Tuesday, 19 October 2010

The Spending Cuts

Here are some thoughts in advance of tomorrow's spending review announcements.  I start from Danny Blanchflower in Monday's Guardian:

"The austerity package is likely to turn out to be the greatest macro-economic mistake in a century. We will fight them on the beaches. We will never surrender. That is the British way."

Steady on Danny.

Lets get some points of principle down that we can all agree on.  The Keynesian "public-spending-now" (or somewhat refined, "not-so-much-cutting-now") argument rests on two hypotheses.

  1. That everyone believes that increases in spending today are cut back tomorrow; or: you may disagree with cuts today, but people have to believe you will cut tomorrow. 
  2.  That, in addition, increases in public spending today will only expand output if they do not crowd out private sector activity.
So what can we say about this?
  1. I fear that the Labour Party's stance on (1) is not credible. It does not help that MilliE was elected by the public sector unions.  He can promise not to sack public sector workers today, but it's going to be mighty hard for him to convince people he would sack them tomorrow.  Alan Johnson's refusal to take questions after his statement on Labour's plans yesterday I don't think helps at all.  Labour, and anyone else leaning in this way, need an institutional fix for this.  I also fear that entering this recession with such high borrowing may well have condemned Keynesian policy as a non-starter before we started.  
  2. Crowding out, in an underutilised economy, would not at first sight seem to be a problem.  But the devil is in the detail.  The IFS, Green Budget, see their table 4 in Chapter 9, highlights the public sector wage advantage: controlling for education, age etc. public sector wages (outside London) are now 5% ahead of private sector wages for men and 12% ahead for women.  And that is before pensions: that loads an additional public sector advantage.  So even the most ardent Keynesian knows that we could not employ more public sector workers: we cannot afford their pensions and advertising new public sector jobs at these prevailing wages would simply attract private sector applicants.  With this crowding out scenario then, we are reliant on private sector employment. 
So what's left?  The answer is to focus on public spending that crowds in private spending or that raises growth.  Supporting the science base is one option for which we have positive evidence of both crowding in and raising growth.  Basic education is another.  Subsidies for aircraft carriers with no aircraft or for middle class benefits looks like they will have to wait until we fix our current problems.

Addendum, 20:10, 2010
A couple of people have kindly replied to the above post.  They point out that the government could simply employ private sector workers for a temporary time, to build infrastructure, houses, roads etc.

I agree with building infrastructure if it has positive effects (externalities) on the productive capacity of the economy.  But once again, I think the devil is in the detail.
  1. The US stimulus experience of infrastructure building seems very disappointing since it turned out to be hard to find "shovel ready" projects.  Here's President Obama himself on this. And the US is a relatively planning free economy.  If it takes a long time there, I hate to think how long it will take here where planning restrictions are so tight that rents in Birmingham are 44% higher than in Manhattan.
  2. I would like to form a clearer view of what infrastructure projects we want to build. I presume we don't want to build another Humber bridge to nowhere or another 10 Olympic stadia.  Roads?  I don't know how this fits into our carbon strategy. Public transport?  Sure, but if that passes a usual cost-benefit test, we don't have to wait for a recession. 
  3. Are we worried about continued cartel behaviour in the building tradeafter the bid rigging findings? Such behaviour means taxpayer's money subsidies illegal monopolies.
  4. Are we sure that infrastructure projects will employ the people we want to help, that is young unskilled men in unemployment blackspots?  Does that mean we have to build infrastructure in those neighbourhoods? Are unskilled building jobs mechanised now, so that most employment is for skilled electricians etc?  And will we end up employing mostly Hungarians (which is perfectly fine, but not, I think, what Keynesians have in mind).  I don't know, but I would like to know something about this before we start.
The infrastructure option gets a maybe from me, but it's not an immediate employment generator and needs forensic intervention by a network of government agencies.