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It’s the Economy Stupid

It never ceases to amaze me how bad a grasp politicians have on how national economies work.  I think it is deliberate rather than ignorance. Or rather they think that we are too stupid to understand how a national economy differs from a household economy. They may even be correct about that assumption…

Received wisdom on the economy (according to politics)
– growth needs to be sustainable
– the deficit should be reduced
– austerity is necessary

Most commonly our main political parties use a household analogy to explain their economic policies. This is a very wrong thing to do. It sort of ignores the interdependency of national economies, and it over simplifies things. That said it is something that most voters can relate to.

A better, but still flawed, analogy would be a multi person multi income household. Imagine a family unit with some older adults and some grown up kids old enough to work. One of those older adults is the Government and they collect money from all the working residents to pay the mortgage, credit cards and all the other bills. They look after the house and make sure everyone is OK and safe.

If some of the people in the household don’t make quite as much money as usual there is a choice about how the homemaker deals with the cash flow. Either, persuade others to pay more, make economies (with the consent of the household), put more on the credit card, or put off things that can wait.

If everyone is happy for their standard of living to fall then economies can be made. However the key deal (sustainable growth) is predicated on standards of living improving over time. If that objective overrides the short term cash flow then you need to take up the slack with the credit card.

This is where the analogy falls apart. In the national economy when you make economies people lose their jobs. Not just public sector workers, but private sector ones too. Most government work is done by private companies overseen by a handful of civil servants. There are about 400k civil servants in the UK, who oversee central government spending in the hundreds of billions range. You take a 10% cut of them and there is a gearing effect.

On top of that, when private sector workers lose their jobs the public sector starts to support them through benefits and assistance in finding employment. So there’s a sound reason why government spending needs to increase during a recession.  Static on normal activities to avoid causing more job losses and increases in supporting the unemployed finding gainful employment.

It doesn’t end there though. Even in my extended analogy I talked about putting stuff on the credit card. This is sort of a proxy for the national debt. The national debt is itself a gearing mechanism invented to allow government to work at scale and continuously. It first came into being in a war against France so that Britain could field forces necessary to win but which cost more than we could afford in a single year. It worked then, and it still works now albeit now it funds the welfare state and corrects short term dips in tax income.

Government debt is smaller than household debt by income, and it should be viewed on the scale of a mortgage rather than a credit card. If nothing else the Government pays less on interest on its debt than any consumer does. We don’t put 2% of our annual income on a long term credit card balance because we’d be paying 20% interest on it. On the other hand we happily commit to 200% of our annual income on a 25 year mortgage at about 5% interest.  In the latter case we know that interest rates change, but equally we expect our income to outstrip the payments.  The national debt is exactly the same, except typically the proportion of income borrowed and  interest rates are lower and there is no fixed repayment date.

Any thoughts or comments gratefully received.

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