Cross Post: Peter Swan AM – In defence of fiscally conservative treasurers

Many highly distinguished economists such as my friend Geoff Harcourt come from what is commonly known as the Post-Keynesian school. This means they believe the theory of economics and fiscal policy applied to the nation bears little if any resemblance to the brand of economics that you and I as individuals are subject to.

Writing for The Conversation’s recent series on the language of economics, Geoff finds that when treasurers use phrases such as “you are using taxpayers’ money” they are confusing affairs of state with decisions that should be left to individual households.

No, my treasurer does not suffer from deficit fetishism

But every treasurer should be aware each dollar of expenditure must come out of the pockets of taxpayers eventually, even if they borrow to finance the outlay in the short-term. Exactly the same is true for you and me. We cannot borrow indefinitely to fund our consumption.

Geoff believes it is fallacious to “balance the budget over the cycle”. But if the government fails to do this then the outcome is undoubtedly eventually the Greek and Spanish solution. This means more bailouts, massive rises in unemployment, a collapsed economy and departures of the able-bodied to work in economies such as Germany that have displayed better fiscal discipline.

Yes, if on average the economy were growing sufficiently fast, and the government borrowed during recessions and repaid the debt with a sufficient surplus in booms, then perhaps balancing the budget over the cycle could be relaxed slightly.

Of course, what we have seen is massive borrowing when the economy was doing quite well during the global financial crisis (GFC) due to China, and even more borrowing during the sequent post-GFC period. Now there’s little chance of balancing the budget over any foreseeable period.

Hypothecation may have been more successful if doctors were the beneficiaries

Geoff is closer to the mark when it comes to hypothecation. For example, if police patrols are rewarded based on fines imposed on speeding motorists, they may become excessively zealous. Medical research funding is more properly determined by its social contribution – not based on a Medicare co-payment.

Countries with as good or better health care systems than ours, such as New Zealand and Singapore, rely far more on co-payments. The insurance aspect of Medicare requires subsidies to life-threatening and expensive medical intervention and not to regular GP visits.

Cynically, would the AMA have been more amenable to co-payments if all the revenue raised were to be paid to doctors rather than medical researchers?

Geoff points out that government expenditure has a significant impact on the efficiency and productivity of the nation. Not always beneficial, I might add. He indicates that this may be especially true of capital expenditures.

There is always a real burden due to borrowing

Geoff then goes on to make the remarkable claim that domestic borrowing to fund such deficits entails no real burden since both the taxpayers and the interest recipients are Australians. I agree, it is true they could in part overlap.

So the government borrows a dollar, perhaps to fund more welfare benefits. I as the taxpayer lend a dollar to the government instead of investing it in (say) advances in technical know-how to raise our future living standard. Activities other than welfare suffer in the Australian economy.

The government then raises the tax on me in order to pay the interest it owes me. I now work less hard because leisure and idleness remain untaxed. Taxes are then raised again in order to repay the principal as well as the interest on the loan I have made to the government. I consume more idleness and the Australian economy suffers yet again.

The burden is no different if foreign borrowing funds it. Geoff points out that repayment of principal and interest must come out of export earnings. These additional export earnings have to come at the cost of lower domestic consumption and investment, that is lower non-welfare related activities. The tax burden is the same as in the case of domestic borrowings.

All borrowing, whether domestically or foreign, entails a tax burden with the burden increasing in the size of the deficit. Only if the borrowing is to fund long-lived public goods that I, and others, benefit from collectively is the borrowing justified. Most federal borrowing is to fund current expenditures and interest payments, not infrastructure.

‘Scare tactics’ are no more than the law of economics

Geoff concludes that “the end result has been the use of scare tactics over a wide range of issues, tactics which have no foundation in proper economic logic”. Yes, I agree scare tactics have been tried. Not very successfully so far because senators fail to see that in one way or another taxes have to be raised or outlays slashed to fund the repayment of principal and interest.

Are these tactics contrary to the laws of economics when applied to deficits? No. In fact, these laws are rigid and ultimately are little different from that faced by you and me as individuals.

Peter Swan AM is a Professor of Finance and UNSW. Originally published at The Conversation. Cross posted with Peter’s permission.

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15 Responses to Cross Post: Peter Swan AM – In defence of fiscally conservative treasurers

  1. Shy Ted

    Dear Geoff, you do realize you’ll never get anywhere with such sensible ideas?

  2. Elizabeth (Lizzie) B.

    As a non-economist, one sometimes wonders why it is so hard to actually come to this right conclusion.

  3. Lizzie, the only reason that Keynesian Theory is such a popular one amongst our ruling gentry, is because it allows them to spend, spend, spend.
    You and I have to live within our means. They don’t. We is just the ‘little people’

  4. rebel with cause

    Geoff then goes on to make the remarkable claim that domestic borrowing to fund such deficits entails no real burden since both the taxpayers and the interest recipients are Australians.

    This fallacy was debunked by James Buchanan back in 1958 in a little book called ‘Public Principles of Public Debt’. In short, the people who loan the money, the people who get the government spending, the people who pay back the money, and the people who receive the payback are all different people. You can’t aggregate up the effects of borrowing in the Keynesian fashion and claim they all cancel.

    Further, as Friedman pointed out, someone who advocates for government borrowing today to finance spending is really advocating for higher future taxation. The full cost of government is what it spends today, not the amount of tax it takes.

  5. Rabz

    someone who advocates for government borrowing today to finance spending is really advocating for higher future taxation

    Or, heaven forbid, a reduction in real future levels of government spending ‘services’.

  6. Diogenes

    Cynically, would the AMA have been more amenable to co-payments if all the revenue raised were to be paid to doctors rather than medical researchers?

    No cynicism at all the AMA has proposed a $6.15 co-payment from everybody(except some categories), all of which goes to the GP

  7. .

    I’m shocked by how many times Keynesian policy has to be empirically discredited.

    There are some interesting theoretical points or policies made on their own by the continuing schools of Keynesianism, but are valid when they are consistent with classical economics (e.g., fiscal theory of the price level).

    Keynes only has an appeal because it is easy to teach in a toy model with easily simulated policy results.

    The level of empirical invalidation of Keynes is far and wide. The assumptions, results and workings of the model and other metrics have been found to fail consistently across many nations in many time frames in many natural experiments. The counter arguments usually consist of extremely weak and short sighted nit picking of no consequence.

    Winston is right. It won’t die because the political class view it as a way to get something for nothing and justify their avarice, whims and empire building volition.

    At a base level, it is flawed theory based on assumptions that have been disproven. Anyone who has read Mises will understand that demand simply cannot be manufactured, Keynesian policy is entirely a false economy.

    For the Australian example, John Humphreys and Tony Makin have shown that it has had a deleterious impact on the Australian economy. My view is that the last round of stimulus accelerated the decline in private capital expenditure.

  8. closeapproximation

    My view is that the last round of stimulus accelerated the decline in private capital expenditure

    Spot on.

  9. Squirrel

    I’ve noticed that those who are in favour of “balancing over the cycle” (or something vaguely along those lines) never, ever define the cycle – so truly difficult decisions are always fobbed off until next year, and the year after and so on – it’s just a weaselly rationalisation for over-spending.

    If our public officials – elected and otherwise – managed public funds in the same way as a prudent household, we would be in a much better position than we now find ourselves. Arguments that the rules of prudent household (or business) management do not apply to public funds is patronising sophistry, and just like the “over the cycle” escape clause, an attempt to justify over-spending by public officials.

  10. sdfc

    Of course, what we have seen is massive borrowing when the economy was doing quite well during the global financial crisis (GFC) due to China,

    You’ve got a bit of a timing issue there Peter. The terms of trade and export values slumped in late 2008 / early 2009.

  11. .

    sdfc
    #1433233, posted on August 29, 2014 at 7:14 pm
    Of course, what we have seen is massive borrowing when the economy was doing quite well during the global financial crisis (GFC) due to China,

    You’ve got a bit of a timing issue there Peter. The terms of trade and export values slumped in late 2008 / early 2009.

    The Chinese stimulus was worth 586 bn USD and concentrated on rail and low cost housing.

    The filip for iron ore and copper producers is fairly obvious.

  12. sdfc

    Like I said Dot there are timing issues there. The Chinese stimulus came too late to prevent the slump in late 2008/ early 2009.

  13. .

    The slump lasted a couple of months and contracts rarely use spot prices.

    Please stop clogging up a sensible discussion with assertions you cannot back up.

  14. sdfc

    The slump in the terms of trade and national income is a matter of history.

  15. .

    ?

    You are just trolling with asinine, spambot like commentary.

    My comment posted on August 29, 2014 at 10:23 am sinks Keynesianism dead.

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