Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 18 May 2012

Dangerous Voices and Macroeconomic Spin

                Dangerous voices are what the British Prime Minister called those who criticised austerity in a speech on Thursday. In response one of those dangerous voices, Martin Wolf, became shrill in Friday’s FT ($). After noting the observation by Jonathan Portes that public investment could currently be financed very cheaply because UK long term real interest rates are so low, he writes “it is impossible to believe that the government cannot find investments .... that do not earn more than the real cost of funds. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way. No sane institution analyses its decisions on the basis of cash flows, annual borrowings and its debt stock. Yet government is the longest-lived agent in the economy. This does not even deserve the label primitive. It is simply ridiculous.”
                Ridiculous it is, but as a piece of spin, the focus on reducing debt works as long as the Euro crisis lasts. I was puzzled at first by the phrase ‘dangerous voices’ in the Prime Minister’s speech. Why focus on the act of saying, rather than the content (as in ‘dangerous advice’ for example). Maybe it is just a little Freudian. They are dangerous voices, not because the advice they offer is dangerous, but because they offer a persuasive alternative to the dominant macroeconomic spin. Let’s start with that spin.
                It is good politics to say that “there, but for austerity, go us”. I doubt very much that the government actually believes what it says, but the spin is too good to abandon. Why can I claim that the government does not believe what it says? Because, if debt was the constraint, the government would have tried balanced budget fiscal expansion. Balanced budget fiscal expansion is the growth plan that does not conflict with (and probably helps) the debt problem. Sure, long term supply side reform is good too, but we need demand stimulus now. See, for example, Ian Mulheirn here, or indeed the IMF. I’ve explained the logic many times, and Pontus Rendahl gives a nice theoretical account of why this works (and a new model) here.
                If the government really believed that the markets would not let them borrow to expand, but wanted to do something nevertheless, then this is the obvious way out. So why have they not taken it? One answer (there are others) is that the short term lack of growth in the economy, and rising unemployment, is not actually a big problem for the government (or at least the major part of it). It is consistent with their five year strategy. The prime aim of this strategy is to shrink the size of the state, and the need to reduce debt provides an obvious public justification for this. Balanced budget expansion goes in the wrong direction, at least for a time.
                But the government wants to get re-elected. Here the calculation might be as follows. First, the recession has not hit the Conservative’s political base hard, so in the short term there is no overwhelming internal pressure to change policy. Second, by the time of the next election in 2015, economic growth will have returned, and the macroeconomic spin will be “we said it would be hard, but growth shows the policy has been successful”. Some economists will complain about the output gap, but that will get lost in argument over what the size of the output gap really is. Others will point to average growth over five years, but then the well tested line about clearing up the mess we were left will come back into play.
                In terms of macroeconomic spin, I think it is a pretty good strategy. Good spin is simple, and plays off real events. So the line “we have to reduce debt quickly because otherwise we will be like Greece, or Spain” works, while the response “but the Eurozone is special because member countries do not have their own central bank” is too technical to be an effective counter. In contrast the argument that Wolf and Portes put forward above – why not invest when it’s so cheap to borrow – is effective, which is why it is dangerous. So of course is “austerity is stifling growth”, as long as growth is negative or negligible. However, come 2015, the spin “we have done the hard work and the strategy has worked” will accord with (relatively) strong growth, while talk of output gaps and lost capacity will have less resonance. True, unemployment will still be high, but not many of the unemployed are Conservative voters, and the immunising spin about lack of willingness to work can be quite effective.[1]
Will the strategy, and the associated spin, work? The risk that growth will not be respectable in 2014 must be low: by then consumers and firms should have adjusted their borrowing and wealth sufficiently such that growth can resume.  If there is a chance that it might not be, I expect to see some measures in next year’s budget that do not conflict with the overriding ideological objective, such as incentives for firms to bring forward investment. The fact that the main fiscal mandate involves a rolling five year horizon means there is always room for such measures.
The Office for Budget Responsibility, that very positive innovation by the current government, will in all likelihood be pointing to the need for continuing austerity, because the earlier absence of growth will have (or appear to have) reduced capacity through hysteresis effects. I suspect that this was not in the original game plan. However I also doubt that it will be a fatal flaw either. Indeed, while austerity may be becoming unpopular now, do not be surprised to hear the following bit of spin in 2015: “Austerity laid the foundation for our current growth, so we need to stick with it to ensure growth continues”.  As you can see, I think the connection between macroeconomic spin and macroeconomic reality is pretty tenuous. Please someone convince me that I’m being too cynical.

[1] Some argue that the “Labour isn’t working” advert in the 1979 election was effective. However high unemployment did not prevent Mrs Thatcher being re-elected. Perhaps unemployment is more of a problem for Labour than Conservative governments? 


  1. Not cynical. What they're doing is transparently ideological as you've pointed out here and elsewhere.

    But it's also incompetent. Again as you say: the Freudian slip belies subconscious acknowledgement - perhaps he hasn't completely forgotten the macroeconomics component of his undergraduate years.

    It may be unfashionable to invoke rational voting, but for this incompetence I do not rate their chances at the next general election.

  2. Various commentators seemed not to understand Jonathan Portes' arguments. Not just the complicated bits about deriving formal proofs for "intertemporal government budget constraints" , which is understandable (I have to say that, as I have not yet worked through that). But the simple, basic point that long term borrowing, in real terms, is astonishingly cheap.

    Having read your post, I can't help wondering if there isn't a certain Nelsonian blindness at work.

  3. No, I think you are right. The 2012 Budget was the most overtly political Budget for a long time, and Osborne is clearly motivated primarily by his desire to be re-elected in 2015 (and maybe become PM after the next election). He's a dangerous man and he's playing a dangerous game with the lives of the British people.

  4. But will the economy be recovering in 2014?
    This year and most of next year are a complete write-off and most of the cuts have still to take effect.
    Why do they not start some new investment now, it could easily be clothed as a good investment and as a result of their low interest rate austerity policy?

    The reason is that are completely hamstrung by their own ideology, they wouldn't spend the money even if they could.

  5. You're forgetting one more argument that will definitely be in play in 2015 and overrides all the other ones you've made.

    "Austerity saved/killed the Euro." What level of growth or unemployment will not matter in the context of whether the Euro lives or dies in the next two years. If the Euro can survive, The Austerity crowd will claim vindication, no matter how unjustly (Mitt Romney just claimed credit for saving the American Auto-industry for God's sake). And, even if the public doesn't understand the technicalities, they can certainly get their arms around the idea Austerity was practiced across the Eurozone and bears the responsibility for when the Euro dies.

  6. Hey,

    So... the message of this is it is a systemic problem of the system of government, a kind of principle-agent problem, where the government's best interests in continuing to be the population's agent are not the same as the best-interests of the population.

    I guess I can believe it.

    I'd failed to identify this as a problem myself - since you're (clearly) some way ahead in this thought process, do you have some proposed solution?


    1. The post is really about the disconnect between macroeconomic spin and reality. Ideally we should try and reconnect the two, although I've written in previous posts on why that can be difficult (e.g 18/2/2012). I think yesterday's post identifies one particular problem: the focus on changes (i.e. growth) rather than levels, or equivalently the relative lack of concern about unemployment. I'm old enough to remember when there was almost too much concern about unemployment (which some argue helped allow the inflation of the 1970s), so the interesting question is why its different now.

  7. It's a very difficult problem. In a super complicated world – it's not 1810 anymore, like the right thinks it is and wants it to be – there's going to be a lot of ignorance about a lot of things, and ignorance is the rights strongest ally, on economics, global warming,... It just takes substantial time to learn economics, and people have a whole lot of other things they'd rather do with their too scarce free time.

    An important step is teaching about market problems (externalities, etc.) in econ 101 and 102. These courses are required for most college students (at least in the US). But when I had econ 101 and 102, market problems were never taught. You only heard about how wonderful the pure free market was (and by extension how bad and wasteful government always was). Market problems were left for intermediate econ, courses few students took.

    If people learned that the market wasn't always perfect and government wasn't always a waste in college, then over a generation that would make the rights propaganda a lot less effective. Market problems are too fundamental and important to be left to intermediate econ., which almost no one ever takes. And society has paid a terrible price for that.

    1. The problem with the way market failures are taught is the suggestion that the government can solve them. In practice, the government is unlikely to have the necessary information to be able to intervene effectively.

      And that's ignoring the fact that the whole conceit of welfare economics is pseudoscientific. The idea that the "right" policy is the one that maximizes the nonexistent utility of an imaginary agent, might be compelling if we were all Utilitarians, but we are not.

    2. When you survey people you find that they're largely utilitarian, and there's hardly any support for extreme libertarianism when people are asked about the specifics and implications. People favor largely utilitarian policy vastly more than extreme libertarian policy.

      History and evidence disagrees with you that government can't take many measures to greatly improve on the market problems and failures. Look at, for example, governments' free and supported education, basic science, infrastructure, universal healthcare versus the alternative, measures to deal with natural monopoly,...

      You act as though the ideal is for government to do nothing because of potential government problems (which can be dwarfed by the market problems from doing nothing). This ignores tons of evidence. It's case by case, cost-benefit analysis, not cost-cost analysis.

    3. "When you survey people you find that they're largely utilitarian"

      They may say that, but it's not reflected in the choices they make either in their personal lives or when electing governments. People consistently put the wellbeing of themselves, their friends, family, and countrymen above the happiness of the greatest number. If people were utilitarian, there would surely be far more redistribution, both within countries and from the rich nations to the developing world.

      People also value tradition and freedom far more than abstract concepts like utility. They may not always value other peoples' freedom or culture, but that doesn't make them utilitarians.

      "History and evidence disagrees with you that government can't take many measures to greatly improve on the market problems and failures."

      I didn't claim that the government has no useful function; one doesn't have to be an anarchist to be skeptical about the ability of government to correct market failures. I would note that most of your examples of successful government intervention also provide evidence to the contrary. Government run schools and hospitals have proved disastrous. The only useful role in these areas is to ensure affordability, either via a negative income tax or a voucher system.

      "It's case by case, cost-benefit analysis, not cost-cost analysis."

      But the problem is that we don't know the costs and benefits. All we have are some crude estimates based on economic theory (i.e., opinion dressed up as objective facts). If it were simply a question of computing the social costs and benefits and determining the appropriate prices and regulations, the socialist command economies would have been more successful.

    4. You're simply wrong, "econojon". Government run hospitals are on average, consistently, everywhere, better than privately run for-profit hospitals. This is absolutely uniform across all studies. When your facts are wrong, no wonder you have wrong conclutions.

      And as for successful government intervention? Pollution controls. Nothing else is *capable* of fixing the market failure of pollution, and historically nothing else every attempted *has* fixed it; government fixes it very well.

      Also, what you say doesn't disagree with the claim that people are generally utilitarian. Their utility metric may value some people more than others, but they are absolutely utilitarian if the contrast is between "utility" and "liberty". This is proven out by a long history of examples, where if given the choice between bread and freedom, the majority choose bread.

    5. Just want to say that in the university I'm going to in Ireland they do talk about externalities and market failures in first year economics. We also touched on 'the economics of happiness' and the 'quality of life index'. I guess what's taught varies somewhat around the world.

      I agree that government sectors can be and often are very effective- and certainly much much better than private enterprise in some areas. They also tends to exercise more social responsibility, and to have such responsibility demanded of them.

      I remember being shocked when i found out that some americans would consider some european countries relatively 'socialist'.

      If Ireland didn't have free/affordable third level education, social safety nets, and lots of free healthcare then it would be a much nastier place to live for both rich and poor, and would be economically much weaker. As it is, it is mostly a very pleasant country to live in. If it wasn't for the economic crash caused by the housing bubble and the banking crisis it would be a prosperous country. It's worth noting that this wasn't caused by 'the welfare state' but rather by the folly of private interests: bankers, developers, and new homeowners, which led to the bursting of a housing bubble, and a major banking crisis. Unsecured bondholders would have lost 10's of billions of euros because their financial bets went sour. However the Irish government decided to pay their debts which has massively added to the sovereign debt crisis and contributed to Ireland not being able to borrow on the international markets (interest rate too high).Questionable private interests are what led to the 'bust', both nationally and internationally.

    6. " Government run hospitals are on average, consistently, everywhere, better than privately run for-profit hospitals. This is absolutely uniform across all studies."

      Oh, sorry, I must have missed those "studies". I wonder, in that case, why it is that people are willing to pay vast sums of money to be treated in private hospitals rather than the government-run alternatives. All I know is that I have experienced both private and NHS hospitals, and there is no comparison.

      I take it you concede that private schools are consistently better than government schools, or do the "facts" contradict that, also?

      "Pollution controls. Nothing else is *capable* of fixing the market failure of pollution, and historically nothing else every attempted *has* fixed it; government fixes it very well."

      Oh, I see. That's why there's no pollution, is it? Or are we supposed to believe that the current levels of pollution are "optimal". If so, perhaps you can explain to the asthmatic why he can barely breathe in cities such as London or LA, or to the impoverished family who can't afford to pay their heating bills due to "pollution" taxes on the production of a harmless gas (i.e, CO2).

      "Their utility metric may value some people more than others, but they are absolutely utilitarian if the contrast is between "utility" and "liberty". This is proven out by a long history of examples, where if given the choice between bread and freedom, the majority choose bread."

      I'm not an expert on the different forms of utilitarianism; I was under the impression that a key tenet was that everyone was considered equal. Perhaps not. It would seem to me that if we can't agree on how to value each other's utility, then utilitarianism is pretty useless as a moral philosophy. If I regard my utility as more more significant than yours, and I derive utility from killing you, then murder becomes a moral act. I don't think that's quite what Bentham had in mind.

      In any case, I hardly think placing a basic human need above one's taste for freedom demonstrates a devotion to utilitarianism. Yes, humans require food to live. So what?

    7. Allright, I should be more precise here. Few people are Mother Theresa, willing to sacrifice everything for the greater good. What I mean when I say people are largely utilitarian, and support largely utilitarian policy far more than extreme libertarian policy is this: If it's for the greater good, if it does vastly more good than it costs, and it doesn't cost the person being asked, or it costs them a modest amount, then they usually support it, even if it's very un-libertarian.

      Examples include large public support for government paid for education of all children (government paid for, but could be by voucher or charter), Medicare, Social Security, universal healthcare everywhere its been try-and-see'ed, unemployment insurance, aid to those considered truly deserving and very poor,...

    8. And also you can add public investment like basic scientific and medical research. You could say people support this because it's in their best interest, and it is for most people, but it's still un-libertatian, in that it's force by the government that everyone pay taxes for it whether they want it or not, and some people don't want it and won't benefit, like some members of the very old who may die before it comes to fruition. But a large amount of basic scientific research is highly popular for selfish reasons, and with the justification that although not everyone gains, the overall good, especially to future generations, vastly outweighs the cost, i.e. a utilitarian justification.

    9. Two posts ago please insert "net-costs" for "costs", just to be very precise and clear here.

  8. Hard to be too cynical, but what about the Liberal Democrats ? I think it is clear that thy are heading for political catastrophe (not their last -- the worlds oldest political party has been attempting suicide for well over a century and hasn't managed yet). My guess is that Clegg at al understand that this will be their only experience in government eer and want it to last. I mean betraying all of one's principles and causing a recession is fun I guess.

  9. I think one has to recognize that the government has a different view of economics to that espoused by the "dangerous voices". Conservatives remember the 364 economists in the 1980s, and they are remembered (perhaps unfairly) for being completely wrong. Conservatives believe Margaret Thatcher was vindicated in pursuing polices of austerity during that time, and seem to think the present circumstances are analogous.

    Or at least, I think this is what was believed during the election. It's now becoming clear that--whatever your view of the 1980s--the present policies of austerity are not working and the academic economists are being proven right. But it would be politically disastrous to admit this publicly, so Cameron has to stick to his guns even if he is beginning to have doubts.

    I also think the Tories have (again by analogy to the 1980s) in mind the idea that austerity is the best way to reduce the size of state. When people argue for deficit spending or balanced-budget expansion, they are effectively calling for a bigger government. The obvious solution is to set a long-term strategy for reducing the size of government, focus on temporary stimulus projects rather than blanket increases in departmental budgets, and make permanent tax cuts an integral part of any stimulus package.

  10. Hmm, but none of this explains the reasoning of the Lib Dems. I can easily see that someone like Danny Alexander (someone with no experience whatsoever) may be very naive and easily manipulable. And I can see that someone like Nick Clegg may be one of those centrist types who don't much care about the size of government and its role in the economy (You know who it goes: "oh those Labour/Tory politicians, always wanting to nationalize/privatize and increase/decrease spending, such ideologues!"). So Clegg sees Labour calling for stimulus and thinks "same old, same old".

    But what then explains the thinking of someone like Vince Cable? Here's an article of his from just over a year ago:

    He decrees the Keynes would be on the Coalition's side of the argument. I'd be interested on your comments on that article which is in need of a good fisking.

    1. I agree that the Lib-Dem position is more 'interesting', because it is harder to explain in rational terms. I read the article, and I'm not sure if I'm any clearer. I'm reminded of something wise I was once told. If someone is late for a meeting, and they give you three different reasons why it was not their fault, it probably was. If I had to summarise it would be 'the economy is doing just fine, and if it turns for the worse monetary policy will come to the rescue.' Well the economy was not doing just fine, and for whatever reason monetary policy did not respond.

      My own theory is that they were spooked by Greece at the moment the coalition agreement was being drafted, and once they signed up for Conservative austerity they felt trapped. But the politics still seems amateur. To use another example, when they lost the PR referendum they had a real opportunity to demonstrate their independence by killing the NHS bill. I cannot see why they did not do this.

    2. My theory is that the LibDem leadership has lost their minds. Nothing else explains their behavior.

    3. Of course the destuction of the Lib-Dems will be a useful (and intended, BTW) byproduct of the Tory strategy. But it really is a puzzle why the Lib-Dems are so acquiescent in that destruction.

  11. You are spot on. Before the last election, austerity differentiated the Conservatives from Labour, so they went for it. The gamble has always been that the economy will have improved enough by the next election to make it seem like austerity has worked.


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