Tuesday, 18 November 2008

The economy: Is it stupid?

I'm not going to pretend I have a clue what is going on with regards the economy. Recession. Boom and bust. Fiscal stimulus packages. They might as well be talking Basque - I'd understand about as much. So when the Tories announced today that they are to scrap plans to match Labour's spending if they win the election I was left even more confused.

You see, "Dave" wants to create a "low-tax, low debt economy" and run away from Labour's "spend today, worry about tomorrow tomorrow" financial policy. Obviously I'm paraphrasing slightly - I don't have a clue what they're talking about.

The Chancellor, Lord Badger Alistair Darling slammed the plans, saying governments have to pump money into their economies to help populations struggling with the credit crunch. He is expected to announce a number of tax cuts and increased public spending. Which I'm not sure go together that well.

In fact, and I don't say this nearly often enough(!), I think Stephen Glenn is probably right when he says that if Labour go ahead with cutting taxes next week, they will inevitably have to raise taxes again soon, in order to pay for their public spending - which is not to be cut

Again, I'm not really in a position to evaluate each of the tax plans in detail. But simple household budgeting is evidence enough that if you cut the money coming in (say, by giving up your job to start a PhD) you have to also cut the money going out (like going to the pub/ rugby/ theatre). So how is it that a government cuts the money coming in, it can keep spending? Isn't that what got Aberdeen and Edinburgh councils into financial difficulties? Wait a minute... isn't that what got the UK into this financial mess? Banks - and indeed governments - spending money that they didn't have in the first place?

Not that I'm sold on the Tories idea at all, but if Darling made the mess, why should we trust him to clear it up?


Stephen Glenn 18 November 2008 at 16:54  

Quite right Malc. At least the Lib Dems want to look at the whole tax and expenditure situation and make it sustainable, fairer and able to pay for itself to a greater extent to provide am impetus.

Stuart Winton 18 November 2008 at 18:29  

Well government borrowing per se isn't something that ANY of the parties will dismiss completely; it's merely a question of degree.

Thus borrowing will rise in the recession whatever party's plans are adopted, but the big issue is the extent to which borrowing should should rise to stimulate the economy during the downturn.

Stephen and the LibDems clearly don't want much of a fiscal stimulus at all, while I think your stance is at odds with the SNP, Malc.

Sam 18 November 2008 at 18:37  

The whole point of what the Americans call a 'stimulus package' is that it is a "short-term cash bribe" as Stephen puts it. That's what is required to free people up to spend more as they have a larger disposable income, thus boosting consumption in the economy & increasing national income through the multiplier effect. This is Keynesian economics, while classical (& neo-liberal) economists would argue that the same effect results from decreasing the rate of interest as the Bank of England has been doing so dramatically (these are good times for students of economic theory Malc!).

Anyways, the point is that increasing the economic output, hopefully creating more jobs for people and business for firms, is what we generally do when facing recession. Hence 'spending your way out of recession".

It is a short-term measure, and it does require taxes to go down & public spending to increase, thus increasing government borrowing (which incidentally is probably nothing to worry about as we don't live in a banana republic & thus should be able to pay it off eventually when income tax revenues rise as economic growth recovers).

But government borrowing certainly did not get the UK into its current mess. That was down to banks massively overvaluing their assets, realising that, restricting lending to other banks in case they were as stupid, not having enough money to lend to businesses & individuals (the "credit crunch") and thus restricting our ability to spend our way out of a recession caused by the housing price bubble collapse in the US & here, increasing energy prices and the general tightening of belts resulting from the credit crunch.

Blame the banks for overspending & the neo-liberal economists in charge of the international financial architecture for giving them the power to. Lax regulation on the part of Western governments didn't help either.

In the domestic context, its probably true that tax cuts won't work because they are unfunded, thus they won't be very big, and if people think taxes will go back up soon, even just to the same level as now, they will probably save rather than spend. I will. But increasing government borrowing is not nearly as harmful as doing nothing, as Cameron's not-so-different-after-all Tories propose.

On the other hand, paying for tax cuts by increasing taxes on the rich or scrapping truly wasteful government spending on projects like ID cards might be better. And it would probably get votes. But that unwillingness to go against the business lobby, rich donors and discredited economists is Labour's real failure.

Neil,  18 November 2008 at 19:40  

I wonder where having an extra 40,000 people on the doll queue, potentially higher mortgage rates, lower savings/current account rates, losing hundreds of branches and creating a tesco-style superbank fits into Alistair Darling and Gordon Brown's reflationary package? The takeover of HBOS will not help the financial situation it will make it worse. Why has David Cameron had nothing to say on it? It is not just a Scottish matter this is going to be very damaging across the UK.

Holyrood Patter 18 November 2008 at 20:05  

I plan a lengthy series of economy posts when a brush op on my knowledge. But this sounds like the large scale equivalent of encouraging someone in a lot of personal debt (say 30% of their income p/a) to buy loads of new furniture on high interest, buy now pay later schemes. Unfunded tax cuts will put money in people pockets, but in these current financial circumstances, wheres the evidence to say they will spend it?

We need to not put money directly into people pockets where it will automatically be swallowed up by them placing into savings accounts or repaying obscene mortgages. The banks need to be told, not persuaded to pass on interest rates. The Govt needs to remember they are in control, and if they are not, its their fault. I want to see tax increases on energy companies at as obscene a rise they place on customers. I want to see tax increases on tax dodgeers, and on bonuses. City bonuses last year were 8.8 billion, compared with the estimated 5 billion to eradicate child poverty. Im in debt to the tune of thousands, why build a hospital?

And we are at it, the civil list should read £0.

Rant over, sorry Malc

Sam 18 November 2008 at 21:15  

The difference between a national government with an economy in the top 10 of the world's largest and you average high street furniture buyer is that the UK government is not considered a credit risk.

It will pay off its debts when income tax receipts go up as the economy starts to grow (about 18 months to 2 years according to general consensus), and when the banks recover & we make a profit (or at least take the debt off the Balance of Payments) from the shares the government took in them when refinancing them.

Remember the debt really isn't as bad as it sometimes gets portrayed.

I agree with HP on the rest, but you're not going to see New Labour attack the economic and financial system it helped build over the last 11 years. And the opposition, led by the billionnaire-schmoozing wannabe-City-boys and public school old boys, yes hello Messrs Cameron & Osbourne, would probably be worse.

Malc 18 November 2008 at 21:30  


Thanks for that.

If I didn’t make it clear enough in the piece, let me say it now: I’m not an economist and I don’t really understand what is going on with the economy right now. And I’m not against government borrowing – its government borrowing when they don’t have the means to pay it back that worries me somewhat.

I’m not totally clued up on what the Lib Dems or the SNP want but I’ll also say this. My blog is my own opinion, not a mouthpiece for SNP propaganda. I think I’ve proven that in the past. I’ll praise them when I think they are doing well and kick them when they’re doing badly – as I will with any party. But I simply don’t know where you get that my stance is at odds with the SNP. I’m not really at odds with anyone since I don’t really have a position – I don’t know enough about it. Though Sam’s Economics 101 is somewhat helpful.

Malc 18 November 2008 at 21:36  


Thanks for the 426 words on the economy. Let me ask you something though - what happens if you do both? Like a stimulus package to boost consumption and cut interest rates (as is likely to happen)? Won't people then stick their money in bank accounts - or worse, under their beds? And how will that stimulate the economy?

My point is this: If it doesn't work, what will happen?

Taxes will return to current levels (or higher), people still won't spend anything, more jobs will be lost (possibly breaking the 3 million barrier) and the government debt will have increased. And we're still in a recession.

Malc 18 November 2008 at 21:38  


I’d guess “Dave” thinks that the matter should be in the hands of shareholders and not politicians – hence the not getting involved. Or, like me, he doesn’t know the first thing about it…

Malc 18 November 2008 at 21:45  


That’s kinda what I said in the last comment – that people won’t be willing to spend money when they think that taxes will increase again next year.

Tax on energy companies sounds fair. Tax increases on tax dodgers? If they’re dodging tax, they’re not paying it… so presumably that gets us nothing! But city bonuses? You want to tax people for doing their job so well that the market place sees fit to reward them? How is that fair?

Holyrood Patter 18 November 2008 at 23:16  

Apologies, i meant get tighter rules on tax dodgers. I followed the libel claims between Tesco and the Guardian with interest.

I am all for bonuses as a concept within aswell as outwith the city, from salary based to a small employer laying on an xmas party for hardworking staff.

I am not for moral panics, but in the civil service aswell as the financial service, there are plenty of people who havent earned their bonuses this year.

Sam 18 November 2008 at 23:33  

Malc, you're right, the tax cut is a big gamble, the bet being that the increased consumer & business spending will keep the economy at a level which doesn't increase the spending the government has no choice over such as unemployment benefits. But as you say, because the loyal opposition is talking up tax cuts it isn't guaranteed spending will go up.

The Bank of England's cuts in interest rates, which incidentally are outside direct government control, will certainly help. They'll make it less worth saving (interest earnings on current/savings accounts aren't as good) & make it easier to pay off mortgages (less interest to pay). Those factors both increase the amount of disposable income in peoples pockets. The question is whether they'll be enough.

On your point about the market: any market which "sees fit" to reward people with vast amounts of money for short-term gains without recognising the long-term risks, or taking into account the possibility of unforeseen risks, is not fit for purpose. Paul Volcker, ex-chairman of the Federal Reserve, says so too.

If anything the energy companies are doing a more morally honest job. They don't manipulate the markets, they simply make profit off energy prices which are set so high because they obey a proper supply/demand mechanism reacting to massively increased demand and ever dwindling supply. If people & governments faced up to the reality of carbon-driven climate change they wouldn't bleat about ever-increasing prices.

Stuart Winton 20 November 2008 at 06:28  

Malc, there's no guarantee that the stimuli(!) will work. Indeed, I think the reason the fiscal stimulus is being pushed now is that the monetary stimulus - lower interest rates - may not be working as well as it would normally. For example, my mortgate rate was only decreased by 0.3% as compared to the 1.5% drop in Bank of England interest rates, and there's reports of the banks increasing some lending rates. Likewise, there's no guarantee a fiscal stimulus will work either - tax cuts could just be saved, as you said.

As for the SNP point, I don't doubt that you are critical of the party when you consider it merited, but I made the point simply because you said you didn't know all the ins and outs, so I thought it worth pointing out that it seemed that if you concur with Stephen then that would seem to put you at odds with the SNP.

You say now that you don't really have a position while your blog post said that Stephen is "probably right", thus I think I was at least partly justified in assuming you had at least some vestige of a viewpoint on the subject.

Malc 20 November 2008 at 11:08  


Thanks for that. What I meant about Stephen being right wasn't necessarily with Lib Dem policy (me agree with LD policy - surely not!) but that he was right when he said that "tax cuts now will mean tax raises next year."

On the basis that I don't really understand any of it, I don't have a position that puts me at odds with the SNP or with Stephen in terms of policy.

If I knew what SNP/ LD policy was, I'd be sure to let you know what I thought though!

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