All 12 entries tagged Recession

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.

Mark Harrison : 02 Apr 2009 13:08 |  Tags: G20 Globalization Politics Recession War |  Comments (5) |  Close comments |  Report a problem

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.

Mark Harrison : 13 Mar 2009 11:19 |  Tags: G20 Globalization Obama Politics Recession |  Comments (0) |  Close comments |  Report a problem

What Does Coventry Do Best?

Writing about web page http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/

Last week, the Economic and Social Research Council awarded a £3.6m contract to the University of Warwick for a centre on Competitive Advantage in the Global Economy.

This seems a good moment to ask, where is Coventry's competitive advantage? What do we do best today? At a time of recession, when many are losing what little sense of security and prosperity they had, what is our city's future?

I arrived in Coventry in 1974. At that time, Coventry was England's motor city -- its Detroit. A friend told me half the city's population belonged to two trade unions, the transport and general workers and the engineers. I don't know if that was true, exactly, but it certainly felt like it.

Between then and now, Coventry has not had it easy. In a way that is nothing new; Coventry's industrial history has seen continual change, from ribbons and watches to bicycles, munitions, machine tools, motor cars, and synthetic fibres. But in the 1980s deindustrialization hit our city hard. The great vehicle building and tool making factories melted away. Employment and wages sagged. Then, other jobs sprang up. Coventry recovered.

What has taken the place of manufacturing? Coventry has a new competitive advantage. It sells to an international market. In the current downturn this market is proving resilient so far: in fact, while global demand for everything else is falling off the shelf, the market in which Coventry is now competing is rising against the trend.

Leading this trend are new corporate giants that have grown up stealthily among us. They are local firms, with their roots are firmly bedded in our region, but they already export a large fraction of what they make.

What are they? The new giants are our city's two universities, Coventry University and the University of Warwick. (For those reading this column at a distance, the University of Warwick is nowhere near the town of Warwick; it is on the edge of Coventry, half in the city and half in the fields of Warwickshire. Coventry University is right in our city centre.) The two universities are not only among our city's biggest employers. Their combined corporate revenues come to around £500 million a year, or nearly £1,700 for every one of Coventry's 300,000 residents. 

The universities are part of a bigger picture. Around them, and not only because of them, a new economy has sprung up; according to the West Midlands Regional Observatory, knowledge-based activities now employ half of Coventry's working population.

Coventry once had a competitive advantage in engineering things. Now, what Coventry does best is the engineering of ideas. At one time, half of Coventry bashed metal; forty years on, half of us bash keyboards. Science and technology parks have sprung up where engines and car bodies were once assembled in giant hangars. The toilets are a lot cleaner, even if the language is just as filthy.

Like the motor factories they have replaced, our universities are big exporters. Instead of selling metal fabricates, they sell and certify knowledge and understanding. One difference is that the customer comes here to collect. Every year more than 10,000 students arrive from continental Europe and beyond to study in our city. The typical international student is likely to pay around £6,000 in annual fees and spend another £6,000 in annual living costs. That would make their total contribution to the economy of Coventry and its South Warwickshire hinterland, and to our national export revenues, £120 million a year and rising. 

The demand for higher education has an important feature that makes it different from the demand for motor vehicles -- it moves against the business cycle. When the economy booms and there are many vacancies, young people entering the market are tempted straight into employment. When the vacancies evaporate, they enroll for courses in order to improve their chances when things pick up. Right now, both our universities are experiencing a small boom in admissions, particularly to courses in management and economics. (Unfortunately, they are also suffering from the slump in everything else from the arts and entertainment to the conference trade.)

How can Coventry make the most of its future? Good management of our universities is important, but it is not the only thing that matters. The poor management of the British motor industry has been criticized, but would better management have saved Coventry's industrial past? It seems unlikely. At best, the decline might have been postponed by a few years.

More important is to understand how our future will remain bound up with the global economy. The international recruitment of academics and students is vital to the competitiveness and prosperity of Coventry's knowledge sector. That's obvious. Less obvious may be what follows.

If we are to maximize our new competitive advantage, and so focus on what we now do best, we have to let others do the same. One country can't do everything best. Today, we are best at science and education. If we are to put our resources into that, then let others exploit their competitive advantage in making the textiles and machinery we used to make and now buy from elsewhere.

Sometimes people feel bad about buying cheap clothes from abroad. There's a "Buy British" lobby that works to make us feel guilty when we do this. We should resist it; it is bad logic. Buying British would mean chopping out the roots of Coventry's knowledge economy just when we need it most.

Think about this: if students from Austria, Bangladesh, China, Dominica, Ecuador, and the rest of the A to Z of nations are to come to Coventry to be educated, their families or governments must have the pounds to pay for them. They can have these pounds, only because we are willing to buy the goods that they make cheaper than we can. When we buy their stuff, we enable them to buy ours. It's a virtuous circle: by trading, everyone can do what they are best at. When everyone is free to exploit their competitive advantage, everyone gains! There are not many such virtuous circles in this world, so we should make the most of them when we find them.

Whatever we do, times are going to be hard. It looks like our political class is going to let us down; obsessed with blaming the bankers and each other, they are failing to do elementary things at home (enacting a fiscal stimulus) and abroad (coordinating fiscal action) that would rapidly improve our situation. To turn our face away from the world, from our competitive advantage, would just make our future harder still.

For the time being, Coventry's future lies in the global knowledge economy. It is what we do best. It is another chapter in our history, one that is still being written.

Mark Harrison : 02 Mar 2009 13:51 |  Tags: Coventry Recession Universities |  Comments (5) |  Close comments |  Report a problem

New Romantics

Writing about web page http://www.guardian.co.uk/commentisfree/2009/feb/20/economics-emotions-human-values

There is a strong case for thinking about how emotion and mood affect economic decisions.

Does my own mood affect my decisions? I discussed this with my wife, and she agreed I'm a model of level headed rationality. But she knows lots of people for whom that wouldn't be true. She's not saying who (but I bet they're not economists).

If mood can affect decisions, does it affect the decisions that really matter? Not all decisions are important. But isn't it at least possible that powerful emotions like joy, fear, sadness, or enthusiasm interfere with our ability to calculate an optimum? Suppose that emotions frame our vision of the future; suppose they are capable of boosting our willingness to provide for the future or winding it down; suppose they make us more or less willing to shoulder risks. In that case, important economic decisions will indeed swing with our moods.

Again the net effect, averaged across millions people, might not add up to much. If one person's mood cancels out another's, the total effect should be zero. But if the moods of millions swing together, in a concerted way, billiions of pounds could swing with them into -- or out of --  particular markets.

And it is intuitively plausible, to say the least, that the mood of millions of people is taking a hit at the moment, as homes and jobs are lost and the fear of loss infects our nation.

As Jon Elster pointed out some years ago in The Journal of Economic Literature (1998), economists have given much closer attention to cognitive limits on rationality than to emotional limits.

Which brings us to the critics of orthodox economics. There are so many at the moment ... it seems invidious to pick and choose. But choose we must, so we'll pick from my daily newspaper which, despite the fact that it is written mainly by and for lunatics, remains The Guardian. On February 16, 2009, Larry Elliott wrote:

There have been many economists down the years who have expressed scepticism about reducing their discipline to a mechanistic subject. Malthus told Ricardo to be wary of becoming too attached to abstract hypotheses; Schumpeter talked of creative destruction; Hayek saw the market as a voyage of discovery; Keynes stressed the importance of "animal spirits."

And:

Mervyn King says Britain is in a deep recession ... Interestingly, the governor cited Keynes at the Bank's inflation report press conference, noting that animal spirits were currently depressed. With confidence so weak, it is hard to envisage an early or a robust recovery.

Two days later, Sam Whimster (Professor of Sociology at London Metropolitan), commented: 

We should also consider the place of emotions in economic life. The share price of UK banks fluctuates wildly as traders attempt to calculate their capital value from future estimated losses and profits. Keynes, in 1933 in his lectures on his General Theory, said that current yields of firms exercise an "irrational" influence on estimating future worth.

In the boom years that have ended so abruptly, Whimster continues:

Infectious greed and optimism was the mindset of economists, bankers, politicians and regulators - leading to behaviour that no regulatory mechanism could have controlled. But the extent of the greed and adventurism, and the flouting of standard banking precautions which had been stress-tested by decades of history, raises the question of what determines which emotions come to the fore.

The question of whether economists should take emotions into account is a good one. But where are the answers? Not as easily to hand as one might hope. Let me mention some issues that everyone should think about at this point.

To begin with, emotions are just one more variable. There is a lot going on in the world economy that we understand all too imperfectly. But it doesn't help our understanding to say, after the event: Oh -- people have been behaving irrationally, it must be because of their emotions. Change the context a little and you'll see how fainthearted and pathetic this is. Imagine me telling my wife: You've been behaving irrationally, it must be because of your emotions. (I can't imagine saying it, but you can try.) She'd kill me, and rightly so. The reason is not just that it's insufferably patronising, but that it also devalues emotions into something irrational, flighty, whimsical, and beyond understanding.

In different words, adding another variable, the variable of emotions, to a model does not add to its predictive power unless the added variable is itself predictable. Are emotions predictably variable?  It is entirely possible that aggregate moods are predictable -- in fact, I made a prediction above when I suggested that "that the mood of millions is taking a hit at the moment, as homes and jobs are lost and the fear of loss infects our nation." If so, perhaps we should be working towards a model of emotions. But be aware that it may not be worthwhile. If the aggregate mood just goes up and down with the rate of unemployment, for example, then modelling emotions may add complexity without increasing the predictive power that is already taken there in conventional models.

A deeper question is whether emotions truly vary in ways that are beyond our individual control. Consider hatred. Two sorts of people can kill without hating. Some are trained and paid to do so to defend us against our enemies, and these are our soldiers. The rest are few in number and we call them psychopaths. The majority of people kill only those whom they hate. So, hate first, then kill. But here there is a problem: the idea that killing, or any kind of premeditated violence, is the deterministic result of uncontrollable feelings, flies in the face of our traditions of personal moral and legal responsiblity. In fact, it is possible that we must first allow ourselves to hate those whom we have a prior intention to kill. Decide to kill, then hate, then kill. If so, emotions as such do not decide what we do; we decide what to do, and then select the emotions that validate our decisions. This is a difficulty that must be resolved before we can understand whether emotions add anything to economics.

Clearly, we must learn more about the psychological laws underlying emotions. I am open minded as to whether we will ultimately need more complex economic models. Whatever we decide, I am in favour of economic models -- maybe not more complex ones, but just better ones.

If so, I am going to disappoint Elliott, in whose view:

The mechanistic approach to economics has failed.

"Mechanistic" is a prejudicial term in this context, however. Economic models are just thought experiments. They are mechanical in the sense that they are formal (as opposed to purely literary and intuitive) and logical (as opposed to internally inconsistent). They still seem like useful things to me. For argument, I will quote briefly from the best essay written on this subject in the last 30 years: Paul Krugman's "Two Cheers for Formalism," published in The Economic Journal (1998); I also strongly urge you to read the original in full:

First, much of the criticism of formalism in economics is an attack on a straw man: the reality of what good economists do is a lot less formalistic than the popular image. Bad economists, of course, do bad economics; but one should not confuse a complaint about quality with a complaint about methodology. Second, when outsiders criticize formalism in economics, their real complaint is often not about method but about content - in particular, they dislike "formalistic" arguments not because they are formalistic, but because they refute their pet doctrines. Finally, as a practical matter formalism is crucial to progress in economic thought - even when it turns out that the ideas initially developed with the help of formal analysis can in the end, with some work, be expressed in plain English. Moreover, this is especially true precisely in the sorts of areas that economists are often accused of neglecting, such as those that involve imperfect competition, incomplete rationality, and so on.

I'm not sure where I should leave Whimster, who starts his comment by asking to bring in emotions and ends up bringing in values; the problem, he concludes, has been that:

Anglo-Saxon attitudes have been dominated by what Weber would have called the values of adventurer capitalism, and the economist and sociologist Werner Sombart would have called the lust for wealth ... Aesthetics, harmony with nature, the ethics and politics of community - these need to be reasserted as values independent of and superior to market values, which as the Romantics pointed out should be merely means to other ends. It is time for what Nietzsche termed the revaluation of values.

Don't you love the wedge that's driven between "market values" and higher things? We're losing a hundred thousand jobs a month, but it's okay because we should refocus on "aesthetics, harmony with nature, the ethics and politics of community."

Markets that work well have allowed millions of people to live and work as they choose, enjoy the freedoms of the press and media, travel the world, and address the world from their own homes. Markets that work well have another virtue, as Hayek understood so clearly: they allow one person's end to be another person's means, without anyone having to rule on or even consider the difference. Millions of people aspire to what well-functioning markets can offer: opportunity, mobility, prosperity, stability, insurance, the backdrop to the everyday joys of friendship, love, sex, children, and families -- or not, if you don't want them. I don't know what's higher than that.

That's why, when markets don't work well, it's so important to fix them.

Mark Harrison : 23 Feb 2009 22:56 |  Tags: Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem

Automatic Destabilizers

Writing about web page http://www.coventry.gov.uk/ccm/content/chief-executives-directorate/corporate-policy/communications-team/news-releases-2009/coventry-residents-set-for-44p-a-week-rise-in-council-tax.en

The day after Leeds City Council announced the loss of 650 local authority jobs because of "lower government grants and the economic downturn," it's Coventry's turn. According to a news release on Coventry City Council's website, our city faces a "budget gap" of £13.5 million. More than £9 million of savings have been identified. These include, in addition to "efficiency reviews of services," "a £469,000 reduction in publicity and advertising budgets, 3% cuts in grants to voluntary organisations and £530,000 through increasing charges in some social care services." It is expected that 190 posts could disappear. Councillor Kevin Foster, Deputy Leader of Coventry City Council, is quoted:

The Council, like all councils, is facing a number of challenges over the coming year. Clearly the recession is having a major impact on our finances ...

Oddly enough, this is not what is supposed to happen in a recession.

As I wrote here, faced with the current collapse of aggregate demand, "the government faces a bitter choice. It can stabilize its budget, or it can stabilize the economy, but it cannot do both." The recession is plunging the budgets of central and local government alike into deficit. Stabilizing the budget means cutting government spending and jobs as revenue falls. Stabilizing the economy, in contrast, means maintaining spending and jobs, borrowing to cover the widening budget gap. In the interests of us all, including the interests of tomorrow, the government should choose the latter course.

In theory, some stabilization of the economy should happen automatically. In our economy, taxation is progressive; this means that, when personal incomes fall, the government's tax take should fall more than proportion. As a result, personal incomes should fall by less than the country's national income, and this should to maintain spending and employment. Part of what the government spends is also progressive: as jobs and family incomes fall away, the government should automatically replace part of what is lost by meeting entitlements to unemployment benefits and other income support. These "automatic stabilizers" don't make things better. They just make things a little less bad than they would be otherwise.

Think about that word, "otherwise." It means: in the absence of the automatic stabilizers. If, say, the government always spent every penny it received, but never more, the government would continually add to the natural volatility in the economy. Every time there was a boom, the government would experience a rise in its revenues and, by rushing out to spend them, heighten the boom. Every time there was a slump, the government would respond to its lost revenues by spending less and so deepening the recession. It doesn't just sound like a bad idea: it is an absolutely terrible idea.

Yet this idea is currently being put into effect by local authorities up and down the country. As property values and business and personal incomes fall, city councils are losing revenue from council taxes and charges. At the same time, for exactly the same reason, local claims on services and benefits are growing. But our cash strapped cities not only cannot meet these rising demands; they must cut back provision.

Rather than mitigating the jobs crisis, they are adding to it and deepening it.

This is the result of a policy failure on the part of central government -- a failure of scandalous proportions. While Westminster plays the blame game -- who should be punished for the failures of our banking system? -- the real economy is sliding down into depression. The solution is well known: a strong fiscal stimulus. But, while Westminster talks, what our country is actually experiencing is the exact opposite: a powerful fiscal brake that is spread by the collapse of local government finance and adds to the burden on us all.

The failure is scandalous because the solution could be put into effect overnight. The Treasury must promise now to stabilize local government funding at its pre-recession level. Local authorities should be enabled to plan for the future without adding to the pool of the unemployed. When the economy recovers, the additional subsidy from the centre can be gradually withdrawn.

I can see two obstacles to this simple course of action.

First problem: Purists may object that our cities are subsidy junkies already; if the subsidy from central government is temporarily increased, it may be politically difficult to withdraw it later when conditions improve. I acknowledge this danger. It is an example of what, on January 20, Bank of England governor Mervyn King described as

the paradox of policy at present – almost any policy measure that is desirable now appears diametrically opposite to the direction in which we need to go in the long term. Spending now supports the economy, but in the long run we need to save more and borrow less. Public borrowing sustains spending, but in the long run needs to fall. Banks are encouraged to run down their capital to enable them to absorb losses while continuing to lend, but in the long run they will need more capital. Interest rates have fallen to unprecedented levels, but in the long run will need to rise to more normal levels.

In the same way local government in the UK must be allowed to spend its way through this crisis, yet in the long term become fiscally more self-reliant. But there are ways to achieve this; for example, local authorities could take out loans from the Treasury with repayment contingent on local incomes or employment rates returning to their pre-crisis levels. But the time for complicated solutions may be already past; this is, after all, a crisis.

Second problem: The Westminster government may positively not want to do this. Whitehall is full of spending ministers. If there is to be a stimulus package, they will want to monopolize it and claim the credit for it. Scattering central funding across many local authorities, many (like Coventry) managed by parties that are in opposition in Westminster, may not look like the best way for Labour to prepare for the next general election. I suspect this is the most important obstacle to the action that our country needs. If so, it makes the failure to act even more scandalous.

Let me repeat: allowing local authorities to keep up their spending during the current recession is not a solution to the crisis. It is just a way to neutralize a mechanism for destabilization, one that is currently making the crisis worse than it needs to be.

Mark Harrison : 17 Feb 2009 11:02 |  Tags: Coventry Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem

Stupid After the Event

Writing about web page http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article5663091.ece#cid=OTC-RSS&attr=1882523

We're all wise after the event.

The public would have like it better if more of us had been wise before the event. The bankers that are sorry now didn't see it coming. The politicians and regulators won't say they are sorry, but they didn't see it coming either. Who else should have seen it coming? Anatole Kaletsky (in The Times, Feb. 5, 2009) says that economists should join the others in the dock; they are "the forgotten guilty men." By economists, he adds,

I do not mean the talking heads (myself included) employed by the media and financial institutions to “explain”, usually after the event, why share prices or currencies have gone up or down. Nor do I mean the forecasters whose computers churn out scientific-looking numbers about what will happen to growth or inflation, but whose figures are revised so drastically whenever something “unexpected” happens - as it always does - that their forecasts are really nothing more than backward-looking descriptions of recent events.

What I mean by “economists” are the academic theorists who win Nobel prizes, or dream of winning them.

Why economists? The financial crisis, Kaletsky notes, was caused by practical men, not academic scribblers. But Keynes wrote, as Kaletsky reminds us:

Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

This seems harsh to me. Not all economists were stupid before the event. I'm not well enough connected to have conducted a census, but Robert Shiller was writing about irrational exuberance in financial markets ten years ago. In 2002 my colleague Andrew Oswald predicted the great UK house price crash of 2003 to 2005. (If only he'd been right; we would all be hurting a lot less now.) In the same year other colleagues past and present – Marcus Miller, Lei Zhang, and Paul Weller – warned in the Economic Journal of the "Greenspan put," a "one-sided intervention policy on the part of the Federal Reserve which leads investors into the erroneous belief that they are insured against downside risk." Yes, some were wise before the event. They are people I can only bow to.

What about Kaletsky himself? Two years ago, on March 9, 2007, Kaletsky gave the Colliers CRE annual economist briefing. This is just some of what he said:

Kaletsky firmly believes that there is 'good news' supporting long-term trend growth in the global economy ... A 'mid-cycle slowdown', rather than a recession, is now overdue ... Kaletsky believes that we will experience a slowdown rather than an outright recession. This means we will not see a sharp rise in unemployment and bankruptcies ... The US housing market has undergone a strong slowdown ... Kaletsky is confident that we are much more likely to see a soft landing in the US housing market than a collapse ... Kaletsky firmly believes new home sales have reached a bottom in the US and is confident that 2007 will see signs of a pickup ... The UK will stand out against the tide of slowing growth in Europe ... the financial sector - led by London - will go from strength to strength ... Although a number of commentators have focused on the risks of a house price crash, Kaletsky believes these to be overstated.

In January 2008 I attended an AEA panel in New Orleans where Shiller, along with Paul Krugman and Nouriel Rubini, academic scribblers all, acurately predicted the coming huge bust in the U.S. housing market. A month later, on February 5, 2008, Kaletsky told Colliers CRE:

We are approaching the end of the credit crisis in terms of time, if not necessarily pricing, and that it will be resolved one way or another in the next month ... The US is experiencing its worst economic downturn since the 1990s, but Kaletsky believes the worst may be over, although the risk of recession remains.

Of course, Kaletsky said a lot more than I have quoted, and I have quoted very selectively. If you prefer to read the full texts of his briefings, they are both here. Let me add that, in his 2008 remarks, Kaletsky made one other very important point: 

in 2005, the International Monetary Fund (IMF) conducted a study of recessions around the world. Of the 74 recessions studied, only four were predicted in the preceding year. Furthermore, only one third of forecasters interviewed in a recession year actually spotted the recession in that same year.

So what? Here's what.

Nearly everyone has been wise after the event, not before. Don't get me wrong: being wise after the event is very important; let's not undervalue it. Being wise before the event is best, but being wise after the event is the next best thing. And being wise after the event definitely dominates being stupid after the event. This is a danger that I'll come to.

If we want to be wise after the event, it's time to rethink. What are the parts of economics that need rethinking? According to Kaletsky it is our concepts of

the “efficiency” of markets and the “rationality” of the investors, consumers and businesses who inhabit them.

I agree! We should rethink the way we use the rationality assumption. As an economic historian, I use it in all sorts of peculiar context. I have argued (here for example ) that the value of the axiom lies partly in helping us draw a line between what we do and do not understand. If we assume that individuals behave with full rationality, subject to constraints, and our models works in terms of simulation or prediction, then we can at least kid ourselves that we have understood that behaviour in the sense that we don't need anything more complicated to analyse it. If the model doesn't work, it tells us we failed to grasp something – some constraint on behaviour or some bound on rationality – that is missing from our model. In short, the rationality assumption helps us draw a line between what we understand and what we don't.

Recent events are shifting that line, but in different ways for different people. First is a relatively narrow group, those (not all) financial economists that bought heavily into the efficient markets hypothesis and rational expectations; they have seen their frontier with the unexplained collapse inwards. Second are a much wider group, the macroeconomists that did not buy the efficient markets hypothesis, but nonetheless believed that in the event of market failure governments had the power, the monetary and fiscal instruments, the capacity for international coordination through G8, G20, IMF, and so forth, and the will to avert the worst consequences. We are watching events unfold, but I am much more pessimistic than I was.

The main problem for economics that I see is this. Most professional economists are clever people. Clever people have one weakness: they are clever in many ways. One of these is getting at the truth. Another is being contrarian. In fact, because they are clever, and often highly motivated, clever people tend to be good at denial. They can think up a thousand sophisticated arguments to defend manifestly absurd ideas. My rule of thumb is that everyone, including me, believes in at least one completely crazy idea; the trouble is, I don't know which one it is. So look out for a lot of clever economists who are going to be stupid after the event, because of some idea they are wedded to and will continue to defend while the world walks off in the other direction.

If I'm clever enough, I may well be among them.

The main problem for politics is different. It is that it is much more fun to play the blame game than to do something – something for which, in future, you may be blamed. As a result, politicians and journalists in our country (and no doubt elsewhere) are now sitting around throwing accusations at bankers, economists, journalists, and each other – particularly at bankers, which is fine in a way because monetary policy can currently do nothing more to make things better, so why not?

Except that it is a diversion from the one thing that can now make things better, the promised fiscal stimulus. We are losing 100,000 jobs a month – and unemployment is a lagging indicator. To make a difference, the fiscal stimulus was needed six months ago. It seems that we cannot even count on the automatic stabilizers that should limit recession. While local authorities lose revenue, for example, councils are cutting jobs and services that they can no longer afford but the community needs ever more desparately. The current lack of fiscal action on the part of our government is scandalous. Stupid after the event.

Mark Harrison : 12 Feb 2009 15:01 |  Tags: Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem

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 ...

Mark Harrison : 03 Feb 2009 20:19 |  Tags: Coventry Globalization Politics Recession Universities |  Comments (0) |  Close comments |  Report a problem

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.

Mark Harrison : 22 Jan 2009 11:23 |  Tags: Globalization Keynes Politics Recession |  Comments (0) |  Close comments |  Report a problem

Three Myths of the Credit Crunch

Three myths are current in public discussion of the credit crunch and the recession that we face today: "We should make the banks lend out the money we've given them." "We can't spend our way out of this recession." Worst of all, "We are burdening our children with debt." What's wrong with them?

We should make the banks lend out the money we've given them.

Since November the following story has been in circulation; it started from Downing Street, but has found wide support. It goes like this: We, the government, have given the banks billions of pounds of your (the taxpayers') money. Instead of translating your cash into new lending, the banks are sitting on it. This is helping to drive cash-strapped businesses into insolvency, and is not fair. The banks are breaking a moral contract. We should now set targets for bank lending and punish banks that fail to meet them.

The story's wrong. We're forgetting something. Question: What was the worst case that the bank bail-out was designed to avoid? Answer: Bank failures on a catastrophic scale. And this has been averted. Our government bailed out the banks because the alternative was a financial Armageddon on the scale that ushered in the Great Depression. So far, this worst case has been avoided. For example, no British saver has yet lost a penny from deposits in a British bank. If the worst had happened, there would be ruined savers in every neighbourhood in the country. Conclusion: the banks are doing what the bail-out intended: they are holding our cash, because they need it to hold in order to stay afloat.

If we want bank lending to increase again, our government must increase the cash available still further, or at least extend its promises. That is approximately what the government is doing now, through credit guarantees to small businesses, for example.

Another version of the same fallacy goes like this. The Bank of England's discount rate is at a record low of 1.5%. Banks (including some mortgage lenders) are unfairly increasing the margin above this level at which they are willing to lend. Public pressure or legislation should bring lending rates down. But one cause of the credit crunch is that banks have underestimated the risks of lending. As a result, the gap between their borrowing and lending rates, which includes their evaluation of risk, has been too narrow. Restoring the banking system to health must provide for larger risk premiums than before.

At this point, pressure for more bank lending and lower lending margins may not be for the best. We are in this mess because banks lent unwisely. Pressing or guaranteeing them to do more of the same, especially for the sake of small businesses that have a high failure rate even in good times, does not seem to point a way back to prudence. As has been commonly observed, monetary policy in Britain as in the United States is simply running out of ammunition. Public spending may now be more effective as a way of keeping viable businesses afloat, and should take up the burden. Which leads us to the second fallacy:

We can't spend our way out of this recession.

In 1976, prime minister James Callaghan famously remarked: "We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step." This has been widely cited recently by critics of the government such as (but not limited to) John Redwood.

If more public spending is the right answer today, why was it the wrong answer then? The reason is that that our economic predicament today is wholly different from that of Callaghan's time. In the 1970s, inflation and unemployment were rising together. That was the signal that the UK economy's problem lay on the supply side, not the demand side. The economy was rigid and uncompetitive. Industry was dominated by loss-making firms that were kept in existence by public ownership and public subsidy. The difficulties of the time required supply-side solutions: better incentives through increased competition and lower taxes.

Today, unemployment is rising and inflation is falling. This signals that the UK economy faces a deficiency of demand, not supply. Moreover, the loss of demand at home and abroad is on a scale not seen since 1929. A demand deficiency can be countered by monetary measures to some extent, but for the next few months the overworked cliché is correct: cutting interest rates is like pushing on a piece of string. (The cliché is overworked because, over a somewhat longer period, the monetary relaxation should have a powerful real effect through a more competitive sterling exchange rate.)

When demand is deficient, the quickest way to restore it may be through increased public spending. Tax cuts may be preferable in theory, since each of us knows better how to spend our money than the government does, but in the grip of current uncertainties it is likely that households will save most of any tax cut will be saved, and so the tax cuts will not contribute much to higher demand.

Rapid increases in public spending are likely to be inefficient since there is not enough time to plan them. The composition of any increase is likely to be determined more by competitive lobbying than by cost-benefit calculation. There may well be some degree of consensus that we need to invest in green technology, transport, and IT. As soon as you look at these in detail, you can watch the vested interests line up -- for and against nuclear power and carbon capture, motorway and airport expansion, and so on. However, if our immediate goal is to combat the worst consequences of the crisis, it may not matter if some projects are ill-chosen; at least they will create jobs and cash flows to replace those that are now being destroyed.

Here are two things that could and should be boosted right away -- and it would be efficient to do so.

• UK local authorities are planning for catastrophic shortfalls in council tax revenues at the same time as demands on their services are multiplying from citizens faced with losing their jobs and houses. It is shameful that local government cutbacks should be contributing to the economic downturn, rather than softening it. The government should immediately commit central funding to neutralize the effects of the recession on local government revenues.
• Iraq and Afghanistan have taken a heavy toll on the combat readiness of the UK's armed forces. The Ministry of Defence surely has a long shopping list of equipment that is needed just to reset the armed forces to their pre-conflict readiness. There is absolutely no reason to think we will need our armed forces any less in the 2010s than we did in the 1990s. We should start this restocking process now, and this will incidentally make a large contribution to the revival of UK manufacturing.

Can we use public spending to mitigate the recession? The answer lies with Obama, not Callaghan: Yes, we can.

It's true that using public spending in this way will widen the excess of spending over taxes, and cause public debt to balloon. This takes us to the third fallacy:

We are burdening our children with debt.

British politics needs an effective opposition. Just when I hoped the Conservatives were becoming one, George Osborne has come up with this: "Every child in Britain is born owing £17,000 because of Labour’s Debt Crisis."

This story is misleading, rather than false -- but it is deeply misleading on several different levels. It is true that higher public debt must be repaid sometime. As I noted here, however, the implied increase in Britain's debt implied by present policies is relatively modest and sustainable. The government deserves blame for the fact that Britain entered the recession with its current deficit in a bad way, but the accumulated level of public debt was modest, and we can easily withstand a proportionally large increase in it.

But the idea that we are burdening our children with debt is misleading at a deeper level. For one thing, they will inherit our private debts too. What is happening today will eventually lead to a considerable reduction in private debt, whether through repayment or default. At the same time public debt will be higher. So our children are likely to inherit more public debt, but less private debt.

And another thing: Our children will be better able to shoulder the public debt we will pass onto them in the future, if we don't burden them (and ourselves) with a Great Depression now. The last Great Depression impoverished families and children and threw millions of workers on the scrapheap of long-term unemployment. Worse, it paved the way to global economic disintegration and global war. Do we want to burden our children with that?

And a final thing: If it works, our children will live better than we do. As adults, they should share the burdens we face today. But I won't tell my children that. They'll say it's not fair.

Mark Harrison : 14 Jan 2009 17:05 |  Tags: Economics Keynes Recession |  Comments (4) |  Close comments |  Report a problem

In 2009, Let the Poor Have Debt

Writing about web page http://www.telegraph.co.uk/news/newstopics/religion/3981635/Bishops-deliver-damning-verdict-on-Britain-under-Labour-rule.html

Too much debt is bad. There has been too much borrowing and lending. Now we are all paying the price in bankruptcies and layoffs.

Coupled with that, a big reaction is under way against the idea of debt and the people who make debt possible: the lenders. There's a lot of anger around that is being directed against bankers. There's also a lot of ex post moralizing: the recession is poetic justice, collective punishment for past collective excess.

It's transparently obvious that we need to adjust to some painful lessons. When they created assets or bought assets that others were selling on, many bankers forgot about exercizing due diligence. They misunderestimated the risk. Those that made the biggest mistakes will have made the biggest losses, so the market has now delivered rough justice. The trouble is that, because market justice is rough, we will all suffer with them.

How far should we all adjust? When people are in a fix and feelings are running high, reactions can go too far. Over Christmas there has been a lot of opinionating about debt. Interviewed before the holiday on Radio 4, the Archbishop of Canterbury said that debt cannot be the foundation of sustainable prosperity. Although he agreed it would be "suicidally silly" for him to start dispensing economic advice, this did not stop five other Anglican bishops from issuing a Boxing Day fatwa against the "buy now, pay later" society.

So, it's time to speak up for debt. Too much debt is bad. But too little debt is bad, too. Even today, if you look at economic conditions around the world, it's almost certainly the case that the damage caused by too little debt hugely exceeds the suffering caused by too much of it.

How's that?

Scattered around the world are many profitable investment opportunities. Many of these are in poor countries; these countries are poor, precisely because many opportunities are not exploited. The poor can see many of the opportunities just as well as the rich -- in fact, often enough, better than the rich, because the opportunities are close by where the poor live: the returns to educating children and to small enterprises, for example. But can the poor take advantage of these opportunities?

It's easy to see how the rich might jump in. After all, they are rich and can afford it. The rich might not want to, though. For one thing they may not see the opportunities hidden in the midst of poverty. For another, they may not see how to make a profit for themselves; it takes a philanthropist to want to educate a stranger's daughter, or fund a competitor's business.

So, if the rich people don't jump in, what about the poor? The problem of poor people is: they're poor. 

The only way the poor can take advantage of these opportunities is by borrowing. The poor need to be able to go into debt. 

In fact, often enough, it is being unable to incur debt that keeps the poor in their place. While the poor cannot borrow, their children stay illiterate, their land stays unfertilized, and their talents remain idle.

In 2006, Muhammad Yunus was awarded the Nobel Peace Prize for his work in bringing debt to the poor. Here are the opening words of the Prize Committee's citation. "Professor Muhammad Yunus established the Grameen Bank in Bangladesh in 1983, fueled by the belief that debt is a fundamental human right. His objective was to help poor people escape from poverty by providing loans on terms suitable to them and by teaching them a few sound financial principles so they could help themselves."

(Oh -- I changed one word in the quote. Where the original reads "credit," I wrote "debt." You can check the original here. Get the difference? Bring "credit" to the poor -- you're a saint. But those who bring "debt" to the poor -- which is exactly the same thing -- are often seen as in league with the devil. Hmm.)

In poor countries, bringing debt to the poor can be immensely liberating. Poor people that cannot borrow are condemned to live in impoverishment and insecurity; they must remain at the mercy of the existing power structures. Debt lets the poor invest; it has the potential to raise the poor above their station and enable sustainable, long-run development. Yes, real development! It's true, investment is risky and not all investments will pay off. But without debt, the poor will lack even a chance of escaping poverty, for it is then certain that the poor will invest nothing and get nothing.

Yes, it's still true that too much debt is a bad thing. But no debt at all is bad too! In fact, it can be even worse!

Again: in rich countries, even poor people would sometimes like the security and pleasure of living in their own homes. They can have it, but only if they borrow. If you don't let the poor borrow, what you are saying is: Hurray for the landlords! Long live buy-to-let! Keep home-owning for the rich! For people who cannot put down the full value of a house, being able to get a mortgage is productive in a real sense: it is productive of things that we all value, of security and family life, in fact, of exactly the same "non-material" values that the bishops think has gone missing from British culture.

No, it's not a great idea to give poor people borrow more credit than they can ever repay. But to go to the other extreme and tell the poor they must wait until they have earned it -- forever, that is -- is Victorian values of the wrong kind.

The main problem our own rich country will face in 2009 and the years beyond is not too little debt. It is the composition of the debt. A huge shift is under way in Britain from private debt to public debt. Households will tighten their belts, reduce their outgoings, pay down their mortgages, and rent new homes instead of buying them. As a result, private net indebtedness will fall.

Meanwhile, the government will splurge on unemployment benefits, housing support, and capital projects. Because of the expected fall in tax revenues, the government will pay for it by borrowing. Public debt will balloon. While short term interest rates are now at an all time low, long term rates will remain high. In the future this will be a barrier to renewed growth of private indebtedness.

And that's a good thing! When anyone borrows, they should do so in the expectation of a personal gain that exceeds the interest rate; otherwise, don't do it! Making everyone, rich and poor, leap over a higher interest rate hurdle before they borrow is not a bad idea when the problem has been too much debt.

But that's just to ensure that debt performs its proper function: to sustain development. If the poor are to participate in development, they must be able to borrow. The poorest places in the world are the places where the poor cannot borrow.

Mark Harrison : 30 Dec 2008 14:23 |  Tags: Economics Keynes Recession |  Comments (0) |  Close comments |  Report a problem