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


Is Australia near the fiscal tipping points of Europe?

Although in Australia the current economic situation may seem bad, it is nothing like as dire are Europe.

There is a new issue. After a long period of surpluses in 2009 the government created significant deficits. These do not seem justified by the small slowdown in economic growth. Any ideas?

Using World Bank Data, many of the Eurozone countries have been running large, structural deficits for years. Australia only went into deficit in 2009.


As a result, Australia’s national debt is small relative to GDP compared with the European nations.


The relative problem can be seen from the growth rates. Australia has yet to go into a full year of recession. That is growth of less than zero.


Neither has growth dipped much below the average for 1998 to 2007.

Joseph Stiglitz on the causes of the current crisis

Roger Pielke Jr. takes a critical look (here and here) at a novel theory of the recession from Nobel Laureate Joseph Stiglitz in Vanity Fair, the eminent economics journal. This is an extended version of the comment that I made on the second posting.

The Stiglitz theory would make a bit of sense if it were not for what he misses.

  • Your evidence that other countries, like, Germany, have similar increases in productivity but not the endemic problems.
  • That output per capita is identical in National Income Accounting with income per capita. Therefore, the long term rise in per capita income is a result of increased productivity per capita.
  • Since the start of the industrial revolution, real per capita output has risen (in the wealthy economies) more than 200 times. If there has been no corresponding increase in per capita income, unemployment would be greater than 99%.
  • Stiglitz quite rightly points to the rise in personal debt. He makes no mention of public sector debt. In the USA and in Britain in the period 2000 to 2007 government finances swung from a small structural surplus to significant structural deficit. If deficit-financed investment is expansionary, it was not just the low interest rates that kept the boom going but the fiscal stimuli. Similar structural deficits were present in many European countries like Greece, Portugal and Italy.
  • In the 1990 Japan entered a prolonged slump. In the following decade the economy stagnated despite huge public works investment like Stiglitz advocates. The Japanese national debt spiralled to 300% of GDP, with nothing to show for it, except a lot of fantastic roads to nowhere.
  • Japan was fortunate in that its borrowings are at near zero interest rates. The European economies are not so fortunate. Those European economies with large deficits reached a crisis tipping point when interest rates exceeded 7%. To save the economy, radical contractionary policies have been implemented.

I would therefore contend that Keynesian fiscal expansion in the USA or elsewhere would not only be ineffective (coming on top of other fiscal expansion), but carries a huge risk of making matters dramatically worse. Morally I believe that economic policy-making has a powerful analogy to medical practice. It is not just a matter of diagnosing properly the type and extent of the ailment. It is providing, at a minimum, a remedy for which there is a reasonable expectation that the patient will be better off being treated than not. Like with a GP, an economist has a duty of care in what they advocate, particularly when there are very clear and evident risks. Joseph Stiglitz seems to take no such care.

Prejudiced economic analysis in South Manchester

Have responded to a letter in the South Manchester Reporter of 3rd June.

GM’s letter of last week is prejudiced against a small minority and ignorant of economics. The need to cut is mostly due to the government running up a deficit during the boom years, and then going on a wild spending spree to try to shore up the vote as an election approached. (The cyclical part will be (mostly) taken care of by a strong economic recovery.) So in this area, we can look forward to some shiny new trams and gleaming school buildings along with a generation of cuts to pay for it. For instance, the £120m for the Didsbury spur of the Metrolink alone is equivalent to over 30,000 teachers and nurses doing without a 3% annual pay rise for five years.

The consequence of this fiscal irresponsibility is not just financial. People will lose their jobs or have careers de-railed, others will be made ill through over-work, or through seeing their livings standards fall salaries are frozen, whilst taxes, prices and interest rates rise. Rather than opposing cuts now, people should look to areas where they are least painful. That means shelving some of the recently signed-off “investments”, such as the extra bus lanes on Wilmslow Road; less government advertising; or finding better value for money in the provision of local services. The consequence of not doing so is even bigger cuts later, and lower living standards for the next generation.

But why call somebody prejudiced and ignorant? I quote

“Once again, those who really control the wealth and power (the gambler’s in our casino economy and the obscenely wealthy) have demanded that their government makes the poorest people in society pay for the economic crisis.”

 

“….John (Leech MP) will no doubt remind him (The Chancellor) that the multi-millionaires are unlikely to feel any effect whatsoever from the cuts to education, benefits and the health service that will inevitably follow in 2011”

The underlying cause of the recession, I believe, are:-

-         The prolongation of the last boom through cutting interest rates after the dot-com bubble burst in 2000, and again in 2001.

-         Failure to raise interest rates in 2003. This would have been very difficult politically.

-         Failure of the regulatory authorities to realise the systemic risks building up in the financial sector, and the risks building up in individual banks.

-         Deficit spending in the boom years, which kept the boom going at the expense of creating structural deficits.

-         Political spin, and dubious accounting (PFI contracts to put liabilities outside the National Debt figure), to hide the reality.

Whether I have highlighted all the points, I am sure to be closer than someone who just blames the rich. The reason is that I, at least, attempt to understand the issues.

Risk, Volcanic Ash, Regulation and the Leaders debate 2

John Redwood today makes some brilliant observations on “Bash the banks and Praise the Regulators”. His comparison with the ash cloud and the banking regulation is particularly apt. But it is not just the cost of inappropriate regulation that there is a similarity. The leaders’ debate of tonight showed crystallised the issue for me. It is how do the authorities deal with an unprecedented situation? The risk-averse say let us do nothing until there is full information. On the financial system, nothing was done to control the excesses. On the ash cloud everything was stopped until the scope of the problem could be assessed by the experts.

There is a way of going into the unknown without full information. You set general rules and assess the magnitude of any problem.

-         On the ash cloud, you compare the risk with the size of the eruption, the size of the particles and the distance from the volcano. From this, you would have found no evidence of large jet aircraft getting into emergency situations 1,000 miles from an eruption, in an ash cloud that is hardly visible.

-         From the financial system, the situation was evident that house prices and consumer borrowing was going to unsustainable levels on an unprecedented scale from 2003 onwards. The 0% interest credit cards and the large discounts for changing mortgages were evidence of this in the UK. The sub-prime boom, with mortgages deals agreed whereby in 3 years the borrowers could not meet their repayments was evidence of this in the USA. It was the very magnitude of the problem that should have merited special attention. The action should have been to raise interest rates and increase cash requirements for banks.

On the surface the action was the opposite – One to stop what was already happening, the other that immediately stopped anything from happening. But the cause is the same – by requiring detailed rules and acting on how others will perceive our actions, the authorities took wrong course of action.

 The Leader’s debate crystallised it for me. There was one leader who stood out. His reaction to any problem is not to take any risks.

-         He will not risk safety by letting planes fly.

-         He will not start cuts now to risk the recovery.

-         He will not risk banks ever getting into trouble again.

-         He will not risk a foreigner being unidentified.

-         He will not risk existing jobs.

-         He will not risk offending our European neighbours by disagreeing with them.

-         He will not risk independent MPs, by banning them from second jobs and monitoring every penny they spend.

-         He will not risk independent thought, by stipulating what religions should believe.

-         He will not risk diversity in education by allowing independent schools to be formed in the state sector.

 In so doing, after another 5 years of his leadership we will have no recovery; we will have no decision-makers in government – just be taking orders from Brussels and the IMF; we will have no risk-takers in business as most will not want to overcome the ever-higher regulatory hurdles for achievements that are taxed away and vilified.

We will also have no future.

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