Interesting to read this from  Lord Oakeshott, the Liberal Democrats’ former Treasury spokesman

“The economy is as flat as a pancake. No growth means no progress in the Coalition’s central purpose of reducing the deficit. We Liberal Democrats did not sign up to stagflation and a vicious circle of self-defeating cuts. It is time to challenge the Treasury orthodoxy that has learnt nothing since the 1930s.

The Treasury View could be summarised as the belief that:

• The budget deficit needs to be reduced whatever the economic circumstance. The Treasury view states  that balancing the budget is important for restoring confidence. (See: Confidence Fairy)
• The Treasury view usually states that austerity measures will not adversely affect the economy. e.g. Cutting government spending will cause a rise in private spending to replace it. In other words, government spending is crowding out private spending.

The Keynesian view criticises this Treasury orthodoxy because they argue in a recession, government spending is not crowding out the private sector.

In 1931, Treasury officials put pressure on the government to implement an austerity budget – Tax increases, and cuts to unemployment benefits in the middle of a recession. (It led to the minority Labour government breaking up, with most Labour MPs leaving government. The hapless Ramsay McDonald  was left to form a National Coalition with mainly Conservative MPs.

The austerity during the height of the Great Depression made the economy worse – though leaving the Gold Standard did help.

The sad thing is that the Treasury view had also prevailed in the UK during the 1920s.

In an effort to reduce national debt as a % of GDP, throughout the 1920s, the UK ran primary budget surpluses throughout the decade (excluding interest payments, tax revenue was greater than government spending). Yet, despite these efforts at fiscal austerity, national debt as a % of GDP was stubbornly high and failed to fall because (apart from a few years) growth was stagnant.

Years of austerity failed to make a dint in national debt as a % of GDP.

Read more

The past few years have seen many big names on the High Street close down. Chains such as Comet, HMV, Borders, Virgin have all been victims to the recession and competition from online retailers.

I was listening to a radio debate following the closure of HMV and some young girls said that usually when shopping, they went to the high street, tried on clothes, and then went home to order them online. This gives shoppers the best of both worlds. They get the enjoyment of the actual shopping experience (looking at and trying on clothes), and then they get the benefit of being able to buy the goods cheaper from the internet.

This doesn’t just happen for clothes and record companies, but many high street stores. People like browsing through the store, but then go home and buy from the internet.

The problem is –  how long will we be able to enjoy the best of both worlds? If shoppers increasingly window shop on the high street but buy online, high street shops will continue to close down to be replaced by charity shops, pound shops, cafes and those rather soulless mini city centre supermarkets.

If you asked most people whether they would like their bookshop and record shop to be replaced by another mini Tescos or Poundlandshop, I’m sure most people would choose to have the old fashioned shops. But, do we like them enough to keep buying and paying more expensive prices – when we could save a few pounds buying online?

There is a free-rider problem involved in buying from High street shops. We want to be able to have the opportunity to browse these shops, but we’d prefer it if other people do the buying, and we get to enjoy the browsing for free and buying online.

Read more

Readers Question: In a non-recession situation, if a government reduces it’s borrowing and thus it’s spending, how can that have a depressing effect on the economy? Wouldn’t that money be either be loaned to someone else or spent to on goods and services by the people who have it?

Yes. If an economy  is growing rapidly, a reduction in government borrowing (thought government spending cuts) shouldn’t have a depressing effect on the economy. This is because if the economy is strong, a fall in government spending, is usually absorbed by the growing private sector. This is related to the principle of crowding out. – The idea that during economic growth, government spending is crowding out private sector spending. Therefore, as government spending falls, this ‘crowded out’ private sector can increase.

Example

If the economy is growing strongly, then investors will be keen to invest in private enterprise – loans to firms, buying shares on the stock market, buying commercial bonds e.t.c. This is because during an economic boom with rising incomes, investors feel that the private sector is going to give a relatively good rate of return.

Therefore, if the government wishes to borrow money in a period of economic growth, it will have to work harder to attract private investors to buy government bonds. If the private sector is giving a rate of return of say 5%, then, ceteris paribus, the bond yield on government debt will have to be at least 5% to attract borrowing.

If the government wishes to borrow more during times of economic growth, it is competing with private sector investment, and this competition to attract buyers will most likely push up bond yields.

Read more

For the past few years, it has felt a bit repetitive always asking the same question – why can’t the EU policy makers see unemployment, social exclusion and rising poverty as the real challenge facing Europe? In the current climate it is not bond yields, inflation targets or levels of debt that are the real threat to European stability. The real threat is from rising unemployment, declining living standards and increased inequality. But, whilst EU policy tinkers at the edge, it has seemed to ignore the more pressing problems of the real economy.

After being rather dismissive of the EU policy for economic growth for 2013, a recent report on Employment and Social Developments in Europe 2013 is much more encouraging.

Firstly, there is a clear recognition of some of the real problems facing Europe. Rising unemployment, social exclusion and inequality. The above graph shows levels of NEETs

NEETs – stands for Not in Employment, Education or Training. It is a guide to the number of people without work, but also lacking any positive action to get back into work. It is a situation that can easily lead to demotivation, and when concentrated amongst young people, cause social unrest.

Read more

The EU has recently entered a double dip recession, with southern Eurozone countries particularly badly affected. As a consequence of the recession, EU unemployment continues to rise. Over the last twelve months, the number of unemployed people has increased by 2 million,
to reach more than 25 million. The unemployment rate is up to 10.6% in the EU and 11.6% in the euro area.

To restore economic growth, the EU has produced an Annual Growth Survey 2013 to try and deal with these issues. They have suggested concentrating on:

1. Pursuing differentiated, growth-friendly fiscal consolidation
2. Restoring normal lending to the economy
3. Promoting growth and competitiveness for today and tomorrow
4. Tackling unemployment and the social consequences of the crisis
5. Modernising public administration

Differentiated, growth-friendly fiscal consolidation

The EU report states that, in recent years,  sovereign debt in the EU has increased from 60% to 90% of GDP, and therefore debt levels need to be reduced quickly. However, they admit that fiscal consolidation (tax increases and spending cuts) might lead to lower growth. However, they argue that some types of fiscal consolidation may have a smaller negative impact on economic growth. For example.

• Reducing taxes on labour could help create employment. Lower labour costs could help improve competitiveness. This is important for countries like Portugal who are relatively uncompetitive. (see also: Fiscal devaluation)
• They state reducing  government spending has a lower negative multiplier effect than increasing taxes.
• Consider raising retirement ages and prevent early retirement being taken – this can reduce government spending with less impact on economic growth..

Evaluation of ‘Growth-friendly fiscal consolidation’

• ‘Growth friendly fiscal consolidation’ seems a contradiction in terms. The basic problem is that fiscal consolidation has significantly reduced economic growth. There has been a large negative multiplier effect within the EU
• Spending cuts do have a large negative multiplier effect. Cuts to welfare benefits have led to lower spending and greater poverty amongst the unemployed.
• The EU claim the stability and growth pact has flexibility. ‘For example, during 2012, the deadlines set for Spain and Portugal to bring their government deficits back below 3% of GDP were extended by one year, giving them until 2014 to achieve this goal.’ But, this really isn’t flexibility. A country with the depth of recession of Spain and Portugal shouldn’t be trying to achieve a budget deficit of 3% of GDP in 2014, when private spending is falling.
• There is no mention of monetary policy (e.g. some form of increasing the money supply). If correctly implemented, monetary policy could provide a boost to aggregate demand as fiscal consolidation reduces AD.

Read more