Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday 17 May 2017

But do the numbers add up?

The (official) launch of Labour’s manifesto saw mediamacro on display in all its unabashed pre-Keynesian ignorance. The idea that we could spend more on health and education by raising taxes on companies and high earners was so novel and (to many) attractive, the broadcast media collectively decided there had to be something wrong. The manifesto appeared to have increases in current spending exactly covered by increases in taxes, so surely there had to be some mistake.

Step forward the Institute of Fiscal Studies (IFS). Now I have huge respect for the IFS and the way it is run. Over the years it has established itself as the organisation of choice from where the media can get unbiased assessments of the size of individual fiscal measures or fiscal packages like budgets and election manifestos. But with this influence comes responsibility. Paul Johnson will freely admit that the IFS does not do macroeconomics. For many years before 2008 the IFS could get away with that, but no longer.

The IFS quite rightly said that tax estimates were uncertain because people can take measures to avoid tax increases or new taxes. The manifesto had made an allowance for this, but presumably the IFS thought it was not enough. In the media framing of measures having to ‘add up’ that suggested a potential problem with Labour’s figures. What the IFS did not say (or at least were not reported as saying) is that - when interest rates are at their lower bound - a tax funded spending increase would provide a much needed boost to activity, which itself would raise taxes. This is the famous balanced budget multiplier, which still holds in state of the art New Keynesian models when rates are stuck at their lower bound.

The IFS said raising corporation tax would cut investment, but did not note that raising demand would have the opposite effect. Because the IFS does not do macro, these points were simply not made. No one made the point that increasing public investment when real interest rates were about zero not only made good economic sense, but would also boost the economy, probably raise productivity, and itself bring in more taxes. In other words the IFS were implicitly assuming that this package would have no impact on output. [1] When interest rates are at their lower bound that is highly unlikely to be true. Even if interest rates did rise to exactly offset the demand impact of the balanced budget expansion, the increase in public investment will have positive supply side effects. I’m afraid this is a case where not doing macro means that what the IFS says is hopelessly one-sided. It has been 7 years since 2010, which is surely time enough to learn a bit of macro.

But this was nothing compared to media incredulity over failing to ‘cost’ the various nationalisation measures. Again the media have had years of being told that privatisation saves the government money, so surely reversing privatisations must cost them money. Of course neither is true in a macro sense. As any business will tell you, if you borrow to buy an asset, you get a return which should pay for the borrowing. When the government has no problem selling its debt at around zero real interest, the question ‘how much will it cost’ is completely irrelevant. The issue is whether this industry should be a private monopoly or state owned.

I should record two caveats to this familiar complaint about mediamacro in the coverage I saw. First, the BBC’s economics editor Kamal Ahmed did give a 30 second slot to someone from the IPPR, who very succinctly made the macroeconomics case for both a balanced budget spending increase and additional public investment. It was a single ray of sunshine in an otherwise dreary day. Second, senior Labour politicians still seem unable to robustly defend their own position on this. You don’t respond to questions about why nationalisations have not been costed by saying you do not know what the share price will be. You say as long as we pay a fair price it does not matter what it costs, because the state is buying an asset that brings a return that more than pays for the borrowing.

Of course journalists should ask hard questions at a time like this. I just wish they would not persist with questions which show their own macroeconomic ignorance. (It is a problem that arises with Budgets just as much as with election manifestos.) As any macroeconomist knows, there is no reason why the numbers have to add up, and if they didn’t on this occasion that is actually a benefit given rates are at their lower bound. The media’s focus on adding up misinforms viewers, and is classic mediamacro. As any economist knows if this government buys an asset by borrowing at zero real interest rates it really does not matter how much you have to borrow. Ask Labour politicians why they think the industry would be more efficiently run under public ownership, not how much will it cost.

But let me end on a positive note. It is great to finally have at least one of the two main parties putting the case for a large increase in public investment when the government’s borrowing costs are so low. It is great to see one party prepared to raise taxes to stop the growing squeeze on the NHS and the new squeeze on education. It is great that Labour have a fiscal rule which tries to represent current macroeconomic understanding rather than the wisdom of the Swabian housewife. Let’s hope this lasts beyond this election.

[1] In principle that could influence the ‘highest tax take since 1940s' line, but the impact on GDP would have to be quite large to do that. (HT GT) 


  1. I was expecting to see something written in French about Simon Wren-Lewis's hands, but then I realised I misread the title of the blog as "Mainly Macro" ...

    1. I feel your persistent dyslexia should be treated. I assume that this time you misread it as "Mains Macron" but then got hoist by your own disability . . .

  2. Great post - two correct non-trivial propositions that need repeating:

    1. The IFS is not the font of all wisdom. You're right they pretty much make a virtue of not having any macro-economists. They are surely incompetent when assessing macroeconomic consequences.

    You might also have pointed out that the actual evidence on aggregate investment is that it is substantially more sensitive to GDP than to price effects (as embodied in interest and tax rates).

    2. A balanced budget is neither necessary or sufficient as a criterion for evaluating policy. Yes on average in the long run. But surely not at a point in time when the returns to investment exceeds their costs - as any decent manager in the private sector will tell you. A really simple argument apparently beyond the ken of any of our media.

    When the 1945 Labour administration surveyed the post-war macroeconomic situation - with public debt at 200% of GDP - twice what it is now - what did it do? It invested. Why? Because there were clear returns to doing so. It built the NHS and the modern welfare state - social security in the best sense of the words - and subsequent growth in real GDP per capita for the next 15 years averaged over 3%.

    Please please keep on banging the drum!

  3. One the nationalization front, I think it's hard to argue that there is no embedded cost in the process. The proponents are basically arguing we should distribute the sector profits as either better services or lower fares.

    To argue that the utility and transport sector would generate similar returns under state ownership is equivalent to state that they would be run under the same profit motive they would be in the private sector. This seems unlikely to me.

    If you purchase a business with the explicit promise you will push its margins to zero, then the purchase cost is the actual cost: you are promising to never generate any profits.

    Nationalization in itself does not increase the deficit I agree. Running those companies with the aim to break even definetly would.

    So you'd ever have no change in the service (which would kinda break the promise they make) or we'd get less profits from the sector.

    Of course you could imagine that the government could somehow increase the underlying sector productivity. While I agree privatization is unlikely to do much for that, I very much doubt nationalisation would do that....

  4. Earlier today, I heard Camilla Cavendish (once of the No. 10 Policy Unit) assert on the "Today" programme that "we can't afford to borrow any more". I sent a tweet to her asking why not, when real interest rates are negative, and debt service costs as a % of GDP are at historically low levels. As yet I've had no reply.

  5. The balanced budget multiplier was a cute construct in its day. But in an open economy where the government is fully sovereign it is an irrelevant idea to resurrect.

    Once you open the economy and have income-sensitive tax revenue then the leakages are much higher and this reduces the overall impact of the spending increase on aggregate demand and while the multiplier remains positive it is much lower than 1.

    Shiller must have dug out an old 1950s or 1960s American macroeconomics text-book which derived all the main macroeconomic results as if the economy was closed. In those days, the external sector and trade were often examined in the closing chapters. This was justified by the fact that the US economy was a large and fairly closed economy.

    He also makes some very large assumptions about the external sector.

  6. I was thinking about this earlier. Whilst I accept that the multiplier effect could work for the Labour party, I'm not sure how many of their spending plans would directly increase growth. Nationalisation is a transfer of ownership, though there is the potential to offset costs against revenue that doesn't really add to gdp. the replacement of loans for university fee with grants won't have much impact. Because the repayments are fairly small anyway, and the impact would take a few years to come into effect anyway.

    Removal of the bedroom tax would have a small impact, but too much of this money is being spent on right past Tories injustices, as they see it , rather than being directly used for growth.

    So that is a lot of extra taxation, especially on businesses, for not much increase in gdp.

    You're right in principal, but when I looked I couldn't see that many Labour spending commitments that would have an unquestionable impact on growth, even those that might are extremely dependent on the competence of those carrying out the policies. Sorry.

  7. A bullseye.

    The IFS uses the dog-whistle word "competitive" when it comes to tax rates, e.g. here
    which is also the result of their 'not doing macro' - leading them into the fallacy of composition: assuming that better fortunes for the corporate sector translates automatically into better fortunes of the economy as a whole. Which clearly ain't so, given that lots of corporate profit is (financially) extracted from other parts of the economy. Fabulous article.

  8. Thank you for writing this: the media are driving me nuts.

  9. The investment is welcome, but the business tax rises didn't convince me at all in the context of Hard Brexit, supported by Labour.

  10. On the BBC News tonight (17/5/17) Kamal Ahmed's report on the pay squeeze didn't mention Brexit once.

  11. I was wondering about your comment about the ZLB and spending matched by taxes in the context of a DSGE model.

    Are there models were you get that sort of multiplier effect -- without presuming an irrealistic lump sum tax?

  12. Ask Labour politicians why they think the industry would be more efficiently run under public ownership. quite. define "public".

  13. There is a good blog post on the BBC, the Labour Party and this election at the LRB 'Post-Democratic Broadcasting' by Tom Mills, 18 May 2017.

  14. Geoff Roughton18 May 2017 at 15:09

    An interesting read for a layman such as me. Interestingly the Tories produced a document, using their own formula, that shows a rather large black hole in the sums. I'm curious if the same formula used by the Tories to the Labour manifesto was applied to the Tories claimed fiscal performance over the last 5 what it would show?

  15. 'How much will it cost?' is a good question.
    It is just being asked in the wrong sense.
    Just look at Venezuela and see that state control of economic activity comes at a high cost.

  16. One would have thought that at least the F.T. has journalists who could provide a thorough analysis of the macroeconomic aspects of the manifesto, and who would be interested in doing so. I think I read all their articles on the Labour manifesto. I only saw a few lines that mentioned the overall deficit and debt framework in passing, with no real attempt at analysis. This compared with lengthy detailed discussion of the tax plans.

    If even the F.T. can't be bothered to take the macroeconomics seriously, there seems little hope that the rest ofthe media will.


  17. Many thanks - I really appreciate the clarity of your argument which helped me come to grips with (a) some things I'd felt but hadn't consciously formulated, or not formulated for a while (the advantage of near-zero interest rates), and (b) other things I hadn't thought about at all (the fact that it doesn't matter that renationalisation costs hadn't been covered)

  18. Fantastic article for someone who is quite ignorant about economics in general (me!). Thank you.


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