Policy Research in Macroeconomics

The mystery of Jeremy Corbyn and the deficit

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Let me confess, I am now confused as to what Jeremy Corbyn’s policy is on budget deficits, their causes, impacts and remedies. Two weeks ago, I thought I understood what he was saying, and was mainly supportive of his approach.  Now those speaking on his behalf (I assume) have made things a lot less clear, and probably a lot worse.  They seem to want to swallow Osborne’s deficit poison pill, but also to spit it out. This doesn’t work.

Corbyn’s deficit policy – via John McDonnell

On 11th August, the Guardian’s  “Comment is Free” section published an article by Labour MP John McDonnell headed “Jeremy Corbyn would clear the deficit – but not by hitting the poor”.  So far so maybe OK.  But he goes on to say:

Let’s see if, at least on economic policy, we can return to some level of rational debate. Let’s start by tracing out where there is absolute agreement.

First, it is unarguable that no modern party leader can win an election if behind in the polls on economic competence. Ed Miliband, sadly, was proof of this truism. Second, deficit denial is a non-starter for anyone to have any economic credibility with the electorate. This was a key finding of the poll recently published by Jon Cruddas, examining why Labour lost the election.

So let me make it absolutely clear that Labour under Jeremy Corbyn is committed to eliminating the deficit and creating an economy in which we live within our means. [my emphasis].

Rational debate? No way – “deficit denial”… “eliminating the deficit and living within our means” – these phrases are straight out of the George Osborne “My greatest political hits” songbook.  

But clearly John McDonnell was not speaking out of turn, for on the Today programme this morning, up popped Ken Livingstone to defend Jeremy Corbyn – and his first line was also to talk about getting rid of the deficit.

Intermezzo – governments are in no way like households

Underlying much of the political discourse is the flawed analogy, “the government is like a household”.  So Let’s get the following basic points out of the way: 

  • the government is not like a household, whose members can ultimately be made bankrupt, or lose their home if the mortgage or rent is not paid
  • The government is not even like a local authority (e.g. the former Greater London Council which Ken Livingstone and John McDonnell once ran), which has a legal duty to balance its budget annually, whatever the impact
  • Unlike a household, or indeed Eurozone governments like Greece, the UK government has its ‘own’ central bank that uses monetary tools (including e.g. low interest rates and QE) to support both the private and public sectors of the UK economy
  • Unlike a household, the government has almost guaranteed income in the form of tax revenues; these may fluctuate, but unlike a private firm’s income from sales etc., payment is a legal duty  
  • Unlike a household, a government cannot be ‘liquidated’ – it cannot go bankrupt – so while it may get in difficulties for a while, it cannot be ‘liquidated’ in the way a company can.
  • Unlike a household, the government cannot control its deficit, which rises or falls depending not just on its own acts and decisions (as with individuals), but largely on the health of the rest of the economy
  • unlike a household, the government has overarching responsibility – which it cannot shirk –  for the well-being and security of all citizens (including future citizens), not just its own “family and friends” or a set of selected charities 

What Corbyn has said

Back to Messrs McDonnell and Corbyn.  Let me concede, you don’t need to run a current budget deficit in years when the economy is doing well – though it is not likely to be a problem if you do have a modest current deficit if the economy is doing well. 

There is however a strong political and economic argument for always treating borrowing for long-term investment, which benefits future generations, separately from current expenditure.

This is a distinction that Jeremy Corbyn is well aware of, and stoutly defended in his policy document, “the Economy in 2020”.  In a recent PRIME article “What the Labour leadership cnadidates say on macroeconomic policy”, I quoted this passage:

We all want the deficit closed on the current budget, but there was no need to try to do it within an artificial five years or even the extra five years George Osborne mapped out two weeks ago.

If the deficit has been closed by 2020 and the economy is growing, then Labour should not run a current budget deficit – but we should borrow to invest in our future prosperity.  

You don’t close the deficit fairly or sustainably through cuts.

You close it through growing a balanced and sustainable economy that works for all.  And by asking those with income and wealth to spare to contribute more.

If Osborne’s forecasts are right there won’t be a deficit by 2020, but if – like last time – he is proved wrong and he only again manages to halve the deficit then I make this pledge:

Labour will close the current budget deficit through building a strong growing economy that works for all. We will not do it by increasing poverty…

Rather than remove spending power from the economy and damage growth and future prosperity, Britain needs a publicly-led expansion and reconstruction of the economy.”

This is a very different tone from the “living within our means” meme in John McDonnell’s piece – and rightly argues that developing “a balanced and sustainable economy that works for all” is the only progressive and sensible way to deal with (eliminate!) current budget deficits.  Moreover, he makes clear that borrowing for investment is part of his positive policy for building “a strong growing economy”.  

The multiplier

The reasons for this are evident – it’s our old friend the multiplier.  When times are bad, cuts in spending on public services (or major increases in taxation) reduce the size of the economy by more than the size of the cut, because of the knock-on effects in terms of loss of spending power of those made unemployed, plus the cost of an increase in unemployment benefits – the negative multiplier.  

But when the economy is not fully productive, increases in publicly-supported investment (much of which will be implemented via the private sector) tend to provide more decently-paid jobs, paying more taxes, and reducing the cost of social security benefits.  The workers thus employed buy more stuff, leading to more employment and production… And society ends up with new bridges, or railways, or energy-efficient buildings, or a universal fibre-optic network…The financial benefits (including knock-on economic effects) to the public purse outweigh the cost. This is the positive multiplier at work.  

Let us note too that Liz Kendall – seen by many as the most right-wing candidate of the four – has argued that deficits are indeed sometimes necessary:

It is also true that countries are not like households. Sometimes, in some years, governments need to run deficits. If Britain had not run a deficit at the start of the financial crisis the social and economic costs would have been much higher.”  

As we have pointed out before  the UK has very rarely, since at least 1960, NOT had an overall budget deficit.  But for much of this period the debt to GDP ratio fell or was stable because the borrowing did not exceed the rate of expansion of the economy.  So “living within our means” – if by that one means having an overall balanced budget – does not mean never having an overall deficit. Far from it.  

Tackling the deficit

John McDonnell combines two very different strands of “deficit tackling” in a single sentence, which to my mind confuses the issues:

We don’t believe that the vast majority of middle- and low-income earners who didn’t cause the economic crisis should have to pay for it through cuts in tax credits, pay freezes, and cuts in essential services. Instead we believe we can tackle the deficit by halting the tax cuts to the very rich and to corporations, by making sure they pay their taxes, and by investing in the housing and infrastructure a modern country needs to get people back to work in good jobs.”

First, if, for example, you aim to get rid of a 3% deficit in a single year in this way, tax income from the rich needs to rise by more than the same amount, i.e. around £60 billion.  Not all of this sum would reduce current year private sector spending in the UK (we don’t adhere to trickle-down economics!) but undoubtedly some of it would do so, and is therefore somewhat deflationary, and acts as a negative multiplier.

(This point is independent of the positive role of tax justice as an instrument of social policy, as an issue of justice and for diminishing wealth and income inequality – not mainly for instant deficit-crashing, since tax increases can have a bad economic impact (recall the recent VAT increase in Japan as part of Abenomics).  If tax rises diminish economic activity, the deficit will – perversely – rise. )

Second, the investment programme added here as a deficit-tackling instrument does not (in the short term) “save” money, but spends it – for good reasons.  The financing can be by borrowing, but if so, the borrowing counts towards the overall deficit which may therefore tend to rise initially!  The positive multiplier expected from the investment will give benefits in future years, not in year 1. 

Carney on the “bridge-building” role of deficits

For why be so coy and defensive? Even Bank of England Governor Mark Carney is clear about the need for public deficits in difficult times.  In a speech in Dublin on 28 January 2015, he pointed out that

In the decade before the crisis, private financial balances became unsustainable…

Yes, private finances… He went on

The UK had the space to allow its automatic stabilisers [i.e. benefits etc.] to cushion the impact of the recession. With the deficit rising to a peak of more than 10% of GDP before steadily consolidating, fiscal policy effectively recycled elevated private savings and built a bridge to the period when private balance sheets were repaired and confidence returned.

That is, the public deficit is a function of the overall state and balance of the economy as a whole, not a thing-in-isolation.  UK public debt in 2007/8 was just 37% of GDP, and the current budget deficit 0.5% of GDP. Borrowing for capital investment was 2.2%of GDP.  Yet the financial crash occurred, for reasons quite unrelated to public debt and deficits.

In defence of deficits

Maybe I have misunderstood something in all this.  Maybe “living within our means” – for Messrs McDonnell and Livingstone as well as Corbyn – is to be understood and treated as a longer cyclical issue, covering a span of years, so that deficits in bad times are still okay. Maybe it is intended that references to “eliminating the deficit” should really be understood as “eliminating the current deficit”. Maybe it is agreed that borrowing for long-term investment is acceptable even though it may create an equivalent “deficit” .

In which case, they should make this clear, and not dress up key points of  policy in the linguistics of the radical right, nor hide the actual policy behind their veil.

It may be politically hard to make this case for the positive role of deficits – in many circumstances – with a public who have for so long been lectured by Very Important People from the Conservative, Liberal and Labour parties that deficits are by nature lethal, and There is No Money.  

But if even politicians of the left come to adopt language and arguments that underpin Osbornian politics – and are constantly preached from the neolithic (pre-Keynesian) cult temples of classical economics – we are lost in a new Dark Age.

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11 Responses

  1. Agree with Andy etc. you can’t re-frame the debate with ‘deficit dove’ (we’ll pay it back when times are good) arguments because ultimately all that does is validate the very household framing you wanted to reject in the first place.

    Re-framing means rejecting the whole caboodle. And that demands honest statement of the facts as outlined by Modern Monetary Theorists such as Bill Mitchell.

    I sincerely hope Bill’s meeting with Ann this week proves to be productive on this very issue.

  2. There is a basic error underpinning this article and Corbyn’s unfortunate take-up of the neo-liberal framework on deficit reduction. That is :

    Taxes do not fund government spending
    Borrowing does not fund government spending
    Government spending furnishes taxpayers with the funds to pay their taxes and to lend to the government earning interest. In other words to net save.

    The accounting says so. Logic says so. Even the bank of england more or less says so

  3. "UK public debt in 2007/8 was just 37% of GDP, and the current budget deficit 0.5% of GDP. Borrowing for capital investment was 2.2%of GDP. Yet the financial crash occurred, for reasons quite unrelated to public debt and deficits."

    Jeremy the main trigger for the 2007/2008 Great Recession began in the United States with Bill Clinton’s decision to believe in the ill-thought-out NeoLiberal mantra that sovereign governments should act like households or businesses and aim to balance their budgets or better run a surplus. Clinton decided to prove his virtuousness and run a surplus. As Neil Wilson has implied Clinton did no sectoral balances analysis and therefore failed to make allowances for any private sector desired level of saving and the impact this would make on money flows in the American economy. Here is one article and a paper chronicling the impact and forewarning about the impact of Bill Clinton’s government surplus decision:-

    http://www.businessinsider.com/how-bill-clintons-balanced-budget-destroyed-the-economy-2012-9

    http://www.levyinstitute.org/pubs/sevenproc.pdf

  4. Strikes me that if the left of centre press (Guardian and Independent) had their wits about them, they’d publish an article or series of articles with a headline like “Comparing household budgets to government budgets is bullshit” – preferably in extra large type. (Excuse my language)

    Sub heading could be “Comparing household debts to government debts is an even bigger load of bullshit”.

    There are any number of household name economists who would put their names to such an article: Simon Wren-Lewis, Ann herself, Bill Mitchell, etc.

    The fact that the left of centre press does not do that indicates to me that they’re not too clued up on economics or politics.

  5. A cracking article – but these points need to be hammered home on the news and in the media day after day otherwise the economic debate will never be ‘re-framed’ !

    Ann- please advise Corbyn.

  6. It’s important to point out, and unfortunately this article doesn’t, that the size of the government deficit is determined by the savings desires of the private sector and not tax policy.

    Leaving aside supply side issues, you can collect the entirety of government spending with a tax rate of 1% as long as people spend the money as soon as they get it as income. That is just the consequence of a basic arithmetic progression. So what causes deficits to build up is people not spending the money fast enough within the measured period – aka saving. It’s that simple.

    Tax policy can alter the distributional flow of income across the economy – speeding up its spending in some areas, and passing it through differing tax points more quickly by putting it different people’s hands. That is after all what the ‘multiplier’ is all about. But regardless of how you configure that policy, the deficit will come about because people overall have decided they want to save more than they are borrowing.

    Which is why your policy should be about the real outcomes – full employment and price stability – rather than just an end of period accounting residual you can’t directly affect.

    Trying to make the a particular number look good by causing a recession, or a credit boom is neither sensible, nor desirable.

  7. My greatest concern about a Corbyn leadership is who he will end up working with, both as advisers and in Parliament. It is not just the narrative sold to voters, it is the need for a real understanding of economics and money to underpin policy. There seems to be a great fear in the Labour party of challenging Osbourne’s narrative on the deficit, but with the current account deficit being so gaping this should be easy. However a failure to replace the narrative of "If we don’t get rid of the deficit we will end up like Greece" with, for example a sectorial balances narrative, will promote a confusion that will exclude many of the people he will need to develop useful and salable policy.

  8. And which candidate does not view governments as households? It is the ubiquitous myth or metaphor. Clearly wrong, but …

  9. I’m not so sure there is a ‘ Corbyn position’ as represented by others on his behalf. Another endearing and refreshing difference. If he wins I’m sure a team of economists will retrofit the detail! Afterall there are enough around!

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