Sometimes everything comes together in unintended ways. That has happened to me this week. I…
Here is some twisted logic if you ever saw it. Sydney Morning Herald main economics writer Ross Gittins wrote yesterday that the Opposition leader’s scaremongering about the build-up of debt is a faux concern and amounts to hysteria. So he sets about soothing us with some explanation. But it is the explanation that leaves out some of the more important insights which if known would alter the way the reader understood the article and the issue being discussed.
Once again it is an example of a senior economics writer in the dominant media misusing that position to perpetuate misleading economics analysis in the name of informed comment.
The article begins with the claim that the Opposition leader is:
… exaggerating the size of the debt, misrepresenting the cause of the debt, exaggerating the difficulty we’ll have repaying it, misrepresenting its effect on our prospects and pretending we’ll end up with little to show for it.
He makes two obvious points that the conservatives are lying about how much debt there is currently using the worst case scenario at June 2014 as if it is now and that they deliberately use gross debt when talking about the current situation but net debt when they talk about the time they were in government. Total dishonesty. I agree.
He “explains” how around 50 per cent of the debt is not due to discretionary government decisions but rather reflects the automatic stabilisers. Okay, that means that when the cycle rises the debt will disappear as automatically as it appeared. Fine.
He then proceeds to address the children will have “to repay the mountain of debt incurred by this Government” hysteria and concludes that:
This is alarmist nonsense. It’s true that when you borrow money you have to pay interest on the debt until it is repaid. It is true, too, that the interest on the debt will be paid from our taxes. But it is not “punitive”, it happens with all borrowing, whether by businesses, households or governments.
Well it is alarmist. We can all agree on that. But then we see how misguided this article becomes. First, the interest on the debt will not be paid from taxes. That assumes without argument that taxes fund government spending which reflects a fundamental misunderstanding of how a fiat monetary system operates. It is “gold standard” reasoning.
Second, the household/private business analogy is also flawed at the most elemental level. A sovereign government, which issues the currency as a monopoly and is never revenue-constrained bears no similarity to a household, which is the user of the currency and is always revenue-constrained. Propagating this neo-classical logic merely perpetuates the confusion that burdens the public debate and allows the government to avoid delivering on its responsibilities to maintain full employment.
To see how misleading the “informed commentary” is here is his conclusion:
Do you believe that someone with a credit-card debt or car loan can’t enjoy a rising standard of living over time? That a family with a mortgage can’t prosper until the mortgage is paid off? Of course you don’t. Whether people become better off over time is a function of the pay rises and promotions they get, not whether or not they have to use part of their income to service their debts. Similarly, the notion that real GDP per person can’t rise if the Federal Government has a bit of debt is absurd. Economic growth comes from improved productivity, more machines and more workers, not from the absence of public debt.
First, whether people are better off over time depends on their real command over resources and pay rises do not necessarily deliver that if they are only nominal movements in line with the price level. As Gittins himself acknowledges in the next sentence.
However, this goes to the heart of the intergenerational issue. The only lagacy we leave the future generation is the real possibilities and opportunities that we provide to them. Scorching the natural environment will leave a burden – perhaps a fatal one. So pursuing green behaviour should be a priority.
Running down our education and health systems and forcing people to endure spells of unemployment are also ways of creating burdens on the future generation. So using budget deficits now to make sure our public health and education systems are first class and there is high equity participation in both is a fundamental way in which our governments can act on our behalf to make sure the next generation is better off.
Further, keeping everybody employed earning and accumulating is also a fundamental way to enhance the welfare of the next generation and beyond.
The level of public debt is irrelevant to these realities.
Second, once again the family analogy is totally inapplicable. A household uses debt to bring forward consumption but does so by sacrificing future consumption. That is the nature of a revenue-constrained decision. The fact that household income might rise over time providing more space for the households to service the impositions on their income does not alter that reality.
Further, for a household, if their income falls (perhaps due to unemployment) then their nominal commitments become jeopardised and insolvency beckons. Again a basis fact arising from being revenue-constrained. So while private debt can help us intertemporally re-arrange consumption possibilities it also carries risks and the basis of the financial crisis that is now a real crisis reflects this reality.
But this analysis does not apply to a sovereign government. Its capacity to spend in the future is not reduced if it holds debt no matter if the economy is growing or in decline. It can never be insolvent even if its tax revenue declines signficantly. Its balance sheet can never become precarious in the same way that a household balance sheet can.
It is very important to understand these differences. This raises the more fundamental point – the point of the blog indeed. If you were intent on educating the public by way of informed commentary then why would you accept the basic myth that pervades the entire analysis? That is, why not expose the reality that the debt is a voluntary act of a government that does not need to raise revenue.
Why not discuss how we got to the point that the government feels compelled to go through the hoopla of issuing debt $-for-$ into the private markets using an auction system that allows the private market to determine the yields? In other words, enter the ideological discussion that exposes the neo-liberal myths.
Why not discuss that lying at the basis of this behaviour is the quantity theory of money which says that any net public spending will be inflationary? Why not educate the public to the fact that this theory was discredited fundamentally in the 1930s? Why not educate the public and tell them that an essential part of this theory is the loanable funds doctrine which was similarly discredited in the 1930s? This theory fails to understand that income adjustments determine the available saving not interest rate movements.
Why not more fundamentally explain to the public that the funds that the government borrows when it issues debt are sourced from its own past spending in the first place? What would the public think if it knew that the government just borrows its own spending back so that the private sector can earn a return on their accumulated financial assets?
The point is that this knowledge completely alters the way we think about public debt. But by failing to use the high profile column space to educate and instead use it to perpetuate basic myths – the commentary becomes part of the problem.
Which brings me to the other article I took notice of this weekend in the press. In a Financial Times article published on August 5, 2009 entitled How to rebuild a shamed subject, Robert Skidelsky who wrote the biography of Keynes, questions the responses made by economists at the British Academy to the Queen about the state of economics.
Recall that the Queen had asked why the profession had not seen the economic crisis coming and they replied that there was a failure of all the bright minds to pool their collective imaginations. See my blog Economists might usefully desist for more on that issue.
Skidelsky says that:
… it is natural that the failure of the economics profession – with a few exceptions – to foresee the coming collapse should have discredited its scientific pretensions. Economics is revealed to have no more clothes than other social science.
The main argument that Skidelsky makes is that economics is not a predictive science but is much more like the other social sciences – subject to the uncertainties that defy prediction. The neo-liberal approach to economics assumes otherwise (rational expectations, perfect foresight, probabilistic risk etc).
Of this, Skidelsky says:
An important implication of this view is that shares are always correctly priced. This is the basis of the so-called efficient market hypothesis that has dominated financial economics. It led bankers into blind faith in their mathematical forecasting models. It led governments and regulators to discount the possibility that financial markets could implode. It led to what Alan Greenspan called (after he had stepped down as chairman of the US Federal Reserve) “the underpricing of risk worldwide”.
It has also led to the discrediting of mainstream macroeconomics. The efficient market hypothesis is simply an application of the recently triumphant New Classical school, which preaches that a decentralised market system is always at full employment. In their obsession with getting government out of economic life, Chicago economists claimed that any consistent set of policies will be learnt and anticipated by a population, and will therefore be ineffective. Since people – apparently including the 10 per cent or so unemployed – are already in their preferred position because of their correct anticipations and instantaneous adjustment to change, “stimulus” policies are bound to fail and even make things worse. Recessions, in this view, are “optimal”.
This is the standard macroeconomics text book view that I criticised in the related blog – Economists might usefully desist.
Skidelsky, however, wants a return to the economics of John Maynard Keynes, who he rightly says “exploded these fallacies 70 years ago.” It was the work of Keynes and others such as Kalecki who exploded the errors of reasoning in the quantity theory and the loanable funds doctrine and allowed us to understand how income is determined by aggregate demand. As an aside, it is debatable who is the dominant intellect in this era but it was Keynes who gets the plaudits largely because the publishing industry did not choose to give Kalecki (a Polish Marxist) much scope.
It is clear that a movement away from neo-liberal macroeconomics requires economists to recognise that their arrogant belief in their own infallibility is deeply flawed. There has to be a recognition that (as Skidelsky says):
It is only by imagining a mechanical world of interacting robots that economics has gained its status as a hard, predictive science. But how much do its mechanical constructions, with their roots in Newtonian physics, tell us about the springs of human behaviour?
This will require the profession come to terms with the other social sciences and this has to begin in the university system. I am in agreement with Skidelsky about this. We should abandon the gold standard macroeconomics (which included Keynes’ General Theory by the way!) and consign it to a course in History of Thought. For that is what it is.
Common with most progressive economists (so-called heterodox economists), Skidelsky would have us return to Keynes as the basis for our understanding of the way macroeconomics works. But that would be a fundamental mistake and embed the student in a world of classical labour market thinking (Chapter 2 of the General Theory) and closed economy gold standard economics (if there was ever such a confused universe!).
What is required first of all is that students come to terms with the basics of modern monetary theory which allows them to understand how the system actually operates and what opportunities this provides to government. Randy Wray and I are currently working on a textbook that will provide students with an accessible entry into modern monetary theory. It is due in 2010 and will likely be published by Edward Elgar (UK).
Then interaction with other social sciences will allow ideological considerations to play out more fully.
This would stop columnists like Ross Gittins perpetuating the myths that appear weekly in his columns and are considered to be reliable commentary by even reasonable (but ill-informed) people.