James Burdett

31st Mar 2011

I often think one of the curses of politics is the idea that complex problems are susceptible to overly simplistic solutions. This is a curse that stretches across party lines and touches many issues. Let us look at one in particular which has been in the news of late, the economy. Here we have a complex problem that is being plagued with two competing overly simplistic solutions. On the left hand side we have the idea that the problem of a gap between income and outgoings is soluble simply by increasing the income by clobbering people. On the right hand side we have an extreme view that says pare everything to the bone and then slash taxes, actually it tends to be slash taxes and then hope that two things hold true one that you are the right side of the laffer curve and two that you can get away with axing vast swathes of spending.

The truth is almost certainly neither of these, firstly if you jack up taxes on certain groups of people they just pick up their sack of loot and take it elsewhere. The more you increase taxes the more you have to increase them because you never quite get near to closing the gap that way. Something similar is true with the slasher approach, spending money on the part of the government isn’t entirely unproductive. There is a point at which government spending crowds out but it is not the case that all government spending is bad spending. Some is necessary, and dare I say it some is actually beneficial. Also hacking back tax rates only works if you are the right side of the laffer curve and one has to be careful that you can afford your changes before you make them just in case you don’t get an increase as you move back towards the peak of the curve.

The one thing that extremists on both sides of the divide don’t ever pay heed to is that the economy isn’t some arbitrary machine that will spit out the same result with the same input all the time. It isn’t, an economy is made of of the individuals active in it and they will make choices that impact the efficacy of certain policy decisions. If you cut or increase spending people will notice and change their behaviour, but not necessarily in the ways you predict or intend. The same with increasing or decreasing taxation, what happens when you do this rather depends on the prevailing mood, recent history and many other factors. The idea that seems to exist for proponents of overly simplistic solutions is that the outcome is self-evident and good. It may not be. I think that when dealing with the economy when it is in virgin territory a note of caution is advisable.

In the recent economic crisis a number of decisions were made that were unorthodox and a little contentious, things like Quantitative Easing, even now the decision to not put interest rates up is causing consternation in certain quarters. Let’s look at that interest rate decision then, I actually don’t have a problem with it myself, I think that it is the right thing to do at the moment. There may come a time to increase rates but that isn’t yet. If we look at inflation across the piece we see that certain items are subject to greater inflation than others and if we look at real disposable income it is being slowly inflated away at the moment. The biggest contributor to inflation at the moment appears to be food and commodity prices. Jacking up interest rates may therefore just increase the erosion of incomes without making any discernible difference to what is causing the inflation that we are currently experiencing. In other words there could quite easily be pain without gain.

The same goes for those who want to see cash terms cuts in spending, it is a nice concept but ignores the fact that expectations are built in for the average person of what they will see from government. Slamming the spending brakes on in such a fashion is likely to give most actors in the economy a bad case of whiplash. Also it is not entirely clear what the effect of hacking back spending on the NHS, Education and the like would achieve. It is certainly the case that the mass exodus of the state from the economy that that would represent wouldn’t necessarily result in growth, or at least not quickly.

The last thing the economy needs is to have a few years of excessively savage retrenchment followed by the floodgates being opened again. By and large I think the government are getting the balance broadly right. I think there are things they could do differently and some cuts are a bit too timid, however moving from an economy where expenditure was mismatched to income to one where the two are broadly matched cannot be achieved overnight and the idea that we should seek to start cutting debt now with the implied effect on current budgets is simply bizarre. Yes we are all overpaying for past mistakes but we cannot seek to evade that cost by doing equally imprudent things in the here and now. We need to recognise that overly simplistic solutions to complex problems sound good but don’t actually work.