxation has shifted from big business and the rich to workers and the poor over time, it is clearly imperative that the former should bear the burden of increased taxation. In just one example, Thatcher inherited a Corporation Tax rate of 60% and Osborne will bequeath a rate of 18%. That trend should be reversed. To the argument that this undermines private sector investment, this has been in sharp decline even as taxes have been cut (Fig.1 below, which originally appeared on the PWC website).
Fig.1 Investment as a proportion of GDP
The British economy is participating in an investment crisis of the Western economies. It also has its own structural investment crisis, as the chart above shows. It is this twin problem that Corbynomics can address, and so raise living standards through growth led by investment – including the creation of a National Investment Bank.
There is strong opposition to this policy from capital. If the state increases its rate of investment, necessarily a greater proportion of the means of production will accumulate in state hands not those of the private sector. The entire Reagan/Thatcher era was designed to do the opposite and we are still living in that era. Attempting to accelerate the gradual run-down of the role of the state in the productive economy their programme was to attempt to remove it altogether – the policy Osborne is continuing.
But we should be clear the advocates of the ‘small state’ confine this to investment – because it means an interference in the means of production. They have had far less difficulty, and in many cases no difficulty, in increasing Government consumption as Fig.2 below shows. The Thatcherites were really primarily advocates of ‘small state investment’.
Fig.2 US Government consumption rises as Government investment falls
Osborne seems set on turning that into ‘no state investment’. But this curtailing of state investment is directly counterposed to the needs of the great majority of the population. This is why Labour, by setting out the goal of growth created by investment, including creation of an National Investment Bank, aligns its policy with that of the population. By taking the position of a balanced budget over the cycle on current expenditure but borrowing for investment John McDonnell has adopted the correct position in terms of economic theory and simultaneously, and for that reason, restores public credibility to Labour’s economic policy.
By setting out clearly that the there is an alternative to Tory policies, and that the opposite of austerity is investment, the Labour leadership team can demonstrate that its policies are superior and can deliver prosperity for the overwhelming majority.
*Keynes, Quarterly Economic Journal, OUP, February 1938.
Economics of budget deficits
The debate is continuing on the purpose of government borrowing and the role of ‘balanced budgets’ - which was started by John McDonnell’s position of balancing the budget on current expenditure but borrowing for investment. This is not surprising given that economic policy has to be the core of the programme for a Labour government.
A thoughtful addition to the debate is this piece by Jo Michell in the Guardian, who asks for a real alternative to Osborne, which SEB has provided in relation to the Fiscal Responsibility Act. But an important misunderstanding should be clarified. That article argues that advocacy of a balanced current budget over the business cycle would be to 'emulate Ed Balls and austerity lite.' That is incorrect. It would only be the case if the level of government investment were maintained at current miserably low levels. Instead what is proposed here is a transformational increase in public investment, sufficient to foster a sustained recovery led by public investment. Far from this being ‘austerity lite’ it makes state driven investment a key to economic policy – entirely unlike the policy of Ed Balls.
The piece below examines this attachment to persistent government budget deficits, which have been combined with a simultaneous long-run decline in public investment.
The position on Osborne’s proposals that a Labour government should balance the budget on current expenditure over the business cycle but borrow for investment is set out in an earlier article here. It follows from the fact that the purpose of economic policy is, or should be, to optimise the growth in the sustainable living standards of the population. Increasing living standards requires growth – internationally over 80% of increases in consumption are due to economic growth. Since it is not possible to increase the fundamental productive capacity of the economy without investment, investment is the decisive factor in producing growth (in an overall framework of increasing the division/socialisation of labour). Therefore economic policy, including fiscal policy, should aim at increasing investment and gradually enhancing the proportion of output devoted to investment. This is the precondition for more rapid growth – ‘growing the economy out of the crisis’ as John McDonnell and Jeremy Corbyn put it. Borrowing should primarily be confined to investment, only resorting to support consumption in specific exceptional circumstances – such as to maintain living standards of the least well off sections of the population during economic downturns. Social protection should be financed via taxation – levied in a disproportionate way on the richer sections of the population.
However, permanent or structural budget deficits have become a shibboleth for many ‘Keynesians’. This has almost nothing to do with Keynes, who himself responded to critics by arguing that the General Theory was primarily focused on the ‘regulation of the investment function’ (and barely mentioned budget deficits)*. Instead, the attachment to budget deficits is a product of the post-World War II economic consensus. In Britain this was known as Butskellism, the Tory/Labour bipartisan approach to policy which ended in spectacular economic failure by the early 1970s.
This consensus failed because it was based on a myth. The reality is that at the beginning of ‘Butskellism’ Britain and the US had experienced war-related booms. In four years of World War II the US economy doubled in real terms, and was to take another 22 years before it doubled again. In Britain the economy expanded by 55% in 10 years to 1943 and it was to take another 25 years before it increased by another 55%.
The false economic consensus was that the ‘post-WWII boom’, which some even dubbed the Golden Age of capitalism simply required expert ‘demand management’, where every sign of downturn was met with more government borrowing to finance day-to-day spending (and government-run industries were starved of investment). The true position is that this was the dwindling of the war boom, when government investment and direction of the dominant sectors of the economy had predominated. The attachment to persistent or structural budget deficits, on current expenditure and not for investment, arises from this post-WWII economic failure. The success was state-led and directed investment of the war and war preparation years.
It is a rather strange feature of the debate that many ‘Keynesians’ also regard themselves as scourges of the finance sector in general and its dominance in British society in particular. Yet as both Adam Smith and Karl Marx noted, the material power of the finance sector derives largely from its parasitic relationship to government. The interest which fattens the finance sector comes significantly in the first instance from the government, and the taxes it levies on the productive economy. As for Keynes, it is the opposite of his ‘euthanasia of the rentier’, to continually hand state assets to the finance sector. When, briefly, the Thatcher and Blair governments each had budget surpluses, there were howls of protest form the City about the ‘death of the gilts market’.
If there are deficits on current expenditure, including all the very valuable functions that can or should be performed by government, these should be met with progressive taxation. As the burden of taxation has shifted from big business and the rich to workers and the poor over time, it is clearly imperative that the former should bear the burden of increased taxation. In just one example, Thatcher inherited a Corporation Tax rate of 60% and Osborne will bequeath a rate of 18%. That trend should be reversed. To the argument that this undermines private sector investment, this has been in sharp decline even as taxes have been cut (Fig.1 below, which originally appeared on the PWC website).
Fig.1 Investment as a proportion of GDP
The British economy is participating in an investment crisis of the Western economies. It also has its own structural investment crisis, as the chart above shows. It is this twin problem that Corbynomics can address, and so raise living standards through growth led by investment – including the creation of a National Investment Bank.
There is strong opposition to this policy from capital. If the state increases its rate of investment, necessarily a greater proportion of the means of production will accumulate in state hands not those of the private sector. The entire Reagan/Thatcher era was designed to do the opposite and we are still living in that era. Attempting to accelerate the gradual run-down of the role of the state in the productive economy their programme was to attempt to remove it altogether – the policy Osborne is continuing.
But we should be clear the advocates of the ‘small state’ confine this to investment – because it means an interference in the means of production. They have had far less difficulty, and in many cases no difficulty, in increasing Government consumption as Fig.2 below shows. The Thatcherites were really primarily advocates of ‘small state investment’.
Fig.2 US Government consumption rises as Government investment falls
Osborne seems set on turning that into ‘no state investment’. But this curtailing of state investment is directly counterposed to the needs of the great majority of the population. This is why Labour, by setting out the goal of growth created by investment, including creation of an National Investment Bank, aligns its policy with that of the population. By taking the position of a balanced budget over the cycle on current expenditure but borrowing for investment John McDonnell has adopted the correct position in terms of economic theory and simultaneously, and for that reason, restores public credibility to Labour’s economic policy.
By setting out clearly that the there is an alternative to Tory policies, and that the opposite of austerity is investment, the Labour leadership team can demonstrate that its policies are superior and can deliver prosperity for the overwhelming majority.
*Keynes, Quarterly Economic Journal, OUP, February 1938.
Subscribe to:
Posts (Atom)
Posts
