Debt And Destruction

Accepted wisdom is that after the next election, whoever wins, there will be swingeing cuts in Public Spending in order to reduce the huge amount of Public Debt, run up to bail out the banks, and to provide a Keynesian fiscal stimulus to offset the effects of the recession. I’ve never been one to simply go along with accepted wisdom.

Arguments For Cuts

The argument put forward for the need to reduce the debt is straightforward. Debt has to be paid for by interest payments. Its not the Government that pays for it, but taxpayers, and that means imposing a burden both on individuals and businesses, draining resources that otherwise would have financed consumption and investment, and thereby reducing growth and prosperity. The additional argument to this is that the borrowing undertaken by the Government is met by lending by other states and financial institutions, who at very high levels of debt might decide that Britain’s creditworthiness is in doubt, and so will demand much higher rates of interest on the money they lend, thereby again leading to a drain of resources and restriction on growth. These arguments are bogus.

The last argument is the easiest to deal with. Moody’s, the credit rating agency has recently stated that there is no possibility that Britain’s AAA credit rating will be downgraded. It is true that in the past there has been a group of people known as the “Bond Vigilantes”. This was a group of large institutions and investors who specialised in Bond Funds, that is Funds whose returns for investors in them was based on both the interest payments received, and Capital Gains made on, the Government and Corporate Bonds bought by the Fund. They had such weight in the Bond Markets that if they felt that inflation was likely to rise as a result of too lax monetary policy they could push down Bond prices, and thereby push up interest rates in spite of the rate set by the Central Bank.

But, the Bond Vigilantes have not been pushing up interest rates. In fact, rates along the yield curve – that is the rates payable on Bonds of different lengths of maturity – have been falling both due to the reduction in economic activity, and due to the vast amounts of money pumped into the system via Quantitative Easing. Moreoever, QE, actually undermines the ability of Bond purchasers to push up interest rates. Although Government Debt Offices increase the demand for money, by issuing Bonds, that increased demand can be completely neutralised by the Central Bank printing an equivalent amount of new money with which to buy those Bonds itself! Moreover, in Britain Pension Funds are obliged to buy a certain amount of Long Dated Bonds in order to guarantee a long-term income stream from which to pay pensions. That places a bottom under the level of demand for those Bonds with the consequent effect on their price.

Over the last 20 years Japan has issued far more debt than Britain, its debt as a proportion of GDP is far higher than any projections for Britain, yet it has had no difficulty whatsoever in selling Bonds to cover that debt. The same is true for the US.

The first argument is, however, more substantial. In my previous blog I wrote about the consequences of debt or savings when combined with the magic of compound interest. However, the first thing to say here is that states are not individuals, and the same rules do not apply. For one thing, individuals cannot simply print money to pay for their debts, unless they want to risk gaol for counterfeiting. There is some similarity, however, with the current vogue for IVA’s to deal with individuals debts, and the way state’s can deal with a similar situation. Poorer countries tend to have their debts simply cancelled or written down like an IVA, whilst richer states tend to effect the same thing, by manipulating their currencies, paying back their creditors in devalued money.

Bill Jeffries of Permanent Revolution has a good account of the economic reasons why there is no need to resort to such cuts to deal with the debt. From Credit Crunch To Class Crunch , though I disagree with the conclusions he arrives at. As he states there not only does the increase in money supply mean that a certain amount of nominal economic growth is built in simply through higher prices for a given amount of output, thereby providing the basis for higher nominal tax revenues, but at some point the massive investments in the banks amounting to billions of pounds will be paid back – possibly with big Capital Gains on them. As I have written elsewhere the easiest option by far for Capital to deal with the debt is the way Government’s throughout human history have dealt with it, to simply inflate it away. See: Paying For The Crisis .

Capital And Public Spending

There are a number of reasons why Capital attempts to reduce Public Spending. Firstly, is the basic reasoning presented here. That is, it is paid for by taxation, which, as Marx demonstrated, in the end is a deduction from Capitalists’ Surplus Value. They, therefore, seek to minimise this deduction. Secondly, there may be areas of economic activity undertaken by the State, which private Capitalists could undertake, and make profits from, whilst at the same time reducing the cost to Capital in general. Thirdly, where demand for inputs is constrained, thereby pushing up their prices, Capital may seek to make those inputs available for itself, by reducing the demand for them by the State. This was, for example, the argument about “crowding out” in the late 70’s and early 80’s. Basically, with the amount of Money Capital available for investment limited – because this was at the end of the post war Long Wave boom – the demand for it from Government, to finance its operations, “crowded out” private Capital, who found that either they could not borrow sufficient Capital, or else its cost was pushed up to levels, which meant that any investments made were unprofitable. The same argument can be made if there is insufficient Labour, or Land.

Let’s take these arguments in order. This argument applies all the time, not just now. Capital always wants to minimise its “faux frais of production” as Marx called it, the overheads which are necessary, but add nothing to value. But, Capital is not omnipotent. It attempts to achieve things, but is subject to the law of unintended consequences. Capitalists in the 19th Century increasingly withdrew from their direct role in production, because the task of management became more complex, and it became more profitable to employ professional managers. Although, it was more profitable those Managers as a result acquired considerable power through their own direct control over the means of production, their specialised knowledge etc. As Marx shows in relation to the salaries paid by workers to the Managers employed by them in the Co-operative factories, the salaries paid to managers in the factories of the Capitalists were grossly inflated. That unintended consequence arose out of the rational decision to increase profits by employing professional managers.

The same is true with the bureaucrats employed by the State. Capital allows the State to undertake certain functions, which it cannot at any particular time undertake profitably itself, but which are necessary for the functioning of the system as a whole – faux frais of production for Capital as a whole. In doing so, it hands over considerable power to those bureaucrats who thereby gain control over huge economic resources. Like the Managers in the individual enterprise, although their function is to serve the needs of Capital, and their actions are constrained by that function, their position affords them considerable power to look after their own personal interests, even as this conflicts with the interests of Capital to minimise those overhead costs.

In almost any sphere of Public activity the same experience can be seen. Where attempts are made to cut spending it is the front line service that gets cut, whilst the back-room staff, the supervisors, the administrators, the accountants and monitors of all sorts increase, often by more than the number of front-line staff has been reduced! Despite the reductions in the Civil Service in Job centres etc. the total number employed in the Public Sector has gone up significantly in recent years. The reason, as I have said before, for that is simple. The top bureaucrats status, power, and salary is not based on the number of low-paid staff they have under them, but the number of highly paid, high status staff. That is how bureaucratic empires are built.

When I worked for a Local Council I had direct experience of that. Although, I had been employed as an IT specialist, the fact that I was also an economist meant that I was drawn in to help produce budgets and estimates. During the 90’s when the Tories were introducing cuts every year, we were faced with demands to cut spending by at least 5% every year. The response was simple. Managers began by asking what the most important projects were for Councillors. So the offered up cuts would be in high profile things such as close a Community Centre or Park or Playground, or reduce the number of times the grass was cut per year. That way each Department attempted to push the cuts on to some other Department. But, over a period of ten years 1,000 workers at the depot went as a result of CCT – which led to a massive increase in the number of Managers and Supervisors who now had to draw up specification documents, supervise the contractor and so on, and of legal work for the solicitors who had to ensure the Contracts were right, and Accountants, because separate Client and Contractor accounts had to be kept, and so on. Community centres were closed or handed over to local communities, playgrounds were rune down, and so on, but the number of managerial and administrative staff grew continuously. A Public relations Department was created where none had existed, which came to employ about 8 people, the wages office was divided up creating a new post of Personnel Director, again employing more people, millions was spent on new computer systems, and so on. In short, whatever happens to front line services the mandarins will do all in their power to ensure that their empires remain in tact.

Nigel Hawthorn may be dead, but Sir Humphrey is alive and well.

The only real way in which Capital can deal with that is if it is able to privatise the function. It is one reason for the growth of companies like Capita and Serco who take over the management function. But, there are large swathes of Public Expenditure that are not susceptible to privatisation. If they were they would already have been privatised in the great drive of the Thatcher era, and the early years of New Labour. Technological developments, especially with the growth of IT and the Internet, means that increasing numbers of activities become susceptible – which is happening with the Post Office now – but this is an on going process, not something determined by the economic crisis or the current level of debt.

Finally, this is not the 1970’s. There is not a shortage of investable Capital. On the contrary there are vast reservoirs of Surplus Value around the globe looking for a home. And QE means that in the coffers of the Banks and financial institutions there is a massive pool of money available to be borrowed at low interest rates. Nor is there a shortage of Labour. Not only has the low growth of Britain over the last decade due to the overhang of debt meant that employment has not risen as fast as it might, but in this first stage of the Long Wave, the increase in Labour productivity derived from utilising new techniques and inventions from the innovation cycle means that increased economic activity always fails to mop up the reserve army. Were that not enough, then Capital can simply meet its labour requirements for particular skills by simply importing skilled labour from Europe and other parts of the globe.

Surplus Value

The only economic argument that really stands up is that paying for the debt involves a deduction from Surplus Value. So let’s look at that. In a sense, that cost is the cost that Capital has to pay for the fact that the debt was run up in order to avoid a much bigger reduction in Surplus Value, and destruction of Capital in the first place. But, that is no reason why Capital would not still try to minimise that cost. The question then is what happens if it attempts to do that? What are the costs in turn of making such cuts?

Keynes produced a basic formula that equated total output to total income. Its based on Adam Smith’s “Trinity Formula”, which basically says that the value of output is equal to the sum of the incomes paid to the owners of the various factors of production – Rent (Land), Profit (Capital), Wages (Labour). In fact, Marxists would have a criticism of Keynes formulation for the same reason we disagree with Smith’s Trinity Formula, which I will deal with in the next part of my series on “Reclaiming Economics”. But for now let’s stick with Keynes equation. The importance of the equation is this; if you want to bring about full or higher employment then this implies increasing the level of output. But, output can only be increased if there is a demand for it, which in turn implies sufficient income to create that demand. The demand for output can two from two initial sources from that Trinity Formula – wages or profits (within which can be subsumed Rent, and Interest Payments to Landlords and Money Capitalists). Demand from wages is demand for consumer goods, whereas demand from profits can go into consumer goods and demand for Capital Goods. The two main forms of demand are then Consumption (C), and Investment (I).

But, Keynes recognised that the basis of Neo-Classical economics, and of Say’s Law, that markets automatically clear as a result of adjustments of prices does not hold. The Great Depression illustrated that. There is a separation of Production and Consumption, and not all income may go to consumption or Investment. Some may go to saving, and so there will be “underconsumption” of the given level of output, which will result in output being reduced, which will in turn result in incomes falling, which will result in more underconsumption, and so on. A new equilibrium level will be arrived at, but it will be a level where resources will be unemployed.

Keynes argued, then that under such conditions it was necessary to crate another type of demand to make up for this lack of demand from Consumption and Investment. That is the role of Government. By stepping in to spend money the Government creates new incomes for firms and individuals, which are in turn spent, which creates new employment, which creates new incomes, which are then spent, which creates new demand and so on. A new equilibrium is reached at higher levels of employment. This is what Governments around the globe have done over the last year. In fact, the spending by the State does not inject demand into the economy only equal to the amount of money it spends, because of the process described above – what is called the multiplier effect.

Suppose, on average everyone spends 90% of their income. If the Government creates a job for someone, and pays them £20,000, this individual will then spend £18,000, saving £2,000. Now that £18,000 will go say to a third person from whom goods are bought. Of this income of £18,000, £16,200 will be spent and so on. In fact, the multiplier will be equal to 10. That is from this initial £20,000 of new income, new demand of £200,000 will arise. There are leakages from this. To the extent that money is spent on exports then that money will go to create incomes in some foreign economy, and so on. In fact, although the savings rate in the UK is low, the latest estimates of the multiplier put it at only around 1.1, or for every £1 billion of new income created, only £1.1 billion of final demand is created.

But, this works in reverse too. If money is taken out the effect is greater than the initial reduction. Some commentators have spoken of reductions in Public Spending of between 10% and 20%. One commentator said recently that if this were translated directly into Public Sector job cuts it would mean between 700,000 and 1.4 million job losses. The higher figure would mean increasing current unemployment by more than 50%, directly. But, the increase in unemployment arising from the secondary effects described above as all that income, plus all the attendant expenditure that in turn goes to a wide range of firms and suppliers of goods and services, was taken out of the economy would be much more than that. And, part of the consequence would be a massive increase in the amount of Public Expenditure that then went to cover the Benefits payments of those made unemployed with a simultaneous reduction in taxes paid due to the huge reduction in income!

Even for someone like me that argues that we are in a Long Wave boom it is difficult to see how this massive reduction in income and output could be quickly replaced by an increase in private sector Consumption and Investment! On the contrary, not only would Consumption fall from such action, but seeing that fall – including for many companies that Supply the Public Sector, a massive reduction in their order books – firms would be hardly likely to increase their investment!!! Moreover, one consequence of economic uncertainty is that individuals and firms increase what Keynes called the Precautionary Demand for money. In other words, they increase their savings to try to guard against unforeseen events. That has the effect of raising interest rates, and of simultaneously reducing consumption even further.

Given that this huge economic contraction would be taking place whilst Britain’s economic competitors have all said that they intend to continue their stimulus measures for as long as necessary, the other consequence would almost certainly be a fall in the value of the pound, from its already low levels against the Euro. Although, that would benefit exporters, it would push up the prices of imports considerably with a knock-on effect to firms costs.

Capitalist Strategy

Simply in economic terms it seems difficult to see how such a course of action is in the interests of Capital. But, there are even bigger costs and dangers for Capital in such a course of action. One possible area of cuts would be in Benefits. A Government might hope that opposition to such cuts would be muted because those affected are not organised in Trade Unions, they are atomised. But, the recipients of Benefits tend to be clustered in deprived areas. Such action could well be an eruption of the same kind of inner city riots that were a feature of the early 1980’s. That in itself could create a social climate hostile to Capital.

But, cuts on the scale described would have to hit other vital areas of provision, including large scale closures of things such as schools, day care centres etc. Where such closures at the moment tend to be individual events opposed by relatively isolated groups of affected people, widespread closures would result in such opposition being widespread, and potentially could be linked up. Such opposition from communities, alongside industrial action by Public Sector Trade Unions – where the majority of TU strength resides – would create massive social unrest with the high potential for it removing the Government in the way that Heath’s Government was kicked out in 1974, and with little chance that an incoming Government would then try to repeat the exercise.

Of course, Capital could resort to the methods of the strong state to smash down such resistance, but that poses even greater threats for Capital if it fails, and the question is given the simpler option suggested previously of simply inflating away the debt, why take those chances in a period of potentially strong growth, and corresponding social peace??? It makes no real sense for Capital, which is why I think its unlikely.

That is not to say that there will not be cuts, but the scare stories being touted at the moment set the stage for ensuring that the opposition is muted to any small-scale cuts that do arise, as people are encouraged to think they have dodged the bullet. It also sets the stage for people being unprepared for the real means of resolving the issue of debt by inflation, which is required if that tactic is to succeed. If people are expecting inflation they can act accordingly pulling out their savings, and putting them where they won’t be destroyed by inflation, preparing to fight for higher wages and so on – again something workers will be frightened off doing if they think that job cuts are likely. Economic growth does not require additional stimulus, but it does require no major reductions in public spending until private consumption and investment increase to a level where they can sustain it.