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Fighting the 1930s arguments all over again

Some commentators are suggesting that next week’s budget of retrenchment results from a re-run of the argument that arose in the 1930s. Introducing an article in the Financial Times on 17 June under the heading “Once again we must ask “Who Governs?”, Lord Skidelsky, emeritus professor of political economy at the University of Warwick, wrote.

“In one sense, next week’s emergency Budget is simply the logical working out of an intellectual theorem. The implicit premise of the coming retrenchment is that market economies are always at, or rapidly return to, full employment. It follows that a stimulus, whether fiscal or monetary, cannot improve on the existing situation. All that increased government spending does is to withdraw money from the private sector; all that printing money does is to cause inflation.

“These propositions are a re-run of the famous “Treasury view” of 1929. By contrast, Keynes argued that demand can fall short of supply, and that when this happened, government vice turned into virtue. In a slump, governments should increase, not reduce, their deficits to make up for the deficit in private spending. Any attempt by government to increase its saving (in other words, to balance its budget) would only worsen the slump. This was his “paradox of thrift”. The current stampede to thrift shows that the re-conversion to Keynes in the wake of the financial collapse of 2008 was only skin-deep: the first story remains deeply lodged in the minds of economists and politicians.”

Both views wrong?

What if both views are wrong? Experience shows that wages do not drop to market-clearing levels. They can’t. The minimum wage is the least that anyone is willing to accept in order do the work required. This may be set by benefit levels or it may be determined by minimum wage regulations. In either case it is normally little more than bare subsistence. However, due to labour-related taxation, which for all practical purposes functions as a payroll tax, the gross labour-cost to an employer is around 70% higher than net take-home pay. Thus, the tax system – that is PAYE Income Tax and “employers” and “employees” National Insurance contributions, make it impossible for workers to price themselves into work without their net pay falling well below the bare subsistence level provided by benefits or the minimum wage legislation. The proposition that spare labour will quickly be soaked up following a shake-out is nonsense.

The Keynesian view is equally nonsense, though of a different kind. In the first place, the notion that there can be a “shortage of demand” begs many questions. Where does demand come from? Supply, of course. If one has nothing to supply, then one can demand nothing. To suggest otherwise is to imply a circular argument. That there is a blockage in the production process comes about because there is not a free market in one of two primary factors of production, land. The price of land does not fall to market-clearing levels in a recession, as is evident from the number of long-term vacant sites and buildings.

This is one reason why pumping public money into the economy merely to stimulate demand is ultimately inflationary, as experience has always shown. But it need not be so under certain circumstances.

If the government were to invest in good infrastructure projects – and it is essential that they are good projects and not merely for prestige or vanity – then the eventual result is that land values are enhanced. If, in addition, a system of land value taxation were in place such as we advocate, then the result is that the land value growth is at the same time a growth in the tax base. Infrastructure projects funded by bonds secured on the land-value growth arising from those projects are not inflationary. On the contrary, this is prudent investment – basic good housekeeping that would build up the stock of the nation’s capital. And times of economic recession are precisely the times when this kind of housekeeping work is best carried out. It is no use waiting “until we can afford it” any more than the farmer sows next year’s seeds at the same time as he is reaping the harvest.

Why do so few politicians or economists see things in these terms?