You go to the newsagent to buy a paper and find that you only have a £20 note. You pay the newsagent £20 and receive £19.20 change. What did your newspaper cost? Most of us would say 80p, but almost any economist or politician would tell you that your paper cost £20 and was unaffordable. They would look at the £20 but ignore the £19.20 you got back.
Makes no sense? Well, perhaps, on a good day, economists and politicians can be trusted to buy newspapers. But they make exactly this sort of mistake when discussing government spending.
A few months ago, Rishi Sunak explained that continuing the £20 a week uplift in Universal Credit would have cost an extra £6bn a year. However, this would only have been correct if the government got none of its £6bn back.
The £6bn would not have disappeared. It would have circulated in the economy.
Some of it might have been used to buy groceries. If so, the supermarket would have paid tax on its profits. It would have employed staff who paid tax on their wages. At each cycle some of the £6bn would have come back to the government as tax.
The government should gradually get its £6bn back, little by little.
Government spending is much closer to investment than it is to our own everyday spending. If I invest in a share on the stock market, I hope I am buying a stream of future dividends. When the government invests in the economy via its spending, hopefully it is buying a stream of future tax returns.
First of all, there really is a Magic Money Tree. Every £ we possess has been plucked from that tree. A £ is simply an IOU from the government. When the government wants to spend money, it can write new £IOUs, it can reuse £IOUs that it has collected back as tax, or it can borrow some of the £IOUs that it created earlier.
If the government makes a good investment and the economy grows, it may even get back more than it spent.
But surely any expert will tell us that greater government spending will “inevitably lead to inflation”? This may be collective amnesia about the law of supply and demand. If demand exceeds supply, then there will be inflation. But if spending is in areas where supply keeps pace with demand, why should prices rise?
Banks are given a licence to print money
If government spending will not inevitably lead to inflation, can something else go wrong?
Many people do not know that the government licenses banks to “print money”. They are allowed to create government-backed £IOUs, which they use to make loans.
Currently, more £IOUs may be created by banks than by the government. Strangely, when economists and politicians agonise about the government “printing money”, they do not seem to notice that banks may be “printing” even more money. When an alarming figure for public debt is presented, one third of the figure is imaginary money that the government owes to itself.
In 2008 they refused to replace the lost cash
If £IOUs that the bank printed no longer exist, replacing them will not be inflationary, but failing to replace them will cause deflation and recession. This is the story of the last 11 years. The government refused to create and spend money to replace the money that banks had destroyed in 2008. Gordon Brown, with his “quantitative easing”, simply helped to keep the right amount of money in the economy – there was no need to try to claw back more.
Economists’ models and politicians’ “common sense” do not seem to allow for getting back a dividend when the government spends money – or getting change when you buy a newspaper. .
When you allow for dividends, it seems to me that Labour rather than Conservative policies often make the most economic sense. This is because more Labour spending would be in areas where the money keeps on circulating.
So don’t ask where will the money come from. Ask what will happen to the money after the government spends it.
Lord Agnew resigned over £4.3bn fraud write-off
About £4.3bn was claimed fraudulently under a package to support businesses during the pandemic. Lord Agnew has described how spending a small amount beforehand, to set up and keep proper checks in place, would have been an investment that paid for itself many times over.
And here’s another: the government used to employ a UK company to provide red UK passports. The company paid tax and employed UK workers, so that the money stayed in the UK economy. Eventually the government should have got all or most of its money back as a tax dividend.
To celebrate our new-found freedom and to “save money”, the government now gets blue passports made in the EU. The EU companies and workers do not pay UK taxes.
The government pays a little less up front… but gets nothing back.
To delve further into these points, you can check out some of Michael’s articles on this subject on the Progressive Pulse website.