Thursday, 21 October 2010

Are Cameron, Clegg and Osbourne "clueless dorks"?

The (almost always) excellent Brad De Long blogs on the UK Spending review.

"Is the prospect of rising unemployment in the UK supposed to enhance business confidence and trigger a surge of private-sector investment? Cameron, Clegg, and Osborne don't tell us.
They don't tell us because they are clueless dorks".

Steady on Brad.

Let's get some facts on the table:
  1. Cuts take us back to 2005. According to the IFS, if the cuts are followed through, spending will return to 2005 levels. Not 1895 levels, but 2005 levels.  That is not to deny that it will be painful for all those gainers over the last 5 years: it will be, but let's not be too apocalyptic.  We are not returned to Victorian England just yet.
  2. Public sector pay is relatively high. Also according to the IFS, public sector pay has now got quite a way ahead of the private sector.  Have a look at the IFS Green Budget table 4 in Chapter 9.  Controlling for education, age etc. public sector wages (outside London) are now 5% ahead of private sector wages for men and 12% ahead for women.  And that is before pensions: that loads an additional public sector advantage.  I would guess, and I have no evidence for this, that the implied value of longer holidays and (until now) relative job security would make even these estimates a lower bound.  (Incidentally, Polly Toynbee, says that public sector pay "had lagged behind" the private sector for a decade, but that is over now).
  3.  Public sector productivity has fallen since 1997.  This is fiendishly hard to measure, but Joe Grice's team at UKCEMGA are the leaders on this and even quality adjusted, every measure they have shows falling public sector productivity, of around 0.5%pa see figure 1.1.
Let's now get two principles on the table.
  1. Spending more now has to be accompanied with a credible promise to cut in the future.
  2. Spending more now will not expand output if it just crowds out the private sector.
 What do I conclude from this?
  1. Even if we wanted to, employing more workers in the public sector is out. We cannot afford their pensions.  And in those regions of public sector pay advantage, almost certainly any public sector employment expansion will crowd out the private sector   

  2. Thus our only Keynesian expansion option, it seems to me, is for the government to (a) borrow to then (b) spend to then (c) employ workers in the private sector.  But only temporarily.  And everyone has to believe that it is temporary. 
Where does that leave us?
  1. Brad may be right that cuts may not crowd in private investment to the extent that cuts lower private sector confidence.  But it does not mean that that expansion works: a public sector employment expansion will crowd out and so any expansion will have to be managed very carefully.  And it might well be better to have a temporary tax cut such as the VAT change rather than try to engineer a temporary private sector only spend rise. To this extent, I agree with Martin Wolf in this morning's FT who suggested a temporary employment tax cut. On infrastructure, I am a maybe.
  2. I think all this says that more spending on an unreformed public sector is ruled out of court. I wonder, along with Peter Robinson, whether history will judge spending on an unreformed public sector as a mistake.

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