Duncan’s Economic Blog

New Blog

Posted in Uncategorized by duncanseconomicblog on October 6, 2009

A friend of mine (Labour Party member, teacher, nice bloke) has started a blog over here.

I really enjoyed his long-ish post on Tory education policy. Certainly worth a read.

Osborne: Neo-Classical Nonsense

Posted in Uncategorized by duncanseconomicblog on October 6, 2009

I just read Osborne’s speech. Despite the headline grabbing stuff (cutting a third of white hall, public sector pay restraint, the raising of the retirement age, etc) it was actually fairly light on detail.

As Osborne said:

I can’t give you the 2010 Budget in 2009.

Quite right. Which makes his calls for Labour to be ‘more honest’ about future plans even more infuriating.

What the speech did contain was some idea of the basic ideas behind Tory economic policy. The central thrust was:

We want to turn an economy that borrows into one that saves.

At every stage we will support the culture of saving, and for those who show responsibility for themselves and others.

Encouraging savings is why I made my promise that only millionaires would pay inheritance tax.

Of course this financial crisis means it cannot be a priority for our first Budget, but in the lifetime of a Parliament we will honour that pledge.

A savers society is our ambition.

I’m starting to think that Osborne actually doesn’t understand economics at all. What does he think will happen if people spend less and the government spends less?

I’ll tell you what will happen in one word: Ireland.

Nearly one year on, what has been the effect of these polices? Irish GDP is expected to fall by 12%, a staggering decline. Unemployment has reached 12.4% and is still rising. The economy is now in the grip of a severe deflation (minus 5.9%). Finance Minister Brian Lenihan openly talks of the need to “get our cost base down” in order to regain competitiveness. A policy of aiming to balance the budget and drive down wage costs is a throwback to the so-called Treasury View of the 1930s, a policy rejected then by progressives and rightly rejected now. The final irony is that, despite all of this needless suffering, the Irish Government will still be running a budget deficit of 12% of GDP this year while the ratings agencies have already cut Ireland’s sovereign bonds from AAA to AA.

To me the question is not how do we pay down debt, it is how do we return to growth. As I’ve made clear my preference is for higher investment.

Now, I should imagine many ‘informed’ Tories would accuse me of inconsistency here. A basic accounting relationship in economics is that savings are equal to investment.

But ‘savings = investment’ doesn’t really tell us much. As Paul Krugman has argued:

The effect of this upward shift in desired savings at any given level of GDP is, paradoxically, a fall in actual savings and investment.

One key implication of the fact that we’re living in a paradox of thrift world is the folly of demands that we reduce budget deficits in the near term. Slashing spending or raising taxes right now wouldn’t just deepen the slump — it would actually make us poorer in the future, too, because it would lead to lower overall saving and investment.

In other words raising the savings rate (as a % of income) can actually lead to lower savings as the reduced spending in the economy causes income to fall.

As I’ve noted before:

Thus, Post Keynesians and neoclassicists can pretty much agree on definitions of saving and investment, for example. They can also agree that in a simple economy with no government and no foreign trade, savings must equal investment. This is, in fact, a basic national income accounting identity. Where these two schools differ is not here, but in how they see the causal nexus between the two. For neoclassicists, savings cause investment; it provides the funds needed to build new capital equipment. In contrast, Post Keynesians hold that investment determines savings. Investment can be financed by borrowing from banks, which does not require savings because banks create money by lending. Investment, in turn, generates jobs and incomes. Some of this income will be spent, and the rest saved; thus, at the end of the process, savings.

 

Empirical Post Keynesian Economics, Holt & Pressman (Emphasis mine).

 

This is more than an academic economic theory debate. George Osborne is pushing a neo-classical (almost classical!) line that the government spending less and people saving more, will lead to high investment and higher growth. That’s been tried before in the real world – in the 1930s. The result was depression.

The UK economy is far from out of the woods and quite frankly, I’m scared of what an Osborne Chancellorship would be like. 

What is need are policies to raise investment, not policies aimed at removing demand from the economy.

Follow

Get every new post delivered to your Inbox.

Join 69 other followers