We really do need a property crash

I was musing the other day about what FatBigot Towers would command on the "open" market if it's value had increased at the rate of general inflation. Of course there is no way of knowing because there is no such thing as a single rate of non-housing inflation - it all depends what products you include in the calculation. To arrive at some sort of figure I googlised "UK inflation since 1993" and found a fun site that allowed me to find the value in 2010 of any given sum at an earlier date (here). I know not how accurate it is, but it's fun anyway.

What I found is that the rates of inflation used at that site indicate FatBigot Towers to have increased in "value" by almost two and a half times general inflation. That really is an absurd state of affairs, not that I mind because free money is free money and I might get around to cashing it is in the not too distant. One factor that needs to be borne in mind is that I purchased my modest hovel at a time when prices had fallen substantially and the market was extremely flat, prices could well have been below a fair market price due to suppressed demand. The vendors, who were and are friends of mine, had found their ideal property and beaten the price down substantially, they also had not needed to use estate agents, so it might well be that I paid a bit under the odds. Even so, FatBigot Towers would seem to be "worth" well over twice what it would have cost today had house price inflation been roughly in line with general inflation.

I can understand why the current government feels it would be politically dangerous to allow the property market to correct itself. We had a decade of Blair and Brown telling people they were rich because their houses had gone up in value, boom-and-bust was a thing of the past, caution was thrown out of the window and a lot of debt additional to house-purchase loans was secured on homes. That sort of thing gives rise to expectations. The government had made them so much richer than they were before, they thought, and if they still hold that view there is every likelihood that they will consider the government to have made them poor if prices crash to a sensible level.

The position is a little different to that of twenty years ago. The price bubble is much larger than it was then and far more people have dipped into the bubble to pay for holidays, cars and electronic goodies. Although a lot of loans have been repaid since things went bang that process has itself made people feel poorer, so adding a drop in house prices to the pot would risk adding insult to injury. There is also the psychological effect of the sums of money involved. Twenty years ago a property previously priced at £200,000 might have fallen to £140,000, that's £60,000 and no one sniffs at that. By contrast, today the equivalent sums for the same property might be £400,000 and £280,000; £120,000 is so much more, not least because it is six figures rather than five. The general inflation calculator I linked to above says £60,000 in 1991 is equivalent to £96,000 in 2010; for the loss to be £120,000 not £96,000 gives the impression things are worse even though the same percentage of bubble has been removed in the two examples.

Looking back to the early 1990s I cannot recall any significant political backlash as a result of the property market collapsing. It had collapsed by the time of the general election in 1992 but the incumbent government won a majority (albeit much reduced). All the usual suspects were bleating on about people losing their homes but when details were given it became apparent to all that the genuine stories of bad luck were accompanied by many more of people borrowing more than they could afford to repay. In those days that seemed to be considered the fault of the borrowers rather than the lenders. Interest rates soared because base rate reflected the state of the government's finances and the ERM farce had rather pissed in the soup in that regard. Nonetheless, the government got back in and, not least because bad debt had been written off rather than carried over, it took only a few years for the nation's finances to be on a very sound footing.

The whole mood seems to be different now. No doubt it is due in part to so much of life now being tied into government activity. Never before have so many been dependent on government for so much of their income - due in large part to the evil tax credits scheme. And never has government presented itself as having magical powers to solve all ills as it has over the last ten years or so. A problem arises and government appoints someone to deal with it and/or throws money at a quango to solve it. The problem usually doesn't go away and the level of amelioration provided in return for the taxpayers' buck is pitiful, but the problem is now in the hands of government. No other solution is affordable because no one has the money government has, and failure to solve the problem can only be explained by not enough tax having been thrown at it. And we are led to believe that more and more of life's problems are under the control of government because they have outlawed this, regulated that and have an army of day-glo jacketed wardens imposing fixed penalty notices for everything else. No solution exists other than government. Two consequences follow. First people believe government can control things it actually has no ability at all to control and, secondly, any problems that remain are placed firmly at the door of government whether or not it is realistic to do so.

Allow a collapse in the bogus wealth contained within the house price bubble and government runs a huge risk to its chance of surviving the next election. Or so it thinks. Maybe it is correct in that thought although I have my doubts. I talk to lots of people about these things, not just fellow pompous barristers but ordinary people doing ordinary jobs to support themselves and their families. The only people I hear supporting government involvement in everything are the "liberal" Islington chatterati who seem to have the view that only they are capable to supporting themselves and everyone else, all the little people, need a massive network of support and counselling in order to boil an egg. The people doing ordinary jobs just want to be taxed less and left alone to look after themselves. It does not, however, follow that they would vote for a governing party that withdrew all the nannying unless it also reduced their tax bills.

Against that background I can see why the current government will not step aside and allow property prices to fall to affordable levels as their predecessors did two decades ago. Ironically, the one thing they want to achieve is more economic activity in the country and a thriving property market helps achieve that because moving home always involves the purchase of new stuff for the new abode. A thriving property market is one in which there are many transactions and has nothing to do with the nominal value of each transaction. At the moment the complaint of those involved in the business of property is that few transactions are taking place. Were prices more realistic it is reasonable to infer that there would be more. The other side of the coin is that some would be lumbered with negative equity and would be unable to move or would even face insolvency. It happened before and things soon recovered. You cannot set economic policy by trying to protect everyone from ever making a loss on a deal - well, actually, you can but you would create something nearly as bad as the mess Gordon Brown left the country.

In this respect, as in many others, I despair at the lack of guts displayed by the current government. They know houses are grossly overpriced and that the result is the current generation of young adults being priced out of the market completely unless their families already have money. They also know that all sorts of businesses benefit from property transactions - builders, painters and decorators, carpet suppliers, white goods suppliers, garden centres and a host more; their trade is suppressed if the property market is suppressed. Although it would be a short-term political gamble, a government of principle would say it is the right thing to do and would explain why. My money would be on that position being accepted by far more floating voters than the number who reject it. In any event, and I know I am dreaming here, I wish that just once we had a government that looked to the interests of the country rather than to its own electoral prospects when deciding policy.

Quantatively easing the curry house

I was in the curry house last night while the cleaner, Mrs Slipshod, did her best to rid the windows of FatBigot Towers of tar and cooking grease.

The conversation got onto quantitative easing. One of the proprietors said it sounds like a scam because the words used to describe it don't mean anything to the man on the street. He asked whether I know what it involves. I'm not sure that I do, but came up with an explanation and would be grateful for comments if I've not grasped it correctly.

To illustrate my understanding of the matter he sat opposite me and placed a £20 note on the table. He pretended to be a bank and I pretended to be the government. He lent me £20 for one year and I gave him an IOU promising to repay £20 in one year's time.

So far so good, the government has given an IOU and received a £20 note while the bank has parted with a £20 note in return for an IOU. Everything is in balance.

The government then decides to buy-back the IOU. It costs £20 to do so. Instead of using the £20 note it borrowed, it prints another £20 note and uses that. The bank is perfectly happy, it has received £20. The government is laughing because it still has the £20 it borrowed and no longer owes the bank £20. It has gained £20 by printing another £20 note.

By the simple procedure of buying an IOU using newly printed money the government had given itself an extra £20. It's tooth-fairy money, it doesn't really exist. Multiply that exercise by 8,200,000,000 and you have the "quantitative easing" project to a tee. I think.

The cost of shedding public sector jobs

I can't now remember where I saw it but a couple of days ago a singularly absurd comment was left on a blog. It might have been one of the BBC blogs. The topic under discussion was a televised debate between the chief treasury spokesmen of the UK's two main political parties and a dancing gnome bearing a yellow rosette. One of the points made by the author of the blog was that none of the three debaters gave sufficient details of where and how they would reduce government spending so as to make either serious inroads into the annual budgetary deficit or into the cumulative debt resulting from year-after-year of annual deficits.

It is noticeable how politicians often fail to distinguish between annual deficits and government debt. The point is really very obvious. If you have £20,000 to spend this year but actually spend £25,000 you run a deficit of £5,000 and start next year with a debt of £5,000. That debt doesn't disappear at the end of the year, it stays with you until it is repaid. The next year you might still have £20,000 to spend but actually spend £22,500. Your annual deficit has fallen by half but it is still a deficit and at the end of the year you owe £7,500 (£5,000 from the first year's over-spend and £2,500 from the second's). Reducing the deficit does not reduce debt it merely increases it by less than during your previous period of profligacy. You can only reduce debt substantively by running a surplus rather than a deficit - for example by spending £19,000 out of your £20,000 so that you can repay £1,000 of debt.

In the comments to the piece a whole range of points were made, as one would expect. Among them was a full-frontal attack on the concept of running a deficit at all and a call for government to cut it's spending very substantially so as to run an annual surplus of income over expenditure so that the debt can start to be repaid. In answer to this obvious and sound approach was the comment that caught my eye. It's quite interesting how the mood of a writer can be clear from the way he or she expresses himself on the page. One or other of my regular readers can probably tell when I've had two bottles of wine before setting out my verbiage and when I am stone-cold sober, but it is also possible to tell whether something is written in a calm and reflective state of mind or as a result of furious exasperation. The mood appearing from the comment in question was undoubtedly one of "how can you be so stupid?" I could almost hear the deep sigh issued by the commenter before he put digit to keyboard. Perhaps you can will be able to tell how loudly I sighed on reading his comment from what I am about to write.

The comment can be summarised as follows: it is counter-productive to cut public sector jobs because it reduces income tax receipts and increases the welfare bill. I had read similar comments before and each time my lower jaw has been drawn downwards by something other than the weight of my chins. People actually believe that shedding someone from the public sector payroll costs the Treasury money. It's really quite staggering. Actually, it can happen, but only if the cost to the Treasury of him leaving his job exceeds the cost of employing him. Say his salary is £30,000 excluding employer's National Insurance Contributions. That means the Treasury's piggy-bank is reduced by £30,000 each year (employer's NICs are neutral because they are just one office of the Treasury paying money to another office of the Treasury). He pays, say, £6,000 in income tax and employee's NICs, so £6,000 that was taken from the piggy-bank is put back into the piggy-bank. More accurately, his income tax and employee's NICs are also just transfers from one desk at the Treasury to another desk and represent neither expenditure by nor income to the Treasury. The cost of employing him is his take-home pay, £24,000 on the figures I have given.

The mistake made by the commenter was to overlook that people paid out of taxes do not in reality pay income tax and NICs - income tax and NICs simply reduce the amount that is paid to the State employee but they are not receipts to the Treasury. The story does not stop there, however, become people do not live in a vacuum and their income does not exist in a vacuum. There are three respects in which dispensing with a State employee (let's call him Mr Paperclip) causes costs to the Treasury in addition to the cost of paying benefits.

First, let's assume Mr Paperclip had a net income of £24,000 and now receives £10,000 in benefits. The saving to the Treasury is £14,000 but Mr Paperclip also has £14,000 less to spend. The figures can be minced anyway you want, I will assume he would have saved £4,000 and spent £10,000 of which £8,000 would have been spent on things subject to VAT at 17.5%. The VAT on £8,000 of spending is roughly £1,200 (because the figure of £8,000 is the total of the cost of goods and services at about £6,800 plus VAT at 17.5%). That is a loss of tax revenue as a result of him no longer being employed so the saving to the Treasury is reduced from £14,000 to £12,800.

Secondly, because he spends £8,000 less at Mr Patel's Merrymart, so Mr Patel receives £6,800 less (not £8,000 because £1,200 of it goes in VAT rather than to Mr Patel). Had Mr Patel received that £6,800 he would have spent £4,000 at Mr Choudury's Cheerful Cash-n-Carry buying replacement stock and pocketed £2,800 himself on which he would have been liable to income tax and NICs of, say, £900. The Treasury loses £900. Mr Choudhury receives £4,000 less which represents £1,500 profit and the loss of a further £500 in tax and so it goes on through a whole chain of transactions. At each link there will be a loss of tax as business takings and profits are reduced but at each link the loss to the Treasury gets smaller and smaller as Mr Paperclip's initial withdrawal of custom is diluted. The financial benefit from dismissing Mr Paperclip is reduced by these knock-on effects.

Thirdly, Mr Paperclip himself is only one person, it will take a whole warehouse of office equipment to lose their jobs before any real effect is made on the government salaries bill. There will be chain-reactions of loss of turnover for many businesses and some of them will have to lay-off staff or even close completely. The loss of a private sector job is a real cost to the Treasury. Income tax and NICs are no longer received and benefits are paid, all of which affect the books directly; there is no element of the Treasury losing money which would have come out of its own coffers in the first place unlike the nominal "loss" of income tax when Mr Paperclip joins the dole queue.

For these reasons reducing the public sector payroll saves the Treasury the immediate net cost of employing people but not the whole of that cost is saved because there are knock-on effects on tax receipts and the cost of benefits. Nonetheless a net saving will undoubtedly arise because not every redundant public sector employee will remain unemployed for life, not all will draw benefits and the chain-reaction of tax losses involves ever-smaller sums.

The truth from the shop floor

Yesterday I watched an interesting television programme about the John Lewis business. For anyone who doesn't know, John Lewis has department stores and a grocery business called Waitrose. It is not a limited company but operates as a partnership in which all its employees have a stake. Perhaps because of its unusual ownership structure it was chosen by the BBC to be the subject of a fly-on-the-wall type of show in which the state of the business is being examined as well as day-to-day operations in some of its shops.

One theme dominated the first edition, namely the effect of the recession on retail trade. A compelling difference was apparent between the attitude of the head honcho of John Lewis and the position adopted by politicians of all parties. He expressed the view that recovery from recession will be slow and that he did not expect the spend-spend-spend years to return. Politicians seem unable to recognise this obvious truth, or if they do recognise it they don't seem to want to say so for fear that it might not be what the electorate wants to hear. It is, however, of fundamental importance if the path out of recession is to be realistic and sustainable.

I can illustrate the point simply by reference to my favourite emporium, Mr Patel's Merrymart. Mr Patel was ticking along just fine. He worked in the shop together with three other full-time staff and four part-timers. The business neither expanded nor contracted because it was what it was, it paid for Mr Patel and his loyal staff for a decade with no real variation year-to-year. All of a sudden customers had a lot more money to spend because they had borrowed against the perceived value of their homes. Sales were rocketing which required Mr Patel to take on extra staff, one more full-time and two more part-time. And here's the important bit - he took them on only because he had to and he only had to because the shop became much busier. Then customers stopped borrowing and started repaying what they already borrowed. Turnover at the Merrymart fell to below the level before the boom. The new staff lost the jobs they had been in for three years of boom and one of the old part-timers had to go.

How do you measure the decline in Mr Patel's business? Is it realistic to treat the boom times as a true level of business and to compare the new situation to those times? Or is it more realistic to treat the previous decade as the true "par value" and the boom as a blip? To my mind the answer is obvious. For three years the shop benefited from additional business that could not be sustained over the long term. It was nice while it lasted, but the shop is what it is; it is a small shop with a small catchment area. Run well it could always expect to provide a living for a certain number of people. For three years there was an upward blip. Now, as potential customers pay £50 a month to Visa rather than putting in his till, Mr Patel will find his takings fall below par value. Over time it is realistic for him to expect sales to go up as credit is repaid and the extra £50s come his way.

When an economy has been boosted in an unsustainable manner by an orgy of borrowing and spending it is inevitable that GDP will rise. When the tide turns and GDP falls people wring their hands and wail "recession, recession", as though it is necessarily a bad thing. In one way it is bad because all the additional staff taken on by businesses like the Merrymart find themselves drawing benefits when previously they had work. What cannot be ignored, however, is that they had work only because of an entirely bogus and unsustainable increase in business activity. Similarly, increased tax revenues during the boom years were illusory. They appeared as numbers on a computer screen but they were only ever temporary. A reduction in business activity was always inevitable because it was always inevitable that the added sales made with borrowed money could not continue indefinitely.

The true level of GDP, like the true level of sustainable business for the Merrymart, is not defined by a temporary upward blip any more than the true level of someone's annual income is defined by a once in a lifetime win of £5,000 on the lottery. You earn £30,000, you win £5,000, in the year of the win your income is £35,000, yippee; but next year you are back to £30,000 again. It is not realistic to look on this as a reduction in income, the substantive position is that your income has remained static but you received a one-off lucky bonus.

The boss of John Lewis understands this. He knows his business got lucky when people borrowed money and stuffed it into his tills and that he should not expect to get lucky again. He measures performance now not against the lottery years but against the real, stable, sustainable years. Front bench politicians of both parties (with one exception) have not recognised this truth openly. They measure current GDP against GDP in the lottery years and claim to have policies to bring back those heady days. It isn't going to happen. The wise exception is Ken Clarke who recently called for a shift in the whole structure away from credit splurging and towards saving and paying your way. Such a change will mean setting sights much lower and accepting that any given measure of GDP is not a minimum standard for future levels of business activity.

Once you acknowledge that poor Gordon's boom of doom was a blip giving rise to misleading headline figures for GDP and misleadingly high levels of tax revenue, it becomes obvious what must be done now. Expectations must be changed and budgets must be set according to what is sustainable in the future not according to some fairy-dusted period of fictitious wealth. Of course the recession is affected by factors other than the end of the credit boom, but that is no reason to pretend that the business created by the credit boom will reappear. It won't. Mr Patel knows it. The boss of John Lewis knows it. Ken Clarke knows it. I would suggest that every fair minded observer of matters economic also knows it.

We have witnessed a fall in GDP of somewhere between 5% and 6%. But that is a fall from a false high level because part of the starting measure was unsustainable and would have disappeared anyway once people stopped borrowing and started repaying. Whether that is 0.5% or 3% or somewhere in between is anybody's guess. For so long as politicians pretend that the credit boom represented real and sustainable business activity we cannot expect them to put forward a credible path to recovery.

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.

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.

Meanwhile, back at the recession ...

While we have been distracted by MPs being paid by us for giant topiary bathplugs and the exposure of the true weakness of Gordon Brown's grip on power, our old friend the recession has been carrying on doing its own thing. Jobs have been lost in huge numbers in the manufacturing, service and retail sectors. House prices have levelled-out temporarily due to the annual Spring rush but remain well above realistically affordable levels. Increased activity in the housing market will provide a small knock-on boost for manufacturers and sellers of carpets, furniture and washing machines.

In the last week news has come of 800-odd jobs going at LDV, with thousands more at risk in associated businesses, 700 at Hewlett-Packard and more than 1,600 at Lloyds Bank. These are the headline-grabbers but there are many more coming from the closure of, and cost-cutting in, small businesses. There is clearly a long way to go before the effect of all these redundancies works its way through the system. In the meantime other businesses will be affected by the loss of spending power by those who have lost work (and tax revenues will fall).

When asked in an interview last week why he refuses to call a general election Gordon Brown said he was busy dealing with the recession. We have heard a lot of references to "steering the country through" and "leading the fight again" recession in recent months but the reality is that there is almost nothing he or any politician can or should do. There is a reason LDV is closing - it cannot make vans that people want to buy at a price that makes a profit. There is a reason Hewlett-Packard is shedding jobs - it doesn't need them and cannot afford to continue employing them. There is a reason Lloyds Banking Group is closing its Cheltenham & Gloucester-branded branches - it cannot afford to keep them open. What can the government do about any of these cases? The answer, of course, is absolutely nothing other than offer subsidies and hope that, by some miracle, keeping loss-making enterprises open will turn them profitable. It is no surprise to find the trades unions arguing for exactly that to be done but it is a wholly futile exercise which simply increases losses in the long run.

We are in recession because our economy was unbalanced, being kept afloat by hot air and unaffordable credit. There is no escaping the fact that a contraction was necessary, the only question is how large that contraction needs to be before balance is restored. No one knows the answer now any more than they did a year ago because the national economy is not one big thing it is an aggregate of millions of little things. Mr Smith in Brighton and Mrs Jones in Birmingham might earn similar salaries and have similar debts and expenses, but one might choose to reduce their debt and the other might not, or both might, or neither might. These personal decisions affect consumer demand are wholly unpredictable. Similarly, the effect of reduced demand on individual businesses will vary according to how they are run and the wishes of their owners; seemingly identical businesses in Brighton and Birmingham might take completely different approaches. There is nothing government can do about that. And then there is the question of how people react now to the stark fact that taxes are likely to have to rise substantially in the next year or two (and thereafter). Some will ignore it and hope it goes away, others will cut spending now and save to prepare themselves for the onslaught. These personal decisions will have a dramatic effect on how quickly recession ends yet no amount of speechifying and theorising by politicians or anyone else will change them. The real economy, comprising those millions of individual decisions, will find its own response to the current situation. The little people are the real economists in all this.

The best thing poor Gordon can do is sit on his hands and hope the damage he did to the economy in his decade as Chancellor is not as bad as it is.

Cats and teeth are expensive things

One of the blogs I follow contains the thoughts of Mr Stan. He has written about a recent report that people are abandoning their pets to animal welfare organisations because they cannot afford to keep them. The specific point he addresses is vets' bills. I am not an animal man unless the animal is in front of me on a plate, with gravy, I have never had a pet and do not understand the concept of pets at all, but I do understand that others derive some sort of pleasure from having creatures roaming around their homes. So be it, it's their choice.

The particular example Mr Stan gave was of a visit to the vet more than a year ago which cost £250 for a consultation and the supply of antibiotics for a cat. It made me think of my visit to the dentist last week for an examination and the removal of tar and plaque from my stubby brown teeth. That set me back £70, I need to have one filling replaced which will cost between £150 and £200. It seems an awful lot of money until you think of what is involved in running a dental practice, and I presume similar points can be made about veterinary work.

I happen to know a little about the costs my dentist incurs in running his practice. The surgery is very pleasantly appointed in premises which would otherwise be a shop of some kind. He pays £23,000 a year in rent and business rates to occupy those premises. The practice requires a receptionist (salary, £18,000) and a fully qualified dental nurse (£24,000). He has only recently moved into his present building and had to pay for it to be kitted out for his needs, the building work and purchase of furniture and equipment cost more than £70,000. He requires professional indemnity insurance, insurance for the building and contents and must pay National Insurance contributions for his staff. He budgets for £12,000 each year for the next ten years for capital expenditure to cover the cost of kitting out the surgery and replacing furniture and equipment as necessary. There are also various other necessary costs such as cleaning, electricity and telephones. Before drawing a penny himself or using a single dose of anaesthetic or a taking a single x-ray he has overheads of around £90,000. Assuming he works 45 weeks of the year even I can work out that he must bill £2,000 a week or £400 a day just to stand still. If he wishes to draw, say, £45,000 himself that figure goes up to £3,000 a week or £600 a day.

There will always be some voids when patients don't turn up or no one is booked-in, so out of an eight-hour working day he might only average six billable hours. So, he must bill £100 an hour after the cost of materials used in order to pay his overheads and draw the salary I have assumed for him; actually, make that £115 because he has to charge VAT at 15%. Add in a couple of x-rays, fancy modern white filling materials, porcelain caps and all the rest of the necessary paraphernalia and necessary billing rates might have to average well over £200 an hour even if he restricts his pay to £45,000 (which would be modest in London).

£250 for the examination of a cat and the supply of antibiotics might seem a lot but I think I have some idea why it is so much.

Pain now, gain later

In the comments to my last piece Mr James observed that substantial reductions in public sector employment would make things worse by taking a fat chunk out of aggregate demand (I hope that is a fair summary of his position). I would suggest that his observation is (i) correct in part, (ii) incorrect in part and (iii) neither here nor there, all at the same time.

He is correct in that sacking a civil servant from his job and giving benefits instead will reduce his spending power. Sack a thousand and collective spending power is reduced even further, sack the half million or so who need to go and shops will be hit. The songwriters Kander and Ebb knew about this sort of thing when they wrote the song Money,Money, including the line "money makes the world go around". Spending power from private sector employment falls as jobs are lost and this impacts directly on shops and thence on wholesalers and manufacturers. Whether a job is lost in the private or public sector, the direct loss of spending power is the same at the same salary.

He is incorrect in that the saving does not just disappear. Rather than being spent by the sacked civil servant it is now available to be spent on something else, be it repaying debt to reduce future expenses or reducing taxes to increase the spending power of others. No doubt there will always be a time-lag in which the additional fall in spending power can have a damaging impact, but it is not a one-way street. Private business doesn't shed staff in difficult times just for the fun of it, it does so because it has to in order to stay alive. No one would argue that the private sector should just rack-up vast amounts of debt in order to keep people employed and thereby maintain aggregate demand, this would just increase costs in the long run and add to the risk of businesses folding completely. The fall in aggregate demand is an unpleasant consequence of planning practically for the future. I see no reason in principle why the public sector should be different.

The reason why I say his observation is neither here nor there follows on from my last point. There will come a time, sooner or later, when the recession bottoms-out. Any real growth in the economy from then on will be a consequence of all the factors that apply generally, including having as low a burden of costs as possible. Maintaining public sector spending on fripperies rather than reducing government debt or taxes will necessarily add to costs in the longer term (subject to being inflated away, which gives rise to different problems). Growth can only occur out of profits; the higher the costs the lower the profits at the same selling price. Much of current government expenditure on pet projects (such as regional government, fussing about food and doing a King Canute on the climate) was only entered into because they felt it could be afforded out of the tax proceeds from poor Gordon's boom of doom. Those proceeds aren't there any more and these projects (along with many others) are now plainly unaffordable. Retaining the unaffordable out of stubbornness or a misplaced desire not to add to current problems merely bottles up the problem for a later date.

In the same way that I consider it sensible for individuals to live within their means rather on credit because they will find their money goes further, so the enormous sums raised in taxes will go further if they are not having to be spent paying interest on accumulated debt, a pretty large chunk of which will go overseas, and on non-essential matters.

What I am suggesting is a wholesale change in the way the public sector views itself. In a narrow way maintaining public sector employment in the short term can be beneficial in that it can help ease the effects of recession, but it cannot do so free of charge. The charge bites in the future, and will inevitably slow recovery. In the long term I suspect the detriment will outweigh the short-term benefit by quite some margin. Just as taking your golf clubs out of the car benefits fuel consumption, so taking unnecessary weight off the back of the private sector (the only sector of the economy that can create wealth) increases its ability to perform efficiently and profitably.

A welcome call for austerity

It's always nice to read something in a national newspaper supporting what one has written for months. Today Libby Purvis, writing in The Times, emitted a call for a bit of common sense to be applied to the public sector. Her main theme was that the public sector must pare-back on all non-essential expenditure and must apply a real-world view to what is essential.

Hundreds of commentators far more knowledgeable and lucid than my mere self have made the same point over and over for years because the public sector has been sucking life from the productive sector through the dead weight of pointless and very expensive interference. What I find so pleasurable about Miss Purvis's contribution is that she had the guts to use the noun "austerity" to define the proper approach.

Both my regular readers will know I have been arguing for public and private sector austerity for some time. Not out of any sense of wanting people to suffer, because austerity is not a recipe for suffering. Austerity is a recipe for being able to cope with whatever the world throws at you. Austerity is about cutting out the frills and living firmly within your means. It is about sitting back while your neighbours acquire endless gadgets on the never-never. It is about eschewing credit that does nothing other than advance the acquisition of ephemeral pleasures in return for a higher price than if you waited until you had the cash in the bank. It is about putting aside something for a rainy day because rainy days happen whether or not they are expected or deserved.

It never occurred to most of those of my parents' generation to borrow money for treats because they knew borrowed money is expensive money. Both their day-to-day lives and their long term financial wellbeing was based on spending only what you can afford, and part of what had to be afforded was a little protection by way of a lump sum in the bank or building society. That attitude did not generate unsustainable demand and it did not create precarious employment based on such demand, but it did give stability. It gave stability because it limited the number of outside events that could rock the family financial boat. Of course unemployment could do so, but changes in interest rates, fluctuations in the fortunes of the stock market and the calling-in of credit could not.

Contrary to the desires of our current government, one consequence of the recession is that little people have been saving more according to a report in last Saturday's Times. Orders that they must spend so the country could return to the prosperous pomp of yesteryear appear to have met with the response: "bugger that, old chap, I'm protecting myself". When put in a difficult position common sense comes to the fore. Fancy economic theories are nothing compared to real life and real life requires people to find a way to pay bills and prepare for an uncertain future. The only way they can do so is by marshalling the limited resources at their disposal. That which is obvious is being practised, namely that credit is a luxury and security lies in living within your means.

There is, as far as I know, nothing magical about public sector spending (apart from the ability of that sector to deliver a staggeringly small return for the amount it spends). The argument that recent increases in public sector spending have to be maintained in order to prevent a bigger slowdown in the economy than would otherwise be suffered seems to me to miss the point. One might as well argue that businesses must stay afloat to keep their employees in wages so that they can spend to keep the economy going. That argument is a non-starter, however, because loss making businesses have to lay people off or fold when they have insufficient income to keep going.

We are in a time of significant restructuring. The loony left argues that capitalism has failed and must be scrapped. When all they can offer is the economic miracle of the Soviet Union I feel comfortable rejecting their suggestion. The failure was not of capitalism but of consumerism. In the private sector consumerism manifests itself in (i) people buying stuff on credit rather than waiting, saving and only buying when they have the money to do so and (ii) spending everything (with or without utilising credit) rather than setting something aside for the future. That is changing, people are now repaying credit card debt and putting money aside. It is a change in culture, a change in the way money is seen. Public sector spending on fripperies such as a dance development officer for Blackpool or a head of the NHS low carbon programme for Cornwall and the Isles of Scilly is consumerism on a different scale but the problem with it is the same. Yes, spending money on anything creates jobs. Spending it on crap you can't afford creates jobs now but it also creates a liability for the future. That liability carries a huge price both in lost hope for those rendered unemployed when the illusion is burst and for lost spending power for those who need to repay their debts.

Miss Purvis is right to call for austerity. It is already being practised by the little people. One day government might learn that what is good for the little people is good for the public sector too.

"All of time is squeeze margin down no profit"

I learn a lot by talking to those who run small businesses. By the way isn't "small businesses" a horrible term? It makes them sound unimportant when they are actually the backbone of the economy. But I digress, and that's not good when it happens in the second sentence of a piece, so I must return to topic double quick.

Yesterday evening was great fun. Being a day ending in Y, there was nothing on the telly so it seemed a good day to eat out and curry seemed just the ticket. It's a good stroll to the closest local curry houses. I say houses because there are two next door to each other. One has been there for as long as anyone can remember, the other started ten or so years ago, and both have always enjoyed excellent reputations. My custom always went to the longer established place for the simple reason that I went there before it's competitor set up in business. When the old couple who ran it decided to retire their restaurant was bought by the people next door. Not because they particularly wanted to expand but to ensure that a new and aggressive competitor would not enter the fray. Now they operate two different restaurants next door to each other but will convert into one large establishment when the time is right.

On the waddle home it was necessary to pop into the greengrocers to top up my stocks of vegetable and fruit based products, on this occasion cigarettes and cider. The owner was bemoaning the presence a few doors away of a new competitor who took over a small failing off-licence and stocked it well with a range of general grocery products (including cheap large tins of fruit in sticky syrup). The newcomer isn't doing a lot of trade, in fact I would be surprised if he lasts a year, but it is a worry nonetheless for the established shopkeeper. To seek to maintain his hold on the local market he has undercut his new competitor with special offers on beer and wines, cutting deep into his own modest profit margin.

Both the owners of the curryhouses and the owner of the greengrocery have seen their takings fall considerably over the last year. They both told me they cannot see enough business for more than one shop of their type in the immediate vicinity. Part of me thinks "they would say that, wouldn't they?" but I think there is actually more to it. These are people who know their market well, they talk to their customers and gauge the mood. When the greengrocers tells me, through his thick Turkish accent, "all of time is squeeze margin down no profit" I am inclined to believe him. When he tells me "1990 business stay good, 1980 business stay good, this time no, this time worst", I am inclined to believe him. When a restaurant proprietor who set up in business next to an established rival and saw both businesses do well tells me he cannot see enough trade for both to make a living in the medium to long term, I am inclined to believe him, particularly because he opened his shop just after the last recession.

This sort of anecdotal evidence doesn't prove anything concrete, but it does give a hint that real businessmen see something different about this recession. They see it as something that will change spending patterns for a long time to come. I suspect they are right and would certainly trust their judgment more than that of any number of academic economists who have never actually put a bank note in a till or paid a member of staff.