BBC sees no alternative to cuts

The BBC have a story today on their website called “Will the public accept the cuts to come?” The first sentence is “Whoever wins the election, more cuts are on their way.” Cuts are inevitable, end of discussion. The article then goes on to list all the areas of public spending that could be under threat, and whether the public will stand for what’s coming. While it’s certainly true that all the main parties agree they need to “balance the budget”, and think they need to cut spending by roughly the same amount in order to do so, the question of whether we actually need to balance the budget or to achieve this through cuts to expenditure is far from a settled question. The BBC can argue it is being impartial by saying that all parties agree cuts are coming, by unquestioningly accepting the need for cuts, it’s not really providing readers with a complete picture.

At the end of the BBC’s article, it says “While the economists and analysts of the Westminster village are aware more austerity lies ahead…”. It could try asking some of those economists what they think about the state of the economic debate in the UK, to see how closely the political discussion mirrors the debate in academia. They might be surprised. It would be pretty easy to find some economists (even rather mainstream ones) who would question the entire premise of the BBC’s reporting here, which in my view would be very healthy indeed.

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On welfare cuts and automatic stabilisers

Cuts to welfare spending seem to be in the headlines daily nowadays. Every time a bad bit of economic news is announced (which is often), the prospect of yet more welfare cuts seems to raise its ugly head. Just this week, following the terrible Q4 growth figures, there was a story in the Independent about certain ministers who are pushing for further cuts to welfare.

There are a number of issues around welfare which are regularly discussed. These include ‘fairness’ and ‘making work pay’. A lot has been written on both sides of the arguments on this, so I’m going to focus on the likely economic impact of welfare cuts.

Now a key argument on welfare cuts is that the deficit needs to come down and everyone needs to contribute (we’re all in this together remember). Putting aside the fact that I don’t think we should try to reduce the deficit at the expense of jobs or living standards, I want to look at whether the claim that welfare cuts help reduce the deficit stand up to scrutiny.

A lot of people would say that the purpose of working-age welfare benefits is to provide a subsistence level of income for those who are either unable to find work, or unable to work altogether due to ill health or disability. While that’s true, welfare payments also serve a very important macroeconomic function. They act as an ‘automatic stabiliser’.

What are automatic stabilisers? From Wikipedia:

“In macroeconomics, automatic stabilizers describes how modern government budget policies, particularly income taxes and welfare spending, act to dampen fluctuations in real GDP.”

In other words, in a boom, the government collects more taxes and pays out less in benefits which helps put the brakes on to prevent the economy from overheating. Conversely, in a slump (like the one we’re in now), less tax is collected and welfare payments soar as people lose their jobs and businesses make less sales. This acts to prevent the economy going into free-fall. The stronger the automatic stabilisers, the shallower are the slumps and the quicker are the recoveries.

In response to criticism of his economic policies, George Osborne has claimed his plan is flexible because he has “been prepared to let the automatic stabilisers operate..”. I’m not sure what he means by that. What would not letting them operate look like? I suppose you could stop paying benefits to new claimants, or make people pay the same rate of tax even when their incomes fall, but no sane person would advocate that. So in Osborne’s world, ‘flexibility’ seems to mean not taking complete leave of your senses.

In any case, the Government are not letting the automatic stabilisers operate, they are trying to weaken them all the time. Bedroom taxes, Atos reassessments, cuts to council tax benefits, these all weaken the automatic stabilisers. What does this mean? It means that income will be taken out of the pockets of the poorest (who by the way spend most of their income), who then spend less in local businesses. These businesses then make less sales, leading to the government collecting less in tax, while the businesses might decide they don’t longer need as many staff, or even go bust.

Spending is a circuit. It goes round and round the system, not stopping after its first use. The government thinks by cutting the amount it pays benefit claimants by x pounds, it will save x pounds. It’s easy to see the flaw in this logic though. If you give someone £100 less in benefits, that’s £100 less going into the economy. Someone else has lost £100 in income (unless that person’s taxes are cut by the same amount, but the Government are not proposing to cut taxes). The actual saving for the Government will not be £100, but a figure much much smaller. It could even be negative if the cuts further depress employment. The welfare bill could actually go up.

This, in a nutshell then is why cutting spending by x pounds is only cutting the deficit by (-)y pounds. This confuses all sorts of people who are starting to claim austerity is not happening because the deficit is rising.

What the cuts to welfare also mean is that the next time there is a crisis, it will be much deeper, because our new, weakened automatic stabilisers are not strong enough to stop the slide and spark the recovery.

There’s actually a strong case for strengthening the automatic stabilisers. You could do this on the tax side by perhaps linking national insurance rates to the unemployment rate, or on the welfare side by guaranteeing jobs for those who are made redundant following an economic slump.

Cutting welfare in a slump is a very dumb thing to try to do. It won’t work and will make things worse. They will be disastrous on an individual level for many families bearing the brunt of these cuts. With jobs not being created in sufficient number (no matter what the Government tries to say), there’s no possible way the cuts can act as an ‘incentive to work’, and as we’ve just seen, in macroeconomic terms, weakening automatic stabilisers in a slump is an awful idea. Dumb, dumb, dumb.

More arguments to counter myths about austerity

This post follows on from part 1 here. Here’s three more commonly heard arguments made to justify austerity or policies associated with it.

1) Gordon Brown spent all the money and now there’s none left. Just ask Liam Byrne

This line of argument conjures up a couple of misleading images. The first is that somehow there was a bank vault somewhere full of money which Gordon Brown kept dipping his fingers into and spent without putting any aside for a rainy day. He didn’t “fix the roof while the sun was shining” as right wing buffoons are fond of saying.

This is quite easy to counter. The next time someone says we’ve run out of money, just ask them how that is possible when the government can print money? They’ll probably look at you like you’re mad, and then say something about hyperinflation, but they will have to concede that we can’t actually run out of money.

This moves the conversation onto inflation. Won’t printing money cause inflation? Printing money cannot and does not cause inflation. If the government printed £100bn and just left it in an account at the BoE, how could that be inflationary? It’s the spending of money that can generate inflation, but government money creation is no more inflationary that private money creation by the banks. The inflation comes from too much money chasing too few goods i.e. the constraints are real – the ability to produce goods and services – not financial. Money can and should be created up to the point where the economy is at full employment. If the private sector does not create sufficient money to get us there, the government should make up the shortfall.

The other part of point 1 above I object to is the oft repeated line about Liam Byrne’s famous “no money left” note. If anyone drops this into the conversation, it’s your turn to look at them like their crazy and say i) the note was a joke; and ii) Liam Byrne is a joke.

2) Cutting x will save £y

This is a very common argument we hear, often in relation to welfare cuts e.g. uprating benefits by 1% will save £3bn and this will reduce the deficit by £3bn. That is the gross saving only though. The government may pay out £3bn less to benefit claimants, but this in turn means they have £3bn less income and £3bn less to spend on goods and services in the private economy. Those business then have less sales which means they pay less tax. Because of lower sales, they may need to let staff go. Those staff in turn then may claim benefits, so it’s easy to see that cutting payments to benefit claimants may actually end up increasing the deficit rather than decreasing it.

This is why you hear a lot of right-wingers say that there have been no cuts. They see the deficit rising and think its because the government is not cutting enough, when in fact it’s the cuts themselves that are increasing the deficit, and outcome predicted by many Keynesians.

3) What would you cut?

This is a common response by those in favour of austerity to those arguing against the cuts. There are a couple of unspoken assumptions behind this statement: i) deficit reduction must be a specifically targeted policy and is an end in itself; ii) the only way to achieve this goal is to cut spending and/or increase taxes.

The first assumption is false because it misunderstands what a deficit is and what it tells you. I explained this a bit in part 1. What the government should actually target is unemployment, poverty, living standards etc i.e. things that actually impact upon people’s lives.

The second assumption is also wrong. In fact the opposite is true. I would argue that cutting spending and raising taxes will increase. not decrease the deficit, and any attempt to cut the deficit through austerity will ultimately fail.

With these two things in mind, the question “so what would you cut” should be rejected out of hand. The question we should be asking is how best to reach full employment, how to reduce poverty, increase living standards. Only when we start asking these questions will we start to find solutions which actually bring about economic recovery and reduce the deficit to boot.