Tuesday, 14 February 2012

Moody's, Ed Balls & the Tories' Plan 'A'

Let's be clear how little room for movement the Government has. The deficit is falling but remains at around 8% (down from well over 10%). Debt remains reasonable (by Europe's disastrous standards) at 70% of GDP or so. Just because other countries are worse, doesn't mean the UK can carry on spending however.

The evidence appears to be that any stimulus from deficit financed government spending stops when debt reaches 80% of GDP, and that debt burdens over 120% of GDP kill growth (look at Italy and Japan. So, that's a clear instruction to cut spending as fast as possible, because we will start breaching these limits next year? Well not so fast! There is evidence that cutting spending by more than 2% in real terms in any year tends to have people out on the streets chucking rocks, and this isn't good for wealth or happiness either.

The UK government is cutting spending in real terms (which when inflation is high means the cash spending is growing...) by about 2% across government.

Let's rule out the Labour plan to slow down the cuts. They will simply lead to higher debt in the long-term. At best this will be pointless. At worst, we could end up like Japan, where decades of "stimulus" have failed to produce growth and left the country with a debt burden in excess of 200% of GDP. Ed Balls' wittering on about "plan B" doesn't change the fact that his predecessor, One-eyed lunatic McDoom, wasted all the available "stimulus" ammunition while the going was good, leaving, as former Minister, Liam Byrne said "...No Money Left" for a Keynesian stimulus when the music stopped in 2007. Labour's "plan B" should be seen instead as merely the self-interested wailing of the public sector salariat, who had it good for a decade, and now the music's stopped, they're complaining.

But what about the right, for whom the spending cuts are not nearly fast enough? Well, because I would rather see the Government achieve its fiscal aims without widespread violence, thank you very much, I think 2% a year real-terms cuts are about right.

Does Labour's charge that "cuts kill growth" stack up? Yes it does, but this is a small truth, big error. In the short term, an enormous amount of public sector demand is removed and this is not instantly taken up by the private sector. However, freeing the resources, especially competent labour, will in time lead to faster growth as confidence, investment and hiring picks up. Even in the apocalyptic business environment of the last couple of years, private sector hiring has run at three times the job losses in the public sector. However, despite the observation that slowing "the cuts" might help GDP in the short term, it is not clear that any further stimulus is possible, so it is better that this necessary shift from public sector to private happens now, before it is forced upon us by the markets. It is better to have a few quarters of stagnant growth than the violent catastrophe which about to befall Greece, or the enormous disruption which will be forced on Italy or Spain.

Of course the UK can print its own money. So perhaps a better model is Japan, where Government spending was jacked up in response to a balance-sheet bust caused by over investment in property and other assets. JGB yields remain low, mainly as the country has spent most of the last couple of decades in a deflationary spiral. Stimulus spending has not worked, mainly because the bad debts have not been purged from Banks' balance sheets, and have acted as a mill-stone round the country's economy. Thankfully (yes, thanks in part to Gordon Brown) the Banks in the UK have aggressively written down their bad debts. That's why their losses were so enormous. The purge of bank bad debt has an analogue in the non-financial economy in the form of a recession, as assets and labour are reallocated. Endless "stimulus" is just bailing out the malinvestment rather than purging it.

At present, UK 10-year gilt yields are 1.9% or so. Moody's who've just put the UK on Negative outlook, still gives the UK a 70% chance of retaining its AAA credit rating. When S&P downgraded the USA, the markets ignored it, and pushed US treasuries to their lowest yield on record soon afterwards. On the other hand, the Markets ignored France's downgrade to AA, because the French had long traded as such. A yield in line with Germany's and the USA's is the mark of credit worthiness, not the mere opinion of a rating agency.

Furthermore, Moody's, for what it's worth (not very much...), explicitly supported the UK "austerity" program. Which rather leaves Ed Balls in a quandary. Yes, growth is what is needed, and to some extent, in the short-term, austerity hurts. But the austerity measures, by freeing resources and making them available to the dynamic part of the economy create the conditions necessary for growth in the future, so no serious economist or agency thinks more stimulus is desirable necessary or indeed will work in the UK. The Government deficit is 8% of GDP. That's as much stimulus as the country can take right now.

A "balance-sheet" recession always leads to slow growth afterwards as both public and private sector retrench. This sort-of-non-recovery was predicted, not least by me, in this blog. The good news is the Private sector de-leveraging is going well, and may even be complete. Both personal and corporate debt are at historically low levels. UK Banks are well capitalised, and there's a pool of surplus labour, not all of it the unemployable long-term unemployed. When confidence returns, there are all the conditions for a long boom. looking at the evidence and concluding that I can't see how the Government could do things much differently will lead to accusations of being a Coalition shill. Politicians can be right sometimes you know, and I think things will get better surprisingly quickly from here. And that's the most controversial thing a blogger can say. Moody's "negative outlook": whatever Ed Balls says, there's nothing to see there.


Mark Wadsworth said...

Slightly o/t, and going back to your recent post about manufacturing not being in decline, there's a handy chart half way down this article headed "Output of manufacturing and services" which illustrates your point.

Mark said...

This blog states that increasing government debt leads to economic stagnation. What is the mechanism?

If people have no desire to spend their money, there are only two solutions. One is for the government to spend it for them on potentially useful projects, the other is to spend it on allowing people not to work.
(I take it that everyone agrees that starvation as motivation isn't an option)
Some people might argue that it is more efficient to pay people not to work, either because unemployment will inspire people to invent the next wonder-product, or because entrenched government spending causes a greater long term drag on the economy than a short-term slump.
(Personally I'd argue in favour of paying people not to work on humanitarian grounds... but anyway...)

However, it doesn't seem to me that the current debate regarding the deficit is focused on these issues. While this might be the real motivation of right wing austerists, it isn't the debate we are having. (probably because the economic evidence is against them)
The current debate in the UK is based on the idea that an increasing government debt will eventually lead to economic collapse.
I think that everyone accepts that while the private sector doesn't want to spend, interest rates can remain low without any risk of inflation and there will always be demand for government debt.
However, the austerians claim that after the private sector has built up a massive amount of savings, if demand returned, interest rates would rise and the debt would become unmanagable for the government, resulting in either massive inflation or bankruptcy.
I don't agree with this. The government can quantatively ease to it's heart's content to control interest rates and control inflation through taxation and spending.
It's possible that if British people save enough money, during a long period of sluggish growth they will end up losing in "real terms" on their saving, due to either increasing inflation or taxation - but if we have slugglish economic growth, this is an absolute inevitability.
So if we are interested in protecting savers the real debate should be about how we can promote real economic growth, not about the government debt boogey man,

Jackart said...

I don't posit a causal path, because I don't know what one is. Nor could I be bothered trawling through Google Scholar for the article on Government debt which reached those conclusions.

But I suspect the mechanism is something along the lines of ricardian equilalence, plus the fact that Government spends much less efficiently than the private sector.

So. You can't (it seems) grow faster by spending more, better to trust what's worked in the past, cut spending and work on the supply-side.

It's just that's painful medicine in the short-term and lefties are like children. They want jam today, and hang the consequences.

Mark said...

A lot of British government spending is made up of transfer payments, to pensioners, the poor, financial industry workers etc.
Is it really meaningful to describe this as "less efficient" than private sector spending? There is no possible alternative to the public sector in this area.

Jackart said...

Transfer payments are about 1/3rd of managed expenditure, true. So there's no deadweight cost of the tens of thousands of civil servants administrating the benefits?

I shall alert the Nobel Committee.

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