Monday, November 24, 2008

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.


  1. Hello, I like your blog. You mention often 'real wealth' but perhaps you could elaborate on what that is? Isn't wealth as illusory as money?

  2. cynicus

    Given the recent lunacy by the government and the extra £ 450 bn borrowing figure, which will be wildly exceeded as its based on what can only politely described as optimistic growth figs.

    Have you revised your forecast for a UK sovereign debt default ie brought it foreward.

  3. I don't know what strange thoughts are churning around in Gordon Brown's head, but I suspect he thinks he is disguising his previous mistakes, rather like torching the scene of a crime to mask the evidence.

    And by encouraging other countries to do the same, he wins whether they join him or not: the countries that don't join in can be blamed for scuppering the whole scheme, and the ones that do will suffer the same economic consequences as the UK, thus letting him off the hook for damaging the UK's economy uniquely badly.

    Maybe he genuinely thinks there's a chance the scheme will work, too. If it does work, NL stands a good chance of being re-elected in 2010, and if it doesn't the Tories are left to clear up the mess, which will require measures so drastic and unpleasant that they will not be re-elected for decades to come. So inside his head, at least, he can't lose.

  4. It is indeed madness.

    You might wonder, if they keep destroying the private sector and then being 'forced' to recruit those workers into the public sector, are we actually seeing the creation of a socialist state by the backdoor?

    After all, if everyone works for the government, and everyone is paid by the government, that's one big hurdle to a new socialist experiment out of the way.

    Most people are afraid, first of all, of losing their home. Some protection to prevent this during the crisis would go a long way to settling public nerves, if not resolving hardship. Perhaps by protecting people who lose their jobs from repossession (if they bought the house before the start of the current crisis.)

    The next thing to do is to force the banks to reveal to one another the true level of debt on each others books. The current secrecy is a major cause to the banks mistrust of one another. Once the truth is, as they say, 'out there', we can get along with dealing with it.

    In the way of working our way out of the recession, my preference would be for a fiscal stimulus that was primarily targetted at helping Industry and Agriculture become profitable and successful again. Outside of that, slashing the insane public spending budgets and encouraging a nationwide 'belt tightening' would be more honest.

    If the government keep promising a magic wand solution, people will keep expecting the faeries to save the day.

  5. The explanation for the strange bar chart at the end of your 24 November 2008 post may be found here:
    The pie chart at the beginning of the document and the graph at the very end are particularly revealing. The distorting visual impact of the bar chart you found is heightened by it's use of a false zero and the cunning way it starts at 1999 instead of 1997.

    Once again, thank you for your blog.

  6. Mark

    Alistair Darling on the Today Programme this morning:

    "...debt levels as we go into this are lower than other comparable countries because we did reduce debt over the last 10 years... our debt levels did fall over the last 10 years; by any measure they fell..."

    (about 14 minutes into the interview)

    Is what he says correct?

  7. Very interesting reading:

  8. Brown and labour will not cut or stop spending.. They are socialists to the core. They believe that the system is wrong and only they can deliver a just and fair society. What ever just and fair means. So they will carry on spending, until the IMF is called in.. The country collapses.. Or we elect a new government.. They are now starting a class war, standard divisive action. Blame the rich. The trillions in pounds he has raised since coming to power yet he still had to borrow.

    What ever happens the road ahead is looking very bleak..

    The social consequences if the gamble fails are dire. Yet brown, darling and labour are quite happy to do it.

    About cuts, Check the proportion of workers working in the public sector by region. Over the last ten years all they have done is create public sector jobs in their heartlands..

    If cuts do happen the heartlands will be hit, Labour will of course play on the north south divide.

    Scotland and wales they will play the nationalist card..

    The urban centers they will play the race card.

    Socialist, nasty to the core.

  9. Marxist new Labour.

  10. Henry George is good on wealth. This is what he has to say...

    As commonly used the word "wealth" is applied to anything having an exchange value. But when used as a term of political economy it must be limited to a much more definite meaning, because many things are commonly spoken of as wealth which in taking account of collective or general wealth cannot be considered as wealth at all. Such things have an exchange value, and are commonly spoken of as wealth, insomuch as they represent as between individuals, or between sets of individuals, the power of obtaining wealth; but they are not truly wealth, inasmuch as their increase or decrease does not affect the sum of wealth. Such are bonds, mortgages, promissory notes, bank bills, or other stipulations for the transfer of wealth. Such are slaves, whose value represents merely the power of one class to appropriate the earnings of another class. Such are lands, or other natural opportunities, the value of which is but the result of the acknowledgment in favor of certain persons of an exclusive right to their use, and which represents merely the power thus given to the owners to demand a share of the wealth produced by those who use them. Increase in the amount of bonds, mortgages, notes, or bank bills cannot increase the wealth of the community that includes as well those who promise to pay as those who are entitled to receive. The enslavement of a part of their number could not increase the wealth of a people, for what the enslavers gained the enslaved would lose. Increase in land values does not represent increase in the common wealth, for what landowners gain by higher prices, the tenants or purchasers who must pay them will lose. And all this relative wealth, which, in common thought and speech, in legislation and law, is undistinguished from actual wealth, could, without the destruction or consumption of anything more than a few drops of ink and a piece of paper, be utterly annihilated. By enactment of the sovereign political power debts might be canceled, slaves emancipated, and land resumed as the common property of the whole people, without the aggregate wealth being diminished by the value of a pinch of snuff, for what some would lose others would gain. There would be no more destruction of wealth than there was creation of wealth when Elizabeth Tudor enriched her favorite courtiers by the grant of monopolies, or when Boris Godoonof made Russian peasants merchantable property.

    [29] All things which have an exchange value are, therefore, not wealth, in the only sense in which the term can be used in political economy. Only such things can be wealth the production of which increases and the destruction of which decreases the aggregate of wealth. If we consider what these things are, and what their nature is, we shall have no difficulty in defining wealth.

    [30] When we speak of a community increasing in wealth -- as when we say that England has increased in wealth since the accession of Victoria, or that California is a wealthier country than when it was a Mexican territory -- we do not mean to say that there is more land, or that the natural powers of the land are greater, or that there are more people, for when we wish to express that idea we speak of increase of population; or that the debts or dues owing by some of these people to others of their number have increased; but we mean that there is an increase of certain tangible things, having an actual and not merely a relative value -- such as buildings, cattle, tools, machinery, agricultural and mineral products, manufactured goods, ships, wagons, furniture, and the like. The increase of such things constitutes an increase of wealth; their decrease is a lessening of wealth; and the community that, in proportion to its numbers, has most of such things is the wealthiest community. The common character of these things is that they consist of natural substances or products which have been adapted by human labor to human use or gratification, their value depending on the amount of labor which upon the average would be required to produce things of like kind.

    [31] Thus wealth, as alone the term can be used in political economy, consists of natural products that have been secured, moved, combined, separated, or in other ways modified by human exertion, so as to fit them for the gratification of human desires.


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