In many parts of the developed world, governments are busy concentrating their minds on cutting budget deficits and debt-to-GDP ratios. It started in the so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain), but has spread to several other European countries.
The most recent and acute example is the UK, where chancellor of the exchequer George Osborne revealed swingeing plans to cut government departments’ budgets last week.
On the face of it, this is good stuff; it is becoming obvious that the previous Labour administration left the UK’s finances in a truly parlous state. Like most incumbent governments facing a general election, Labour embarked upon something of a spending spree in the months leading up to the election in May.
But questions are now being asked about the severity of the proposed cuts. In some departments, cuts of up 40% will occur. The only possible outcome from such action will be the wholesale loss of jobs in the public sector. Many in the private sector view the public sector as being a bloated bureaucracy and that job cuts are a necessary evil in reducing waste, and hence the budget deficit.
However, if one takes this argument to its logical conclusion, it becomes apparent that individuals in both the private and public sectors will become far more prudent in their savings and spending habits. Wary of losing their jobs, people will be less inclined to spend and will instead save, even at the pathetically low rates of interest currently being offered by banks and other financial institutions. Traditionally, this savings pool would be transformed into investment, but if demand is perceived as being weak for years to come, investors will have to be extremely long-sighted or stupid to invest heavily now.
This type of behaviour was encapsulated by John Maynard Keynes in his General Theory in the 1930s in the wake of the Great Depression as the “Paradox of Thrift”. Basically, this states that what may well be good for an individual is not necessarily good for the greater economy.
By saving for the proverbial rainy day and thus “under-consuming”, individuals are effectively denying jobs to many of their peers. The Paradox of Thrift, like an economic “black hole”, eventually consumes itself by causing a recession or even a depression.
Investec CEO Stephen Koseff neatly summed things up at a recent pre-close briefing to analysts when he said, “The people to whom we want to lend don’t want to borrow and the people who do want to borrow are not credit-worthy”. Only when these dynamics change and people across the social spectrum are willing and able to borrow to spend will consumption (and by definition economic growth) start improving again.
It will be truly instructive to observe how George Osborne’s strategy plays out. In March, Bank of England governor Mervyn King remarked that the required spending cuts to be made after the May general election were so severe the governing party would be so unpopular that they would be kept out of office for a generation (usually reckoned to be 30 years).
Whoever won the election would have been faced with the same problems; only the length and severity of the remedies were in question. Osborne’s cuts are so severe he has a good chance of reducing the budget deficit by half within a two- to three-year timeframe. People will stop spending, through fear and higher indirect taxes and there is a good chance the economy will shrink during that time. And this is a five-year fixed-term parliament, as agreed to by the Conservative and the Liberal Democrats when they formed their coalition. So the coalition partners must be hoping the economy can turn around sharply in the two years between 2013 and the next election in 2015.
This is a huge gamble. It requires that consumers change their savings habits in a relatively short time and begin spending again from around 2013 onwards. It also assumes the coalition remains intact and the Lib Dems don’t defect en masse in reaction to the impact of budget cuts.
As the late former Labour prime minister Harold Wilson said in 1964: “A week is a long time in politics”. Five years is an awful lot longer.
Like your pieces very much BTW, Chris.
Mr Gilmour, in the past decade over 50% of all the new jobs created in the UK were either public sector, or directly dependent upon public sector finance. Tell us, where should the UK government get the money to maintain all the spending required to prop up this massive phony economy?
Perhaps they could increase taxation, you might say, but this should hardly help to grow the private sector, the essential host drained of resources to feed government's insatiable appetite.
In any case, what's the point of having a private sector if non-productive yet lavishly-paid bureaucrats and sycophants are the key to prosperity? I guess the Bank of England could always just print the money, another favoured solution of Lord Keynes.
(which, of course, you ostensibly are not)
yes, you are right; austerity measures will make consumers spend less - less on credit, which is exactly what we need
accusing me of withholding a job from a peer because i stay debt-free and don't devour every cent of my earning ! you charlatan...have you no shame ?!
it is the decades-long fundamental application of you hero keynes' antiquated mantra that got us into this mess into the first place
It's perfectly safe to tax the rich "until the pips squeek" as Gordo once said. Raiding overseas bank accounts and tax havens and whacking top earners with 50-80% wouldn't affect private spending at all because the money being taxed wasn't doing anything useful. It's just sitting there collecting rent off the backs of working people or pumping up speculative bubbles like the South-East property market. LIfe has been very good for the UK's rich for the last 30 years or so. Time to put something back into the country I say.
Also, the main reason the UK's deficits suddenly jumped so high was because Gordo decided to bail out Northern Rock, RBS and pals instead of letting them burn. Why should pensioners do without their hip replacements and kids without their teachers because traders in the City were playing casino?
I have yet to see you waste a chance to denounce the principle of paying tax. I can't help but wonder what SARS would find if they gave you long, hard audit.
;)
The argument then (in which Keynes won the PR battle), as it is now, is about the pain of creating the pool of money from which real economic growth is funded. Funding spending from savings and from improvements in the efficiency of economic units of production, takes time and there is pain, but the longer term consequences are sustained economic advancement and the pain of periodic crashes is removed. By contrast funding spending from deficits, from fractional reserve banking and artificially created interest rate environments will ultimately result in a run on banks and the crash. Mostly political expediency over rides economic sense and the Keynesian like views are adopted, for short term political gain at the cost of the future.
Is there a middle ground? Is there a way to return the fractional reserve to greater than one over time? Many of the ideas and investment instruments being proposed around the world to create cash reserves for failing banks especially from the ranks of those “too big to fail” are really attempts to increase the fractional reserve. Why not just systematically drive the fraction to a whole number or a number greater than one?
I agee with your comments on the fractional reserve.
Is a bigger issue not the need for banks to get back to their core businesss - accepting deposits from savers and lending these savings - at a margin - to borrowers?
What I am referring to is the risk that bankers expose their organisations to through dealing in the derivative markets (often earning nice bonuses in the process).
As long as the governments (read present and future taxpayers)keep bailing these speculators out, they will be encouraged to continue to take unreasonable and poorly quantified risks.
I had to laugh at Stephen Koseff's comments - he seems to be confirming that old adage that banks are institutions that lend money to people that don't need it!
Are we in SA not perhaps heading in the same direction as the Europeans with our burgeoning civil service?
I recall a recent article in which Mike Schussler indicated that civil servants are paid a 40% PREMIUM over similar work in the private sector (sounds logical - the pay increases awarded to civil servants and parastatal employees seem to be well above inflation and to what is being achieved in the private sector).
When I started working,many, many uears ago, the axiom was that civil servants were poorly paid - well BELOW private sector rates, but it was sheltered and cushy employment - at least the last part has not changed!..............
I agree about banks core business, but I think that governments setting interest rates is at the heart of the madness.
The interest rate charged to banks by their lenders, the government, at rates so low that risk is gone. The US Fed started their interest rate cut cycle in around 2001 if I remember, political expediency over common sense, stimulate the economy the US and Euro economies were slowing. Already low interest rates were cut further and budget deficits increased. Banks print money by ever decreasing fractions and off balance sheet credit swaps and you could do no wrong, underlying assets increased because money was being invented and then leveraged, money was invested in investments etc. I often wonder should interest rates set themselves?
If the market was free (rather than interfered with by central banks) then supply and demand would set the interest rates essentially based on the premium people are prepared to pay for money now as opposed to deferred gratification. (Naive I know).