Governments shouldn’t worry about red ink.

In this age of blogs, Twitter and newsfeeds the default position for most people is to ingest content that they find agreeable and which is presented in digestible chunks.  When 140 characters is the go-to format for most opinions, a 500 word piece for a blog or a newspaper is rarely on the menu.  Many of the arguments against the coalition government’s policy of fiscal consolidation have therefore attempted to conform to the preferred format of the content browsers who flit from one opinion tree to another.

This has meant that many opinions end up sounding shrill (Laurie Penny and Owen Jones, I’m looking at you) or failing to convey the subtlety that is important to so many economic issues.

An article by Oxford economist Simon Wren-Lewis in the latest issue of the London Review of books illustrates starkly why this is dangerous. (yes, it’s more than 500 words)

Public endorsement of the policy of fiscal consolidation (or austerity) has been fed by the presentation of the economy as being like a household or a business that has to balance its books to survive.  This simple analogy has been used by the Chancellor to demonstrate the Conservatives’ frugality and competence at economic management – everyone else has to try and stay in the black, so government should too.

This view has been mostly swallowed whole by the media and regurgitated to the public with little criticism. Media economic correspondents and commentators have tended to focus on the views of City economists who, as Wren-Lewis points out are generally either trying to be sensationalist or advance the interests of their investor clients.

The fact that the coalition government continues to poll well on economic management is based on the public having a completely wrong view of how a national economy actually works.  Regardless of whether you think the country would be better off with a smaller state, we should all be appropriately informed about the pros and cons are of the various ways of achieving it.

“Balancing the books” of government when the country is in a recession is a very bad idea. A very, very bad idea.

If a business or household is constantly spending more than it earns then its stock of debt will increase. For a business, increasing debt to make an investment can increase revenue, but using debt to finance your operations isn’t going to end well if there isn’t some external factor that is going to improve your margins.  Using debt to finance an investment is still risky as well because it may not pay you back – people might not buy the product, the oil well might be no good, the big machine may not be reliable.

When you’re running a national economy many of the constraints a business faces are absent.  For example, a government’s revenue comes from taxes.  Taxes increase with economic activity, either from income tax, corporate profits or consumption (via VAT).  Therefore, if a government can increase economic activity then they may be able to achieve a prolonged increase in tax revenue as people continue to spend money and add value with services and products.  Reducing current taxes is one way to do this – VAT was reduced in 2009 as a way to stimulated purchases.  Increasing spending is another way to stimulate economic activity.  Investment is a particularly good way to stimulate activity because an asset is created which generally delivers some improvement to the country’s infrastructure (better broadband connections, better roads etc, better school buildings) and also results in the people working on the infrastructure having more money in their pockets to spend on goods and services. The first effect is a bit risky; like the big machine, it may not work as intended.  However, if you pay a company to build a road then the workers and owners are definitely going to be better off.

The only thing that ever prevents this from being maximally effective is if people save the money they have.  In some countries this could be an issue: Japan and Germany.  However, one thing the UK population is particularly good at is spending money!

There are various ways to pay for these types of policies, but that is a separate issue.  The analogy of balancing the books with respect to budget deficits is completely bogus – the media should stop being so ignorant about the issue, academia should help them do this, and we the public should beware of politicians who present such simplistic arguments.

In 1925 Winston Churchill followed a similar policy to Osbourne’s in order to maintain the gold standard.  The British economy was crippled by debts to the USA after WW1 and Churchill’s attempts to ‘balance the books’ brought the country to its knees.  Things only really started improving with re-armament after 1935.  This was such an appalling misjudgement that John Maynard Keynes wrote a 32-page essay called The Economic Consequences of Mr. Churchill on why Churchill was an idiot.

If only Keynes were alive today (if only…), he would have written The Economic Consequences of Mr. Osbourne, and he would have been able to summarise it in 140 characters.


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