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.


  1. "Crowding out, in an underutilised economy, would not at first sight seem to be a problem."

    You should have quite while you were ahead. Are you really saying that you think the *only* form of fiscal stimulus available to the state is employing more people?

    How about paying private sector firms to build stuff; roads, railways, power plants, housing...

  2. Agree with Oliver, a ridiculous thing to say. No Keynsian would advocate employing more public sector workers on a permanent - you'd contract the private sector to build roads and houses etc. which would take a couple of years to build

  3. Dear Andy and Oliver, thanks very much for your interest, I have added an addendum. yours, Jonathan Haskel

  4. Thank you for an interesting response.

    I'm not sure your points 3 & 4 are strictly relevant, since those problems would be with us whether we undertook publicly-financed investment or not.

    Builders are crooks? Engage in more vigorous cartel busting.

    The disappearance of unskilled jobs is indeed a huge problem, and one which a public sector investment programme probably won't solve, but nor will doing nothing. Better treat that issue separately, since it's going to be with us indefinitely.

    The US shovel-ready question doesn't really translate to the UK, since it's a problem exacerbated by the federal/state division. California's roads are falling apart, but the federal government can't fix them; only the state of California can decide to do that, but despite being the 7th (is it?, or 8th?) largest economy in the world, its politics are now so dysfunctional that it can't pass a budget adequate to maintain even a basic level of provision of essential public services (slight hyperbole here).

    (And more generally, as a fan of Brad Delong, you'll be aware of the 50 mini Herbert Hoovers issue; much fiscal stimulus at the federal level has been offset by budget cutting at the state level).

    But I agree, there is an onus on Keynesians to advocate things which actually could be implemented within a reasonable timeframe.

    The state of much public sector housing is pretty shocking. A programme of housing stock renovation could be undertaken fairly speedily, and some of that would be in those blackspots you mention, so it might even reduce the very high unemployment in those areas.

    I agree, by the way, that investment in science, technology and education are all essential. But those are investments in human capital with quite long payback periods, and I doubt whether they would have much stimulative effect in the short run.

  5. Thinking about it some more, it's the fact that in open economies fiscal stimulus can be quite leaky is the real challenge.

    But again, that should be a spur for problem-solving, not a counsel of despair.

  6. I am very pleased to read someone trying to put the debate on deficit reduction on a more rational basis, rather than start from an entrenched political position. You might like to read my own essay on the subject entitled, 'Economic Misunderstanding: The Keynesian Legacy', which you can find at http://thinkingwithahammer.blogspot.com/