Catch 22? Is it really such Wonderful News that Government Borrowing is Down?

April 26, 2018 9:44 AM

moneyThe Banking Crash of 2008/9 could have been an utter disaster personally for millions of families. While we can criticize Brown's Labour Government for its "light touch" banking regulation - which contributed to that crash - we must also be immensely grateful that they they acted so promptly and decisively when disaster struck. Huge sums of money were pumped into the banks to keep them going and many were effectively nationalised. However this was very expensive indeed because most of that had to be borrowed - at high interest rates. Then for several years the high interest rates meant the debt continued to rise slowly.

The following Conservative government's response was, reasonably enough, to reduce government spending, but they also - unreasonably - refrained from putting up taxes and in fact reduced a few. Worse than that, because they imagine you can operate the UK economy like a 1950s housewife controlled the family budget. And they think that there's a simple relationship between government spending cuts and deficit reduction. There is not. The relationship is complex and involves several negative feed-back loops. So they were disappointed in the results time after time and piled cut upon cut.

They froze public sector pay, cut benefits, starved the NHS of cash to help cope with the ageing population, cancelled infrastructure projects and withdrawn the Rate Support grant from local councils - leaving them barely able to cope. They have softened Inheritance Tax, maintained pensions and resolutely shunned any income tax rises.

In other words the Tories have punished the poor, the disadvantaged and the sick and rewarded the prosperous, elderly middle-classes - plus of course that large group of the elderly middle-classes that think they're prosperous or have illusions that their children might be one day. Good politics if you have a Tory mind-set, but socially unjust and perhaps not sustainable for very long.

And the feed-back loops? Well, government spending actually ends up in private pockets. Pensioners and benefit claimants have more money - and more money to spend. More doctors, nurses, teachers mean more people with wages or larger wages - and more money to spend. Companies doing work for the government get paid - and that means more money for a bigger or more hard working labour force. Again, more money to spend. In this way a £1 increase in government spending can produce an increase of between 50p and £1.70 in national income. The exact figure depends on how willing the population is to spend, rather than to save. However in the UK we are very good at spending and very poor in saving. The so-called "multiplier" can in practice be well in excess of 1.0. The point is that this works in the other direction too. So a cut in government spending of £1 can result in a reduction of 50p to £1.70 in national income.

So what is it in the UK in the recent past? Well, right-wing people and right-wing institutions - like the International Monetary Fund - believe the multiplier is less than 1.0 and so they would say the UK government has done the right thing. On the other hand many econommists say that the consistent errors in UK Treasury and IMF forecasts of future growth in the UK economy show that the Treasury and the IMF are using a multiplier which, for the UK at least, is far too low and must be greater than 1.0. This seems to be the case for the USA as well. Possibly 0.5 might be the right figure for the German economy, where people save a lot more of their income than we do.

Here in the UK we have the OBR - the Office of Budgetary Responsibility - a government department suppopsedly independent of the Treasury. However the OBR has used the Treasury figure of 0.5 for the multiplier to make forecasts - so it's not a surprise really that successive chancellors, Osborne and Hammond, have had to keep revising their economic forecasts downwards. The figure they used implies they're doing the right thing (of course) and that their austerity has not been doing our economy much harm. However, now even the IMF has moved it's estimate of the multiplier for the UK up to a range of 0.9 - to 1.7. In 2017, the TUC has calculated that if you use the IMF mid-range value of 1.3 - more realistic and consistent with the USA - then you can see that the Tory austerity has damaged our economy to the tune of £76 billion, just for the 5 years from 2010 - 2015.

The damage of Tory austerity has been at least 1% less for our GDP each year - in addition to the stress and hardship for the low paid, the disadvantaged and the sick.

Now we're asked to rejoice at a small reduction in borrowing. But slower and steadier might well have achieved a better result with less human cost - and how will we fare if interest rate rises suddenly make servicing the debt more expensive and start pushing the deficit back up again? This Tory government seems to have only one strategy for the economy - based on a biased assumption and consequently doing more harm than good. It's like taking some toxic Victorian potion in an attempt to regain good health!