Page 50 

Backbeat

Deficit deception

Chancellor George Osborne’s plans to cut the financial deficit can’t work. Director of Advocacy International and Fellow of the new economics foundation Ann Pettifor explains why.

‘The hole in the public finances was so great and the debts were so large, and people at home know, if you have got a debt problem, you have got to deal with it,’ said Mr Osborne.

 Daily Mail 23 June 2010

It is a myth that government debt is like household debt. ‘Government budgets must be balanced, just as household budgets must be balanced,’ coalition supporters parrot.

But this is not so. This is a myth used to promote an ideology that aims to shrink the state, and assert the primacy of the finance sector over both industry and labour. A myth that promotes the right of bankers to demand protection from the public purse, but not any other productive sector of the economy. A myth used to slash public services and deny teachers decent pay, suitable schools and a stable pension.

George Osborne and the coalition, Treasury, City of London and media seek to blot out a number of truths. Namely:

• Government budgets bear no resemblance whatsoever to household budgets.

• George Osborne and the Treasury do not have the power to lower the deficit.

 • Micro-economic reasoning cannot be used to predict macro-economic outcomes. These outcomes are often the reverse of outcomes based on microeconomic reasoning.

Yet the myths prevail and they must be challenged.

1 ‘The government’s budget resembles a household budget.’

 When a householder spends money having her home insulated, the builder pockets the payment and spends it.

When the government makes a similar investment, it pays for itself because it employs people. They pay the money back to government, in taxes. Businesses make a profit when people spend their earnings, then pay corporation tax. Business profits can mean new employees – who pay tax, multiplying government revenue.

A terribly simply idea: public works expenditure creates jobs, savings, tax revenue – and cuts spending on benefits. It pays for itself. If a government increases unemployment, as the coalition sets out to do, it bites the hand that feeds it and pays out more in benefits. And the deficit rises.

2 ‘The government’s budget must be balanced.’

 Why? If the fraud and incompetence of bankers leads to a collapse in confidence and profits and a rise in bankruptcies, governments must step in and defend voters’ livelihoods. If the government’s budget gets out of balance, it will recover when the economy recovers. In the meantime, why should public servants suffer?

Governments can intervene and protect the wider economy because, unlike households, they can draw on ‘quantitative easing’: a system of funding created by the Bank of England, which has been deployed since 1694 to assist governments at times of stress.

3 ‘George Osborne and the Treasury have the power to cut the deficit.’

 They don’t, because the impact of their actions is beyond their control. It depends on how the rest of the economy reacts to their actions.

When you and I want a surplus, we can cut expenditure or raise income. This need have no effect on the wider economy. When the government wants a surplus, it may cut expenditure and increase taxes. If the rest of the economy – you and I – reacts by ‘tightening belts’, not shopping, cutting investment, going bankrupt and laying off staff, then we wave goodbye to ‘balancing the budget’. Tax revenues fall and benefits rise. And the deficit will worsen.

If the rest of the economy increases investment – in creating jobs and expanding production – hey presto! The budgetary outcome will improve.

The debate is not between deficit cutting and stimulus, but expenditure cutting and stimulus. The question is whether expenditure cutting and tax raising will actually result in a reduction in the deficit, or an increase. Research* using UK data from 1918 to 2009 shows that persistent cuts in expenditure are correlated with a rise in the debt/GDP ratio. And expansions in expenditure are correlated with a fall in public debt relative to GDP.

In other words, the impact of what government does is often the reverse of what ‘people at home know’.

* by Professor Victoria Chick and Ann Pettifor. See www.debtonation.org/2010/07/comment-on-the-economic-consequences-of-mr-osborne.

 See also www.bloomberg.com/news and search for Ann Pettifor.