Having spent a long time researching and understanding economics, I’ve noticed a variety of bizarre economic claims in the political campaigning of recent weeks. The below is intended to give you a 10-minute crash course in understanding the economics of government.
Government debt is not like credit card debt
Lib Dem leader Nick Clegg claimed, in the latest 7-way election debate, that not cutting the national debt would be like him and his wife not dealing with a credit card debt. Not quite. Not at all, actually. A government is a rule of an entire country, which has its own economy. This means that things are very different when the government borrows money than when an individual person borrows money.
A government, for instance, can enact policies that raise standards of living, increase employment rates, raise wages and therefore naturally decrease the value of money. This might seem all very complicated, but it’s really not. Things naturally cost more as time goes on; as prices for things rise, wages rise. There’s no need to go into the more complex historical reasons why this happened, or why it continues to happen, but it directly affects debt. Here’s why:
An individual’s credit card debt will not greatly decrease in value, regardless of inflation (a decrease of the value of currency), because the rate of interest in these relatively small levels of debt is almost always large enough to significantly increase the value of the debt above inflation. I’ll explain with the use of an example, in case your head is already spinning (don’t worry, this is the most complicated bit!). Imagine the interest on a credit card is 15%, which means 15% of the debt is added again annually. Inflation might only be 2% (this means the value of things has increased by 2%, so the value of money has decreased by roughly 2%). So in this example the interest-driven rise in the debt (15%) far outweighs any attempt by inflation to decrease the value of it (2%).
By contrast, government levels of debt are huge amounts of money (trillions), with relatively low amounts of interest (2-3%), and therefore inflation can reduce the value of the debt over time without reducing the actual amount of debt. By decreasing the value of money itself – as strange as that sounds – governments can decrease the relative value of their debt.
Clegg’s analogy of credit card debt is therefore a poor and inaccurate one, which is why it is so confusing. A better one would be the example of a farm. Imagine you have five milking cows, but you owe another farmer a cow. You can give him that cow now, and reduce your own milk stocks by 20% immediately (1 in 5). Alternatively, you can keep the debt until each of your cows have given birth, and each of those new cows have given birth. The interest on the debt might have doubled due to interest, as you’ve taken so long to pay the debt, meaning you now owe him two cows. However you have now grown your collection of cows to 15 rather than 5. So your debt is only worth 13% of your wealth, rather than 20%. Had you paid your debt immediately, not only would you have paid more of your wealth than you otherwise needed to (by using the cow in the meantime), but you would also now have fewer cows than you do; you would have had 4 cows reproducing, leaving you with 12 cows altogether. Because you waited to pay your debt, and invested that which you could have paid as debt, you ended up with more capital and a less economically damaging debt too.
This is a great analogy for explaining the relation between GDP (the total amount of money the country has). When GDP is low, and things aren’t great, you can stimulate a better economy by borrowing more – another cow. Then, when things are better, you can pay more back, but the debt will have paid for itself.
The analogy isn’t perfect: it only works if your economy does actually increase. However an extra cow is an extra 1/13th of an economy. On a farm it’s just one cow, but 1/13th of an economy is huge amounts of money. It is also useful to mention that the UK has previously suffered national debt which is much higher a percentage than it currently is. We have more debt than ever before, purely as there are now more £-sterling that we owe, but we aren’t in a worse position than ever before. Don’t let the credit card analogies fool you.
Austerity hasn’t necessarily helped our economy
The Conservative argument is that cutting our budget deficit significantly has helped our economy out of recession. They argue we need to keep going to finish the recovery. Well, first of all, interest rates still haven’t risen, which means we are still begging people to spend (higher interest rates are used to encourage saving – as it rewards money saved in bank accounts). We would move this up a little, to help our long term economic future, if we believed we were recovering already. Let’s also consider that whilst the budget deficit has fallen (the difference between the amount we spend and the amount we have, prior to borrowing), the actual debt hasn’t. These points are interesting, but don’t tell us whether austerity has helped or not. The opposite of austerity economics certainly has a point which should be heard, though.
Keynesian economics argues that you actually need to increase public debt – in the same way as the farm analogy which I mentioned in the last section – if you want to grow an economy. And also increase public borrowing, as well, most of the time. This is relatively rational. To get people spending, you need to give people jobs; income to spend. That involves employing people to build roads, work in hospitals, etc. You have less jobs and less income if you cut public spending in order to reduce a budget deficit. Hence the farm analogy is very attractive.
The Conservatives evidence to counter this is that we now have two million more jobs than five years ago, and that this shows austerity is working. It really doesn’t. First of all, five years ago we were in the midst of a global economic collapse. Most of which was not even caused in Britain. Unemployment rocketed, largely due to issues out-with the UK, which knocked into us like falling dominoes. As things have improved gradually elsewhere, especially in the USA, Spain, etc, we have been in a naturally better economic place to benefit – regardless of austerity – as our economy didn’t quite collapse as it did in places where our competitors are (like in Spain, Greece, Ireland, etc). We had far too many advantages to claim that austerity was the cause.
Arguably, in fact, less austerity would have meant more public spending, therefore higher wages, higher sales profits for private UK companies and therefore a greater ability to take advantage of exporting. In turn, our economy would have grown faster in relation to our heavier disadvantaged competitors. We can’t know for sure, but the argument for austerity is shaky at best. We do know that this has been the longest recession for a long time, and that many economists have been making the case against austerity and the ‘confidence fairy’ it claims to be. Why do they call austerity a ‘confidence fairy’? Because there’s no evidence that slashing government debt encourages any kind of economic growth, and there is some evidence that the opposite is true (such as previous depressions). The economy will arguably, eventually, start growing again regardless of whether we make cuts or not, and there’s no real way to tell whether the cuts have slowed or sped it up. I’d bet on the former, given the evidence we’ve so far talked about.
If business leaders back a party, it’s got nothing to do with the economic strength of their policies.
Another Conservative economic tactic of recent times – indeed of several past governments – has been to produce documents, signed by business leaders, saying that a certain parties’ policy on the economy is working (or will work).
Unfortunately, not only are business leaders subject to the same political bias as the rest of us, they are also not great judges of economic policy. Businesses, as a purely structural matter, are interested in medium levels of unemployment (leaving it high enough to allow a good pool of desperate workers, but low enough to mean people buy their products), as low taxation as possible (to increase profits) and an environment with as little competition to them as possible. Not to mention restrictions on companis in emerging, competing industries (the oil industries’ views on alternative energy, for example).
An economy requires objective decisions by neutral parties, taking account business wishes but also those of the businesses, workers and consumers. Very seldom do companies agree wholesale with even the consumers, in fact, who generally benefit more from increased competition, higher taxes and lower unemployment. If you want to judge how good your economic policy is, business leaders – with their necessarily biased interests – should not be anywhere near the top of your list.
Did the Labour party put us in a dire position by increasing debt too much?
The Labour party took control of Britain for 13 years, from 1997 until 2010. They followed a Conservative government who governed the country for even longer – 18 years – and arguably through a culture which changed greatly from the late 70’s to the late 90’s.
The Conservative agenda for those 18 years had been set by Thatcher and consisted of some fairly unpleasant policies if you were poor or left-inclined. These kind of hostile political decisions were justified by all kinds of economic theory which we no longer have evidence for – such as ‘trickle down’ economic beliefs, in which they thought the rich would essentially create wealth for us to share (through paying more taxes, even though they didn’t pay much higher ratios of tax). It didn’t work out that way, for reasons which seem obvious now but which were labelled as pessimistic and ideological back then.
Labour certainly shifted to the centre in order to hoist the right-wing Conservatives from power (infamously referred to as New Labour), however they kept a good deal of their sentiment for the left. Increasing public spending was a large part of this: we had been suffering from some fairly bias and poor economic decisions – especially regarding the tax on the wealthy – for many years, and as a result there weren’t as many taxes coming in as their needed to be.
As a moral decision, you can make your own mind up as to whether Labour were right to increase public spending. I believe it’s a no-contest ‘Yes’. However they could not do it through immediately doubling the tax on the wealthy, or anything so controversial, as they would not have been given the keys to government had they done this. You still have to please the voters, and voters, for some reason, still see much higher taxes on the rich as somehow economically disastrous (at least they did then). So Labour’s option was to get the economy flourishing and to reduce social issues, by increasing spending. Economically speaking, they made mistakes – especially with regards to banking regulation – however it is very difficult to argue that they didn’t do well on the economy. It did flourish, and only a global economic collapse wrecked that. Similarly, you can’t justifiably argue they spent too much, or wasted too much, as in many ways they were rebuilding a public sphere of services that the Conservatives had spent 18 years minimising (decimating, almost).
As time goes on, of course you can make these systems better and more efficient – which is, ironically, something the current Conservative government has begun doing. But I can’t see an argument that says Labour spent too much. They were elected to do this, and they did it. They kept the economy flowing, and not one other political party predicted the financial collapse, which was the real stinger of our public debt.
You can’t disagree with economic growth and economic austerity – the two are incompatible (sorry, Greens)
The theory of anti-austerity economic policy, as earlier mentioned, stems from Keynesian economics. The primary belief of this is that higher public spending is the best economic policy – especially in recessions – as it helps to grow GDP (our annual pool of money – the total of products and services we sell, essentially) faster. Government debt isn’t like a credit card, its value is determined by its relative size to GDP, so you can potentially rack up more real debt whilst declining its relative value. It’s pretty clever, and its worked before. You can also describe it like a farm, if you are so inclined. You can certainly get it wrong: borrow too much, increase the debt too much, etc. But it can work.
However, some parties, like the Greens, embrace anti-austerity policy but also think economic growth is a folly too, as they believe it is unsustainable. This doesn’t make sense. You can happily embrace anti-austerity policy, as you can find ways of making increased debt pay itself off when you are in government. But you can’t do this whilst thinking that economic growth is unsustainable, else you’ve contradicted yourself by saying that increasing public debt can’t be dealt with.
It might sound like a clever middle finger to the banks, who are lending you the money, but if you’re not paying it back, not growing your GDP, and gradually borrowing more each year, then your credit rating will drop. Whether you like it or not. After that? Interest on debt that you borrow will increase, and, eventually (in the not too distant future) banks will stop lending to you altogether as they see you as a bad debt. That’s when economic policy does become like credit card debt. Eventually, people won’t trust you to lend you anything.
What happens to society after this stage is not so difficult to work out: austerity measures. When public services are no longer funded because you can’t get the funding, it means forced austerity. Or, more likely, before we get anywhere near that the government would get a vote of no-confidence and be banished from the controls. At which point a pro-austerity party would almost certainly be voted in, as a backlash to the perceived ‘freeloading’ of the previous government.
To summarise: a lack of consistency between beliefs about austerity and economic growth is disastrous. Austerity can be opposed, but only by belief in and focus on economic growth, whilst economic growth can be opposed, but only by including immediate spending cuts and reduction of national debt.