Tuesday, May 29, 2012

The inefficient state fallacy

One of the fundamental beliefs of the orthodox neoliberal is that government spending must be cut because state spending is less efficient than private sector spending. This is a form of reductive fallacy, in that a vast amount of economic circumstances are being reduced down to fit a simplistic right wing platitude.

On the face of it the fallacy is absurd, there is nothing that makes a worker suddenly become more productive once he is working for a capitalist boss rather than a state run enterprise, in fact the short-term profit motive can actually make private sector businesses much less efficient in the long-term as they slash investment in training, research and modernisation order to provide larger short-term profits to shareholders (a philosophy called Shareholder Value Maximisation). The idea that all state spending is inefficient is as simplistic and absurd as the idea that all private sector spending is efficient. If all private sector activity was "efficient", there wouldn't have been over 230,000 bankruptcies since the Coalition government came to power in 2010 and the state wouldn't have had to have intervened to save the deregulated financial sector from the consequences of their own reckless gambling.

These selected fiscal multiplier statistics demonstrate that well spent
state funds can provide significantly more economic benefit 
than returning the cash to the private sector via tax cuts.
One of the economic tools for determining the monetary value of state spending is the fiscal multiplication value. A score of 1 would mean that the state investment returned exactly the same fiscal value to the economy as it cost. It has been calculated that state spending on construction can create very strong fiscal multiplication values (estimated to be as high as 2.84 in the UK) as large labour intensive projects tend to add to aggregate demand, whilst tax cuts for the extremely rich (the lost revenue is considered as spending) often create extremely low fiscal multiplications. In the United States making the Bush tax cuts permanent created an extraordinarily low fiscal multiplication value of just 0.29. In 2008 the strongest fiscal multiplication effect in American state spending (as calculated by Moody's) was a score of 1.73 for the temporary increase in the provision of Food Stamps to impoverished American families.

Another area that creates strong fiscal multiplication is state spending on tax enforcement officers, who can often return an average of more than ten times their own salaries in what would have been lost tax revenue. If the ideologically driven neoliberal decides to slash the number of tax inspectors as part of their austerity drive, any savings on salaries and overheads are more than wiped out by the resulting loss in recovered tax revenue. Even if these recovered tax revenues are spent on slightly inefficient state spending projects with fiscal multiplications of 0.6-0.9, this would still create a vast amount more localised economic activity than simply allowing the cash to disappear into some foreign tax haven.

It is clear from these selected fiscal multiplication statistics that some forms of state spending create vastly more economic benefit than returning the funds to the private sector (via corporation tax cuts) or to the public (via the Bush tax cuts for the super-rich). If all state spending was truly inefficient, then the fiscal multiplication effects should be the other way around, with state spending and investment failing to break even and the tax cuts for private and corporate interests making large positive returns.

If a government initiates a strategy of indiscriminate across-the-board cuts in government spending they are likely to destroy a great deal of fiscal multipliers in the process, throwing the baby out with the bathwater in effect. To give another hypothetical example of false economies driven by an ideological stance on state spending:
In order to meet their ideologically driven austerity objectives, a government attempts to cut public sector spending on policing. These cuts end up leaving one neighbourhood with very few bobbies on the beat. Criminals begin to realise that the area is poorly policed and begin a campaign of car thefts, household burglaries and business burglaries. Over the next year or so insurance companies pick up the growing crime trends in the Post Code area and hike rates for car, home and business insurance. The large above inflation rises in car and home insurance eat into the disposable income of local residents, meaning they have less money to spend in local businesses. The rise in crime and unruly behavior on the high street deters older people from doing their shopping there and combined with the huge hike in business insurance rates several local retailers go bankrupt. In the act of saving the salaries of a dozen policemen in the area, the government has ended up losing a great deal of corporation tax that would have been paid by the busted businesses, the income tax of their now unemployed staff, the VAT on the produce the businesses used to sell, and the unpaid back taxes of several of the bankrupted businesses. The state also faces the additional costs of paying the redundancy pay and then the unemployment benefits for the dozen sacked policemen and the unemployment costs of dozens more people that used to be gainfully employed in what has rapidly turned into a high street filled only with abandoned premises, gambling shops, pound shops and predatory lenders offering 4,000%APR loans to the growing number of unemployed people in the area.
Anyone that tries to make the claim that all state spending is by definition inefficient and supports across-the-board cuts in state spending and investment, really doesn't know what they are talking about. Economics, just like the rest of the World, is not clearly divisible into simplistic categories of black and white or good and bad.

In reality the field of economics is coloured in ambiguous shades of grey. Some state spending is terribly wasteful (absurdly inefficient PFI contracts, crazy outsourcing deals or huge arms deals for weapons that will never even be used) yet other forms of government spending are incredibly efficient, creating far more in economic benefits than the initial investment cost.

Looking back to the most successful period in British economic history, which was the mixed economy era of 1948-1979 in which the economy grew by an average of 4.5% of GDP per year and over the 32 year period the national debt was reduced from 237% of GDP to only 43%, this period of extraordinary levels of economic growth and debt reduction coincided with vast levels of state investment in infrastructure, social housing, power stations, NHS facilities, the motorway network and countless state operated enterprises. The UK has never again seen economic growth and debt repayment on this scale, ever since Thatcher initiated the neoliberal revolution in 1979 and started slashing government investment and selling off profitable state run enterprises. Tony Benn summed up Thatcher's indiscriminate attacks on state spending and investment by saying that "her whole philosophy was that she measured the price of everything and the value of nothing".

There is absolutely nothing wrong with demanding that the state uses taxpayers' money more efficiently but demanding that they implement indiscriminate across-the-board cuts in spending and investment (as a whole bunch of so-called business leaders did in a letter to the Telegraph in 2010) is extremely likely to result in worsening economic conditions (the double-dip recession). Simply slashing government spending by arbitrary amounts for ideological reasons (demanding that the NHS save £20bn for example) is extremely unlikely to achieve good economic outcomes. The best way to achieve better state sector efficiency is to establish which areas of state spending and investment are creating strong fiscal multiplication effects then increase spending there, and then set about cutting spending in areas that create the lowest fiscal multiplication values.

It is also important to recognise that state spending has more than just financial outcomes. As much as the right-wing brigade would like us to believe that "there is no such thing as society" and that pure self-interest is the only true virtue, there are actually more than just economic costs to state spending. Even if the economic benefits of the outcomes are not immediately apparent, with a little thought it is easy to understand. Investment in health care increases economic productivity by keeping workers healthy and alive for longer, investment in education is economically beneficial because educated workers are productive workers, investment in policing is economically beneficial because crime is one of the most economically harmful activities. Investment in welfare payments to the extremely poor are extremely beneficial, since poor people tend to spend their money in the local economy (increasing aggregate demand) and the relatively low costs of making welfare payments is much smaller than the scale of economic damage if desperate people start turning to criminal activities in order to meet their basic needs.

A rational economic recovery strategy would be for the government to focus upon the fiscal multiplication values of state spending and investment and target additional investment at areas which have high fiscal multiplication values (construction, house building, welfare provision, research and education) whilst cutting spending in areas that create very low economic returns. The problem is of course that all three of the Establishment Westminster political parties are still enamoured with their defunct orthodox neoliberal ideology, which dictates that state spending is bad for the economy, hence the near unanimous mantra of "austerity" from the Tories and Lib-Dems and "Austerity-lite" from Neo-Labour.                
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