Derek Scott

Tom

Over the weekend I published a blog  “Here’s the political Tom McPhail – is he the Tory counter to Torsten Bell?”. It excited an interesting conversation.

1. Derek Scott says:

   Yawn.

   McPhail’s argument may be a coherent political position but seems to me a weak macroeconomic argument.

   The better part is his criticism of some taxation and the accumulation of private wealth. The wrong is his assertion that the answer is therefore “ruthless cutting back of the public sector.”

   We are yet again neglecting the possibility that reducing public spending can reduce aggregate demand, incomes and tax revenues.

   The decisive constraint is ultimately real resources which are available and productive capacity which is underutilised or underdeveloped.

   Could Tom please show us the real resource constraints?

   If Britain lacks the doctors, nurses, builders, scientists, engineers, energy and the productive capacity to provide more public services, which we clearly do in many places, we need to increase those, not cut them or put fiscal budget constraints in their way.

   Don’t simply assume the answer is to provide fewer services.

   That seems a considerably harder argument for advocates of public-sector retrenchment to answer, and which they simply ignore.

   Maybe we have too many traditional “civil servants” and advisers, with the scale of their central offices which are no longer necessary because of WFH. Too many NHS managers and not enough doctors and nurses. Too many admin technocrats and other bureaucrats.

   But there are exceptions, some of the civil servants who do get out and about amongst the real economy, who decide the allocation of benefits which are sorely needed and/or approve plans for action rather than delaying them at every turn.

   All that seems to me to require a far better solution of reallocation, rather than simply harping on all the time about cutting budgets and certain taxes and benefits.
2. Tom McPhail replies

   Derek, I’m not an economist so I’m straying out of my lane a bit here but on the Macro perspective, I think there are two reasons why I think you’ve missed an important perspective.

   Firstly, we’re up to our eyeballs in debt. 100% of GDP, spending more on debt interest every year than we do on schools, defence or transport. Governments of every colour over the past 25 years are guilty of causing this, but it has to stop. We’re not the only ones, see France, US, Japan etc but look at our Gilt yields, now way higher than in Liz Truss’s day. The bond markets are asking for a higher yield from us specifically because they don’t like what they see. Only a serious uptick in growth and/or serious cut in spending will solve this problem politicians are unwilling to confront the uncomfortable truth: We are living beyond our means, paying for NHS wage settlements, welfare hand outs, a military, we can’t afford. We either cut back voluntarily or a crisis will be forced upon us but one way or another, the state has to get used to spending less, at least for a while.

   Secondly, the state is not good at allocating scarce resources that have alternative uses. Time and again, we have real world examples, the more the state runs the economy, the less it grows. In 1990, household incomes in the USA were roughly 6X higher than in Soviet Russia. People weren’t trying to escape from West Germany to East. Venezuela is hugely rich in natural resources, ruined by a central planning state. The list goes on and on. Show me the incentive, I’ll show you the outcome. Private enterprise is always in the end, better incentivised and better able to do things well than the public sector. If you don’t believe me, look at the productivity stagnation in our public sector over the past 30 years…as we throw more and more money at it, it has got no better at doing things. We now have the highest tax burden since the Second World War and still things get worse, because it is the wrong medicine.

   If you want good public services, you have to let the free market determine where economic growth can best be found, then you extract from that profit-making free market the minimum necessary to provide the public services you need. This isn’t trickle down economics, so much as a rising tide which will ultimately lift all boats. Give people back more of their own money, let them decide where to spend it, the economy will grow again. Cut regulation, reform the energy market so we don’t have the highest electricity prices in the developed world, simplify planning laws, cut the tax burden and shrink the state, we’ll all get richer and then we can afford to pay for those public services we want.
   • Derek Scott says:

     Thank you for responding, Tom.

     I note you’re “not an economist”, and neither am I, although one of my undergraduate degrees was in political economy.

     When I joined the Railpen board in 1997 and had to explain my undergraduate studies were in PE mand accountancy to a fellow board member, the late Michael Posner, a Cantab economics lecturer who’d gone on to become a government adviser, Posner said it was always better to have more than one economist in the room so we could disagree with each other!

     You cite “two reasons”, but I think there are at least threen separate issues between us here which are in danger of being conflated.

     Is UK debt too high?
     Does that require cutting public services?
     Is a smaller state necessarily more productive?

     One, I accept that debt interest is a serious problem.

     But “debt is around 100% of GDP” doesn’t by itself demonstrate that Britain is “living beyond its means”, still less that cutting public services is the only solution.

     The real constraints, as I said, are ultimately the British economy’s productive capacity and the resources available to our governments.

     I’m also not convinced higher gilt yields demonstrate that markets are specifically demanding cuts in public spending.

     Gilt yields reflect expected central bank rate, inflation, global rates, term premia, fiscal expectations, and demand from pension funds wedded to LDI, among other things.

     Two, a fiscal contraction can reduce demand, but it can also reduce economic output and investment.

     The bigger question is what happens to the whole economy, not simply to the government’s expenditure lines.

     I think we agree that government finance shouldn’t be analysed as though the UK Treasury were a household, even if sadly our mainstream media tend to adopt this position in trying to “simplify” things for us all. It’s unhelpful.

     That doesn’t mean I suggest unlimited spending. Inflation and real resource constraints do very much matter.

     But it changes the bigger question from “where will the government find the money?” to “what real resources can our governments mobilise without creating unacceptable levels of inflation?”

     The Bank of England currently pays central bank rate on reserves largely because remunerating reserves is integral to the way monetary policy operates in the present floor system.

     There is a substantial interest cost associated with this monetary architecture which was created by quantitative easing.

     I’m not saying simply abolishing reserve remuneration would be a free saving. The Bank of England says, I think, it would probably cause banks to attempt to reduce their reserves which could undermine confidence in the current operating framework. But the architecture of QE is surely overdue for review and at least some amendment?

     Where we disagree most, I think, is, three, your implied assumption that a smaller state equals faster growth in the economy.

     Britain already has a predominantly market economy.

     The more interesting question isn’t state versus market, but which activities are best allocated by each.

     Public investment in infrastructure, education, health, energy and scientific R&D can increase private sector productivity rather than crowd it out.

     So we agree that productivity growth is a key part of the ultimate answer.

     Where we differ is that I don’t see cutting public services as synonymous with increasing productivity.

     I’d rather ask which public spending increases productive capacity, which merely transfers income, and which is genuinely wasteful, and then tackle each of those categories differently.

     In closing, I repeat my banking reserves remuneration point, which I believe exposes something important.

     The interest burden isn’t simply an unavoidable consequence of government having borrowed too much, when some of it arises from deliberate choices about how the monetary and banking system is designed.

     The Bank of England says that remunerating reserves is part of its monetary policy transmission mechanism.

     Why have we chosen a monetary system in which a very large quantity of central bank money bears interest, and is that still the best system as QE unwinds?

     • Tom McPhail replied

       Derek, you’re asking good questions and I regret I’m insufficiently economically literate to answer them, particularly the question around the monetary system and the potential consequences of restructuring the reserve banking system.
       On the point about the market economy, I think we have become markedly less so in recent decades. Not only has the state’s share of GDP steadily increased – tax now at around 40%, but also the almost infinite regulatory constraints which inhibit the free market from operating. We have upwards of 400 quangos, including too many financial regulators.

       The Lower Thames crossing has already cost over £1 billion and nothing has been built yet, that’s just the planning. For less money the Norwegians have built the world’s longest road tunnel.

       On energy, the state is directing vast subsidies to inefficient production methods and paying even more to upgrade our energy network to accommodate them, hence why we pay more for our electricity than anyone else.

       There are very few things the state actually does well.
       We have a health care system that produces mediocre outcomes and which no one else in the world has copied, yet we keep throwing more money at it.

       I like your framing around investment to increase productive capacity, redistribution and waste.

       I’d start from a different place though: what does the state have to do because the free market won’t do it itself?

       Some infrastructure, defence, welfare, some education, some healthcare, local government, bins, roads…not much else.
3. Richard Chilton joined in:

   Many years ago I remember paying some Income Tax at the 60% rate. The government of the day then cut the rate to 45% and I thought “but I don’t need this extra money”. The reduction in Income Tax made no detectable difference to my career or my life.
   • dearieme continues:

     Then I trust you wrote to the Treasury and handed over the unwanted cash, asking them to devote it to reducing the national debt.
4. PensionsOldie joined in:

   I think we have got to think about happens when we maximise personal free cash flow (income less taxes less essential living costs). Apart from a few, we do not tend to increase our discretionary expenditure proportionately, especially not in expenditure that feeds back into the UK economy. Instead we tend to accumulate more assets e.g. property, investments (even pension pots), possibly with a view of passing them on to the next generation, rather than gifting them out of our current cash flow..

   The results of this are inflated house prices which reduce the free cash flow available to others. The same appears to be the case with other investments:
   – most clearly and with greatest proximity to agricultural land prices.
   – also consider dividend yields on equities, there used to be a pension scheme valuation assumption for what we now call “growth” assets of the dividend yield capped at gilts plus (x) percent with zero real dividend growth. It is clearly not realistic to now value equity assets with a yield of 1.43% (MSCI World Index 31st July). This tends to suggest that when considering future income or consumption, whether by the individual or descendant, equities are over-valued.

   – this also appears to repeated with derivative investments such as private equity, LTAFs and property funds, even closed ended funds, where the outcome can be so badly affected by cash flow driven disinvestment requirements of other investors.

   The problem is when we move our investment horizons out of our national boundary we become subject to the effects of the excess cash flow in other economies, particularly in our case that of the US.

   I do not consider myself a socialist but I do wonder whether progressive taxation does not have the effect of turning free cash flow into GDP growth.

   • and Tom McPhail replies:

     I think for most people you have got this wholly wrong. Most people aspire to a better lifestyle and if given the opportunity to spend more, to eat better, buy more stuff for their kids, go on better holidays, buy a bigger car, this is what they do.
     The problem, hasn’t been getting people to spend less, it has been getting them to save more…I think maybe if you think differently, you need to get out a bit more and see how most people’s lives are lived.
     Cut people’s taxes and/or pay them more and most of it absolutely will get spent.
     • PensionsOldie continues:

       While I don’t doubt that people with greater free cash flow spend more, but I do believe that for the economy it is a law of diminishing returns with a small group spending more and a much larger group struggling to maintain their discretionary expenditure in real terms. The increased discretionary expenditure might also end up funding the lifestyles of people who do not contribute to the UK economy or tax revenues.

       A relative shift in the tax burden off the rich is only going to reinforce this.
       Do we really need the higher rate taxpayers to “save” more – I believe that in terms of economic growth we need to provide the lower paid with the capacity to save or even pay pension!

       The point I am trying to make is as a society we need to consider where the savings are going – are they just creating a higher price for a finite pool of assets with no real increase in value to the individual or to the economy?