Living within our means

John McDonnell’s speech seemed to go down well with his supporters. Institute for Fiscal Studies boss Paul Johnson found it a bit confusing though:

There was quite a lot of nodding towards things, or directions that he would like to take. So, unlike what I had understood him to say on Saturday [that he would accept George Osborne’s fiscal charter], he didn’t say that he would be in favour of balancing the books by the end of the parliament. He didn’t say anything specific about a Tobin tax [the financial transaction tax]. He didn’t say anything specific about people’s QE. But he did talk in general terms about the need to support growth, to reduce corporate welfare, to raise money from people like Starbucks and Google and so on.

So what one got the sense of was a desire to raise taxes, as is often the case with politicians, from other people , be they multinational companies, or the 1%, or the rich or whatever. But, to make what he’s saying balance, that is a significantly large amount of tax in that.

That was the slightly confusing thing in a way. He did not really talk very much about spending cuts at all. To meet the fiscal charter, certainly to meet the government’s fiscal plans to get to balance by the end of this parliament, you either need really very significant spending cuts – and that’s what this government has laid out, and let’s be clear they are very significant spending cuts, we saw some of them announced in the budget, we are going to see some more in the spending review – or you need some really, really big tax increases. So, if he really does want to go down that route, then there’s a lot more to spell out.

It’s not just me then. (See yesterday’s post.)

Why the vagueness and confusion? Most of the post-mortems seem to be saying that Labour lost the election because it was not seen as being economically competent. I suspect this is behind all the “live within our means” rhetoric and the reluctance to say too much about borrowing.

As John Van Reenen explained:

Part of the problem was that Labour was reluctant to highlight its rather sensible pledge to eliminate the current deficit by the end of the next parliament. Instead of being proud to say that public investment should not be included in plans for eliminating the deficit as capital spending has a longer term return than current spending, it prevaricated out of fear of looking fiscally irresponsible.

The crazy part about all this is there’s a good story here, it’s just that the Labour Party was reluctant to tell it during the last election and seems to be just as reluctant now.

Before the election, the Institute for Fiscal Studies published a report on the fiscal implications of the major parties’ policies. The key difference was that the Conservatives wanted a complete end to government borrowing by 2019-20 whereas the other parties aimed to eliminate the current spending deficit while still borrowing to invest. This means that all day-to-day spending on public services plus social security and debt interest would be covered from tax revenue but capital investment projects, such as new railways and roads, would be funded from borrowing.

Given the growing pressures on public finances over the next decade, it makes sense to get back to a point where day-to-day spending is being covered by tax revenues. Even Simon Wren-Lewis, one of Jeremy Corbyn’s new advisers (congratulations Simon) and Jonathan Portes, who are certainly no cheerleaders for austerity, agree that the UK needs to reduce the public deficit. Just eliminating the current deficit would be enough to start reducing the UK’s debt-to-GDP level by the end of the decade. A paper by NIESR just before the election calculated that, by 2020, under Labour’s policy we would have higher debt and higher growth, under the Conservatives’s policy, lower debt and lower growth but under both plans public debt would start to fall relative to GDP. As the IFS shows, debt wouldn’t fall as quickly by reducing only the current deficit but it would still be on a downward path and we wouldn’t have had to wreck our public services to achieve it.

Screen Shot 2015-09-28 at 17.09.49

This would still mean some spending cuts or tax increases. The Resolution Foundation calculated £7 billion, which sounds a bit light to me, given that the NHS will probably need  more cash before the end of the decade. Even so, it’s still nowhere near the amount needed to achieve George Osborne’s target of an absolute surplus.

If we must use household spending as an analogy for the national accounts, the current deficit is like your overdraft and credit card debt while borrowing for capital spending is like your mortgage or a loan for home improvements. It makes sense to clear your overdraft and pay off your credit card from your monthly salary. It doesn’t make sense to pay off your mortgage more quickly if by doing so you will damage your family’s health and future prospects. This is especially true of you can borrow at fixed rates on historically low terms.

Why cut down on the quality of your food, your trips to the gym or sports clubs and extra tuition for your children just to pay your mortgage off more quickly? If you could meet the repayments, surely it would make more sense to borrow money at today’s rock bottom rates to convert your loft, giving the children an extra bedroom or study. This would add to the value of your house and improve your children’s exam results and future earning prospects.

Covering day-to-day living expenses from salaries is what most people would consider living within their means. Trying to cover investments in things like houses or home improvements from day-to-day wages is something few families are able to do. And if they could borrow at fixed low rates, as governments do, it would be really crazy to bust a gut trying.

There is a good story to be told about living within our means while still investing for the future but Ed Miliband’s team didn’t tell it or, if they did, few people heard. A reasonable and sensible policy was squeezed between allegations of deficit denial from one side and austerity-lite from the other. The IMF and credit ratings agencies are saying that governments need to invest, both to build infrastructure for the future and to boost economic growth, and that now is the time to do it.

It makes sense to live within our means and to invest for the future. There is no contradiction between the two. It’s time someone on the opposition benches stood up and said so.

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15 Responses to Living within our means

  1. Luis Enrique says:

    “you either need really very significant spending cuts…. or you need some really, really big tax increases.”

    or you need to magic up some growth. Corbyn team rhetoric is about growing its way out of the deficit via more investment. I don’t know what the IFS assumes about what impact public investment has on GDP growth, tax revenues and expenditures, but I am guessing it’s less powerful than implicit in the we can close the deficit via growth story.

  2. Pingback: Living within our means | Flip Chart Fairy Tales | sdbast

  3. Truth to Power says:

    Rick,

    Most economists view the world through the lenses of Keynesian economics (a macro economics perspective) where they appear to ignore ‘private’ debt.

    Processor Steve Keen has been making the point that you need to consider both ‘government’ and ‘private’ debt http://www.debtdeflm/blogs/2014/11/09/what-austerity-hawks-ignore/ also see Steve’s YouTube videos who sees the world through the eyes of micro economics.

    The article explains that ‘austerity proponents see the entire problem as government debt, and ignore private debt’ but maybe the Corbynites are being influences by Steve Keen’s thinking. That the government should spend more money … that is my interpretation. But I agree with you that it appears to be illogical.

    Certainly Yanis Varoufakis who worked with Steve Keen had a different view to the Keynesians.

    Keen did predict the 2008 crash!

  4. Truth to Power says:

    As you will see on the link Prof. Steve Keen is one of Corbyns advisors.

    http://www.cityam.com/222906/corbyn-backed-anti-austerity-lobby

    It is fascinating.

  5. ChrisA says:

    In an ideal world, with a philosopher-dictator in charge, of course public investment in infrastructure makes sense. In a real world the money is most likely to be wasted on either the wrong projects, over-inflated salaries or just plain incompetence due to no market signals. Most of the voting public understand this which is why “austerity” is popular and Labor lost the last election and will lose any future one.

  6. Malcolm Chainey says:

    Aditya Chakrabortty in the Guardian today (http://www.theguardian.com/commentisfree/2015/oct/13/tories-big-business-tax-loopholes) suggests corporate tax avoidance exceeding £1 billion per annum. If this is true, and if this amount can be clawed back, then this changes the calculation markedly.

  7. mrkemail2 says:

    Stop issuing Gilts, over half of which go to foreigners. Can I win the Fake Wally Nobel Prize🙂

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