The UK Observer Editorial yesterday (October 30, 2011) – The economy: we need Plan B and we need it now – was focuses on a so-called Plan B that has surfaced as the progressive democratic alternative to the now failed Plan A which the British government has been ideologically ramming down the throats of its citizens since it was elected in May 2010. Plan B was put together by the UK Compass Organisation and apparently (in the words of that organisation) represents where “where is the left on the economy”. My reaction is that if that is what goes for “left” these days then what do we call “right”. If this is what goes for progressive economic analysis then what happened to progressive. Today’s blog thus continues my theme – When you’ve got friends like this – and constitutes Part 7 of that sequence. The main thing I find problematic about these “progressive agendas” seem to be falling for the myth that the financial markets are now the de facto governments of our nations which becomes a self-reinforcing perspective and will only deepen the malaise facing the world. The essence is if Plan A has failed and Plan B is as outlined by Compass then the world desperately needs Plan C.
The Compass Organisation promotes itself as providing “direction for the democratic left” but my feeling is that the way in which it characterises macroeconomics and, specifically, the way the monetary system operates, will only serve to retard the progress of the construction of a credible and enduring left economic policy position.
I am not attacking the ideals or the motivation of the Compass Organisation. I suspect that there is a high degree of overlap with my own ideals and motivations. But when organisations step into the economic debate and present what are incorrect logical or conceptual arguments which are in no way different to the essential underpinnings of the stereotypical neo-liberal myths then I think they do the progressive side of the argument a disservice – no matter how well-intentioned the authors may be.
That is the basis of my series – When you’ve got friends like this. These self-styled progressive left agendas are based on faulty understandings of the way the monetary system operates and deny the opportunities that a sovereign government has to advance well-being.
Progressives today seem to be falling for the myth that the financial markets are now the de facto governments of our nations. It becomes a self-reinforcing perspective and will only deepen the malaise facing the world.
The Observer Editorial is similarly mislead and chooses to rehearse the Plan B in an uncritical manner. Again this serves to reinforce the arguments that progressive will have to refute in order to create an educated space to develop the alternative policy framework which appeals broadly to the intuition of the voting public. At present that public is so consumed by neo-liberal constructs that a mass education campaign is required to debrief the voters. The motivation for my blog is to provide a little bit of progress towards that goal.
I was a speaker at an “alternative” conference in Sydney on Saturday. I see these functions also in terms of my role as an educator. In this case, the participants were broadly well intentioned with solid democratic values and a penchant to redress societal ills and advance equity and inclusion.
But a strong shared sentiment among this group (which I detect among the Occupy movements around the world) is that they are demanding governments to balance budgets, the banks to be prevented from issuing credit and the economy to be returned to a gold standard with fixed exchange rates. That would be the more moderate “progressive” desire.
The more vocal “progressives” want local currencies to spring up and run parallel with national currencies and to “share the unemployment” by cutting the wages and hours of work of those currently employed and introducing income guarantees.
My talk on Saturday was that if they pursued these policy agendas they would deny the economy the capacity to deliver progress towards their aspirations and goals and would be playing right into the hands of the power elites.
I argued that progressives have to come to terms with the fact that currency-issuing government sector has to be at the apex of the monetary system if they want to achieved goals such as full employment and equity (recognising broadly defined concepts of productive employment).
The challenge is to ensure the citizens control the government they elect not the financial and corporate elites. The elite capture of our governments is the problem not the existence of government as a monopoly issuer of our currency.
On the “sharing unemployment” point there was a strong sentiment expressed by this group (and I have heard it regularly at like functions) that people should work part-time and re-connect with higher order values. I am happy that people can find contentment by adopting a low material standard of living and reduce their reliance on paid work for their sense of being and welfare.
But to impose that choice on everyone is draconian and that is why I advocate there being enough work made available to satisfy the preferences of the workforce. By adopting notions such as “sharing unemployment” we essentially acknowledge the neo-liberal constraints that politicians have voluntarily imposed on themselves by which they deliberately choose to suppress aggregate demand and thus run the economy lean of working hours.
Why would we want to accept that artificial constraint which plays into the hands of the power elites who desire some surplus labour to keep wage demands under control. This is one of the reasons the distribution of national income has swung dramatically away from wages towards profits over the last two decades in many advanced nations.
The real income that has been redistributed to profits away from wages has provided the wherewithal for the spectacularly obscene executive salaries that have emerged over this time and the “casino chips” for the financial sector to play with at our collective expense.
The reality is that only a small minority will adopt the ascetic lifestyle and “sharing the unemployment” would only inhibit the happiness of the majority. Full employment is the best way to rebalance the labour market towards a more equitable collective bargaining environment.
My view is that we have to eliminate unemployment not share it.
So that was background. I read the Compass Plan B report after I had returned from the workshop in Sydney and just thought – not more of the same.
First, on points of agreement. It is clear that Plan A is not working for Britain. It has sabotaged the emerging recovery and on many fronts – unemployment, consumer and investor confidence, real wages, household income, real GDP growth, manufacturing activity, housing etc – it is failing. The most important economic indicators are all suggesting the British economy is heading backwards and will continue to languish for some years to come.
Eventually it will recover – but from a level that is both dire and unnecessary. A government cannot argue that its austerity strategy has been successful when growth eventually emerges if along the way it has left a trail of damage. I realise this is the sort of nonsense that is now being used to justify the Irish austerity plan. Ireland will grow again – but from what base?
Plan A has to be rescinded immediately. It is as the Compass Organisation says:
… an act of economic sado-masochism …
If I had have included the full quotation where they made that judgement you would begin to see the problem immediately.
They talk about the need to get the “structural deficit” down in Britain and use terms like leaving “the public finances in a worse state than ever by 2015”. So an uninformed but intelligent reader would be perfectly within their rights to conclude from this that budget deficits are bad and larger deficits are worse.
Modern Monetary Theory (MMT) tells us that there is no meaning to terms like “deteriorating public finances”.
First, the movement in the budget balance does not send a clear signal about the discretionary choices of government. That is because of the operation of the automatic stabilisers which lead to budget deficits rising as tax revenues collapse and welfare payments rise during a downturn in economic activity. So in this case a rising budget deficit will signal undesirable economic developments – rising unemployment and falling economic activity.
But the budget deficit might also rise as a result of the government expanding their discretionary spending to support the desire to save in the private sector. In this case employment growth might be strong, unemployment low and the economy close to capacity. That situation would signal a virtuous conjunction of events.
So the ambiguity is clear – and should disabuse us from focusing on the budget outcome per se. It is the real economy that is of importance and that should always be the focus of our attention.
Second, and in that context, the Compass Organisation displays no understanding of the concept of a “structural deficit” other than it is what is left after you take the cyclical (automatic stabiliser) component out of it.
The section of the Report (Section starting Page 11 – “Cyclical or structural deficit?”) could have been written by a moderate mainstream macroeconomist. It recognises that “public finances are affected by the business cycle” as noted above and that the “structural deficit is the size of deficit that the UK would be running if the economy was operating at full employment”.
All economists will agree on that no matter what their ideological or theoretical position is.
But then we read:
… before the Great Recession of 2008, the UK economy was running a small structural deficit of around 1% (excluding investment spending, which is vital for generating future growth potential). In retrospect this was unwise, as was the preposterous claim that ‘boom and bust’ economics had been abolished, and the UK would have weathered the Great Recession better if the public finances had been running a small structural surplus.
So you can see the Compass Organisation is trying to distance themselves from the mainstream by rejecting the “Great Moderation” rhetoric (the “business cycle is dead” rubbish) that was an increasingly popular view among economists in the decade before the crisis and which justified the claim that the only reasonable role left for government was to dispense with fiscal policy tinkering and, instead accelerate microeconomic reforms such as more deregulation of labour and financial markets.
Please read my blog – The Great Moderation myth – for more discussion on this point.
But then consider the view that “a small structural deficit … was unwise” and that a “small structural surplus” would have allowed the UK to weather “the Great Recession better”.
Recall that the UK was running current account deficits throughout this period, which means the external sector was draining demand. Additionally, the private domestic sector was increasing its levels of indebtedness significantly over this period as the speculation of housing prices dominated the economy.
The UK economy also did not achieve full employment during this period. The collapse in the British economy was not due to the small budget deficits (whether they were structural or not is debatable).
The collapse occurred because the private credit bubble burst and households and firms began the long journey that will be necessary to restore the health of their balance sheets.
Given the economy was not at full capacity at the time the bubble burst the deficit can hardly be seen to have been pushing aggregate demand too fast. The problem was that private demand was being driven by credit growth and less by real wages growth. That was always going to be an unsustainable growth path.
Had the government been restraining the growth process via structural surpluses (that is, imparting fiscal drag on spending) then the crisis would have been deeper more quickly once the private domestic sector started to constrain their spending.
This also puts the proposition that a prior budget surplus would have allowed the economy to weather the crisis more easily. That is absolutely false. It would have made the crisis worse.
A sovereign government such as exists in Britain has no revenue constraints because it issues the currency. It can always respond to the need for increased public spending whether it has been running prior deficits or surpluses. Prior surpluses do not increase its capacity to spend in the future.
That proposition is a basic neo-liberal myth which is based on the erroneous government budget constraint that is the centrepiece of mainstream textbook chapters on fiscal policy.
It gets worse though.
The Compass Report says:
The UK is not ‘on the verge of bankruptcy’ as George Osborne and other adherents of Plan A have claimed.
That is exactly correct. George Osborne and David Cameron lied to the British people when they said that. Repeatedly lied. The justification for the fiscal austerity (Plan A) which the British government has sadistically imposed on the economy has as much credibility as the lying stories about WMD that were used to justify the invasion of Iraq. The UK were also party to that disgraceful abrogation of democracy (in the nations that invaded!).
So what is the problem? Here is the logic the Compass Report uses to justify that correct assessment:
First, any business would accept that running a debt to pay for investment spending, which can produce returns later, is totally acceptable – indeed it would be bad economic policy not to invest in such circumstances. Similarly, deficit-financed government investment spending delivers returns to the economy later on … Second, the vast majority of the current public finances deficit and the increase in the national debt has been caused by the severe economic recession of 2008–2009 … and was therefore largely unavoidable.
Comparing a sovereign currency-issuing government with a financially-constrained private corporation which has to “use” the issued currency indicates a lack of understanding of the difference between “issuer” and “user”.
The government budget constraint literature is based on this miscontrual – it claims that the government budget is just like a household budget only larger. Neo-liberals claim that governments, like households, thus have to live within their means.
When British Prime Minister David Cameron said that the government deficit is just like credit-card debt and that Britain was facing bankruptcy, he was invoking the false neo-liberal analogy between national budgets and household budgets. This analogy resonates strongly with voters because it attempts to relate the more amorphous finances of a government with our daily household finances.
We know that we cannot run up our household debt forever and that we have to tighten our belts when our credit cards are maxed out. We can borrow to enhance current spending, but eventually we have to sacrifice spending to pay the debts back. We intuitively understand that we cannot indefinitely live beyond our means.
Neo-liberals draw an analogy between the two, because they know we will judge government deficits as reckless.
But the government is not a big household. It can consistently spend more than its revenue because it creates the currency. Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like whenever there are goods and services for sale in the currency they issue.
Budget surpluses provide no greater capacity to governments to meet future needs, nor do budget deficits erode that capacity. Governments always have the capacity to spend in their own currencies.
The Compass Report in this regard would leave an uninformed reader indifferent between their narrative and the standard neo-liberal explanation of debt.
The reality is that a sovereign nation like Britain can never become bankrupt for financial reasons – that is, an inability to service their public liabilities. A crazed government might for political reasons choose to default but that would be unrelated to their underlying capacity to always be able to spend.
There is no solvency risk entailed in rising budget deficits and accompanying public debt buildup for Britain. That is the message the progressive agenda should be hammering home as part of a re-education process.
Not that it is okay to borrow sometimes because just like a private company it is normal to pursue a rate of return.
It would also be okay to borrow and burn the funds if the government wanted to! I don’t advocate that but there would be no solvency risk in doing so. Public education has to provide valid information.
The Compass Report is not the slightest bit progressive in its narrative or construction.
Another claim is that the current British government deficit equivalent to about 10 per cent of GDP is “structural” because:
… the recession was so deep that it permanently destroyed productive capacity, particularly in the financial services sector, which had contributed large amounts of tax revenue in the run-up to the crisis, and then required huge bailouts during the crisis itself – amounting to over 100% of annual GDP in 2009 according to calculations by the IMF.
The collapse in tax revenue was cyclical. In the next paragraph they somewhat confuse the reader by referring to a Cambridge academic who said that “a careful reading of the evidence suggests that at least some of the so-called structural deficit is actually a particularly acute cyclical deficit – the economy is operating well below full employment and full capacity utilisation, largely because spending cuts in the UK and elsewhere in the global economy have reduced demand”.
So what is it – structural or cyclical? But moreover, why concentrate on the headline figure? We know that a budget deficit of 10 per cent of GDP at present is inadequate because of that ” the economy is operating well below full employment and full capacity utilisation”.
Why not just concentrate on that rather than making the deficit outcome the topic of the conversation. As an educational construct, the focus on the structural-cyclical issue is misleading.
It gets worse.
Under the section entitled Interest rates, austerity and the ‘bond vigilantes’, the Compass Report correctly criticises the current British government for claiming that:
… the deficit has to be reduced as a matter of urgency … otherwise we will face action by the ‘bond vigilantes’ in the market for the UK’s sovereign debt.
The Report then proceeds to discuss Eurozone issue and claim that imposing “savage austerity measures – involving huge spending cuts and tax increases in an attempt to eliminate the structural fiscal deficit – has actually made the interest rate problem worse”.
Yes they have but what has that got to do with Britain which operates within a totally different monetary system where the national government issues the currency in use (rather than use a “foreign currency” as the member EMU nations are forced to do) and has no intrinsic dependence on the international bond markets?
When an analysis conflates two very different monetary systems – which provide very different opportunities and impose very different constraints on governments within them – you can conclude that these differences are not well understood.
Mainstream economists continually make this error. The US, Australia, Japan, Britain and most other nations (even South Sudan) do not operate like the EMU nations.
Please read my blog – Who is in charge? – for more discussion on this point.
Which makes a mockery of the Compass Report’s attempts to be “reasonable” when they say:
This is certainly not to say that deficits can be ignored completely ad infinitum, or allowed to explode upwards uncontrollably … While the UK has not (yet) been in any danger of attention from the ‘bond vigilantes’, this is largely because as a country with our own currency we have been able to undertake a substantial devaluation to keep our exports competitive – which is not an option open to Eurozone members. But over the next few years it is much more likely that extreme austerity will result in a sovereign debt crisis for the UK than that such a crisis will be caused by high levels of public debt.
It is true that the British economy has a flexible exchange that can respond to trade imbalances in a way that the EMU nations individually cannot. But the depreciation of the pound is not the reason the bond markets cannot get enough of British government debt.
The reason lies in their observation – that Britain is “a country with our own currency”. That is the reason. There is no solvency risk because the British government issues its own currency.
That is where the public education emphasis should lie.
Which then makes the last claim that Britain will face a greater “sovereign debt crisis” under austerity than otherwise to be total nonsense. The capacity to issue their own currency does not necessarily stop the private bond markets from taking negative positions on the government’s debt. It usually will mean that the bond markets will desire as much of that government’s debt as they can get (other things equal).
But what it ultimately means is that the government (consolidated treasury and central bank) always have the capacity to deal the private bond markets out of the equation should they become problematic.
In the EMU, no single member state can do that. Only the ECB has that capacity and is currently demonstrating it every day. The British government can always control yields should it wish to and can, if it chooses, not issue debt at all and still spend.
So unless the government mismanages the situation (by denying its own capacities) then there can never be a sovereign debt crisis in Britain like there is currently in the EMU. Clearly the ECB is demonstrating – not that any of the Euro elites care to talk about it in this way – there is no real sovereign debt crisis in the EMU either. There is a solvency crisis which the ECB could resolve categorically any time it chose.
The fact that the EMU economies are being subjected to vicious austerity measures is a political choice not an economy inevitability. Sure, private spending collapsed. But government spending should have replaced it and the ECB could have funded that fiscal expansion without problems.
They have only started funding the deficits when the inherent solvency risks of the Eurozone monetary system became acute. No such risks exist for Britain and the Compass Report is playing into the hands of the neo-liberals for claiming otherwise.
I am running out of time today so I will only consider their Plan B – their so-called “left” alternative – briefly. There are many things I agree with but among the logical inferences there are also some “howlers”.
We agree that labour and financial market deregulation under the neo-liberal policy regimes was excessive and contributed to the crisis in an intrinsic way. Their inference that the collapse of the Bretton Woods system was tied up with the financial deregulation is unfortunate.
The return to flexible exchange rates allowed governments to use fiscal and monetary policy to maximise domestic outcomes (public purpose) with external constraints. It did not necessitate the excessive financial market deregulation that followed. The two developments are not logically connected at all.
Further, while progressives think that fixing exchange rates will somehow reduce damaging speculation the opposite is the case. The correct approach to the inherent speculative attacks on a currency are to regulate and/or ban financial transactions that do not contribute to real gains in the economy. So the problem is not the flexible exchange rates (which free domestic policy instruments) but the lack of financial market regulation.
The Compass Report, however, falls prey to the fixed exchange rate argument:
One function of global governance would be to establish a more stable international exchange rate regime and a mechanism that prevents excessive current account imbalances.
Please read my blogs – Gold standard and fixed exchange rates – myths that still prevail and An international currency? Hopefully not! – for more discussion on this point.
The other short-run policy suggestion under Plan B that is worth noting is their concept of “Green quantitative easing” (from Page 19). They say that:
But using QE to give banks a further £75 billion in the hope that this time they will lend enough to business will be a hugely unproductive missed opportunity. QE should instead have been used to increase economic activity and hence jobs and business opportunities. Without that the policy fails to address the real problem, which for many businesses is increasingly a shortage of sales and not a shortage of capital.
We recommend instead using a large scale package of QE to finance a Green New Deal to make all UK buildings energy efficient. This would help kick start the economy by training a ‘carbon army’ to implement a multi-billion pound, carefully costed programme to fit energy efficiency and appropriate renewable genera- tion equipment to all UK buildings, thus gener- ating tens of thousands of jobs where people live. The savings from household and business fuel bills would be recycled into the UK economy, providing a further badly needed stimulus.
I am lucky I have a full head of hair!
Please read my blog – Quantitative easing 101 – for more discussion on this point.
Then you might like to read the following blog – Building bank reserves will not expand credit.
QE merely buys bonds held in the private sector so as to keep the yields in the maturity segment of those bonds down. The hope was that the lower interest rates would stimulate borrowing.
The central bank purchased bonds and credited bank reserves accordingly. Even the most primitive understanding of the way the banking system operates tells us that banks do not lend reserves – they are used to provide integrity to the payments system.
Further, the restrained bank lending has nothing to do with the banks not having enough liquidity. That is the neo-liberal myth that you will find in chapters on money demand and supply in their textbooks.
Banks can create liquidity at the stroke of a pen. Their lending is never reserve-constrained. Please read my blog – Lending is capital- not reserve-constrained – for more discussion on this point.
Banks will lend to credit-worthy customers whether they be “green” or whatever. If there are viable “green projects” and entrepreneurs who can make an adequate business case around those projects then banks will extend credit.
We do not need QE for that to happen. To think otherwise is to totally misconstrue the way the banking system operates.
If the British government is keen to fund green projects and “improved transport infrastructure and the building of homes on brownfield sites” then it doesn’t need to engage in QE. It could simply credit bank accounts upon HM Treasury’s instructions to the Bank of England and let the deficit increase accordingly.
Overall, I agree with many of the policy proposals put forth in the Compass Report although I cannot understand why they do not propose widespread public sector job creation. I also disagree with several of their policy proposals.
Many of them are very “private enterprise” biased whereas for a green economy I consider the balance between public and private has to shift strongly to the public using more resources over time – providing sophisticated non-carbon services etc.
This blog has thus concentrated on the negatives and I have only highlighted some of the negatives. There are many. But I realise that this approach does not give you much idea of where the agreement lies. You can read the whole Report and make up your own mind. I didn’t have enough time today to write anymore.
But the principle issue is that the economic argument is clothed in the same erroneous monetary constructs that neo-liberals use to attack government. As an educational device the Report – therefore – becomes part of the problem!
That is enough for today!