In this blog I will attempt to provide a very brief overview of the economic woes we experience today in the United Kingdom, and to uncover the root cause of these woes. The conclusions I draw are neither new nor definite, but I hope to present what is an immensely complicated economic situation in the simplest terms and to identify a cause that if not wholly responsible, must surely at least bear some degree of responsibility.
I will try to avoid economic complexities as far as is possible in such a discussion; I have little formal education in economics, and I do not intend for this discussion to be only accessible to those with good knowledge of economics. Instead, I will assume as true economic factors that are widely accepted by economists, and focus as much as possible on logic and critical thought.
Many people may be unclear on the nature of debt, deficit and recession, and so I shall start by outlining the issue posed by each and try to identify which are responsible for our current predicament, and from there I will discuss what is the ultimate cause.
UK national debt is, historically, relatively very low. It is not the case, as Conservatives would claim, that Labour “maxed out the nation’s credit card”, nor does our national debt represent impending economic doom. Economists do not regard government borrowing as a bad thing (it is encouraged), yet our current government are treating the reduction of the national debt as their number one priority. They have their priorities wrong. The debt itself does not represent a problem for the day to day life of the UK citizen, it is only when the debt reaches a level that we cannot afford to repay it that we have problems. We are nowhere near that level and there is no reason to think we will reach it. Theoretically, interest payments on the national debt mean we are losing money that could be spent elsewhere, but it is worth noting that borrowing itself provides funds that can be spent elsewhere. Inflation and GDP growth devalue debt over time so that the payment of interest becomes less of an issue. For example, if I borrow £100 on the understanding that I pay back £150 in 5 years time, I lose no money in real terms if in 5 years time £150 could buy me the same as what £100 could buy me today. To lament that our debt repayments could have paid for X number of hospital beds is either disingenuous or myopic.
Since the financial crisis began in 2007/08, debt has risen rapidly, and it is the case that at some point we will need to tackle it lest it become unsustainable, but it is wrong that is should be the number one priority when we are experiencing an economic slump.
The deficit is the shortfall between government revenue and government spending, and is the reason debt is rising. If our outgoings are less that our income, we have to borrow to make up the difference. It is important to establish the difference between a structural deficit, and a cyclical deficit. Running a cyclical deficit is not necessarily a bad thing (in fact in some situations – such as a recession, it is considered a good thing), but most economists believe a structural deficit is a bad thing. The structural deficit is the level of deficit experienced when an economy is at it’s peak. In other words, if we have a structural deficit then we will always have a deficit and our debt will rise. Cyclical deficit is any deficit experienced beyond structural deficit. It is the case that we need to eliminate the structural deficit, and deficit reduction is the current government’s approach to debt reduction. It is not the case, however, that it is imperative this reduction occur immediately. Mainstream (Keynesian) economic theory holds that with nil structural deficit, budget surplus in economic booms cancels out a budget deficit in slumps. In an economic slump, government spending (and therefore deficit spending) should increase as job creation and investment in infrastructure promote economic growth. We are in an economic slump.
Recession occurs when GDP decreases. This represents the biggest problem for the UK citizen as poorly performing businesses fail, lay off employees, or freeze hiring – all of which contribute to rising unemployment. Furthermore, wages either fall or rise more slowly, meaning that when combined with inflation, the cost of living in real terms increases. These are real issues that affect us all. Not only that, but the secondary problems of budget deficit and debt were caused by the recession; government revenue decreased due to diminished tax receipts (due to reduced consumer spending, poor business performance and unemployment) and spending increased (unemployment results in greater benefits payout). Hence the increase in deficit which caused the increase in debt.
We are currently technically in recession, experiencing in 2012 the double-dip that Vince Cable warned us spending cuts would cause back in 2010. In the period between the two recessions, growth has been negligible. This is the primary problem we are facing. Not only are the deficit and debt secondary problems that were caused by the recession and should only be dealt with once we have established economic growth again, but it is the recession itself that impacts on the lives of everyday people. The culture of austerity is mind-boggling; it is one of the fundamental basics of economics that you don’t cut during a recession. It is increased spending that is needed, that if used wisely will kick-start the economy.
What caused the recession?
The economic downturn is a direct result of the financial crisis experienced in 2007/2008 (this is not contentious). The cause of the financial crisis is heavily debated but started with the sub-prime mortgage crisis in the US (unscrupulous lenders increasingly lent to high-risk customers, resulting in defaults when house prices started to fall in 2007 and mortgages started to become worth more than the real estate, the result being the collapse of financial institutions) and was compounded by the collapse of the unregulated shadow banking system, and widespread misinformation, risk-taking, off-the-book practices and corporate malfeasance in the financial sector. The result was the fall of high profile businesses in the US, damaging investor and consumer confidence and willingness to lend by financial entities, leading to a massive reduction in consumption that characterises recession.
However strong the various factors that caused the crisis are, there are two clear underlying causes of them; avarice and lack of regulation. The government failed to regulate the financial market (particularly the emerging shadow banking system) and a culture of greed was allowed to run unchecked. How could this happen?
Libertarian philosophy holds that the role of government should be minimal. People and markets should be free from government interference; “let me do what I want and leave me alone”. Libertarianism naively assumes that government, and not other people, are the major threat to the individual. It is mid 20th century libertarian thinkers such as Ayn Rand and Robert Nozick who influenced the economic policies of Margaret Thatcher and Ronald Reagan. It is the deregulation that these politicians set in motion that is ultimately responsible for the financial crisis. They created a surge in laissez-faire economics (unfortunately continued by their successors) that encouraged greed and removed repercussions. They were responsible for a culture where government regulation was viewed as a restriction of liberty and therefore undesirable. This culture is why the government failed to regulate the financial sector adequately.
Libertarianism has failed. It is inadequate economically; supply-side economics is largely discredited and economic libertarian ideology is ultimately responsible for the global financial crisis. It has also failed morally; the culture of greed and selfishness inherent to it cannot reasonably be deemed morally acceptable, and the inequality it promotes is profoundly unjust (just look at how the rich/poor divide has increased since libertarian ideology took hold in the 70s). What reason is there left for anyone to cling to libertarian beliefs? Good old fashioned paranoia about government?
It’s not difficult to at least appreciate the appeal in libertarianism. A focus on the individual; self-ownership and self-sufficiency. It seems intuitive and fair. It is a fantasy though, because it only works for the strong. The libertarian wants everyone to be the master of their own destiny, and yet a libertarian society is hugely environment-based. Libertarians cling to the childish notion that anyone can achieve something if they try hard enough, conveniently underestimating that a person has a much better chance at life if they’re born into a rich family. That isn’t meritocratic, it doesn’t give the individual power over their own destiny – it’s just brute luck. A libertarian society is precisely the kind of society that goes against libertarian principles.
I also understand why the philosophy came about; after the totalitarian governments of the 20th century, it’s not surprising that an anti-government political movement has become prominent. It has gone too far though. Hopefully an equilibrium can be achieved – but libertarianism is dead.
Next time you hear a Conservative moaning about the mess Labour left us in, remind them that it was actually the previous Conservative government that caused the mess – Labour just failed to clean it up. Blair’s premiership should certainly be criticised, not because of excessive spending, but because he embraced Thatcher’s ideology and took his party right of centre. He is responsible for what happened. So is Thatcher, so is Reagan, so is Rand, so is Milton Friedman. Libertarianism is the root cause of the global financial crisis and it’s time for a paradigm change.