Public budgeting for public purpose
We learned earlier this week that UK public borrowing — the difference between what the government spends and its income — has fallen to its lowest level in 13 years on the back of increases in tax returns. The news was generally greeted in the media and by politicians as a very good thing. After all, the public budget is not different from a household budget. Whether you’re a government that makes up 2/5ths of the economy’s spending or a nuclear family with a dog, the same rules apply: if you spend more than your income on a regular basis your debts will become unsustainable, and you will eventually go bust.
This simple and commonsense idea has legitimised ongoing cuts to public services in most advanced economies under regimes of ‘austerity’. Ministries of finance have made reigning in the deficit built up in the aftermath of the financial crisis — much of which was spent on bailing out the banking system — their number one priority. In the UK, to take just one example, local government funding has been halved since 2010 despite rising demand for services, resulting in the withdrawal of services supporting the most vulnerable, including the elderly, the homeless and children in care, not to mention a ‘pot-hole epidemic’ estimated to be costing around £1m a month in motoring claims.
But is the public budget really like a household budget? U.S. economist Stephanie Kelton doesn’t think so. As former Chief Economist of the US Senate Budget Committee and Economic Advisor to the presidential campaign of Senator Bernie Sanders, she has real world policy experience of the topic as well as many years of academic research. Last week, as well as attending the UCL Institute for Innovation and Public Purpose (IIPP) advisory board meeting and speaking at our Patient Capital workshop at the House of Lords, she joined us to give the 5th in IIPP’s public value lecture series in collaboration with the British Library.
Kelton made two important points. The first is to do with what economists call the ‘fallacy of composition’. This is the idea that what applies to an individual (household in this case) applies equally across a whole economy or a whole government. If I cut down on my spending, I reduce my debts and the interest I pay on them and I’m better off. However, if all households do the same, the economy will grind to a halt, since firms rely on household consumption for their sales. As a result, these firms will cut back on investment and eventually lay people off, triggering a recession.
This is where the state comes in. Because it is such a larger actor in the economy relative to either households or firms, it has the power to boost demand by spending money itself on the purchase of goods, infrastructure or services, or keep households spending by creating new jobs and providing unemployment benefit. As IIPP has shown, via mission-oriented innovation policy, it can also shape and create new markets and technologies to help meet major societal challenges. Both activities can create economic multiplier effects meaning the return on the initial spend is greater than one. This means that government spending can actually enable growth at a faster rate than increases in borrowing, meaning that over time the debt to GDP ratio can fall even if the spending is funded by borrowing.
Money as a creature of the state
So the government budget is not like a household budget because of its macroeconomic importance. But there is an even more fundamental difference. This is to do with the nature of modern money (Kelton is part of a growing economics school of thought called “Modern Monetary Theory”). With the household budget analogy, money is talked about as if it is physical commodity that can ‘run out’. The Prime Minister has informed us that ‘there is no magic money tree’. When money was backed by gold, there was some truth to this argument. But today, money is not ‘backed’ by any commodity. Rather it is better thought of as a relationship between society and the state.
In Britain, if you want to buy something or pay somebody, you must use a specific ‘unit of account’: pound sterling. If you try and pay for a pint of milk in the local newsagent with dollars or pretty beads it will generally not be accepted (at least not without a discount relative to £s). Why do we use ‘pound sterling’? Ultimately, it is because of the state has determined that we must pay our taxes — our most legally important routine payments — using these particular tokens.
And it is the state — today mainly via publically owned central banks — that is the original source of this money. The central bank also grants other institutions the privilege to create money and settle payments in sterling via the granting of banking licenses, but even these entities must ultimately settle their payments with each other using state currency issued by the central bank — money has a hierarchy. The state asserts its monopoly power over the right to issue sterling by deeming it ‘legal tender’ and putting you in prison if you attempt to forge the currency.
All of this means that it is impossible for sovereign states with sovereign central banks and currencies to ‘run out of money’. The limitless power of central banks to create money was evident in the aftermath of the financial crisis with Quantitative Easing programs. The Bank of England has created £445bn of new money under its program and used most of it to buy up the same amount of government debt, meaning effectively the government owes the debt to itself as the bank is anyway owned and indemnified by the government.
It was this, rather than austerity measures, that prevented the UK from ‘following Greece in to the Abyss’ as George Osborne argued. As part of the Eurozone, Greece had no independent currency or central bank to buy up its own debt indefinitely and keep interest rates down — the bond market vigilantes understood this very well.
As Kelton argues, a sovereign nation can ‘afford anything for sale in the domestic currency’. It doesn’t follow from this that governments or central banks should not put limits on spending for other reasons. Inflation is still a danger if the economy is at full capacity. And since not all goods and services can be easily produced domestically, exchange rate management is still important.
However, this (correct) understanding of money has important consequences for the role of the government budget. It means that government spending should be seen as a strategic policy tool to support a healthy society and economy rather than a finite resource that may one day run dry. The limits of policy should then be constrained by the actual resources available in society, not any artificially constructed deficit target.
So when the private sector (households and firms) is reducing their spending, investment or wages, it makes perfect sense for the government to spend to maintain growth. Indeed Kelton argues that a key policy goal should be full employment and a ‘Job Guarantee Scheme’. This would pay every citizen who wanted to work a living wage. It could act as a powerful countercyclical policy tool and also serve to boost private sector wages. As Kelton eloquently, put it, “Austerity forces the economy to balance the budget. A full employment policy would force the budget to balance the economy”.
That sounds like public budgeting for public purpose.
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