Monday, 22 February 2010

How very stimulating

We have heard an awful lot over the last couple of years about governmental "stimulus". I have severe doubts about the benefit of it, after all if there were no downside all we would need for perpetual riches beyond imagination is ever greater government spending. Being a simple soul I have a simple view of the matter. Let me explain.

Mr Ordinary earns £10,000 a year after tax. Assume he will earn £10,000 a year after tax for each of the next five years. Mr Average lives next door to Mr Ordinary and he earns the same. They each have £7,000 to spend after housing and utility costs and they do all their shopping at Mr Patel's Merrymart. In Year 1 Mr Patel receives £14,000 in his till, £7,000 each from Mr Ordinary and Mr Average.

On January 1st of Year 2 Mr Average loses his job and is paid £6,000 a year in benefits rather than £10,000 in earnings, his bills remain the same so he has only £3,000 for other shopping. On the face of it Mr Patel will receive £10,000 not £14,000. Oh woe, poor Mr Patel. Mr Ordinary decides that the risk of Mr Patel's Merrymart going out of business is too dire to contemplate, so he decides to borrow money to help Mr Patel stay afloat.

He borrows £4,000 over 4 years at 7% interest. In the first year of the loan Mr Ordinary has £10,720 at his disposal (his earnings of £10,000 plus the £4,000 be borrowed minus £280 interest on the loan minus £3,000 of other bills). Mr Patel's takings are therefore almost what they were before, he gets £10,720 from Mr Ordinary and £3,000 from Mr Average, making a total of £13,720. The Merrymart survives, hip-hip-hooray.

In year 3 Mr Ordinary only has £6,720 to spend (£10,000 minus £3,000 of bills minus another year's interest of £280) and Mr Average still only has £3,000. Mr Patel's till receives just £9,720.

On the 1st of January in Year 4 Mr Average gets back into work at the same rate of pay as before, but Mr Patel still loses-out. In year 1 he received £14,000 but now he receives £13,720 because Mr Ordinary has to spend £280 on interest.

In Year 5 Mr Ordinary decides to repay the loan in equal monthly instalments over the year. The total interest he pays for that year is £140 but he also loses £4,000 through having to repay the sum he borrowed. Mr Average still has £7,000 to spend but Mr Ordinary only has £2,860, Mr Patel's takings are only £9,860. Maybe the Merrymart survives, maybe it doesn't, but the result of Mr Ordinary's stimulus package is a long-term reduction in takings.

Had Mr Ordinary not borrowed money to fund his Merrymart stimulus package Mr Patel would have taken £14,000 in Year 1, £10,000 in Year 2, £10,000 in Year 3, £14,000 in Year 4 and £14,000 in year 5; a total of £62,000. As it is he receives £14,000 in Year 1, £13,720 in Year 2, £9,720 in Year 3, £13,720 in Year 4 and £9,860 in Year 5; a total of £61,020. The difference is the interest paid by Mr Ordinary. Of course growth in the economy generally might occur thereby resulting in Mr Ordinary and/or Mr Average receiving pay rises which allow the overall takings in the Merrymart to rise. But it might not. What is certain is that borrowing to boost Mr Patel's takings in Year 2 will result in a reduction in disposable income until such time as the loan is repaid. Economic growth does not change this fact, £980 goes in interest rather than being taken by old Doris on the till whether or not that £980 comes out of static earnings or growing earnings.

The gamble is that the boost to Mr Patel's takings will allow his business to survive in Year 2 when otherwise it would have failed. The problem is that, in the very basic example I have given, if it would have failed in Year 2 it would also be at risk of failing in Years 3 and 5 because the borrowed money can only be spent once (in Year 2) and repayment of the debt reduces takings below what they would have been in Year 2 had no borrowing been incurred.

Obviously the example I have given is extremely simplistic, nonetheless it illustrates the difficulty I have with the concept of the "economic stimulus". Giving a boost now is all very well but it results in lower disposable income in the future because debt must be repaid. Who can say whether the instant benefit of giving a boost now is greater or less than the future detriment? The answer, of course, is that no one can say.

1 comment:

Roger Sowell said...

Mr. FatBigot, excellent post. Thoroughly enjoyable.

My point is that it makes all the difference as to how the stimulus is spent. For example, spent on fish, or on a boat and fishing equipment. If spent on fish, the result is as you described as this is consumerism. But if spent on the means to produce wealth, it may be well-spent, especially if that wealth-producing capital would not have been purchased otherwise.

If spent wisely on the means to produce wealth, then the economy may (not will, but may) grow sufficiently to pay back the capital plus interest.

Sadly, the folks in charge in the USA (and perhaps in the UK) fail to grasp this fundamental point. Hence, the prevalence of give-away programs that reward the lazy, the idle, and malingerers.

I wish everyone could and would read the autobiography of an American capitalist who invested in the means to produce wealth, starting with a small shop that sold ice-cold root beers for a nickel each, in Washington DC. His name was J. Willard Marriott. His last name may be found on hotels world-wide. He could have spent his seed capital on a lavish banquet to entertain his friends, a one-time occasion. Instead, he started a vast business empire.