March for WHAT alternative?

It's on days like yesterday that I love my country. You look at the news around the world and see protestors against their governments' policies being shot, imprisoned, tortured and eventually silenced. Here, we had so many people filling Hyde Park today that the organisers stopped counting and no one is doubting there is a decently sized movement "for the alternative" to the Coalition's deficit reduction plan. It's not a national movement and it's not a majority - 250,000 to 500,000 people are about 1% and 2% of the voting population. It's a collection of interest groups who are affected or will be affected by the policies. But that doesn't make what they are saying any less important to hear. It's absolutely vital that people of this country have the right to protest and hold the government to account, scrutinizing their policies.

However, good though they are at articulating the problems with "the cuts", I'm still waiting to hear a coherent, economically sound alternative. It is extremely important that this arises soon.

For instance, until Ed Miliband actually explains HOW he would halve the deficit in 4 years (as would have been the plan had Labour been in Government) then his contribution to this debate remains the same knee-jerk children oppositionism that seems to see him blindly flailing around shouting "Thatcher! 80s! Ideological!", in a sure-fire short-term poll raising strategy that won't get him elected in a million years.

While we're at it, can someone explain why it is OK for the UK to be paying more in debt interest at the moment than we do on national defence, and why it would be OK to end up paying more interest than we spend on our education system - which would be the case in 2015 EVEN IF we clear the deficit (remember - we need to have enough surplus to pay off over a trillion pounds of debt which could take around 50 years). That debt interest has what is known in Economics as an opportunity cost. Every penny could be spent on something useful, instead - it is spent on paying off debt. And for those today who advocate that we simply refuse to pay the debts we have - are you seriously trying to bring down the entire world's financial system?

I would also be grateful if someone can explain how the 'Robin Hood Tax' would actually help reduce the deficit. I get the idea - it sounds wonderful - tax the rich and give to the poor. Lovely. Politically and socially wonderful. Trouble is - it will raise LESS tax revenue. People will leave the country (taking the jobs they create with them) or will do what they can to avoid the tax (I'll come to THAT in a minute) or work less (because it's pointless working hard as your pay gets taken from you) and there will be LESS tax revenue. This is the difficulty of setting up a tax system. FACT - when the higher rate of tax went from 60% down to 40% in 1988 the tax take ROSE and the amount rich people paid ROSE.  So, someone tell me how it would reduce the deficit please.

Now, tax avoidance. Again I think it is a very important point and, using the figures from UK Uncut and the TUC today it would raise £25bn if it was sorted out. But, as I address in a previous article on this site (click here) that is not likely to raise as much as it might seem. The Coalition government IS attempting to close more loopholes - particularly for non-doms, but it is right that a light is shined on this area as more should be done.

Then there is this notion that we should not be spending money on the wars Iraq, Afghanistan and now Libya. It's hard to get away from the fact that when the cuts are costing jobs it is a shame we are spending such a huge amount of money in Iraq and Afghanistan. But unfortunately we are there are we can't just walk away as we really do have to clear up the mess we made.

As for Libya, I find it interesting the amount of those protesting yesterday with signs saying things like "Hands off Libya". First of all - let's not forget that all but 8 (eight) of our elected representatives voted for the Libyan operation. Let's also not forget either that there was about to be a massacre committed there. I have discussed Libya elsewhere (click here and here), but I must ask the question...if there is a moral case against cuts do those morals take a backseat when money that might be spent on you is instead spent on saving peoples' lives?

Also there is the whole question of putting "protect the public sector" in the same paragraph as "concentrating on economic growth". Which one do you want? Let's put them together - can you get economic growth by protecting all public sector jobs? If so, how? There are three ways of getting income in this economy:

1) You receive money direct from the public purse in the form of benefits
2) You receive money direct from the public purse in the form of wages for working in the public sector, which you give back in the form of taxes and national insurance
3) You receive money from private companies which you give back in the firm of taxes and national insurance

It doesn't take much to see that the only way out of those three in which the UK purse gains more than it loses is 3) wages paid by the private sector. If we want sustainable economic growth we need to empower the private sector to pick up the slack on employment and therefore growth. The amount of resources devoted to the public sector causes something called "crowding out" where resources (financial, human, land, capital, everything) are diverted from the private to the public sector. Examples could include the fact that the increased borrowing by the government to fund added government spending could cause interest rates to rise, making it more expensive for private businesses to borrow money. Another example could be where an employee, instead of working for a private company, getting paid wages and paying tax to the UK is instead employed as, say, the "walking co-ordinator" for a local authority (and don't go on about "nurses and teachers" - it's not them being cut, but it may be the person who interviewed my mother-in-law for her own NHS job that she had been in for 20 years twice  in one year when she moved from 5 days a week to 3 to 4). Or it could be that a private company can't afford rent to move to a bigger office because a public sector organisation is offering a larger rent. The point is, protecting public sector jobs is not the alternative, the case for that is completely different.

Finally, there is scrapping Trident nuclear system. I can absolutely see the case for doing this, given the sheer amount we would be spending on something that, should we ever have to use it then we are basically at the end of the world anyway. But, my understanding of the international power system is that should we not have any nuclear capability, we will literally "lose our place" at the top table of international politics. Whether that is right or not, and whether we should care, is another thing. I do care, but I'm just one opinion.

Before I conclude, I must add that too much of the argument against the deficit strategy in built on an outright lie. The lie is that the financial position this country is in is all because of the banks and nothing to do with the Labour Government's economic policy. This is a convenient lie, as it allows people to say the banks should pay to clear up the mess. To be clear, at the end of one of the longest periods of continuous economic growth in our history, the UK had a budget deficit, rather than the surplus that could and should have been built up by a prudent government during the boom part of the economic cycle. I should also point out that to fund the structural deficit (that part of the deficit not caused by the economic cycle) that existed BEFORE the recession the Labour Party were happy to borrow from the banks, and that borrowing was, in theory, put to good use. As I have said elsewhere (click here), there is no reason why a coherent case can't be made to justify this risky management of UK funds, because a lot of spending was needed to clear up the mess left by chronic underinvestment in public services from 1979-1997 BUT that doesn't mean the lie should continue to be propagated that the trillion pound debt and £145 bn deficit was caused by the banks. It was caused by the feeling on the part of the Labour Government that the boom would never end then exacerbated by the depth of the bust when it did end, and that depth WAS caused by the banks. Again, Labour may be getting short term polling gains by not admitting their responsibility for the deficit but they simply won't get elected again unless they show they won't put the country in that position again.

In conclusion. It is extremely important in this austerity age to have this level of political debate and protest, and I am proud that we are having it. But please, somebody with some form of economic literacy, explain to me an alternative strategy that actually makes economic sense, and explain how it would be done. Because I didn't hear it yesterday and I haven't heard it yet.

Inflation isn't the problem. Stagflation could be.

We are about to see an example of how psychologically influential inflation is in the UK. There can be no other reason why the Bank of England could even be considering raising interest rates right now.

Recently (10th March 2011), the Bank of England Monetary Policy Committee (MPC) voted to leave its Base Rate at 0.5%. This means the rate has been at an all-time low for 2 years now. But, like a swan, the serenity on the surface belies a lot of action underneath, and it is almost certain that this vote was very close and we're about to see some real action in the form of a rise in interest rates. But the fact that this might happen when we are possibly in the midst of a double-dip recession (should April's growth figure be negative then we are officially back in recession) shows the problem with the Bank of England's sole objective, to target inflation.

When teaching macro-economics, I am at pains to point out to students that when faced with an essay on policies to deal with a problem they must consider openly the cause of that problem. So, should they be asked to discuss policy options available in the event of rising inflation, they would struggle to get near top marks should they not point out the dependence of the corrective policy on what caused the inflation in the first place.

My view on this is that the causes of this inflationary spike cannot be remedied by raising interest rates. Therefore doing so could cause worsening unemployment and confirm the journey back into recession. I also suggest that the only reasons why interest rates would rise is because the Bank of England is too focussed on its primary aim (inflation stability) at the expense of its secondary aim - to support the government in meeting their targets for growth and employment. This may be because of the hold that inflation has on economic fears. Maybe the MPC thinks Britain needs inflation credibility more than anything. Well, I would like to control inflation too, but not at the expense of growth and employment at a time when we don't have enough of either. It's frustrating enough waiting for the Coalition government to come up with a strategy for growth without the MPC making it even more unlikely.

Anyway, back to causes. In this case, inflation is now consistently running at and over double the Bank of England's target - which is 2% (plus or minus 1% let's not forget) - for three main reasons:

1) The rising oil price
2) The rise in VAT from 17.5% to 20%
3) The rise in food prices

The rising oil price

The rising oil price is a particular problem for the UK. It pushes up inflation because we import so much oil so business costs rise, pushing up prices and consumers spend more on the petrol made with it. It also can cause unemployment because as it pushes up business costs rational employers may look for other ways to cut costs, through firing or not hiring people. It can also cause a slowdown in economic growth and possibly cause a recession. Inflation is often caused by rampant economic growth, with a concurrent growth in employment. This time, we have inflation accompanied by negative economic growth and high unemployment. That is called 'stagflation' and the problem is that it's more or less here. Raising interest rates will do nothing to stop the rising oil price. The Government can reduce fuel duty on it - BUT they have to reduce the deficit, so they are stuck in a bind too.

The rise in VAT from 17.5% to 20%

This automatically put prices up. Remember, inflation is measured using a basket of goods, weighted for the importance of the items within it. Many of those items have just seen their prices go up by the amount of the rise in VAT.  This was done by the Coalition government, again because of the need to raise tax revenue to deal with the deficit. An economist from afar who didn't know this happened might think that consumption had gone up, raising aggregate demand and so raising interest rates would help, but the VAT rise makes that connection different. Raising interest rates will do nothing to deal with the impact of this rise.

The rise in food prices

This has mainly been caused by extreme weather events in the major food producing countries. It has been exacerbated by speculators but they are not really to blame. The problem again here is that the rising cost of food imports  pushed up the costs of many businesses who then pass those onto customers in the form of higher prices, causing inflation. Again, rising interest rates will not stop this happening.

It would be nice to think that there was a simple answer to the economic ills of the UK. We have a massive deficit, massive debts, huge unemployment, a government without a recognisable growth strategy and now inflation. We need to deal with all of those problems and a rise in interest rates will probably make them worse.

For instance, the upcoming job losses in the public sector are supposed to be offset by job gains in the private sector. But the investment needed in the private sector for that to happen would need to be funded from somewhere, and a rise in interest rates will make that more expensive, and therefore less likely.

Many commentators feel that in the medium term there is more of a danger from deflation, in which case nothing should be done now to hurt growth.  I'm going to add my name to them.