US Economists on the UK Austerity

As you may have noticed, last Wednesday George Osborne announced the Comprehensive Spending Review, to much fanfare.

There are a few things to say in addition to linking up a couple of comments from US economists (against is Paul Krugman, for is Stephen Williamson).

The most important is this: When you're doing economics, try as best you can to separate what politics from economics. All politicians have a rather distorted view of economics: Tory ministers blame anything and everything on Labour, Labour ministers blame anything and everything on the Conservatives. Of course, they both have their economists, but the point is: Soon you'll be able to understand which bits each set of economists is ignoring to come to its conclusions.

For example, according to the Tories Labour is entirely responsible for the recession we suffered, and the budget deficit that has resulted. They support this with some assertions (apparently lax regulation from the FSA, not "fixing the roof when the sun was shining" whatever that actually means!). But what you will learn this year is that recessions happen: They are part of the natural cycle of the economy, and no amount of government action will solve that (Tories are right to laugh at Gordon Brown's comment years ago about ending boom and bust it's fair to say).

Additionally, government finances are a product of the economic cycle: In recessions, people are out of work and hence they don't pay taxes and instead claim benefits. So the budget deficit will worsen in a recession, especially the worst one in 70 years.

You'll learn next term about why economists worry about these cuts in spending (regardless of their views about how large the state should be). It's something called Aggregate Demand, and the Multiplier principle. The practical upshot is found in warnings by KPMG that the public sector cuts have a direct impact elsewhere because many small businesses rely on the public sector (councils, etc) for contracts, and hence many may go out of business as a result.

Fiscal Austerity Won't Be Painless

In second term (econ101b), you'll start to learn a lot about macroeconomics, and so the current debate over the macroeconomy and fiscal austerity will start to make a lot more sense after that.  You'll learn about a concept called Aggregate Demand and you'll learn about contributions to it and to economic growth via something called the Circular Flow of Income.  Later in term you'll learn about the money markets, interest rates, and something called the LM curve.

These are basic economic theory concepts, and they allow us to start thinking about the impact of government spending, and help frame the discussions that have been had amongst politicians over the last year relating to austerity.  The Labour party emphasised the impact of spending on Aggregate Demand, saying that big cuts in spending will reduce aggregate demand and plunge us back into recession - less money going around the Circular Flow of Income.  The Tories on the other hand, argued that the government is too big: It "crowds out" the private sector.  We need to cut back government so that the private sector can flourish.

Of course, the problem is putting numbers into these concepts.  They are all well and good as concepts but how big are they?  Labour would argue crowding out isn't that important, particularly at a time of recession and low aggregate demand; Labour would also argue that the multiplier (the factor by which GDP grows given an increase in government spending) is large.  On the other hand, the Tories would argue that crowding out is important, and the multiplier is small.  So who is right?

The Economist reports on two studies which give conflicting viewpoints on this: Welcome to economics!  One research paper, by Alesina and Ardegna, suggests that fiscal austerity can help stimulate growth; the other, from the IMF, says it won't, and picks holes in the Alesina-Ardegna strategy.  The devil is in the details, but what this speaks of most is that, unfortunately, putting numbers on things in economics is very hard work indeed, and often you'll find that people put the numbers on things that they want to see via clever techniques and border on the deceptive, in order to further their case.

Economists and Immigration

There's little doubt that one of the major news topics of recent years has been immigration.  It was an election issue, and will no doubt be a recurring issue.  Ed Balls is chipping in as he bids for the Labour leadership.  Politicians are falling over themselves to sound more and more like Joe Bloggs on the street, who is very concerned about immigration.

The Coalition government has taken steps to introduce its promised cap on non-EU immigration, and would, given the opportunity, do more.

But is this good for us?  What does economics tell us here?  It can tell us many things.  First, it begs the question: Why restrict?  By restricting the free movement of factors of production to their most productive uses, we must therefore end up with a less optimal solution.  The same or inferior output at higher cost, as we throw out the non-EU worker who was selected as the best person for that particular job.

Hard headed and brutal as it is, there simply is no economic argument for restricting immigration.  Let's think a little more about the consequences of restricting.  Poor quality British workers get jobs, they're protected, and have little incentive to be anything other than mediocre - they won't be replaced by that more highly skilled Aussie or Canadian because they are now ineligible for the job.

You will probably notice during your time even as an undergraduate in Birmingham that the overseas students you see amongst you are by some distance the most hard working and keen to learn.  They emerge with the better qualifications and knowledge, and are likely the more employable people.  But they won't be employable legally in the UK.  We'll be poorer as a result.

We'll be poorer because meals in restaurants will cost more and will be delivered by unmotivated, overpaid British waitresses instead of motivated and hard working immigrants.

I could go on.  The simple fact is, there are no good reasons for restricting immigration.  What about overcrowding, you might ask?  Well, there will become a point where migrating to the UK is no longer beneficial to people elsewhere, if we left things unrestricted.  The marginal benefit of doing so would be outweighed by the marginal cost.

We'd have more things produced because the world is not a zero-sum game.  If immigrants take some jobs, there are still plenty of others out there, and those displaced should be motivated to upskill themselves and find a new job.  If they aren't prepared, I don't want to know about them and I certainly don't want to hear their moaning - the kind of moaning that has secured the current anti-immigrant sentiment in this country.