Friday, April 30, 2010

Economics and the Tories

I'm immersed in multiple Facebook debates with friends of mine on the election and how the economy matters in my thoughts about the election.

I wrote the following note today which I'll post here. If it's already obvious, I'm a Christian and so some comments on the note relate to that; but I think these kinds of things should form one's views on other aspects of life such as the economy. Anyway, here goes:

Quite a few people perhaps are interested in my thoughts on the election as an economist. I'm far from the only economist in the world, and my background is as a Labour voter. So hopefully my economist friends will comment on this also and correct me where they think I'm wrong - in case it is (which I hope not) that political matters are clouding the economic judgement.

If you're linked in, I've debated with you on Facebook already so thought you might be interested.

Where to start. Hopefully as I go through these things it'll become clear that my take on how the economy work means naturally I'm more inclined towards Labour than the Tories. More inclined towards Lib Dems too, for that matter.

Deficit. Basic economic theory says that the total demand for goods (stuff produced in the economy and imported) is called Aggregate Demand, and made up of what we as consumers consume (called C), what firms invest in for future production (given the letter I), what the government spends (G), and net exports (NX, so if more people buy our goods abroad than we buy of their goods then this term is positive). So: AD=C+I+G+NX.

Furthermore, money in the economy goes round and round - between firms and workers who consume and so it goes back to firms, who pay workers, and so on...

So: There's something called a multiplier effect. If the government ploughs in some more money (G goes up), then that extra money goes round a few times as firms pay workers who buy stuff in Tescos etc). So that means a £1bn injection of government money will lead to total output (GDP) going up by more than £1bn because we spend it quite a few times between us.

The same has to work in reverse. Pull out money, demand falls, goods aren't sold, the economy has to shrink.

But should we put loads of G in the mixture? No - other economic theory talks about the crowding out effect: Lots of government spending raises interest rates meaning firms invest less and their share of the economy falls. So we can't just go on raising G all the time, that won't lead to strong growth because firms are crowded out of the picture.

So when should G fall? G should fall when its negative impact won't be enough to tip the economy into a recession. Governments should not be compared to households for reasons I may touch on later, but they can be compared to firms in some contexts - one I'm thinking of is this. As a firm, if you borrow to start up, you pay the money back once the firm is profitable - you don't do it immediately because then you'd never get off the ground. So we need to cut later.

And we need to cut: The government's share of the economy can't be the 50% it is now. It is too high. But it's 50% because it owns Northern Rock and most of RBS and Lloyds TSB, and because many jobs have been lost in the private sector in the recession. These are rather special (as in different, peculiar) times.

So as you can see, nothing controversial in there, it's all very basic economics. And it so happens it corresponds to the Labour policy on getting the deficit back under control.


More generally, where do I stand on the economy? Economics teaches that markets are very effective tools for helping the economy function. Via the price mechanism, where the price moves in a market to equate supply and demand, information is immediately conveyed to all people about the state of the market.

But markets are far, far from perfect. Some people in the market are uninformed, and those well informed exploit them. Other times, if left to the market some things (benefits for those unemployed) just would not happen.

So the power of markets needs to be harnessed. That's regulation mostly. Not nationalisation most of the time (tho the army and some thing of course need to remain nationalised). Financial markets are everyone's favourite target, and rightly so.

Perversely, a right-wing view on regulation has held sway since the 1970s (not just under Labour!), and politics has reflected this, and regulation has got lighter. Alan Greenspan in the US (former governer of their central bank) has come under a lot of fire for honestly believing financial markets could regulate themselves. Of course they can't when some people have a lot of knowledge, and others have little, yet a lot of money is going around.

So I'm left of centre on how the economy should be run. But not much left of centre. The benefits system has got to be, as much as possible, not open to abuse (but we live in a fallen, imperfect world, people will always abuse the system). But it's got to be there. As people we just aren't charitable enough.

A tax system should also be progressive. Many right-wing economists (that the Tories love) would say that highly progressive taxes discourage effort - and in the extreme I think this is true. But to use that kind of idea to justify their cuts on inheritance tax just stink and reveal much about their priorities (given their track record).

On purely economic grounds: It's poorer folk that spend a higher proportion of their income, hence if you're aiming tax cuts, you'd aim them at the poorer people not the richer. But of course, I don't form my beliefs on taxation by economics alone, but also as a Christian. A realistic Christian. Of course, it's not nice that the government forces us to pay tax to redistribute income (Toby - you moan about how inequal income is now in the UK - but if the Tories came in nothing they do would reduce inequality!). But left to ourselves, we're sinful and greedy. There's just no way we'd pay enough in charity to ensure abject poverty was avoided. Why did the welfare state come about in the first place?!

Few more election related things. IMF. All parties are as bad as each other at spinning and distorting, but the Tory IMF thing is just wrong on so many levels. Not least this: The IMF was called in in 1976 to bail out the UK. In 1977 there was a hung parliament. Hence the Tories are wrong historically on the link between the two.

Will the UK become like Greece? Dave's linking of our currently deficit to Greece's is almost entirely irrelevant. Bit like saying I'm spending too much today, and so is that guy over there who is about to file for bankruptcy. Our debt is massively smaller than Greece's, and has historically been so. Furthermore, our debt is long-term (10-15 year bonds), Greece's is very short term - hence they keep having to appease creditors that they'll pay eventually. Finally, the UK's debt is given the top rating by credit agencies: Greece's is junk. Maybe the UK will suffer a downgrading (but I doubt it - the last S&P statement basically said there was no risk of this), but the UK has an infinitely better track record than Greece, and hence it's fairly unlikely.

Are business leaders backing the Tories btw? The Tories would like to tell you that, but businesses are after a credible deficit reduction plan, and the IFS has made it clear none of the parties do enough. I'd personally like better, more clearer plans - but I want more clearer plans to reduce the debt once the economy is growing. It simply isn't sensible to cut it and send the economy back into recession.

That's enough for now. Hopefully it's clear why I vote Labour based on my principles formed from being a Christian and an economist.

Incidentally, I just finished chatting with John Fender (on BBC and Sky News in the last day), and despite being a Lib Dem voter, he is most convinced by Labour on the economy.

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