The Tories’ Plan to sink the (non)recovery

Oh come on guys! Are you doing this specifically to annoy me?

George Osborne should introduce emergency tax breaks paid for by welfare cuts to “shock” the UK economy back to life,  according to the Conservative MP Liam Fox. Fox called for capital gains tax, currently set at 28%, to be suspended and reintroduced after three years at 10%. These should be paid for by benefit cuts, said Fox… “We need to have a look at everything that we have in terms of paternity leave and all the other things that are there.” He added: “With the sort of economic problems that we face in the UK it is irrational and unreasonable to expect that those in work should keep all their social benefits and workplace benefits should be protected, at the cost of making the next generation unemployed. That is not a sustainable generational compact.”

Liam Fox is proposing a policy which will make the slump worse, not better. Sadly, Liam Fox has chosen to drop this clanger behind the Times paywall so I can’t find the exact quotes or policy. Presuming, rather generously, this is not just a political salvo and is a thought through policy. On its own terms it completely fails, let me explain why.

Let’s leave aside the unsubtle class war and the political manoeuvring – other blogs do that better – and assume this is a serious policy. What effect would it have?

I want to ignore the small details (like fathers not seeing their children grow up or people pushed into poverty) and focus on the macroeconomics, because that is the sort of hip, cool blog this has become daddio. Fox is portraying this as a “shock” treatment to promote a rapid economic recovery. This is bullshit, in the classic sense of the word. Fox is indifferent to whether it is true, it just sounds good, so he says it. The policy is a jobs killer.

To understand why just think of Fox as the anti-Simon Wren-Lewis. David proposes a balanced budget multiplier. If the problem today is too little demand and a fragile debt market then the solution is normally simple – cut interest rates. At the moment interest rates are at zero so some help from fiscal policy may be necessary. [1] Normally this refers to deficit spending, but if you’re genuinely worried about debt this is unacceptable. You’re left with one option, raise spending and raise taxes. In doing so you increase demand because, although all the money is spent now, some of the money taken as taxes comes out of savings, not consumption. This means aggregate  consumption increases temporarily. No increase in debt, but more demand.

Liam Fox is demanding the opposite cut taxes and cut spending. In his scheme welfare payments are cut; this self evidently leads to less spending because nearly all benefits are spent. They are cut to give businesses and the wealthy a tax cut, some of which will be saved. We know lots of it will be saved because firms are already sitting on a cashpile of £64bn, which they are not spending. So if make the safe assumption that Liam Fox is proposing this policy to be fiscally neutral, then there will be no increase in debt, but there will be less demand.

Quite how a policy which reduces aggregate demand is meant to “shock” the UK economy into recovery, I don’t know. Thus I conclude: Liam Fox, bullshitter and class warrior.

_____

[1] The Bank of England could theoretically offset a policy this stupid, but will they? Well, with the most incompetent central banker in Britain’s history behind the tiller, I’m not confident enough to try. Fox is either a brave man or an idiot…draw your own conclusions from that little thought experiment.

Filed under: Economics, Politics, Balanced Budget Multiplier, Capital Gains Tax, George Osborne, Liam Fox, Simon Wren-Lewis

Why you can’t rely on the railways: Institutional constrains to fiscal stimulus

The timing of infrastructure spending should be strongly countercyclical so government can employ people without crowding out private sector activity and provide jobs when they are scarce. But, as Chris shows, government investment is in fact rarely strongly countercyclical. Simon Wren-Lewis is understandably annoyed that David Cameron is true to form in this respect. There will be no economic growth this year, borrowing is cheap and yet there will be no new infrastructure spending.

The coalition has announced £9bn of rail infrastructure spending, which is great – gentlemen, get your rivet guns ready! – apart from the fact the spending won’t hit until 2014 (and most of it has already been announced). This is because Network Rail’s investment in the rail industry takes place over five years plans control periods. We are in the middle of control period 4, which runs from 2009 to 2014, and we have just had the announcement for work to take place in control period 5, from 2014 to 2019.

It isn’t a physical problem which has pushed investment to 2014 it one of organisation. The are many shovel ready projects in the rail industry. Newark could use a flyover to ease congestion, electrifying the Barking to Gospel Oak line would open a freight corridor linking east and north London, the Welsh valleys which are to be electrified have needed more investment for decades.

So while there are rivet gun ready projects, we have to concede that investing in rail does takes a lot of planning. Since privatisation that planning has taken a very particular form. Every five year the DfT announce what infrastructure they expect Network Rail to deliver and the Office for Rail Regulation decide whether or not that is realistic given the industry’s business constraints. There is tooing and froing as they negotiate and they eventually settle on the work to be done.

It would be possible to bring forward infrastructure spending but you would have to pass new legislation to do so. The Office of Rail Regulation would need to look the other way while you stuff money and project managers down Network Rail’s throat. Gordon Brown called himself a restless reformer, rail has felt the worst of a political culture that makes a virtue of constant turmoil.

After more than two decades of regular reorganisations and continuous micromangement, there is no industry more in need of certainty over funding, infrastructure and organisation than rail.  The final round of organisation reform, infrastructure spending, spending priorities and fare structure may finally leave us with something approaching a decent railway by the end of the decade.

Fiscal policy is just one aspect of what a Government does. Countercyclical investment projects can and should be prepared, they could and should have been included in a separate schedule of possible work for this control period, but they were not. The lesson here is that where institutions have been established after hard bargained the feasibility of idiosyncratic countercyclical spending is reduced.

_____

PS This bargaining determined capacity for idiosyncratic countercyclical spending explains the lack of countercyclical investment before Thatcher discussed by Chris. Before the 1980s institutions were much more rigid; labour unions demanded more predictable working patterns and there was less entry and exit of firms and facilities with the greater prevalence of state owned industries. This is rather a counter intuitive result given the trumpeting of China’s countercyclical prowess.

Filed under: Economics, Politics, Chris Dillow, HLOS, Network Rail, railways, Simon Wren-Lewis, SOFA, trains