Good Grief, Not That Analogy Again | TheCritique Archives

It seems to have taken more than five years for the following argument to make it from the doorstep to the TV debating programme – five disastrous years for British politics, in which people who simply don’t understand the workings of the economy have been able to pretend they do, simply by waving their credit card at you and saying “maxed out”.

These are the people who voted Conservative in 2010 and 2015, in the mistaken belief that George Osborne had told them something approximating the truth about how the economy works.

Silly, silly people. George Osborne doesn’t understand the economy himself, so he’s hardly in a position to explain it to others.

It’s true – This Writer had an argument with the Treasury about Osborne’s economic policy a few years ago, pointing out that it was based on a theory that, itself, is based on a spreadsheet mistake. The responses I received tried to justify Osborne by pointing at other academic literature – which was also based on the same mistake.

I was watching BBC Question Time on Thursday evening, and would have written something similar to what follows if I had not been duty-bound to be elsewhere for most of yesterday. Martin Odoni got there first, on his excellent blog, The Critique Archives. He writes:

I should know better than to watch BBC Question Time… I was soon listening to one of the most obtuse audience-members Question Time has ever had. He said, as follows; –

‘Economics is really simple. I’ve got ten pounds in my pocket. If I go out and buy three pints of beer in Cambridge, I’m probably borrowing money. If I carry on doing that, then I’m gonna run out of money, and I’m gonna go bust. It’s not difficult, guys.’

So yet again, Joe Public thinks the words ‘economics’ and ‘budgeting’ are freely interchangeable. I was mentally screaming at my PC screen as he spoke, something I do a lot when watching Question Time, which is one of the reasons I tend to avoid it these days. But this was particularly maddening, as it reminded me that way too many people still think that they can use their private incomes as an analogy for a national economy.

The guy in the audience did not help himself in that he chose to make the comparison while arguing with Yanis Varoufakis, one of the better-informed economists in all of modern Europe, and sure enough Varoufakis slapped him down with relaxed ease.

But we should still make no bones about this; the guy in the audience is completely illiterate economically. Not just slightly, completely. [bolding mine – VP] And so is anyone who agrees with him. For not only does a national economy work differently from a household budget, it in fact works the opposite way in several critical respects, as any activity put in has feedback effects that do not happen to the money people spend when they ‘go out for a few drinks’.

Let us compare; –

A household budget is linear; the household receives money at the beginning of the line, what we call the ‘income’, saves it for a while, then spends it at the end of the line, what we call ‘outgoings’. Before and after this line, the money is not part of the household budget.

An economy is a circle. The Government issues money via the Central Bank to pay for services, the money goes round and round the population, and then eventually it arrives back at the Government in the form of tax, whereupon more money is issued to pay for more services, and round it goes again, ad infinitum. The money does not leave the economy at any point in this circle (except when used for foreign trade, but even then it will probably soon be back).

Cutting spending in your private life is likely to result in you having more money, certainly. But for the nation’s Exchequer, cutting public spending usually means also reducing the income heading the other way, so it may not result in having more money. In fact, it can be a very delicate calculation, sometimes even dependent on luck, establishing what to target spending on, how much to spend in order to get the right feedback, and predicting precisely how much the feedback will be.

What is this calculation? Well, the term whose meaning we can be sure the guy in the checked shirt is unaware of is ‘fiscal multiplier’.

Now visit The Critique Archives to learn why – and discover the effect of George Osborne’s childishly illiterate economic policies on the UK economy.

Source: Good Grief, Not That Analogy Again | TheCritique Archives

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10 thoughts on “Good Grief, Not That Analogy Again | TheCritique Archives

  1. Matthew Goldsmith

    I know very little about economics but when I do put the effort into understanding certain terms or calculations it turns out to be a lot simpler to understand then I originally thought it would be. Based on this I would assume that the fiscal multiplier when explained or studied by the general public would help people to understand why the bank bailouts were a bizarre decision and why corbynomics makes a lot more sense.

  2. Norma Roberts

    Perhaps basic economics should be taught in our schools? Then again, the powers that be probably do not want us to know how it really works.

    1. Mike Sivier Post author

      I thought economics was taught in school – it certainly was in my day (albeit only in the Sixth Form). Trouble is, there are plenty of different interpretations – as we can see with the Neoliberal v Keynesian argument we’ve been having for the last five years and more.

  3. mohandeer

    I have been studying economics in an informal way for a while (twenty odd years), I too was watching BBCQT and threw my arms up in the air and yelled at the chap with the check shirt.” It’s not difficult guys” had me howling with laughter and saying out loud “obviously is for the numbskulls like you” ( at which point my dogs had had enough of me shouting at the tv and buggered off into my bedroom). I could not believe that there are people out there who know so little about economics and how the country’s economy works. That was truly one for the books. This unfortunately means that Corbyn and McDonnell are going to have a struggle on their hands “explaining” Corbynomics, PQE and a number of other terms. If Yvette Cooper, who purports to be an economist can’t get her head around something as simple as PQE (when applied correctly) what hope has the rest of the Labour Party?

  4. John D Turner

    “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.

    Osborne admits of no influences, intellectual or otherwise, so he is his own madman in more ways than one!

    On the other hand, Jeremy Corbyn’s scribbler is still very much alive, but, to be fair to Richard Murphy he is not, by his own admission, much of an economist as he only studied the subject as part of a degree he took at the University of Southampton before going on to specialise in bean counting, sorry, accountancy and tax. And he is certainly no labour market (or construction sector) expert, given his continuing assertions that the capital expenditure planned to be financed through Peoples Quantitative Easing poses no inflationary risks.

    For those of us who remember a rather fractious ménage à trois of the late Thatcher years, Richard Murphy looks all set to become the poor man’s Alan Walters to John McDonnell’s Nigel Lawson with Corbyn standing in for the blessed Margaret (which is rather apt given that both Corbyn and Thatcher share a reputation for being nothing, if not conviction politicians).

    Seriously, I do strongly recommend that everyone studies economics in depth, in an informed way and in the round. Start by studying positive economics and only then move on to normative economics (http://www.investopedia.com/ask/answers/12/difference-between-positive-normative-economics.asp). You will, in the process, learn, amongst other things, about the Multiplier Effect (and its potential limitations) and that the only certainty in economics is that, quite often, there is no certainty!

    I would definitely suggest that the writer of the quoted post makes a better study of the circular flow of income (https://en.wikipedia.org/wiki/Circular_flow_of_income#Five_sector_model) before making statements like, “The money does not leave the economy at any point in this circle (except when used for foreign trade, but even then it will probably soon be back).” The money that does leave the economy is that which is spent on imports, ranging from food to cars to railway trains to foreign holidays, and the last time I looked we are big on such leakages. And when imports exceed exports one gets trade deficits wherein the money does not come back!

    Incidentally, any serious student of economics would know that allowing one or more UK clearing banks to collapse would have been a disastrous decision. That so many, not all on the left, would even contemplate not bailing out a clearing bank shows how deep and widespread economic illiteracy is in the UK. A level of illiteracy that seemingly suits both Osborne and Corbyn.

    Lack of financial literacy among voters is a ‘threat to democracy’ (http://www.theguardian.com/politics/2015/mar/16/lack-of-financial-literacy-among-voters-is-a-threat-to-democracy)

    Post-crash economics: some common fallacies about austerity (http://www.theguardian.com/business/2013/nov/21/post-crash-economics-austerity-common-fallacies)

    Post Crash Economics Society (http://www.post-crasheconomics.com/)

    By the way, given that cumulative Personal National Debt matches in size that of the Government National Debt it follows that voters, whilst worrying about debt over which they have little or no control are quite relaxed about that over which they have a much greater degree of control. Moreover, confusingly, they worry about a National Debt (mortgage) of less than one year’s National Income whilst taking out mortgages that are a multiple of their annual household income …

    The voters, as evidenced by their attitudes towards their own and the Government’s finances, are perverse or, as Winston Churchill put it, “The best argument against democracy is a five-minute conversation with the average voter.”

    Given the historically low interest rates at which the UK Government may now borrow, we have the option to refinance our existing National Debt and thus incur lower interest rates going forward. Households refinance when they re-mortgage so, yes, sometimes there is a correlation between how Governments and households behave. By the way, that opportunity to refinance is a rational argument against using Peoples Quantitative Easing as a way of funding increased Government capital expenditure, because we may borrow enough from the money markets to both refinance and invest.

    Corbyn’s £120 billion of public investment is rather lacking in aspiration. Under Blair and Brown, we would have expected that £120 billion to be at least matched pound for pound by the private sector. In the case of Advantage West Midlands, it was estimated that at the end of AWM’s life £1 of its expenditure was pulling in £8 from other sources, including the private sector. Under Corbyn, the private sector will have a big say in where the money is spent; will get most, if not all of the contracts for delivering the spend; will be the prime beneficiaries of the resulting increase in the UK’s capital assets and all, seemingly, without putting any of their own money in. Big business has currently little or nothing to fear from Corbynomics.

    No wonder then that a hedge fund manager has been quite positive about Corbyn’s proposed approach? Who would be opposed to seeing the value of their hedge fund increasing without having to spend a penny? One might almost think Corbyn is seeking to set out to prove that there would be such a thing as a free lunch (for parts of the private sector) if he became Prime Minister.

    1. Mike Sivier Post author

      Wow – long comment!
      Osborne admitted being influenced by Reinhart and Rogoff. That’s why he dug in his heels when they were proved wrong. Note that he relaxed his austerity after the mistake was revealed, though.
      What do you think of the new economic panel set up by John McDonnell?
      I would be extremely wary of any suggestion that Blair and Brown’s encouragement of private-sector investment in public-sector services was a good thing. The effect of PFI on everything it touches is crippling. That’s not the same as the public sector providing the money and contracting the private sector to provide services – in such a scenario the private sector would be bound to do exactly as the government requires and would not have a say in where the money is spent. Of course the private sector would benefit; the idea is to expand the economy. That’s why Corbyn and McDonnell aim to close the tax gap. In every other respect, though, why should big business fear Corbynomics?

      1. John D Turner

        Sorry! Economics is an odd subject. We are affected by what the study is about throughout our lives, but most remain (blissfully?) ignorant about it. Thomas Carlyle referred to it as the dismal science so I well understand why people would wish to steer clear of it. One, therefore, is unsure how much to explain.

        For example, the demand for domestic energy in the UK is price inelastic (as is the demand, seemingly, for the traditional route to a degree) and what that means is that the demand for energy is unlikely to fall much, even if prices rise by quite a lot. And the domestic energy market is one operating under conditions of oligopoly. Price inelasticity plus the six company dominated market explain why prices move very little, either up or down. There is a few hours in just unpacking those three sentences (and I could throw in my, thankfully short, experience of working for the electricity regulator to flesh out the explanation).

        I had to look up Reinhart and Rogoff. Did they decide their conclusion first and then look for data to back it up or start with the data and see where it lead them? You are supposed to do the latter and be cynical about anyone who opts to do the former, regardless of their politics! Milton Friedman, when asked why monetarism had failed in the UK in the 1980s responded by saying Mrs Thatcher had not applied his theories in the right way. The economist blaming his tool?

        I think the panel is rather interesting, because they have a Council of Economic Advisers in the USA and in Scotland. The latter includes business people. All McDonnell’s members seem of like mind and are mostly macro-economists so I think a wider group, broader mix and/or ad hoc co-optees would command greater credibility. I am all for a bit of creative tension or, if you prefer a free and frank exchange of views. Without details of how the committee will work it is hard to judge its role. Sounding board, scrutiny committee or developer of policy or all three? Time will tell. Although, Bernard Shaw did say that if you laid all the economists in the world end to end that they would not come to a conclusion so …

        As the former chair of governors of a school, two thirds rebuilt courtesy of PFI, I must declare an interest. The reality is that the sleight of hand of PFI made it possible to tackle 18 years of under investment in the public realm without jeopardising the chance of achieving a second term by either massively increasing taxes and/or public borrowing. Realpolitik trumped the alternatives. And I would rather have had a 100% new school through PFI than no school at all as without the investment it would have closed. Saying that, the Value For Money of each PFI scheme needs to be assessed against whole life project costs, usually around 30 years in the case of most projects, and the hard to quantify social returns of say, keeping a well loved local school open. One should avoid being seen to know the price of everything and the value of nothing. We now may buy out the remaining PFIs and bring that experiment to a close. I bear a fair few scars from being a ‘customer’ as a civil servant!

        Much of the £120 billion is designed to improve the productivity of the economy so it must be to the benefit, in the main, of the private sector, although I would expect both the public and voluntary and community sectors to be lesser beneficiaries of any investment. The private sector must, therefore, be asked what they want, regardless of how the finance is raised, or else the expenditure may not reap the maximum amount of outputs and outcomes possible. My point is that, in the past, we expected them to at least provide 50% of the cost of any project like, for example, the money needed to assemble the amount of land required to create a brownfield site of sufficient size for redevelopment. In many cases, their contribution was much greater than 50%. The public investment acting as seed corn to attract or a catalyst to unlock significant investment from all three sectors of the economy, but preferably from the private sector. Heseltine has argued for much greater direct private sector contributions for projects like HS2. He has a very good point there. After all, if they will not contribute to a project then is it worth the public sector spending any money? It is worth mentioning that such grant aid is only claimed by the applicant after the applicant has spent their own money up front. A bit like getting your expenses re-imbursed!

        The big issue in spending £120 billion and achieving VFM is procurement. I would suggest that legislation to reform public procurement should be a higher priority than renationalising those elements of the rail network not already in public hands. I would like to see John Seddon (and perhaps people like me) being consulted by the Labour Party as much as macro economists. We know where the shoe pinches.

        Seddon writes on http://www.theguardian.com/profile/john-seddon and I strongly recommend everyone concerned about good quality, personalised public services, delivered (mostly) by the public sector with an eye to reducing costs over time, read http://www.triarchypress.net/the-whitehall-effect.html He talks a lot about single tender procurement which fell out of fashion in the public sector about 20 years ago. I actually undertook such a procurement have surprised people when explaining how it works.

        http://www.theguardian.com/public-leaders-network/blog/2011/sep/29/universal-credit-fail

        http://www.theguardian.com/public-leaders-network/2012/oct/11/locality-public-sector-scaling-design

        Incidentally, if Labour wants to reconnect with public transport users and workers lacking the clout of the media and trades unions then it should be talking about buses not trains. A small investment in buses will affect more people across more parts of the UK (and in more seats that Labour needs to win) than a similar amount invested in rail. That is what I regard as good VFM!

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