Tuesday, 13 October 2015

Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne

By John Ross

If Osborne’s Charter for Budget Responsibility, which seeks to ban all government borrowing over the business cycle, was read naively you would assume it was written by an economic ignoramus who does not understand the difference between investment and current expenditure. But of course its economic howlers do not flow from ignorance but from a deliberate attempt to obscure issues which is driven by an ideological agenda to prevent the effective way for the economy to grow – by the state investing when the private sector does not.

In this deliberate attempt to obscure elementary economic realities Osborne is aided by sections of the media, such as the @bbcnickrobinson or @JohnRentoul, who equally talk about the budget ‘deficit’ without distinguishing between investment and current expenditure – although in their cases pure economic ignorance cannot be ruled out. However as other journalists such as @afneil (Andrew Neil) are capable of perfectly correctly understanding and expressing the issue, whatever their differences on other questions, it is more likely that some media comment follows Osborne’s deliberate attempts at confusion. As Osborne claims to explain things in homely ‘family terms,’ and as 'common sense,' we will do so equally – a second article will give a more formal economic statement related to present economic conditions.

The nation’s credit card and the nation’s house purchase mortgage

Virtually every family in the country in fact understands the difference between borrowing for investment and borrowing for current expenditure because that it how they organise their finances. To take Osborne’s analogy of the ‘credit card’ anyone who simply continues to run up debts to buy groceries on their credit card (current expenditure) without being concerned about whether they can repay them is heading for financial trouble. But no rational person decides to buy a house (investment) by first saving up the money and then buying the house – they take out a mortgage to do so.

This difference is even expressed formally in a balance sheet. If money is spent on food or other current expenditure there is an expenditure item and no corresponding asset – the expenditure has just been consumed, both literally and in economic terms. But the expenditure on the house has a corresponding asset – the house. This is a reason the borrowing for the house is entirely rational while ever increasing borrowing for current expenditure is not.

Osborne’s ‘Charter for Fiscal Responsibility’ is an attempt not only to limit expenditure on the credit card but to make it illegal to take out a mortgage to buy a house.

How factory machinery is financed

Another analogy, in this case from business, makes the situation equally clear. A company does not finance purchase of machinery, for example to build cars, out of its cash flow. It borrows the money, buys the machinery, and then repays the loan from the production. If it did not do so, and waited until it had saved the money for the machinery from current cash flow, that company would be totally outcompeted by companies which had borrowed the money, purchased the machinery, could now produce more efficiently, and had therefore gained a competitive advantage. That is why borrowing for investment is not merely economically rational but necessary.

George Osborne tries to obscure these elementary economic truths for his ideological purposes – he prefers the economy not to grow rapidly, and people to be poorer, unless it is done by the private sector. Sections of the media, by talking about the ‘budget deficit’ and borrowing without distinguishing between investment and current expenditure either are economically illiterate or themselves attempt to deliberately obscure elementary economic realities.

John McDonnell’s position has so far been correct. There is a clear economic difference between consumption and investment. The government should not borrow for consumption over the course of the business cycle. The government should borrow for investment. Osborne’s  ‘Charter for Budget Responsibility’ should be amended to allow borrowing for investment. If it is not permitted to amend it, the Charter should be voted against. That has become Labour’s position and it is the correct one.

1 comment:

Londonschild said...

I have no doubt that MCDonnell is right re the nonsense of the Charter however he was politically inept in that he did not put these arguments from the beginning. I have an uneasy feeling that this will be a pattern where Labour will win the evidence based arguments and loose the political ones.