The Damage Bill Is Coming Due

The Damage Bill Is Coming Due. By Phil Mullan. This is primarily about Britain, but the same issues are affecting all Western countries.

Both the advocates and critics of Truss’s plans described them as ‘tax-cutting’, ‘free market’ and ‘small state’. These tired labels say more about the poverty of intellectual thought today than they do about Truss’s specific economic policies.

For a start, there was not much actual tax-cutting, even in the first mini-budget. About four-fifths of the measures announced were just to reverse recent tax increases or planned future ones. Furthermore, there was nothing ‘free market’ about the market-distorting energy package shielding households and businesses from increased gas and electricity prices.

There is also nothing ‘small state’ about plans that involve the government spending more than four out of every 10 pounds produced each year. In truth, it is not possible for any government to circumvent the role the state now plays in advanced industrial economies, no matter how much it might talk up its ‘small state’ credentials. …

Productivity is all, in the long run:

The underlying economic problem that has dominated Britain’s recent history is productivity — that is, the amount of output produced in every hour. In the long run, productivity growth, or the ability to produce more with less, is all that really matters for rising living standards.

This depends on business investment in technology and innovation. The challenge, therefore, is to identify and overcome the barriers that have been holding back this investment. …

Government holds back productivity by over-regulating, taxing too highly, and propping up inefficient and low-productivity enterprises. But worse, it interfered in the marketplace to decree easy money and low interest rates, especially from 2008:

Truss’s key contention was that tax cuts would automatically increase businesses’ willingness to invest. Yet a comprehensive review of multiple studies earlier this year concluded, on balance, that corporate tax cuts do not have a definitive effect on business investment. Neither Truss nor Kwarteng made any effort to explain to people why this time would be different. For instance, we heard no answer to the question as to why Britain has long had one of the lowest corporation tax rates among the G7 leading economies and yet has the lowest business-investment levels.

There was also a conceptual flaw in the overall tax-cutting approach. Truss assumed that providing extra incentives would be enough to get businesses investing and driving up productivity. Yet this approach ignores the fact that only offering incentives for investment has not worked and will not work — because the disincentives to investment from a stagnant, congested, zombified economy have proved to be more powerful. Without removing these disincentives, any incentivising approach will fail.

Indeed, the suffocation of the creative-destruction process has been a huge and under-addressed factor behind Britain’s economic stagnation. Too many low-productivity businesses have been clogging up the economy — ranging from barely alive, debt-dependent zombie firms to the ‘long tail’ of mediocre businesses that have been unable to invest very much. Those firms surviving on state life support, hoarding workers and resources, also inhibit the development of the strongest companies.

Our low-productivity economy is a result of weak investment in years past. But it also blocks future investments. This is the real reason we have a ‘vicious cycle of stagnation’, as Kwarteng described it, and that has to be broken. …

It is just not possible to build a high-productivity, faster-growth economy when most of the UK’s businesses are slow-growing, low-productivity ones. The harsh truth is that the bulk of these low-productivity operations won’t be able to regenerate themselves. They need to be replaced. There are no easy solutions or painless routes to a better economic future. Every economic policy decision will create tensions somewhere. …

Economic renewal comes not from continuity and stability, but from change. And this could involve the destruction of some businesses. Consider the higher productivity-growth decades of the 1950s and 1980s. Both followed periods of business restructuring — the first through the upheavals of the war economy and the second after the deep recession and business closures of the early 1980s. Contrast those periods with the past two decades, in which struggling, low-productivity businesses have been sustained through cheap-and-easy credit facilities underpinned by central-bank policies. Productivity has flatlined as a result. …

Bureaucrats get paid regardless. They don’t really understand productivity in private enterprise, but they increasingly rule and override the voters’ wishes as expressed by their elected politicians:

Truss’s government failed to understand that the only audience that it should be accountable to is the electorate, not the fetishised ‘financial markets’, the International Monetary Fund (IMF) or the Office for Budget Responsibility (OBR). …

The OBR is not on par with God. It is an unelected ‘fiscal watchdog’ with a short history, having only been established in 2010 by the then chancellor, George Osborne. For centuries, his predecessors had been happily presenting their budgets without the need for assurances from this ‘executive non-departmental public body, sponsored by HM Treasury’.

The OBR … was designed to operate as yet another unaccountable body through which an elected government could dilute its political responsibilities and avoid democratic accountability. The fact that the government’s opponents have in recent weeks bestowed even more authority on the OBR as an ‘independent’ gatekeeper is a further blow to democracy. …

The problem comes back to money manufacture — who gets to make “money,” under what circumstances, and who really benefits? For instance, can you make money out of nothing? Not unless the bureaucrats have granted you a banking license. (What can you do for them?)

For many years, knowledgeable observers of Western financial markets have been warning of the disarray to come. They have been particularly worried about what would happen when central banks in the US, Europe and Britain began to reverse years of super-easy monetary policies. Established in the aftermath of the 2008 financial crash, these policies involved low interest rates and quantitative easing, whereby state banks directly buy financial assets including government bonds (the IOUs that finance public expenditure in excess of tax revenues).

In the immediate aftermath of the 2008 crisis, these policies shored up financial institutions. But the longer they continued through the 2010s, the more they have distorted our economy. This has led to inflating price bubbles not just in government and corporate bonds, but also in other assets, including shares and property.

Meanwhile, what seemed to be permanently low interest rates encouraged greater indebtedness across households, businesses and governments. In short, the gap widened between these financialised asset prices and debt liabilities and the production of genuine value in the economy. And the larger the gap, the greater the eventual implosion in the financial markets.

Actually the bubble started in 1982, but it was a private sector bubble until 2008, when it started faltering. Then governments stepped in and kept it going by decreeing low interest rates and printing oodles of new money. What could possibly go wrong? Asset bubbles and inflation, perhaps? Well, courtesy of the covid acceleration, the endgame of modern banking is almost here. Buckle up.

For new readers, the most important graph in economics: