The question that was not asked

I had the (mis)fortune to listen to the BBC’s World at One while returning home from a lecture yesterday. The second item (20 minutes in) was about the new fiscal rule proposed by Labour’s John McDonnell in a speech that morning. The item contained three segments. The first was from a BBC political reporter, the second an economist at the IFS, and the third from Labour’s 2015 election campaign director.

The reporter, Ross Hawkins, described the zero lower bound knockout as a ‘loophole’, and also talked about taxpayers money. He then described how the knockout would work (the MPC would decide), but went on to relate how a Labour press officer had described his questions as being from a Tory crib sheet and had walked away. The economist Carl Emmerson did a solid job of saying what the rule would mean post 2020, although he had to respond at least once that just because the ‘borrowing to invest’ idea was not new did not make it bad. Then came Spencer Livermore to say exactly that - as it was similar to Labour’s rule for the 2015 election, and as this had failed, Labour needed something new and radical. He did not say, and was not asked, what this new and radical fiscal policy might be.

It occurred to me afterwards that at no point did anyone ever ask whether this rule was better or worse than George Osborne’s fiscal charter. Carl Emmerson tried to contrast the two rules, but natural questions like ‘should we borrow to invest’ or ‘does it make economic sense to have a zero lower bound knockout’ were never asked. Just think about that: the opposition proposes a fiscal rule that is quite different from the government’s, and in 10 minutes of radio no one asks which is better.

Livermore was not asked what his new and radical fiscal rule might be because it was of no interest - all that was of interest to the interviewer was that he was criticising his own side. That was not an accident of the way the discussion went, but inherent in the way the segment as a whole was constructed. If listeners had been looking for any kind of discussion of the economic merits of the new rule they would have been disappointed.

Unfortunately this particular programme was not an isolated case. Channel 4 News took a similar line, interviewing Livermore again, with no economist in sight. I once saw a chart somewhere that looked at who talks about economics in the media, and less than 10% of the time it was economists. This matters, because it is how we end up with governments pursuing policies that sound good in soundbites, but cause considerable damage to our economies.

Flooding and the fiscal charter

We now know that at least one of the flood prevention schemes that was axed when spending was first cut back in 2011 was in one of the areas of the recent flooding. It always angers me when journalists of a right wing persuasion argue that the the public has not noticed any effect from austerity under the coalition. As if increasingly missed NHS targets and crises in A&E do not count, because NHS funding has been ‘protected’. In the case of flooding earlier disasters may not have been connected to austerity because hardly anyone in the media made those connections.

My impression is that the media has been a bit more inquisitive this time around. For example the BBC’s Newsnight showed a chart of actual spending, revealing clearly the cut backs from 2011. Their subsequent interview with Neil Parish, now Conservative chair of the Environment and Rural Affairs select committee, was interesting. He suggested that maybe we (his government) should be spending more money on flood defences. The reason he gave was, to an economist, compelling: the estimated rate of return on such projects is very high.

Yet this kind of logic is completely anathema to the framework in George Osborne’s fiscal charter. This has an overall budget surplus target, which includes spending on public investment. As a result, if a strong investment opportunity like this arises, it can only be funded by cutting back on other items of public expenditure, which is always politically difficult.

Ministers argue that over the next five years capital investment in flood prevention has been ‘protected’ in real terms. With the impact of climate change on extreme weather events becoming increasingly apparent, that is completely the wrong reference point. We should be substantially increasing spending on flood defences, and those schemes should not be built to specifications that are based on past weather patterns. That kind of flexible response to recent disasters is all but ruled out by the fiscal charter.

Where would you get the money from?

In the recent furore in the UK over tax credits, I do not recall any government minister being asked the following question by a journalist: why don’t you just borrow more? Yet to any economist that is the most sensible, and indeed obvious, question to ask.

I just do not think most journalists (and I’m tempted to write and therefore politicians) have yet realised this crucial difference between austerity in 2010 and austerity now. [1] In 2010 debt to GDP ratios were rising fast, everyone was talking about market panic, so people like me who thought deficits should be larger had some explaining to do (although, as Ben Bernanke recently said, we were right). But now austerity already enacted has stabilised debt to GDP ratios, not just in the UK but in the US and Euro area. Over the next five years debt to GDP ratios in the UK will be falling.

This means that further austerity is no longer about stabilising debt and an imagined market panic. Instead it is about an obsessive need to cut debt to GDP really fast, or more likely a desire to shrink the state. It isn’t primarily about Keynesian economics any more [2], but instead about any kind of economics. Remember there are no economists prepared to defend Osborne’s fiscal charter. In economic terms the fiscal charter itself is the real embarrassment. The issue is no longer do we increase the level of government debt for the sake of the economy, but do we need to raise tax credits or cut vital public services just in order to cut government debt quickly.

Perhaps the most charitable explanation for this failure of journalism is that most people do not understand some very basic points. Governments running surpluses are rare. Unlike individuals, nearly all governments have always had a large amount of debt. Unlike individuals, nation states live for a very long time. Because the amount they produce also grows over time (real growth and inflation) that means that the ratio of debt to GDP (which is what matters) can stay constant even if they run deficits. For example with debt at 80% of GDP, and a conservative estimate of average 4% nominal growth, the UK’s debt to GDP ratio would stay constant with a deficit of 3.2% of GDP.

3.2% of GDP is a lot of money. It means the government could run deficits of £60 billion today (£70 billion by 2020) and not raise the debt to GDP ratio. By comparison, the now derailed cuts to tax credits were worth less than £5 billion, and the spending review is trying to save £20 billion.

So here is a simple exam question for journalists. If any politician over the next 5 years proposes not to cut some item of expenditure, or not to raise some tax, and they are asked where is the money to do this coming from, which of the following answers is most convincing?

1. We would generate more tax receipts by making the economy stronger.

1/10. Every political party thinks their policies will raise growth and therefore bring in more revenue, but they should never rely on this happening. In some cases political parties (pretend to?) believe things that we know are untrue, like tax cuts will pay for themselves. Of course some policies, like cutting tax credits, could well damage the economy by reducing labour supply, but again it is highly unlikely that such damage would make tax credits self-funding. So any interviewer would be quite right to raise their eyebrows at this answer.

2. We would save money by making public spending more efficient.
   

1/10. Same problem as above.

3. We would print more money.
   

3/10. Not as silly as it may sound when central banks have already created a huge amount of money (QE) to buy government debt. So no raising of eyebrows (or worse) appropriate in this case. But in the current UK and US context (but not the Eurozone) where central banks are talking about when they might start reducing QE it looks like an answer which is out of its time.

4. We would cut the following expenditure instead, or raise the following taxes, or get rid of the following tax breaks.

8/10. A good answer, particularly if the funding measures are specified and the sums are realistic and not double counted. Works in all seasons. Right now opposition parties have plenty of scope here, as Jolyon Maugham spells out.

5. We would borrow more.

10/10. In the current UK context the best answer, although if you had given this answer in Ireland or Spain in 2004 you would get 0/10. It may seem too easy to be true, but in the rather peculiar circumstances where you have a Chancellor that is pursuing reckless austerity for extremely dubious reasons it would be utter foolishness to turn your back on this gift horse.

Yet most politicians are incredibly reluctant to give that answer, in large part because they think they will get the raised eyebrow treatment from journalists or worse. So we have the crazy situation that no single economist is prepared to endorse the fiscal charter, but pretty well every journalist treats any suggestion that we should depart from it as unacceptable. That just cannot be right.

[1] Andrew Rawnsley rightly points out that the political reaction to the tax credit cuts over the last five months shows how little most journalists know about ordinary people as well as economics (yes, that Westminster bubble), but he fails to note the critical role of the fiscal charter, and so treats the need to find some extra money as self-evident.

[2] There still is a Keynesian argument about risk, but take that away and the case for a more gradual pace of deficit reduction is still very strong.   

Bernanke on austerity and the fiscal charter

When I and others say that the intellectual debate on the wisdom of embarking on fiscal austerity as we recovered from the Great Depression is over, some think I am indulging in exaggerated bluster. I'm not. Central bankers are notorious for their conservatism and their aversion to budget deficits, so you would expect the man who until recently ran probably the most important central bank in the world to be at best equivocal on this subject.

Here is an extract from an interview with Ben Bernanke by George Eaton in the New Statesman:

Though a depression was averted in 2008, the recovery in the US and the UK has been slow. Bernanke partly blames the imposition of fiscal austerity (spending cuts and tax rises), which limited the effectiveness of monetary stimulus. “All the major industrial countries – US, UK, eurozone – ran too quickly to budget-cutting, given the severity of the recession and the level of unemployment.”

Partly thanks to Bernanke’s leadership (and knowledge), the Great Recession was not as bad as the Great Depression of the 1930s. Monetary policy reacted much more quickly, and financial institutions were (nearly all) bailed out. In 2009 we also enacted fiscal stimulus, but in 2010 we reverted to the policies of the early 1930s with fiscal austerity. That mistake was partly the result of panic following events in the Eurozone (see the IMF analysis discussed here), but it also reflected political opportunism on the right.

In the UK that opportunism continues with the new fiscal charter. Here is more from the Bernanke interview:

He criticises George Osborne’s new budget surplus law, which prohibits government borrowing when the economy is growing by more than 1 per cent. “I would be very cautious about putting in rules that would prevent a timely fiscal response to a slowing economy, particularly in a world of very low interest rates.” He adds that “a period of excess labour supply and low interest rates is not only a good time to invest, from the perspective of the recovery, it also makes sense from a long-term productivity perspective”.

Bernanke is again reflecting the consensus among economists: I have not found a single one who supports this charter. Alas winning the intellectual argument does not mean immediately winning the political argument. But even though I am scathing about what I call mediamacro, surely our political commentariat must notice at some stage that the rationale George Osborne gives for cutting tax credits and yet more departmental spending is built on sand.

Linking tax credits and the fiscal charter

I have made fun in the past about Labour politicians and supporters who in public trip up once the word borrowing is mentioned. An interviewer only has to ask ‘but if Labour reverses this cut it will mean more borrowing’ and the interviewee stumbles around in a way that shouts to anyone watching that Labour have a vulnerability here.

It is a vulnerability that helped lead to the disastrous decision under the interim leadership not to oppose Osborne’s cuts in tax credits, and to McDonnell’s embarrassing initial decision (now reversed) to support the charter. But now that Labour has sorted itself out on both issues, it needs to stop avoiding the borrowing question. Take this otherwise assured performance by Owen Smith on Newsnight last night (27 minutes in, HT Owen Jones).

Here is what Owen Smith should have said when asked whether reversing the cuts to tax credits would lead to more borrowing.

“The Chancellor has said he needs to cut tax credits to meet his new fiscal charter. Labour oppose this charter, because it makes no economic sense. Osborne cannot find a single economist who supports his plan. Imposing a work penalty to pay borrowing off more quickly is just counterproductive, because discouraging people from working makes the economy weaker. This was supposed to be a government that encouraged work, yet here is the Chancellor doing the opposite in order to meet a charter that only his MPs support.”

If the interviewer persists with “so you will borrow more”, say

“Labour would not need to cut tax credits because we would balance current income and spending, leaving room for the country to invest. Labour would borrow to invest, whereas Osborne is paying for the little public investment he is doing by cutting tax credits. What matters is government debt in relation to GDP, and our policy would mean that debt relative to GDP would fall under Labour.”

I am sure those skilled in spin could sharpen this, but you get the idea. The days when deficit fetishism gripped voters are coming to an end. Labour needs to change its rhetoric to reflect this, and paint Osborne into the ideological corner he occupies.