The "fully costed" fallacy

One of the many irritants of this election campaign is the demand by the media that the parties’ spending plans be “fully costed”, and the parties’ kow-towing to this demand: listen, for example, to this exchange between Sara Montague and Tim Farron (2’23” in).

What’s irritating about this is that rests upon an elementary fallacy – that governments must act like prudent housekeepers, accounting for every penny.

This ignores the fact that the public finances are not under the government’s control. Government borrowing is the counterpart of private sector saving (both here and overseas). If the private sector wants to save more, then government must borrow more; the alternative is for it to depress the economy by cutting spending or raising taxes.

My chart shows the point. It compares actual government borrowing against forecasts made in March 2012. It’s clear that borrowing has overshot – by a cumulative £107bn. That means the Tories have, in effect, made £107bn of “uncosted” spending over the last five years. Meanwhile, journalists whine about a few hundred millions of "uncosted" Labour spending.

In truth, though, nobody much cares about that £107bn of uncosted spending. Whilst the Tories have "overspent", bond yields – the cost of government borrowing – have consistently fallen. The two are related. The same global savings glut and demand for safe assets that have driven down bond yields have also caused higher than expected private savings and hence higher than expected government borrowing.

The main task of government is not to fully cost its spending. It is instead to ensure a healthy economy. And for now at least this requires higher borrowing - or uncosted spending. Negative real gilt yields mean that financial markets are paying the government to borrow: why not take up the offer?

"Expenditure creates its own income” said Keynes:

The only chance of balancing the Budget in the long run is to bring things back to normal, and so avoid the enormous Budget charges arising out of unemployment…Look after the unemployment, and the Budget will look after itself.

Strictly speaking, this isn’t wholly true: low wages and a lack of capital spending are damaging the budget as much as unemployment, and it’s worldwide stagnation that’s the problem rather than just UK weakness. But the wider point holds – that the government budget will balance if and only if the economy is healthy. Demands for prudence and full costings won’t help and will in fact be counter-productive.

Now, you might think I’m just making elementary economic points here. I am. But there’s something else. It’s that the demand by political journalists for full costings isn’t just lousy economics. It’s also deeply biased. It’s based on the assumption that political “competence” consists of mindless penny-pinching rather than a grasp of economic reality. This generates a bias against economic understanding amongst the electorate, and against those politicians who do understand economics. You didn’t think the BBC was impartial, did you?

This doesn’t just coarsen political debate. It ruins lives. Why should children suffer the lifetime burden of being badly educated because of the economic illiteracy of imbecile journalists?

Comments

[Luis Enrique]

so ... I presume you don't think governments should act as if they face no budget constraint* (you don't conclude from "expenditure creates its own income" that expenditure should be set to infinity). How do you think politicians should handle the question of what is affordable, or not?

* please MMTers, spare me

[Britonomist]

Costing DOES matter. Yes we should deficit spend if the private sector starts to rapidly "save"/deleverage (i.e. go into recession) - this is what *discretionary spending* is for. We shouldn't make ourselves structurally insolvent as a form of stimulus - that's a ridiculously blunt instrument, and brings with it all kinds of other dangers, because it is inherently uncontrollable.

[Gary]

Plans are useless. Planning is useful.

[Dipper]

Corbynistas are approaching politics as if we are customers in a shop, saying we'd like some of this, and then we'd like some of that. But we aren't customers. Its our shop. We are looking for someone to run it for us. Having some idea about prioritisation, how to run things, how much things cost, are all the kind of basic attributes you look for if you are employing someone to manage your business.

[bill40]

@Luiz Enrique

Why should MMTers spare you? The budget constraints are available Full Employment and available real resources.

Nobody anywhere is proposing spending to infinity which is what you fear happening. I am merely pointing out your fears are unfounded.

[Peter K.]

In the U.S. now that Trump wants to cut taxes for the rich, it's okay to "bust the budget." The corporate media doesn't have a problem with it then.

The problem is center left economists who complain that the budget has no room for tax cuts. Then it has no room for spending, like Hillary's Clinton plan which Alan Blinder said wouldn't effect the Fed's reaction function.

[Luis Enrique]

bill40

it was reductio ad absurdum

OK well MMTers have at it. Instead of thinking in terms of whether we have enough money (fiscal space - taxes, borrowing, seigniorage) to pay nurses more, renationalise railways, provide free higher education etc. politicians have to find a way of setting budgets for all categories of government spending, and communicating the constraints that explain those choices to voters who understand spending in pounds sterling. How do you say "we think that we can afford to increase spending on X thus far but no more" ?

And a politician says we will spend an extra £m on X! and £m on Y and they are asked, can you afford that, do we have the resources, what's the cost, how do you answer?

If you answer every question with oh we think we aren't yet at full employment and capital is not fully utilised, so more spending is not a problem, how does the voter tell the difference between competent MMTers with an accurate conception of real constraints and a lunatic who thinks some half-baked theory they read on the internet says they can spend as much as they like so long as there is still some unemployment?

[Ralph Musgrave]

Basic budget rules:

1. Given a recession, run a deficit, as prescribed by Keynes. And as Keynes said, it doesn’t matter whether the deficit is funded via new money or new national so called debt.

2. If interest demanded by debt holders is anything significant, tell them to get lost and fund the deficit via freshly printed money.

3. When the economy gets to full employment, the latter printing will prove inflationary. So rein it back.

And finally Keynes’s claim that “The only chance of balancing the Budget in the long run…” is very questionable. Reason is that in an average year, there will always be a deficit. Reason is thus.

If the national so called debt and stock of base money are to remain constant relative to GDP (which in the very long term they do) then given inflation and economic growth, the real value of the latter stocks relative to GDP will fall. Ergo those stocks have to be topped up. And the only way of doing that is via a deficit. In fact if you do some back of the envelope calculations which should take you all of 30 seconds, you should come to the conclusion that the deficit in an average year will be roughly 2% of GDP.

Incidentally the sum of the latter two stocks is sometimes referred to MMTers as “Private Sector Net Financial Assets”. It’s an important quantity.

[Dipper]

@ Ralph Musgrave

We are at full employment so time to rein in the QE?

Or is employment that is only made possible by extensive working tax credits not really employment?

And are we really at full employment if due to FOM there is a large supply of effectively unemployed workers in Eastern and Southern Europe?

[Peter K.]

"This doesn’t just coarsen political debate. It ruins lives. Why should children suffer the lifetime burden of being badly educated because of the economic illiteracy of imbecile journalists?"

And it doesn't just ruin lives. It snowballs. Bad policy and bad economics leads to Brexit, Trump and Le Pen.

See Benjamin Friedman's The Moral Consequences of Growth.

In a somewhat contradictory manner Paul Krugman says Macron's victory shouldn't make European elites complacent about their failed policies of austerity and tight money, but then he insists Trump's victory has nothing to do with the poor performance of the economy over the last 40 years.

[Luis Enrique]

post script

If 'fully costed' means just from tax holding GDP constant, it's dumb. Legit to respond we will fund X with borrowing and assume some multiplier back to tax revenues too.

I'm actually open to idea that economy could bear considerable fiscal expansion right now, before inflation would be a worry, think multiplier on high side, and I'm even open to direct monetary financing of some of that, which puts me on whacky fringe of the mainstream. But here's how I fear MMT would play out.

Chancellor Murphy: we think the economy is below capacity, and we believe we can increase capacity through investment, and don't you know the government can create money simply by crediting the bank accounts of recipients, no need for taxes which as we have come to understand do not truly finance spending, so away you go Prime Minister, have at it

Prime Minister Corbyn. Splendid, right lots more for the NHS, education, social security, nationalise rail, free university education, national investment bank, and all without raising taxes or borrowing please, as you assure me that's unnecessary.

** rate of seigniorage increases 5000 fold. Inflation ensues **

Chancellor Murphy: No worries boss, misjudged things a little, just need to adjust the thermostat, we simply raise taxes which destroys money don't you know.

** sharp tax increases, recession, riots, government falls **

[gastro george]

Dipper: [Makes an unreal analogy] But it's not true. Ha! Corbynistas!

So what are the correct priorities (in the context of this post)?

@Luis: The question is, I guess what you prefer. Is it a set of economic "rules" that aren't based in reality that lead to false decisions being made, (currently) austerity, and periodic crashes. Or to base your economics more on reality, and risk that politicians have good judgement? Given that, in the current system, good judgement is hardly being shown, I'd prefer at least to base my economics on reality. Or to rephrase: what do we gain using the current falsities?

[Eminent emigrant]

Of course the journalists may be suffering a lifetime of economic illiteracy because they were badly educated :)

[Luis Enrique]

George

Those setting policy may be disconnected from reality, but MMT is no closer to reality than mainstream public finance economics.

There's some underwhelming 'insights' into how money is created and the idea you can money finance expenditure until the economy hits capacity.

And mainstream economist get shit for drawing too strong conclusions from simple theory!

You've seen all the criticism of NAIRU right? What makes you think MMTers going to be any better at identifying the 'just right' level of spending? And as for the idea you can simply vary tax rates as a stabilisation tool. Pull the other one. Have these people looked outside their windows?

[MJW]

The problem is that it's easy to make claims about how you're going to spend extra on X and Y if you don't have to account for where the money is coming from or how it fits in to some overarching approach to finances. In the world of the magic money tree we don't need to worry about such things, so we don't need to worry about the consequences: sustainability, efficiency and effectiveness of spending.

Wasteful spending happens when we haven't clearly considered what we are trying to achieve and whether it fits well with the other decisions we have taken, that is true of households, businesses and governments. So voters are right to consider costed plans as a sign of basic competence, not having them is a sign of dangerous magical thinking. There is a whole other issue over whether the costings are realistic, technically correct or contain a spurious level of precision and we get to pick over such things. It's a truism that voters want more spending on the things they want, and they largely want others to bear the (bulk of) costs but they are not so stupid as to believe there are endless free lunches to be had out there.

[BenM]

Hi

Reading the March 2012 budget book I see a PSNB cumulative of £1,472bn forecast as at March 2017.

But outturn was £1,729bn. So a gross Tory overspend of nigh on £250bn over the 5 years.

Spending is only allowed to be unlimited when a Tory government is doing it apparently.

[Luis Enrique]

Ben, you make a good point, but that's not overspend, that's spending cuts failing to translate one for one to deficit reductions. Imho that's one of the most important, least acknowledged recent economic facts.

[reason]

Luis Enrique/Bill 40
My rule of thumb is that long run the government should aim to run a deficit at about the same level as desired nominal GDP growth. That way the GDP/debt ratio will remain roughly constant. And NOTE this is NOT the same as a balanced budget. Short run of course you can go up and down based on how much you actual nominal GDP growth is varying from desired.

[e]

@ Louis Enrique “Those....disconnected from reality” I could be wrong of course, but I think the essential is: MMT an understanding of what is, not what might be.

[Luis Enrique]

e

Everybody is trying to understand how the world really works, but if mmt isn't saying we could be doing things very differently to we are now, what's the big deal?

[e]

@ Luis Enrique Because currently it seems only the right holds 'permission' to ignore, in their favour, the imaginary rules.

[Thaomas]

The effect that a spending decision had on the deficit is not a valid decision rule. If the spending passes an NPV test (much more likely when real interest rates are low and -- in recession -- the marginal costs of some inputs is below their market price), the spending should go ahead. In this sense, government should be run like a business, not a credit constrained household. It is depressing that journalists still do not understand this.

[gastro george]

@Luis

Just to be clear, my comment wasn't intended to make a criticism of mainstream economics from an MMT perspective, but to support the criticism of deficit fetishism as per Chris' post.

[Dipper]

@gastro george - fair question.

Here's Dipper's manifesto. you can decide where it sits on the political spectrum. I have no idea.

1. The government needs to be free to raise more money. Our infrastructure limits our ability to grow profitable business, for individuals to fully participate in society, so we need to invest in that. National Investment Board to invest in infrastructure - transport, telecoms, energy. Build a new major city - either round Oxford or Cambridge. Serves them right for voting Remain. Funded through borrowing. Limit investment to £70 billion per year with the understanding non-investment spending will balance over the parliament

2. We are not spending enough on vital services - NHS, education, so I would put 1p on basic rate, 2p on higher rate, and increase corporation tax to pay for this.

3. Working Tax Credit makes work pointless to many people due to marginal tax rates of >90%. Continue with the roll out of Universal Credit to make work pay for working people. We expect people to work and to benefit from it.

4. Long term care for the elderly is going to cost the earth. Tax breaks for people who volunteer to look after their ageing parents.

5. Government has a role in ensuring large companies are not ripping off customers. Give regulators power to stop profiteering by energy and telecoms suppliers, and to require clear pricing and ease of change in transport, banking, and insurance.

6. NHS is held back by conflict of interest arising from being both purchaser and provider. Encourage outsourcing of services to get innovative and cost-effective services whilst simultaneously strengthening NHS's ability to set and monitor standards of care. encourage co-operatives and co-ownership of services by healthcare professionals.

7. Expand medical training places for nurses and doctors. Introduce bursaries for medical training places.

8. Impossible to limit use of services whilst widespread immigration and lack of documentation; introduce national identity scheme (passport/driving licence/ID card).*

9. Limit Immigration. UK expects companies to invest in training workers. Allow professional moves and intra-company moves on a relaxed basis, but give right of residence of worker and family rarely. Set aside 20,000 per year for refugees, based on a broad interpretation of refugee and who would be good for the UK.

9. Make a success of Brexit. Understand the people have rejected the EU dictating key parts of government policy. Reject any deal that does not leave UK government in charge of borders, immigration, and expenditure.

And if anyone asks, this is just a draft.

* I was intrigued to discover from a "revenue enforcement officer" (socially not in the course of his job) that it is a criminal offence not to provide your name and address when asked, or to provide a false one. so resistance to ID cards is largely symbolic.

[Luis Enrique]

Ta George sorry I got wrong end of stick

[Guano]

Dipper:- "Make a success of Brexit".

That's more of a vague aspiration than a policy. It doesn't tell us what "success" is and how it will be achieved.

If by success we mean "no unpleasant economic consequences" it should be noted that (on her first day as PM) Theresa May set two conditions that make a successful Brexit very difficult: opt out of the ECJ and opt out of free movement of EU nationals. That implies either

- leaving the Single Market completely with no deal with the EU (and no plan has been made available that shows how that can be achieved without unpleasant economic consequences)

- negotiating access to the Single Market while opting out of the ECJ and free movement of EU nationals (and as yet there is no evidence that Theresa May is capable of negotiating this or even interested in serious negotiations).

So, in the absence of evidence of a plan for a Brexit that doesn't have unpleasant economic consequences, my view is that saying "Make a success of Brexit" is just hot air.

And the EU does not dictate government policy, nor does the UK not have control of its borders.

[Dipper]

@Guano.

It is a manifesto, so by its nature it is aspirational. It is not the place to discuss the detailed negotiating strategy. There have been question marks over whether Labour really wants to leave, so I say loud and clear we are going and we are ambitious to make it work.

As for the rest of your comments - well maybe, but the manifesto makes it clear what the priorities are so if the negotiations mean that we cannot meet those priorities and have a beneficial deal well so be it. The people will have voted, and I will have stuck to my promise.

Despite Chris's next post, people aren't stupid. They understand political language, and all that that entails.

[C Adams]

Re: MMT fears. Compare an overshoot on government spending (fiscal policy mismanagement), to overshoot on bank lending (monetary policy mismanagement): Do economies recover more quickly from inflation or a private debt overhang? What are distributional effects? Does fiscal mismanagement mainly hurt the rich, whereas monetary mismanagement followed by austerity mainly hurt the poor? What are the longer term implications for inequality, economic and political stability? Are the answers more a question of political choice then economic certainties?

[Guano]

" .... if the negotiations mean that we cannot meet those priorities and have a beneficial deal well so be it" (Dipper)

No evidence has been presented that negotiations will lead to a beneficial deal. No evidence has been presented that there is a negotiating strategy and no evidence has been presented that the government knows what to do if/when that negotiating strategy fails.

If the other points in Dipper's manifesto depend on negotiations leading to a beneficial deal, they may as well not be there: they depend on achieving something that is just wishful thinking: nobody can say how it will be achieved.

[Dipper]

@ Guano but we are going to be leaving the EU and whoever is in charge will be negotiating a deal. Obviously we will have to adjust to whatever is agreed, but the vote was clear.

A risk, by definition, means uncertainty of outcome. Otherwise it wouldn't be a risk. You can live a risk-free life if you want, but the price you pay for that guarantee will be enormous, and even then you may find you don't like it. For most people, and also for the UK as a nation, we discover ourselves when we take risks and live with the outcomes.

[Guano]

Dipper - your manifesto should be in the following form.

Start by saying that everything depends on a successful Brexit, and define "success".

Then explain carefully what will determine whether Brexit is a success or not and how likely this is. Note that the assumptions presented in the referendum campaign about how easy it would be to negotiate a trade deal (eg German car manufacturers would pressurise the EU to give us a good deal) have proved to be false so explain what new assumptions are being made.

Then present two sets of policies: one for a successful Brexit and one for a failed Brexit (and thus explain who will pay the price for a failed Brexit).

PS I am all in favour of taking risks in dealing with a real problem: eg climate change, antibiotic resistance. Brexit means taking an enormous risk (that few people have faced up to) to deal with a non-existent problem: the EU does not tell us what to do.

(I am just reading a Chatham House paper about European energy cooperation, that discusses the difficulties created by Brexit for the energy sector and points out that the UK never had any difficulties with EU energy regulations because they were almost completely in line with what the UK wanted.)

[Dipper]

@ Guano. no that is exactly what not to say. the manifesto is a prospectus. This is who we are. This is what we believe in. This is who we stand for. This is what we are going to do. State we are going for a Brexit that preserves UK independence, gives us back control of our borders, control over our laws, if the negotiations don't go well just blame it on the EU - shows we are right to be leaving. People understand that governments have to respond to events. no need to raise the possibility at the outset.

I'm delighted to hear the EU doesn't tell us what to do. We'll just stop Freedom of Movement, remove the ECJ and European Law from our statutes, tell the EU we've changed our minds and remaining and by the way we won't be sending any money. I'm sure Brussels will welcome us back with open arms.

The UK outside the EU will still want to co-operate with other European countries both inside and outside the EU on energy. I don't see why that should be dependent on us being in the EU.