The announcement by the British finance minister, George Osborne that the Conservative government will legislate to force governments to run annual surpluses on their budgets has provoked an explosion of debate among economists, particularly the Keynesian school.
Outlining plans for a law that forces the Treasury to run a surplus in “normal times”, Osborne said: “With our national debt unsustainably high, and with the uncertainty about what the world economy will throw at us in the coming years, we must now fix the roof while the sun is shining.” The chancellor also argued that the discipline imposed by a new law would support future generations who faced being saddled with sky-high debts.
Now Thomas Piketty, David Blanchflower and 75 other economists signed an open letter that was published in the British newspaper, the Guardian, to condemn this proposal (http://www.theguardian.com/politics/2015/jun/12/osborne-plan-has-no-basis-in-economics). According to these economists, such a measure was ignoring ‘basic economics’ and was ‘not fit for the complexity of a modern 21st-century economy and, as such, risks a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three‘.
The academics said Osborne was shifting the burden of debt from the government to ordinary households because “surpluses and debts must arithmetically balance out in monetary terms.” The economists summarised their position in this way: “Economies rely on the principle of sectoral balancing, which states that sectors of the economy borrow and lend from and to each other, and their surpluses and debts must arithmetically balance out in monetary terms, because every debit has a corresponding credit. In other words, if one sector of the economy lends to another, it must be in debt by the same amount as the borrower is in credit. The economy is always in balance as a result, if just not at the right place. The government’s budget position is not independent of the rest of the economy, and if it chooses to try to inflexibly run surpluses, and therefore no longer borrow, the knock-on effect to the rest of the economy will be significant. Households, consumers and businesses may have to borrow more overall, and the risk of a personal-debt crisis to rival 2008 could be very real indeed.”
They added: “These plans tie the government’s hands, meaning it won’t be able to respond appropriately to constantly evolving economic circumstances, good or bad. The plan actually takes away one of the central purposes of modern government: to deliver a stable economy in which all can prosper. It is irresponsible for the chancellor to take such risky experiments with the economy to score political points. This policy requires an urgent rethink.”
Now I was asked to sign this letter and/or support it and several economists who would consider themselves Marxist did sign. But I stood back. This was not because I thought Osborne was right. Clearly, his aim of forcing governments by law to run ‘surpluses’ of tax revenues over spending every year was ludicrous. It was really aimed at reducing the size and role of government in the capitalist economy.
Also Osborne intends to achieve this ‘permanent surplus’ over the life of the current parliament to 2020 by the most vicious reductions in social welfare spending and public services, involving up to a 30% real reduction. He could have achieved the same result by increasing taxation on the richest earners and holders of wealth, by ending tax evasion and avoidance on an industrial scale and by reducing the ludicrous spending on arms and defence.
Indeed, if his aim was simply to reduce the public sector debt burden, then that could be achieved, assuming the UK economy continues to expand (a big assumption) and still run a small annual budget deficit. As one of signatories, Simon Wren-Lewis, has put it: “This question is really the same as asking what the long run target for government debt should be. I recently discussed an IMF paper which suggested that, as long as the market was happy buying the debt, there was no need for the government to reduce the level of debt from current levels (around 80% of GDP). That policy would imply running deficits of around 3% of GDP, which is a long way from a surplus. I also said that might be an extreme position. In this post I gave various paths for deficits and debt, where the other extreme was balancing the budget. A balanced budget could involve debt falling rapidly to around 40% of GDP by 2035, and by 2080 the debt to GDP ratio would be close to zero. I also gave various paths in between these two extremes.” http://mainlymacro.blogspot.co.uk/2015/06/should-we-aim-for-budget-surpluses.html?utm_source=feedburner&utm_m
But the real problem with Osborne’s position is that he actually believes that if government is small and plays no role in the savings and investment flows of an economy, then the ‘private sector’, or more particularly the capitalist sector, can flourish and grow without hindrance. Just the experience of the Great Recession and the global banking crash shows that belief is unreal. Capitalist accumulation is chronically subject to regular and recurrent crises, leading to collapse and the need for government to intervene to bail out banks, corporations and subsidise investment and employment as best it can. And anyway, there is absolutely no chance of Osborne achieving regular budget surpluses, given the weak and low growth in GDP and, above all, in investment by the capitalist sector. That sector is not going to spend more as the government saves.
So growth and employment will only be supported by rising household debt to buy ever more expensive housing and through injections of fictitious capital. It is this scenario that the signatories highlight when they say “Households, consumers and businesses may have to borrow more overall, and the risk of a personal-debt crisis to rival 2008 could be very real indeed.”
But this is where I stand back from the signatories of the letter. Is Osborne’s position ‘bad economics’? A future crisis in British capitalism will not be caused by Osborne trying to run annual surpluses on the government budget. Crises will occur in the private sector (more specifically in the capitalist business sector) whatever Osborne does. Osborne’s policy is just unreal but not necessarily ‘ignoring basic economics’.
After all, even Osborne realises that in an economic recession, governments are forced to run deficits and borrow more by issuing debt to help correct a collapse in ‘effective demand’ in the private sector (profits and wages). And Martin Wolf makes the point (http://www.ft.com/cms/s/0/11c048cc-0dcf-11e5-aa7b-00144feabdc0.html#axzz3cqFN3P3j) that there is “the time to reduce public debt comes when “economies boom and interest rates are far from the floor”.
The problem with the ‘economics’ of the letter signatories is that they assume that running a ‘permanent’ annual government surplus must necessarily lead to excessive borrowing in the private sector and crises. That’s because they have signed up to a back-to-front view of the Keynesian macro identities, or the ‘sectoral balances’ that they refer to.
Consider the Keynesian identities. Overall, what is invested in an economy must have been saved (we are excluding money printing here), so total investment must equal total savings (I=S). Sectors within an economy can run surpluses or deficits of savings over investment. But overall, I=S.
There are four sectors in the economy in the Keynesian macro model. They are Consumers = C; Government = G; Business investment = I and net trade with the rest of the world = E. Now if G runs a permanent surplus (savings over investment), then the other three sectors must run a combined deficit, so that C + G + I + E = 0. But the deficits to balance the government surplus (G) could be businesses investing more (borrowing over and above their profits) and/or households borrowing more than their wages and/or the economy exporting more than it imports and so borrowing from foreigners. The Keynesian model makes no distinction, even if the signatories suggest there is one (“The economy is always in balance as a result, if just not at the right place”).
Now the signatories say that “The government’s budget position is not independent of the rest of the economy, and if it chooses to try to inflexibly run surpluses, and therefore no longer borrow, the knock-on effect to the rest of the economy will be significant.” But that is the point. The government sector is not independent. In a capitalist economy, whether the government sector is in surplus or deficit will depend on what is happening in the private sector. If a capitalist economy is booming, incomes will rise along with increased investment and borrowing. So a government will be able to run an annual surplus. But if an economy is in a recession, companies will stop investing (increase net savings) and households will have stopped spending (increase net saving) and so the government will become a net borrower (assuming a zero balance on trade).
So the signatories have the argument the wrong way round. Osborne can get government surpluses if he wants to in a boom but not in a recession (something which he actually recognises). The government will not be able to run annual surpluses if corporations stack up profits, pay down their debt and don’t invest; and households don’t spend but just pay down their debts (ie in a recession or very weak recovery). So Osborne won’t cause a “knock-on effect to the rest of the economy that forces households, consumers and businesses to borrow more overall.” Governments react to a boom or recession in the capitalist sector, not vice versa. The Keynesians argue that “the government’s budget position is not independent of the rest of the economy” and then go onto warn of dire consequences if Osborne opts for government surpluses as though he could make the government’s budget position “independent of the economy”.
Martin Wolf is right when he says that “it would have made little difference to the outcome of the crisis if Labour had run a balanced budget before the Great Recession. Consider Ireland and Spain. Both started with fiscal surpluses and very modest levels of public debt. Yet the financial crisis devastated both these economies.” Exactly: running government deficits or surpluses ‘makes little difference’. That’s because, under capitalism, whether a government runs a deficit or a surplus will depend on the growth of savings and investment in the private sector, not vice versa.
Let’s consider the Keynesian sectoral balances with some real figures. As of the beginning of 2015, this is how the sectors line up, according to the data from the Office for Budget Responsibility (OBR) (http://budgetresponsibility.org.uk/category/topics/public-finance-forecasts-topics/). The government is still running an annual budget deficit (net borrowing) of 4.4% of GDP and the UK economy is running a huge payments deficit with the rest of the world of 5.3% of GDP. Households are running a tiny net borrowing deficit of 0.1% of GDP and the capitalist business sector is running a deficit of 1.5% of GDP i.e. it is actually investing more than it has in annual profits by borrowing (of course, this investing may not be in productive assets).
The graph below shows the UK sectoral balances now; where the OBR reckons they will be in 2020; what happens with a government surplus delivered first by a consumer boom and then by an investment boom.
The OBR reckons that the government can run a small annual surplus by 2020 because households will have increased their net borrowing to 0.8% of GDP (green) and businesses will have raised their net borrowing to 2.4% of GDP (blue), while there will have been a massive reduction in the net trade deficit to just 2.3% of GDP (grey). The OBR’s forecast implies a consumer-led boom because net household borrowing is usually only at that forecast level during the height of booms, while business net borrowing (investment) is usually much higher. How the trade deficit would narrow so much is not explained or credible. Indeed, if the net trade deficit were to stay at around 5% of GDP and there was no change in business investment, then the UK economy would eventually experience a massive credit-led consumer boom (as shown in the graph) that was liable to lead to a ‘personal debt crisis to rival 2008’, as the signatories forecast.
But there is nothing to suggest from the ‘sectoral balances’ as such that we could not produce a different result. Assuming the government is running an annual surplus of 1% of GDP; this could be ‘balanced’ not by a consumer-led boom but by an investment-led one in the capitalist sector. If the household sector were to be in balance and the net trade deficit were to fall to 3% of GDP (likely in an investment boom), then net borrowing (investment) by the capitalist sector of just 4% of GDP would do the trick (as shown in the graph). That is not inconceivable if capitalists are keen enough to raise investment (although the OBR does not think such a level of investment is likely). The point is that if capitalists are making good profits, they could step up investment, while households still do not borrow ‘too much’ and the government would get its annual surplus.
Wolf says that Osborne’s “policy would take economics back to the logic of the Victorian era, and is not achievable in the 21st century”. If he means by that Osborne’s drive to reduce the public debt burden at all costs, that might be true. But if he means that governments should run surpluses in times of boom “to deliver a stable economy in which all can prosper”, to use the phrase of the signatories, that is pure Keynesian counter-cyclical policy and not ‘bad economics’ in Keynesian eyes.
Keynes too wanted ‘balanced budgets’ over the ‘business cycle’, running surpluses in times of boom and deficits in times of recession or depressions. His difference with the ‘classical economists’ was that they thought there could be no recessions except through temporary shocks while Keynes thought there could be long-lasting depressions that required government deficit spending to get out of them. But once things were okay in the capitalist sector, then surpluses would be prudent to avoid inflation and overheating.
What decides the issue is not whether the government runs a ‘permanent surplus’ or not, but what is happening in the capitalist sector. Under capitalism, the level of ‘net saving’ in the business sector depends on profit generation. And from capitalist investment, there are flows to employment and wages and thus the net savings-investment position of households – and government balances. This is the Marxist view of macro balances (see my post, https://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/).
The forecast about a future private sector debt crisis being ‘caused’ by running a permanent government surplus is not from Keynes, but comes from Hyman Minsky, namely the view that crises comes from excessive private debt and inherent financial instability leading to a consumer crash (see Steve Keen for the modern version of this,
The signatories implicitly assume that this is the main cause of crises and ignore the possibility that crises can happen in the capitalist investment sector through a lack of profitability. The signatories also assume that a ‘stable economy’ is one of the ‘central purposes’ of government policy as if it were possible to stabilise capitalism with government fiscal policy. This post-Keynesian view is an illusion. Why do the signatories think that this is possible when the post-war history of macro management of capitalist economies has been a dismal failure?
Martin Wolf comments that “Osborne thinks he can cut to a surplus when the reality is that the only way to a surplus is to get consumers to borrow more, business to invest more and overseas to buy more of what we make. These options of cut or promote activity are not alternatives, as the basic formula shows. If you want to cut the deficit you cannot cut to achieve that goal: you can only stimulate what is not happening [you can’t do that either – MR]. Osborne has simply got his logic wrong.” Exactly, but then so have the signatories in thinking that government surpluses will cause the deficits in other sectors. The reverse is the reality.
This is what the signatories of the letter ignore. “George Osborne does not know that C + G + I + E = 0,” says Wolf. But the signatories do not seem to accept that the balance of G depends on the balances of C+I+E under capitalism (and in particular, I). The latter decide the former. Government budget surpluses or deficits cannot alter the ultimate course of a capitalist economy and neither can government fiscal policy, whatever the signatories think.