The prime minister’s speech at the lord mayor’s banquet was notable in part because its main message, that “we need to do more with less. Not just now, but permanently,” was delivered from a throne bedecked in gold to applause from members of the financial elite.
Alas, the prime minister shares the view of the aforementioned “experts” that the current crisis, with its economic stagnation, is permanent. This of course does not sit well with those who want a return to the welfare state, among them again Mark Blyth:
But it’s the other less commented upon aspects of the speech that signal why the government feels confident enough to reveal its true colours. David Cameron’s claims simply don’t add up to a coherent explanation as to why “more with less” – perma-austerity – is a policy worth pursuing. First of all, he insisted that “the biggest single threat to the cost of living in this country is if our budget deficit and debts get out of control again”. Yet while the deficit rose to 11.2% of GDP in 2010, the markets that fund British debt never once thought the situation “out of control”. Quite the contrary occurred as the interest payments due on UK bonds have gone steadily down since 2006, and have only risen now, when the UK is supposedly in recovery.
One reason why interest rates went down is that the ECB promised to flood the world with euros if necessary to support the most critically troubled of Europe’s welfare states. the recent uptick is related to the general concern for inflation, both in the United States and in Europe.
That said, Blyth’s comment is valid in that some governments can borrow exorbitant amounts of money without having to pay an interest rate penalty. The problem arises when we draw policy conclusions from this fact, as Blyth does:
A much more likely culprit for the drop in living standards is the fall in British real wages of over 5% since 2010 coupled with high price inflation, but that doesn’t fit with the story of “out of control” spending needing to be reined in for the common good. Second, when you have a deficit, you can either raise taxes or cut spending to fill the gap, and the coalition have favoured the latter. And because of these efforts British government debt has gone up, not down, despite the cuts, from 52.3% of GDP in 2009 to 90.7% in 2013. This is hardly a surprise given that exactly this same pattern of cuts leading to more debt as the underlying economy shrinks has been the story throughout the Eurozone too.
In short, Blyth wants higher taxes and quite possibly more government spending. He does, after all, suggest that there is a positive correlation between government spending and GDP growth: less government spending means lower GDP growth and vice versa.
The problem for him is that evidence points in the exact opposite direction:
Academic research clearly shows that government spending, once it reaches above the level needed to finance core responsibilities such as the rule of law hinders economic growth by misallocating labor and capital. Indeed, there is even a well established relationship, illustrated by the Rahn Curve, showing how larger levels of government spending are associated with slower growth and economic stagnation. Researchers do not agree on the precise number, but there is general agreement that the growth maximizing level of government is between 15 percent of GDP and 25 percent of GDP, far below current levels.
Nevertheless, this unbreakable belief in government as the economic savior is what keeps Europe from evolving beyond the welfare state. This belief is in fact so pervasive in Europe that whenever experts or “experts” speculate about what to do about the sinking ship they end up with the kind of introvert table talk littered throughout the video above.
Europe needs a complete macroeconomic reboot, one where the free market and the free individual is made the first priority of all policy.