The economic consequences of fiscal consolidation
Although Friedrich Hayek described Keynesian economics as “the pseudo-scientific economics of averages” (Hayek, 1972, p. 20), he could not have anticipated the use of eight paired averages to represent events over the course of a century. These data are the annual average change in (i) government debt as a percentage of GDP and (ii) the percentage growth in nominal government expenditure. A fitted linear equation is the basis for substantial conclusions: (i) a 3% rise in fiscal expenditure is associated with a 5% drop in public debt; and (ii) “fiscal consolidations have not improved the public finances” (Chick and Pettifor, p. 14). A second presentation is even more parsimonious. From six observations, a correlation coefficient of minus 0.5 (between averages for debt and interest) is sufficient to “decisively rebut the notion that higher debt is associated with higher interest.” (ibid.)
Further comments are: that post-1945 government expenditure “as a share of the economy” is twice that of the 1920s; that the “quarter century after the war is rightly known as the ‘Golden Age’” (note bene: its forced termination by rising unemployment and inflation receives no mention); and that the reversion to “a more market-oriented economy from 1976” is associated with relatively poor output performance. The authors “look to macroeconomics” for an encompassing explanation of their findings, the nub of which is stated as:
“Given spare capacity, public expenditures are not only productive but also foster additional activity in the private sector. Productive activity generates revenue and economises on benefits (and then debt interest) expenditures.” (p. 15)
The key assertion that “public expenditures are productive” raises an important question: “What do public expenditures produce?” They certainly produce public sector jobs, which now account for over 20% of UK employment; but a more focused appraisal would relate production to the creation of value and only indirectly to the creation of jobs. Where private expenditures (more aptly cited as “costs”) create net value, relevant enterprises may prove viable. If they are not, resources are reallocated by market forces; but with public expenditures few activities are subjected to market evaluation. The “value” ascribed to those activities (by public sector employees who compile the national income accounts) is by the costs incurred. Upon that basis alone is value attributed to public sector activities, which implies that poor cost control and lax procurement procedures raise levels of recorded value.
Public sector make-work schemes do not trigger sustainable private sector growth. Spades produced to shift soil between adjacent holes have no value; and, if workers digging holes for the state were previously in receipt of state welfare benefits, there is no net gain. So there is nothing in that activity which “economises on benefits”. Only if earnings exceed earlier welfare benefits is there additional expenditure; but that requires spending new money into circulation, which is to start an inflationary process.
Many allusions are made to the “pump priming” metaphor. Whether or not this is correctly ascribed to Keynes, the metaphor is inappropriate: with a primus stove, initial priming is sufficient to sustain greater efficiency in fuel combustion; with a fiscal stimulus, output and employment revert to their original levels unless the stimulus is sustained. Ever-rising debt is necessary to support a constant level of employment; but this invokes a more-fitting metaphor. To engage in a Keynesian stimulus is to grab a tiger by the tail. Thereafter, “[i]f the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished!” (Hayek, 1972, p. 112).