Good Grief, Not That Analogy Again
September 25, 2015
by Martin Odoni
I should know better than to watch BBC Question Time. I have largely stopped watching it, especially over the last two years, as I have become fed up of its thinly-veiled bias – its tendency to give incredibly disproportionate exposure to members of the UK Independence Party in particular – and its considerable dumbing-down since the late-1990’s. Habitually inviting pop-culture celebrities, where once it might have included scientists or public workers, often lends the programme an air of triviality.
But today I decided to give last night’s episode a viewing on iPlayer , and yes, it was a mistake, as I was soon listening to one of the most obtuse audience-members Question Time has ever had.
He said, as follows; –
Economics is really simple. I’ve got ten pounds in my pocket. If I go out and buy three pints of beer in Cambridge, I’m probably borrowing money. If I carry on doing that, then I’m gonna run out of money, and I’m gonna go bust. It’s not difficult, guys.
So to sum up, his very basic argument was that spending cuts, greater than any done so far since the start of the period we call ‘Austerity’, are necessary, because if spending costs more than the amount of money the Government has, that would mean borrowing is necessary, and the more we borrow, the longer it will take us to pay off the National Debt.
Wow. Shrewd calculation.
(There is a clip of him that has been shared on YouTube.)
So yet again, Joe Public thinks the words ‘economics’ and ‘budgeting’ are freely interchangeable. I was mentally screaming at my PC screen as he spoke, something I do a lot when watching Question Time, which is one of the reasons I tend to avoid it these days. But this was particularly maddening, as it reminded me that way too many people still think that they can use their private incomes as an analogy for a national economy.
The guy in the audience did not help himself in that he chose to make the comparison while arguing with Yanis Varoufakis, one of the better-informed economists in all of modern Europe, and sure enough Varoufakis slapped him down with relaxed ease. But we should still make no bones about this; the guy in the audience is completely illiterate economically. Not just slightly, completely. And so is anyone who agrees with him. For not only does a national economy work differently from a household budget, it in fact works the opposite way in several critical respects, as any activity put in has feedback effects that do not happen to the money people spend when they ‘go out for a few drinks’.
Let us compare; –
A household budget is linear; the household receives money at the beginning of the line, what we call the ‘income’, saves it for a while, then spends it at the end of the line, what we call ‘outgoings’. Before and after this line, the money is not part of the household budget.
An economy is a circle. The Government issues money via the Central Bank to pay for services, the money goes round and round the population, and then eventually it arrives back at the Government in the form of tax, whereupon more money is issued to pay for more services, and round it goes again, ad infinitum. The money does not leave the economy at any point in this circle (except when used for foreign trade, but even then it will probably soon be back).
The amount of tax a Government receives is directly proportional to the amount of activity there is in the economy. In which case, provided it is targeted sensibly, more spending will mean more activity in the economy and more money coming back in than was paid out.
This is little different from profit margins for a private company; a factory is useless for making money, unless money is invested to begin with on machinery, staff, raw materials and the like, and continued payments are needed for more raw materials, maintenance, ongoing wages and so forth. Without that investment, all you have is an empty building. A national economy without an outlay is also an empty building.
So when our esteemed audience-member with his checked shirt says, “It’s not difficult, guys!” he is wrong. Cutting spending in your private life is likely to result in you having more money, certainly. But for the nation’s Exchequer, cutting public spending usually means also reducing the income heading the other way, so it may not result in having more money. In fact, it can be a very delicate calculation, sometimes even dependent on luck, establishing what to target spending on, how much to spend in order to get the right feedback, and predicting precisely how much the feedback will be.
What is this calculation? Well, the term whose meaning we can be sure the guy in the checked shirt is unaware of is ‘fiscal multiplier’, which is roughly the public sector equivalent of a ‘profit margin’ in the private sector. A fiscal multiplier is the calculation of how much Gross Domestic Product activity is ‘fed back’ from an investment by the state. A multiplier of 0.5 means that the GDP activity generated is only fifty per cent of the amount invested. A multiplier of 1.0 means that the GDP activity generated is equal to the amount invested. A multiplier of 1.5 means that the GDP activity generated is fifty per cent greater than the amount invested. A multiplier of 3.0 means that the GDP activity generated is three times the amount invested. And so on.
Now, the International Monetary Fund revealed in 2012 that the average fiscal multiplier during the years of the Labour Government was 1.3, meaning a ‘profit’ of thirty per cent on average. And our current Chancellor of the Exchequer, the ever-beloved George Osborne, has spent the last five years hacking away at the services that generated these margins. The result has meant a net loss of wealth for the country. The growth in GDP that began two years ago only became possible after he slowed down the pace of cuts. (Even then, he was still lucky that the banks decided to start lending again.)
In fairness to Mr Checked-Shirted-Expert-On-Cambridge-Beer-Prices, he was not the only one in the audience who seems just to assume that spending cuts automatically mean less of a deficit. A few minutes earlier, a guy with glasses and what appeared to be a black eye was arguing that Austerity should carry on, and perhaps be spread to pensions. Pensions are funds that the retired have spent their lives paying into under a strict guarantee of regular payments in their old age, and therefore there are no moral or legal grounds for cutting them. But also, our bespectacled audience-member seems not to have considered what would happen to the economy if millions of pensioners suddenly lost money and had to reduce their spending accordingly. That would be an awful lot of businesses suddenly selling less to them, getting less revenue from them, and therefore forwarding less Value Added Tax to the Government. And lower tax-receipts for the Government by definition mean the deficit is going up, offsetting much or all of the downward pressure the initial cuts have applied.
See how it works?
Indeed, the latest figures released this week show that the deficit is going up again, even though spending is not. The reason for the increase is quite explicitly because tax receipts are going down, which was always going to happen sooner or later with Osborne’s occasional cutting frenzies. When you reduce spending that has a healthy fiscal multiplier, you make it more difficult to close the deficit. (That is, if you truly believe that closing the deficit down completely is a necessary thing to do, but I have discussed the drawbacks of that idea abundantly elsewhere. As has Professor Simon Wren-Lewis, who has a greater mind on this subject than mine will ever be).
The fact that fiscal feedbacks still need to be explained is depressing. Until a far wider expanse of the population grasps how economic cycles and state-spending really work, audience-panel shows like Question Time, at least when discussing economic issues, are never going to be worth the bother of watching.