There’s been some controversy about the impact of ‘austerity’ measures on the UK growth rate. Britain’s economy has been described as ‘flatlining’, but that doesn’t take into account the erosion of the value of its currency. I’ve been looking at the World Bank’s World Development stats. It may be difficult to pick the trend out from money values alone, so I converted the figures for GNI per capita to index numbers, taking 2008 as 100. It makes for a neat interactive graph on Excel, but I couldn’t work out how to display it in the blog, so here’s a table instead.
The UK performed worse in the period 2008-2011 than every other country in this list – it’s not quite the worst performance in the world, but it comes close. Some countries which have been castigated for poor performance – Greece, Spain and Italy – also had declines in outcomes in the later two years, but none of them has done as badly as Britain over the four-year period. That may be because the other three are in the Euro and the value of individual incomes in the Euro zone has not been eroded in the way that they have in the sterling area.
Angela Merkel, in an interview for the Financial Times, suggests that Europe has to spend less on welfare to be competitive. “If Europe today accounts for just over 7 per cent of the world’s population, produces around 25 per cent of global GDP and has to finance 50 per cent of global social spending, then it’s obvious that it will have to work very hard to maintain its prosperity and way of life.” She cites the problem of competition from other countries: “Other models have long since emerged: China, India, Japan, Brazil, and they will be joined by other countries that are working hard and proving to be innovative.”
She’s missing something important. All the countries she’s mentioned are committed to social support as well as economic development. Japan has long established networks of solidarity; China, Brazil and India have all been extending their systems of social protection. So have other countries she doesn’t mention, such as South Africa, Mexico and Indonesia. Developing security, reducing vulnerability and improving welfare is a large part of what prosperity is for.
It was once received wisdom in economic theory that social security had a beneficial effect on the economy, because it increased at times when demand was deficient. This is from a book published in 1960, Richardson’s Economic and Financial Aspects of Social Security (I have it on my bookshelf):
“The two main benefits that fall in prosperity and rise in depression are unemployment insurance and public assistance payments. They put a brake on books and reduce the severity of depressions. … If social security benefits are paid, business will not decline as far as it otherwise would.”
I referred to this argument briefly in a recent interview, and a note from Adrian Sinfield has encouraged me to look at it a little further. A couple of days ago, the IMF conceded that it has got the multipliers wrong – the extent to which changes in government spending stimulate or depress the economy. (The issue is explained on the TUC’s Touchstone website.) The multipliers are probably between 0.9 and 1.7; they were formerly assumed to be 0.5-0.6. If government spending stimulates the economy, it needs to be increased during a depression; cuts lead to economic decline. The multipliers say how big the effects are. And the size of the error means IMF has been underestimating both the benefits of increased spending, and the harm to the economy caused by cuts.
Social security benefits are not, however, quite the same as public spending – treating them as if they were is one of the central confusions of current policy. Most are transfer payments, meaning that someone gets money which otherwise someone else would have had. Transfer payments should be assumed in the first place to be neutral; they stimulate the economy if the people who receive are more likely to spend it than the people who are paying. It’s likely that this condition will be met, because people on very low incomes can’t save, but the effect is not the same as either government spending financed in other ways, or as spending on infrastructure. Spending money on unemployment assistance makes a modest contribution to stabilisation; spending it on public works or job creation stimulates the economy far more.
The continuing crisis in Greece has been presented in questionable terms. First, we have been told that the alternative to ‘austerity’ is a disorderly default. Defaults do not have to be disorderly. New York and Cleveland, both members of a different currency union, have defaulted on their debts in the past; the dollar was unharmed, and they were not forced to adopt a new currency.
Second, we are told that Greece will have to leave the Euro. Greece cannot be forced not to use the Euro. Money is what people accept as a unit of exchange, and if people in Greece opt to trade in Euros, they cannot be stopped. Some countries use other countries’ currencies informally; some (like Ecuador, which uses the US dollar) do it formally. Germany might have more success in insisting that Greece should use a different currency from them if Germany itself was to leave the Euro, but that seems unlikely.
The economic policy that the EU, and Germany and France in particular, are forcing on Greece has led to a major depression – and the problem does lie in that policy, not in Greece’s deficit. Austerity is the worst possible answer to an economic depression; and austerity which is targeted on the poor is indefensible morally as well as economically. If France and Germany want to ensure that Greece does not default, to protect their own banks, they need to take steps to shore up the Greek economy. At present, they are doing the opposite.
The level of money in the economy has an important influence on demand, and so on economic production and growth. The Bank of England has expanded its quantitative easing, injecting money into the British economy, by a further £50 billion, taking the total to £325 billion. At the same time, reports which focus on the rewards given to RBS’s Chief Executive have been emphasising what a splendid job he has been doing in rationalising the bank’s balance sheet, shrinking its holdings by £600 billion to date, with a further £200 billion to come before long. That seems to square with a view attributed to some banks – “no business is good business”. These two figures are not commensurate or directly comparable – RBS is disposing of assets as well as loans, outside the UK as well as within it – but the relationship is close enough to raise questions. While the BoE is injecting money into the economy, RBS is working assiduously to take money out. And that raises the question, not whether Stephen Hester is being overpaid, but much more seriously, whether he is being paid to do the wrong things.
I have written before about plans to inject money into the economy, and for the present I am going to leave aside the arguments for and against doing it. The Conservatives are pleading for tax reliefs; Liberals, for a rise in the tax threshold; Labour, for a cut in VAT and more quantitative easing. The question I want to address is a simple one: what is the best way to inject money into the economy?
There seem to me to be three main criteria. The first is effectiveness: the money needs to arrive in places where it will stimulate the economy. Too often in the past, indiscriminate financial stimuli have led to inflationary demand or to money leaking abroad. Second, there needs to be some consideration of the distributive impact. Third, the stimulus has to be practical: one of the reasons why Labour went for a VAT cut was that it could be done immediately, when changes to income tax would have been much slower. Cutting income tax fails on all three criteria. VAT meets the third criterion; it has limited benefits for the second, because VAT is only slightly regressive; and it fails on the first.
Some benefit payments could serve more effectively as a stimulus than tax cuts could. Although there is a case for higher benefit levels in general, the implementation would be too slow and complex, and it would be politically controversial. It is however feasible to make additional payments to the recipients of certain benefits. Child Benefit goes to every family with a dependent child; Winter Fuel Payment (disregard the label!) is an ad hoc payment to every older person. In other words, the administrative mechanisms exist to deliver one-off payments directly and rapidly to individual households. The distributive effect would be generally progressive (it could be made more progressive still if the payments are treated as taxable); and it would lead to an immediate, localised stimulus to spending that would fall roughly in proportion to the prevalence of deprivation. And if such payments happened to do a little to alleviate child poverty, that is a side-effect I think we should be able to bear with equanimity.
The government has represented its spending plans as the only option available. The Labour opposition has called for an alternative approach, “Plan B”, involving Keynesian stimulation of the economy through tax reductions and quantitative easing. It looks as though the government is sticking to “Plan A”: but is it? The recent spending review points to the gradual emergence of an alternative strategy. In November, the government announced funding for 250,000 work experience placements and 160,000 job subsidies, all aimed at young people aged 18-24. Less prominent, but possibly more significant in the long term, were the low-key declaration of a National Graphene Institute, and recent announcements about support for life sciences. These initiatives suggest that the government may be starting to move in the direction of a policy to foster development in selected industrial sectors. That, ironically, was the policy of the Labour government in the 1970s, which sought to pick winners through the National Enterprise Board – for example, its investment in Inmos and microchips.