Suyts on Krugman

Suyts quite rightly criticizes Paul Krugman on the Nobel Laureate’s latest ramblings. However, his analysis misses a couple of issues. This is an extended comment.

You are quite right on two issues here, which I believe have been called the ratchet effect and the debt servicing impact.

The first is that it is easy to increase government expenditure, but much more difficult to scale it back as there are entrenched interests to stop the scale back. It is easy to give people welfare benefits or create jobs. But try to take these away and people will fight like crazy to keep them.


The second on debt servicing you demonstrate very well. As total debt goes up, so does the interest on that debt.

There are other issues that should be taken into consideration on the deficit and debt problem.

The first issue is the size of government. When an economy enters recession, the tax receipts fall and expenditure rises. Corporation tax is the first area to go down, followed by income tax as unemployment rises. In expenditure terms, welfare payments will rise along with (possibly) business bail outs. With small government, taxing little and spending little, this impact was small. With large government – in Britain rising nearly 50% of GDP – this effect is large. A 6% decline in GDP perhaps increased the deficit by 6-7% of GDP. Under the Eisenhower administration, a similar decline would worsen government finances by maybe 2% of GDP. Big government exacerbates the size of cyclical swings.

The second issue is the position at the start of downturn. In mid-2008 both USA and Britain had structural deficits – in the USA to finance the wars in Iraq and Afghanistan, in Britain finance a huge increase in public sector pay and capital spending on schools and hospitals. A structural deficit is the measure of the average government deficit over the course of the business cycle. In Britain at the top of the cycle, the actual deficit was around 3% of GDP, with a planned rise to 4%. The structural deficit was probably greater than 4% of GDP in mid-2008 in Britain and maybe slightly smaller in the USA. Below is my estimate of the impact of Britain’s structural deficit in April 2010. I estimated that the structural deficit built up between 2001 and 2008 would in the long-term increase National Debt by 40% of GDP. I was overly optimistic in my assessment.


The third issue is with the classical Keynesian Multiplier. Crude textbook Keynesianism of the 1960s for a closed economy stated

E = C+I+G

Or national expenditure is the sum of Consumption, Investment and Government expenditure.

The theoretical impact of increasing government expenditure on total output, when the economy is at less than full employment, is Y/G. If government expenditure is 10% of national income, then increase G by $1 and Y will increase by $10. If government expenditure is 40% of national income, then increase G by $1 and Y will increase by $2.50. However, crudely put, if the government expenditure does not take up the slack in the economy (the deficit in aggregate demand), then (in an inflation-free economy) the government expenditure “crowds out” private expenditure. Another way of putting the situation, if the economy is not “stuck in a rut” as Keynes assumed in his “General Theory”, but merely reacting to overinvestment (such as a housing bubble), then increased government expenditure will have no effect on total output, but “crowd out” other expenditure. It will also add to the nominal national debt, without adding to total national income, thereby increasing national debt as a percentage of national income, or expanding national income leading to increased tax revenues and thus closing the deficit.

The fourth issue is fiscal tipping points. If the increased government expenditure fails to stimulate the economy, then the result will be a larger structural deficit. If, like some European countries, there is a further contraction then the deficit will increase. In Greece, Spain, Italy and Portugal, this further downturn has led to increased economic risk, pushing up interest rates. This increases short-term debt costs, further increasing the deficit. The only way to stem total collapse is to massively cut public expenditure and increase taxes to not only pay for the debt-financing costs but to rapidly cut the deficit as well. In climate change there has been much spurious talk about possible tipping points in the remote future if certain things come true. But in OECD economies, with some already having gone beyond the fiscal tipping points, many (including Krugman) seem oblivious to the possibility. Should we not use a smidgeon of the precautionary principle in economics , proclaiming austerity as an insurance against severe depression.?

Kevin Marshall


Boris Johnson spoils a good polemic on Fuel Costs

Boris Johnson is in great form in today’s Telegraph on the escalating cost of fuel. However, he is wide of the mark on the costs side.

The cost of the fuel for deliveries does not impact not through greatly price of goods in the shops. Our distribution systems are fairly efficient – though the low volumes to small shops proportionately big impact than deliveries to Tescos or Sainsburys.

It is on the consumer that this pays a larger impact, but less than you might think. Take somebody with a 1995 petrol Toyota Previa living in London and doing 5000 miles per year at around 18mpg. That is 278 gallons per annum, or 1264 litres. With petrol at £1.29 per litre, that is £1630 per year. That seems a lot. But add in £1000+ for maintenance and the MOT, £1000+ for insurance (if a VIP it gets quite steep), £200 tax, and £200 for depreciation, then it is not a huge cost. Trading in for a more modern monster could make out jolly Mayor worse off. Spending £15,000 on a secondhand Galaxy Diesel will save on fuel, the occasional big maintenance bills, maybe nothing on the insurance, but will cost £2000+ more on depreciation.

Consider also

The electric revolution is happening, but it will not be overnight. The up-front cost of the vehicles remains high, and there is still no electric people carrier. For the foreseeable future, millions of people will have to invest not just in a car but in an overpriced lagoon of fossil fuel.

The reason that the costs of fuelling electric cars are so much cheaper is that the only taxes for domestic customers are the additional 5% VAT.  The excise duty and petrol, plus the 20% VAT add more than 100% to the cost. They may be more fuel efficient because they are so much lighter. Furthermore, a new electric car can only have a comparable cost to an efficient diesel with huge subsidies. If you look at the true cost per mile excluding tax and subsidies, then it would be twice the cost. And the cost distinction will get worse not better. The chemicals in the batteries are scarce, so the phenomenal push for electric cars will push up the costs of the chemicals exponentially. And this government does not help – the ConLib Coalition one. The government’s plans for new “alternative” electricity supplies will push up real costs by at least 30% in coming years and even more when it cannot keep up with the extra demand.

       The worst part is the government finances. When Mayor Johnson gets his electric people carrier, he will deny his government £800 a year in taxes, have a subsidy of £5,000 from the worse off to help pay for it and still be out of pocket. Oh – and the people carrier will be more Meriva than Previa in size.

Cutting Government by Rules of Thumb

Over at the Admin Smith Institute Blog Dr Eamonn Butler has a short paper “Rebooting Government”. Just six pages long it looks at short, medium and long-term measures to reduce the deficit and keep it low. Well worth a read.

However, in evaluating what governments should do I advocate more general rules of thumb.

  1. Proportionality. Rather than trying to evaluate the relative worth of policies, try to see if the cost is anything like proportional to the benefit. That is a quick analysis to cull those policies where costs vastly exceed the benefits.
  2. Despinification of government. Cull those policies or regulations that where introduced as knee-jerk reactions, or on the basis of “research” that was discredited. This may include changing the language of government, with reports stating conclusions clearly and how they were reached, not waffling on for pages but saying nothing of substance.
  3. Temporal diminishing returns. Many initiatives have some initial benefits or successes, but later those benefits diminish for various reasons. (Not to be confused with diminishing returns to scale). The initial effects wear off. The organisation solidifies, the most needy processed first, or people get used to, or by-pass the intiative. Much the same way shock adverts only work being more graphic than the last one, or congestion charging only reduces traffic until people can adjust their budgets to afford the extra cost.
  4. Changing from direct provider to provision enabler. For instance, from providing schools to providing education vouchers (with many shades in-between).
  5. From detailed management to general objectives. A failure of government has been conformity to detailed standards by form-filling and inspections, whilst failing in the bigger picture. Social Services Departments, or General Hospitals that fall significantly shortly after having scored highly in performance evaluations. Or regulators who missed banks failing, despite receiving detailed and regular information about their operations.

Cameron gets the message on the Legacy of Labour

David Cameron yesterday started blaming the current deficit problems on the last Labour Government.  Benedict Brogan on his Telegraph Blog quotes Cameron

 “I think people understand by now that the debt crisis is the legacy of the last government. But exactly the same applies to the action we will need to take to deal with it. If there are cuts – they are part of that legacy.”

I have been thinking along the same lines for a while now. See for instance.

http://manicbeancounter.wordpress.com/2010/03/21/the-impact-of-labour-on-the-current-crisis/

http://manicbeancounter.wordpress.com/2010/03/22/the-economic-legacy-of-labour-a-summary-for-the-tories/

http://manicbeancounter.wordpress.com/2010/03/24/the-golden-rule-has-lead-to-economic-ruin/

http://manicbeancounter.wordpress.com/2010/04/04/labour-bashing-business-to-save-facing-their-awful-reality/

I believe it is as important for the future to understand the political element of how Labour went so wrong. The Golden Rule and the denial of the problem until it was too late have made a serious recession into a painful period of painful cuts in expenditure and large tax rises. This nation will be poorer for a generation as a result.

Higher Tax Rates – a Poison Pill for Government Finances?

John Redwood and the Adam Smith Institute may have inadvertently exposed a poison pill left by the outgoing Labour Government.

I completely agree with the contention that in the medium to long term higher tax rates reduce revenue. The ASI obtain this conclusion from the analysis of Capital Gains Tax Rates and revenues over the past fifty years. However, looking at the ASI’s graph on page 3, suggests something important for short-term tax policy as well.

For instance, in 1986, the year before tax rates rose from 20% to 28%, revenue rose 96%. In 2002, the year before tax rates dropped from 20% to 15%, tax revenue dropped 26%.

The expectation of a change in tax rates is highly significant on short–term revenue as people optimise the year in which they declare the capital gains

The UK had just the same effect with income tax in March. The deficit for the last financial year was £11bn lower than forecast in the last budget, (due to higher tax receipts from top earners than expected), and over £20bn lower than forecast last autumn.

In the budget I would therefore expect an adjustment for lower than expected tax revenues from higher rate tax payers in next month’s budget of at least £10bn.

Manchester Withington Polling Fiasco

Whilst the Chair of the electoral commission should carry the can for the travesty that occurred, there are also lessons to be learned. As a voter in Mancheter Withington, I believe the following should be looked into.

  1. Mcr Withington has always had the highest turnout of the 5 Manchester constituencies. Was this allowed for?
  2. Students tend to vote late – on the way to the pub. The problems were mostly in areas with high student numbers e.g. Fallowfield and Ladybarn.
  3. Was lack of voting booths (2 per station) an issue?
  4. Were there procedural changes? The clerks seemed to take longer than usual (there was local elections as well). Was this due to having the electoral lists in postal address order, rather than alphabetical order of name or street address?
  5. Queues were already forming at 11am. Why did none of the clerks summon help? Or if they did, why was none available?
  6. Also, why did it take much longer in Manchester Town Hall to count the vote? The result was at least 3 hours later than usual. I think this happened in lots of other areas as results seemed to come through more slowly.

 

If government agencies cannot get a simple procedure like voting correct, then what hope have we for reducing the impact of cost-cutting in more complex areas? By improving and simplifying procedures, productivity can increase, so standards of service will not be reduced as much. Understanding a simple failure can give insights into other areas.

The Two Faces of Labour

The gaffe and very humble apology later by Gordon Brown may have a significant impact on the General Election. But, as I wrote on John Redwood’s blog, there is a deeper public v private face to the Labour campaign.

In recent years our politics has become too like those of the countries that have defaulted in the past – like Brazil, Argentina and like Greece has become now. It has become about presenting a public face of concern and competency, whilst privately just wanting power and prestige. It is also about defending of that image by denigrating the opposition and distorting the reality of events to an extent that George Orwell would not have imagined.

 As a result, we had a structural deficit built up in the boom years and a refusal to recognize that growing debt was an issue. We have delay upon delay about tackling the issue, or even recognizing the problem. Now every minor proposal to tackle it is met with cries of destroying public services and ruined lives.

 The false face of the boom years and the delayed recognition means we have a much bigger problem. It will mean more painful cuts and more growth-damaging tax rises. However, like with personal debt problems, being open and honest there is a severe problem is the first step to solving it. Then you prioritize what is most important, both by area and within each area. That priority should be based on meeting needs – on serving the public – and not on maintaining jobs.

 As part of that recognition, we should divide the deficit between the structural part (using OECD guidelines) and the cyclical part.

 Like with a financial plan for families who have got into debt, we can see, year-by-year, how that deficit is reducing. It should not be enshrined in law, but at least will show how the pain of narrowing the deficit is bringing the nation back to financial health. Then we can also explain how targets are not being met – e.g. through growth faltering, or failing to meet targets.

We need, as a nation, to admit to the false face that all put on. We should now shun the spin, and recognise the poor state of the public finances so that we can repair the damage with the minimum of adverse consequences.

Why Labour has not the Courage to cut Public Expenditure

18 months ago, I voted on the Congestion Charge. I went into the ballot box having been promised  

 ‘There’s no Plan B. If we vote NO in December the money goes back to Government, all £3 billion of it.’

  See wevoteyes facts 09 Nov 08

I was one of the 812,815 who voted against, a staggering 78.8% of the votes cast.

Depite this promise, six  months later Manchester gets the Metro extensions – the big ticket item. Costing £1.4bn. South Manchester Reporter had the story here.

 

We now have a huge deficit to tackle. If Gordon Brown cannot keep to a firm promise in the face of strong opposition, how resolute will he be on the unspecified commitments to cut the deficit?

 NB the pdf is from wevoteyes.co.uk. This website has now been taken down. For the full story see http://en.wikipedia.org/wiki/Greater_Manchester_congestion_charge

Ken Clarke is right on the IMF

Ken Clarke is correct to state that there is a risk of the UK having to call in the IMF if there is a hung parliament. The reason is simple. The Budget Forecast was that the National debt would reach £1400bn in 2014. This will be around 85% of GDP. For this to be a peak the following has to happen.

  1. The economic recovery has to be rapid. Yet IMF thinks Darlings forecasts too optimistic.  
  2. Most of the deficit reductions come from this strong economic growth, not from expenditure cuts and tax rises.
  3. A hung parliament would mean including the Liberal-Democrats. Their tax increases rely on cutting tax avoidance and increasing taxes to the rich. Such tax rises are unlikely to generate the necessary revenue AND they would be a disincentive to invest in the UK.
  4. Labour sharing power might be worse than Labour on their own for indecision. They have put off a comprehensive spending review, despite a huge change in the Government’s finances. Further they may further put off starting cutting expenditure. It will be damage a party who has said for so long “Labour Investment or Tory cuts” to start cutting.
  5. Further, if they sincerely believe £6bn (0.5% of GDP) cut in waste might tip the economy into recession, then they would also baulk at real cuts necessary to make the deficit peak at 85% of GDP.
  6. The main spending cuts are unspecified. A coalition government might dither at signs of protests from much of the state sector. The IMF could be called in the muscle through the necessary cuts.
  7. There could be another external shock. If interest rates rise, then consumer spending will fall. Also house prices could resume their downward path. Also interest rates rising will also mean an increased deficit. By 2014 each 1% rise in the average level of interest on the debt will add £14bn to the deficit.

 

Extending the period of cutting the deficit, has a compound effect. If each year the target deficit is missed by 1% of GDP, then after 5 years it is over 5% of GBP extra.

Lib-Dem Manifesto – an appeal to the Labour Left

After Nick Clegg produced the best performance in last night’s ITV debate, it is time to examine their manifesto. Others has so far failed. John Redwood attacks the £5bn hole in the Lib-Dem figures, but misses the more important bits. Brian Barder on LabourList has clearly not read the Manifesto and Tom Harris thinking that the policies are irrelevant. However, the manifesto is significant for anyone (like me) sad enough to read the thing. In detail it is a direct appeal to the Liberal Left. It is far more re-distributive than Labour, whilst also scrapping some of Labour’s more authoritarian policies like the ID cards.

For instance

-         In the army, reducing the top brass to fund increased pay for the lower ranks.

-         Tax increases for the rich (CGT, pension tax relief, mansion tax)

-         Anti tax avoidance measures.

-         Hitting big business with higher corporation tax.

-         Devaluing the Nations investment in the Banks by a banking levy; by breaking them up; through state sponsored competition in the form of a PostBank; and a UK Infrastructure Bank (high interest safe returns for “green investment”).

-         Cancelling a replacement fo the Trident nulear missile system. They say they will look for cheaper alternatives, but this is unlikely to happen soon with even bigger cuts in other areas necessary to pay it.

Added to this the fact that Labour have created a structural deficit that will undermine public spending for a generation, and you have a strategy to overtake Labour as the party of the left. Perhaps it is Nick Clegg’s strategy to emphasise this in the third debate when Gordon Brown thinks he will avoid Clegg’s criticism.

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