2020 11 Editorial – The Deficit Myth

The Deficit Myth

Can Labour present itself as an alternative to the Tory Party if it does not understand the reality of a currency creating state?  The question is not idle speculation.  In the Furlough scheme the state paid 80% of the wages of those in employment who could not work because of the pandemic.  The scheme was described by many as generous.  This misses the point.  80% was the rate necessary to ensure that all the industries that could still work throughout the pandemic would not experience any significant drop in demand for their produce.  Such a drop in demand would have further exacerbated the unemployment problems directly created by the pandemic.  Although the Furlough scheme was a move in the right direction it had some serious limitations which resulted in those claiming universal credit increasing from 1.2 million in 2020 Q1 to 2.7 million in 2020 Q3.

The chancellor, Rishi Sunak, had made clear he intended to end the Furlough in a speech on 8th July 2020.  In that speech Sunak also said “And we will deal, too, with the challenges facing our public finances. Over the medium term, we must, and we will, put our public finances back on a sustainable footing”.  It was not the intention at that time to replace the Furlough with anything else.  The Treasury’s deficit fixated view was in the ascendant.

But by September it was clear that the pandemic was coming back.  Sunak refused to countenance the continuation of the Furlough but announced on September 24th that it would be replaced by a ‘Job Support Scheme’ which was designed to significantly reduce government expenditure.  As the pandemic spread it became evident that the Job Support Scheme would cause a massive increase in unemployment post Furlough.  So, two further government schemes were announced on 9th October and 22nd October.  In both schemes the pre-occupation with limiting the fiscal deficit is much in evidence.  And now, as we go to press, Johnson has announced, that something close to the original Furlough scheme will be re-introduced.  Details are unclear but it is likely that the self-employed will fare very badly under the revised Furlough scheme.  Fewer businesses will now cease trading but expect unemployment to rise significantly.  And now evictions will be allowed.

Labour is struggling to respond to these government policies because its hands are tied by a belief that the size of the fiscal deficit (the difference between what a government spends and what it raises in taxation) should be a cause for concern.  As long as Labour holds to this false belief the Tories will always be able to win the argument about government expenditure.  Annaliese Dodds is Labour’s shadow chancellor.  She has strong socialist principles and, unlike many of her fellow MPs, worked hard to have a Corbyn government elected.   But socialist principles are not enough.  Dodds and the left generally need to understand much better how a currency creating state works if they wish to oppose the emerging Tory return to austerity.

Sunak justified the ending of the Furlough scheme by raising the issue of its cost and the consequent increase in the fiscal deficit and the national debt (cumulative government expenditure less cumulative taxation).  According to Sunak the difference between government expenditure and taxation must be funded by borrowing from the private sector.  This is not the case.  The UK state is a currency issuing state.  It simply instructs the central bank to pay those from whom it wishes to buy goods and services.  It never has to check whether it has the money.  As the monopoly issuer of the currency it has as much money as it wants.  It has no need to borrow from the private sector to finance anything.  To the extent that the state borrows from the central bank there is an increase in the national debt.  But the state owns the central bank, so it is effectively borrowing from itself. 

Since the government of a currency creating state can buy anything that is for sale in its own currency what should determine its spending?  A government will clearly spend in pursuit of its policies around education, health, defence etc.  Apart from that, unemployment and inflation should be the primary drivers of its spending.  The government should make spending decisions because of unacceptable levels of unemployment or inflation.  These spending decisions will have implications for the fiscal deficit and national debt.  But it is most certainly not the size of the fiscal deficit or of the national debt that should drive the spending decision. 

Unemployment occurs when the private sector, for whatever reason, does not wish to hire all those who want to work.  In this situation the state should finance the employment of these people in doing work that their local communities think is valuable.  In this role the state is not trying to compete with the private sector.  Quite the opposite.  It only employs those whom the private sector does not wish to hire.  It would pay these workers a level of wages which meant that all their basic needs were met – food, rent, energy, health, education, holidays, etc.

Employment by the state while the private sector does not wish to hire would likely be a temporary phenomenon.  The fiscal deficit and national debt would both certainly rise because the difference between what the state spends and raises in taxation would be increasing.   But since the national debt of a currency creating state is effectively a debt owed to itself the matter is of little consequence. 

Explaining why the fiscal deficit and the national debt are irrelevant is not however a simple task.  We have all been taught to believe that the economics of a currency creating state and those of a household are identical.  The idea achieved dominance in the 1970s.  Thatcher promoted the idea with her endless references to “taxpayers’ money”.  However, a household is a currency user.  It must always finance excess expenditure by borrowing.  It cannot create money.  All institutions, other than the currency creating state, are currency users.  Councils are currency users.  They raise a certain amount locally through council tax to fund their activities.  If this is insufficient, they are dependent for the rest on central government finance.  If that is not forthcoming there is little they can do.

This discussion may seem somewhat academic but in fact it is highly relevant to what is happening in Britain currently.  Andy Burnham, the mayor of Greater Manchester, opposed implementing the governments restrictions on economic activity in that city unless the city was given greater financial support.  But Burnham never directly challenged the basic premise of the government that the size of the fiscal deficit is of any consequence.  Burnham should argue that as long as government spending into the economy is beneficial and not inflationary then it should be made.  By continuing the Furlough scheme many workers could continue to live decent lives.  Furthermore, if many of these workers were to lose their employment under the proposed ‘Job Support Plan’ this would have the effect of reducing demand in the rest of the economy.  Workers who could continue working even in Pandemic conditions would find themselves being laid off due to a drop in demand for their products and services.  But Burnham is unable to make these arguments because in his heart he believes the size of the deficit and of the national debt does matter.

Another example of the importance of grasping the irrelevance of the fiscal deficit and national debt is shown in the newly founded ‘Alliance for Full Employment’  formed by the elected Metro Mayors in England, the First Minister of Wales, the Mayor of Bristol and former Prime minister Gordon Brown.  This alliance gets close to saying that unemployment is unacceptable  It’s most interesting demand is for ‘changing the constitution of the Independent Bank of England to match the new priorities of the US Fed such that it targets low unemployment as well as low inflation’.  But the ‘Alliance for Full Employment’ also holds back from boldly stating that the size of the deficit and national debt do not matter.

In Parliament on 14th October Annaliese Dodds, the shadow chancellor, called on Sunak to do whatever it takes.  She was effectively telling him to ignore the size of the deficit and national debt without daring to use those actual words.  She moved a motion:

That this House believes the Government should do what it takes to support areas with additional local restrictions, currently the North of England and parts of the Midlands, Scotland, Wales and Northern Ireland, by reforming the Job Support Scheme so it incentivises employers to keep staff on rather than letting them go; ensuring no-one is pushed into poverty when they do the right thing; providing clear, consistent and fair funding that goes hand-in-hand with the imposition of new restrictions, including using the £1.3 billion underspend on the grants fund to support local jobs; fixing gaps in support for the self-employed; and extending the ban on evictions.

But again, Dodds, like Burnham and Brown, holds back from taking that breakthrough step and stating that the size of the deficit and national debt is not the issue.  Unemployment is the only issue of importance.  Dodds should be saying forget the deficits and public debt – focus on what the net spending is doing to advance well-being.  Focusing on the financial parameters will just divert our attention away from what is important.  Labour should seize this opportunity to reset the agenda to one in which unemployment is the main issue.  If they do not, they will not win the next general election in 2024.