Cameron & Crowding Out
In his speech today David Cameron made a rather bold claim.
The idea that the deficit brings the risk of higher interest rates for businesses and families isn’t a theoretical possibility – it is actually happening already.
One of the things that is limiting the supply of affordable credit is that banks need to build up their deposit bases and become less reliant on unstable wholesale funding.
But amazingly the most attractive – and therefore competitive – one year savings product on the market at the moment is actually being provided by the Government, through National Savings and Investments.
So the Government’s need to finance its borrowing is already affecting the supply of credit to families and businesses – and its cost.
In other words, government action is already beginning to crowd out the private sector.
Essentially Cameron is advancing the ‘loanable’ funds’ theory – that there are a certain amount of savings out there and that the government is taking up too much of them through borrowing. The private sector is crowded out. This was the prevailing economic wisdom of the 1930s.
The premise of Cameron’s argument can be challenged with reference to the Bank of England’s latest Survey of Lending:
Overall, demand for new bank lending was expected by the major UK lenders to remain subdued during the remainder of the year. The outlook for 2010 would depend on the prospects for working capital and mergers and acquisitions activity in particular. On the supply side, the major UK lenders noted signs of increasing competition among those lenders currently active in the market. Some business contacts of the Bank’s regional Agents — particularly from larger firms outside of the property sectors — also reported that credit availability had eased.
The Bank believes this is much a problem of demand for finance as it is of supply. Not something covered by Cameron.
But, leaving aside empirical evidence (as Conservative economic policy making is want to do), the speech highlights the theoretical approach of Tory economic policy. The ‘loanable funds’ theory is an 1930s throw back and only holds if an economy is operating at full capacity – a situation far from what we have presently. As Paul Krugman has written:
So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.
Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.
Cameron, like his Shadow Chancellor, is advocating what I’ve dubbed ‘neo-classical nonsense’. As I said then:
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.