A “Budget Responsibility Lock” – a ridiculous proposal

The US Koch brothers provide substantial funds to the George Mason University to ensure it remains a bastion of so-called libertarian, free-market thinking. The brothers don’t really want a free market but it just serves their political and commercial aims to tell everyone that is what it is all about. The Economics Department at this university pumps out propaganda about the virtues of deregulation. One academic (Bryan Caplan) goes further and claims that democracy is a bad idea when compared to taking the advice of economists who advocate free markets. This idea that somehow policy choices conditioned by what would advance the best interests of the public are inferior to those advocated by economists who know what is best for all of us has permeated the debate over the last few decades and led to some very undesirable developments. This was on my mind when I was reading the Manifesto of the British Labour Party which proposes, wait for it – a “Budget Responsibility Lock” – as a framework for fulfilling its responsibilities to the British public. This is a ridiculous proposal.

I thought of Caplan again today, when I read Gregory Mankiw’s latest atrocity in the New York Times (April 24, 2015) – Economists Actually Agree on This: The Wisdom of Free Trade – which was highly misleading, given that the title is about “Free Trade” yet the article is in support of the proposed Trans-Pacific Partnership (TPP) among other things.

It is impossible to say anything about the TPP and we are certainly not able to conclude it is the exemplar of ‘Free Trade’ because it is shrouded in secrecy and our democratically-elected governments are behaving as if they are North Korea, their so-called pariah state.

I will write more about the TPP when I know more. At first blush, it appears to be anti-freedom which will put power in the hands of a small, unelected cartel of elite lawyers and similar and allow this group to punish states who follow the will of their voters to preserve local well-being.

If the stories about it are true then we should fight against our governments signing such a deal which will end democracy as we know it.

Mankiw’s insidious offering was to praise economists for having the wisdom to know about the benefits of such agreements and vilify anyone who dares to question the process.

This is even though “Mankiw … has no way of knowing whether TPP is a free trade agreement” (as William Black pointed out in his retort (April, 26, 2015) – Mankiw Mendacity and Morality and his League of Failed Economists).

But Mankiw’s reference to Caplan went like this:

If economists are so sure about the benefits of free trade, why are the public and their elected representatives often skeptical? One answer comes from a 2007 book by Bryan Caplan, a George Mason University professor, called “The Myth of the Rational Voter: Why Democracies Choose Bad Policies.”

Mr. Caplan argues that voters are worse than ignorant about the principles of good policy. Ignorance would be random and might average out in a large population. Instead of being merely ignorant, voters hold on to mistaken beliefs.

It is a rather extraordinary proposition that economists are the knowledgeable sages and the rest of the population are not only ignorant but, as a collective, are likely to believe things that are wrong.

The last part of the proposition – that “voters hold on to mistaken beliefs” might be true – but it is also true that they get these ideas from the deviousness of economists who hold out their predictions and analysis as if it is scientific knowledge, when in fact it is ideological blather with little basis in reality.

It is the constant nonsense flowing from mainstream economists that influence politicians. PhD graduates from mainstream schools fill up treasury departments and central banks and pompously claim to know the truth.

If you have read Caplan’s book you will understand that these free-market zealots have a basic, inbred hatred for democratic choice and believe it interferes with the purity of the market and its ‘value free’ determinations.

It is a particularly odd argument when you think about it. The idea is that voters basically misunderstand economics and so pressure politicians to make poor decisions about matters relating to employment, immigration, growth, welfare etc.

But if we are so riddled with these misunderstandings how could we be trusted to ‘vote’ in the free market properly, when the optimality of that institution-free arrangement requires us to be rational decision-makers with perfect (or rational) foresight?

Caplan fudged the answer to that question by arguing that mostly we are rational – when it hurts us in dollars not to be. But apparently we are dichotomised individuals who jump from cool-headed rational decision-making when buying milk to irrational and fanciful ideas when supporting political decisions.

And our politicians who are advised by economists who know what is the best policy for the nation are constrained by what the irrational and ignorant public will accept. The political system then becomes caught up in an impasse where the politicians have to choose between poor economic policies (to retain the support of the ignorant public) and sound policies (which they know will be best for the economy).

It is an extraordinary thesis. These politicians are apparently innocents. They are not in the pay of the lobby groups and they don’t condition the public opinion, they just respond to it as best they can.

It also assumes that mainstream economists know best, a proposition that surely cannot be sound given the systematic errors that economists make when predicting outcomes of their policy advice. The IMF, for example, has an appalling record and admitted in October 2012 that the ‘modelling’ it provided as part of its role in the Troika, which conditioned the Greek bailout strategy (if you can call it a strategy) was completely wrong.

Analysis would suggest that politicians take advice from the conservative economists and then seek to construct narratives that convince the public that a particular course of action is in their best interests, when it it clear that the advice given is wrong and the action pursued detrimental to public interest.

Where does the public get the idea that fiscal deficits are bad from? It is not intuitive. If you have a conversation with a child and explain things clearly they instinctively can grasp the principles of Modern Monetary Theory (MMT).

Unburdened by all the ideological conditioning that the economists introduce into the public policy space, they know that if a factory can sell something it will employ people to make the product. They know that people have to spend for there to be sales. They know in a two-person economy if the private person does not want to spend, then the public person (government) has to spend or else there would be no sales.

They know that if the government issues the currency and the public use it then the former can spend as much as they like and the latter has to get the currency from the government somehow.

They know that if there are no further real goods available to buy then the government is reaches a limit on their effective spending capacity but up to that point it can buy what it likes simply by spending the currency it issues.

All this weird stuff that fills up economic textbooks about governments running out of money, and having to issue debts to get some more money and/or taking it from the private sector via taxation, and the rest of the fiscal myths that pervade the public debate are lost on someone not burdened by the years of conservative conditioning.

But the claim that democracy (public opinion) undermines sound economic policy has spawned a range of anti-democratic developments over several years in policy making.

The so-called independence of central banks is part of the mantra. Please read my blog – The sham of central bank independence – for more discussion on this point.

The creation of independence fiscal monitoring authorities (for example, Congressional Budget Office (CBO) in the US, the Office of Budget Responsibility (OBR) in the UK and the Parliamentary Budget Office (PBO) in Australia), which attempt to shift the responsibility of fiscal policy away from where it can be held accountable at elections to organisations that are replete with mainstream economists who have no responsibility to uphold public interest.

The fiscal rules implemented in the Eurozone that have ground down prosperity over the last seven years are examples of this trend.

The aim is to eliminate discretion. One of the earlier Monetarist arguments propagated by Milton Friedman was that governments should be bound by rules and not be allowed to exercise policy discretion. He claimed that policy makers were likely to be incompetent and were operating in an uncertain environment so that their discretion would mostly lead to bad outcomes.

The so-called superiority of rigid rules have left its imprint on the way politicians now behave and the way they condition the public.

As an aside, imagine if the central banks around the world had have been constrained by Friedman-type rules about balance sheet expansion in the early days of the GFC, when there was a real possibility that the world’s financial system would collapse.

The discretion used by policy makers in the US (and Australia) saved those economies from a much worse fate than was already experienced.

I was thinking about all this when I read the British Labour Party’s absurd proposition outlined in their – Economic Manifesto – the so-called self-imposed “Budget Responsibility Lock” – which is designed to present it as a party of fiscal prudence.

Its first economic statement is that it will “reduce the deficit” and “balance the books without extreme spending cuts”.

The “Budget Responsibility Lock” has three components:

We will cut the deficit every year with a surplus on the current budget and get the national debt falling as soon as possible in the next Parliament.

We will make fair and sensible spending decisions, including capping social security spending so that it is properly controlled, stopping the payment of the winter fuel allowance to the wealthiest five per cent of pensioners and capping child benefit rises for the next two years.

There is not a single policy in this manifesto that is funded by additional borrowing. There are tough decisions to be taken and we haven’t made any commitments that we can’t keep.

This apparently will “build a strong economic foundation”

The UK Guardian article (April 13, 2015) – Ed Miliband rebrands Labour as party of fiscal responsibility – reported that the Labour leader said that the “Lock”:

… does something different: its very first page sets out a vow to protect our nation’s finances; a clear commitment that every policy in this manifesto is paid for without a single penny of extra borrowing.

Those who have a grasp of MMT will know that there is no such things as protecting a nation’s finances when referring to the public fiscal policy operations. What is there to protect?

Households have to safeguard their finances to ensure they don’t overcommit relative to income sources and end up bankrupt.

But the British government can never become bankrupt.

And how is running a declining deficit each year and the guarantee of a surplus within 5 years sensible policy?

I have searched for Labour Party projections of current account balances and private domestic balances over the next five years to no avail.

None are published alongside their fiscal balance pledges. But we know that the external sector is in deficit as the much-lauded export growth strategy adopted by the current Conservative government is in tatters.

So there is income being drained from the British economy by the external sector via the deficits.

We also know that the household sector is heavily indebted and doesn’t have much scope to go further into the red.

We also know that economic growth is lagging in the UK, real wages are flat and the employment situation is being flattered by the rapid growth in self-employed – that is, the labour market is weak and productivity is low.

I take those facts together and conclude that at least in the foreseeable future, the British government deficit has to rise not fall.

Any idea that a fiscal surplus would be a sensible target to aim for given the reality is crazy.

The “Lock” looks to be like one of those gimmicks that represent fiscal irresponsibility.

Please read the following introductory suite of blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3 – to learn how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.

Further, note that the British Opposition ties deficits together with public debt, thus perpetuating the myth that the currency-issuing government is financially constrained. It clearly isn’t and it is time that politicians started to break out of those self-imposed constraints which only serve to limit the scope of fiscal policy to achieve its aims.

The public debate about fiscal policy has become so far removed from the reality of the underlying economics that it is little wonder that these politicians think these propositions are a good thing.

The British cybernetics expert Anthony Stafford Beer – introduced the term – POSIWID (the purpose of a system is what it does) – into the public sphere and it has relevance for this discussion.

What is the purpose of the economy? To answer we need to ask: What does it do? The economy is not there to deliver fiscal surpluses to the government.

The economy is where goods and services are produced, incomes are generated and people find jobs. The role of government therefore is to make those things happen not to undermine them.

Government policy makers should be firmly focused on maximising the potential of its population. The sustainable goal should be the zero waste of people! This at least requires the state to maximise employment – which means provide work for all those who desire work at the current wages.

It should not mean anything less than that. Policy should always be consistent with that goal.

Remember always that the Economy is Us

People created the economy. There is nothing natural about it. Mainstream economists think there are ‘natural tendencies’ to equilibrium where satisfaction is maximised and governments only serve to undermine that state.

But when we use terms like natural we have to ask – natural in relation to what? The mainstream define the problem away rather than address the ideological benchmark that the term ‘natural’ disguises.

The reality is that human interaction and choices, initially simple and localised, and later, significantly more complex and spatially distributed (globalised), creates what we call the economy. We are in charge here.

At some point, we realised that we needed an agent to do things that we could not do ourselves – either easily or at all. We formed governments. We also came to understand that our creation – the economy – would only serve our common purposes if it was subject to oversight and control by our agent.

We had operated under the mistaken view propagated by economists that this agency role was unnecessary because our spontaneous interactions would sort things out in our favour. This is Mankiw’s world – or so he would have us believe.

It didn’t happen and when the consequences of this failure became so obvious – during the Great Depression – we accepted the agency role as being fundamental to ensuring that the capitalist monetary system behaved itself.

We learned then that capitalism which had developed into a broad system of wage labour was subject to basic tensions between labour and capital. We also learned that the so-called “market” signals (prices that brought demand and supply together) would not deliver employment outcomes that satisfied the desires of labour for work.

We learned that this system could easily equilibrate (a state where there was no further dynamic for change) in a state of mass unemployment. The Great Depression taught us that our agent (the government) could ensure that the system did not get stuck in this state because it had the spending capacity to ensure that total spending in the economy generated enough output that would fully employ all those who wanted work.

The simple understanding of that period was that the economy was a construct we could control in order to create desirable collective outcomes such as improved living standards – better housing for all, improved public education and health standards etc. All outcomes that required real resources to be brokered by the public sector in cooperation with the private firms and workers.

While there was a strong conservative element that resisted the Post-World War 2 consensus, the government mediated the class conflict to ensure the system did deliver social as well as private returns. We understood that if employment fell it was because there wasn’t sufficient demand and because the economy was us, we knew what to do about it – spend more. The question was how would this be accomplished.

Economists certainly understood that private spending could become stuck – while the unemployed certainly had a demand for goods and services, they only sent a notional signal to the firms of that desire. The private market only works on effective demand and supply signals – that is, demand intentions backed by cash and the unemployed didn’t have any cash because they had lost their job and employment provides income which funds spending.

While the way the macroeconomists spoke of such things was reserved for the academy (full of jargon etc), the concepts were also broadly understood by the public and we knew that a government fiscal deficit was required to ensure that total spending was sufficient (for full employment) when the rest of us (the non-government sector) were not recycling all our current income back into the spending stream (that is, saving).

Once the private sector has made its spending based on its expectations of the future, the government has to render those private decisions consistent with the objective of full employment or else there will be national income losses and social dislocation.

Non-government spending gaps – defined as insufficient spending relative to what is required to sustain output at full employment levels – over the course of the cycle can only be filled by the government.

The national government always has a choice:

• Maintain full employment by ensuring there is no spending gap – that is run budget deficits commensurate with non-government surpluses; OR
• Maintain some slack in the economy (persistent unemployment and underemployment) which means that the government deficit will be somewhat smaller and perhaps even, for a time, a budget surplus will be possible.

So when a political party prioritises a particular fiscal balance target independent of the real purpose of the economy and its role as our agent not our confessor, then you know that POSIWID is being violated.

Further, it is here that I always make the distinction between a ‘bad’ versus a ‘good’ deficit and the distinction rests on understanding the automatic stabilisers.

The automatic stabilisers attenuate private spending gaps because falling national income ensures that fiscal deficits rise (as tax revenue falls and welfare spending rises) to support (to some extent) overall spending.

But in a period of spending decline, the resulting deficits will be driven by a declining economy and rising unemployment. These deficits are ‘bad’ because they are not the result of discretionary choices of our agent to advance our welfare.

They symbolise that our welfare is in decline. The decline is not due to the rising deficit. But the rising deficit reflects that decline.

Fiscal sustainability is about running ‘good’ deficits to achieve full employment if the circumstances require that. You cannot define fiscal sustainability independently of the real economy and what the other sectors are doing.

The automatic stabilisers make a mockery of rule-driven budget targets. Once we focus on financial ratios – deficit to GDP ratios – public debt ratios – we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end). That is why fiscal rules as stand-alone goals are meaningless or ideological.

Any financial target for budget deficits or the public debt to GDP ratio can never represent sensible policy conduct. The actual fiscal outcome is largely endogenous anyway (beyond the control of government) because it is driven by private spending decisions.

It is highly unlikely that a government could actually hit some previously determined target if it wasn’t consistent with the public purpose aims to create full capacity utilisation.

As George Osborne discovered when he went hell-for-leather with austerity in the first year or two of the Conservative government – the deficit rose as real growth plummetted.

In discussions of austerity there are often incompatible goals specified by proponents. The classic is their claim that austerity will allow both the private and public sector to reduce debt, when there is an external deficit. That is an impossible troika.

A national government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.

The real question is what are the limits on government spending? While a sovereign government is not financially constrained it is nonetheless constrained in real terms. It can only buy what is available for sale. Unemployment is a sign that at least one resource is available for sale.

It is true that there is some uncertainty in designing and introducing fiscal interventions. Please read this blog – The inexact science of calibrating fiscal policy – for more discussion.

Automatic stabilisers have the desirable characteristic of providing immediate, counter-cyclical spending injections (or withdrawals) when private activity fluctuates. They avoid the so-called policy lags which relate to the time delays in the government identifying that a significant shift in private demand has occurred, designing a policy response to that shift, providing appropriate legislation to support an intervention, and then executing the intervention.

In some cases, the time delays can result in the major part of the policy intervention arriving too late and working to destabilise the cycle. For example, if by the time the government has designed and implemented a new discretionary spending injection, the private sector has already resumed trend spending growth, then the impulse of government spending might lead to the economy overheating.

There is some sense in building public purpose goals into the automatic stabilisers so that as they go to work in a cyclical fashion the outcomes will be desirable and avoid the uncertainty of discretionary interventions (timing lags, etc).

This builds on yesterday’s blog – The Job Guarantee would enhance the private sector.

MMT shows that an unconditional, demand-driven employment guarantee, run as an automatic stabiliser, is the most superior buffer stock approach to price stability. Conditional (supply-driven) approaches not only undermine the job creating potential but also reduce the capacity of the scheme to act as a nominal anchor.

The Job Guarantee functions as an automatic stabiliser rather than as a discretionary program. It builds further endogeneity into the fiscal balance but we know that public purpose is being served when the fiscal deficit rises in this case.

When the economy turns down, the Job Guarantee pool of workers will rise as displaced workers elect to take the guarantee.

When the economy starts to improve again, the private sector merely has to offer a wage (or conditions) better than the Job Guarantee wage and the Job Guarantee pool will largely decline again.

The discretion by governments is thus reduced. A pool of projects would be agreed upon with local communities and the expansion or contraction of the scheme would be automatic. There would be no big bailouts of banks or business firms. The financial markets would be largely dealt out of the game.

The Job Guarantee is not a universal panacea. It is a safety net employment capacity that provides a nominal anchor for the macroeconomy via the fact that the government would never be competing for resources with the private sector.

The private sector can bid the workers away any time they want to pay above the minimum wage (and provide reasonable working conditions). If there are inflation pressures, tighter policy settings would redistribute workers from the inflating private sector into the fixed price Job Guarantee pool and stabilise prices. That is how buffer stocks work.

The value of this approach is that the government knows exactly how much stimulus is required to achieve this ‘loose’ full employment on a daily basis.

The tap turns off when the last worker walks in the door on any day looking for a job. This provides daily feedback to the fiscal system and overcomes the uncertainty of timing and guessing the size of the stimulus.

The fiscal deficit is calibrated to the last dollar as a minimum starting point.

Once the economy is at full employment – in this sense – the government can then design other stimulus measures that it deems to be politically sustainable (and which hopefully add social value) to create employment and activity elsewhere.

But it always knows that if the nominal demand levels come up against the real capacity of the economy then employment will just be redistributed if policy tightening is required rather than unemployment being created.

Conclusion

The challenge is always to make our governments work for us rather than the elites. MMT is not naive to the capture of our governments by the latter. But what we do about it is in the political domain – the class struggle etc.

MMT does provide a full employment and price stability framework which helps reduce the change of this capture.

Concepts like a “Budget Responsibility Lock” only undermine government capacity to fulfill its legitimate role. I would not vote for a political party that proposed such a ridiculous concept.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.