On austerity: Some questions and comments

“The person who proves me wrong is my friend”. [Socrates]

Austerity seems to involve a set of theories and practices whereby the financial and economic matters which resulted in the “crisis” of 2008 are addressed. This seems to involve reducing governmental expenditure on infrastructures so that such expenditure matches or approaches the taxation income. Any difference between infrastructure expenditure and tax revenue seems to be met by governmental borrowing. This facet of Economics seems to be based upon the premises and assumptions of current Economics theory and practice.

The precipitating factors in the crisis are to be found in the USA with its housing boom and the growth in Collateralised Debt obligations [Unredeemable debts sold on to investors] and Credit Default Swaps [Insurance policies bought by speculators on CDOs they did not own and could undermine]. The three biggest rating agencies gave erroneously optimistic assessments and lots of them. Some financial corporations went bankrupt, some were taken over by the government and some were bailed out. The global financial system became paralysed. Layoffs and foreclosures continued with unemployment rising to 10%. During this financial bubble, the financiers frittered money on the high life and when it burst the personal fortunes of the financial bosses remained intact.

We were affected by this because of our close connections with the USA and our similar circumstances of inappropriate financial regulation, banks being excessively concerned with prioritising profit and income above national economic welfare, weak corporate media analysis, and general public ignorance of economics made worse by the “misinformation spread by the economics profession”. We too have had a “leverage bubble that drove asset prices skyward whilst starving British industry of development capital. We do also have an excessive Private Debt to GDP ratio which is a foundation of the crisis – 70% in 1939: c.160%  in 2017. 

 Alas, Austerity has a net negative effect on the economy and underperformed in deficit reduction. In 2010 it was stated that the deficit would be eliminated by 2015. In 2017/18 the deficit was £40.7 billion, wages had the biggest collapse on record and the mega-rich have doubled their wealth. [AAV 22/08/18] Might this affect the demand for support infrastructures and reduce tax returns?

Is the aim of “balancing the books” valid? The government is the sole institution in society which is not revenue constrained because it “owns its own bank”. “Its spending can systematically exceed taxation without imposing a burden on current or future generations” [Keen: Ibid] When it puts out more than it taxes back, this puts money into the private sector beneficially unless there is excessive inflation.

We are told that the government has to borrow its money. How can a sovereign state not have control over its own currency/money? Who gets the money we pay to borrow our money?

Whilst a short “taking stock” austerity might be OK, we need solutions to our economic problems.

Might tax dodging be reduced if, instead of taxing corporations, they allocated the equivalent proportion of non-voting shares to the government? 

Might we limit housing bubble inflation by limiting bank lending to a multiple of the income-earning capacity of the property? 

Might we have publicly owned rental properties to compete with the private?

Might we have a national bank to compete with the private banks and mutual?

Can there be real competition when there is only a difference of brand and not fundamental foundation and ethic?

Might we introduce “Entrepreneurial Equity Loans” which would create money for and through an entrepreneur and give a bank an equity stake as a return? [From Keen: Ibid]

Might we change the “pecking order” in the event of a bank collapse and put customers ahead of investors and senior staff?

Might we seek a better banking system in a more stable capitalist economy set in a well-informed, compassionate society? 

* Steve Trevathan is chairperson of Lyme Regis and Marshwood Vale Liberal Democrats.

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27 Comments

  • I’m sure Peter Martin will be along soon to talk about austerity and balancing the books, but I’ll chip in with a few other answers:

    “Might tax dodging be reduced if, instead of taxing corporations, they allocated the equivalent proportion of non-voting shares to the government?” – this is unworkable, and the calculation as proposed in the article you link to is nonsense. To require all company owners to hand over 20% of their companies to the Government because we have a 20% Corporation Tax is a crazy form of uncompensated privatisation and would destroy the value of most people’s pension schemes, ISAs etc.. And there is no guarantee it would actually leave the Government better off in terms of income, while making it harder for companies to raise finance.

    “Might we have publicly owned rental properties to compete with the private?” – Wouldn’t they be council houses? We should certainly look at untying the hands of councils when it comes to social housing provision.

    “Might we have a national bank to compete with the private banks and mutual?” – No. It’s not the job of Government to compete with the private sector, and while there is much to dislike about the banking industry, we don’t want it destroyed. We do need more private sector competition though.

    “Might we introduce “Entrepreneurial Equity Loans” which would create money for and through an entrepreneur and give a bank an equity stake as a return?” – No, that’s the job of Venture Capital / Private Equity firms. Equity investments are inherently risky and we don’t want the banks taking more risks (remember 2008?).

    “Might we seek a better banking system in a more stable capitalist economy set in a well-informed, compassionate society?” – Yes!

  • “Can there be real competition when there is only a difference of brand and not fundamental foundation and ethic?” There’s a bit of competition between mutuals (credit unions and some building societies) and banks – but only in consumer finance. There’s a common view that this competition doesn’t support small businesses sufficiently well – one example is the impact of the loss of bank branches. A more general concern is that business (of all sizes) in the UK is much more reliant on bank finance that business in some other countries, including the USA.

    “Might we change the “pecking order” in the event of a bank collapse and put customers ahead of investors and senior staff?” There’s already a system of deposit insurance designed to protect customers (deposit-holders) in the event of a bank collapse.

  • Peter Martin 29th Mar '19 - 12:29pm

    @ Steve,

    Before we can attempt to answer your other questions we need to resolve the first and most important one ie Is the aim of “balancing the books” valid?

    We need to do a simple ‘thought experiment’. We physicists like that idea of those. It saves us the bother of actually doing too much experimental work but that is always needed as a final check – of course.

    So say we have a closed community of a number of individuals which is ruled by a chief. He’s the big boss. What he says goes. He decides to introduce a monetary system having previously managed without one. So where does he get the money? He simply creates it.

    Say he creates a large number of ‘crowns’ and spends them into his economy, paying his servants and supporters. He has to create a demand for the crowns so he imposes a tax on huts, boats and land etc. Where does everyone get their crowns from to pay their taxes? They have to work for the chief and do what he tells them. So they get the crowns to pay their taxes and the Chief gets some of them back. But he can’t get back more than he created in the first place. He’s always in debt and deficit. But he doesn’t really care because he’s created them in the first place. The difference will become the monetary base and be used as the means of exchange in the economy. If anyone wants to save for the future they might want to deposit them back with the chief who’ll probably agree to pay them a small measure of interest. 1% or so but probably slightly less than the inflation rate so it won’t cost him anything overall.

    Once he gets the hang of it all he’ll realise that if he gets his spending and taxation levels just right he’ll optimise his economy. Too much spending/too little taxation will produce higher than desirable inflation as the economy isn’t capable of supplying the aggregate demand. Too little spending/too much taxation will create the opposite effect of deflation and recession.

    But why. otherwise, should he worry about his taxation receipts being less than his spending?

  • Joseph Bourke 29th Mar '19 - 12:33pm

    Steve,

    it is worth reading Vince Cable’s pamphlet – Beyond Brexit. He writes:
    “…in fact both the Brown Labour government and the Coalition did many of the right things to minimise and the repair the damage (resulting from the finacial crisis). The banking system was prevented from collapse and then made safer, by reducing leverage and through the structural reforms of the Coalition (the Vickers reforms). Demand in the economy was sustained by initially running a large, though unsustainable, budget deficit and then by the Bank of England’s aggressively loose monetary policy while the budget deficit was brought down. By 2016 the economy had largely recovered andBritain had the fastest growing economy in the G7. ”
    “… austerity- variuosly described as stagnation in living standards or reduction in the government’s fiscal deficit or debt cannot simply be stopped by a change of government. There are some elements of choice – the reliance at present on government spending curbs rather than taxation to stabilise the budget is one, and the coalition government could have permitted more public investmentto revive the economy immediately after 2010. But it is a fantasy to majic away the difficult choices that have to be made and will in future. The revenue base of goverment will be steadily eroded by a combination of technolgy and global business trends. This will make choices still more painful; fundamental, if unpopular, changes to the tax system will be imperative.”
    “…the economy relies heavily on worrying levels of debt – household, corporate and government- which are sustainable only in an abnormal environment of very low interest rates. This in turn relates to the way in which the banking sector combines with a dysfunctional housing market to generate high levels of mortgage debt and the way the tax system encourages debt creation rather than equity financing.”

  • @Nick
    To require all company owners to hand over 20% of their companies to the Government because we have a 20% Corporation Tax is a crazy form of uncompensated privatisation and would destroy the value of most people’s pension schemes
    Some years back the figure was 30% and no corporation tax, for plc’s this isn’t really an issue as currently they simply mint new shares to satisfy liquidity and bonus scheme demands and thus dilute the existing shareholdings. The real problem with this, is that holding shares in say Amazon’s various UK operating companies which are largely operated as cost centres, isn’t the same as holding shares in Amazon Inc.

    “Might we have a national bank to compete with the private banks and mutual?”
    I thought as a result of 2008 we did, it was called RBS… 🙂
    Although, this (RBS) nicely illustrates a problem with government shareholdings; since the 1980’s successive governments have sold them off to fund opex rather than capex…

    “Entrepreneurial Equity Loans”
    I agree with you, however, there is a hole in the market for seed/Angel funding ie. pre-VC. However, given the track record of “the banks” (including RBS) with the maladministration of small business loans, I wouldn’t want them involved.

    What seems to have been dropped is the idea of a Sovereign fund, I know the government at the time the idea was raised though it would be used to fund “infrastructure” investment, I think if its investments were structured more along the lines of the lottery monies, it might encourage investment in exploration of new business ideas. Also, it might get away from the seemingly typical government investment where say £200m is ‘invested’ in some sector, only for £70~100m of that to go on building a shiny new building with specifications that match existing vacant commerical properties – funnily, I’ve not worked in a startup that thought it was a priority to build their own ‘prestigious’ premises before they had actually developed and sold anything…

  • Dress it up with all the fancy words and reasons you like but ‘Austerity’ is the main reason that headlines such as “4.1 million children in poverty”, “Poverty increases among children and pensioners across UK”, “70% of children in poverty are from working families”, etc., occur with disgraceful regularity.

    Hand wringing in this party is a shameful refusal to accept what happened between 2010-15.

  • Peter Martin 29th Mar '19 - 4:45pm

    @ Steve @ JoeB

    “the economy relies heavily on worrying levels of debt – household, corporate and government- which are sustainable only in an abnormal environment of very low interest rates”

    Worrying? To whom? The simple fact of the matter is that if the UK as a whole is importing more than it exports then someone in the UK has to do some borrowing (or desaving) to pay for it. Penny for penny.

    In the strange workings of the neoliberal mind, trade and current account deficits don’t matter. At one time, they would be newsworthy items. Now they aren’t. I can’t remember the last time the BBC reported what they were. On the other hand the debts that are caused by the imbalance do matter.

    Go figure!

    And while we are in the EU we can’t apply any tariffs to correct the imbalance. We let the £ float so there’s nothing we can do in that respect either. All we can do, and stay within EU rules, is to depress the economy to quell the general appetite for imported goods. In other words, impose economic austerity.

  • Daniel Walker 29th Mar '19 - 4:54pm

    @Peter Martin “All we can do, and stay within EU rules, is to depress the economy to quell the general appetite for imported goods. “

    We could do what Portugal did, apparently. Portugal is in the EU and the Eurozone.

  • Peter Martin 29th Mar '19 - 5:15pm

    @ Daniel Walker,

    Yes there is a way out of eurozone induced problems for countries like Portugal. Simply export more. The last figure I can find for Portugal was about a 0.5% current account surplus for 2017. I would expect that to have increased significantly for 2018. I’ve previously made the point that a country can survive reasonably OK in the eurozone with a trade current account surplus of over 3% of GDP.

    A country needs more currency in its economy to grow. Net exports are the only possibility in the EZ without falling foul of EU debt rules.

    According to this link:

    https://www.worldfinance.com/markets/how-portugal-engineered-a-remarkable-recovery

    Export revenue has increased by more than half since 2008, improving Portugal’s trade position by nearly €20bn ($22.78bn), and creating a newly discovered sense of self-sustainability.

    So I’d expect they’d be pretty close to that 3% target by now.

    But this is a beggar-thy-neighbour approach to solving economic problems. Not all countries can run a trade surplus which effective exports their unemployment problem to someone else.

    The eurozone won’t have stable finances until it is at least possible to run a successful economy with balanced trade or a small deficit.

  • Yes there is a way out of eurozone induced problems for countries like Portugal. Simply export more.
    Isn’t this is something the Brexiteers want the UK to do (ie. export more) – with all those ‘exciting’ trade deals we’ll be able to sign, because the EU prevents us from exporting, hence why the UK’s non-EU trade has been increasing…

  • Peter Martin 29th Mar '19 - 6:43pm

    @ Roland,

    Yes it’s fair enough for the UK to export more because we run a substantial trade deficit. We shouldn’t try to copy the Germans and run a trade surplus though. That’s in no-one’s interest.

    Ultimately exports are a real cost and imports are a real benefit. Google that phrase if you are inclined to disagree.

  • Peter Martin 29th Mar '19 - 6:48pm

    @ JoeB,

    I’m not sure what you are trying to argue here. You can’t say we have an over reliance on debt when that debt, is to the penny, to finance the trade deficit.

    The Government hasn’t wanted to shoulder it’s fair share in recent years so has simply encouraged everyone else to to borrow more which has created a debt bubble in the private sector.

    The only way to be less “reliant on debt” is to balance our trade and that means holding the pound down on the forex markets.

  • Peter Martin 29th Mar '19 - 8:54pm

    @ JoeB,

    Borrowing in the private sector is nearly always for the purpose of spending. It could be a car or a holiday in which case it is easy to see how it it adds to aggregate demand. But if its used to buy a house or some shares the house or the shares will have a seller and they have to do something with the money too.

    As I’ve said often enough you just need to look at the sectoral balances to have a pretty good idea of what’s happening in the economy. If the private sector is borrowing then they are bring forward future consumption and there’ll be a boom. If the private sector has stopped borrowing and is paying down debt there will likely be a bust – unless the Govt plays its part and starts to increase its spending to prevent it.

    It will probably do that only after the bust or crash. So, then, we see such Govt schemes as cash-for-clunkers or panic reductions in VAT to try to minimise the damage afterwards. In Australia I remember being sent a cheque for $900 and implored to go out and spend it!

    That was quite nice of course but it’s really no way to run an economy.

  • Katharine Pindar 29th Mar '19 - 10:15pm

    I’m not following all this, because, as expats commented, austerity to Lib Dems is or maybe should be mainly focused on the poverty in this country which we need to address. But people may like to remember that the excellent policy passed at the Brighton Conference last September, F28 entitled Good Jobs, Better Businesses, Stronger Communities, in the section from line 48, subhead Create a fair economy that works for all … is this paragraph (lines 79 to 84):
    d) Challenging the growing concentration of market power – including in energy, banking and the new ‘tech titans’ – with stronger regulation of monopolies, enhanced consumer protections, greater rights over data and by sharing economic benefits more widely through an innovative Citizens’ Wealth Fund. (That idea is explored more in the Consultation Paper on which the motion was based.)

  • Peter Martin 30th Mar '19 - 6:27am

    @JoeB,

    Many houses purchases are new properties. So it’s obvious that these add to GDP. Purchases of existing properties often involve large expenditures on renovations. This again creates economic activify. Moving house is often a good opportunity to borrow a bit extra to buy a new car.

    The sellers may not reinvest in other assets. At the end of the chain there will be someone that won’t and will use the money to make other purchases. These are often beneficial to the economy but, at the same time you can’t just ignore them in macroeconomic calculations.

    Steve Keen makes the point that one big failing of orthodox economics is to ignore the effect of private debt. We see this in the rules of the eurozone. No rules on private debt levels but lots of rules on public debt.

  • Steve Trevethan 30th Mar '19 - 7:48am

    YES!!!
    Current economic theory and practices are difficult to understand.
    This is a deliberate purpose of current mainstream “economics” so that the most of us can be taken advantage of.
    Please look at the film “Inside Job” to see how self serving many leading and powerful mainstream theorists and practitioners are.
    It provides a quick, easy and gripping way to understand vital aspects of economics now.

  • The basic problem with economics is that of arithmetic. In order to add numbers together you must demonstrate that, for example seven is always equal to seven or two multiplied by three is always equal to six. In other words we need a robust definition of one and two and zero.
    So how to calculate my worth. I have a house, a car, some money in the bank, some clothes and so on. In what strange world can each of these be measured using the same numbers? I realise of course that these are issues that economists have grappled with, and that in fact they lead to an estimate of uncertainty.
    But then they wish away the estimates of uncertainty. They hope people won’t notice and use the their ideas to advance their political theories.

  • Nick Baird – “No. It’s not the job of Government to compete with the private sector, and while there is much to dislike about the banking industry, we don’t want it destroyed. We do need more private sector competition though”

    “No, that’s the job of Venture Capital / Private Equity firms. Equity investments are inherently risky and we don’t want the banks taking more risks (remember 2008?)”

    Actually there are countries that have some kinds of national banks, notably German Kfw which provides finance for SMEs, manufacturers and exporters.

    Venture capital sector in UK and Europe as a whole is not as huge as in the US, and the VC funding seems to go to “fancy tech” startups more than “hard tech” businesses (I mean those that actually manufacture hardwares/visible products rather that just providing “solutions”).

  • Joe Bourke – “spending on existing house purchases and share purchases have no impact on GDP and neither do the proceeds of sale if as usual the proceeds are reinvested in other assets. The great majority of household borrowing in the economy is for house buying and in the corporate sector for share buybacks/investments, mergers and acquisitions. Most capital investment is financed from retained earnings, These borrowing and spending transactions for mortgages and purchase of own shares do not add to GDP as measured by spending on output. They inflate asset prices as Hudson notes in his interviews”

    Inflated house prices do encourage household consumption via wealth effect, even if the houses are purchased with mortgages and the house owners’ fraction of equity in the houses are small. But of course this is unsustainable.

  • Peter Martin – “Yes it’s fair enough for the UK to export more because we run a substantial trade deficit”

    Not to mention that the value-added from a specific sector, let’s say car manufacturing, would be lower if too much of the production inputs, especially the high-value components, are imported. I mean if this is the case then that sector is not so much different from those South East Asian assenblers who just assemble foreign components into finished goods.

  • Sue Sutherland 30th Mar '19 - 12:36pm

    The problem with austerity combined with low taxation is that the rich get wealthier and those in need no longer have the services and benefits they require. In my view that makes for a stressed and unhappy society. In addition the middle and working class are suffering a squeeze so the process of creating a larger middle class with money to spare (which was an important factor in the Industrial Revolution) is being reversed and the economy is suffering as a result.
    If this analysis is correct what I would like our Lib Dem economists to do is find a way to reverse that process, or at least make an attempt to do so, so that our party’s economic policies reflect that ambition. Is anyone with me?

  • Joseph Bourke 30th Mar '19 - 12:56pm

    Thomas,

    yes, wealth effects from higher house prices and share prices are associated with increased levels of consumption. But these increases in asset prices are not themselves a component of GDP and as you note are themselves unsustainable and subject to reversal i.e. declining prices.

    The real issue for the great majority of people is real wages. Living standads increase because we are able to acquire more and better quality goods and services for the same or less amount of labour time than we could in years past. This s a result of labour specilisation, technological advances and globalisation with many manufatured goods produced at low cost in Asia.
    Per capita real wages have been fairly stagnant since the early 2000’s but total wages as a share of national income has been fairly constant astotal employment has increased.
    What has changed is that the proportion of spending on food and consmer goods has declined as a % of disposal income,. Rents and mortgage costs have increased, taking a far greater share of disposable income than they were previously. Rents have increased from 10% in the 1970s to 30% of disposable income today (15% and 40% in London).
    With so much of disposable income being taken up by rents/mortgage payments on inflated land values demand for produced goods and services is depressed.
    Where housing coss are high due to inflated land prices/rent extraction, wages have to be higher to meet living costs. If wages are driven higher by inflated housing costs then businesses input costs become less competitive – higher trade deficits and unemployment ensues. The only winners in this situation are the landlords. There is too little of wages left after housing costs to be able to buy up the supply of domestically produced goods and services.
    Michael Hudon in his interviews refers to Henry Ford who paid his workers good wages understanding that these same workers were his customers. If all their wages were used to pay basic subsistence costs for food and shelter they would have no disposable income to buy consumer goods like mass-produced cars.

  • Joseph Bourke 30th Mar '19 - 1:45pm

    Sue,

    “what I would like our Lib Dem economists to do is find a way to reverse that process, or at least make an attempt to do so, so that our party’s economic policies reflect that ambition.”

    Vince on page 17-18 of his pamphlet distributed at conference ‘Beyond Brexit’ writes:

    …Importan public goods are underfunded (health, education, policing) and taxes need to be raised to pay for them.”
    “One important question, not raised since the debate around the poll tax a generation ago, and its replacement by a new form of residential property taxation, is whether the tax base should change in a fundamental way. The one, big, radical reform which is crucial is to shift tax from work (income tax and national insurance) to land. Land taxation has long been advocated as a form of tax which is economically sensible (it taxes something in fixed supply, encouraging efficient use), which cannot be avoided by shifting overseas (as can taxation of income and profit) and is relatively efficient (requiring collection from landowners rather than vast numbers of property-owners). A prototype has been designed, replacing business rates by a landowner’s levy, which could progress from there to residential land (also replacing council tax). There are administrative and political challenges, but it is the direction in which we should be travelling.”
    “Anothe fundamental change, which is obscured by arguments about how to squeeze more tax out of companies, is to shift tax away from equity (risk capital) and onto debt, which is currently treated as tax-deductible. The coalitio recognised the need to make this change as a step to a more entrepreneurial business sector but it has not yet been followed through.”

  • @Peter Martin – “Ultimately exports are a real cost and imports are a real benefit. Google that phrase if you are inclined to disagree.”

    Don’t disagree, with the entire premise of this Economic viewpoint, however, applying it to the present day situation (ie. Single Market v. WTO) and it is very clear why Brexiteers (including Tim Worstall) avoid substantive economic discussions about the benefits of Brexit, because it is clear the Brexiteer economic argument is based on a misreading of economic’s such as that encapsulated in this simple statement.

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