Saturday, 20 February 2010

We are all expert economists now

So, twenty "expert" economists say the government should start to cut it's spending now and sixty-four "expert" economists say it should not. What fun. That tells us all we need to know about "expert" economists. Economics is not an empirical science. Even when a decade or two suggests that a particular policy is likely to promote growth or limit inflation, the next decade might throw-up different circumstances that render previous policies wholly useless.

What I find so fascinating about the current debate is that it revolves around essentially simple concepts, albeit concepts that the "experts" seem determined to make complicated.

Take Mr Earnest, a diversity facilitation counsellor. He creates and adds no value anywhere yet some public sector body is stupid enough to pay him £15,000 after tax. He spends it all, that's £15,000 going into tills and helping to pay the wages of those employed by the businesses he patronises. Take him off the payroll and give him £10,000 in benefits rather than £15,000 in nett salary and the amount he will put in tills is reduced by at least £5,000, with a knock-on effect to the financial well being of the businesses that previously enjoyed his custom.

Then take Mr Widget who works in a factory and also receives £15,000 after tax and would receive £10,000 in benefits if made redundant. He also spends his £15,000.

The effect of each of them being made redundant is the same, their redundancy diminishes the amount of cash sloshing around in tills in the places they shop.

There is, however, a significant difference between the two. Mr Earnest can never make a contribution to the economy other than to spend his salary. Nothing he does in his job can ever add to the country's wealth because he does not produce anything and he does not add value. On the other hand Mr Widget's job does add to wealth provided the company he works for can sell its products at a profit.

If you had to choose between spending taxes to save Mr Earnest's job or Mr Widget's, which would you choose? I would think the answer is obvious, you save the job which has the potential to add value to the economy rather than the one which is guaranteed never to add value.

But does it make sense to save either job? The problem with using taxes to save Mr Widget's job is that it could not guarantee that his employer's business will be profitable, so there is no guarantee that saving his job will add to wealth, it might just be a wasteful subsidy. We've had plenty of experience of government throwing money into non-profitable businesses, it is almost certain to be a complete waste because government cannot create a market for goods where the market says there is no market.

So, why not save Mr Earnest's job given that Mr Widget's is going anyway? At least Mr Earnest's spending power will allow Mr Patel's Merrymart to continue to employ old Doris on the till for three afternoons a week. That's all very well, until one realises that the money paid to Mr Earnest does not come from a magic money tree. It comes from taxes raised from profits and from taxes that reduce other people's spending power. Why is it better for Mr Earnest to receive £15,000 of spending money rather than for other people to have £15,000 of reduced taxes so that they can spend the same amount? In terms of the economy as a whole the direct effect is the same.

My view, for what it's worth, is that what matters is not the direct effect but the indirect effects. The most obvious indirect effect of reducing government spending on non-value-added activities is that it allows taxes to be reduced so that break-even businesses become viable because their overheads are lower. Not only does this give them a reason to continue, it also generates genuine profits which, in turn, generate affordable taxes. Although it is a trite point, it is worth saying that the employment by government of hundreds of thousands (if not millions) of people in non-value-added activities does not generate wealth. That they are employed by government rather than the private sector carries no magic. Every pound they are paid can only be spent once. Either they spend it or the person from whom it was taken spends it, either they save it or the person from whom it was taken saves it, either they invest it in a potentially profitable business or the person from whom it was taken does the same. A pound in Mr Earnest's pocket is not worth any more than a pound in Mr Widget's pocket or that of anyone else. Yet every pound in Mr Earnest's pocket comes from personal or business profits and reduces the ability of those people or businesses to make further profits.

One can test the sense of keeping Mr Earnest in a job very simply. If his spending is beneficial it must follow that employing a further ten diversity facilitation counsellors would be ten times as beneficial and clearing the dole queue by employing all unemployed people in non-value-added government jobs would solve all our economic woes. It's just nonsense in loud trousers. Maintaining non-value-added jobs is nothing but a drain on resources. It drains resources now by requiring tax to be taken from the value-added side of the economy and it drains resources in the future by building up debt that must be repaid with interest.


Mark Wadsworth said...

That's a good summary, especially this:

"The most obvious indirect effect of reducing government spending on non-value-added activities is that it allows taxes to be reduced so that break-even businesses become viable because their overheads are lower."

And the tax that is most likely to send break-even businesses over the edge is of course VAT (which a business has to pay, even it is making losses - unlike corporation tax!).

(Now, try applying the same logic to Business Rates - while it may, superficially, send a business over the edge, it would only do so if there is another slightly more profitable business ready and willing to occupy those same premises (if not, then the rental value and hence the business rates would adjust downwards), ergo Business Rates tend to increase rather than decrease economic activity).

Alex Cull said...

Good to see you back, FatBigot, I've missed your commonsense and trenchant analyses of our economic/political woes!

Norman said...

Welcome back.

I do think that we have lost sight of what public services are during this recession. A public service is a service provided to help the private sector. Rather than my business open a hospital it makes more sense for all the businesses in my area to join together and open a hospital. The government saves us having to do this by doing it for us for which we pay them in taxes.

You can say the same for any arm of the public sector save a few, CDC springs to mind, tourism boards too.

The government now seems to view the public sector not as some necessary evil to support the private but as a means and an end in itself.

Roger Sowell said...

Very good read, Mr. FatBigot. I very much enjoy reading your blog postings, as you have a unique viewpoint express it quite well. Blog on, sir.