There is of course a deluge of comment on Brown’s TUC speech (see yesterday‘s piece).  Some are word-counting:  Brown used the C word, so he has finally come clean about Cuts.  As Brian Groom says, “semantics matter”. Other commentators (Polly waiting for the detail; FT Leader claiming he flunked the test) seem to agree with me thatmore detail is needed. Nothing Brown said gave us much of a clue of what department will lose what cash.

So, just by saying Cuts, is Brown being honest?

I think not.  When the Prime Minister first tried to squirm out of the realisation that public spending cuts are inevitable, it was already painfully obvious, as we argued on Freethink.  It was a tactical mistake as well as a moral one: given that the public were bound to understand this truth by election day, the Labour party needed to maximise the amount of time to display the differences between their cutting plans and the Tories.  Instead, they have allowed circumstances to dictate the pace of this debate. As the FT argues, “But he has made his job harder by initially rejecting the idea of cuts and being so imprecise now.”

But – what about the Keynesian views I have noisily espoused for so long?  Surely, the course that displays “judgement” is the one that postpones cuts until the recovery is right (to quote the phrase used by Anthony Painter on Labourlist, which echoes Lord Skidelsky.

Yes and no.  Timing cuts for this year or next would be crazy.  As Duncan points out, we are NOT getting a big “no” from the markets that lend us the money.  As Polly and Anthony argue, large economy finances are not the same as those for a household (it may be different for small economies – see my piece on Iceland’s Littleness).   The “demands” that a household generates use up its income; for a country, they may boost its income by employing idle resources, and through associated multiplier effects.

However it takes years to get spending cuts in place, and to make them effective, fair and acceptable to a general public that will be extremely sensitive to fairness, it will take a continuous dialogue between our leaders and the public.   Our lead researcher on public spending, John Springford, has been studying the examples of Canada and Sweden, which both went through wrenching fiscal consolidations in the 1990s.  Building broad consensus was crucial, and this takes time.

But, I hear you ask, what about Rational Expectations? Won’t the public/business, knowing that the government will be withdrawing support in the near future, draw in their horns, cut their spending in the present, damaging economic demand now? This may be a matter for judgement, as Anthony says, but my judgement is that refusing to discuss cuts is still a bad idea because:

1. Fibbing about it is not managing expectations – it may lower confidence (‘our leaders are in cloud cuckoo land’)

2. Keynesians have good reasons for mocking rational expectation theory, particularly after the crunch.  They don’t believe in Ricardian equivalence in one direction, so can’t in another.

3. Financial/credit crunch constraints have already cut private consumption to a low level.  So long as people do not lose their incomes (i.e. spending cuts become effective now), consumption will not be affected by the announcement of future spending cuts – and investment is already low, so can’t respond negatively very far.

So.  We need a discussion about spending cuts, Anthony (and Gordon): but we need them to actually take place in a few years.  I stand by my view that only Vince is being honest so far about it (Bagehot agrees)

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5 thoughts on “Public spending, continued

  1. Giles,

    Thank you for your comment on my LabourList piece and I will post these thoughts there also. And apologies for the delay….

    Actually, I agree with you. My fear is about emphasis and that the ‘cuts’ narrative can gather a muscular dynamic of its own. That is where I judge HM Opposition to be and there is a risk that the Government risks being sucked into that also. The only safeguard is, to coin a phrase, to be insistently resolute on an ‘it’s the economy, stupid’ line.

    I thought that Vince Cable’s report for Reform was a very useful and practical contribution to the debate. His zero baseline budgeting approach is one that must be seriously considered. His line by line analysis was useful also. My only substantive beef with it is the title: “tacking the fiscal crisis.” We have had, and still do have in my view, a financial crisis one of the consequences of which is a large (voluntary and involuntary) fiscal deficit. By focusing on the symptoms we risk leaving the disease untreated.

    Having said that, of course fiscal retrenchment will be necessary at some point. Will that means cuts overall? Well, once you take into account interest payments, yes in all probability though we don’t know whether tax revenues will bounce back (they did in Japan before this latest crisis but that may due to Japan’s tax code.)

    That doesn’t mean that the fiscal planning should not start immediately. For example, I would like to adopt Vince Cable’s zero-base budgeting and then analyse expenditure in two ways: do we need this socially, and is this expenditure contributing to short term demand and/ or raising medium term productive potential. If the answer is no to both questions- say ID cards- then it goes into the cut box for me.

    But to come back to the point, in which we are in agreement I believe, we are not out of the financial woods yet and any reckless fiscal retrenchment that hits aggregate demand at this stage could be disastrous. When should the ‘cutting’ begin? That’s a very tricky question but to go back to Richard C Koo’s point, it is better to ‘err on the side of incaution’ and that will need just as much political support as any programme of fiscal retrenchment. That s what HM Opposition have sought to undermine, completely irresponsibly in my view.

    Looking forward to further discussion….Very best wishes.

  2. Hi Anthony – thanks for the clarification, and I think we are broad agreement on Tory policy at least, particularly give the possible persistence of deflation. If George Osborne is determined to come in and 2 weeks later have a Budget that really slashes spending, the possible knock-ons to confidence are pretty bad. It is beyond my experience to judge what the markets would think are bad, what unemployment effects would look like – how lagged, how large, etc – and given that we are in an open economy, the possibility that this might be countered by a fall in sterling (boosting exports etc)

    Osborne is apparently relying a bit on the last point. He

    “cited Ben Broadbent, chief UK economist at Goldman Sachs, as saying that fiscal tightening in an open economy “has little appreciable impact on aggregate output” because it shifts demand from non-traded goods towards the traded sector, with exports replacing government spending.

    http://www.ft.com/cms/s/0/829d469e-a21e-11de-9caa-00144feabdc0.html

    Wow – this is the man who warned about a sterling crisis in November – but now is hoping to produce one in order to rebalance the economy. What, exactly, is the Conservative attitude to the pound (a post on this)

    But, larger point, which I heard indirectly from a leading politician, is this. There wil obviously have to be spending restraint and tax rises. But if we PROCEED with the latter, the public – in particular, the public watching Labour – will be unconvinced that a decent trade-off is being planned. They want to see the politicians ‘taking some pain themselves’ before they (the public) agree to take a hit through tax rises. If the narrative starts with tax rises, the public will feel than an unequal cheat is going on. Particularly if they are listening to a Left party, which has yet to prove that it CAN deliver spending restraint (this probably applies to Lib Dems too – drunken sailor comes to mind for some of their activists).

    I know this is unfair, and a bit illogical: the public is hurt by public spending cuts, it is not the politicians spending on themselves . But the public are perfectly convinced of any government’s ability to raise taxes once in power: even Tories struggle to cut spending once behind the wheel, so that is where all the rhetoric is going on. Ironically, it is probably only the Tories that don’t really need to convince the public that they think like Mark Wadsworth about this:

    http://markwadsworth.blogspot.com/2009/09/frontline-services-smokescreen-from.html

  3. I love the Wadsworth post and the fact that he has just forgotten things like local government, transport, the civil service, international development, diplomacy, climate change, science, etc! Good luck to him.

    On to more serious business……

    I don’t doubt that Ben Broadbent has a very sophisticated set of models. And I don’t doubt that in normal times they are very useful. They are somewhat less useful in these abnormal times.

    There are two questions would a depreciation adequately replace say £100billion of cuts and would the pound depreciate adequately. The latter: inflationary expectations are already low as witnessed by long term IR’s etc. So cutting pub ex will have little impact on that (though I do still like your notion picked up by Cable of index-linking gilts). It has to have an impact on growth expectations so that would precipitate a reduction- though there already has been a large fall. But maybe not, capital may just flow to other assets and the depreciation may be minimal.

    All this is speculative. And that’s the problem. We *know* pub ex creates domestic demand. Without it we risk a second credit crunch as happened in Japan in 1997. So why take the risk?

    Just say the £ does depreciate as per expectations. Well, yes, we may well produce more Minis and have to build more hotels. But the issue is not that domestic demand is weak but global demand is strong. It’s universally weak so you have to question whether private sector demand can- in these circumstances- mop up the slack from reduced pub ex. Again, the recent Japanese history suggests not. And again, why take the risk? Why experiment now of all times?

    Finally, Goldman Sachs has a lot of brilliant financiers in London. If the £ were to depreciate significantly further, I wonder how they will be able to keep that pool replenished? Open migration at the upper reaches of our skill set is, of course, one significant aspect of our openness…….

  4. I think Broadbent is good, but you are precisely right: such models rely on high enough global growth that the UK becoming cheaper can produce an elastic increase in demand.

    Also – we don’t have an export sector that could quickly respond to an increase in demand of £100bn. We only export about 400-500bn, so the immediate effect would be a bidding up of labour costs in that area, and unemployment in the afflicted (public services) area.

    Plus a collapsing £ would play havoc with inflation. Mervyn would act. Work it out, George!

  5. Pub ex down and interest rates up. That is a shuddering scenario currently- when you consider the number of people now on standard variable mortgages and trackers and businesses on LIBOR linked debt.

    Of course, King would be hawkish. Though the Bank does have a statutory duty to support the government’s growth policies so which way the MPC would go is not clear. But as we discussed, the policy is unlikely to work anyway. Especially as the £100billion cut I quoted could, if Sunder Katwala is right, be much less than Osborne is considering.

    Which brings me back to one of my conclusions in the piece that provoked this discussion:

    “Should the Conservatives secure an election victory that they crave but do not deserve, they will face a stark choice just as the Hashimoto and Koizumi administrations did. Either the economy or policy is jettisoned. Should George Osborne become Chancellor then I have a prediction. By his second Budget he will be in the midst of a panicked reversal of his Government’s economic policy.”

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