As a late convert to Twitter I've been surprised and delighted by the way you stumble across people with interesting things to say about all aspects of political and cultural life. Recently I've been chatting to a guy called Bruce Greig about the economics of government borrowing. Bruce's view, expressed here is that the tax returns on increased growth more than pay for the investment, even when you have to borrow the money to do it. It works because of something called the fiscal multiplier. Here's my reply.
Hi Bruce.
Firstly, let's be candid about our various levels of
expertise. I'm not an economist and I suspect neither are you. We are both
probably interested amateurs trying to make sense of the economic and political
landscape. So we turn to outside sources to try and buttress what may be
instinctive views.
In your post you rely on the IMF. Fine. But just how reliable
is the IMF?
In January 2013 its chief economist admitted in a paper that the fiscal multiplier – put at 0.5 - it had used to calculate the effect
of austerity measures on European economies had been wrong. You’ll remember in January 2013 the same
economist – Olivier Blanchard – criticised George Osborne’s economic policy and
said “there should be a reassessment of fiscal policy”; Osborne was “playing
with fire”. When growth returned to the UK economy later that year Blanchard
had to admit he was “pleasantly surprised” by the UK’s performance. By January
2015 Blanchard’s boss Christine Lagarde was saying, “It’s obvious that what
happened in the UK actually worked”.
I recite this to show that the IMF is fallible. Its staff
don’t even agree with each other. Here's another IMF paper.
Its authors say on Page 1 that “the fiscal multiplier is . . . zero in
economies operating under flexible exchange rates”.
Yes, that’s zero. Not 1.5
or 2.5.
On Page 26 we get “in economies open to trade or operating under
flexible exchange rates, a fiscal expansion leads to no significant output
gains. Further, fiscal stimulus may be counterproductive in highly-indebted
countries; in countries with debt levels as low as 60 percent of GDP,
government consumption shocks may have strong negative effects on output”.
The UK’s current debt to GDP is 82%.
Even the IMF paper you cited yourself is equivocal. Have a look at page 83. It states that a “debt-financed” public
investment shock of 1% of GDP increases output by 2.9% over four years.
That’s a multiplier of less than 1 isn’t it? How is that
going to pay for itself when you take into account the cost of the debt?
I offer you the following propositions –
1.
The fiscal multiplier will vary according to the
situation.
2.
No-one knows exactly what it is in any given
situation.
3.
In some circumstances an increase in expenditure
will pay for itself, but sometimes it won’t. Given 1 and 2 above a degree of
circumspection is understandable.
One other consideration.
Where will the money HMG borrows to fund this expenditure come from? About
70% of UK government bonds are held by UK individuals and institutions. If new
bonds are issued roughly in the same proportion, most of the money will come
from within the UK.
In other words the expenditure HMG undertakes on the back
of this borrowing will not be new money.
It will not be new demand. It
will be money that would have been spent or invested in the UK anyway. The likelihood is that the multiplier will be
reduced by 70% accordingly.
Even economists can’t agree about the effect and size of the
fiscal multiplier. For we amateurs that’s a consolation, but also a warning –
maybe this is a subject which is as much an art as a science. Perhaps we should
be warier than we have been of stating categorically what works and what doesn’t.
Perhaps we should accept that, maybe, we just don’t know.
