Preview: Dear Mr Osborne, Here's your Plan B

World leading economists present the Chancellor with alternatives to austerity.

In this week's magazine, nine of the world's leading economists -- including a Nobel prize winner, one of the Chancellor's own advisers and three former members of the Monetary Policy Committee (MPC) -- write open letters to the Chancellor, George Osborne, urging him to adopt alternative and radical policies to stimulate growth and create jobs.

 

Christopher Pissarides: Cut VAT back to 17.5 per cent

Professor Christopher Pissarides holds the Norman Sosnow Chair in Economics at the LSE and in 2010 was awarded the Nobel Prize in Economics. Writing exclusively for the New Statesman, he tells the Chancellor: "I know you worry about the deficit but I think that you worry about it too much. . . The markets are clearly telling us that you are too worried about the deficit". Pissarides accuses Osborne of being "inflexible" and says the cuts could "slow down the recovery and may even cause a double-dip recession". In his letter to the Chancellor, the Nobel laureate explains the need for a fiscal stimulus to boost employment:

I don't think reducing the top income tax from 50p to 40p in the pound will create many more jobs . . . Cutting VAT back to 17.5 per cent, or reducing National Insurance contributions for those on low incomes, will revive job creation and reduce unemployment. Deficit reduction is best done with spending cuts when the economy is recovering, not with higher taxes in a downturn. There is enough time in the life of this parliament to achieve your deficit-reduction objective with a policy that is friendlier to job creation.

 

Sushil Wadhwani: print money for the public

Economist Sushil Wadhwani, a member of the Bank of England's MPC from 1999 to 2002 and founder/chief executive of Wadhwani Asset Management, outlines his own radical proposal for stimulating consumption and growth, following the latest round of quantitative easing. He tells George Osborne:

We need to ensure the extra money leads to higher demand. One good place to start is with the textbook example of printing money to finance consumption - sending every adult in the country a voucher that can be spent in the next three months. Allocating £300 to each of Britain's 50m adults to spend on goods and services would cost £15bn, or 20 per cent of the £75bn created by the new round of QE. (In 1999, the Japanese government distributed $175 vouchers to the public - 99.6 per cent of them were spent within the six-month limit.) Perhaps you can persuade the MPC that this is preferable to buying gilts?

 

Jeffrey Sachs: agree financial transaction tax

Professor Jeffrey Sachs, a personal adviser to George Osborne on development issues, and director of the Earth Institute at Columbia University, urges the Chancellor to reverse his stance on a Financial Transaction Tax and raise more revenue from the banking sector:

I am strongly supporting the call for a Financial Transactions Tax, or FTT, which I believe would add efficiency to the global financial system by reducing destabilising speculation.

Sachs appeals to the Chancellor to play a leadership role on the FTT, urging:

Please do use your global influence within the G20 and bilaterally to ensure that the US signs up to the FTT . . . Even if the US does not, I would hope that the UK and all of the European Union would agree to such a tax.

 

David Blanchflower: reduce NI contributions

Warning of a future "lost generation" as the number of unemployed young people nears a million, the New Statesman's economics editor, former MPC member and professor of economics at Dartmouth, David Blanchflower, tells the Chancellor:

I suggest you increase the number of university places by 100,000 at once - the universities have a capacity. You could even insist that the extra places be primarily in science and engineering, which would help future growth. Second, give a tax holiday for two years on employer and employee National Insurance contributions for anyone under the age of 25.

 

Robert Skidelsky: Start a national investment bank
Skidesly, emeritus profess of political economy at the University of Warwick and biographer of Keynes, dismisses the paltry funds allocated to the government's new Green Bank, telling the Chancellor:

"We need a proper national investment bank, with more capital and the ability to raise private money . . . You should use part of the proceeds of the sale of government shared in bailed-out banks to increase the capitalisation of the national investment bank."

 

Jonathan Portes: Lift the cap on immigration
Portes, the former chief economist at the Cabinet Office and director of the National Institute of Economic and Social Research, states:

"There is a simple way the government could boost growth not just in the short term but over the medium to long term, too, while reducing the deficit. That is to reverse the damaging restrictions the government has introduced on skilled immigrants and students from outside the European Union."

 

Ann Pettifor: Launch a green new deal
Pettifor, the co-founder and director of the think tank Prime (Policy Research in Macroeconomics), and one of the few economists to have predicted the crash, calls on the Chancellor to ditch austerity, and instead tackle the threat to Britain's economy and environment:

"We need public works programmes that will mobilise a "carbon army" of "green-collar workers" and offer major incentive to environmentally friendly businesses."

 

George Magnus: Lend directly to small businesses
Magnus, the senior economic adviser to UBS Investment Bank, reminds Osborne that "extraordinary times call for comparable economic thinking", proposing that:

"The Bank of England could get involved in direct lending to SMEs and to the government, so that the latter could fund infrastructure and other programmes to boost employment."

 

Chrostopher Allsop: Set up a recovery fund
Allsop, the Oxford professor of economics and a member of the Monetary Policy Committee between 2000 and 2003, tells the Chancellor that "the only lever left is fiscal policy":

"My preference would be public investment for infrastructure, which is sorely needed and could be financed, currently, at negative real interest rates. How about a recovery fund, financed by index-linked gilts?"

 

Alice Gribbin is a Teaching-Writing Fellow at the Iowa Writers' Workshop. She was formerly the editorial assistant at the New Statesman.

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?