Saturday, 12 May 2012

Is it all Gordon Brown’s fault?


                Someone reading my recent post on major UK macro policy errors asked whether my blog was becoming more political. I hope not, in the sense of being party political for its own sake. However, when the issue involves macroeconomic policy, then I do my best to say what I think is right rather than what is politically expedient. This is in part because I have very negative views about the role of ideology (left or right) in influencing economics. (Incidentally, I do react badly to those who say ‘ah, but all theory is ideological, it’s just that you pretend what you do is ideology free’. I guess this makes me one of those old fashioned fogeys who believe in the possibility of evidence based social science.)
                Perhaps this is why I have not so far explicitly commented on the oft repeated refrain by the current government that austerity is necessary to ‘clear up the mess’ left by excessive deficits under Gordon Brown? It is nonsense of course, but like all the best slogans it contains a half-truth. I think it is certainly true in hindsight, and almost certainly true ex ante, that spending in the later Brown years was underfunded (or excessive, depending on your viewpoint). By exactly how much I plan to explore in more detail for a paper over the next few months. The untruth, of course, is that this problem had to be corrected immediately and quickly during a recession.
                This issue arose from my recent post where I listed what I considered to be the three major UK macroeconomic policy errors over the last 30 years. I said that underfunded spending by Brown was an error, but that I did not consider it a major one because it did not lead to the same scale of welfare losses that occurred when unemployment became unnecessarily high (like now). Chris Brown commented that “The loss in social welfare [caused by excessive deficits in a boom] is never felt at the time of the increase in government spending (the reverse is true) but after the party is over (i.e. today)”.
                I think this comment is right in two ways, but nevertheless it does not imply that Brown’s underfunding was a major error. Let’s start with where I agree. First, additional spending paid for by debt which is then paid off at some future date by cutting spending clearly raises welfare today but reduces it tomorrow. If the additional debt is paid for by raising future taxes (i.e. we are permanently increasing the size of the state) then the situation is more complicated. If consumers are completely Ricardian then the timing of the tax increase does not matter for welfare, but let’s leave that complication to one side. Second, I agree that pro-cyclicality in spending decisions is a common vice, and that because it tends to be asymmetric (it happens more often in booms than recessions) it can lead to deficit bias. This is certainly bad policy.
                But are the welfare costs of this that high? Not, in my view, if the subsequent correction is done at the appropriate time. To take a simple case, suppose monetary policy is able to completely offset the demand impact of both the excessive spending, and the subsequent cut in spending designed to pay off the additional debt. The only welfare cost then is an intertemporal misallocation of public goods. It is my judgement that these costs are of an order smaller than the costs created by raising unemployment by a few hundred thousand for a few years when unemployment is already high. (I have to say judgement here, because most formal analysis of measuring the welfare costs of business cycles takes place in representative agent models where ‘unemployment’ just means everyone working a few less hours. This does not begin to capture the true impact of unemployment on well being.)
                Now if it was true that the additional unemployment caused by austerity today was an inevitable consequence of underfunding in the Brown years, then the comment would be exactly right. But it is not. Paying off the debt created by the underfunding should be done during the next boom, and not now. As a result, Gordon Brown’s error gets relegated to minor status when compared to what is happening now.                

10 comments:

  1. I really appreciate the attempt that this article makes in acknowledging that there is more than just the bare economics to be considered when evaluating government policy. However once you try and evaluate the welfare cost of unemployment you have essentially crossed a line and must therefore include the various costs of a larger set of government policy. What I am getting at is that Brown's high spending was entirely bound up with an unwillingness to address the structural issues in the public services he was spending the money on. In my opinion the welfare cost of this failure is high. Of course there are various opposing opinions here and I have strayed way beyond economic issues, but it was this blogger that crossed that line first.

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    1. Government share of GDP was in line with the previous decades under Thatcher. The recession created the deficit because of a reduction in tax revenues and increased welfare payments.
      The government spending didn't create the deficit, the recession did.

      If output levels were raised to previous levels the deficit would fall. Norman Lamont allowed the deficit to rise in 1992 and then cut once the recovery was under way. It was very successful both in creating growth and in reducing the deficit. Shame this "ideological" government didn't do what the previous Tory government did.

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  2. What about Gordon Brown's responsibility for the financial crisis? London is arguably the centre of the international banking system. The financial crisis was due to a lack of regulation, or at least inefficient regulation of the international banking system. Brown was responsible for regulation pertaining to London, and thus deserves a large share of the blame for the crisis.As a concrete example, consider his decision to end the Bank of England's role in overseeing the stability of the financial system in favour of the "tripartite" system.

    Given that the financial crisis was the underlying cause of the recession, Brown's failure to effectively regulate the banking system implies a major policy error.

    As for whether the blog is political, I think one of the reasons economics should not be regarded as science is that it's virtually impossible to analyze economic policy without politics creeping in. It is simply not possible to say, objectively, what constitutes the "right" policy; it all depends on your point of view. Even when discussing economic events (such as a recession) there are bound to be differences of opinion regarding the causes and consequences (since the data is inconclusive and open to interpretation) and these will depend on the political perspective of the economist.

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    1. You imply that the buck should stop with Brown but the fact is that the whole "big bang" in the City was carried out under Thatcher. The regulatory set up was born under the previous twenty years of Tory government which was a period of unprecedented growth in the volume and value of financial services.
      There was certainly no clamor from any quarter, Tories, Bank of England, bankers or Europe, for more regulation. In fact quite the reverse.
      Brown is to blame because the crash happened on his watch but it was the whole global and banking system that has collapsed.
      Is Brown also to blame for the Eurozone collapse?
      Blaming individuals for a systemic collapse, which is still on going, is not a sustainable analysis.

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  3. "This is in part because I have very negative views about the role of ideology (left or right) in influencing economics. (Incidentally, I do react badly to those who say ‘ah, but all theory is ideological, it’s just that you pretend what you do is ideology free’. I guess this makes me one of those old fashioned fogeys who believe in the possibility of evidence based social science.)"

    I'm very surprised by this statement.
    To pretend that economic theory exists in a vacuum and can be isolated from the political and social context is a very strange assertion.

    Keynes was a capitalist and a liberal before he was an economist.

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    1. I'm not entirely certain who I'm siding with when I say this, but IMHO the problem with Economics as a science (and I do believe that econ is a science) is that we can't as researchers entirely seperate ourselves from our ideological biases when we work. It is a little niave to think that we can--when I do physics (I'm a former physicist) I don't have a strong opinion on what the mass of the neutrino ought to be, but I do have strong opinions about the role of the government. This of course informs my analysis.

      At the same time, if we do our jobs right, it shouldn't matter that we have these biases (not ultimately, at least). As an evidence-based endeavor, eventually the facts should trump ideology. For this reason, I would defend Prof Wren-Lewis--in science, ideology doesn't exist in a vacuum either; it must coexist with known facts.

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    2. Bseconomist, I agree that there's no reason we can't ultimately overcome biases and preconceptions. But I'm not sure such preconceptions are a problem unique to economics or social sciences. There is a human tendency to try justify what we think we know, not tear it down. So if you've spent your life "proving" that merinos weigh x, you might not do experiments that would disprove that (may not be a great example).
      Back to the post, interesting and I'd been wondering about this.

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    3. Damn predictive text. Merinos should be neutrinos.

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    4. "As an evidence-based endeavor, eventually the facts should trump ideology. For this reason, I would defend Prof Wren-Lewis--in science, ideology doesn't exist in a vacuum either; it must coexist with known facts."

      The problem is that in economics, facts are in short supply. In science, one can do experiments to confirm the mass of a neutrino, or the effects of gravity, or whatever. In economics, we typically just have some statistical evidence (often of questionable quality) from uncontrolled "experiments", and a bunch of anecdotes. As Krugman wrote recently,

      You can turn to detailed econometric evidence — although my experience is that essentially nobody, including the econometricians, is convinced by that sort of thing. But the way I usually try to do it is to ask whether the available facts fit the “signature” the story seems to imply — that is, do we see the general pattern that the argument would suggest we’d see?

      The "facts" that Krugman has in mind are things like: unemployment is high, inflation is low, etc. In other words, facts that can be explained by multiple theories, and are therefore inconclusive from a scientific point of view. To establish more meaningful facts (e.g., unemployment is high because demand is too low) we can try using econometrics, but this is often misleading or inconclusive. So, Krugman is advocating the use of common sense and intuition.

      I agree with Krugman that this is a good way to do economics, but it's hardly science.

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  4. "If the additional debt is paid for by raising future taxes (i.e. we are permanently increasing the size of the state) then the situation is more complicated. If consumers are completely Ricardian then the timing of the tax increase does not matter for welfare..."

    I think high social return public investment should be mentioned here.

    Contrary to what the right would have us believe, not all government spending is handouts and ditch digging. If the government spending is on high expected return basic scientific research, education, alternative energy, smart infrastructure, etc., then it's not at all just about shifting consumption. The interest and principle on the government borrowed money may be far more than paid for by increased future production (and utils) from these investments, investments a lot more productive than tax-cut financed yachts, mansions, and resorts for the rich.

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