Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
It is the season of “mini-budgets” with the Australian Treasurer launching the Mid-year Economic and Fiscal Outlook 2011-12 yesterday (November 29, 2011) and his British counterpart – the Chancellor of the Exchequer – releasing his Autumn Statement. At least Australia has summer coming tomorrow to look forward to. Both documents outline strategies of failed governments. I am watching the Australian Treasurer on the news screen at the airport right now as he asserts over and over again that even though they are now forecasting a rise in the unemployment rate over the next year there is “growth in the pipeline” and so aiming to achieve the largest fiscal consolidation in history (of the world) in one year is still a sensible strategy. I described the strategy on national radio last night as madness! Worse applies to the British government’s fiscal strategy. I consider that to be venal rather than misguided.
I have already written enough about the Australian government’s current fiscal approach. Please read the following blogs – Economy faltering – Australia’s wind-up Treasurer “We will cut harder” and Don’t send more workers into the mine when the canaries start dying – for more discussion on this topic.
I gave a bevy of interviews yesterday and this morning on the topic for national media.
On the national ABC current affairs program PM last night (November 29, 2011) I was quoted in the segment – Australia now fully AAA, surplus or not. Here is the snippet:
REPORTER: Many local economists, like the University of Newcastle’s professor Bill Mitchell, say the Government’s attempt to eke out a surplus is crazy.
WILLIAM MITCHELL: Well I think it demonstrates the incompetence of the Government. We’ve got a situation where the world economy’s slowing and probably major areas in the world are going to go back into recession. We’ve got the private sector in Australia spending very modestly, wanting to save, trying to bring down the debt that they ran up before the crisis began.
And under those circumstances, with employment flat for almost the whole year, you’ve got a government that’s proposing that they’re going to cut spending further. That’s just madness.
That was part of a longer interview I gave to PM. It also spawned the headline for a related story on the topic – Swan’s pursuit of surplus branded ‘madness’.
Anyway, enough said. I realise the changes announced yesterday were relatively small. But the fiscal adjustment envisaged for next financial year rely on so many forecasts (real GDP growth, private investment spending, exchange parities etc) which I do not believe will be achieved.
And, in trying to achieve a surplus when it is clear that a structural deficit is warranted (given household saving plans, external deficit), notwithstanding the expected boom in private investment.
But I will make a few comments on the Autumn Statement of the Chancellor in Britain. Clearly, I have written a lot about the failed fiscal strategy of the current British government and so will try to focus on some of the more interesting issues that arise from the latest statement. If I get into repeat mode – give me a kick and I will stop! (-: Although, to paraphrase some local comedians here – when you’ve said something too often you have barely said it enough.
The Autumn Statement has a price tag on it – £45.00 – which is about £45.00 more than it is worth.
The Chancellor’s Speech is free but still takes time to read it – time better spent!
The Chancellor began by further crafting his recent patsy:
Much of Europe now appears to be heading into a recession caused by a chronic lack of confidence in the ability of countries to deal with their debts.
The actual reason why Europe is heading back into recession is because aggregate demand is chronically and deliberately suppressed as a result of government austerity packages being imposed on flat private spending with little chance of exports filling the gap.
The chronic lack of confidence is the result of entrenched unemployment and the overhang of the credit binge that has weighed down the private sector.
The credit binge was directly the result of the sort of policies that the British government considers appropriate – more deregulation, suppressed public spending, lack of oversight of the financial sector.
The Chancellor further demonstrated that he doesn’t understand the capacities that he is responsible for:
But if the rest of Europe heads into recession, it may prove hard to avoid one here in the UK.
A well-crafted fiscal policy response can always insulate the domestic economy from external demand shocks such as will emanate through the world economy if Europe goes back into recession.
The government can always lift net public spending (via increased spending and/or tax cuts) if aggregate demand falters.
What the Chancellor should have said – reflecting the reality – is that Britain is heading for recession on its own account because the Government is deliberately damaging aggregate demand and refuses to alter its stance in any significant way to reflect the decline it now has on its hands.
Which means I don’t think the Autumn Statement does very much at all.
At one point the Chancellor said:
There is a suggestion from some that if you spend more, you will borrow less.
This is something-for-nothing economics.
No, it is actually a reflection of: (a) the immediate and short-run impact of government spending on economic activity; and (b) the eventual impact of the increased income and private sector economic activity on taxation revenue and welfare spending.
The only reliable way to drive down a budget deficit that has been pushed up by the automatic stabilisers is to reverse the stabilisers through growth.
It is also rarely useful to consider borrowing in absolute terms. That is why economists mostly focus on public debt ratios – which of-course typically fall as growth occurs.
The reaction by Keynes’ biographer – Robert Skidelsky in the UK Guardian yesterday (November 29, 2011) – Autumn statement: George Osborne’s cutting fantasy is over is also relevant here.
The article highlights the credibility aspects of a “deficit-reduction programme”.
Robert Skidelsky said:
Let’s start with the theory of the matter. “Look after unemployment,” JM Keynes said, “and the budget will look after itself.” This was a neat way of saying that a credible deficit reduction plan depends on growth. All governments have large deficits at present because their economies have shrunk. The deficits will decline automatically as their economies start growing.
But policies of deficit reduction will not in themselves produce growth. Nor will they eliminate the deficit. Trying to reduce the deficit by cutting spending and raising taxes means taking spending power out of the economy, when what a depressed economy needs is more spending. A government can always cut its own spending. But it cannot control its income. If cutting its spending leads to a fall in its revenue, it is little nearer “balancing the books” than before. One person’s spending is another’s income. If the government reduces the economy’s spending, its own income will fall.
The point that governments have the discretion to cut their own spending (if they can surmount the politics of doing that) but that they cannot control their income is what the austerity proponents fail to understand or consider.
The basic lesson of Macro 101 is in that paragraph – spending equals income. If the government cuts spending then national income falls and with it government revenue.
I was asked in a radio interview yesterday when I thought the government should be aiming to get into surplus. My reply was that the government shouldn’t target or emphasise any particular budget outcome. The focus should rather be on ensuring aggregate demand is sufficient to sustain high employment levels.
If they achieve that goal then whatever the budget outcome is would be “optimal”. They have the capacity to achieve that aim but by obsessively focusing on a particular deficit outcome (target) they almost always fail to advance public purpose.
Robert Skidelsky notes that “(t)his grisly truth is at last starting to pierce the fog of rhetoric” and is referring to the downgraded revenue estimates from the Office for Budget Responsibility and the extended horizons for bringing the British budget back into surplus:
The economy has not grown for a year and … is now likely to contract … The shrinkage in demand is becoming a collapse. Unemployment will still be rising in 2013, real wages will continue to decline and as households stop spending, company profits will suffer. The deficit will not be gone by 2015. Even to get rid of it by 2017 – the latest estimate – will require a further £23bn of cuts. But as these will reduce growth even further, the elimination of the deficit can safely be postponed to never-never land.
Neo-liberalism is eventually self-defeating and once caught in the death-spiral the failures come one after the other. For some years (15 or more) economic growth was driven by private consumption funded by credit growth rather than wages growth. This was an abnormal period and was always going to collapse.
But the neo-liberal elites milked it for what they could by both expropriating ever-increasing proportions of real income (as the wage share fell) and demanding (and getting) more deregulation which made the first task easier.
Now the “prosperity” that they told us about has been wiped out by the crisis and governments are locked into this austerity mindset there are no growth engines available and we are thus witnessing the vicious cycle of austerity driving higher unemployment and lost private income driving rising deficits which feeds back into more austerity.
The politics will eventually sort this out and force governments to make reversals in strategy. Just the fact that the Chancellor announced some spending initiatives means he knows full well that spending is needed to create growth. But a major reversal will take some time yet and in the meantime the damage will be immense.
The other major issue that the Chancellor chose to focus on was that a major aim of the Government’s fiscal strategy was to pacify the bond markets and that the strategy had been very successful as evidenced by the low interest rates and the fact that the credit rating had not been downgraded.
This is the same argument that the Australian Treasurer was using this morning to defend his own (less harsh) austerity strategy at a time when unemployment is rising and employment is barely growing.
The British Chancellor said:
… the absence of a credible deficit plan meant our country’s credit rating was on negative outlook and our market interest rates were higher than Italy’s.
Eighteen months later and we are the only major western country which has had its credit rating improve.
Italy’s interest rates are now 7.2%.
And what are ours?
They are less than 2.5%.
Yesterday, we were even borrowing money more cheaply than Germany.
Those who would put all that at risk by deliberately adding to our deficit must explain this.
It is easy to explain.
First, the UK is a sovereign nation with zero risk of insolvency in relation to debt denominated in its own currency (unless the politicans get a Republican-style brain-snap and decide not to honour their obligations).
All the EMU nations are burdened by default risk. The bond markets know that and act accordingly.
Second, if sovereign credit ratings mattered might the Chancellor please explain how Japan has maintained low interest rates for two decades despite being downgraded severely several times by the rating agencies. Why do the bond traders queue up to get hold of Japanese government debt?
Further, if ratings mattered why has the US still got low yields on government debt and bond traders gueue up to get US government debt?
Third, the Government itself can control the yields on its debt via central bank intervention. Ultimately, for a nation that issues its own currency the bond markets are passive and the government the ruler.
Please read my blog – Who is in charge? – for more discussion on this point.
Fourth, the real price that the British economy is now paying for this mis-guided thinking is huge.
Even the Autumn review notes the long-term (hysteretic) impacts of leaving the economy wallowing in a near-recession mire are acknowledged by the British government. We read (point 1.23):
Compared with its previous forecasts, the OBR has substantially revised down its estimate of the level of potential output.
The forecasters are playing catch-up again – to support the dominant ideology they always over-estimate growth when there is cutting going on and then are dragged into admitting that things have become worse. Surprise surprise.
Robert Skidelsky provides some commentary on the “bond market-confidence” issue:
The chancellor has repeatedly claimed the deficit reduction programme was, and is, necessary to maintain investor confidence in government finances. Confidence is very important, but also mysterious: the bond markets can believe a dozen contradictory things before breakfast. The main point is that confidence cannot be separated from the economy’s performance. As it stalls, the creditworthiness of governments declines as their debt increases, raising the likelihood of default.
Confidence is more important when it is located in the real sector – among consumers and producers. I don’t think the bond markets matter much for a sovereign government which can always exert the upper hand.
But Robert Skidelky’s point about poor economic performance leading to rising deficits and debt – and “raising the likelihood of default” is unhelpful – and analytically wrong.
As noted above the British government can always service its liabilities as long as they are denominated in the currency that it issues. It can never go broke in that sense.
It doesn’t matter how large the deficit is or how much public debt is outstanding. Does Robert Skidelsky believe that Japan is closer to default now than it was in 1990? It is clearly not yet is carrying the largest public debt ratios in the world and has large (relative) on-going deficits – easily matched with new debt issues.
Robert Skidelsky compounds that error in my view with the follow-up:
The chancellor is right to say that Britain is not at the “centre of the sovereign debt storm”. But for how much longer? The eurozone financial crisis – on both its sovereign and commercial bank sides – is the direct result of policies which have brought about the slowdown of the European economies. From August to September industrial production turned sharply downwards in the EU, and especially the eurozone. But our government has been pursuing the same policies, with the same results. This suggests that, without a change of policy, the price of our own government debt will start to go up.
The Euro crisis is a lack of growth combined with governments which use a foreign currency and a private sector that was allowed to build up excessive debt levels.
The policy response should have been to ensure governments could run whatever deficits were necessary to restore private saving ratios (to resolve the balance sheet issues) via growth. Given the flawed design of the system that would have required a major funding role to be played by the ECB.
The British situation is nothing like that. As noted the Bank of England can always control the yields on government debt – growth or no growth.
The left’s reaction, as represented by – Autumn Statement 2011: the Fabian reaction – also made commentary on the bond market issue.
I agree that the British Chancellor has exploited the “Eurozone debt crisis” to divert attention away from his own culpability.
The British government has used the assertion that “irrational bond markets” may turn on the UK at any time if it doesn’t pursue fiscal austerity. The Australian government has also used the “bond market bogey person”.
But then the Fabians claimed that of all the reasons that the British government was proffering to support its austerity that:
… the prospect of irrational bond markets turning on the UK offers the only possible justification for the fiscal stance … That is the thin veneer masking the truth of this Autumn Statement.
The prospect of irrational bond markets is one of the lamest justifications for austerity. For the left to buy this line of reasoning is equivalent to surrendering all the ground that is necessary to combat this nonsense.
As to the Opposition’s response, I agree with much of the Opposition treasury spokesman Ed Balls’ – official response to the Autumn statement which he presented to Parliament.
It was all about Plan A failing (clearly it has), that the growth forecasts keep getting downgraded (which they do),that the plans to reduce public deficits (and borrowing) by cutting have only delivered higher borrowing (which has occurred), and that unemployment is rising when it was meant to be falling (which it has).
It is without doubt that Plan A has failed categorically and that failure has been exacerbated but not caused by the further deepening of the Euro crisis.
But what of Plan X – the Opposition’s insights into what to do. At that point one loses confidence almost immediately. You know that the debate between the major British political parties is really one of degree not substance.
The Labour Party would also be cutting discretionary net spending now if they were in power. They would say they would be taking a more balanced and careful approach but the same ends would be achieved or not as the case may be.
Ed Balls did not come out at any point in his speech and declare that they would significantly expand the budget deficit to ensure that demand drove growth in incomes and employment.
Like the Chancellor, he has some notion that growth will come with public cutbacks.
To put a finer point on this, during his speech Ed Balls said:
And he still clings to the illiterate fantasy that low long-term interest rates in Britain are a sign of enhanced credibility and not, as they were in Japan in the 1990s or in America today, a sign of stagnant growth in our economy.
Which means he buys the idea that bond markets will demand higher long-term interest rates if there was strong growth.
Low long-term rates exist because the central bank decides to pursue a policy consistent with that. It might be that in a period of strong growth, the central bank pushes up short-term rates and allows the long-end of the yield curve to adjust accordingly to maintain aggregate demand within non-inflationary boundaries.
But that story is quite different to the one that the Chancellor (and Ed Balls) believe in.
You realise that the Chancellor is not fully on top of things when you consider some of the initiatives to increase the supply of credit.
The Autumn Statement contains several measures including the Chancellor authorising “an increase in the ceiling on … [the Bank of England’s] … asset purchases to £275 billion” (who said the central bank was independent?), extra business funding via the ” Enterprise Finance Guarantee scheme”, a “National Loan Guarantee Scheme” and other initiatives.
In relation to the extra “quantitative easing” that:
This will support demand across the economy …
How will it do that? Interest rates are already very low and have been for some years now.
The reality is that there is a demand for credit problem – firms do not want to borrow because consumers don’t want to spend because they have too much debt already and unemployment is rising and threatening their existing income earning potential.
There is no real evidence that banks are withholding loans to credit-worthy customers in the UK.
Robert Skidelsky comments on this point:
What the chancellor is trying to do is to increase the supply of credit. But the austerity side of his policy is choking off the demand for credit by reducing the market. The new policy is therefore incoherent.
I agree with that point.
My final observation relates to the notion of waste. I regularly hear commmentators argue that if the government is cutting what they call “waste” then fiscal consolidation is a good thing. Often “waste” is equated with public sector jobs. There is this view out there that public servants do not do much compared to their private sector counterparts.
The same people, presumably are among those who complain the loudest when the queues through customs at airports get longer when cuts to public sector staff leave the ranks depleted.
The same people bang on about law and order breakdown when the police fail to respond to all the calls for help because they have lost staff due to cuts.
Ambulances late, schools that are overcrowded, hospital waiting lists, poor road services, bridge bottlenecks, and the list goes on.
There is an amazing capacity to disassociate the benefits we enjoy every day because of the hard work of public servants and the public infrastructure they manage from the narratives we support in the public debate – such as – public servants do not do much.
Equally, I have seen many private sector workers “sitting on their shovels” just as I have seen public sector workers “doing crosswords”. There is nothing intrinsic about the sector in this regard.
The point is that I am against waste if it can be defined free of prejudice and ideological biases. No one wants water to run down the drain unused and wasted. So I support efforts to streamline operations wherever possible and to utilise real resources to their potential.
But we still have to address the macroeconomic imperative. A pay cheque to a public servant who “does nothing” is still a pay cheque that is spent into the economy on goods and services which supports income and jobs elsewhere.
We might not notice the loss of function if the specific job is eliminated but we will see the loss of demand manifesting elsewhere in the economy.
Thus, we have to separate out the issues. Eliminate waste by all means but make sure any aggregate demand implications are considered and addressed.
The upshot is that if the government cuts public sector employment in search of “efficiency” (and I caution against equating public service with inefficiency) then it has to spend more elsewhere to preserve the aggregate demand that would otherwise be lost.
If the government fails to that they will be creating the greatest inefficiency of them all – unemployment.
Neither response – the Autumn or Spring responses of the British and Australian governments, respectively – meets the challenge they are facing. Australia is in better shape because of our relationship to China and the likely investment that will occur over the next several years.
Whether that is enough to drive growth sufficiently to bring down labour underutilisation from its heights (12.5 per cent) remains to be seen. But it is a better bet than what is facing the British economy at present.
The Autumn Statement begrudgingly makes some concessions to spending – and does offer some national infrastructure support. But overall the accompanying documents from the British Treasury tell us that things are going very wrong in that country.
Plan A has failed spectacularly and the Autumn response should have been a major reversal. Unfortunately, the response of the Opposition and the Left has been pretty wan.
At least Spring gives way to Summer tomorrow and today is 32 degrees Celsius. The Brits are facing a long and cold winter.
That is enough for today!