Sharing the Proceeds of Recession
Having seen a shop on the high street advertising that it would pass on the proceeds of the VAT cut, one wonders what will happen when it gets raised to 18.5% later on.
Will they continue to pass the costs on, resulting in reduced trade, or will they keep their prices down, reducing their profits and thereby risking downsizing? Either way, any apparent recovery will be stymied.
It looks more and more like cynical positioning than sensible economics.
Sphere: Related ContentThe Limits of Keynesianism
Back in Fashion
The Writings of John Maynard Keynes have experienced something of a renaissance. The apparent success of the bailout to save the global financial system from itself has exposed the limitations of concepts based on absolute rationality and brought back an emphasis on the need to adopt special measures in periods of economic turmoil. With the Prime Minister finally admitting that Britain is going to enter a recession, discussion on the measures to take could not be more appropriate.
The underlying concept, that governments need to spend more during recessions, is a fundamental truth of finance. The level of public spending as a proportion of income inevitably rises during a recession as tax revenues dry up. Intervention is also a necessity in a market that operates according to the complex realities of human behaviour rather than idealised abstractions. It preserves order and prevents the irrational anarchic panic of a downwards spiral into a brutal recession. Intervention is required to establish the limits on moral hazard; protecting those liable to suffer from the irresponsible actions of others. Keynesian interventions are also necessary to preserve some of the core skills that underpin the economy. An open letter to the Times today by business and Trade Union leaders emphasises the importance of retaining the skills base of the UK economy.
It is important to remember though that Keynes was by no means an opponent of capitalism. The ideas put forward in The General Theory of Employment, Interest and Money were designed to operate as an additional refinement of the only system that has repeatedly demonstrated its effectiveness in achieving prosperity. Keynesianism does not replace capitalism, nor should it. The burdensome and inefficient economies of the 1960s and 1970s were the result of trying to operate according to such systems beyond recessions, and were in many ways woefully ineffective. Growth and demand ultimately come from below in such systems and the state is rarely a particularly efficient or effective agent. Interventions must be there for as long as necessary, not as long as possible. After the recession has ended, governments will have to reduce the size of their programmes in order to save money for the next downturn.
Bearing this in mind however we must concede that we are very poorly placed to act. Ideally, governments should run a surplus during boom years to save for the rains of the bust ones. Reductions in tax revenues during recessions make this sort of saving necessary, particularly as Keynesian programmes often need to be further supported by responsible borrowing. Unfortunately for the United Kingdom, obscene levels of public spending masquerading as “investment”, coupled with gigantic levels of public debt concealed within Private Finance Initiatives and further burdened by the nationalisations of banks that over-lent, means that very little money is available to fund such Keynesian programmes. Further spending risks completely bankrupting the country, and placing us in an even worse position than if no intervention happened at all.
Still going to happen, but the aim is to reduce their size
Nonetheless the moral imperative of intervention to insure against a complete catastrophe is necessary. Given the unpropitious political and financial circumstances any programmes will have to be limited. They must focus on more than just spending, and instead on building the infrastructure and maintaining the skills required to underpin a future period of economic growth. Projects must have clear ends beyond mere maintenance of employment, and instead focus on greater long-term goals. Keynesianism is not about eliminating recessions, but lessening their impact. It is not a panacaea, but an analgesic. Politicians must bear this in mind and avoid an orgy of self-righteous public spending that risks deepening and lengthening a recession.
One must also be aware of the limitations of projects capable of implementing the objectives of Keynes’s economics. A new government spending project takes, from conception to implementation, roughly eighteen months. That often means that by the time it is able to intervene, much of the recession has passed and a well-meaning initiative becomes just another financial burden to bear during the process of economic reconstruction. Governments should therefore be wary of new projects and initiatives proposed by various interest groups promising greater employment and infrastructure. Unless it can be demonstrated that any such projects are genuine investments (and not just expenditure masquerading as investment), they should not be supported. Unless there are genuinely good reasons to shorten the conception to implementation period, this process should, in general, be avoided. A far better method would be to expand the scope of existing projects, accelerate their implementation, and move further towards implementation those projects that have already been conceived. Working with what one has is infinitely better than having to start such projects from scratch. Crossrail and the London Olympic developments here stand as good examples, as others have already mentioned.
In all this one must however remember that much of the existing data on Keynesian programmes is skewed by the events of the late 1930s. The transition of much of the United States, Britain and Germany into total war economies means that the level of acceptable state intervention is far greater than what one could even begin to countenance in a time of relative peace. The results are therefore difficult to discern having been overtaken and distorted by events.
What none of this must conceal however is the moral necessity of reductions in public spending. The arguments for nationalisations in previous weeks does not detract from the legitimate criticisms of the inefficiency and waste of the public sector. At a moment no more timely, a report released by the Chartered Institute of Personnel and Development suggests that the public sector wastes billions by failing to adequately deal with people taking spurious sick leave. Denis MacShane, a former Labour minister, bemoaned “the waste of money on pointless projects, publications, or legions of press officers that add no value“. These inefficiencies have restricted our ability to effectively finance the measures necessary to lessen the blow of a recession, and during a recession itself, such abuses of power are inexcusable. The case for cutting spending is clear: the money is now urgently needed to be allocated to those projects and parts of the economy that are genuinely deserving of money.
The re-appraisal of Keynes in this period is necessary, but we must not accept any policy with his fingerprints on it uncritically. The government has to realise that it cannot cure the recession but only lessen its impact, and resist the nostrums many will attempt to sell under such an illusion. We must acknowledge that we are poorly placed to implement an effective series of Keynesian programmes, and that our efforts must be specific, limited, temporary and with a clearly-defined set of objectives. We should favour expanding existing programmes over new ones. Spending in non-essential sectors will have to be cut to make room for vital projects and the expansion of welfare to accommodate the unemployed. Above all, the damaging hyperbole favoured by many on the left must be resisted in favour of a more measured long-term view. We must accept the limitations of Keynes’ ideas, and must not accept any programmes with its label uncritically.
Sphere: Related ContentCommon Responses to the Crisis
This is a reposting of an article that originally appeared on John Redwood’s blog, but given the proliferation of misinformed opinions around the financial crisis it deserves wider dissemination.
Sphere: Related ContentLast night I travelled to Hatfield to speak at a dinner. The roads were eerily emptier on a Friday night - a sign of things to come. I am grateful to the audience - and to all of you bloggers - for your thoughts on the crisis. I would like to comment on some of the most common responses.
“Too much deregulation caused this mess” - showing the eternal power of Labour spin. The extreme version blames Margaret Thatcher for this “crisis of capitalism”!
The great difficulties in banking have occured in the most regulated of industries. Regulation of banks and other financial institutions has expanded greatly in recent years. This is a failure of regulation as well as a failure of banking. It is not that we had too little regulation - we had the wrong type of regulation regulating the wrong things, allied to weak regulation of what matters, capital and liquidity.“People like you called for deregulation, so you caused the problem”!
This is the fatuous BBC line. It ignores the fact that I issued warnings about the dangers of the Bank of England have too little power to regulate banks and other financial institutions. It also is a muddled proposal in its own terms, as an Opposition MP calling for something does not mean that something happens! I thought Labour was in government and calling the shots on how much regulation we needed.“Banks should not be allowed to lend more than they get in deposits, so they would be stable.”
The run on the Rock which brought the Rock down shows that deposits are not a stable source of cash if confidence goes. There is a lot to be said for a model where a bank draws its money from a wide range of sources, to reduce risk.“Banks should not borrow short and lend long”
Borrowing short and lending long is a normal banking approach to making money and helping the economy. Done in moderation it makes sense. The interest rate is usually higher for longer term loans than for short terms. Intelligent exploitation of this difference can earn a return for bank shareholders. Of course, taking it to extremes can jeopardise confidence. The problem in the summer of 2007 was the Central banks, especially the Bank of England, left markets so short of short term funds a crisis was likely.“It’s not fair of you to call for lower interest rates - this means savers will be hit”
In this crisis we are all going to be hit. Savers can only enjoy high rates of interest if people and companies can afford to pay even higher rates of interest to borrow the money. If rates are too high too little money is borrowed, and too high a proportion of exisitng borrowings are not repaid. Savers and borrowers depend on each other. At the moment it is too difficult for borrowers, so the savings rates have to come down to prevent the system breaking down completely. I would have thought the experience in the Icelandic banks might start to show savers the dangers of wanting too high a rate of interest for current conditions.“We should limit people to borrowing just 3 times their income again, as they used to do, when taking on a mortgage”
I agree banks and Regulators need to look again at how much they are prepared to lend against any individual property, and how big a multiple of income they will allow. Today, however, the problem is not limiting the amount banks will lend, but getting them to lend enough. This is a something for the future when banks do want to lend more. Many of us were warning against the extreme deals we saw being advertised in 2006-7 before the crunch.“Nationalising the banks would sort all this out - why don’t they just do it?”
Transferring problems from the shareholders to the taxpayers sorts out nothing. The day after you still have the same underperforming loans and the same need for extra cash and capital. The banking sector is too big as a whole for the UK state to take on. Why should the UK taxpayer have to pick up the losses, when we did not enjoy the bumper years for banking profits and bonuses?
Windfall Taxation is Lunacy
The left wing of the Labour party have written a letter to the Guardian calling for a windfall tax on the profits of oil and energy companies in the face of the rising costs of living. The problem is that this proposal is utterly illogical and counterproductive.
First, let’s look at some simple flaws in the thinking. A windfall tax can only be levied against those companies that operate in UK legal jurisdiction through ownership. When it comes to the oil companies, that leaves us with BP and half of Shell. Levying a tax on them would be damaging to British industry, hampering its ability to compete. As a result investment will go elsewhere and the overall tax revenues will decrease.
Any revenue raised will not help those in fuel poverty. With the public finances in as parlous a state as they are presently, the chances of revenues being ring-fenced for this purpose are roughly equal to Lord Lucan being found in bed with Nessie. It is a luxury the government simply cannot afford. Moreover, the proposed use of the money on a large-scale insulation scheme would take so long to implement that it would provide little in the way of tangible relief for those in fuel poverty.
More importantly, those who are going to modernise Britain’s energy supplies in the next decade will be the energy companies themselves. Taxing their profits, rather than encouraging responsible reinvestment, will hamper our ability to conduct research into cleaner forms of energy and power stations. Money will be diverted from research and development. The problems we need to deal with now will come back to haunt us later. The “victory” of a windfall tax would be Pyrrhic.
The only thing this tax is likely to provide more fuel for is the recession, worsening the lot of the poorest in Britain. The theory the proposal is based on is that the energy companies are squeezing the consumer to further their own self-interest. Just look at the language of envy the letter employs. Based on that assumption, the logical conclusion is that any increase in taxes, even if on a one-off basis, will be passed on to the consumer. The result: further rises in energy prices. A windfall tax is entirely counterproductive in that it will be the taxpayer, not the energy company, who ultimately pays it.
A windfall tax, if it is to exist at all, should only be used in the most extreme scenarios where no alternatives exist. If they are used outside these limited situations then they will scare off investors. The UK economy is already poorly placed to deal with the oncoming recession, and reducing profitability further will only worsen the investment environment. That will lead to further economic slowdown, the results of which will be greater unemployment, and rising costs of living.
The biggest oil profiteer
Let us for a moment however accept the logic of the letter. The idea is that the money gained in increased revenues from rising oil prices is hurting the citizen, and should therefore be redistributed to them. In that case the biggest culprit is not the energy companies, but the government. The UK pays the highest fuel taxes in Europe despite having some of the lowest fuel prices prior to taxation. If the money made from rising oil prices is “unearned”, then so is the increased revenue the Treasury gains from these taxes. The biggest beneficiary of the rise in oil prices has been Her Majesty’s Treasury, to the tune of around six billion pounds. That is far more than any windfall tax could provide.
If Compass seriously want to ease the cost of living for the poor, they should be encouraging Alisdair Darling to reduce its taxes on fuel and VED. This proposal for a windfall tax is little more than economically-illiterate unreconstructed envy politics. All it will do is help usher in another period of 1970s stagflation, all for the sake of a poorly conceived project that will be of little immediate benefit for those currently in fuel poverty.
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