Category Archives: Fiscal policy

Whoever won the debate, economics lost

bal-clinton-trump-debate-a-bad-tv-night-for-the-reality-tv-star-who-would-be-president-20160926-1

You lose

I try to avoid politics on this blog and keep it focused on economics but sometimes politics and politicians just won’t leave economics alone. When that happens you have a right and possibly a duty to check what they are saying. After watching last Monday night’s presidential debate between Hillary Clinton and Donald Trump, one thing we can say with depressing near certainty is that the next president of the United States will be almost totally clueless about economics.

Hillary Clinton

Investment vs spending

Hillary Clinton seems to have discovered Gordon Brown’s old trick of referring to every penny piece of government spending as ‘investment’. She would not be spending money on this, that, or the other, rather she would be investing money in this, that, or the other. “I want us to invest in you. I want us to invest in your future.”

But investment isn’t just another, cuddlier term for spending. It actually means something. When you invest you are spending money in such a way as to increase your future income. If a driving licence will enable you to get a high paying job then paying for driving lessons is investment. If you spend money on food and clothes, necessary as that me to keep you going in the here and now, it is consumption spending, it is not investment. There are greyish areas. A suit bought for a job interview is clothing and also an investment.

Government can invest but it often doesn’t do it very well. Look, for example, at the histories of Britain’s coal and steel industries. Both had vast sums of money lavished on them by government with the aid of dragging them into the late twentieth century. Almost all of that money was wasted, going on higher wages – consumption – rather than actual investment. But that’s politics. Miners and steelworkers vote. Modern machine tools don’t.

Simply put, an enterprise which, via the government, has access to taxpayer funding has no bottom line to worry about. They can be as inefficient as they like, they will be bailed out. And, yes, many banks are an example of this these days. Competitive businesses however, with access to no funds other than those which people will give them willingly (either as loans, investment, or payment for goods and services) have to worry about their bottom lines. They have an incentive to invest profitably, not in whichever direction is most expedient over the election cycle. And if they get it wrong, they carry the can, not the taxpayer, ie, you.

As an illustration, Clinton gave the politically popular area of renewable energy as an example of somewhere she’d invest: “Take clean energy. Some country is going to be the clean- energy superpower of the 21st century”. The experience of Solyndra – a politically well connected solar panel producer which took took $535 million of taxpayers money and went bust without producing a single solar panel – doesn’t bode well.

Tax the rich

Clinton claimed that she would be able to pay for all this ‘investment’ by taxing the rich. “Because what I have proposed…would not add a penny to the debt…What I have proposed would be paid for by raising taxes on the wealthy, because they have made all the gains in the economy. And I think it’s time that the wealthy and corporations paid their fair share to support this country.”

I’ve written before about the futility of British governments trying to wring a greater share of the national income out of the public in tax revenue: “Whether the top rate of income tax is 83%, as it was in the 1970s, or 40%, as it was in the years before 2010, the British people seem to have decided in some mysterious way that 35% of their income is all the government is going to get.”

Something similar applies in the United States. As you see in Figure 1, in the ten years 1972 to 1981 inclusive, the top rate of Federal income tax was 70%. Over those years the share of national income taken in by the Federal government in tax averaged 11.67%. Over the ten years from 2003 to 2012 inclusive the top rate of Federal income tax was half that level, 35%. And, over those years the share of national income taken in by the Federal government in tax averaged 9.83%: a difference of 1.84 percentage points.

Figure 1

picture1

Source: World Bank and the Tax Foundation

You can take any message you like out of Figure 1 depending on which bit you choose. The steep rate cut in 1982 was accompanied by a decline in the share of national income taken by the federal government, but the even steeper cuts of 1987 and 1988 were followed by no such decline. Rises in the top rate of federal income tax from 1991 to 1993 might have started the rise in the federal government’s share of national income beginning in 1993, but this rise continued until 2000, seven years after the rate stopped rising. Indeed, since then, if anything, it looks as though it is changes in the federal government’s share of national income which have led changes in tax rates.

Indeed, as Figure 2 shows, the share of the US national income taken by the federal government in tax seem more closely correlated, in recent years at least, with economic growth.

Figure 2

Picture2.jpg

Source: World Bank and the Tax Foundation

The policy lesson would seem to be that if you want the government’s share of national income to rise you’re better off working to get the economy growing rather than tinkering with tax rates.

Clinton also blamed the housing boom and bust of the 2000s on the Bush tax cuts. “Well, let’s stop for a second and remember where we were eight years ago”, she said, “We had the worst financial crisis, the Great Recession, the worst since the 1930s. That was in large part because of tax policies that slashed taxes on the wealthy, failed to invest in the middle class, took their eyes off of Wall Street, and created a perfect storm.”

In am not aware of a serious economist, in their serious work at least, who thinks that tax cuts were even in part behind the housing bubble and its bursting. Indeed, there is a surprising amount of consensus that the causes were monetary, not fiscal.

Joseph Stiglitz has written that following the burst of the dot com boom in 2000

“…Greenspan lowered interest rates, flooding the market with liquidity…[the lower interest rates] worked – but only by replacing the tech bubble with a housing bubble, which supported a consumption and real estate boom”

Nouriel Roubini wrote

“The bubble eventually burst in 2000, and Greenspan’s Fed responded by slashing interest rates by 5.5 percentage points – from 6.5 percent to 1 percent – between 2001 and 2004. The rising tide of easy money helped cushion the bursting of the tech bubble, but it fed another bigger bubble in housing”

Thomas E Woods writes

“That year [June 2003 to June 2004] saw eleven rate cuts. The unsustainable dot-com boom could not, in the end, be reignited…But the Fed’s easy money and refusal to allow the recession of 2000 to take its course led to an even more perilous bubble elsewhere”

The gender wage gap and the minimum wage 

Beyond this, Clinton showed that she is interested in solving problems that aren’t problems and using solutions that aren’t solutions. Paradoxically, she claimed that, while cutting regulations for small businesses, “We also have to make the economy fairer. That starts with raising the national minimum wage and also guarantee, finally, equal pay for women’s work.”

As has been pointed out time and time again, the gender pay gap is a myth. The oft repeated charge that “the typical woman who works full-time earns 79 cents for every dollar that a typical man makes” is completely bogus. It is derived simply by taking a ratio of the difference between women’s median earnings and men’s median earnings: 21 cents. It takes absolutely no account whatsoever of the different types of work men and women do. When factors like that begin to be figured in the gap disappears.

Indeed, Clinton herself might not actually believe it. At one point in the debate she said “(Trump) doesn’t think women deserve equal pay unless they do as good a job as men”, leaving me asking “Well, what’s wrong with that?”

Clinton also said she would raise the federal minimum wage as part of an effort to help the middle class (a policy Trump also supports). It will do no such thing. Put briefly, if an employer estimates that a worker will add $8ph to their revenue, they will hire that worker at any wage up to $8ph as they will be adding more to their income (the revenue) than their costs (the wages) by doing so. If the minimum wage is raised so that that worker cannot now be hired at any wage less than $10ph, the employer will not hire them. Doing so will add more to costs (the wages) than to income (the revenue). No company that increases costs more than income will be around for very long.

All a raise in the minimum wage from the current $7.25ph to $10ph would do is lock out of the labour market workers whose contributions to turnover employers estimated at less than $10ph. These will be the lower skilled workers Clinton presumably seeks to help. As I wrote recently, one way to help these workers is to help them acquire the skills to raise employers expectations of what revenue they might generate. This is somewhere where genuine government investment could play a part.

Donald Trump

Corporate Tax

Indeed, the first bit of economic sense came from Donald Trump. “So what (companies are) doing is they’re leaving our country, and they’re, believe it or not, leaving because taxes are too high and because some of them have lots of money outside of our country.” He went on to argue that one way to bring them back is to lower the tax on corporate profits.

This makes sense. The United States has the third highest rate of corporate tax in the world. You can’t really blame companies which increasingly do business in multiple political jurisdictions for choosing to domicile in one that doesn’t take nearly four in every ten dollars profit they make.

Indeed, the tax should be abolished completely. Just because a tax is called a ‘corporate tax’ does not mean that corporations pay it. The incidence of the tax, ie, who the burden of paying for it actually falls on, is a different thing altogether. In reality, corporation tax is paid by either consumers, shareholders, or workers.

When tax on cigarettes are put up the cost is not paid by the tobacco companies in lower profits but by the addicted smokers in higher prices. The price elasticity of demand for the product is low so the producer can pass the full cost of the tax on to the consumer.

If the price elasticity of demand for a product is high, ie, an increase in its price will see consumers buying less of it, then the tax will be paid by either shareholders or workers. How the burden is split between these two categories depends on how many of each there are relative to the other. If there are lots of workers around, they will accept wages low enough to offset the burden of the corporate tax. By one estimate, the average share of the corporate tax burden borne by workers is 57.6% of the amount raised by the tax.

Monetary policy

Trump was also onto a winner with his comments about Federal Reserve monetary policy.

“Now, look, we have the worst revival of an economy since the Great Depression. And believe me: We’re in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that’s going to come crashing down.”

“We are in a big, fat, ugly bubble. And we better be awfully careful. And we have a Fed that’s doing political things. This Janet Yellen of the Fed. The Fed is doing political — by keeping the interest rates at this level. And believe me: The day Obama goes off, and he leaves, and goes out to the golf course for the rest of his life to play golf, when they raise interest rates, you’re going to see some very bad things happen, because the Fed is not doing their job. The Fed is being more political than Secretary Clinton.”

This echoes something I wrote three years ago

“As interest rates are lowered in response to an adverse shock investment, calculations change, especially when, like Alan Greenspan, those behind the policy publicly promise its continuance. To the extent that this fosters a wealth effect, consumption, as well as investment, may be stimulated. And this, in fact, is exactly the way the policy is supposed to work.

But the rates cannot stay that low indefinitely, nor, despite the jawboning by monetary policymakers, are they intended to. At some point they will rise. Again, this actually is the way the policy is supposed to work.

And when those rates do rise what happens to those marginal investors who made their decision when rates were at their lowest? What happened to the NINJAs who bought condos in Michigan when interest rates were 1 percent when the rates went up in 2006? They were scuppered. And what will happen to all the enterprises which are currently dependent on interest rates remaining at their historic lows when those rates start to rise? It is because more people are now asking that question that markets have turned skittish recently, since Ben Bernanke even began to discuss a possible future ‘tapering’ of Quantitative Easing.

Those rates will have to rise at some point. But, when they do, whichever bubble we have now will burst. Our monetary authorities have printed themselves into a corner.”

Shortly afterwards I wrote

“On Aug. 15, the London Telegraph reported that British retail sales had risen unexpectedly sharply and that American unemployment had fallen to a six-year low. This would usually be promising macroeconomic news, but that day major indexes—the Dow Jones Industrial Index, the S&P 500, the CAC 40, among others—tumbled. Markets, hooked on the Fed’s cheap liquidity cocktail, were terrified that an improving U.S. economy might see the punch bowl removed with a Fed “taper” of quantitative easing.

A day later, when the results of a U.S. consumer confidence survey came in “far worse than expected,” stock markets rallied. Markets are supposed to be driven by the expectations of a stock’s perceived profitability, not the pursuit of speculative gains caused by the manipulations of central bankers. Now the economy appears to be in a position where the interests of financial markets are precisely at odds with the interests of the rest of the economy.”

International trade

And then he went and blew it. “You look at what China is doing to our country in terms of making our product” he said, “They’re devaluing their currency, and there’s nobody in our government to fight them. And we have a very good fight. And we have a winning fight. Because they’re using our country as a piggy bank to rebuild China, and many other countries are doing the same thing.”

I recently wrote

Indeed, it is true that policymakers in Beijing have tried to keep the yuan weaker against the dollar that market forces might allow…But…this has not been a costless exercise for the Chinese.

By holding down the value of the yuan the Chinese government has held down the purchasing power of Chinese producers. This has effectively worked as a subsidy from Chinese producers, with an average GDP per capita of $14,100, to US consumers, with an average GDP per head of $56,000. If anyone should be angry about this arrangement, it should be Chinese producers.

Indeed, the argument that the Chinese have been using the US as a piggy bank to fund investment in China is exactly the wrong way round. Instead, the US has been using China as a piggy bank to fund American consumption.

Trump often talks of international trade as a struggle with winners and losers. But trade is not a zero sum game in which the benefits for one are offset exactly by losses for another. This fallacy, the root of much modern misguided economic rhetoric, is based, essentially, on the ancient misunderstanding that for two things to exchange for each other these things must have an equal value.

But logically that must be wrong. If I hand over £1.10 for a tuna sandwich I do so because I value the tuna sandwich at more than the £1.10. Conversely, the unnamed supermarket where I buy my lunch values the £1.10 more than the tuna sandwich. If I valued the tuna sandwich as much as I valued the £1.10, why would I exchange the latter for the former? I wouldn’t and the supermarket wouldn’t either. In fact, trade can only take place because people value things differently. ‘Value’ is not a property inherent in a product, it is entirely a function of the human mind and these value different things differently at different times and in different places. Value is entirely subjective.

It follows from this that people trade less valued things for more valued things. They accumulate value through trade. Both parties gain. Trade is a positive sum game.

The verdict

The United States has been woefully governed by both parties for a long time. On the strength of this debate, that won’t be changing for at least another four years.

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The British state is not being shrunk beyond Thatcher’s dreams

In the Guardian recently, Polly Toynbee claimed that the current British government was “driving the state below the size of anything attempted by Margaret Thatcher”. The truth is that it isn’t.

Chart 1 shows British government total managed expenditure since Margaret Thatcher took office in 1979. It shows it in real prices, ie, corrected for inflation so the numbers across years are comparable.

Chart 1

Picture2

Source: Office for Budget Responsibility

What it shows is that in real terms, on official projections, British government spending in 2020-2021 will be 81% above even the highest figure of Margaret Thatcher’s time in office (1984-1985).

It is difficult to believe that Ms Toynbee is unaware of this. What we appear to have here, then, is another, particularly glaring example, of someone saying something that isn’t true in the hope that nobody will actually check whether it is or isn’t. Sadly, much of what passes for public discourse these days is made up of statements like this.

 

Austerity? What austerity?

Since at least 2010, British political discourse has been dominated by ‘austerity’. With British government finances in a mess following the banking crisis of 2007/2008 and subsequent economic collapse, the coalition acted to close the resulting deficit relying primarily on spending cuts rather than tax rises. This is the ‘austerity’ that is frequently talked about.

The trouble is that its difficult to actually see it in the figures. The chart below shows British government spending since 1900 in inflation adjusted, 2005 sterling.

austerity

Source: UK Public Spending

The post-2010 period does stand out, but not, I think, as a particularly ‘austere’ time in terms of government spending. Indeed, all of the British government’s six highest spending years since 1900 have come since 2010. British government spending has risen from £702.09 billion in 2010 to £748.12 billion in 2015. What has happened since 2010 is that the rate of increase of government spending has slowed drastically.

So do we have ‘austerity’? If austerity = a decline in the increase of government spending, then yes. If austerity = a fall in government spending, then no.

George Osborne hasn’t created more debt than every Labour government in history

Source: Another Angry Voice

If you have been at all aware of British of British politics over the last five years you are very likely to have seen the above. Is it true?

Chart 1 shows the annual increase in the public sector net debt each year going back to the first Labour government, Ramsay MacDonald’s short lived ministry of 1924. Adding these up, the coalition (in green, a mix of yellow and blue) has ‘created’ £523 billion of debt between 2010 and 2015. Adding up all the debt increases under the two MacDonald governments (1924 and 1929), the Attlee government (1945 to 1951), the Wilson government (1964 to 1970), the Wilson/Callaghan government (1974 to 1979) and the Blair/Brown government (1997 to 2010), the total comes to £665 billion.

Chart 1

PictureC

Source: UK Public Spending

If anyone crunches the numbers and comes up with different answers, drop me a line.

Back to the Golden Rule

Recently I wrote about the curiously stable 35% share of GDP which the British government takes in tax. I want to add something about that.

In March 1974, Labour Chancellor Denis Healy raised the top rate of income tax from 75% to 83%. The effect of that on the share of GDP taken in tax (the government’s allowance) over the next five years is shown below

A 75

Source: The Guardian

In 1979, Conservative Chancellor Geoffrey Howe lowered this to 60%. Again, the effect of that on the government’s allowance over the next five years is shown below

A 60

Source: The Guardian

Finally, in 1988 Howe’s successor, Nigel Lawson, reduced the top rate of income tax to 40%. As before, the effect of that on the government’s allowance over the next five years is shown below

A 40

Source: The Guardian

What I think this does is to isolate from the previous chart the effects of quite large changes in the top rate of income tax on the government allowance. Quite simply, there isn’t one, as the chart below illustrates

GA

Source: The Guardian, Institute for Fiscal Studies

Why not? If these changes in income tax rates are not producing commensurate changes in total tax revenues that must be because top rate taxpayers are reducing their tax exposure elsewhere. The lesson is one of the oldest in economics; people respond to incentives. If they are taxed differently they will act differently. There are three things to take away from this.

First, is that estimates you see which say ‘an increase in the x tax rate of x% will bring in £x more revenue’ need to be clear that they mean revenue from that tax, not total revenue. The evidence is that that will be largely unaffected.

Second, ideas, prevalent on the political left, that Britain can increase the top rate of income tax to close the deficit are fantasy.

And, third, the idea, prominent on the political right, that slashing tax rates will ‘shrink the state’, reduce the share of GDP accounted for by government activity, are equally misguided. As well as showing the minimal effects of tax rate rises on that 35% figure, the chart above also shows the minimal effect of tax cuts.

Once again, the British people seem to have decided, collectively but individually, that 35% of their income is what the government is going to get. The sooner fiscal policymakers reconcile themselves to that fact, the better.

Paying for government – From Scotland to Greece and beyond

greece

Governments have three ways of getting money to spend

1) They can tax it

2) They can borrow it

3) They can print it

If you can think of anymore, let me know.

I wrote a little while ago about how the government of an independent Scotland would finance itself. I argued that if Scotland adopted a currency board with England its government wouldn’t be able to pursue 3 and if their fiscal situation was poor they’d struggle do 2, at least at a rate they could afford. This would leave them entirely reliant on 1 and I doubted that that avenue would provide the revenue necessary to sustain Scotland’s present levels of government spending.

The case of Greece is interesting. In the euro its government cannot pursue 3. It’s citizens have a famously low tolerance for 1. It has just about exhausted its capacity for 2. That is the Greek crisis in a nutshell.

If Greece left the euro I believe avenues 1 and 2 would still be closed to the Greek government. I don’t think Greeks are going to suddenly start paying lots more tax and I doubt lenders will reassess the country as a sound credit risk. But the Athens government would reopen avenue 3 – it would have control of a new drachma and could print it to finance its spending.

The obvious drawback is that this would be inflationary. All those euros that Greeks are unable to shift out of Greece would be swapped at some rate for x drachma and that rate would, almost certainly, fall and fall quite rapidly as the government printed more drachmas to continue funding pensions which currently amount to 16.2% of Greek GDP. The spending power of Greek citizens will fall just as surely as if their wage had fallen in nominal terms from €1,000 to €800 a month.

But even this has limits. If they could find a counter party (a big if) holders of drachma could switch their currencies, even at heavy discounts, for other currencies in an effort to preserve something of their purchasing power. This is capital flight. Alternatively, they could swap money for goods and services in Greece while their money can still purchase them. The falling demand for money relative to the demand for goods and services would increase the money price of those goods and services – inflation. Less generally, it could push up only a few prices and create asset bubbles. The point to make is that all money is convertible, even fiat paper money. That, after all, is its point.

Governments always and everywhere have to live within the three means listed at the top. 1 is limited by the public’s willingness to pay. 2 is limited by people’s willingness to lend. 3 is limited by people’s ability to swap their money for something else. Hopefully this will be heeded by whoever is in charge in Greece a month or so from now.

EDIT – This post was picked up by the people at the Foundation of Economic Education

Greece and the euro crisis

drachma

Welcome back

Below is something I wrote for a now defunct website in July 2011. There’s finessing I’d add here and there if I wrote it now, but its exhumation seemed timely.

Greek town squares and streets have erupted in violence. A Socialist government has incurred the wrath of the left by forcing through a package of fiscal retrenchment which would have made Margaret Thatcher blush. Greek interest rates are skyrocketing yet borrowing still grows. Even so, many commentators from both right and left doubt it will be enough. Greece will almost certainly default on its debt. It’s a good bet that it may even be forced to leave the euro.

 How did we reach this state? What will happen next?    

The project for European integration has always been steeped in unreality. One of the great political trends of the last 200 or so years has been nationalism, the breaking down of people into political units with shared characteristics of language, history and culture. This has been seen on bloody fields from Lombardy to Rwanda. The lesson of the First World War was that the other great trend, the basing of society on class lines à la Marx, was a dud. A Sheffield steelworker would rather shoot his fellow proletarian from Essen than his capitalist boss.

The mission to integrate Europe politically runs counter to this. For a combination of reasons ranging from the noble through the potty to the plain sinister the ‘European project’ has always been an exercise in denial, in seeking to bend what is into what its makers would like. The creation of the euro, the single currency, viewed as another step on the road to the “ever closer union” the projects’ leaders alone seem to desire, was born in this atmosphere of denial.

Back in 1961 the Nobel Prize winning economist Robert Mundell wrote “A Theory of Optimum Currency Areas” a paper in which he analysed the characteristics an area must have to be suitable for a single currency. Mundell put forward five criteria; labour mobility across the region, capital mobility across the region, price and wage flexibility across the region, similar business cycles across the region and a risk sharing mechanism across the region.

The euro zone clearly has a high degree of capital mobility though in the globalised world it is not much easier to shift funds between London and Rome as it is London and Hong Kong. In theory the EU should have almost perfect labour mobility so that unemployed people in a depressed area can move to a booming area and the profusion of ‘Polski Skleps’ around the country suggests this is true. But in fact, when compared to another currency area, the United States with the dollar, linguistic and cultural factors are far more of an obstacle in a move from Madrid to Copenhagen than they are from Minneapolis to Seattle. Labour mobility in the EU is far lower than in the US as demonstrated by the shortage of unemployed Greeks and Irish decamping to booming Berlin.

The euro zone scores even worse on the other measures. On price and wage flexibility the euro zone has one of the most rigid labour markets on the planet and the apparent synchronisation of business cycles prior to its launch in 1999 was aided by more than a little creative accounting which the project’s leaders, ever averse to reality, turned their blind eye to.

It is the fifth criteria however, the risk sharing mechanism, or lack of, which is of central importance now. By risk sharing mechanism we mean a way by which, in downturns, fiscal resources can be redistributed from better off areas to less well off areas. This can mean welfare payments to or government projects in depressed areas. In the current set up it has meant a chaotic series of bailouts.

So the theory goes that a single currency means a single central bank and a single central bank means a single government. Simply put, the area covered by the body with the fiscal authority, the government, has to match the area covered by the monetary authority, the new European Central Bank. But though, in the European Union (née European Coal and Steel Community, European Economic Community, European Community), Europe had a political structure which, with only occasional consultation of its subject peoples had, like Topsy, “just growed”, it still didn’t have the necessary fiscal authority to match the monetary authority of the ECB.

The Germans, for whom the old deutschmark run by the Bundesbank has worked so well, were worried by this. They were concerned that countries with less creditworthy borrowing histories, like Greece which has been in default for large chunks of its history, would use the new interest rates, held low by the German reputation for good financial behaviour, to go on a borrowing binge and demand a German bailout when it all went wrong. So the Germans got the Stability & Growth Pact which limited the borrowing of euro members to 3% of GDP. But the still fiscally autonomous Greeks ignored the pact, lied about the figures, and borrowed like mad anyway. And why not? When Germany and France broke the Stability & Growth Pact rules in 2003 neither were fined.

The Irish situation was slightly different. When it gave up some of the independence it had fought Britain for so long for and joined the euro its economy was booming, it needed higher interest rates to cool the boom. However, Germany was in a prolonged period of economic stagnation and needed low interest rates to get a boom boiling. There was no question of the tiny Irish tail wagging the ECB dog and, obeying its German paymasters, it kept euro interest rates low. This was great for Germany but in Ireland, already doing well, this flood of cheap credit stoked a wild property boom. Irish banks borrowed, lent to people to buy houses, and then collapsed when people realised that County Leitrim didn’t need three houses for every resident. The property investments of banks were worthless overnight.

But Ireland’s politicians, a particularly craven bunch, moved to save Ireland’s bloated banks by extending a taxpayer guarantee not only to all depositors, as the British government did, but also, staggeringly, to all holders of the bonds of Irish banks. In other words, the Irish people would be made liable for loans taken out by Irish banks, often from other eurozone banks, to lend on to the Irish people. The cost of this insanity was staggering; about €100,000 for everyone in Ireland. Ireland’s deficit soared above its Stability & Growth Pact limit and, like Greece, drastic fiscal consolidation followed.

So where do we go from here? It is clear that one of the major flaws of the euro, baked in from inception, was the attempt to create a central monetary authority without a central fiscal authority. In the current crisis this has changed. Many of the spending cuts and tax rises which have driven Greeks to riot and Irishmen to grumble more loudly than usual into their Guinness were forced upon them as much by European bodies trying to protect the euro as by lenders concerned about their increasingly apparent status as basket cases. So one possible outcome is that this will continue; we will see the upward evolution of fiscal power to a European body to match the monetary power the ECB already has.

But there is another possibility, one which a growing number of observers predict. The fiscal retrenchment in Greece, Portugal or Ireland could be so unpopular that no government can enact it. In that case the country would default on its debts (or write down or reschedule which amounts to the same thing) and it would be difficult to see how it could continue in the euro zone. In this case, with the country exiting the euro zone, we would see the other possible outcome; the downward devolution of monetary power to a national body to match the fiscal power the national government already has. In other words, the break-up of the euro.

Which of these is more likely? Economics dictates the break-up of the euro which would more likely mean its retreat to the core of ECSC countries. Euro bailouts are at ever higher interest rates. Economic growth when it is positive at all is sluggish and if the rate of interest is higher than the rate of growth you will see the debt burden grow ever heavier. But as we’ve seen the European project is about the active denial of realities. Adam Smith once observed that there is a “great deal of ruin in a nation” and there may be even more ruin in a supra national entity like the EU.  But, as the Soviet Union eventually found, the laws of economics have a way of being enforced with the doggedness of Inspector Javert and the merciless brutality of Dirty Harry. Bet on them being enforced again.

The economics of the BBC

BBC_TV_Centre

Imagine you smoke Rothman’s Royals (my old cigarette of choice) but, to do so legally, you have to pay a flat fee of over £100 a year that goes to fund the production of a government produced brand of cigarettes that you only occasionally smoke.

Or imagine that you shop in Sainsbury’s, but that it is a legal requirement that if you do so, you have to hand over upwards of £100 annually to pay for the operations of a government run supermarket which your may or may not use.

Both situations would be ridiculous; why can’t you just smoke the Royals or shop at Sainsbury’s? But this is the situation that exists in Britain with broadcasting. Everyone in the UK who watches or records TV programmes at the same as they are shown on TV has to pay £145.50 per year for the privilege of doing so with this licence fee going to fund the BBC. You have to pay this fee whether you watch the BBC or not.

Why does the UK have this funding system? Is the BBC a public good such that it should be supported by a tax on TV viewing?

A private good is something like a chocolate bar. You can share it, but if you eat it yourself then 1) the benefit of paying for it accrues to you alone and 2) the chocolate bar is not there for somebody else to eat. In the jargon, private goods are 1) excludable (payers can exclude non payers from enjoying the benefits of the good or service) and 2) rivalrous in consumption (if I eat the bar you can’t).

A public good, by contrast, is non excludable and non rivalrous in consumption. For an example, take Trident, another current public policy debate in the UK. Trident is non excludable; if half the people in Britain pay for it and the other half don’t, the half that don’t cannot be excluded from enjoying the protection it provides*. Trident is also non rivalrous in consumption; the amount by which it protects me is not diminished at all by the amount by which it protects you.

The BBC, or broadcasting more generally, certainly meets the non rivalry test for a public good. The amount of EastEnders you can watch isn’t diminished at all by any amount that I might watch.

But broadcasting fails totally as a public good on the non excludability criteria. If you haven’t signed up to Sky Sports, BT Sport, ESPN, Premier Sports etc and paid for them you cannot watch them. Payers, in other words, are fully able to exclude non payers from enjoying the service provided. Broadcasting is excludable.

There are other grounds on which government provision of good and services are defended. You can use a market failure argument in favour of some form of state healthcare, for example. But given the profusion of TV channels this doesn’t seem to be a problem for broadcasting. If you are concerned that the TV market might fail to produce to produce ‘quality’ content (however and whoever defines that), I would give you HBO and let you know that I spent two hours on Sunday morning watching a couple of old Sarah Vaughn concerts on Sky Arts.

Back in the old days of analogue signals, snow on the screen, wire aerials, and the national anthem at half past midnight, broadcasting might have been non excludable and anyone with a TV and a wire coat hanger could have picked up a broadcast of Queen Elizabeth’s coronation. But technology has moved on since then. New providers like Netflix have even ended the concept of a TV station. Technology has stopped the BBC being a public good and made the licence fee obsolete.

* Assuming it does, but that’s a different question. It’s a question that illustrates, however, that a public good, like Trident, might not be conducive to the public good. They are different concepts but as I had to explain this to someone recently, I thought it worth adding here.

A short history of British government fiscal (un)sustainability

When government finances are discussed you usually see two figures or charts trotted out. One is the government’s deficit, the amount of money it is borrowing, either as a nominal figure or as a share of national income. The other is the government’s debt, usually, again, either as a nominal figure or as a share of national income.

A government deficit may or may not be a bad thing, it depends on the circumstances. But as a figure itself it doesn’t give you the fullest picture of the sustainability of the government’s finances. If nominal GDP, national income, increases at a faster rate than the nominal debt, debt as a share of national income will fall even if there are deficits. So a chart like Chart 1, showing debt falling to the early 1970s, can coexist with a chart like Chart 2, showing government deficits in the same period.

Chart 1

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Chart 2

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The important thing for government fiscal sustainability, it seems to me, is the relative speed with which two magnitudes grow; nominal GDP and nominal government debt. If the percentage growth rate of nominal debt is higher than the percentage growth rate of nominal GDP, government debt will be increasing as a share of GDP and government finances are unsustainable.

Compare Chart 3 with Chart 2.

Chart 3 

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This shows the percentage change of nominal GDP minus the percentage change of nominal debt. Where the figure is negative that shows that debt was increasing as a share of national income and that government finances were unsustainable. It corresponds rather well with the undulations in Chart 1. Better, I think, than in the commonly seen Chart 2.

What is striking is that British government finances have been on an unsustainable path since 2003 – five years before the financial crash. But it gets worse. Take a look at Chart 4.

Chart 4

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The red bars indicate years of recession in the British economy, shrinking GDP. You can see that every period where government fiscal policy has become unsustainable has been preceded by a period of recession. Except one, the expansion under the last Labour government which began in 2003.

One of the hot political potatoes in Britain in the last few years has been the question of whether or not the last Labour government overspent. I think the above shows, quite unequivocally, that they did.

The golden rule of British government spending

As the British general election approaches politicians can be expected to produce more economically illiterate rubbish than usual.

Take, for example, the recent stories about British government spending returning to the levels of the 1930s. Sounds horrible doesn’t it? Except it isn’t remotely true. What might happen is that government spending returns to the share of national income it was in the 1930s. As national income is many times higher now than it was then, so will government spending be.

But take a look at this

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Source: The Guardian

It’s self explanatory I hope. But what strikes you about it? It’s the stability of the line, how constant the share of its income the British public is willing to hand over to its government is*. Whether the top rate of income tax is 83%, as it was in the 1970s, or 40%, as it was in the years before 2010, the British people seem to have decided in some mysterious way that 35% of their income is all the government is going to get**.

And that means, more or less, that 35% of national income (GDP) is all the government can spend unless it wants to pile up debt. If government spending is much above that level, as it is, it will have to fall no matter who is in charge. If government spending is much below that level…well, we’ll see when that happens.

The bottom line is that the number that matters for the fiscal debate in the British general election is not 1930 but 35.

* The mean is 35.1%, the median is 35.3%.

** Two of the three lowest years, 1965-1966 (31.6%) and 1966-1967 (32.5%), were under Harold Wilson’s first Labour government and the two highest, 1981-1982 and 1984-1985 (37.6%), were under Margaret Thatcher’s Conservative government.

EDIT: The Cap X blog made a very similar point to the above a couple of weeks later.