A case for fiscal austerity

The Labour party's talk of maxxing out the country's credit card is an obnoxious lie. But this does not mean the party is wrong to want a tight fiscal policy. There is a good case for it to do so, and it's got nothing to do with arbitrary fiscal rules or the Tories having "spent all the money."

Labour itself isn't going to make this argument, and why should it given that politics is about power and not persuasion? So I'll try.

It starts from the brute fact that unemployment is close to a 50-year low, at just 3.8% of the workforce. Granted there are another 1.9 million people (equivalent to over 5% of the workforce) out of the labour market who say they'd like a job, but many of these are unwell or have caring commitments and so are available only for lighter or more flexible work. The question "where will the money come from?" is a stupid one. But "where will the workers come from?" is certainly not.

Yes, there are some answers: immigration; some early retirees could be tempted back to work by better working conditions; and cutting NHS waiting lists would also get some back to work.

Nevertheless, the fact is that the pool of available labour is small. Yes, there are some GPs out of work, but fewer builders and skilled workers than there were a few years ago.

Which means that any significant rise in public spending and hence demand for labour is likely to bid up wages. The Bank of England will see that as potentially inflationary and would raise interest rates. This wouldn't wholly be disastrous: higher rates would help bring down house prices and reduce some of the more egregiously socially useless financial activities. But it does mean you could kiss goodbye to big housebuilding, as this is the most interest-sensitive sector of the economy.

Yes, Labour could prevent this by raising the inflation target. But nobody in politics is arguing for this. And whilst there's a case for doing so, it doesn't solve the physical constraint, of there being just not enough doctors, housebuilders or skilled workers in the green economy.

You might object that there's an obvious solution to all this: to raise taxes. The need to do this is not to raise money: governments can do that anyway by printing or borrowing. Instead, it is to free up real resources. Higher taxes would cut consumer spending thereby depressing demand for labour in retailing and hospitality, thus releasing workers to go into social care, construction, decarbonizing and the other things we want to do.

There are, however, big problems with this.

One is political. There's been no preparing of the ideological ground - no campaign to say that taxes are the "price we pay for a civilized society" or even that they are an economic necessity if we're to have good public services. From this background, tax rises would look like Labour going back on its word, being duplicitous.

And even if taxes were to rise, there'd still be issues.

One is that the mega-rich don't spend much and so higher taxes on them would not free up many real resources. Justice requires that we tax the mega-rich more and help the worst-off. But this does little to achieve the economic aim of shifting resources towards the public sector and away from the private. That requires tax rises upon those who will cut their spending as a result. If we want better public services, we must pay for them ourselves.

But there are problems with this, even aside from the unpopularity.

One is that higher taxes will cut jobs in retail and hospitality but do little to destroy the many socially unproductive but often well-paid jobs: the bullshit jobs created by managers who expand their empire (or promote an image of "wokeness"!) at the expense of shareholders; the lawyers and tax advisors who exploit an overly complicated tax system; bureaucrats who administer a repressive benefits system; fund managers who rip off investors; and producers of various forms of pollution, be they carbon emissions, financial risk which taxpayers pay for; or the intellectual pollution of the media. To destroy jobs such as these requires microeconomic policies which nobody is even thinking about.

And then there's the fact that, quite simply, reallocating labour takes time.

My chart shows this by plotting a measure of labour reallocation. To see how this works, imagine an economy of five workers in each of two sectors. If employment in both sectors grows at the same rate then net labour reallocation is zero; for any worker shifting from one sector to the other another must go in the opposite direction. If, however, the sectors grow at different rates, labour is being reallocated. If employment in one sector falls from five to four and that in another grows from five to six, net reallocation is one. My chart measures this process across 16 main sectors, with net reallocation expressed as a percentage of the labour force.

This shows that reallocation is typically small - usually not much more than 1% of total employment, or less than 400,000 people per year.

The economy, then, is sticky and slow to change. Most people prefer to stay in jobs they know; employers prefer relevant experience; it takes time for people to discover opportunities in different industries; to decide to make a radical career change; and to retrain. It is only times of distress that force many people into such change; note that the highest reallocation rates were in bad times such as the 2009 recession and 2020 Covid outbreak.

We can't therefore merely flick a switch and move tens of thousands of workers quickly from retailing to healthcare, construction or the green economy. The world just doesn't work like that. Change has to be gradual. Reeves is right to say "we’re not going to be able to turn things around straight away."

There is, therefore, a case for Labour having a tight fiscal policy.

You might object that all this seems to contradict a great point made years ago by Dan Davies: good ideas don't need lots of lies told about them.

I think there's an answer here. Dan's point applies when the audience is intelligent and informed. Which is not the audience for Labour's drivel about the credit card being maxxed out. When Jones, Reeves and Starmer use such language they are speaking not to economists but to political reporters who are institutionally stupid. The arguments they use to other audiences would, I would hope, be a little like the one I've made.

And it is emphatically not a right-wing argument. Macroeconomic policy must not be a matter of ideology but of empirical fact: you should run a loose policy when there's spare capacity in the economy and a tight one when there isn't. Truss's unforgivable error was to not appreciate this.

What's more, a tight fiscal policy is entirely compatible with radical economic policies elsewhere: land value taxes, a basic income, a maximum wage, planning reform, economic democracy, proper regulation of monopolies and so on. And don't think such measures don't address the pressing need to improve public services. They do: anything that gets the economy growing will boost tax revenues.

One of the great failings of social democracy has been think of economic policy too much in terms of public spending and not enough about other policies to foster equality and efficiency. The big failing of Starmer's Labour is not that it is offering fiscal austerity, but that it is offering nothing else.

Comments

[rsm]

Can we please start by cutting all drug enforcement spending? (Why should I want to do menial work for rich people because some ivory tower ergodic model says that is what all of society really wants?)

[TickyW]

Some goods and services will never be produced in sufficient quantity by the market, which is why a government must either procure those goods and services from the private sector or provide them directly to households.

Increasingly, these "merit goods" are procured from the private sector. There's nothing wrong with this except the contracts to supply the goods and services seem to fall into the hands of private equity investors, providing the latter with very lucrative income streams. Despite the exorbitant costs to the tax payer, the services provided, eg childrens' and aged peoples' homes, are frequently graded by the inspection agencies as substandard.

Futher to Chris's point, Rachel Reece could run a tighter fiscal policy by mandating these contracts be put out to tender before awarding them and, subject to quality standards, award the contracts to the lowest bidder and not to the government's chums in the City. The scale of this sector is such that significant savings could be made to public expenditure (but not to public services) by awarding contracts on the basis of at least three sealed bids.

Yes, the private equity institutions will howl, but think of the disadvantaged kids in state care whose life chances might well be improved as a consequence of receiving high quality care and not being traded as a commodity.

[Danny A]

Part of the battle with this line of argument is that "Tight fiscal policy" is currently understood to be caps on public sector wages and limited public investment.
But loads opportunity for tax reforms; I'd start by switching council tax to a % of rentable rate.

[Blissex]

«A case for fiscal austerity»

I am happy that at least there is "fiscal" as a qualifier, but it is still somewhat misleading, because given a fixed inflation target fiscal contraction "forces" the BoE to do high credit expansion to trigger the "wealth effect" for business and land property property owners. The two are part of the same policy, so mentioning one without the other can lead to misunderstanding.

[Blissex]

«Macroeconomic policy must not be a matter of ideology but of empirical fact: you should run a loose policy when there's spare capacity in the economy and a tight one when there isn't.»

Apparently for our blogger policy has no distributional aims or effects, "empirical fact" cannot be that it is loose for some classes but tight for some other classes, there there is spare capacity (several billions underemployed and unemployed in the global labor market) in the market for labor, or tight in the market for properties (workers doubling up all the time because housing growth is much inferior to job growth in those areas where there is job growth).

Our blogger seems to imply that there is a "national interest" of "the country". I guess "we are all thatcherites now", "we are all the in the same boat", "we are all middle class now".

[Counterfactual]

The essence of council tax is that it is local and based on local valuations. Change the mechanisms all you like but raising more money in Kensington does not give more money to Doncaster. If you want to transfer money from rich to poor areas you need another type of tax

[Blissex]

«Nevertheless, the fact is that the pool of available labour is small. [...] raising the inflation target [...] doesn't solve the physical constraint, of there being just not enough doctors, housebuilders or skilled workers in the green economy.»

Arguably, according to mainstream Economics, there is a labour shortage as long as wages are above subsistence level, or at least above the global market price for labour of around £1-2/hour, but I do not detect in the UK labour market a trenchant attitude from workers thanks to such a shortage.

I understand that in this post our blogger is trying to make the case for fiscal austerity that is not necessarily his own argument, but he is perhap trying too hard: in previous posts he has been arguing that wages have been stagnating (but he is sure that is not because of massive immigration) and growth has been missing, and now that is also a labor shortage.

Perhaps it is the usual difference betwene the real world in which our blogger lives and the parallel imaginary one where I live where average real wages have fallen around 8% since 2008 (while average real property prices in the south have rizen by 60-80%) which does not seem to indicate an *average* shortage of labour. If there is a shortage of labour in some categories it may be for CEOs and executives whose "compensation" has been rising faster.

[Blissex]

«reallocation is typically small - usually not much more than 1% of total employment, or less than 400,000 people per year.»

That is "other things being equal" and yet it is pretty large. As in the real world about which our blogger reports apparently there are shortages of labour and in particular in some sectors, wages and in particular in those sectors should rise and provide a strong incentive for more rallocation than usually.

[Danny A]

Council tax *bands* are based on open market (national) valuations from 1991.
Band D for Kensington this year is ~£1500, for Doncaster it is ~£2000.
Of course there used to be a substantial block grant from central government to allow geographic redistribution, the Tories slashed this.
Separating tax-take from spending allows for more effective service provision and investment.

[Blissex]

«Separating tax-take from spending allows for more effective service provision and investment.»

But that is... COMMUNISM!

An essential part of torysm is the this type of thinking "Why should my taxes pay for fixing potholes in another street in this town when my street does not have any?".

Even if some tories may be vaguely aware that reciprocal insurance is not redistribution, and even that perhaps they or their employees or their delivery drivers will have to drive through on other people's potholed streets...

[Blissex]

«there used to be a substantial block grant from central government to allow geographic redistribution, the Tories slashed this.»

Part of this is a a long term goal of separating people by income in different areas, and then devolving most taxation and spending to local areas.

Indeed most new build housing since the 1970s/1980 have been targeted at specific income bands. While apartheid by skin colour is unpopular, apartheid by income class is very popular with the middle and upper classes.

Also ideally low-income areas would be high-density and few (low-income ghettos), so that potential voters for social-democracy or socialism be able to elect only a few MPs even if with large majorities, something that is already happening in many cases.

[reason]

For once, I agree with blissex here! You need to discuss not just fiscal but also monetary policy. The mix between the two has been crazy for some time. You can't build a resilient balanced economy by increasing private debt. Much more of the needed increase in the money supply should come from monetized central government debt. And the particular problems we face (corroding infrastructure, climate change, an aging population, the housing crisis, imply we need to be consuming less and investing more). We need higher interest and higher savings rates and more government investment and more government subsidies for investment. It is all one package.

[reason]

And by the way as we saw in the 60s labour shortages are a good thing. They push up wages and encourage improvements in productivity.