UK Government - More Madness

The madness of UK economic policy has ratcheted up another notch. It is impossible to have missed the latest headlines. This is what Alastair Darling had to say about the cut in VAT:

"This temporary reduction is the equivalent of the Government giving back some £12.5 billion to consumers to boost the economy. It will make goods and services cheaper and, by encouraging spending, will help stimulate growth."

I will translate this statement as follows:

'This temporary reduction is equivalent to UK consumers borrowing £12.5 billion, and will replace the borrowing that consumers are no longer able to obtain with government borrowing instead. Government borrowing will allow less tax to be levied on the sale of goods and services, making them appear to be cheaper, but really it is buy now pay later credit, and this will help stimulate more shopping for goods and services, because consumer shopping = economic growth'

In other words, if consumers can no longer borrow to buy their brand new plasma TVs, the government will now subsidise the purchase of the TV through government borrowing. Buy now - pay later becomes government policy. The real worry is that, at the heart of this economic thinking, there is a belief that consumer spending equals economic growth. Whilst consumer spending creates more activity in an economy, it is only represents real economic growth if it is not funded by borrowing. In other words, economic activity only equals wealth when the economic activity is derived from the transfer and distribution of wealth from productive activity such as manufacturing, the the export of services, or the extraction and processing of commodities. Economic activity built upon borrowed money is spending of future wealth.

Assuming that this cut creates an increase in economic activity (which I doubt), it is fools gold.

The result of this particular foolishness has been a record rise in the FTSE, which just provides further evidence that the city needs to find some new economists. However, we have been here before. If we look back at the banking bailout, the same reaction, then the same evaporation of confidence as soon as the reality of lack of real effect kicked in. Regardless of the bailout, banks were still tightening their lending.

This brings me on to the other subject of my post, which is that (as I predicted) the strings attached to the banking bailout are that the banks must now do the governments bidding. Over a series of articles it is apparent that the government is bullying the banks into lending against their commercial judgement. Just as the banks have (rightly) understood that their previous profligate lending was foolish and unsustainable, the government is telling them to unlearn the lesson, and is therefore storing up future problems for the banks, by forcing them to lend recklessly.

Meanwhile the first of the banking rescues is (again as predicted) showing that the government liabilities are rising. It seems that Northern Rock is going to need more state funding to survive. Even without the government encouraging reckless lending, the same will happen with the other banks that the government has rescued. With the reckless lending the bill can only get ever larger.

On top of all of this, it appears that the relentless growth of the state continues:

'Independent specialists published forecasts showing that an extra 50,000 public officials will have been recruited in the six months to the end of the year.

The Centre for Economic and Business Research (CEBR) forecast that over the same period 300,000 private sector workers will have lost their jobs.'

I am not sure whether I wrote about this on this blog, or somewhere else, but this is an ongoing problem that feeds upon itself. The more people the state employs, the more tax that the government needs to take from the productive parts of the economy. The more tax that needs to be taken from the productive part of the economy, the less able the productive part is to compete. The loss of ability to compete leads to less employment. Less employment in the productive part of the economy means that more government jobs are created to take up the slack, as politicians know that high employment means electoral success. And so the cycle continues....

In this case, if we make a conservative estimate (does anyone have figures, I could not find any) of the cost of these 50,000 new public sector jobs costing £40,000 each (ignoring deferred costs such as pensions), the total cost to the economy is £2,000,000,000 per anum. All of these individuals are not involved in wealth creation. Add in other costs, such as pensions.....

Essentially, what we are seeing is the government putting itself at the centre of the economy, literally trying to borrow itself out of trouble, when the trouble itself has been rooted in the borrowing of both consumers and government. The government reaction to the crisis is to try to replace consumer borrowing with government borrowing. In this case, they are borrowing with the target of increasing consumer spending, a sector of the economy which at best can only redistribute wealth, but can not create wealth.

When the money is borrowed, it increases activity at the cost of future activity. At its most simple, if I spend £50 of borrowed money now, I will not spend that same £50 in the future, because it is already spent. As such, borrowing to encourage consumer activity now may support that activity now, but at some point in the future, it must mean a reduction in activity. It just becomes a question of when that activity must decline. Furthermore, when I spend the £50 with borrowed money, it costs me more than £50 because the cost of the borrowing. As such, not only do I withdraw the £50 from future activity, but I also reduce the future activity by the cost of the interest. As such, a boost to consumer spending through borrowing now means a reduction in future activity of £50 + the interest on the loan. In the case of the borrowing, large amounts (in particular if the source of the borrowing is government debt) are funded externally to the UK, meaning that some of that interest is an export of wealth out of the country - a direct cash loss.

The result is that whilst consumer activity may be supported now, it means a larger shrinkage in activity later.

In amongst all of this activity, is it possible to see any single point which will see the encouragement of new real wealth creating activity (i.e. economic activity that is not centred around funding more consumer shopping, more government activity)?

It is unsurprising that the government have continued on this path of ruin, but I also have an irrational hope that, at some stage, someone in the government will have the courage to call a halt to this madness.

Note 1:

As part of my rooting around for civil servant costs I found a strange chart. Can aynone make sense of this chart (below), taken from a government website? Is it because they are using contractors, more flexi-time and job sharing? How is it that they can create these figures?











Note 2: Sorry not to respond to the many recent comments, but I will do my best to respond in my next post.