To no great surprise, David Cameron has announced an immediate audit of the ‘crazy’ spending of Labour’s last years in power.  Politically, this no doubt makes great sense – “look what those idiots got up to” is perfect scene-setting for the blood-letting that will follow.  But what worries me is what sort of a narrative this tells of the crisis that has gone before – and how such a narrative restricts our future scope for action.

I’m rushing, so I’ll explain.   Look what Paul Krugman has found in the latest IMF report into the sovereign fiscal crises worldwide.  You will notice that it agrees with endless repeated polemics I launch on my slightly smaller blog:

what the report says is that there has been a fundamental deterioration in the fiscal outlook for advanced countries. Not only are they running up a lot of debt in the crisis, but — and much more important — they will emerge from the crisis with large structural deficits that weren’t there before. So spending cuts and tax increases loom.

No arguments so far.

where are those structural deficits coming from? It’s not interest on the debt: the IMF shows a large increase in primary (non-interest) structural deficits. So is it permanent increases in spending? No: the report shows that discretionary spending increases are a minor cause of rising deficits even in the crisis, and these increases will be reversed as stimulus winds down.

As I argue repeatedly, above all in A Balancing Act (see the pie chart), the revenue collapse was what finally revealed our massive deficits, the deficits that will characterise this premiership of David Cameron, and every subsequent premiership he might have.*

Why does all this matter?  Is it not just a matter for historians in what order things happened?  We are where we are: laden with debts and deficits.  Get over it, I hear you call.

But it does matter because the stories we tell of the past influence our future behaviour.  Consider the following crude account of how things happened:

  • We were going along nicely while the banks gambled madly
  • They made the economy collapse.
  • Governments responded by spending masses of money on two things.  Hundreds of billions on the banks (just read Peston)
  • And then this daffy thing called ‘Keynesianism’ encouraged that spendthrift Brown to go nuts with public money
  • Despite all this the economy has tanked by 6%, and is not growing well.  And we have a massive debt

Reading this, what would you conclude?  Well, that saving the banks and doing the Keynesian ‘splurge’ certainly left us with a debt, but only possibly helped the economy.  Next time, if we went badly into recession again, we should on no account repeat the same measures.

Which would be a terrible mistake.  The truth is that we did very little Keynesian spending indeed.  The government’s spending** did not rise very much (check out any economic reports).  The deficits happened because its ability to raise money was muellered by the collapse of the asset bubbles that fed it.  The states that were best able to do the Keynesian spending appear to have had faster recoveries.

I am not sure that I agree with Krugman in thinking this proves we need more spending, now; at some point, the risks of a sudden stop from the bond market just outweigh the benefit.   But we should be very careful that we don’t tell ourselves the wrong stories about the recent past.  We have a truly horrible fiscal situation.  Yes, cut the pay of highpaid civil servants.  But it was not the Labour government going crazy with Sir Humphrey that got us in this mess.  It was a collapse in nominal GDP, and revenues that are far too geared to an asset bubble.  Let’s get on with fixing that.

*amusingly, my working title for that piece was ‘The Cameron Inheritance’.  I was told off for begging the question – but they were 15% ahead in the polls.  Oh, how right the critics were …

**by which I mean its CONSUMPTION.  Look at the supplementary documents in the pre budget reports (table 1.12)

http://www.hm-treasury.gov.uk/d/pbr08_chartstables_501.pdf

and

http://www.hm-treasury.gov.uk/d/pbr09_chartstables.pdf

the figures for 2009 rose by just £20bn.

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22 thoughts on “Crazy spending, or our lifeline?

  1. Sir Alan Budd, who will be tasked with the arms-length/outsourced spending-cuttery, back in 1992 on his advisory role to the Tories in the 80s:

    “The nightmare I sometimes have, about this whole experience, runs as follows. I was involved in making a number of proposals which were partly at least adopted by the government and put in play by the government. Now, my worry is . . . that there may have been people making the actual policy decisions . . . who never believed for a moment that this was the correct way to bring down inflation.

    “They did, however, see that it would be a very, very good way to raise unemployment, and raising unemployment was an extremely desirable way of reducing the strength of the working classes — if you like, that what was engineered there in Marxist terms was a crisis of capitalism which re-created a reserve army of labour and has allowed the capitalists to make high profits ever since.

    “Now again, I would not say I believe that story, but when I really worry about all this I worry whether that indeed was really what was going on.”

  2. “But what worries me is what sort of a narrative this tells of the crisis that has gone before – and how such a narrative restricts our future scope for action.”

    Isn’t that also the point politically?

  3. “revenues that are far too geared to an asset bubble.”

    That’s the bit that makes most sense to me. That Brown’s spending plans were geared towards a continuation of those boom years. But as we’ve noted, some of that boom was phantasmal. So while, yes, nominal GDP has fallen and thus tax revenues have cratered, we’re really seeing a reversal of that phantasm, rather than some blip and we’ll all be back to trend growth lickety split.

    It’s not all that different from the confident predictions about US deficits at the end of the Clinton years. It wasn’t just that Bush cut taxes (which he did of course) it’s that the confident predictions in 99 and 00 were based upon the revenues from a huge asset boom. Which could not, indeed did not, continue.

  4. Giles,
    This is a salutary warning, but the history you give makes no mention of money and its supply.
    Here’s a different analysis and therefore a different solution:
    You could argue that we were all going along nicely with the banks making reasonable banking decisions based on an assessment of central bankers’ monetary policy and how central bankers would react when the inevitable cyclical slow down came in about 2007.
    Business began to sense that slowdown way before the central bankers and politicians who kept money too tight for too long.
    With the economic lubrication light flashing red the slow down was steeper and further than it should have been. Tax revenues plunged, asset values fell, security of loans disappeared.
    There is still insufficient money around and the usual way it is created following bank lending to the private sector is insufficient.
    If deflation or insufficient inflation is the problem, then, it requires bank lending to the public sector, which should also take pressure off the bond market.
    I still think we may be in 1933, but if not, then surely we are in 1937 and the consensus, reinforced by the election, is in danger of seizing up the engine.
    B

  5. The fact is we were not going along nicely before we crashed. We were in very low growth, by world standards & probably only in that because of “Keynesian” spending & house price inflation putting money into the economy.

    Obviously neither were sustainable over the long term hence the crash.

    Attempts to get back to that toboggan run will be no more sustainable. What is perfectly sustainable is growth based on increased productivity which, with technology improving faster than at any time in human gistory can easily be done simply by government getting out of yhe way.

  6. Thanks for the link on Friday Giles. No thanks for the couple of hours I’ve just written off reading your fascinating posts..

    Looking at your pie chart in ‘A Balancing Act’, does that mean we can blame Gordon for about 25% of the debt (16% for spending on the assumption that the economy would continue to grow and 9% for relying on insecure revenues)? Or is that just too simplistic?

    1. Any time, and apologies, sort of …

      Really tricky how much to blame GB for (present him with a bill for £200bn is one solution, of course). Because if he had spent less in 2001-7, say, we would have fewer ‘assets’ and possibly lower growth – though, of course, we might have had a different economy instead (lower pound, higher manufacturing, etc?) if lower deficits had meant lower interest rates …. now my head is hurting.

      Bottom line, he definitely screwed up and only partially made up for it by unleashing the spigot in 2008 – if he had been the Prudent Brown of lore in 2002-7, he might have been able to spend 3-4% of GDP in the dark years instead (cut VAT to 12.5? Massive income tax rebate? etc) and we might have had a far more shallow recession. And he might still be PM. whatif, what if

  7. Do you think though that he could really have taken say a balanced budget position that was forecast to worsen to say 8% of GDP, and say ‘Actually I’m going to boost spending by 4% of GDP to take the budget deficit to 12% of GDP’? I think opinion from the Telegraph to leftish blogs would have said 12% of GDP was never before heard of in peacetime and threatened out nation’s future and so on and so forth.

    I’d suggest perhaps the advantage of having a lower debt position would be he could have promised a modest stimulous for longer.

    1. That sounds sensible – of course, the political possibilities as opposed to the economic possibilities I had not considered. But given forward thinking economic agents – businesses – your route might have had as much bang for its buck as a sudden sharp infusion of spending (which is difficult to achieve in any case).

      However, I also think the Telegraph might be persuaded if the infusion of spending happened via tax cuts rather than govt spending (though of course they might have been saved)

  8. What is not addressed in the post is the issue of what kind of state the Libservatives want. As if the whole “Big Society” thing doesn’t give us enough clues – no wonder they didn’t focus-group the policy, it was aimed at placating Thatcherites. Rather than tell the truth – the deficit is down to the crazy (and greedy) actions of their mates in the City – the Tories are telling a story about bloated bureaucracy, pen-pushers, etc. And when it comes to reducing benefits they’ll retreat into their comfort-zone of blaming unemployment on laziness, etc. – even when they’re adding to the dole queues with public sector job cuts.

    Neo-liberal logic would have been to allow the banks to collapse. The Tories had to support the bailout – though Osbourne’s immediate reaction was to denounce it as socialist nationalisation (tells a lot about his grasp on reality). Latest word is that Cable will be vocal but not powerful – Osbourne will chair the Cabinet Committee to set up an “independent report” on bank reform and no doubt stuff it with Tory bankers like Lord Griffiths.

  9. In what way is the deficit down to the “crazy, gredy” bamkers? This common claim holds no more veracity than the German’s post WW1 claim that losing the war was the fault of the greedy & possibly crazy Jews. The fact is that the deficit is the fault of the people spending the money, raising the taxes & boprrowing the gap namely Labour. In both cases all that is being done is an attempt by government to avoid responsibility by finding a scapegoat.

    1. Uh, the crisis started in the financial sector – bear with me now, Neil – and govts took on the responsibility for the bad debts of the banks, borrowing money to rescue the financial sector from collapse. To compare this with anti-semitic rhetoric of the Nazis tells a lot about your ability to distinguish between an argument based on ethnicity and one based on socio-economic status.

      If Labour had controlled the financial sector since 97 they would bear some responsibility – as it happens, they went along with what the capitalist class wanted and reduced democratic control of the economy, making the Bank of England independent. Even when equity stakes were taken, there was no intention to force financial institutions to internalise social and environmental costs. In fact, the plan was always to return to the status quo ante.

    2. On the contrary, the deficit is what is not spent, i.e. the deficit is that part of nominal aggregate income that is not spent by the non-government sector.

  10. Lot of countries where the banks didn’t fail. The reason they did here was that Labour decided to loosen the money supply & to push up the “value” of houses & let the financial sector rip. This, alone, gave, as I said. the illusion of a boom. The result was predictable & was predicted but Labour wanted that illusion because they were to parasitic to allow the reality. Consider yourself borne with.

    PS If you don’t understand how much socio-economic status played in the rising tide of anti-semitism in Depression era Europe you should check it out.

    1. Of the countries I am familiar with – Ireland and the UK, bank failures. Of the country I cannot avoid being familiar with – the USA, bank failures. Presumably these countries also had Labour governments seizing power and deciding to unleash a boom…

      I understand precisely the role of socio-economic status in the rising tide of antisemitism in Depression era Europe. Most notably in Germany, the capitalist class were happy to see a strongman come to power who blamed Jews, not capitalists, for the woes of working people…

  11. Obnviously not Labour governments since, bear with me, the Labour party are a UK party & thus do not stand in the USA.

    Spain & Switzerland did not have bank failures but Spain has nonetheles managed to have a significant deficit (though admittedly not as significant as the “people’s party” produced here). China & India managed to do without either bank failures or recession – by your theory because their bankers are all inherently nice & generous people unlike our cartoon villains ; by mine because they have competent governments promoting growth.

    1. China = massive fiscal stimulus = faster growth, shallower recession

      UK = no fiscal stimulus = anemic growth, prolonged recession

  12. Which is the advantage of (A) China not going into the recession with an already “fiscally overstimulated” economy & (B) promoting productive technological growth as the real engine of growth rather than enforcing Luddism & trying to make up for it by printing money.

    1. I’m amazed that your promoting China as some kind of model to aspire to given, 1, its mixed economy, 2, its heinous inefficiency demonstrated by 2, its massive levels of over-investment, 3, its neo-mercantilist trade strategy, and 4, it’s reliance on huge fiscal stimulus when it thought that the market outcome was going to be sub-par.

      By the way, apropos “fiscally overstimulated”: it is obviously the case that it is only possible for China to run simultaneous trade and fiscal surpluses because of corresponding deficits elsewhere in the world. Your complaint is akin to Germany complaining that the rest of Europe is not “German” enough. If it the rest of Europe were more German, Germany would have to be less.

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