The Way It Was
Since 2010 the ideology of balanced budgets has dominated economic policy debate in Britain, from the micro (public institutions such as NHS trusts) through to the macro (George Osborne’s “living within our means”). During this dark era, troglodyte macroeconomics (see my Weeks Chapter 7) defined “sound” economic management as balancing the public budget, low inflation and distribution-neutral taxes.
This policy regime produced its predictable results – slow growth, stagnant wages and for most households falling living standards. Also fulfilled were the predictions of sensible commentators that cutting public expenditure represented a slow and ineffective method of reducing a fiscal deficit.
By the election of May 2015 the Conservative chancellor had repeatedly missed his explicit borrowing targets, obvious evidence of policy failure. Nonetheless, in that election Labour Party leaders pledged themselves to an analogous fiscal ideology, that sound economic policy meant balancing the public budget, albeit slower and more equitably.
Whether the Labour leaders’ motivation for endorsing budget balancing derived from principle or perceived electoral necessity, defeat at the polls prompted a new approach.
We find the new approach in the economic policy section of the 2017 Labour Party Manifesto, “Creating an Economy that Works for All”. First and most important, the Manifesto rejects the budget balancing dogma. To do this credibly in the current ideological context is no simple task. On the one hand, the devastation of public services by Tory cuts, justified by the austerity dogma, provokes strong public revulsion.
On the other, when I speak or write in favour of increased public expenditure, one invariable confronts the question, “how will it be paid for?” The deep answer to that question requires understanding and accepting an economic principle apparently counter to commonsense – for central governments in countries with a sovereign currency (e.g. the pound sterling), the purpose of taxation is not to pay for expenditures (sustaining more expenditure does not necessarily require more tax).
Before the neoliberal era, and especially in the 1960s, this apparent absurdity appeared in mainstream economics textbooks as accepted wisdom. In a mixed economy, the macroeconomic purpose of central government taxation is to manage the level of employment and output (explained here).
If private sector demand (business investment and household expenditure) is too low to bring full employment (for example, after the financial crash of 2008), taxes should be reduced or expenditure increased. When our economy overheats, generating excessive pressure on prices, taxes should be raised or expenditure cut. In both circumstances whether a fiscal deficit or surplus results is an outcome derivative from the economy achieving its potential.
However, convincing people that a balanced budget should not be a policy goal goes counter to decades of neoliberal ideology, decades during which the economics profession became increasingly conservative. Imagine for a moment the impact on public opinion of the shadow chancellor saying on the Today Programme, “balancing the budget should not be a policy goal”, or the equally true but lethal statement, “nothing wrong with public borrowing”.
Thus, we have the challenge that confronted the authors of the Labour Manifesto – to reject austerity and budget balancing while convincing the public that doing so is sound economic policy (which it is). This apparent squaring-a-circle task is achieved in the Manifesto, and achieved in a manner easily understood by the general voter and technically justifiable.
The section titled “Balancing the Books” begins with the following statement:
Our manifesto is fully costed, with all current spending paid for out of taxation or redirected revenue streams. Our public services must rest on the foundation of sound finances. Labour will therefore set the target of eliminating the government’s deficit on day-to-day spending within five years.
The two key words in the statement are “current spending”, the same as “day-to-day spending”. The commitment to this balancing simultaneously rejects the central rule of Tory budgeting, that total spending, current costs plus investment, should be matched by current revenue for every annual budget period.
The (total spending must equal total revenue) rule contradicts both logic and accepted business behaviour. As every business person knows, if an investment is sound, it will over time generate the flow of income to replace itself plus provide a profit. That is why businesses always borrow to invest. The same principle applies to governments (unless the government’s policies are set by ideology not economic principles).
The sound principle that borrowing should fund investments implies that a budget deficit is not in itself a bad thing. On the contrary, borrowing to increase the productive capacity of our economy, be it by extending the rail system or improving health systems, is what every responsible national government should do. By attempting to fund investment with current revenue Chancellors Osborne and Hammond have acted irresponsibly, violating sound fiscal principles.
This “Fiscal Credibility Rule” embodies sources of flexibility. One is ambiguities over the division between current and capital expenditure. The absence of a clear dividing line in the Manifesto should not be viewed as a “fudge”. Within the shadow chancellor’s advisory team there may be discussion and debate over this issue, reflecting changing analysis within the economics and social policy professions.
An obvious example is education. Expenditure on a textbook be it hardcopy or on an electronic device is an investment; should not that also be the case for activity of teaching thus the teacher’s salary?
At the outset I explained that a fiscal policy based on sound macroeconomic analysis treats budget balances as outcomes, not goals. Does the second sentence in the quotation form “Balancing the Books” contradict sound policy by setting a target to eliminate any deficit on current account “within five years”?
The linguistic answer is “yes”, and the substantive answer is “no”. There exist specific circumstances that contradict the general rule that a fiscal deficit should not be a goal or target (explained in an IMF guide to debt and fiscal policy). Assessing whether or not a public deficit or debt is in itself a problem requiring policy action involves quite a complicated balance of economic indicators. I consider the Fiscal Credibility Rule in the Manifesto a sensible approximation for that balancing. It is easily understood by the non-specialist, and simultaneously consistent with sound fiscal principles.
The Manifesto section titled “Balancing the Books” is far more than an explanation of how a Labour government would count the fiscal beans.
It rejects austerity.
It rejects the dogma that deficits and borrowing are bad policy.
It asserts and celebrates a positive economic role for our government.
It is a game changer, voters realize it, and in increasing numbers they seem to support it.
Joan Robinson’s claim (previous comment) that Weeks and Murphy are two loan voices “preaching in the wilderness” is rather a long way from reality. There are actually at least two other and more powerful voices promoting a similar message: first Modern Monetary Theory and second, Positive Money.
Re John Weeks’s article, I agree with the basic thrust. But this passage isn’t quite right: “That is why businesses always borrow to invest. The same principle applies to governments (unless the government’s policies are set by ideology not economic principles).”
Businesses do not normally borrow to invest when they have enough cash to pay for investments. Put another way, a significant proportion of business investment is funded via retained earnings.
As to whether it makes sense for governments to borrow to invest, Milton Friedman and Warren Mosler argued for the abolition of all government borrowing. I pretty much agree with them. However, the question as to how much governments should borrow, and if so how much and at what rate of interest is a thorny question. I recently had a stab at answering it here:
Thank you for that, John. You and Richard Murphy seem to be preaching in the wilderness but keep up the good work.