Filed Under (Economics) by Paul on 06-07-2012
I promised a series of Friday blogs about the nature of the current economic crisis and the policies related to it. Last week I hope I explained how the problems the government has with its policy of containing public expenditure impacts the NHS. Despite the government having a policy of cutting public expenditure, it became clear last Tuesday week that it had actually risen over the year by nearly 8%. I think that figure may have had a direct impact upon the NHS’ first entrant into the ‘failure regime’.
Today I want to explore Keynesianism a bit. Whilst Keynes believed it was important to give the public money to spend in a recession the problem now may be that even that might not help a public that is really frightened about the future.
In late May we had one of those great Newsnight moments which demonstrated that in economics – as in so many other areas of life – the fact that views are opposing doesn’t mean that they don’t meet in any way at all. Economics, like a lot of arguments, is very often a dialogue of the deaf where one world view is so different from another that they don’t meet.
The Nobel Prize winner for Economics Paul Krugman was in town to promote his analysis for ending the depression. He is not a standard academic who argues the finer points in academic language but a tough cookie who loves a robust argument. He believes that we won’t get out of the depression until people start buying things – and people won’t buy things unless they have some money with which to buy them. This is one economic orthodoxy – Keynesianism.
This is obviously at odds with one of the main alternatives. The Coalition Government and Angela Merkel see that the problem is public sector debt and that until that debt is reduced the resources will not be there for the private sector to start rebuilding the economy.
What was fun on Newsnight was that Paxman had a Conservative MP, Andrea Leadsom, from the Treasury Select Committee who believed passionately in the government’s policy of cutting public sector debt in debate with the Nobel prize winner.
Leadsom outlined how the government was engaged in creating a new generation of entrepreneurs that would be much better placed to supply goods and services to the market and thereby regenerate the economy through better products and better selling. Paul Krugman said that was pretty interesting but unless people were buying something (anything) the selling of better products was a bit of a waste of time. If people can’t or don’t want to buy things then people who sell them can be the best in the world, but they will still go bust.
Leadsom blinked and continued her policy outline – and for 30 minutes Paxman didn’t have to say a word. There were two world views on display with no meeting of minds at all.
Keynes was a really important economist whose theory was based upon the belief that people would spend money within their local area. Spending that money would automatically create more demand for goods and services. This would work through the economy – being spent and creating more demand for goods – creating jobs which would in turn create more demand for goods. The pound originally spent on their wages would create more demand for more goods and services, which in turn would create more demand for goods and services (this is called the ‘multiplier effect’).
What is clear from all the practical applications of this theory is that it depends on the specificity of both who has the money in the first place and where it is spent as to whether it really multiplies demand over and over again in the local economy.
So, for example, imagine that you are a government that wants to stimulate a national economy. You wouldn’t want to reduce tax for people earning over £100,000 a year because it is more than likely that they might spend the money on a foreign holiday; or buy luxury goods from abroad. This causes the money not to multiply demand within the local economy since it disappears from its work of driving more demand within the nation. (Oops! I realise that this is what our government have done with their tax cut from April 2013 from 50p to 45p for the richest tax payers. This money would be much more likely to work for the British economy if you gave it to the poorest).
Overall this is called putting a ‘stimulus’ into the economy – and whilst the current government might deny the intention – two weeks ago, when they developed a policy of not charging motorists the rise in fuel duty from August, it was an attempt to provide a stimulus to the economy.
The government is quietly beginning the implementation of the plan ‘B’ that it claims not to have. They are providing a stimulus to the economy at the same time as they are trying to take money out through public expenditure cuts. It’s more than likely that the £500 million fuel tax stimulus will be cancelled out by the few billion taken in the same year off of public sector workers by cutting their jobs. But that is expecting too much consistency.
There is a very serious point here about stimulus packages. They only work if the people who get the money, spend it. If, horror of horrors, all they do is pay off some of their debt, then it develops a much weaker, if any, stimulus for demand in the economy.
This is where it gets tricky for the current government. They are clear that it is essential for them to pay off a lot of their public debt before they can move forward and spend again. They talk about how dangerous it is for the government to live with a pile of debt.
But the last thing they want the public to do when they have some money is to pay off their private debt. They desperately want the public to be feckless and spend like there’s no tomorrow – because it is that spend that creates demand and helps the economy.
However if the people learn from the behaviour of the government they will look at the pounds they get from the fuel tax delay and immediately use it to pay off their credit card debt. In following the government’s lead for plan A they undermine the impact of its policy on plan B.
The problem for the Government is that they have spent 2 years frightening the public about the economic future. When people are frightened they don’t spend as much as when they are at ease – which is one of the main explanations as to why the economy continues to contract.
‘Hard working families’ have heard the message from the Government. 2012 is not the time to spend. Meaning 2013 will produce a still smaller economy.
At the moment it looks optimistic to believe that the size of our economy will return to 2008 levels by 2015.
The reason is beyond economics. It is fear.