Keynesians failing their own theory

Allister Heath
LET us assume for a moment that today’s self-styled Keynesians are right and that what the UK and the West need is not austerity but even greater public spending. To me, given that the UK government could borrow £130bn this year, that the OECD puts public spending at 50.1 per cent of UK GDP, and that countries are going bankrupt as a result of spending and borrowing too much, this is a nonsensical assumption. But it is worth exploring, if only better to point out the flaws in the reasoning of many so-called Keynesians, including those in the Labour party (they have distorted John Maynard Keynes’ theories beyond recognition, but that is a moot point).

A proper Keynesian stimulus doesn’t mean an extra couple of billion or a slight slowdown in the pace of deficit reduction. What would really be required is shock and awe. The UK economy is expected to be worth £1.539 trillion this year; so a proper Keynesian-style boost to demand worth a semi-decent 3 per cent of GDP would be worth around £46bn. Arguably, it would need to be even larger, say 4 or 5 per cent of GDP. Yet taken at face value and excluding any damage they would cause to confidence and incentives, Ed Balls’ series of proposals probably amount to a debt-financed boost to demand of £18bn, roughly 1.2 per cent of GDP.

This includes his proposal to cut VAT back to 17.5 per cent, and his bid to move forward infrastructure projects, partly compensated for by yet another crippling £2bn-£3bn tax on banks (additional to Osborne’s own new tax). From a Keynesian perspective, it would make only a small difference. Even on its own terms, it is only just better than a gimmick. It certainly wouldn’t mark a major intellectual shift. Even if it did trigger more consumption, quite a lot of this would be on imported goods, which reduce GDP. A lot of the construction spending would be conducted via imported labour, thus failing to dent domestic unemployment by much.

So even if one were to believe Keynesian models in an open-economy context, and pretend that the markets wouldn’t panic, the boost to GDP would be marginal, probably half a per cent or so in the first year and less in subsequent years. In the longer run, taxes would have to be hiked; given that Balls is obsessed with cutting taxes on consumption, that would mean even higher incentive-destroying taxes on income and capital. It was interesting that Balls said yesterday that “the issue of land taxation is one which we should actively look at” – in other words, he is moving closer to the kinds of crippling wealth taxes beloved of Vince Cable. It is strange that Balls appears to think that what the UK needs more of today is debt-financed consumption; in reality it needs to rebalance towards investment, savings and exports.

What Keynesians should really be demanding if they were serious advocates of their own ideology is a massive cut in VAT to 12 per cent, or the biggest government construction project in UK history, or something of that magnitude. The fact that they are not doing so suggests a singular (and healthy) lack of self-confidence in fiscal demand management. Britain doesn’t need another artificial boost to demand. It needs a genuine boost to the incentives of people and companies to work and invest, together with a credible long-term commitment to balancing the government’s books. Shame that Ed Balls can’t see this.
Follow me on Twitter: @allisterheath