Government & Media Economic Illiteracy

I've been getting increasingly irritated by the Government, and some of the media's, repetition of the same inane question, to Labour politicians, around the question of debt, but also of Labour's inability to provide a simple answer to it. The question is based upon the premise that you can't reduce debt by taking on more debt. But, of course, that premise is nonsensical. Of course you can reduce debt by taking on more debt! It depends on the type of debt, and it depends on the reason for the debt. The fact, that some of the people in the media who pose the question in this way, seem not to be able to understand it, or claim not to understand it, are people with degrees in Economics, makes me wonder about the the recruitment policies of the media companies!

Let me explain it in terms that someone who understands basic maths can grasp.

Suppose you have a firm that produces widgets. It produces 1 million of them a year, and the cost per widget is £1. However, it can only sell these 1 million widgets at £0.90, so it makes a loss of £0.10 per widget, amounting to £100,000 a year. To stay in business, it borrows this £100,000 from the bank, at a rate of interest equal to 5% p.a.

If the business continues in this vein, it will continue to lose £100,000 a year, and each year need to borrow an additional £100,000, plus it will also rack up a further debt of £5,000 a year in interest payments. It is certainly obviously true, that continuing to borrow more on this basis has no possibility of reducing the firm's debt.

However, suppose the firm could borrow an additional £20,000, and use it to buy a machine. The machine enables the firm to increase its production of widgets from 1 million to 1.2 million, but also in the process to reduce the cost of production from £1 to £0.80. Now, in year 2, the firm will produce 1.2 million widgets, and each widget will produce for it a profit of £0.20, or a profit of £240,000. So, at the end of year 2, having increased its borrowing by 20%, from £100,000 to £120,000, the firm is able to not only pay off the £120,000 it borrowed, but also to accumulate a further £120,000 as savings! In each subsequent year this extra borrowing means that rather than racking up debt, the firm racks up increasing amounts of savings.

That is precisely how borrowing more enables you to reduce your debt! The Government policy is like that of the firm in the first instance. Instead of borrowing money to put people back to work, to invest in things that would reduce the production costs of Britain, and thereby increase its income, and more importantly its surplus income, it is simply borrowing to finance unemployment, and trading losses. It is the same failed economic policy that squandered Britain's North Sea Oil wealth in the 1980's on paying Unemployment Benefit, as the jobless total soared to around 5 million, rather than investing in rejuvenating the country's infrastructure and skills, to prepare it for the new global economy. Tory policy then led to the de-industrialisation of the economy, and the rise of the banks that has caused the problems the country faces today. Tory policy now, is taking the economy down the same disastrous route.

The Tories are supposed to be the party of business, but they are in fact the party of only small business, and their outlook is that of the small businessman, whose only answer to such problems is to look to penny pinch, to squeeze a bit more out of the workers, a bit more out of their existing machinery, and so on. The consequence of those short term measures is always negative. A firm that tries to squeeze more out of its workers sees their productivity fall not rise; it sees them demoralised; it sees them look for some other job whenever the opportunity arises; it sees its costs associated with high turnover of staff increase. A firm that tries to squeeze the last bit out of its machinery sees a similar thing. The machine breaks down more often; it causes them additional costs in maintenance; it reduces productivity because while it isn't working, neither is the worker; it tends to produce poorer quality goods and so on. A firm that tries to save money by buying cheaper materials suffers in the same way. It loses customers because the quality o its own product declines; it suffers increased wastage, because more of the poor quality material has to be thrown away; it suffers lower productivity, because the poorer quality material causes problems in production and so on.

The Liberal-Tories have taken that small capitalist mentality into Government, and it is reflected in their economic policy. Its also the mentality of that other section of society on which the Tories are based, the sections of the middle class with an accountant rather than an entrepreneurial or economists outlook. The former only has their eye on the bottom line, on what can be cut to save money. The latter base their outlook on the idea that “you have to speculate to accumulate”, in other words, precisely that to make money you have to spend money, and that means money you have borrowed if you don't have enough yourself!

In fact, the period of greatest entrepreneurialism in Britain was at the time of the Industrial Revolution, and that was a time of huge borrowing in order to invest both at the level of the firm and at the level of the State. The ratio of debt to GDP rose to 250% compared to today's level of around 70%.

Looking at the Liberal-Tory policy of cutting back it would be like the firm producing widgets failing to maintain its machines, or buy new ones when needed.  It would be like them buying cheap material that broke when it was processed.  It would be like them reducing their workers wages, and finding the workers felt demoralised, and sluggish.  The firm might then find its costs rose from £1 per unit to £1.10, so that instead of reducing its debts, they increased, now needing to borrow £200,000 a year.  That is what is happening with Government policy.  It is having to borrow more money, not to increase production and productivity, by investment but merely to finance its own economic failure!

A look at the figures for GDP and Employment demonstrate that.  GDP is a measure of income, and it is declining.  But, the figures for Employment are rising.  By simple mathematics that means that the income of each person in employment is declining.  If 100 people's total income is £1 million, their average income is £10,000.  If total income falls to £0.9 million, but the number of people employed rises to 110, then their income has fallen to £8,181, a fall of nearly 20%.  That is what is happening in Britain.  Behind the Government's flag waving over employment is the stark truth of most of those in that employment suffering significant falls in their income as they are employed on zero hours contracts, in part-time rather than permanent jobs, in self-employment that is really disguised unemployment, as people scrape a living doing a few hours a week as a gardener or window cleaner.

The other side of that is that GDP is also a measure of the value of output.  So, if the value of output is falling, but the number of people employed to produce it is rising then that means that the value of output per person is falling by an even bigger percentage.  At a time when around the globe in places like China and India, productivity is increasing at a rapid pace, because of the introduction of new technology, because increasingly better educated and trained workers are being employed in every higher value production, that in Britain productivity levels are falling is a disgrace.  Its akin to the kinds of labour hoarding policy that was used in the USSR and eastern Europe to disguise unemployment, and which in the process set in train ever declining levels of productivity.

Again, the way to reverse that, is to do what countries like China have done, which is to plough large amounts into investment to raise productivity, and to train workers to take on high value jobs. 

But, its also possible to reduce your debt by borrowing more for other reasons. For example, suppose you have credit card debt of £10,000 with an interest rate on it of 30% p.a., which is not uncommon. If you can borrow instead £20,000 on a mortgage at 5% p.a. you can most certainly reduce your debt, and your repayments of it. Borrowing on the credit card means you will accumulate, an additional £3,000 a year of debt. Within 3 years, your debt will be £20,000. But, borrow £20,000 against your mortgage, and you can pay off the £10,000 credit card debt, and have £10,000 left over, but be paying only £1,000 a year in interest.

That is precisely the kind of option that is open to Government's because they borrow by issuing Bonds of different durations. So, if the interest they are paying currently is high, they can issue bonds of a different duration, and use it to buy back the high interest bonds. Given that at the moment, half of all newly issued Government Bonds are bought by the Bank of England, which is why interest rates are so low, it would be sensible for the Government to issue such new debt, and use it to buy back all of those Government Bonds currently in circulation, on which they are paying higher rates of interest! That is particularly the case given that the Bank of England is in any case handing back the interest it receives to the Government.

If Government Ministers do not understand these basic elements of finance its no wonder they decided to embark on a career in politics instead of in business. The problem is that in the latter it would have been only their only money they would have been wasting, in Government it is all our money they are wasting, and all our lives they are damaging. As for the media, the economics correspondents and editors ought to do a refresher course, and the media companies should examine their recruitment policies.