Spending Away the Debt: The as an alternative to deflation, disinvestment and synchronised austerity. IEA, March 2013

1. Introduction

First, I want to thank the Institute of Economic Affairs for the invitation to address you today.

Given that the approaches the economy in ways radically different from those of the IEA, the invitation was a brave, but – in my view, at least – a commendable one. And so I want to thank particularly Mark Littlewood and his team.

And I’ll begin today by emphasising one area where I think we probably all agree.

I imagine we can all agree that cutting the deficit – the rise in government borrowing – is a good thing.

Indeed I would go further and argue that cutting the government deficit, and paying down the debt is now an urgent task of government.

So please don’t place me in the camp of deficit deniers.

The question is how best to achieve that deficit reduction – and there, I think, we will have very different responses. 2. Green New Deal position

Let me start with a bit of history.

Over the winter and spring of 2007 – 8, I was part of a small, but diverse group that met regularly for heated discussions in one member’s flat in central London. The group, which we called the Green New Deal Group, included entrepreneurs, economists and environmentalists.

The global credit crisis had ‘crunched’ on 9th August, 2007, when inter- bank lending froze.

Yet the financial crisis over that winter was experienced by most of the population, and indeed by most economists, as a vaguely worrying, but still distant rumble. Remember this was before the collapse of Lehman Brothers.

The Green New Deal group was not so complacent, however; indeed we were deeply alarmed about the prospects of global economic failure.

While we came at the issues from different angles, we all agreed on the profound threat of what we were to describe in our report as a ‘triple crunch’: a combination of a credit-fuelled financial crisis, accelerating and growing energy insecurity.

The report was published in July 2008 by the New Economics Foundation, and described these three inter-related threats as, and I quote:

“likely to develop into a perfect storm, the like of which has not been seen since the Great Depression.”

Sadly, we were not wrong. With respect to our first prediction, this is now the 6th year of a widespread, international depression, with 2.5 million of our people unemployed; many millions more under- employed; and with youth unemployment at tragic levels.

Thousands of small businesses have gone bust; banks have failed; and recovery seems remote.

All of this is exacerbated of course by austerity in Europe, where levels of youth unemployment are staggering and threaten social upheaval: above 50% in Greece and Spain.

Here in the UK, as Jonathan Portes has shown, there is little evidence of the strong recovery expected after previous post-war recessions.

So, yes we were right: global economic failure has led to a prolonged depression in countries like our own.

With respect to our second concern, about accelerating climate change, I there is every chance that we’ll remember the year 2012 as one in which, to quote the New York Times, “the weather spun out of control in a chaotic concoction of drought, deluge and flooding”.

Around the world, extreme weather has become the new commonplace.

Last summer, for example, Arctic sea ice hit a record low – smaller, patchier, and thinner than ever.

The New Scientist’s editorial proclaimed “sea ice low heralds end of 3 million year cover”, and went on to explain why the consequences of what is arguably the greatest environmental change in human history will extend far beyond the North Pole.

And then there is the Green New Deal Group’s third prediction on energy insecurity.

One of the most important functions of government is to ensure the nation’s security. Unfortunately this is largely understood as solely a military role.

Meanwhile, the role of guaranteeing the nation’s energy security has been assigned to the invisible and unaccountable – and I would add, irresponsible and distorted - hand of ‘the market’.

This is something for which we will likely pay a high price in the future.

For as Alistair Buchanan, the boss of Ofgem, warned recently: the combination of UK power plants closing, foreign gas supplies shrinking, and demand rising, has made British energy reserves “uncomfortably tight”.

The failure to invest properly in energy efficiency, demand reduction, and renewables, combined with an over-reliance on increasingly costly fossil fuels from increasingly unstable regimes, presents the British people with a very insecure energy future, with grave implications for economic stability as well.

The Green New Deal group made our prediction about a depression, climate change and energy insecurity before we became fully aware of the abject incompetence of economists, central bankers and politicians in handling the crisis.

These policy elites effectively presided over, and allowed the bottom to fall out of, the British economy between 2007-9.

Frankly, it is scandalous that no politician, banker or policy-maker has been held accountable for this failure.

And economists are equally to blame. As Martin Wolf recently remarked “at the end of a 50 year credit super-cycle, economists did not have the faintest idea of how economies work.” 1

1 Remarks to a NIESR conference at Lloyds Bank “Financial structure: fine tuning or radical reform?” After a bungled response by central banks to the August 2007 credit crunch, an initial mild stimulus was applied by governments both in the UK and the US, which had a small but modest beneficial impact.

However, since 2010 central bankers and politicians have presided over the application of brutal economic policies that have impoverished the innocent, enriched global financial elites and exacerbated the worldwide slump.

3. The Cuts Won’t Work

Foreseeing the risk inherent in fiscal consolidation, in December, 2009 the Green New Deal group published a second report, The Cuts Won’t Work.

We explained then what is now clear to all: that austerity and cuts in public spending, at a time of slump, when private debt has grown to become 5 times the size of public debt, at more than 420% of GDP 2 – is delusional economics.

It is extraordinary to me and my colleagues that the government focusses so ferociously on public debt – which now stands at 70% of GDP – but turns a complete blind eye to private debt –now at 420% of GDP.

2 See the McKinsey Global Institute report: Debt and Deleveraging: uneven progress on the path to growth. January, 2012. And this massive overhang of private bank debt goes a long way to explain why banks are not lending and why private sector investment is stalling. 3

Yet, encouraged by the Chancellor’s ideological approach to the economy, and backed by commentators in the media, the public has been led to believe that the greatest crisis facing us all is embodied in the public debt.

These fears are effectively deployed to prevent any initiatives based on public expenditure.

But while the government and the Treasury may be blind to, and misguided about, the state of private debt, people are beginning to wake up to the deception, and coming to understand that public debt is not the threat that the Chancellor and the City of London would want us to believe it is.

And they are beginning to recognise that Treasury complacency and impotence in the face of ongoing economic weakness is now a matter of ideological, not economic, preference.

That ideological preference is informed by flawed economic orthodoxy.

3 Financial Times, 27 February: Economy fails to rebalance. We showed in our report, something that many economists still struggle to understand: that the public deficit is an outcome of policy, not a constraint on policy.

That rises in government borrowing are almost always a consequence – not a cause – of economic failure.

That public borrowing and public debt rises, when the rest of the economy shrinks.

That public borrowing rises, when the private sector – heavily indebted and lacking confidence in government to generate recovery – retreats, hoards cash, and saves.

That public borrowing rises, when financial crisis, sclerotic banks and cuts in public investment cause a loss of confidence. When overall investment shrinks and tax revenues fall.

That public borrowing rises when, in a slump, tax revenues fall, government spending on vital services like the criminal justice system and the NHS remains fixed, and welfare payments rise.

Truly, it’s not rocket science.

But while the parliamentary debate is between the Coalition apparently hell-bent on cutting the deficit, and the Labour Party, apparently wanting to postpone cutting the deficit – there is confusion.

Because, as the public increasingly recognises, that is not the real debate.

The real debate is between expenditure-cutting, and stimulus.

Back then, in our report, we posed the question: will expenditure- cutting cut the deficit?

The Office for National Statistics periodically provides the answer: emphatically not now, and in a slump, never. 4

Looking at the government budget as if it were a credit card, has led George Osborne and Treasury mandarins to a failure in sound analysis and macro-economic prediction.

Just because individuals and households can cut their deficits by cutting spending, and increasing income, this very low level of micro-economic reasoning implies that government can do the same.

It cannot.

Because the government’s budget is not at all like a household budget.

4 For a century’s worth of evidence of effects of expenditure-cutting on government budgets, see the report by Prof. Victoria Chick and Ann Pettifor: “The economic consequences of Mr. Osborne” first published by PRIME – Policy Research in Macroeconomics, in July, 2010. While it makes perfect sense on a household level to rein in spending when the credit card is maxed out, it simply doesn’t make sense at a national and international level, since you end up dramatically shrinking the economy.

Micro-economic reasoning, used to make macroeconomic predictions, leads, inevitably, to mistaken policy action.

Yes, the public debt is growing, as the Green New Deal group argued it would.

But, we also argued, this is no barrier to action. Instead, as we showed in our second report, an active programme of productive investment is the only way to reduce the public debt.

In a recession, spending less and saving more is exactly the right thing to do for individual households and firms in financial difficulties, but it will also damage the economy as a whole.

That means a recession is not the time for public retrenchment. The public sector has to take up the slack by investing in sound projects – projects the private sector will not risk - financed by loans from the Bank of England, or indeed from the Green Investment Bank.

Such sound investment will generate the tax revenues needed to repay the Bank of England debt.

In our first report, the Green New Deal group proposed a massive investment in retrofitting Britain’s ancient housing stock, to ensure we become more energy-efficient and less reliant on unstable governments for our energy supplies – addressing all three aspects of the triple crunch that we’d identified – not just the economic crisis, but the climate crisis and the crisis of energy security as well.

And higher levels of employment will guarantee income and profits – private income - as well as tax revenues for government.

Crucially, what we’re talking about here is not indiscriminate spending and investment, but rather “transitional investment”, which means that our use of energy and materials should be primarily focussed on investment in infrastructure that will eventually lead to a reduction of demand for them in the future.

By this definition, investment in home insulation is clearly transitional investment - where increasing new airport capacity, for example, is not.

And this kind of public investment or spending – believe it or not - pays for itself.

That is why the only way to reduce public debt – is by spending away the debt.

Of course this is counter-intuitive for most of us who are not macroeconomists.

It is definitely counter-intuitive for the majority of orthodox microeconomists.

However, it makes perfect sense.

4. The economic underpinning for spending away the debt

To understand how to spend away the debt, we need to first understand that the challenge is not the availability of finance.

The public now knows and understands that in a developed monetary and banking system, with a fiat currency – that is, a country that enjoys monetary sovereignty - there is no constraint on the availability of funds.

That was made perfectly clear when Central Banks around the world, including our own, created $16 trillion out of thin air, to bail out the banks.

So the public have learned from the experience of Quantitative Easing that in a sound, developed monetary economy the challenge is not the availability of finance. The challenge is the spending of money.

Only the government, working closely with the Bank of England, can now take action to invest in Green projects that will revive confidence; provide income for both the private and public sectors, expand employment by way of infrastructure projects, and help cut the deficit.

Crucially, it will also offer us far greater energy security through investment in energy efficiency, for example.

And it will generate the income needed by both individuals and firms, to pay down Britain’s massive private debt bills.

Borrowing from the government’s own nationalised bank – the Bank of England - would be financed at only a small premium over the Bank of England’s present discount rate of half a per cent.

Right now the Bank of England’s QE scheme is generating finance - liquidity – but this money is aimed largely at Too Big To Fail banks, and their clients.

These generous injections of liquidity by central banks have served as a kind of drug for the international capital markets – and sent them on a ‘high’.

And much of the evidence suggests that Bank of England liquidity has largely been used for speculation – in commodities, Emerging Market currency trades, by buying the and shorting the Yen and investing in the kind of unproductive assets the rich are so fond of: properties in Mayfair and hotels on remote islands in the Indian Ocean; fine art, watches, wine, jewellery or classic cars – in the speculative hope their prices will rise. (See the FT’s House and Home 22 Feb 2013).

Which explains why Central Bank action across the world has done so much to enrich the already rich, while failing to spur economic recovery.

The only possible way of spurring economic recovery is through government action.

Public works spending is the most attractive option because this goes straight to help employment and companies, but also because the projects can add to the well-being of the nation.

And, since the programme of works set out in the Green New Deal are explicitly designed to transform the energy infrastructure of the UK to meet the challenges of climate change and peak oil, they would not need to be permanent. We would have reduced the demand for these energy supplies.

The whole point now is to revive economic activity – which effectively means employment - while simultaneously preparing for future climate change and energy shocks.

As employment and economic activity is restored, the revenue from taxes rises and the cost of benefits comes down, and only then will public borrowing be cut.

That is why we proposed this programme for recovery back in 2009, and that’s why I exhort government to embark on it now.

5. Conclusion - Keynes

And what we are saying is not new. It is known and well understood and evidenced by the economics profession.

JM Keynes argued and proved, back in the 1930s, that spending would pay for itself. Data from a century of national accounts – accounts which he initiated – thoroughly vindicate that argument. 5

And his economic theory was backed in the 1930s, by the Liberal Party which in their manifesto for the 1929 general election, wrote:

‘We are ready with schemes of work which we can put immediately into operation. These plans will not add one penny to national or local taxation.’

This is one of the fundamental propositions of Keynes’s economics, yet the economics profession today remains silent about it, even those who advocate public works.

The fact is this: Keynes is not about borrowing in the bad times and repaying in the good.

5 http://www.primeeconomics.org/wp- content/uploads/2011/06/The_Economic_Consequences_of_Mr_Osborne.pdf

The borrowing in the bad times pays for itself.

Which is why I argued at the beginning of this speech that I, like my Green New Deal colleagues, am strongly in favour of cutting the deficit. But unlike the Chancellor, I believe that goal can only be achieved by government spending away the debt - through investment in sound, employment-generating projects. Not by cuts in government investment.

These arguments must become, once again, the economic justification for the Treasury and government rising from its deep torpor, and finally beginning to undertake the level of public investment needed to reverse this disastrous slump, and protect the British people from both financial and energy insecurity and the extreme weather events brought on by climate change.

Thank you.