Thursday, 23 April 2009

False choices; irrelevant counter factuals

Just before Alistair Darling finished his budget speech yesterday, he made the following supremely fatuous comment:

You can grow your way out of recession. You cannot cut your way out.

The first statement was an oxymoron. If an economy is growing, then it's not in recession. If it is in recession, then it's not growing. The second statement is just plan wrong. If an economy has a large public sector, which crowds out and weakens the private sector, then cutting public expenditure will stimulate growth.

In the mid-1980s, the Irish government provided an excellent example of the merits of public expenditure cuts as a pro-growth strategy. After a decade of appalling fiscal deficits, it introduced a highly successful expenditure reduction programme, which re-established long run fiscal sustainability, and laid the basis for 10 years of solid economic growth. In fact, the Irish experience introduced a new concept - the expansionary fiscal contraction. Of course, the Irish ruined everything by pumping up a huge and unsustainable housing bubble, but that is another story.

However, this is not my main objection to Darling's foolish play on words. He displayed the typical New Labour tactic of posing an irrelevant question in order to deflect from the root of our economic difficulties - debt. Darling wants to distract us from New Labour's continuing contribution to the UK's horrific debt levels.

Households and firms owe too much, while the banks have too many loans that are unlikely to be repaid. Rather than go through the painful process of unwinding this debt, which necessarily involves an deep recession, Darling thinks he can escape the consequences of New Labour economics. The answer, absurdly, is more debt. The public sector, he believes, can take over as the borrower of last resort, and keep the economy growing. He has co-opted the Bank of England, who have obligingly cut interest rates to almost zero.

Eighteen months into this crisis, and this strategy has failed miserably. The economy has already slipped into a nasty downturn, while unemployment is rising. Darling would no doubt argue that things would be so much worse if the government hadn't stepped in, raised borrowing and kept aggregate demand high. This brings us to the second highly dubious tool of the discredited politician - the counter factual. "Things are bad, but there would be so much worse without me."

Indeed, the situation is bad, and Darling made it worse with his reckless budget yesterday. Even under the best case scenario, New Labour has bequeathed this country a decade of historically unprecedented fiscal problems. In the worst-case scenario, the UK could be slipping towards a fiscal crisis, where financial markets question the long run solvency of the UK government and refuse to finance this profligacy.

16 comments:

electro-kevin said...

Could someone please explain the situation when the banking system comes good again ?

Won't the British Govt be sitting on a pile of assets ?

Mark Wadsworth said...

All good stuff, except this:

"the painful process of unwinding this debt, which necessarily involves an deep recession"It's painful for those that have to realise losses, go bankrupt, be repossessed etc, but what makes it worse is trying to re-inflate house price and debt bubbles, and hence dragging it out.

If we woke up tomorrow morning and house prices had halved, then the whole process could be sorted out in a a few months and we'd be back to growth in no time.

Anonymous said...

Could Lloyds, HBOS, RBS be cleaned up and sold for huge profit ?

aSteve said...

Mark W, I share your feeling - but I don't think you're right. Houses are the tangible asset that underlies the vast majority of money in our financial system. If real estate prices half abruptly, we'd see widespread bankruptcies - not only would the over-stretched find themselves wiped out, but also the more prudent - who, for example, might have depended upon the value of their own home as collateral in order to allow their company, with little collateral acceptable to lenders, to fund profitable activities. Another problem is that if the reckless spenders are bankrupted en-mass, then there will likely be insufficient retail demand over the short term from the economically prudent.

Alice, I was also irked by that line... but I know what he meant. This is Keynesianism - the idea that it is the obligation of government to spend when the private sector slows. It makes some sense - though I see it as being no silver bullet... and, obviously, not without risk. My least favourite false statement on this topic was Brown's - where he said "We're all Keynesians now" - a clear indication of hubris and evidence that he is extremely influenced by the Fabian monoculture with which he surrounds himself.

Tuscan Tony said...

Exceeding well put. Directed here by an extract of this post on idle.

Anonymous said...

The future value of bailed out banks is questionable. The profits they posted were clearly inflated by the creative banking methods employed. In the future it is unlikely they will be allowed to indulge, so its unlikely their stock valuations will reach dizzy heights any time soon.

The losses we taxpayers are bearing would have been booked as profit before the crash. The capital is gone ( and might not even have existed in reality anyway). I don't doubt the banks will be privatised in the future, but we'll get to keep the losses.

Anonymous said...

Regards comments earlier - How have those who rode the over valuation in homes to fund business ventures prudent. If they couldn't handle a decline in house prices then they shouldn't have banked their futures and businesses on them.

Also this budget and strategy is not true Keynesianism. True Keynesianism is spending surpluses built up in the good times to then be applied to deficits during the bad times.

This mistake was the same one Labour made in the 1970's because, as back then, I don't see any surpluses.

To spend you way out of trouble with debt simply won't work.

electro-kevin said...

Thanks, Anon at 22.35

sobers said...

Lets face it, this is Gordons budget. The whole mess is his. Darling is just the mouthpiece. To do anything about the deficit (ie raise taxes drastically, or cut spending, or both) would mean that Gordon had to admit he was wrong, that his entire political career was a massive failure.

Not going to happen.

The man is incapable of admitting he was wrong. He will plough on regardless. The estimates for the deficit will rise again over the next year, and nothing will be done to tackle them in the next budget either. The Tories face dealing with the mess after the next election, if the IMF don't get called in first, which in the light of this budget is now highly likely.

Incidentally, I reckon the Tories should call in the IMF anyway after the next election, get them to do an audit and suggest the remedy. That way they can legitemately claim the pain (tax rises, spending cuts) are Labours fault.

electro-kevin said...

After some thought:

"The future value of bailed out banks is questionable. The profits they posted were clearly inflated by the creative banking methods employed. In the future it is unlikely they will be allowed to indulge, so its unlikely their stock valuations will reach dizzy heights any time soon."

*** Do they need to reach dizzying heights? They were purchased at rock bottom. They only need to x2 , x3 or x4 and they will still be tiny fraction of what they were at their dizzying height.

"The losses we taxpayers are bearing would have been booked as profit before the crash. The capital is gone ( and might not even have existed in reality anyway). I don't doubt the banks will be privatised in the future, but we'll get to keep the losses."

*** We own the banks, we own the government, we own the treasury, we own the cash that the banks will turn into. The portfolio of banks under the RBS banner is huge. They have tentacles around the world, they own Natwest, Coutts ( The Queens Bank) ABN AMRO some American Banks.

I'm not wishing to burden anyone here with a response but ...

... am I being obtuse ? Yay or nay ???

K T Cat said...

"You can grow your way out of recession. You cannot cut your way out."

Staements like this are true until they aren't. No graph of returns is monotonic - you can't stimulate endlessly and you can't cut endlessly. It's pretty obvious and will become moreso that the UK is way past the overstimulation / overspending point on the curve.

powerman said...

No you're not being obtuse EK, it deserves an answer.

First of all, you're assuming that those assets will inevitably recover. They could simply be liquidated and their stock price go to zero you know.

Remember, the 'assets' (in reality liabilities) that the UK government has taken on are assets which nobody working for a profit was interested in touching.

That ought to raise a question in your mind about the risk involved in just sitting on them and hoping that they'll recover, just sorta, by themselves.

Brown and Darling might think this will happen, because they seem to believe that business profitability is just a sort of sine-wave that goes up or down without any effort or insight on the part of the people working for and managing a business.

These 'assets' are basically insolvent institutions that got that way because they loaned money to people who couldn't afford to pay it back. Brown thinks that they should be forced to lend even more money..

Do you see a problem here ?

electro-kevin said...

Thank you, Powerman.

Obviously I'm too thick or lowly for other people to respond to - that is clear.

I'm not convinced that everything will stay static or get worse. Especially as Banking shares have trebled since March. ( They went down after they were purchased by the government but have made up that ground.) Toxic assets are supposed to be frozen albeit in negative or negligable territory. The Banks reflect confidence and sentiment in other industries and the housing market, industries share prices are picking up, housing is showing signs of picking up.

Anonymous said...

*** We own the banks, we own the government, we own the treasury, we own the cash that the banks will turn into.
Well, Good for *you* then - The "we" you speak of sadly does not include the other 98% of the population; the ones who are not directly connected to the government by wealth or occupation.

powerman said...

EK, I believe the upturns you are seeing are 'dead cat bounce', but of course we'll only find out by waiting.

Anonymous said...

"The portfolio of banks under the RBS banner is huge. They have tentacles around the world, they own Natwest, Coutts ( The Queens Bank) ABN AMRO some American Banks."

My work colleague took out a mortgage with Northern Rock for 120% of the valuation price, Oh, say two years ago. That house had nothing special going for it and now the value of the property is thirty percent down on the valuation.

He is now sitting on a massive loss. He is reasonably Ok if the government doesn't allow rates to rise and so long as he keeps his job.

Northern Rock had no protection in the loan, there was no 10 - 20% cushion for the lender, immediately the price started to fall the lender was exposed too.

I know another fellow who bought a whole house, I am envious, this is no two up two down property, under pressure from the wife and with help from the inlaws, he is now looking at a five figure loss on the purchase price.

I am not asking you to weep for these folk, simply suggesting that this sort of think won't go away with in a decade.

So, by my assertion it is going to be a decade before the government who have bought these companies NR and RBS, will see break even on the money they have spent.

Meantime, the capital they have expended is making no return for the tax payer. No dividend, no interest and a return on investment - assuming no massive job losses over ten years in the future.

That relates to just the small fraction of the money that was tied up in the UK. The rest of it ... WTF knows?