Watching UK Labour Destroy Itself

Why Reeves' obsession with cutting government spending will deliver decline not stability

Shortly after I posted the previous blog entry, “Watching Two Labour Parties Destroy Themselves”, Robert Peston reported the following speech to Labour MPs by the UK Chancellor Rachel Reeves:

“If we show, as I believe we will, that economic stability is the hallmark of labour governments, there is no limit to what we can achieve, because with that stability comes investment. With investment comes growth. With growth comes prosperity.”

I couldn’t have asked for a better confirmation of the point I made in that post, that Labour politicians are channelling the economics textbooks by which they were brainwashed –rather than educated—at University. As a reminder, here’s what Mankiw’s textbook Macroeconomics says is the impact of increased government spending on investment:

an increase in government purchases … must be met by an equal decrease in investment. (the full quote is in yesterday's blog)

All Reeves has done is reverse the order: a fall in government spending will lead to an increase in investment.

Given that the vote on this issue—effectively eliminating the winter fuel subsidy for pensioners—is being voted on in Parliament today, I will skip the sequence I hoped to write these posts in, and get straight to why this argument is stupid.

This is because, amongst the many false assumptions in this textbook argument, there is the belief that there is a “market for loanable funds”, and if the government spends it takes some of the money on offer away from the private sector, thus reducing investment.

This is bollocks. There is no such market. What there is instead is a monetary system in which banks create money by lending more than they get back in repayments, and governments create money by spending more than they get back in taxation. Reeves’ action, by reducing government spending in excess of taxation, will reduce, not the demand for money, but the supply of money.

This is easily understood when you do the double-entry bookkeeping of government spending—which economists don’t do because, rather than taking money seriously, their macroeconomic models exclude money altogether. The false toy models that textbooks teach students, like the “Money Multiplier”, “Fractional Reserve Banking”, and “Loanable Funds”, aren’t there as serious models of money, but to justify economists not including banks, or private debt, or money, in their macroeconomic models.

Given time constraints (I have a NHS appointment at 9.40am today, to check my left eye after laser surgery on it last week to fix a retinal tear), I’m going to rush out a very basic model of government spending to show that the impact of Reeves’ policy will be the exact opposite of what she expects.

The model lacks the sale of government bonds, but the fundamental effects remain the same when they are included. So all I’ll look at here is government spending and taxation, and their impact on the money supply. I’m also ignoring private bank money creation—all of which I’ll add later. I want Labour MPs to realise that what they’re voting for—the proposal will of course pass, given The Whips disciplining MPs to follow along—will reduce, rather than increase, both investment and economic stability.

This absolutely basic model—which is correct from an accounting point of view, but very incomplete—shows that reducing government spending reduces GDP.

The model starts with Spending being 32% of GDP and taxation being 30%. Then, in three steps, spending is reduced to 30%--closing the “Black Hole”, as Reeves calls the gap between government spending and taxation—and then to 29% of GDP, which in a more complete model will allow the repayment of government debt.

But the impact, far from promoting growth, is to reduce it: cutting government spending reduces the money supply and reduces GDP.

I’ll post a more complete model tomorrow, after this stupid policy has been passed by Parliament. The message will remain the same. Policies which economics textbooks teach gullible students will make the economy better actually make it worse.

The UK doesn’t need to abolish winter fuel payments. It needs to find a new Chancellor.