When Is Austerity Necessary At The Treasury?

I have made clear in the past that I believe that the time for austerity at the Treasury is the boom, not the slump.

However this is a very general and non-specific definition. I want to be a little clearer and more specific.

First, I think it is important to define austerity. Government is a two-way street. It sucks in money through taxation, and it pushes out money into incomes through spending. Net government spending is the net of these two figures. Austerity in a technical sense happens when the change in net government spending turns negative either through spending cuts, or through tax hikes, or a combination of the two.

Second, I think it is important to specify that this is not a debate about the ideal size of government. This is a debate about the short-term government spending and taxation trajectory, which is a very different subject to one’s ideal size of government. It is possible to favour very small government in principle, but at times oppose austerity. It is also possible to favour large and expansive government, and at times support austerity.

Now, to be very clear: the time for austerity at the treasury is the time when government activity is crowding out the private sector. When does this occur? Well, the clearest example that I can think of are World War I and World War II. It is easy to imagine how government can smother the private sector in times of war; resources are centrally controlled and directed to the war effort, labour and capital are directed away from productive activities and toward fighting, toward building bombs and weapons to destroy things. There is little slack in the economy, as in total war the state commandeers as much of society as it possibly can toward the war effort. Notably, austerity programs that massively reduced the size of government following the two world wars were successful, and did not have a long-term downward impact on growth.

In peacetime, it is also possible for the government to crowd the private sector out of the economy, in a similar way. By commandeering large quantities of resources, labour and capital, governments can leave little for the private sector to use to create, build and invent.

The two most important parameters to determine whether a government is crowding out the private sector are labour markets and capital markets. In the broadest sense, the specific parameters are interest rates and the unemployment level. When the private sector is being crowded out in labour markets, unemployment falls to a low level, as the government is utilising all the slack. When the private sector is being crowded out in capital markets, interest rates rise to a high level, as the government is utilising all the slack.

Today, both in Britain and the United States unemployment is elevated (meaning labour is freely and readily available) and interest rates are very low (meaning capital is freely and readily available). First, Britain:

UKAusterityParameters

Second, the United States:

USAusterityParameters

What this means is that in a technical sense — and irrespective of one’s preconceived notions of the ideal size of government — government is not crowding out the private sector. There is plenty of slack in the economy in both labour and capital markets.

Yet in another sense — unrelated to spending — governments may be slowing private activity. By imposing high legal and regulatory barriers to entry, governments can slow business investment and prevent new businesses from forming, and the unemployed from becoming self-employed. Given the massive growth of legal and regulatory burdens in certain industries favouring only large and old competitors who can hire lots and lots of expensive lawyers, it is extremely likely the case that there are some negative effects. The OECD noted in 2006 that “administrative simplification and reducing administrative burdens are a very high priority for OECD member countries”, and red tape levels have grown in both sides of the Atlantic since then. I have repeatedly suggested that in the current economic environment governments ease the regulatory and legal burden for small and new businesses in particular to foster competition and lower unemployment.

However cutting back on red tape is a totally separate matter to fiscal austerity, which in the current environment by definition takes an economy with significant capital and labour slack, and creates even more slack.

The time for fiscal austerity at the treasury is a time of high or rising interest rates and low or falling unemployment, and especially when interest rates are higher than the unemployment rate. The reality is that most of the Western world has the opposite of that right now.

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50 thoughts on “When Is Austerity Necessary At The Treasury?

  1. How about this for an idea, instead of small business collecting PAYE VAT and other sales taxes (at their expense) – get the goverment to collect these taxes at their expense – or pay my expenses in doing so. (I`m in business to make things I`m NOT A TAX COLLECTOR)

    A very recent addition to red tape in the UK is the introduction of real time information (RTI) instead of one report per year, now they want one for every time some one is paid – loads more work for my business accountant (and cost) – zero gain for the business. – Annother example of how little government care or know about small business

    • Interesting suggestion…

      This would cost government a lot… and save small businesses a lot. That would probably be an excellent idea right now…

    • I agree with Robbie.

      In Australia we have the Goods and Services Tax a VAT collected by the business and net remitted to the Government Tax office. Now the Tax office is requiring additional information for payments to contractors in the building industry. Another administrative burden in an attempt to capture under reporting. Where does it end? BTW I do not agree with VAT style taxes. they give the government too much revenue in boom times and not enough in recessions. income taxes are much more stable revenue generators.

      Due to the flaws in Democracy, Keynesian policies do not work. Australia is a case in point. After a decade of the mining boom our government is in debt. pumping the economy will send us deeper in debt, destroying the dollar and causing inflation.

      I am tired of the flaws in Democracy, human nature, the ignorance of the Electorate. I am looking after myself.

      The British empire’s sun set when it pandered to bleeding hearts. Might begets might.

      • You’re worried about Australian Federal debt levels?

        I wouldn’t be. I’d be worried about house prices in a massive country with a relatively tiny population, but the last damn thing I’d worry about are Australian Federal debt levels. Your debt is tiny and rates are cheap.

        I do not agree with Krugmanism (i.e. throw enough money at the problem and it will go away), but adding more slack via government spending cuts to an economy that is already very slack is not a good idea. Fiscal policy should act as a counterweight to slack private activity while the private sector’s structure of production adapts back to growth.

        I personally agree with decentralisation. I think as society becomes increasingly decentralised, the government’s role will become naturally smaller. While systems are large and centralised, we should not be surprised that the central state is a powerful force. We cannot get to decentralisation through trying to impose a centralised solution like getting rid of democracy. Decentralisation will be driven by technology and a desire for self-sufficiency.

        • Without the demand for minerals our AUD will tank, and the government debt to remaining GDP will blow out. We will lose our AAA status and our interest rates will skyrocket. House prices will tank.

          The government should have built a buffer. It has not. This was irresponsible. The incumbent Government lead by a feminazi has a low 30’s approval rating and destined for political collapse. The damage is done and their pensions should be revoked. but it won’t. criminals.

        • Without the demand for minerals our AUD will tank, and the government debt to remaining GDP will blow out. We will lose our AAA status and our interest rates will skyrocket. House prices will tank.

          Under depressionary circumstances (which will come to Australia sooner or later, probably via the route we’re talking about, depressed demand for Australian resources) I would expect interest rates to go much lower. This is the main detail that the Misesean Austrians (Ron Paul, Peter Schiff, Hans Hermann-Hoppe, Bob Murphy, etc) and monetarists/Chicagoans have gotten wrong and the Feketean Austrians (Antal Fekete, Sandeep Jaitly, Keith Weiner, etc) and Keynesians and Post-Keynesians have gotten right. Economic depression lowers interest rates in countries with their own fiat currency, all else being equal. You would be in a similar situation to perhaps the UK and USA, low interest rates, elevated unemployment, etc.

          I don’t like Julia Gillard. She seems very incompetent and focussed on completely the wrong issues. The carbon tax seems like a very destructive force, for example. It is true that Australia should probably be running lower deficits to offset bubbles and saving for the future. But even if Australian GDP falls a lot, and debt balloons, I would not be that worried about that particular variable. I would be much more worried about the potential for rising unemployment.

      • “Government is a two-way street. It sucks in money through taxation, and it pushes out money into incomes through spending. Net government spending is the net of these two figures.”

        You leave out, perhaps, the greatest source of government [potential] spending, that is, “printing” money. The ability to create money is what has both given the nation-state its incredible success [when done responsibly], as well as what leads to its inevitable failure [when done as it is today].

        The degree of taxation seems to be fairly positively correlated with a society’s dys-function/failure.

        • You leave out, perhaps, the greatest source of government [potential] spending, that is, “printing” money.

          In my both my examples (UK & USA) there is a superficial distinction between monetary and fiscal policy. That is, the central bank is removed from the fiscal picture, and governments are superficially revenue constrained to borrowing and taxing.

          Inflation is perhaps a third parameter we could include in this discussion alongside nominal interest rates (borrowing costs) and unemployment. In fact, I considered adding it in when I was writing the post as another sign that government could be crowding out private activity. But I decided that for the sake of simplicity and clarity it is better to emphasise borrowing costs (capital markets) and unemployment (labour markets). Inflation while the most important parameter to consider in monetary policy does not reflect crowding out in either labour or capital markets.

  2. I think your prescription contradicts your thesis. If you eliminate the red tape, you eliminate the need for people to process the forms, investigate violations, enforce the regulations and so on. Limiting red tape would, in effect be austerity because so many of the useless jobs in government are dependent on that red tape. Take away the red tape and you take away jobs.

    • Limiting red tape would, in effect be austerity because so many of the useless jobs in government are dependent on that red tape.

      My definition of austerity is very specific: “Austerity happens when the change in net government spending turns negative either through spending cuts, or through tax hikes, or a combination of the two.”

      This means that so long as the money saved from limiting red tape is re-spent (e.g. tax rebates, infrastructure spending), it is not austerity.

      Limiting waste and artificial barriers to entry is always a good idea, regardless of the level of slack in the economy.

      • Austerity, in its modern usage, is simply transferring money used to provide services for the population, in general, [be it good, bad, or indifferent], to the ruling elite. There is rarely any need to take services away from a population.

        • “Austerity, in its modern usage, is simply transferring money used to provide services for the population, in general, [be it good, bad, or indifferent], to the ruling elite”.

          Thanks for being so blunt…. Austerity in the modern, modern usage is more of a stress test to see which governments/economies should survive intact. It is like culling the herd and consolidation to see who will be allowed into the new G5. There won’t be a need for G20.

          “In my both my examples (UK & USA) there is a superficial distinction between monetary and fiscal policy”. In the US even a superficial distinction is hard to find. The UK might not pass the stress test. Personally I think they should let the UK in by changing to the new G6…

    • Agreed. wealthy connected, educated and over active people need red tape to give them glorified work for the dole schemes. They could all be tradesmen, factory workers, engineers who actually make things.

      Makes me sick how the “connected society” run the system. Sack the lot, reduce taxes.

  3. Hawks 5999
    “If you eliminate the red tape, you eliminate the need for people to process the forms, investigate violations, enforce the regulations and so on. Limiting red tape would, in effect be austerity because so many of the useless jobs in government are dependent on that red tape. Take away the red tape and you take away job”

    Absolute rubbish, you will remove non productive jobs and allow the real wealth creators more time and money to create real wealth creating jobs.

    • Robbie, did you miss the part about those jobs being useless? I’m not advocating for more government misallocation of labor. I’m pointing out the contradiction in the idea of NOT instituting austerity but reducing regulation. The regulations are what give the state lifeblood and a raison d’etre for the labor that government uses.
      We aren’t talking about the size of government per Aziz’s stipulation. If we were, I’d argue for it’s complete elimination.

      • I think it is possible for anarcho-capitalists and Austrians as well as Keynesians as well as Marxists and all sorts of people to take the point I am making, because it is really not incompatible with any of those ideologies. It’s a technical point about the level of slack in an economy.

        If you want “stimulus spending” to be comprised of tax cuts and tax rebates then that’s fine (although some studies suggest that direct spending has a higher multiplier than tax cuts, but that’s another story). You can even reduce government spending if you offset it with an equivalent and higher amount of tax relief (funded by super-low interest rate debt).

        Once unemployment falls below interest rates you can have real austerity…

        • The problem with theoretical Economists is they assume labour can be retrained an reallocated to tight labour markets. I hear this rubbish from Ivory Tower news commenters who say that a Government worker or Banker can be retrained and relocated to our remote outback to take up a mining job. They forget about mental disposition, cultural fit, social dislocation, nagging wives and kids who do not want to relocate.

          I have lived in different socio economic circles, shoveled chicken shit, drove trucks and other blue collar jobs internally audited and offshored jobs and other white collared careers so I understand how everything works and thinks. Economists weild too much power, and are damaging to the fabric of society. Once Econo ics is debated in the mainstream they will have as much credence as the Catholic church has these days.

        • The problem with theoretical Economists is they assume labour can be retrained an reallocated to tight labour markets. I hear this rubbish from Ivory Tower news commenters who say that a Government worker or Banker can be retrained and relocated to our remote outback to take up a mining job. They forget about mental disposition, cultural fit, social dislocation, nagging wives and kids who do not want to relocate.

          With or without retraining, a high unemployment rate is indicative of labour market slack. I agree that the inability to retrain and relocate workers is a significant friction which guarantees that there will always be some slack in the labour markets, but 7-10% unemployment (and I consider this to be an underestimate, because it does not include all the people on disability, etc) is not just a small amount of slack it is vast swathes of people actively looking for work — many of whom have decent levels of skills — who cannot find any.

        • “Economists wield too much power, and are damaging to the fabric of society. Once Economics is debated in the mainstream they will have as much credence as the Catholic church has these days.”

          Religion serves many good purposes in society. Economists, none.

      • A lot of extra work is created both in the private sector as well as the public by the need to constantly monitor workers. This is because of the unequal power relations between employers and employees and managers in the hierarchy of the organization need an excuse for their existence. Procedures and silly rules need to be adhered to. Private firms are protected by government laws so they have been able to create these rigid firms which are inefficient.

  4. I have doubts that any political/social/economic short term tweaking of the system will have much affect good, bad or in between. The state of human affairs that were once quantified at a personal level have evolved and are now measured on a global scale. Individualism and personal responsibility that are basic to a free society have been systematically devalued by government and culturally demonized. I think the road to the economy of abundance is a mean hoax and if pursued will reduce the human race to not much more than kept animals in the zoo.

    • That is why Government officials refer to us as Humans and Consumers. Cogs in a wheel that they control. An example is the Deparyment of Human Services. Or how do we convince Consumers to spend. A disgusting display of disdain.

      Socialism is evil. Crony capitalism AKA socialism dressed up as capitalism is evil.

      The day someone can buy a container of goods and sell them from the back of a truck, anywhere they choose, in return for any form of money they choose then thats the day the world is free.

  5. The problem is how to define Boom vs Slump when you have Boom in certain area and Slump the other at the same time. Just look at the corporate profits and the stock market! Where’s Slump? Housing Booms again again in certain parts of a country and regions around the world. For example here in So California housing market is booming again! The corporations and stock holders are laughing their way to the bank. On the other hand there are still many homeless and unemployed. The Unemployment problem in fact is caused mainly by the corporations massive lay off workers and not hiring or downsizing, which is why corporation are able to make enormous profits.

    So what the Fed do? They are seeing only Slump no boom and continue to print massive amount of money!

    One way of fix unemployment problem is that countries should establish law starting to correct unemployment tax. Or Trade and tariff are inevitable at the end.

    “Dow 20,000 Is Coming in 2014 or Early 2015″: James Altucher

    http://finance.yahoo.com/blogs/daily-ticker/dow-20-000-coming-2014-early-2015-james-160542015.html;_ylt=Ag5z.Vt77m1CNaNKlrtG0V8p2YdG;_ylu=X3oDMTE1Zm4zbWtkBG1pdANEVCBJbmRleARwb3MDNQRzZWMDTWVkaWFCbG9nSW5kZXg-;_ylg=X3oDMTFpMm9iMzh1BGludGwDdXMEbGFuZwNlbi11cwRwc3RhaWQDBHBzdGNhdANibG9nBHB0A3NlY3Rpb25z;_ylv=3#

    “Why You Should Quit Your Job Now”

    http://finance.yahoo.com/blogs/daily-ticker/why-quit-job-now-151346969.html

    • By “unemployment tax” I mean to make the corporations to pay unemployment tax each year. The more the hire the less tax.The more they fire, the more they pay.

  6. John, With continuing digesting of your civilized forum for thought (I feel fortunate to participate), my mind slipped back to simpler times and a couple of one-liners from the 1960’s US pop-culture.

    ” I’m beginning to feel like a Christian Scientist with appendicitis ” and I think I was more confident when ” We all will go together when we go ” was referring to cold war nuclear incineration…

    • I for one am glad that the probability of nuclear war incineration has significantly receded in the past few decades. I’ll take financial chaos over nuclear war any day. Although I’m working hard to minimise probability of the first…

  7. If the level of government spending [one way or another] has an effect on the economy, this suggests that the government is taking WAY TOO MUCH money out of the private economy through theft [taxation, fees, levies, etc.].

    The level of government spending should be tiny, and only grow when faced with a national emergency, e.g., invasion or some such thing. In this case, the government should simply print [spend] money into circulation to pay for whatever paraphernalia is necessary to conduct a defensive posture. After the emergency is over, the money supply should be altered to account for the effect that the emergency spending had on the value of the currency.

    Austerity only comes into the conversation after the horse has been out of the barn for decades. Like all things, one dys-function leads to the next, to the next, to the next,… .

    • People voted for this level of government and taxation. In an ideal world, I’d agree with a much lower level of government economic activity, but this level has a popular mandate, and I don’t want to start taking anti-democratic positions.

      Some Austrian economists like Hans Hermann-Hoppe and Gary North are outwardly hostile to democracy for this reason, because it gives popular mandates to large, expansive government and redistribution of income. I don’t think that that is a tenable position. I think there are ways to vastly improve things without having to totally reject democracy and redistribution.

      • Democracy was peddled by the same people that brought the French Revolution, that brought Socialism and big government. 18 year olds should not vote. Maybe only 60 and above. Like a tribal elder system.

        • Democracy doesn’t necessarily result in big government, or bad government or the French Revolution.

          60+ demographic already overrepresented and with a habit of voting themselves free stuff at a cost to the productive majority. If US Presidential election had been determined by over 60s John McCain would have been President in 2008. As much as I criticise Obama, McCain would have been much, much worse. He would have invaded way more countries already, wasting wealth and power.

          Personally I think we should lower voting age to at least the age where people are fighting and dying in wars (currently 16 in many countries), if not lower.

        • I keep telling you guys that the only reason groups exist is to steal from individuals. Democracy is simply another [albeit potentially less toxic] method to separate individuals from their labor-value earned.

          What other purpose could there possible be to organize people into groups [outside of family]?

        • In order to have a government, including institutions like a bill of rights, infrastructure creation, rule of law, national defence, etc, there has to be some kind of social organisation. Democracy is generally the least destructive and toxic form tried thus far.

          There is nothing necessarily wrong with some separation of individuals from a portion of their labour-value, so long as it is done democratically and accountably, and so long as they are free to leave the democratic system and go somewhere else if they are unhappy with the system. I think one of the main problems with the modern world is that the world is filled with nation-states with similar tax structures, and there are no (or very few) alternative jurisdictions. Once upon a time, a man could go off to the wilderness, build a hut and trap, hunt, live off the land. Nowadays, that is not possible. The wildernesses have been regulated and the frontiers tamed. In the future, there may be more alternatives: seasteads, asteroids and planetary colonies, spacestations, independent economic communities. People who want to live free and maintain a full percentage of their labour-value will be free to go elsewhere, and the rest of society will make do with democracy.

        • “There is nothing necessarily wrong with some separation of individuals from a portion of their labour-value, so long as it is done democratically and accountably, and so long as they are free to leave the democratic system and go somewhere else if they are unhappy with the system.”

          John, you and I need to have a few beers together one of these days. :)

  8. And what does your conclusion mean?

    “The time for fiscal austerity at the treasury is a time of high or rising interest rates and low or falling unemployment, and especially when interest rates are higher than the unemployment rate. The reality is that most of the Western world has the opposite of that right now.”

    Western worlds are currently with high un employment with low interest rates. A centralized austerity? A smothered private sector or at least the 95% smothered private sector?

    To me it does not seem we are in peace, but more that we are at war but we do not know it.

    “It is easy to imagine how government can smother the private sector in times of war; resources are centrally controlled and directed to the war effort, labour and capital are directed away from productive activities and toward fighting, toward building bombs and weapons to destroy things. There is little slack in the economy, as in total war the state commandeers as much of society as it possibly can toward the war effort.”

    The above can be translated to the following:

    ….It is easy to imagine how government can smother the private sector in times of war; resources (all natural resources, government (the people’s) industries and all forms of wealth such as minerals, gold, prime realastate) are centrally controled or forced into being controlled by the government and rich lobbies and directed to the war effort, of taking everything away from the people, (the bad 99%). Labourers are forced to work for the super corporations and capitals are flushed into the tax system, to meet the matured government bonds at absurdly high interest rates pocketed by the banking system. The to big to bust bank system. People are left fighting for there lives to simple stay alive, meanwhile more bombs, financial bombs are being created to continue the economical destruction of the general social structure. There is little slack in the economy, as in this new type of total war the state commandeers are centralizing all wealth to the master minds behind this ghastly plan of war effort against the plebeians…..

    As always though I love your articles and the beautiful debated comments.

  9. John writes:
    “I think it is important to specify that this is not a debate about the ideal size of government.”

    Austerity implies that the size of government is too large to begin with, so how does one remove this from the debate? This would be like saying that your diet has nothing to do with the fact that you have developed Type 2 diabetes. Of course, this may be the case, but most likely, eating for pleasure is intimately tied to chronic disease.

    But, you are correct that, if indeed, boom times correlate with increased tax revenues, then government spending should decrease its spending [lower taxes/reduce debt]. In the same breath, personal savings should increase as well. This has not worked-out so very well over the past 50 years as real incomes for the majority have decreased, and increased government revenues simply means additional opportunities for the elite to plunder national treasuries.

  10. err … Its not just about “red tape” that holds entrepreneurs back, its also the price fixing cartels that are landlords and estate agents and then throw into the mix high asset prices. Is it any wonder why manufacturing went to the east? Wasnt there a piece in the paper about old hezzer saying that britain is too rich and wont let go of the wealth, and this is holding back the country? Enter the estate agents and landlords again.

  11. Do not forget that the labour market available to be employed by this available capital may have been long term unemployed, and therefore not the choice of choosy employers. Therefore labour is imported from overseas. this magnifies long term unemployment.

    There used to be on the job training, foremen, supervisors, remedial schooling paid by the employer. If you can’t parachute into the job, with minimal supervision, then you are in big trouble if unemployed more than a few months.

    Large scale infrastructure spends and armourments manufacture is the only logical way to give long term unemployed the skills and on the job training to revitalise the labour market, and give a pool of skilled workers to business. Third Reich Keynesian and command economy programs make more sense every day.

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