25th July, 2010
Dear readers of this blog…Apologies for the silence. Have been away… travelling, courtesy of TrenItalia’s overnight service to Tuscany, and wonderful it was too. Have thoughts to share after reading Tim Parks’ book on the train – on the Medicis and Money.
But the following is more urgent: a comment below from Prof. Victoria Chick on the confusions that arise from using micro-economic reasoning to determine macro-economic outcomes. Prof. Chick’s comment relates to the debate on fiscal tightening generated by Martin Wolf at the Financial Times.
The government is not in a position to determine its deficit/surplus.
by Prof. Victoria Chick.
Much as I welcome the opportunity Martin Wolf has provided for a debate on the Government’s spending and taxation plans (see ‘Why the battle is joined over tightening’ here ) the debate itself was set up on false dichotomies: between cutters and postponers or the choice between deficit-cutting and stimulus. Let me expand on why these dichotomies are false.
The debate is not between deficit-cutting and stimulus but between expenditure-cutting and stimulus. The question begged is whether expenditure-cutting (and tax-raising) will actually result in a reduction in the deficit or an increase. Research by Ann Pettifor and me shows, using UK data from 1918 to 2009, that a persistent expenditure cut was correlated with a rise in the debt/GDP ratio; and expansions in expenditure with a fall in debt/GDP. (For a short form see our Bloomberg piece here. For a longer essay see ‘The economic consequences of Mr Osborne’ published on 6th June, on this site. )
The belief that it is comes from generalising from the experience of individuals. It is completely spurious to speak of ‘deficit-cutting’ with reference to governments.
You and I are small beer: if we want a surplus, we cut our expenditure and/or raise our income, and what we do is not important to anyone else or to the economy at large (unless many others are doing the same).
Government expenditure is too important for that, even at 1930s levels (9-14 per cent of GDP before mobilisation for the Second World War). The same ratio after the War has never fallen below 20 per cent (these figures exclude transfers). The size and sign of the budgetary outcome depends on the plans of the entire economic system and its reactions to the government’s planned actions.
Even more important than the proportion of government expenditure is the fact that its deficit/surplus outcome must be balanced by a surplus/deficit elsewhere, either in the private sector or the balance of payments. If the government reduces its deficit, which sector is going to reduce its surplus? Surely not the private sector, which is trying to repair its balance sheets. The balance of payments?
To try to cut a deficit by cutting expenditure and raising taxes in a period of slack demand and substantial unemployment is to jeopardise recovery; this argument is well understood.
The counter-argument, that the markets will refuse to buy government debt, is also well understood, though no-one actually knows ‘the market’s’ view: is it more worried by the size of the debt or the threat of further recession?.
But even if a reduction in the deficit were desirable, the further question arises: if government wants to cut its deficit, for whatever reason and however misguided, is cutting expenditure and/or raising taxes the way to go about it? In the light of previous UK experience, the answer is no.
Since the deficit is not something that government can control, setting out to reduce the deficit is to look at the problem through the wrong end of a telescope: the way to reduce a deficit in a time of unemployment and feeble recovery is to spend (preferably spend wisely, e.g. on green technology) to promote employment and permanent improvements to our infrastructure, including our ‘human capital’.