Thursday, 4 August 2016

A reply to Richard Murphy

By Tom O'Leary
The great potential of argument and dispute is that it leads to clarity of thought. Richard Murphy has done the left great service. In his broadsides against John McDonnell's policy framework he has shown his own utter confusion. In this way, clearing up these confusions and clear misconceptions about economics nd economic policy provides an opportunity to clear out some dead wood from the left's economic thinking. That the Murphy objections are unfortunately shared by a number of people who falsely believe that they are 'keynesians' or even Marxists only makes the task of clearance more important.
The John McDonnell framework is that there should be a balance on the current, or day to day Government spending over the business cycle. Borrowing should be reserved for the Government investment. Murphy acknowledges this in his piece. But he seems to have no understanding of what this means. As a result his critique of the McDonnell framework contains howlers. So, he argues that a commitment to balancing the current budget means McDonnell will 'dampen the economy and at least partially withdraw cash from the economy' at a certain point of the cycle. He also argues that the same commitment to balancing the current budget means being committed to austerity. Both of these points are nonsense.
The McDonnell framework places no upper limit on the level of Government investment at all. In the probable economic crisis McDonnell and Corbyn will inherit, Government will need very large borrowing for investment over the longer term, more than one parliament. Government will be boosting the economy for many years to come. The increase on the productive capacity of the economy via investment also means that capacity constraints are way off into the future.
Austerity and the deficit
This large scale increase on investment is not only the alternative to austerity, it is the opposite of it. Tory austerity is comprised of two elements. These are very deep cuts in public investment but public current spending has actually risen. This is not because, as some wild-eyed Tory MPs like John Redwood claim, because there has been no austerity. The cuts have been severe and deep. Women have borne the burden of them, and we await a study showing how black and Asian communities have suffered disproportionately.
But cuts to Government current spending and investment have not led to the elimination of the deficit. The deficit has not fallen at all because of austerity. George Osborne never understood why and it appears Richard Murphy doesn't either.
The deficit has modestly fallen because of modest growth, caused by monetary easing, a falling pound, lower interest rates and Quantitative Easing. This has led to moderately rising tax revenues, not falling Government spending. It is growth that reduces the deficit. It is only growth which can eliminate it. This is exactly what John McDonnell intends.
How is this to be achieved? By increasing Government investment on a sufficient scale to restore robust growth. In this regard, Richard Murphy seems ignorant of two crucial facts.
  1. Any deficit is comprised of two components, expenditure and receipts. A commitment to eliminating the deficit says nothing at all about the level of expenditure alone. Deficits can be eliminated by increasing revenues, either through rising economic activity or (something Murphy ought to know about) tax reform to ensure lower tax evasion.
  2. The deficit on the Government's current account is caused by economic weakness, primarily the weakness of private sector investment. Cuts to Government investment simply deepen this crisis. Therefore any increase in Government investment is expressed first as an increase in economic activity. This in turn is felt as an improvement in Government revenues, as tax rises and Government outlays on poverty fall. This is because the returns on an increase in Government investment come not to the investment account but to the current, or day to day spending. 
To illustrate this point, the Joseph Rowntree Foundation recently issued a report showing household poverty creates a cost to public sector current spending, the biggest cost of all falling on the NHS. The estimated cost is £78billion per annum, almost exactly the same as the total level of the public sector deficit. Put another way, eliminating poverty would eliminate the deficit.

But eliminating poverty cannot be achieved by increasing NHS spending (Government Consumption). Poverty could be eliminated by a very substantial increase in investment, led by public investment. This should create high wage, high skill jobs. It reduces the Government's outlays on poverty and increases the Government's tax revenues. This is what McDonnell means by eliminating the deficit on current spending. It is not cuts, but investment.

Economic Howlers

All of this passes Murphy by. Instead, he argues that the Government should be the 'borrower of last resort', but actually means that the Government should always run a current budget deficit. Otherwise, 'cash is withdrawn from the economy', by which he probably means that the private sector as whole will be obliged to reduce its net surplus.

Currently all three components of the private sector are running a surplus, the household sector (which should have net savings but has to deplete these because of the crisis), the company sector (whose large surplus consists of uninvested profits) and the overseas sector (composed of foreign investors who have been lending to the UK at a record rate, but may choose not to at any point).

These are the counterparts of the Government deficit. But no progressive, or Keynesian economist, or any socialist, would regard either an investment strike and profit hoarding by UK companies as a positive, or increasing indebtedness to overseas speculators as a welcome development. Yet these are the counterparts of permanent public sector current deficits, which Richard Murphy advocates.

But he also goes much further in an attempt to theorise his hostility to Corbyn/McDonnell and their economic framework. In a follow-up piece he argues that there is an identity between Government Investment on the one hand and Savings plus Imports on the other, and that Government Investment has no impact on Consumption at all (!):

'In other words what the identity suggests has happened: what has been considered to be desirable investment has not lead to a growth in net consumption, which is what maters to most people. That's not to say that there has been no growth, but most people have not benefited.'
This is an economic howler, which would produce a Fail for an Economics A Level student. Investment, Savings, Taxes and GDP, etc. are not fixed amounts. The factor which increases the aggregate total is Investment. Increased Consumption requires first increased Investment. Under Murphynomics the Industrial Revolution was a waste of time. Government should have increased borrowing to buy more gruel instead.

Consumption versus Investment

Keynes, unlike the self-styled 'keynesians', was very clear that the decisive factor in economic growth is investment. Against his critics, he argued that this was the central theme of his 'General Theory'. This is an important point of agreement with Marxists and indeed most rational economic schools. Marxists are in favour of the development of the productive capacity of the economy (the 'productive forces'). Keynes, in seeking to regulate the level of investment in order to prevent slumps accepted the need for a 'somewhat greater socialisation of the investment function'. By contrast the 'keynesians', like Osborne seek to regulate the consumption function, and let big business and the banks determine the level of investment in the economy. It is their non-investment which is responsible for the current crisis.

Murphy charges McDonnell of seeking no fundamental change in the economy. Like virtually all of his charges this is posted to the wrong address. It should be a self-criticism of the 'keynesians'. British post-WWII relative and spectacular economic decline was accompanied by and in part a product of 'keynesian' demand management and permanent deficits on the Government's current account. This is the status quo.

A key reason why the current leadership of the Labour Party is so vilified is precisely because its domestic agenda breaks with that status quo. A very large increase in Government Investment would entail in Keynes' term, some increase in the socialisation of the investment function. In Marxist terms the state would increase its ownership of the means of production. This is desirable for economic and democratic reasons, and is something which has been fought against by every British Government after Attlee.

Richard Murphy has betrayed his own lack of economic understanding with his misjudged attacks. But if others can learn from his mistakes, clarity can come from confusion.

4 comments:

Lyn Eynon said...

Thanks for this. I’ve been trying to argue similar points with Murphy on his Tax Research blog, although he tends to block comments he finds difficult to respond to, particularly where they provide evidence, such as references to McDonnell speech to the RSA on 11 March. I did get an admission from Murphy that he had ignored multipliers in his attempt to ‘model’ McDonnell’s fiscal rule to show that it would not increase consumption, which of course invalidates the whole exercise.

It’s not strictly true that “The McDonnell framework places no upper limit on the level of Government investment at all.” The constraint comes from his commitment that he will “commit to ensuring that, at the end of every Parliament, Government debt as a proportion of trend GDP is lower than it was at the start.” This implies an upper limit on investment depending on the level of inherited debt and the assumed trend growth in nominal GDP. But as I pointed out to Murphy, with low-end estimates for these and balance on day-to-day spending, that would allow McDonnell to spend double what Smith has promised in his ‘British New Deal’, an estimate I then saw McDonnell confirm in his Sunderland speech. That said, if the next Labour government inherited a significant deficit on day-to-day that could bite into investment if the commitment to reduce debt to GDP over a Parliament is to be met. So the wording needs to be finessed.

I have seen it asserted from the ‘left’ that any fiscal rule means austerity. The obvious response to that is “it depends on the rule”. On my estimates, the practical limits on expanding investment (resources, skills, planning, etc.) will be more constraining than any financial limits implied by McDonnell’s rule. On day-to-day spending, we could avoid austerity within a balance target by measures such as tackling tax dodging or cutting unnecessary spending (e.g. Trident), while growth itself would help to boost receipts and reduce expenditure. There are risks in excessive borrowing that puts power in the hands of creditors, as Greece and Argentina have learnt.

It also being claimed that McDonnell’s rule means that we could build schools but not employ any teachers to work in them. My response is that this confuses economics and accountancy. I do not believe “investment” has to mean Gross Fixed Capital Consumption. If we need to invest in training, then we should do so and – if necessary – through a specific fund that we would separate out from our commitment to day-to-day balance. As long as we can justify that politically, then I see no objection to not following strict ONS definitions.

Murphy is also claiming that by abandoning PQE for his fiscal rule, McDonnell has moved to the right. He has also implied that Smith is sympathetic to PQE but when I asked him for a reference he admitted he had none. As I understand it, McDonnell still sees PQE as an option (I heard him say that in Bristol a few months ago). Indeed, it might soon come back onto the agenda. If the BoE opts for post-Brexit QE, then McDonnell should certainly argue that this is used to buy new investment bonds, rather than just purchasing existing assets. Doing so would be a challenge to Smith.

Neil Wilson said...

" I do not believe “investment” has to mean Gross Fixed Capital Consumption"

You might not believe it, but that is what it means in the national accounts. And therefore with anything less than about 10% GFC production by government you will have an unbalanced current budget and consequent political suicide.

You don't get to decide the national accounts rules. They are an international standard.

In other words the whole 'rule' is a hostage to fortune unnecessarily. Similarly the view of investment taken in this article is a naive view in a financialised world. There is no mention of the Minskian processes that brought about the 2008 crash, and an discussion of how you have to proscribe bank's asset choices is you want to make investment investment in productive capacity.

Additionally none of this spending addresses the matching issue within the job market and is little more than high end pump priming that will run rapidly into supply side restrictions and likely cause inflation issues.

There is no reason at all to balance the current budget. If you simply give the poor money to spend then you will induce an increase in production from the existing capital base, which naturally increases productivity. That will then crowd in some private investment to increase the capacity to handle the increase in demand.

The issue is simple. The state has no control over the size of the deficit because it is driven by the saving desires of the non-government sector. And if you spend from the Ways and Means account at a net rate of 0% then there is no economic advantage in removing savings from people. Let them count their coins if it makes them happy. They gave you real output in return for nothing other than electronic impulses.

Remember that most of the 'deficit' is backing for private pensions.

The fiscal rule should be the functional finance rules.

1. The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes.

2. By borrowing money when it wishes to raise the rate of interest, and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.

3. If either of the first two rules conflicts with the principles of ‘sound finance’, balancing the budget, or limiting the national debt, so much the worse for these principles. The government press shall print any money that may be needed to carry out rules 1 and 2

Government can then concentrate on what public provision is required for the public good and to support the production of the private sector without worrying whether it is classified as 'investment' or whatever in a modern service economy.

And you can introduce a Job Guarantee as a backstop for the entire system - which ensures that everybody has access to a living wage job and an income for £1625 per month.

Neil Wilson said...

"There are risks in excessive borrowing that puts power in the hands of creditors, as Greece and Argentina have learnt."

That comment in itself demonstrates a lack of understanding of how a sovereign government with its own floating rate currency works.

The UK has no debt in a foreign currency. Greece and Argentina operate in foreign currencies they don't control (Euro and USD respectively).

There is no comparison with the UK. This is fixed exchange rate thinking that simply doesn't apply to the UK. A the Whole of Government Accounts show, government 'debt' is a liability of the National Loan Account, and Bank reserves are a 'debt' of the Bank of England. Since HM Treasury owns the bank of england, moving one to the other is a simple intra-group transfer. The assets of the non-government sector stay the same.

There is no need to pay interest on government debt, no need to issue it, and no need to get hung up about it. The bank reserve layer in the Sterling framework is a closed system.

T O'Leary said...

Neil, thanks for your coments.

You raise many issues but I want to deal with only the most important one, which is how to end this crisis.

This is where you say that, "if you simply give the poor money to spend then you will induce an increase in production from the existing capital base....that will then crowd in private investment".

This is a restatement of the classic under-consumptionism. Based on the idea that demand will create its own supply.

As a matter of economic theory this is completely wrong. Production proceeds consumption and determines it. Nothing can be consumed which is not first produced. Therefore it is only possible to sustain an increase in Consumption if the production is increased first. This increase in turn can only be sustained if there is an increase in the means of production, which requires Investment.

All theory must be able to explain reality. Recent British economic history provides a good test of the notion that, if Consumption is Increased then Investment will follow. Since 2008 Consumption in the UK had recovered and is higher now than before the crisis. But Investment isn't higher. It hasn't recovered and is now actually falling again. Demand hasn't created its own supply at all.

Osborne pre├žisely helped poorer people to buy homes via Help to Buy. It didn't boost housing, which requires investment. It did boost prices. In other areas boosting Consumption has simply boosted imports.

This is because the private sector does not exist to meet demand, but to make profits. Businesses met demand from existing capacity. They have not increased capacity via Investment. In some cases existing capacity has even been scrapped. The capital stock has actually fallen while Consumption has risen!

I hope to be able to give a fuller reply in the near future.