Mismanaging public finances

For years, Keynesian have complained that governments must not treat the public finances as if they were household finances. This complaint lets the government off too lightly, because no sensible household would manage its finances in the way the government does.

Take three recent examples.

First, Osborne promised yesterday to sell the government's stake in Royal Mail to reduce government debt.

This makes no sense. The expected return on that stake should be positive, simply because if the market is valuing Royal Mail fairly its returns should be more or less those of the stock market generally. However, the government is borrowing at a negative real interest rate. Selling a positive-returning asset to pay off costless debt is just daft. It's like a tradesman selling his van and tools to reduce a mortgage whose payments he can easily afford. Nobody would so that.

Of course, selling the stake might make sense if you thought Royal Mail were overvalued or if you expect borrowing costs to rise sharply. But the market does not expect the latter. And the fact that the government sold Royal Mail so cheaply in the first place suggests it has no especial knowledge about its value.

Secondly, Radio 4's PM show has this week been running a series about NICE. This has reminded me of the government's very partial attitude to cost-benefit analysis.

If we take the NHS's drugs budget as fixed, it is entirely reasonable to use CBA to maximize its effectiveness: it's suboptimal to spend £10,000 to give someone a few weeks of impaired life when it could instead give somebody else many years of healthy life.

But how is the drugs budget - and the NHS budget - set? It's not by careful CBA of the sort conducted by NICE but rather by politics and inter-departmental higgling. £10,000 to give someone an extra month of life might not sound a good deal when compared to £10,000 spent on a more effective drug. But what if the comparison is with MPs' salaries, spending on failed IT projects or handouts to Capita?

Applying CBA to only a pre-set portion of public spending is penny-wise, pound foolish. No sensible household would make best use of its food budget, whilst allocating cash between food and other things according to no good principle.

My third example is the most egregious. It's the commitment - shared by David Cameron and Liz Kendall - to spend 2% of GDP on defence.

To see how silly this is, imagine you wanted your family to eat more healthily. So you "commit" to spending 5% of your weekly household budget on fresh fruit and vegetables. You then spend £20 on a single carrot, and as you feast on this, you celebrate meeting your commitment.

This, of course, is bonkers. You've paid no heed to value for money. No sensible household would do this. The same should be true for defence spending: what matters is having adequate military forces and value for money for what we do spend. It's what we get that matters, not what we spend. Given that defence procurement has often been massively wasteful, this distinction matters.

I'm not saying here that households are rational maximizers. It's just that they are not the gibbering idiots that they would be if they managed their finances like the government manages its.

Comments

[Metatone]

Well said.
Question is, how do we get someone with more influence than you to take up this issue?

[oldcobbler]

Not to mention the costs and benefits of legislation. I wonder what the Net Present Value of the Dangerous Dogs Act has been....

[Luis Enrique]

I'm not sure I agree that a sensible household would not first set a budget in a manner not to different from % of income, and then try to get value for money within that.

You could also have mentioned foreign aid which has a set %. This makes no sense, until you start thinking in second-best terms, including global cooperation. In defence, I imagine the 2% is similarly a mechanism for trying to get every country to "do their bit"

By the by, many people in the development world think that DFID is so obsessed with trying to demonstrate value for money that it is to the detriment of real effectiveness (and accounts for a major chunk of overheads)

[James]

Not convinced you can bash national politicians about the 2% commitment to defence - it's a commitment demanded by NATO of member states to ensure that no one nation allows its own defence spending to whither and just take advantage of the shield offered by other nations.

Whilst committing 2% of GDP to defence does not ensure that you will get value for money, there are other ways to ensure that whilst meeting the NATO commitment - competitive tendering, co-operative development programs, etc. To torture your metaphor: whilst you *could* buy one bloody expensive carrot, you could also get a family-sized hamper of good value produce that ensures no-one goes hungry!

[Ari Andricopoulos]

Very true!

And if you were a household could buy lots of land that was classified as green belt very cheaply and then re-zone it, making massive windfall profits. And then could either sell it to developers or borrow at zero interest rates to build houses that you could rent out bringing a stream of future income.

And at the same time everyone said you were helping out with a major social problem. So you would have a massive increase in net worth as well as be a hero to those struggling to get on the housing ladder.

Well, you'd definitely do that.

[Bob]

MMTers on the sale (Neil Wilson/3Spoken):
"It's an asset swap. QE in reverse.

Royal Mail shares are given to the purchasers and the purchaser's cash accounts are debited which then goes to the Treasury and reduces the amount of Gilts the Treasury has to issue that week.

If you treat it like a tax payment where you get a Royal Mail share as a receipt then you'll get the picture.

Importantly nothing changes at Royal Mail. (In general really, but then I'm a postman's son so the intractability of the place is well known to me)."
Household analogies have NO applicability.

[Dave Timoney]

Families adopt multiple budgeting strategies by force of circumstance, including fixed sum or percentage (e.g. entertainment), zero-based (kids), hypothecation (any bonuses towards the holiday fund), rationing (turn the heating off), and trade-offs (buy own-brand food).

The problem is that government seems to be less sophisticated, hence the aversion to hypothecation, the poor public debate about NHS rationing, and the unwillingness to do proper zero-based (e.g. deriving the defence budget from a realistic threat analysis).

The irony is that their tacit defence for this incoherent approach is the lack of political sophistication on the part of the public.

[RJMeyers]

NATO's requirements aside, I'd argue that 2% defense commitment is also a statement of subsidy for the defense industry, not a statement to ensure adequate military protection.

I agree that it's stupid, but only if you're worried about defending your country against an outside aggressor. If the main concern is staying in a military alliance and giving money to your (and your close allies') private defense sectors, then throwing out a flat percent does make sense.

[Bob]

There is no such thing as government money, only taxpayers' money.

[gastro george]

"There is no such thing as government money, only taxpayer's money."

LOL.

[Bob]

Other Bob, where does money get created initially?
Public currency is the proper name.

[Ralph Musgrave]

Re the “Bob versus Gastro George” debate just above, where government spends, the relevant money must come from taxpayers. That is, all else equal, if government is to spend MORE, the private sector must spend LESS. So in that case government’s money is taxpayers’ money.

In contrast, where spending over the economy AS A WHOLE needs to be increased, that is effectively done by creating more money, but that money is not or at least shouldn’t be the property of taxpayers, government or anyone else: it’s common property. It should be distributed evenly amongst the population and between public and private sectors.

[Bob]

" That is, all else equal, if government is to spend MORE, the private sector must spend LESS."
Quite probably so, but not necessarily. Everyone could spend more but output will increase if the economy quantity expands.
The amount of money is mostly determined endogenously by bank loans.