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April 14, 2009

The Other Enemy

Writing about web page http://blogs.ft.com/maverecon/2009/04/the-green-shoots-are-weeds-growing-through-the-rubble-in-the-ruins-of-the-global-economy/

Looking back on the G20, there seems little to say that has not been said better by Willem Buiter in his recent blog. I'm going to address a related question: Are our leaders now doing too much, or too little?

Here are some people who think president Obama and prime minister Brown are doing too much: The British (Conservative) and United States (Republican) oppositions, and the governments of France, Germany, Ireland, and the Czech Republic. In varying terms, they fear the same enemy. Fiscal action to combat the Great Recession will cause very large increases in the public debt. In the medium term there will have to be a heavy settling of fiscal accounts. One risk is that governments that have started to enjoy their wider powers will try to pass the burden onto others through inflation or default. Even if they deny themselves this pleasure, they will have to enact tax increases that risk causing large market distortions. Persistent damage to market institutions could ensue, justifying further expansion of the role of government. This is what people mean when they refer to creeping collectivism or socialism.

As I have said before (but Buiter says it better), there is genuine reason here for concern. But those of our leaders that have lined up in the "too much" camp are facing the wrong way. In doing as much as Obama and Brown have been prepared to do, we risk creating one enemy. But the other enemy is the one we will cede power to by doing too little. And this enemy is the more dangerous of the two.

By doing too little, we will give up the political middle ground to populists and pressure groups of left, right, and middle England: protectionists, advocates of self-sufficiency and economic isolation, nationalists, xenophobes, and proponents of extra-parliamentary politics and direct action. I do not meant that such people are all the same; they are not. But whether they fight side by side or against each other, they are capable of destroying confidence in representative democracy. This would give away far more power to arbitrary government than a little gentle Keynesianism.

No one can be 100% sure, but I don't believe our leaders have done too much. They may have done too little. By doing too little, we risk a future governed by those that want to weaken the market economy permanently, or even destroy it, not fix it.

To try to do nothing in the face of the Great Recession is not even desirable. The unnecessary ruin of hundreds of thousands of businesses and households, and the consignment of a similar number of young people to unemployment, would be a great social crime. Bad as it will be to burden our children with a larger public debt in the future, it would be worse to burden them with a Great Depression in the present. The current wave of layoffs and bankruptcies is already under way, and nothing can now stop that, but we can and should do all we can to mitigate its extent and duration.

To try to do nothing will eventually fail, because our society will not tolerate complete inaction on the part of its leaders. Remedial intervention in the economy is inevitable. This means that, in the next few years, there will inevitably be more public spending, debt, and regulation. Just as most medications have harmful side effects, remedial intervention that is guided by the best intentions and the best judgements will have harmful spillovers and unintended consequences.

I would like to see remedial intervention carried out by politicians who do not relish it, but understand it as a necessary but temporary expedient, to be reversed in the medium term. I would apply this even to banking regulation: clearly, the regulatory framework must change, but it should not leave a permanently greater role for political action.

Maybe that's too much to ask. But it is what our future demands.

The alternative is to give up the keys of the city to the other enemy: to allow the remedial instruments to fall into the hands of state-building entrepreneurs who will use them enthusiastically to accumulate power, build persistent economic and political monopolies, and gradually acquire the means and motives to suppress criticism and opposition.


April 02, 2009

War and the Great Recession: Some Thoughts

A while back, an American journalist wrote to me:

We ... are trying to determine how big of a war we would need to have in order to drive the US out of this recession.  It is common belief that WWII was a major factor in invigorating US economy which had been decimated during the Great Depression.  I was wondering if it would be possible to make a projected estimate for our current situation using that era as a model. 

This question got me thinking and I put quite a lot of effort into some answers, which they did not use. So, I thought I would update them and share them here.

Basically, the question sees the problem back to front and upside down. The problem we should be thinking about today is not how to start a war that can help pull us out of recession. The real problem is that, if we don't pull ourselves and others out of recession fairly rapidly by peaceful means, we will face growing risks of war -- and that could end in a catastrophe for everyone.

So, it is a trick question. Sometimes, however, it is interesting to take trick questions at face value and work out what is wrong with them by seeing where they lead. This is what I did.

  • Is the situation of the U.S. economy today comparable with the Great Depression?

At the moment, the situation of the U.S. economy over the next year or two looks bad compared with the recent past, but it is still way better than it was in the 1930s. Economists often work in terms of what is called the "output gap," the proportion of potential output that is unrealized because there is not enough demand in the economy. The Congressional Budget Office currently expects the output gap over the next two years to average almost 7 percent.

There are various ways of calculating the output gap of the U.S. economy before World War II, and it varied a lot from year to year, but any reasonable estimate would be far above 7 percent. At the bottom of the depression, in 1932, the gap was probably around one third. At the end of the first recovery, in 1937, around one fifth of potential output was still not being realized, and in 1938 and 1939 the output gap widened again. It had got back to relatively normal levels by 1941.

So the good news is that, on present forecasts, the fiscal stimulus that is required to fix the U.S. economy is much less than was called for in the 1930s. What everyone should worry about, though, is that if things play out badly in the world as a whole there is plenty of scope for present forecasts to prove optimistic.

  • What size of war would be required to provide an equivalent fiscal stimulus?

U.S. GDP is currently around $15 trillion a year, and so an output gap of 7 percent means about $1 trillion a year of lost production. Since, in the U.S. economy, an extra dollar of public spending should give rise to about an extra $1.50 of total (public plus private) spending, a stimulus of around $700 billion a year would be needed to stimulate $1 trillion a year of extra output.

As far as I am aware from press reports and so on, the total U.S. budgetary appropriation for the global war on terror (Afghanistan, Iraq, and the protection of U.S. embassies abroad) has reached around $1 trillion in total, spread over the entire period from 9/11 to the present. I am not certain what the annual cost is currently, and I believe that not all of it is explicitly funded (i.e., the GWOT has been partly funded by the Defense Department taking resources from elsewhere.) For the sake of argument, suppose the net budgetary cost of the GWOT has recently been of the order of $200 to 250 billion a year. To provide a stimulus of $700 billion a year, therefore, the required war would have to be the equivalent of three additional global wars on terror, waged on the scale of the recent past.

How does that compare with the fiscal stimulus package that went through Congress recently? The package is $700 billion spread over two years, and much of it is tax cuts rather than public spending, which will have a lesser impact because tax cuts can be saved rather than spent privately. It is one half or one third of the stimulus that would halt the slide, so it runs the risk of being too little, too late.

One reason for the modest size of the package is that President Obama is restrained by conservative opponents of big government in Congress. I suppose someone could argue that a war might help to overcome such constraints. I think that would be a bad argument. It amounts to saying that we should whip up nationalism in order to stigmatize the people we disagree with as unpatriotic and crush them. That is not unheard of, but it does not appeal to me.

  • How good for the U.S. economy would it be to have another war?

History should make us very skeptical. Here are five reasons. First, it is true only in small part that World War II pulled the U.S. out of the depression. In fact, 1940 was the first year after 1919 when U.S. military spending rose above 2 percent of the national income. The fiscal stimulus from New Deal spending was also modest. The main driver of the U.S. recovery up to 1940 was private investment. If World War II had not broken out, this natural recovery process would have continued.

Second, it is true that the wartime period saw a huge further increase in the total output of the U.S. economy. In the three years from 1941 to 1944 the GDP rose by about two thirds. The main element in this was Federal outlays on national defense that brought about a vast increase in the mass production of standardized machinery and equipment for combat and transportation. Because of mobilization and wartime controls, patriotic national feeling, and mass production and the associated efficiency gains, the U.S. economy could temporarily produce far above peacetime norms -- effectively, there was a negative output gap. But the extra output did not make anyone better off; it was mainly in the form of ships, planes, and guns that achieved victory, not higher living standards.

After the war, most of the extra output disappeared and the economy fell back, not towards depression, just towards normal peacetime operation. So the wartime "production miracle" did not bring about lasting gains. The U.S. economy was much more prosperous after 1945 than before 1941, but this was not because of the war. It was because of the return to normal working combined with underlying productivity advances that had continued through the Great Depression, but were temporarily overwhelmed by the lack of demand.

Third, it is true that millions of U.S. citizens had a good war, economically speaking. Many people would previously have expected to live out their lives in poverty in the South and Mid-West. They moved to the industrialized, urbanized North and found new lives there. Many young men gained new skills and experiences by joining the military and fighting or supporting the war effort overseas. You might ask whether there were cheaper ways of achieving the same goals without having to fight a war. I don't mean that American involvement in that particular war was wrong; it was clearly in America's own national interest. But if you want to achieve a more mobile, equal society, and war is not forced upon you, there are cheaper ways.

Fourth, it needs to be said out loud that war is costly to society in terms of death and disability. I looked up what Michael Edelstein has to say in his chapter on “War and the American Economy in the Twentieth Century,” in The Cambridge Economic History of the United States, vol. 3 (published in 2000), on pages 342 and 349. He measures the budgetary cost of war as the cost of defense above normal peacetime operations, and the social cost is the capitalized value of lost earnings of the killed and injured. Everything is in constant 1982 prices. Edelstein’s estimates are: WW1, budgetary cost $378 billion and social cost $25 billion, WW2 $2,460 billion and $202 billion, Korea $206 billion and $27 billion, and Vietnam $313 billion and $46 billion.

You can see a couple of things. One is that, on this measure, the social costs were relatively small. Why? Mainly because the United States could fight all these wars at a distance against much less well equipped enemies. In World War II, U.S. battle deaths in Europe and the Pacific were around 350,000. In contrast, Red Army battle deaths on the Eastern Front were around 8.7 million.

Another thing is that, on the same figures, the ratio of social to budgetary costs rose continually from war to war. As a share of the combined total, the human costs were around 6% in WW1 rising to 12% for Vietnam. Why? I think, mainly because there was rising productivity, so human life got relatively more expensive. In their book on the costs of the Iraq and Afghanistan conflicts, Joseph E. Stiglitz and Linda J. Bilmes come up with various figures but their “realistic moderate” scenario (The Three Trillion Dollar War, published in 2007, page 112) suggests about 12% for social costs as a share of the total of budgetary plus social costs combined. (Stiglitz and Bilmes include items of veterans’ welfare costs that Edelstein I think does not, but these appear on both the budgetary and social sides of the balance.)

What does this mean? Well, if you want $700 billion a year of fiscal stimulus through going to war, you’d better factor in that, for every year at war, the U.S. economy will also lose a future income stream with a capitalized value of $100 billion, because of troops killed and injured. That does not seem like a good idea.

Fifth, a war today would bring huge costs in further disruption of the international economy. In 1941 international trade was a small fraction of its pre-1913 volume, so there was little to lose. The world today is much more interdependent than it was in the 1930s. Stiglitz has pointed up the billions of dollars lost to the U.S. economy because the war in Iraq triggered higher oil prices. You need to factor that in too.

Maybe I should finish this bit by quoting Edelstein again (on page 349):

It is absurd to think that the methods and perspectives of economic history come anywhere near to comprehending the meaning of human losses from war. We are far better served by the speeches and letters of Lincoln or the poetry of Sassoon, Brooke, Owen, Graves, and Seager.

OK, but where does this leave us?

I have two conclusions. One is that the only good reason to have a war would be to defeat an enemy. If our leaders want to make our economy work better in everyone's interests, and if they have legitimate instruments to achieve this, and if such improvements would also be an accidental by-product of a war, then that is not an argument for a war. It is an argument for adopting peaceful ways to achieve these things that carry democratic consent and do not also involve the irreversible losses and persistent collateral damage that a war would bring.

My other conclusion is that the original question ("how big of a war we would need to have in order to drive the US out of this recession?") confuses the problem for the solution. It's true that the Great Depression ended in the most terrible war the world has seen. But it did not end because of the war; the depression would have come to an end anyway. In fact, the war curtailed the natural recovery process.

But why did the war come about? World War II happened for a number of reasons, but one of them was the great powers' failure to avert the Great Depression in the first place, and rapidly to mitigate it once it came along. Many of the ingredients for violent conflict were there, but until the Great Depression they lacked a spark. Before 1929, was Germany evolving gradually towards a normal parliamentary democracy? Yes. Would Hitler have come to power without 30% unemployment in Germany in 1932? Probably not.

Eurasia today, from the Baltic to the China Sea, has many of the ingredients for violent nationalism. Scattered around that vast landmass, there is more than enough petrol and a good supply of oil-soaked rags. Meeting in London today, the G20 has the power to coordinate an effective international response to the global economic calamity that threatens us. If they fail, it is not just an economic calamity that we should fear; the world's leaders are playing with matches.


March 25, 2009

Naomi Klein, Milton Friedman and Me

Writing about web page http://www.warwick.ac.uk/go/markharrison/comment/shockdoctrine.pdf

On February 24, 2009, by Naomi Klein was awarded the first Warwick International Prize for Writing, for her book The Shock Doctrine. On behalf of the panel of judges, the novelist China Miéville described The Shock Doctrine as "a brilliant, provocative, outstandingly written investigation into some of the great outrages of our time."

That got my attention. Here's why. On August 26, 2008, Kurt Jacobsen reported in The Guardian about opposition to plans to set up a Milton Friedman Institute at the University of Chicago. The report included some claims that I thought were wrong. So, I replied. Here's my letter, published on August 28:

Your feature on Chicago's proposal to establish a Milton Friedman Institute of economic research (Milton Friedman gives Chicago a headache, August 26) is misinformed in some important respects.

You state: "In postwar America, Friedman's market fundamentalism was regarded as lunatic-fringe stuff." This was never the case. I learned economics in Cambridge in the late 1960s. My professors followed Keynes and Marx, but they rightly made Friedman's work part of my undergraduate syllabus. Friedman's scholarship, not his opinions, made him one of the most influential economists of the 20th century.

You state that Friedman "worked for General Pinochet". While Friedman visited Chile, he did not work for the dictator. His advice was that Chile should turn back from state control of economic life; in the long run, he argued, free markets and political freedoms go hand in hand.

Finally, you give the impression that the mission of the proposed Friedman Institute is tendentious: "The design and evaluation of economic policy requires analyses that respect the incentives of individuals and the essential role of markets in allocating goods and services ... design of public policy without regard to market alternatives has adverse social consequences." While such a statement may be infinitely qualified, few economists today would dispute the principle.

I didn't expect to get away scot-free. On August 30, The Guardian published a letter from David Waddilove of Teignmouth, Devon:

Mark Harrison (Letters, August 28) is disingenuous about the relationship of Milton Friedman to Pinochet's Chile. Neither does he mention the havoc, bloodshed and mass starvation wrought on the people and economies of, among others, Uruguay, Argentina, Russia and Iraq by the Chicago School's symbiotic relationship with sundry dictators and their personal financial gain from those relationships. Nor, of course, does he mention the benefits to US corporate power wrought by the destruction of the public sector in each country the Chicago School meddles with. It is sad to see Warwick University, once the harbinger of some radical thought, now accommodating such "free" market orthodoxies without reference to their real-life testing grounds. Naomi Klein's The Shock Doctrine should be required reading for anyone interested in what actually happened.

I didn't think of replying, but I didn't like the tone. It seemed to be all guilt by association: Chicago-Pinochet. Chicago-Harrison. Harrison-Pinochet. Harrison-Warwick. Warwick-Pinochet. It looked like I must have blood on my hands. If that was the spirit of The Shock Doctrine, I wasn't sure I wanted to read it. Still, it stuck in my mind.

Months went passed. Then, the prize went to ... Naomi Klein for The Shock Doctrine. Not just any prize, but the first biennial Warwick Prize for Writing, a major literary award endowed by a great university, one that I love and have worked and lived for over thirty years.

Maybe I had missed something.

I got hold of the book and read it. It had a big, important message that I wrestled with. I asked my colleagues what they thought about it. It turned out none of them had read it. I think that is a mistake: the book has already had a significant influence on how people see economics and economists, David Waddilove of Teignmouth being one.

After some reflection, I wrote down what I think about the book in a paper called Credibility Crunch: A Comment on The Shock Doctrine. This is how it begins:

If you think that free markets haven’t worked that well recently, it is perhaps not surprising. If you think that free markets are spread only when business executives, politicians, soldiers, technocrats, and economists join to overwhelm popular resistance by force and violence, then you may have read it first in Naomi Klein’s The Shock Doctrine.

It concludes:

For the [Warwick Prize] panel, China Miéville described The Shock Doctrine as "a brilliant, provocative, outstandingly written investigation into some of the great outrages of our time." The Shock Doctrine merits this praise, but it does not merit belief.

If you are still interested, I hope you'll look at my paper and see the reasoning that fills the gap between my opening and my conclusion.


March 13, 2009

G20: Gordon Brown's Got It … Anyone Else?

Writing about web page http://www.guardian.co.uk/politics/2009/mar/13/g20-obama-brown

On March 4, the Prime Minister told the United States Congress:

... never before have the benefits of cooperation been so far-reaching.

On jobs, you the American people through your stimulus proposals could create or save at least 3 million jobs. We in Britain are acting with similar determination. How much nearer an end to this downturn would we be if the whole of the world resolved to do the same?

... Just think how each of our actions, if combined, could mean a whole, much greater than the sum of the parts ... the impact multiplied because everybody does it - rising demand in all our countries creating jobs in each of our countries - and trade once again the engine of prosperity, the wealth of nations restored.

I guess the President was listening. But did he really get it? My point is this. Brown was not just indulging in the easy rhetoric of let's-all-pull-together and unity-makes-us-strong. What he said is literally, word-for-word true. But you have to get the economics to really get it.

Why? A fiscal stimulus by one country acting alone creates a spillover benefit (economists call this an "externality") for other countries. There is an increase in our national debt, which is a cost to us, but part of the benefit, the global increase in demand, is received beyond our borders through our demand for imports. Because it is costly to us, and others reap part of the benefit of what we do, the incentive is for us to do less than we should.

This barrier to action can be overcome by everyone agreeing to help themselves and each other at the same time. We can pull each other out of the hole. Through international coordination, each country can reap the benefit at a lower cost measured by the increase in the national debt.

Without coordination, in contrast, each country gains privately from protectionism, which internalizes the benefit of a national stimulus package at the expense of other countries; hence, beggar-thy-neighbour. The resulting losses from despecialization will be long-term and the damage to the international economy will take decades to undo. Sounds familiar? Yes, it happened before. That, with a few twists, is the story of the 1930s.

When I heard Gordon Brown's speech I thought to myself: "Yes! He's got it!" Did Barack Obama get it? I hoped he did. According to this morning's papers, maybe not. Maybe Obama thought Gordon's words were just special-relationship type rhetoric. Or maybe he figured: the United States economy is so big that the Americans can go it alone more easily than any other country. A  huge loss for the world, but only a small loss for America. (Hmm. I hope that's not what he figured. I'd prefer to think he just didn't get it.)

Much harder for us to understand is the cowardice of France's Nicolas Sarkozy and Germany's Angela Merkel. France and Germany are not giant economies that can go it alone. Yet this morning's papers report Merkel, following joint discussion, sending "a common signal" to the G20 summit that France and Germany will stand aside from any further fiscal coordination (unless you call it coordination when everybody does nothing at once). Merkel said:

The issue is not spending even more but to put in place a regulatory system to prevent the economic catastrophe that the world is experiencing from being repeated.

I see ... We're sliding towards disaster, but the right thing to do is not avert it, just hold a seminar about not doing it again. If we're still there at the end of it, that is.

The denial that is currently at the heart of Europe extends to the fate of Europe's East. I know Merkel and Sarkozy don't want this, but almost certainly we will have to bail out others as well as ourselves. There will be no choice over this; it's just another thing that Merkel and Sarkozy don't get yet.

One thing we will be able to choose: Eastwards, how far will the European bail-out extend? Can the EU risk letting longstanding members like Greece (and Ireland in the West) go to the wall? Surely not. New arrivals like Poland, Hungary, the Czech Republic, the Baltic? Hmm. And beyond EU borders, there lie Ukraine and Turkey. Somewhere, either within or beyond current EU borders, a line will be drawn. Inside the line, we will prop up what we can. The countries beyond it will go to the wall.

Don't underestimate the importance of that line. The countries that lie beyond it will be greatly impoverished compared with their position a year ago. They will have been impoverished by Europe's indifference, our lack of coordination, our failure to lead.

The Great Depression was followed by a recovery, it's true. But by the end of the Great Depression every poor country in Europe was ruled by a dictator.


February 03, 2009

False Patriots

Writing about web page http://news.bbc.co.uk/1/hi/uk_politics/7866614.stm

So a lot of people would like to send them home – the foreign workers contracted to work in Britain. To judge from the tone, these people are not that interested in a level playing field. They want one that puts the foreign workers on a steep slope – preferably down to the sea.

How much better can that get?

As far as I can work out, there are about six million British citizens living abroad. In the countries where they live and work, they take up jobs, homes, schools, medical facilities, and even benefits – just like foreigners here. In those countries, jobs are going to be just as short as they are here. So, if we succeed in sending the foreigners home, our compatriots abroad are going to be equally vulnerable to the same pressure from the citizens of the countries where they live.

I wonder if these "patriots" are ready to see tens or hundeds of thousands of British citizens forced out of the countries where they have made their homes and sent back here to crowd the jobless queues and social security offices. That is the predictable consequence if they succeed.

We live in an interdependent world. How hard it is for us to weigh the benefits against the costs. All of us benefit, but at any one moment the benefits are imperceptible because they come in thousands or millions of tiny packages. Export industries appear and jobs are created by the invisible hand. Moreover, we do not benefit equally; some gain more than others. And some lose, but each job that is lost is clearly identifiable. At moments of difficulty, our common interest in free trade and movement can be all too easily drowned out by the vocal lobbies that want to block these things.

Take "Buy American." The current amendment to the U.S. fiscal stimulus package before Congress will protect the jobs of a few thousand American steel producers. A hundred million steel consumer in the U.S. will lose in higher prices. It's tragic, but unsurprising, that the U.S. steel lobby could win this one.

The same applies to "Buy British." If we all buy only British, that will cut our imports – but it will also cut our exports! How will foreigners have the means to continue to buy the goods and services we export if we buy nothing from them?

Worse, we will become poorer as a result. "Buy British" will make us buy more of the expensive goods that we are least good at making ourselves. It will protect the jobs that are of least value. At the same time, it will undermine the markets for the goods and services that we are best at, and so add most value.

Take Coventry, where I live. Once, Coventry was Britain's Detroit. It produced motor vehicles for a mass market and exported them across the world. No longer. But Coventry has not dropped out of the world market. Our city has a new export industry: higher education. Two universities, Warwick and Coventry, bring thousands of students from across the world to study here. They pay high fees and living costs worth many tens of millions of pounds to the local economy. The money they spend doesn't come out of thin air; it is financed by the pounds their countries earn by selling goods to us, cheaper than we can make them ourselves – Korean motor vehicles, for example.

"Buy British" means killing Coventry's new exports. It means rolling the clock back from the new to the old -- giving up on what we do with greatest success, and going back to what we once could do but then failed in.

Folly that cloaks itself in patriotism is still folly.

We need all the major countries to cooperate to keep trade and [policy coordination going. On that note, Jeff Frieden has written something that everyone should read. Frieden's point is the importance of political leadership: our governments must create social consent at home and political agreement abroad keep open the channels of international trade and movement. He says:

At the domestic level, governments need to work out an equitable and politically sustainable allocation of austerity across the population.

This means ensuring that those sectors of society hit hardest by the crisis are not also the ones asked to bear the stiffest sacrifices. ... Governments that ignore the social and distributional implications of the crisis are likely to find themselves either driven toward extreme and counter-productive policies, or swept away.

At the international level, governments need to work just as consciously to coordinate not just words, but actions.

This will not happen of its own accord ...

January 22, 2009

The Fiscal Stimulus: Catch 22

Writing about web page http://krugman.blogs.nytimes.com/page/2/

Paul Krugman has made the following point: for the United States, one dollar added to the federal debt by new public spending will save three dollars' worth of jobs. This is despite the fact that the Keynesian multiplier for the United States is only about 1.5. Why? Because every job saved will generate tax revenues that should offset some of the implied increase in the federal deficit.

There's a couple of assumptions in that. One is that interest rates won't change much, which makes sense because right now they are on the floor and likely to remain there. Another is that, oddly enough for a guy that won the Nobel prize for contributions for trade theory, Krugman doesn't mention foreign trade. That makes sense because the United States ratio of trade to GDP is only 10% (exports) to 15% (imports).

The same idea should work for Britain. But it is much less favourable, because we are more heavily taxed and also have a much more open economy. Unless I misled several generations of first-year students, the Keynesian multiplier for an economy with direct and indirect taxes and foreign trade is 1/(1 - c(1 - t1) + t2 + m) where c is the marginal propensity to consume (say 0.6 in the short run), t1 is the direct tax rate (say 0.25), t2 is the indirect tax rate (say 0.15 since Darling's VAT reduction), and m is the import propensity (say 0.25). That gives us a Keynesian multiplier of 1/0.95 which for present purposes is about 1.

Let's assume that interest rates stay low, and the exchange rate stays where it is. Then, every extra pound of public spending generates about one pound of effective demand for goods and services. But then, each extra pound spent will bring back 40p to the Treasury in direct and indirect tax revenues, raising the national debt by only 60p. That makes 60p of new indebtedness the price we will pay to create one additional pound of GDP.

Think about jobs. In the UK economy each person employed generates about £50k of GDP. We are currently losing around 100,000 jobs a month from the economy; to be conservative let's put that at a round million jobs over the next year. To save those million jobs should take a fiscal stimulus of £50 billion a year, starting now, but it will add only £30 billion to our national debt, because if those jobs can be saved there will be a clawback to the Treasury of £20 billion in tax revenues.

There are some catches.

Catch 1. The government is proposing a stimulus of £20 billion over the next two years. Oh – and it hasn't even started yet. Jobs are being lost now. A fiscal stimulus doesn't work instantaneously. Fixated on blaming the banking sector for what is about to happen (in addition to what has happened already), the government is still trying to revive lending rather than to revive spending directly. 

Catch 2. Britain, unlike America, can't ignore the rest of the world. The reason exports don't figure in the Keynesian multiplier is that they're outside our economic system: if our export markets are falling off the same shelf as us, that will have an adverse multiplier effect that works against the multiplier effect of our own public spending.

It is critically important for small open economies like the UK to have a fiscal stimulus that is coordinated internationally. We all make up each others' export markets! If every country would stimulate demand at the same time, and in the same proportion, the trade balance effects would be neutral, but the collective stimulus would be far more powerful. Every country would see a double bonus, the first coming from its own public spending, and the second coming from the public spending of its trading partners, reflected in exports.

Catch 22. The European Union was constituted on the assumption that the problem of deficient demand had been solved. Coordination was needed only for monetary policy (so we have a European Central Bank) and to ensure fiscal restraint (so the Eurozone is supposedly governed by the deflationary rules of the Growth and Stability Pact). There's no mechanism to coordinate a European fiscal stimulus!

So it's up to the G8 and the G20. Let's think about that.

Generations of students of international economic history have learned that a major part of the Great Depression was the failure of international coordination. Our ability to coordinate a response to the greatest economic challenge since the Great Depression is being tested now. Until recently, we thought we knew how to avoid bank runs. Then we had the first major run in 150 years. We also thought we knew how to avoid a major recession. I was about to write: "Watch this space." Depressingly, I'm not sure you need to.


I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).



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  • I asked a friend and colleague, Mark Kramer, to look at my column on McCarthyism and tell me what he… by Mark Harrison on this entry
  • Thank you for your response, Professor. I will reply here in brief, because of the limit of permissi… by Paul Thompson on this entry
  • Thanks for your thoughtful remarks. You will find my (overlong) reply here: http://blogs.warwick.ac.… by Mark Harrison on this entry
  • Mr. Harrison, Your view of torture is confused. Torture is certainly morally abhorrent and therefore… by Paul Thompson on this entry
  • My apologies for being late to the game, but I would like to put forward the view that democracy is … by Paul Thompson on this entry
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