Friday, February 19, 2010

The headline in today's Times states that the 'shock deficit threatens UK recovery'.

On the same day, more than 60 economists have signed letters published in the Financial Times, arguing that moves to reduce the deficit should not be rushed since this would risk a return to recession.

The deficit (that is, borrowing over the year) is large, but the debt (the sum of deficits accumulated over the years) is not. For sure the deficit needs to be tackled sometime soon, otherwise the debt will grow, and ultimately servicing that debt would become a problem. But, in comparison with many other countries, the UK has started out from a good place.

Ponder for a moment why the deficit has grown. National income has declined by over 6% during this recession. During normal times, it grows by an average of about 2.5% per year, so national income is now around 10% lower than it would be had we experienced trend rates of growth over the last couple of years. As national income falls, tax revenues to government automatically fall. This fall has been of the order of £45-50 billion. At the same time, government spending on benefits automatically rise as the recession takes hold. Add to this a variety of special measures that have been taken, and which are time limited - the cut in VAT, the preponing of major construction projects and so on. This all suggests that a substantial proportion of the budget deficit is due to the recession (automatic stabilisation policy) and to deliberate attempts to minimise the impact of that recession (discretionary stabilisation policy). The deficit is there, in large measure, precisely to bring about UK recovery - not to threaten it.

This means that the Times headline is 'through the looking glass' economics.

For sure, books need to balance over the long term. The best thing to do to bring that balance about is to support the recovery. Once the recovery is properly under way, public sector cuts will be needed, and those cuts will hurt. The patient needs to be strong enough to take the medicine. Supporting the recovery calls for careful treatment, not knee-jerk reaction.

Tuesday, February 16, 2010

The CPI inflation rate rose to 3.5% in January. Since this is above the 3% threshold, the Governor of the Bank of England must write a letter of explanation to the Chancellor of the Exchequer. He should not find this task too daunting. The rate of VAT rose back to 17.5% in January following its temporary reduction to 15%. As a result, for the next 12 months, the headline inflation figure will be artificially high.

Far from inflation and overheating, the threat that the UK economy continues to face comes from a recovery that is, as yet, still very weak. The danger of a return to recession is a real threat, and the temporary blip in inflation should not serve to disguise that fact.

Sunday, February 14, 2010

A letter in today's Sunday Times, written by a group of eminent economists, argues for early implementation of government spending cuts. I was a signatory to an earlier letter in the Financial Times that argued the opposite. What should we believe?

There is, for sure, a substantial government budget deficit - currently around £140 billion over a year. A significant part, somewhat more than a half, of this is due to the operation of so-called automatic stabilisers - the tendency for tax revenues to fall, and government spending to rise, during a recession. More is due to the deliberate rescheduling of government spending on projects - bringing them forward so that the economy can benefit from an early injection of spending. This being so, the public finances can be expected, in some measure, to 'rise with the tide' as the economy recovers.

Nonetheless, there will be a need for substantial cuts - nobody disputes that the structural budget deficit is indeed large. Timing is of the essence. While the economy remains fragile, cuts will be premature. Yet confidence in the public sector's ability to manage its debt depends critically on a credible plan being put in place. What is needed quickly is the promise of such a plan; the cuts themselves should wait a while until the recovery is more secure. If we can achieve growth of 1.5% this year, then there will be scope.

Thursday, February 11, 2010

Sir Michael Marmot's review on health inequalities in the UK has just been published. The inequalities that are highlighted are startling, and in themselves call for action.

One of the review's proposals refers to the minimum wage. The review cites work by which argues that a full-time worker on the minimum wage enjoys earnings that are insufficient to meet public expectations of an 'acceptable minimum standard of living'. It then argues for 'the coordination of social support, tax systems and minimum wage levels necessary to enable full implementation of minimum income for healthy living standards'.

This raises several issues. First, the link between the minimum wage and household incomes is tenuous. Workers who receive the minimum wage are not necessarily the chief income earners of a household. Even if they are, they may be in minimum wage employment for short spells in between longer spells of more remunerative work. Many workers who receive minimum wages work part-time. In many cases, young people work in jobs paying the minimum wage, either on a part-time basis or while they are searching for better jobs elsewhere. Put simply, the minimum wage is a blunt instrument in targeting poverty.

Where the chief income earner in a household is being paid minimum wages, for sure the income of the household is low. But the support of households in this position is not limited to the minimum wage - benefits, based on household income, kick in. These benefits are far better at targeting poverty.

Raising the minimum wage can of course help some people in poorly remunerated jobs; that's what they're there for. But it also raises the price of labour for employers. Under some circumstances this is no bad thing - it can prevent exploitation of workers in a situation where the employer has a lot of market power. But substantially to raise the minimum wage during tough economic times would most likely have deleterious effects on employment. It is a policy that would hurt the very people that Marmot is seeking to protect.