What is wrong with "slash and burn"
Samuel Brittan speech Spectator Conference 15/09/09
I am in the delightful position of disagreeing with the consensus wisdom on economic policy. This states that the most important, if disagreeable, task of whatever government is in power after the next election will be to slash the public sector deficit. We can according to this "wisdom" have delightfully fierce partisan arguments about the balance between public spending curbs and tax increases and about where the public sector axe should fall. But the whole debate takes for granted the urgent need to eliminate as much as possible of the budgetary red ink as soon as possible. With great respect - or rather no respect - this view is harmful nonsense, however often it is repeated and however bipartisan the consensus.
The basic fallacy is known as the fallacy of composition: the belief that what is true on the small scale must be true on the large. Shakespeare's Polonius said "Never a borrower nor a lender be." Margaret Thatcher advised young people not to get into debt (except of course to buy a house!) Even accepting these homilies at their face value, they do not necessarily apply to the Government of the whole country.
The big error of the present economic discussion is to treat national budgets as on a par with the budgets of individuals or firms, which need to balance except for narrowly defined investment projects. Even if you also favour a balanced budget at the national level, it is at most a second order rule to give way if it impedes the achievement of broader economic objectives.
In fact the public sector balance has an entirely different function: that of offsetting gross disequilibria in the national and international economy. If attempted savings exceed investment opportunities, public sector deficits are needed for as long as necessary to fill the gap - a job which will otherwise be done by stagnation and unemployment. When economic recovery has reached a certain stage, the time may come to roll back public sector borrowing. But we have certainly not reached that stage yet and it is far too early to rule out a second or even third leg of the recession.
Where will the money come from? The Bank of England printing works at Debden. Thus is not a joke. Under a paper money system the amount of money in existence is a conscious national decision. Don't talk to me about the money printing excesses of countries like Zimbabwe. Just because you cannot draw a line, it does not mean a line cannot be drawn. Ideally monetary policy should be the first line of defence against both slump and inflation. But with official policy interest rates down to ½ pc, there is not much more that can be done by conventional monetary policy; and tax cuts and public works may be necessary to put the money into circulation. (It goes without saying that in opposite conditions of inflationary pressure public sector surpluses would be required.) So far from being socialistic this analysis was developed in the 1930's and 40's by those who wanted to save the capitalist system. But, as always we are in danger of forgetting everything we have ever learned.
As so many people find abstract argument rather dizzy-making, let me end by quoting a few historical facts from Lord Macaulay's History of England. "At every stage in the growth of the National Debt the nation has set up the same cry of anguish and despair. At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever." This passage was quoted by Harold Macmillan in his one Budget speech as chancellor in 1956 when the national debt was just under 150% of GDP - nearly twice the 80-90pc what is now in prospect. In the early Victorian period it was nearly 200 pc and almost reached that level again in the early 1920's. Yet on all these occasions it was successfully and gradually reduced - after 1956 without any heroic sacrifices, through the combined forces of economic growth and inflation - inflation creeping up at a rate not much above current targets.
Of one thing I am sure. If we had the misfortune to engage in a major war we would have far higher deficits and debts than anything now in prospect, and few except some pacifists would worry. Why should it be more alarming for governments to get into debt to put people into useful work satisfying human needs, than to borrow for guns and tanks whose only aim is to kill other human beings?
May I end on a really serious note? There have been all too many allegations that government actions on human rights and foreign policy have been influenced by the desire to sell arms or win oil contracts for British companies. I make no judgment; but I am perfectly sure that if we could administer a truth drug to ministers and opposition leaders they would say, "jobs are at stake". There is nothing dishonourable in that aim. But why is it better to promote jobs through shady deals of all kinds than by an honest infusion of purchasing power through monetary and fiscal policy? I had better not go on or I will be accused of being too emotional.
What are the real limitations on expansionary demand management, other than the time-honoured inflation constraints? These are that if one government goes out too far on a limb it will lead to a depreciation of its currency, which in turn may lead to a deterioration in the terms of trade which could wipe out the gains from the domestic stimulus.
The first thing to say is that this strengthens the case for combined international action by the major western economies. You do not have to be a socialist to applaud the lead that Gordon Brown has given here. It is a powerful reassurance that the United States has been following a similar track, however much the defeated Republicans may complain.
Secondly, even if the UK does go out on a limb, budget deficits are just one of many factors affecting the value of sterling; and even if sterling drops the effect on the terms of trade are far from obvious. I still remember being caught out myself by the very limited and soon reversed effects of the UK's departure from the Exchange Rate Mechanism in 1992.
But let us take the most pessimistic assumption. It is worth pursuing an expansionary domestic policy until the point where the loss on the terms of trade begins to outweigh the gains in domestic output and employment. I cannot pretend to work this out on the back of an envelope; but I wish that some of our econometricians would hazard a few estimates based on alternative assumptions. It would be a more useful employment of their time than the national income forecasts which nearly always let us down at the most crucial moments.
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