Digging holes and filling them back up again

When someone suggests that the government should just create jobs for the unemployed, you often hear the retort, that this is a bad idea, because the jobs they would create would be of no value, akin to digging holes and filling them back up again. The reference to digging holes comes from (I think a misunderstanding of) something Keynes wrote in the General Theory. He wrote:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”

So he is using an example to show that any task (however pointless) that will pay an income is superior to leaving people unemployed and earning nothing, but that we can come up with much more useful things for people to do. So even if the government created some jobs that were akin to digging holes and filling them back up again, that would still be better than unemployment.

I was reminded of this yesterday by Neil Wilson who pointed out that there are however quite a lot of holes that may not need digging, but certainly do need filling up again.

Road repairs are so behind schedule we don't need to dig holes any more. We just need to pay people to fill them in: http://t.co/3IZ0Coevr5

— Neil Wilson (@neilwilson) January 6, 2015

Some joined up thinking needed perhaps?

100 year old excuses for unemployment

Perhaps I shouldn’t be, but I’m always surprised to find out that exactly the same arguments being made today about an issue have also been made in the long distant past. Back then they may not have known any better, today we definitely should. A comment from Peter Martin on Labourlist gave me another example of this phenomenon. He quotes from Robert Tressell’s “Ragged Trousered Philanthropists” which was written in 1912 to show what arguments were being made around that time to account for high unemployment.

Technology:

‘Yes,’ said Crass, agreeing with Slyme……… Then thers all this new-fangled machinery,’ continued Crass. ‘That’s wot’s ruinin’ everything. Even in our trade ther’s them machines for trimmin’ wallpaper, an’ now they’ve brought out a paintin’ machine. Ther’s a pump an’ a ‘ose pipe, an’ they reckon two men can do as much with this ‘ere machine as twenty could without it.’

The immigrants:

‘Why, even ‘ere in Mugsborough,’ chimed in Sawkins–……..We’re overrun with ’em! Nearly all the waiters and the cook at the Grand Hotel where we was working last month is foreigners.’

On cheap foreign labour:

“you know very well that the country IS being ruined by foreigners. Just go to a shop to buy something; look round the place an ‘ you’ll see that more than ‘arf the damn stuff comes from abroad.”

Over 100 years later, this is still fairly mainstream political discourse in the UK. We had this UKIP poster:

I also often see people arguing that cheap foreign labour overseas is costing us jobs in the UK.

And you still hear the Luddite argument that machinery will replace all our jobs. Technology has and will continue to replace jobs that are being done by humans today, but this doesn’t mean unemployment is guaranteed. A lot of people on the left use this argument to advocate a guaranteed basic income, but it ignores the fact that new forms of work are being created all the time, and we could also broaden what we think of as work to include activities that are not being paid to do at the moment.

We had full employment in the 1960s and there is no reason we shouldn’t have it again. As Keynes said:

“…Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.”

“The moral case for welfare reform”

A few days ago the country’s most senior Catholic, Archbishop of Westminster Vincent Nichols raised some objections about the Government’s welfare reforms in comments to the Daily Telegraph. I don’t think we should pay attention particularly to what religious leaders say (about anything), but in this case, the Archbishop was merely stating the obvious. Basically, he said that the reforms were leaving some people destitute (they are), that the reforms are primarily about saving money (yes), and that the reforms are not working (depends on how you define ‘working’).

This seems to have upset David Cameron enough for him to ask the Telegraph for a right of reply. Here’s his article and he tries to answer the Archbishop with a moral argument. His argument is a textbook example of the conservative ‘strict father figure’ framing I’ve been banging on about recently. Here’s some extracts:

“First, our long-term economic plan for Britain is not just about doing what we can afford, it is also about doing what is right. Nowhere is that more true than in welfare. For me the moral case for welfare reform is every bit as important as making the numbers add up: building a country where people aren’t trapped in a cycle of dependency but are able to get on, stand on their own two feet and build a better life for themselves and their family.”

“Those who can’t work will be always supported, but those who can work have the responsibility to do so. “

“I believe very firmly that it is wrong to penalise those who work hard and do the right thing while rewarding those who can work, but don’t.”

In this version of reality (which Cameron may actually believe), it’s not necessarily the people that are to blame, but the evil system which makes people ‘dependent’, even rewarding them for “not making the right choices”.

So the system is immoral and must be ‘reformed’ to ‘make work pay’ and create the right incentives to ‘work hard and get on’. This is classic conservative moral framing, but what Cameron doesn’t mention is the enormous elephant in the room – jobs (or lack of them).

I might have some sympathy with Cameron’s position if there were more job vacancies than people looking for work, and those people were turning down work left, right and centre, but the maths just isn’t in Cameron’s favour. We’ve got around 4.5 million people without a job who want on and over a million more in part time work who’d like a full time job. At the same time, there are just half a million vacancies. Against those numbers, if you cut the amount of money people receive in social security benefits they will just get poorer. They can’t find jobs that don’t exist no matter how hard they try.

So to re-state Cameron’s case: when people stand on their own two feet, work hard and do the right thing, they will succeed, but the evil welfare system makes people lazy and dependent so must be weakened.

So how could we frame this differently? I always think Owen Jones is on to something when I hearing him talk about housing benefit. When is a discussion about how we need to get the housing benefit bill down, he just agrees strongly, but says it should be done by tackling private sector rents and building more houses. Housing benefit should be reframed therefore as landlord benefit. People don’t like feeling like they are being screwed, but anyone who is renting privately strongly suspects they are being. Jones hasn’t quite got his delivery down though I don’t think. It’s a bit machine gun with too much spraying of facts and figures, which probably won’t change anyone’s mind. I think his overall strategy is sound though.

On the welfare system as a whole I think the reframing might go something like this.

“The welfare system needs updating for the 21st Century, but to do so we need to understand the problems. The welfare state we know today was established under the assumption of full employment. That assumption no longer holds. There are simply not enough jobs. We need to rediscover what full employment means and government has a big role to play in that. Young people need paid work experience. People who’ve been out of work for a long time need a chance to get back into the workplace and update their skills. The private sector has consistently failed to perform in this regard, so where the private sector can’t or won’t offer these opportunities, government can and should. As Keynes said:

“The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years…

It’s time to unfuddle our heads. When we talk about people having a responsibility to work if they can, so government has a responsibility to ensure that work is available and that it pays well enough to sustain people in a lifestyle appropriate for a rich country.”

I’ll finish this with a quote from a recent Jack Monroe article which is a pretty good antidote to this ‘work hard and get on’ nonsense:

“Poverty can happen to anyone. That’s why I unsettle some of the stalwarts of the Tory party. Because their rhetoric of “work hard and get on” can fall apart in the blink of an eye. I worked hard. I got on. And I still spent a year and a half scrabbling around in a festering pit of depression, joblessness, benefit delays and suspensions, hunger, and the entrenched, gut-wrenching fear that I was failing as a parent.”

 

Keynes on “The Means to Prosperity”

Here’s Keynes from the opening of his 1933 pamphlet “The Means to Prosperity”. You can read the whole thing here.

“If our poverty were due to famine or earthquake or war—if we lacked material things and the resources to produce them, we could not expect to find the Means to Prosperity except in hard work, abstinence, and invention. In fact, our predicament is notoriously of another kind. It comes from some failure in the immaterial devices of the mind, in the working of the motives which should lead to the decisions and acts of will, necessary to put in movement the resources and technical means we already have. It is as though two motor-drivers, meeting in the middle of a highway, were unable to pass one another because neither knows the rule of the road. Their own muscles are no use; a motor engineer cannot help them; a better road would not serve. Nothing is required and nothing will avail, except a little, a very little, clear thinking.

So, too, our problem is not a human problem of muscles and endurance. It is not an engineering problem or an agricultural problem. It is not even a business problem, if we mean by business those calculations and dispositions and organising acts by which individual entrepreneurs can better themselves. Nor is it a banking problem, if we mean by banking those principles and methods of shrewd judgement by which lasting connections are fostered and unfortunate commitments avoided. On the contrary, it is, in the strictest sense, an economic problem, or, to express it better as suggesting a blend of economic theory with the art of statesmanship, a problem of Political Economy.“

Keynes was writing this at the height of the Great Depression, and although the circumstances were somewhat different than today, there are many similarities in the way Governments (sadly) are reacting today and how they reacted in the 1930s.

David Cameron’s speech on the economy this week included the claim that external factors were preventing a recovery while the Government’s policies were having no negative impact on growth. While Cameron received a rebuke for this from OBR chairman Robert Chote, Cameron’s underlying message of “there’s no alternative” still seems to resonate. This was just the kind of wrong-headed thinking Keynes was trying to rail against in the 1930s, and his key messages about positive government action remain as relevant today as they were then.

What Most Discussions of the Deficit are Missing

This post will attempt to explain a concept in economics known as “sectoral balances”. This might get a bit wonkish, but hopefully not too much.

We hear a lot about the Government’s debt and deficit, how it is too high and must be reduced even at the expense of jobs and living standards. What we rarely, if ever hear about though is the other side of the ledger – the private sector. Here’s an example of what I mean:

Here’s a chart of UK Government debt. It’s risen from around 40% of GDP 25 years ago, to a little under 70% in 2012. A pretty big rise huh? But what about private sector debt?*

25 years ago, total private sector debt was just under 150% of GDP, but by the time the 2008/9 crisis hit, this had more than trebled to over 450%. While the debt households and non-financial companies increased significantly over the period (doubling and trebling respectively), the main culprit was the financial sector, who’s debt peaked at 258% of GDP in Q1 2010. Looking at the two charts above, which problem looks more urgent? But yet the focus on the government’s finances is relentless.

Look again at the second chart, and you’ll see that following the crash, all three parts of the private sector started to reduce their debts, although this year that trend seems to have paused. This is what is known as deleveraging – paying down debt. Economists like Richard Koo have labelled this period of deleveraging a “balance sheet recession“. Basically, when asset prices collapse following the bursting of a bubble, millions of private sector entities find themselves in dire straits, so they all simultaneously attempt to increase savings or pay down debt at the same time, causing a collapse in economic activity.

Now back in 2011, David Cameron drew the ire of some economists when a speech he was about to make reportedly contained the lines:

“the only way out of a debt crisis is to deal with your debts. That means households – all of us – paying off the credit card and store card bills”.

Now Cameron’s problem wasn’t the advice per se, (it’s probably a good idea for households in too much debt to cut back) his problem was that he’d forgotten the economics he’d learned while studying PPE at Oxford, namely Keynes’ Paradox of Thrift. While for an individual, saving or paying down debt may be a sensible thing to do, because my spending is your income and vice versa, if everyone tries to do it at the same time, total savings will actually fall. This allows me finally to get to the point of this post.

While the government’s deficit is always discussed, what is never discussed it that the government’s deficit is equal to the surplus of the private sector. The approach of examining changes in the economy by looking at different sectors in the economy is known as the sectoral balances approach, which was popularised by British economist, the late Wynne Godley. It highlights the accounting tautology that shows:

Private Balance = Government Balance + Trade Balance

The private balance is private savings minus private investment spending, the government balance is government spending minus tax receipts and the trade balance is exports minus imports. This equation is always true whether there is a government deficit, surplus or balanced budget. Here you can see a graphical representation* by way of illustration using real data for the UK.

In this chart, the red bars represent the capital account which is equal but inverse to the trade balance (or current account to be more precise). This just helps to show more clearly how the governments budget position mirrors the position of the non-government sector. So, in the latest quarter, a 5% private sector surplus and a 3% capital account surplus is offset by an 8% deficit.

The point of showing this is to say that the government cannot really have a budget deficit target and hit it because it depends upon what happens in the other two sectors. When Cameron says he thinks households should pay down debts, he doesn’t realise that its impossible for both the government and the private sector to do that at the same time, unless the country has a very sizable trade surplus (which we certainly don’t have). The government can either accommodate the private sector’s desire to pay down debt/save by increasing spending/cutting taxes, or it can try to cut its own spending and at the same time hope households and businesses will be willing to take on more debt.

In a sane world, the government would realise that the first option is preferable, but instead it has plumped for option 2. If you look at the figures produced by the OBR**, you can actually see that deficit reduction is predicated on households going into deficit again. This cannot be a sensible strategy. The problem the government has is that while it can control some portion of its budget, it can’t control other parts like the welfare bill, and it can’t control how much tax it takes in. These things are determined by saving and investment decisions made by the private sector and the performance of exports over imports. Once this is understood, it’s clear to see how commentators like Fraser Nelson are misguided when they say there are no cuts because spending is going up. The government are making cuts, its just that those cuts are causing other parts of the budget (parts they have no control over) to go up.

The sectoral balances approach then allows us to consider how changes in government policy may impact upon the different sectors. Armed with this knowledge you would know that for the government deficit to go down, the private surplus and/or the trade deficit would need to shrink or disappear entirely. At a time of global recession, the prospects for a massively shrinking trade deficit don’t seem good, and the prospects for an already debt-saturated private sector to take on yet more debt also seem less than positive. Both of these things imply that any attempt to reduce the government’s deficit by cutting spending or raising taxes will ultimately be futile, and that’s exactly what we are seeing at the moment.

Here then are the key take away point from this post:

• Outstanding private debt dwarfs government debt, both as a % of GDP and in the extent to which it is a problem that needs dealing with.
• Considering the government deficit in isolation leads to wrong-headed policy making. Policy-making should take account of all sectors of the economy when considering the implications of different policy options.
• The three sectors must balance. In a trade deficit nation like the UK, if the private sector is saving/paying down debt, a government deficit is inevitable regardless of the government’s spending plans. Any attempt by the government to cut it’s deficit will fail unless the private sector is willing to cut its surplus/run a deficit.
• Those who argue austerity is not happening do not understand the points above and don’t get the ‘tyranny of the accounting’.

* The second and third charts in this post have been taken from this excellent blog. The blog’s author Neil Wilson updates these charts on a quarterly basis as new data is published. Here is the post the charts are taken from.

** The OBR publishes forecasts for what they think will happen to the sectoral balances (they call them financial balances) here (Its the supplementary fiscal tables, tab 1.8).

Lerner on Functional Finance

After yesterday’s Keynes quote, I thought I’d follow it up with one from the late economist Abba Lerner. The quote is about ‘functional finance’ that he developed. I’ve blogged about functional finance before here. Here’s the quote:

“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and withdrawal of money, shall be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine what is sound and what is unsound …Government should adjust its rates of expenditure and taxation such that total spending is neither more or less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good or bad, they are simply the means to the desired ends of full employment and price stability.”  (Lerner, 1943. From “Functional Finance and the Federal Debt”, taken from here)

This is kind of what I was referring to in this blog post. It’s the idea that governments today are pursuing all the wrong goals while ignoring the ones that really matter.

Lerner was a contemporary of Keynes and they corresponded in the 40s. There is some evidence that after initially disagreeing with Lerner, Keynes came to accept the logic of functional finance. For an interesting discussion of this, see here. I think we can learn a lot from Lerner’s ideas, and functional finance was built upon by economists from the branch of economics known as Modern Monetary Theory, of which I am a fan. Check out some of the links on the right hand side bar for more about MMT.

Keynes on Full Employment

I came across this quote by Keynes today here and thought I would share it. It’s from a pamphlet written to support Lloyd George in the 1929 general election. It’s message should still resonate today, and serves as a useful reminder that Liberals were not always supporters of junk economics. Their political descendants the Liberal Democrats should take note:

“The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years… Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.”