Labour’s spending plan could humiliate the Tories

"There is an alternative" - and it doesn't have to cost more than we're spending now.

“There is an alternative” – and it doesn’t have to cost more than we’re spending now.

It seems some people are upset that Labour has announced it does not intend to increase public spending, if elected into office after next year’s general election.

This is a perfectly reasonable reaction, depending on the amount of information available to the person holding that opinion.

In other words, if you don’t know why Labour has made this decision, it is perfectly reasonable to assume that the former Party of The Left has turned Tory-lite.

That’s why we’re hearing that Labour will simply continue Tory policies; that the main three parties are “all in it together” (to overuse a hackneyed and devalued phrase).

But evidence is available to suggest that this is a big mistake.

To finance extra spending, Labour would have to borrow more money – but this would push up interest rates and create a potential disaster for people with mortgages and loans to pay off.

According to Modern Monetary Theory – an economic method that seems to have earned credence with all the main parties – government borrowing is not undertaken to finance its spending, but to maintain a target interest rate.

In times of recession, businesses borrow more and households find it hard to save money for a rainy day (as the saying goes). We have spent most of the last decade either in recession or in the slowest recovery in British history and the private sector simply doesn’t have the spare cash to pay higher interest demanded on loans in the wake of higher government borrowing.

Labour wants to safeguard those businesses; Labour wants to safeguard your homes.

The alternative would cost any government much more in the long run.

It’s as simple as that.

So Labour has set a spending target that is the same as the Conservatives’, ensuring that interest rates can be kept under control.

This doesn’t mean it will continue with Conservative-led spending plans. That would be a betrayal of Labour’s core voters.

Instead, it seems more likely that Labour will seek to stimulate the economy by taking funding away from wasteful areas – this blog would certainly wish to see less public money given to private contractors who pocket half of it as profit – and investing it in economic growth.

With more money flowing through the system and coming back to the Treasury in taxation, it will then become easier to relax restrictions on interest rates, which will help the government with its debt issue (this has to do with the way governments borrow money, issuing bonds at fixed rates of interest, and is a story for another day).

If Labour’s plan works, it will mean humiliation for the Conservatives and the Liberal Democrats, as Labour will have spent exactly the same amount doing it as those other parties have been spending for the previous five years – to little effect.

Do not misunderstand; it is perfectly possible that Labour’s spending plans could be entirely wrong-headed! Labour spent most of the last 20 years experimenting disastrously with neoliberal thinking that, continued and concentrated by the Coalition government, has led us to the current pretty pass.

In this case, it seems the Devil really is in the detail.

But the overarching strategy is sound and Labour should not be criticised for it.

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30 thoughts on “Labour’s spending plan could humiliate the Tories

      1. Nick

        indeed mike he was at Cardiff uni last week getting his fellowship award at Cardiff university the day before my daughter got her PHD in European politics and international relations

        his fellowship award at Cardiff can be seen here 1 hour 8 minutes in to the broadcast

        mms://MGRAWWW01.cf.ac.uk/2014-150430hi

        just copy and paste the above link which will then open a box and then tick allow

  1. Penny Ledger

    Labour should put more money into care and support services which provide immediate benefits by employing people to prevent admissions to hospital and care homes, where the money is spent immediately and locally, generating VAT, PAYE and National insurance payments which go back to the government within a few days. This funds the next batch of payments.

  2. amnesiaclinic

    Why would labour have to borrow more money? There surely needs to be the money lost in privatisation recouped as you have said, but also the huge taxes from corporations not collected and the wasted billions from the bank bail-outs and the tax cuts going to the 1%. It seems that labour is not going to tackle what most of us 99% see as the problem – the continual shift of wealth from the masses to the elite.

    1. Mike Sivier

      I’m not sure about your last statement. This is one of the reasons I said the Devil’s in the detail. When we know more about Labour’s plans, we’ll know more about whether they’ll work.

    2. Florence

      I agree with Mike – we need to see the detail. But with some of the pledges – to end the bedroom tax immediately – there are some indications for a major change in direction. I think if the Condems have made anything crystal clear is that once elected, the policies of any party become much more flexible…….

      As for borrowing more money etc, I think that they are planning to use money differently – so that instead of paying A4e and Crapita and G4$ they will end the flow of money-for-nothing to these parasites to use for proper training for the unemployed. to start an immediate building programme, needing builders, and training up in the skills, and so on.

      I really do hope that the hints and clues to the real nature of the Labour government will come around. I just can’t bear to think about the alternative of a nation feeding off the free labour of 5 million who need benefits to crawl up to the poverty line. Of older and sicker people being forced to work for free. Seen the latest Grayling Bill – who thinks that “free childcare” to help people “volunteer” while reducing the potential for “Heath and Safety” legislation leading to increased litigation is about getting more people to volunteer? With the planned reduction of £12 billion from the welfare bill – which has to include pensions – and the revoking of international Human rights treaties, I would rather live in “fear” of higher Labour spending.

  3. Mike Sivier

    The economist Jonathan Portes has raised three points as follows:

    1) No evidence that interest rates driven by borrowing – look at last few years. Interest rates will go up anyway.
    2) Relatively little govt can do sensible about spending in-year – so sticking to plans for 15-16 is mostly just realism.
    3) – beyond 15-16, likely to be significant black hole in any govt’s plans – see @FlipChartRick blogs on this.

    I haven’t looked at those blogs yet as I wanted to get this up. Thoughts?

  4. John

    There is another aspect that will constrain a Labour government: contracts.
    Legally enforceable contracts entered into by earlier governments have to be honoured by any incoming government.
    Some early PFI contracts are still returning around 25 per cent return on capital employed and they are being bought and sold on secondary derivative markets.
    Many existing government contracts have built-in price increase clauses – like the aircraft carrier contracts, which are being delivered late and over budget. All these contracts have to continue being paid off for decades to come. So, a 5-year Labour government may well only make a tiny dent on this aspect of national public finances.

    1. Mike Sivier

      Good point, although if successful in some areas, Labour could use money saved/unspent to buy out a few of those PFI contracts. This is already being done in the health service and could save the country billions in the long run.
      PFI – a dumb Tory idea that a dumb neoliberal in the Labour Party thought was clever.

  5. hstorm

    MMT in fact asserts that the Government doesn’t need to borrow money at all, as such, except in emergencies. It stipulates that Government can simply create money and distribute it, then simply ‘wipe out’ all income it gets from taxation (which strictly speaking is what really happens to tax receipts in a computerised economy anyway – they aren’t hoarded and put in a ‘war chest’, as most people think, they are simply used to count down ‘amounts due’ to zero) to prevent inflation from surging out of control.

    A bit optimistic maybe, but increased borrowing is not really an essential part of the process.

    The ‘borrowing’, by the way, happens whether the Government wants it or not. A lot of what we call ‘public borrowing’ is simply people opening accounts with the Bank Of England, for which they have to place money in. As soon as the account is opened and the money is invested, the Bank ‘owes’ the investor the money, so officially it has been ‘borrowed’, only it’s a lot more passive than the term makes it sound.

    As there is nothing to stop the investors from putting the money in – nor indeed any good reason to stop them doing so – and an awful lot of people who need to do business through the BoE all day every day, it will keep happening, irrespective of whether the Public Sector makes use of the funds or not.

    It’s not a problem, and it never has been a problem, and nor is paying the money back with interest later.

    1. Mike Sivier

      Printing and distributing more money creates inflation, though.
      And in the normal run of affairs, increased borrowing would create increased interest as the person receiving the money would be an increased risk every time they came back for more. Jonathan Portes notes that this doesn’t seem to happen with the UK government though. Interesting?

      1. hstorm

        As I say, they can offset at least some of the inflation effect by simply wiping out any tax receipts over a prescribed period, rather than assigning the amounts into ‘public funding’. That way the money supply doesn’t expand too far or for too long.

        MMT’s main idea is that public spending should go up at times of economic hardship to prevent a recession spiraling out of control, but that it needs to be cut during times of prosperity to prevent market supply exceeding demand, which causes inflation – public spending doesn’t need ending, as neoliberals argue, but it needs inverse-balancing with private sector spending. When the private sector is sluggish, the public sector should pick up the shortfall and keep things ticking over, including by providing sources of extra employment, while when the private sector is working well, the public sector should reduce investment to keep things from ticking over too rapidly. To a small extent this happens by default anyway – a healthy economy tends to have high employment, therefore the amount the public sector spends on welfare goes down automatically.

        MMT also asserts that the Government doesn’t have to impose taxes in order to raise funds at all. Any time it needs to pay someone, it can just create the money. There are two reasons for taxing the population. One, it creates a demand for the nation’s currency, and so it makes sure the population doesn’t start trying to use a different nation’s currency, or other ways of doing business altogether. (Did you know that if you were to visit the Bank Of England to pay your income tax in cash, the notes you hand over will actually be DESTROYED once you’ve paid? The amount you’ve paid is credited into the computer system, at which point the money exists twice over – the notes themselves, and the newly-computerised credit, which constitutes an enlargement of the money supply. So they would have to shred the notes to make sure the sum doesn’t have any inflationary effect.) Two, by changing tax rates up and down, a Government can stimulate and cool down an economy according to how well it is doing. When the economy is doing badly, lowering taxes will encourage more spending. When the economy is doing so well that demand exceeds supply, a rise in taxes will discourage spending, and keep a lid on inflation.

      2. Mike Sivier

        A couple of thoughts that occur immediately, beyond the fact that I was aware of some of this already:
        Let’s look at what the Coalition has done. Employment is up, but tax receipts have not increased because pay rates are plummeting. From what you’re saying, this should cause problems because the system requires pay to be equitable. Yes?
        As for the Bank of England destroying money, what about commercial bank loans? When those banks lend out money, they don’t actually move any credit from their account to the borrower’s – they just credit the amount required to the borrower. That money is created by the bank, which then requires the borrower to pay it back with interest.
        My understanding of the ‘credit crunch’ financial crisis is that too many banks lent too freely, and then speculated too heavily with money they expected to get back from borrowers, and didn’t – because the borrowers were credit risks and were never likely to be able to pay back the loans. How was that allowed to happen, and is it possible to stop it happening again?

    2. John

      It is my understanding that the Bank of England only allows senior employees to open current accounts. They stopped opening accounts for others a long time ago.
      Unless you know different – for a fact?

  6. alittleecon

    Hi Mike,

    Your bit about interest rates is not quite right. It is mainstream economic theory that says increased borrowing by the government increases interest rates. This is called ‘financial crowding out’ in economics and means that if the government competes for scare funds that are available for borrowing, it will drive up rates. In reality though, this doesn’t happen because there isn’t a finite pot of savings waiting to be lent out. Government borrowing some money doesn’t prevent someone else from borrowing. Mainstream thinking also says that if the government borrows too much, it will ‘spook’ the markets and they will raise rates to take account of the perceived additional risk. This story has some truth for countries like Greece, Spain and Ireland because they gave up their currencies when they joined the Euro, and now their central banks have no power. That is not true of the UK however. If the markets ever did become spooked about UK government debt, the central bank could step in and commit itself to buying up any government debt that goes unsold at a rate of interest it chooses. In Japan for example, their government debt is well over double ours, but the interest rates on their debt are amongst the lowest in the world.

    Modern Monetary does argue that government borrowing is largely undertaken to maintain a target interest rate. This bit is quite complicated, but in essence if banks are holding too many reserves (these are the commercial bank’s deposits at the central bank, and too many means above the amount they are required to hold to ensure the payments system works), they will try an loan them out to other banks to get rid of them. If the whole banking system has too many reserves, the ‘overnight’ interest rate will fall to 0%. To prevent this from happening, government’s (through their agents the central banks) drain these reserves by ‘borrowing’ them (essentially swapping them for government bonds). If the government was happy with 0% overnight interest rates, it could just stop issuing bonds altogether and finance its spending purely from newly created central bank money, using taxation to prevent that spending causing inflation.

    So to cut a long story short, Labour’s (and Tory & Lib Dem) thinking around government spending is maddeningly conventional. It absolutely could and should increase spending (or cut taxes, or both) either through increased borrowing externally or from the central bank. This would not raise interest rates (unless the government were entirely negligent).

    1. Mike Sivier

      Isn’t the idea of maintaining a target interest rate what I was suggesting, though? I may have been doing so in a very bad way.

      Whatever happens, the impression I get is that Labour reckons it can manage what the Coalition parties haven’t, starting with the same resources and working up from there. I don’t know whether that is possible. From what you’re saying here, it seems you think they’re too wrapped up in ideas that don’t work and won’t be able to manage it.

      Is that about right?

      1. alittleecon

        The idea on interest rates is that a government can run a deficit without borrowing at all, but if it did that, overnight rates would fall to zero (and most other interest rates are based on these rates). Most Modern Monetary Theorists think this is actually desirable and that we should use taxes to control inflation and just keep interest rates low all the time.

        If we’re talking about doing better with the same resources though, I think the difference is going to be marginal. It then basically comes down to who’s more competent at managing the country. The guys at the top of Labour went to the same universities as the top Tories, so I don’t have a great deal of faith that they’ll be much more competent than the Tories. That doesn’t necessarily matter though if they have better ideas. Big ideas tend to cost money though in the short term (although they could save money over the longer term), so if you start from a position of no additional spending, the range of options is unnecessarily restricted.

        It’s actually quite difficult for a government to target a certain level of borrowing in a given year (as George Osborne has found out), because you can’t be sure what your outgoings will be or what your income will be. It will always depend on the health of the economy. The government can influence real things though. For example if there are not enough jobs, it can make sure there are by simply creating some. If there are not enough houses it can ensure there are by building some. Both these things cost money short term, but long term will grow the economy, cut the social security bill and increase tax revenues.

      2. Mike Sivier

        I certainly think you’re right about creating jobs and housing; for one thing, this government has proved that cutting public sector jobs recklessly can have a disastrous effect on state-run operations.
        What about some of the things Jonathan Portes has mentioned, such as his assertion that a new government can’t change that much, spending-wise, in its first year? This is supported by comments that contracts signed by previous administrations must be honoured.

      3. alittleecon

        Day to day spending like how much is spent on running schools, hospitals, defence etc, will probably be pretty fixed for the first year. No reason why they couldn’t spend on job creation or house-building straight away though. If you remember, when the Coalition came in in 2010, the announced straight away they would implement £6bn of cuts in that year. Labour could do the opposite to that.

      4. Mike Sivier

        Yes, and they could use money re-routed away from private sector parasites to do so!
        I seem to recall that house-building has already been announced as a Labour priority (for obvious reasons – there is built-in (sorry) job creation as well as the infrastructure benefit of having the extra accommodation that this country needs).
        I hope to see extra jobs created – especially in the public sector where the Tory experiment in cutting jobs has created such a mess.

  7. John

    Governments borrow on the international money markets and roll-over debt.
    This is why the euro zone has had so many problems where countries like Greece, Spain, Italy and Portugal are concerned.
    This is also why so much notice is taken of the international credit rating agencies, as their ratings determine the discount or interest rate that will be applied to countries needing to borrow large sums of money on the international markets.

      1. John

        You have a point in this specific instance but the credit rating agencies are not everything. After all, they were the principal agents involved in the massive crash in the USA; after all, they were totally implicit in rating mortgage-backed “securities” which they valued falsely as being of far greater value than they actually were.
        There are some among the senior ranks of the Labour Party who have connections with some of these agencies and firms of accountants who also made money.
        Nevertheless, these ratings have affected euro zone countries and could, under certain circumstances, affect the UK economy too.
        To date, it has been beneficial for Britian to retain the Sterling currency but previous experience has thrown up occasions when Britian stood alone financially – remember Black Monday? Remember Denis Healey having to cancel his trip abroad?
        If international currency speculators target Britain under a Labour government, the same sort of financial and economic nastiness could once again apply to the UK.

      2. Mike Sivier

        Yes of course, we could have a repeat of that 1992 fiasco. Nigel Farage is very good friends with the people who triggered that particular calamity, it seems.

      3. John

        And – from memory – George Soros, who – I believe – made around $1 billion profit?

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  9. beastrabban

    Reblogged this on Beastrabban’s Weblog and commented:
    Mike defends Labour’s plans not to increase public spending by stating that increased borrowing would increase the pressure on people already feeling the pinch through loans and mortgages. All Labour has to do to humiliate the Tories and Lib Dems is concentrate public spending where it’s really needed – on the victims, and increasing the quality of public services, rather than giving money to outsourcing contractors to pocket as profit.

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