Belfast Telegraph

Friday 31 October 2014

The devil may have the best tunes, but money can buy the best arguments

President Obama

It all seemed so simple in the beginning. Basic textbook stuff, really. Private demand was crumbling as banks contracted and confidence waned.

So public demand must take up the slack. The State would borrow and spend to make up for its citizens' unwillingness to do so.

As the credit crisis deepened, the iconic figure of the economist John Maynard Keynes was produced to give credence to this policy.

Keynes's ideas were seen, had they been followed, as the correct way to deal with the Great Depression; and their implementation after World War Two was credited with the success of the Great Prosperity which followed.

All that ended in the disasters of the 1970s — the last time the world faced anything like this degree of economic disorder. So the return of Keynes marks a stunning reversal of post-1970s thinking. It became standard orthodoxy just that governments should balance their budgets — or at least never have deficits bigger than 3% of output, as in the EU's Stability and Growth Pact.

But more than that — the less governments did the better, went the argument.

Still, it was Keynes himself who said that when the facts changed, he changed his mind. And there is no doubt that the global recession cum depression has changed all the facts.

Even so, it is a bit hard to swallow the speed with which so many mighty exponents of the new capitalism reversed engines and began, not only asking for government money, but praising the wisdom of government borrowing and spending.

The one thing which did not change is the beneficiaries from both sets of policies — the banks and the big manufacturers.

They had the most to gain from privatisation, deregulation and free movement of capital. Now, they are getting the lion's share of the increased government borrowing.

That of itself does not change the merits of the arguments; whether for the post-crash new Keynesianism or the pre-crash new Smithism (a la Adam).

It is worth remembering, though, that while the devil may have the best tunes, money can buy the best arguments, be it for government handouts or the merits of eating manufactured fats.

The money and most of the arguments are now backing Big Government. But, in a surprisingly short time, given the scale of the crisis, the counter arguments are beginning to be heard.

Quite the most powerful is the one which asks just how big can Big Government become?

The figures from the biggest of them all — the US — are startling. This year's budget deficit will be around 10% of GDP. I mean to say, that's not far off Irish levels.

In the case of the US, it translates into $1.4trn ($1,400bn) in actual money to be borrowed by the US Treasury. Of this unimaginable sum, only $200bn will be the 2009 cost of President Obama's stimulus package.

This illustrates one problem. Not all, or even most, of the extra borrowing being done by governments is to counter the recession, Keynes-style.

Instead, it reflects underlying weakness in the public finances, where tax revenues do not cover existing spending, never mind future commitments; a weakness hidden by the extra revenues generated during the credit bubble.

Ireland is the most extreme example among rich countries, but Britain and the US are not that far behind. In both cases the underlying “structural” deficit appears to be around 4% of GDP. In Ireland, it may be more like 6%

Faced with this, the Irish Government decided against fiscal stimulus, and who can blame it? It is a rather hazy concept anyway, when public borrowing is rising so rapidly.

No-one can accuse Mr Lenihan of not borrowing to compensate for the loss of private demand — maybe €20bn worth before the year is out.

A “stimulus” appears to mean even more borrowing after the existing bills have been paid, and the extra welfare payments delivered.

It is hard to see much merit in such a policy when the existing bills are so large, or what good it is likely to do.

Borrowing money to put into failed banks may be necessary for the good of the economy; but it hardly counts as stimulus.

So far, the Irish Government has been able to call on past savings, via the national pension fund, to rescue the banks.

It may yet prove the case that the pension fund is not big enough to fill the eventual void in the banks. If so, it could present some very difficult choices for a government which is already close to the limits of its borrowing ability.

And we must not forget the pensions themselves. Whether it was a good idea or not, the National Pension Fund was never going to cover more than a fraction of the future pension costs.

The counterpoint to the 1990s benefits of having such a young population will be the biggest rise in pension costs in the EU, from the 2030s on. The fraction available from the Fund — if any — will be even smaller. For Ireland, as for others, just borrowing our way out of the crisis looks increasingly implausible.

More plausible is the fear that the weight of accumulated debt will constrain growth for years, or decades, to come. But even the theory looks implausible.

Government borrowing cannot match the kind of fall in demand which frightened rich consumers can generate.

Most of us could reduce our spending by 20% without giving up any essentials. If we all did, it would knock more than 12% out of a typical advanced economy.

It might be better to think of government borrowing as a substitute, not for private demand, but for private saving. The bubble has left most countries with too much debt.

Unlike the 1970s, the problem is private debt, not public. The worst is bank debt, followed by household debt. The property boom means Irish corporate debt is pretty nasty too.

All will have to fall by far more than government borrowing can rise.

That will depress the economy while it is happening. But there can hardly be any permanent solution unless the total debt of the most heavily-borrowed countries is reduced. It may provide some consolation to feel cheered by a fall in total national debt, rather than being obsessed by the increase in government debt.

At least one might be looking at the real problem.

Brendan Keenan writes in the Irish Independent.

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