My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author
Last week we covered some aspects of how governments raise finance and how some of the methods used are dubious to say the least. As one commentator said there is no reason why governments should borrow their own currency from bankers but this is the system which has evolved and prevails for the time being; here is the link to last week: Issue 24
In this Issue we will look at how fiscal policy (government taxation and spending) is implemented and how GDP (Gross Domestic Product) is calculated and which forms the standard basis of measurement of an economy’s health. There are critics who say that GDP is not a true measure and is open to manipulation by politicians wishing to explain their policies as being successful.
CHAPTER 5
GOVERNMENT FINANCES
“Government is not reason, it is not eloquence – it is a force! Like fire, it is a dangerous servant and a fearful master; never for a moment should it be left to irresponsible action.”
George Washington
The government’s income and expenditure accounts
One of the main items of government expenditure is that of their employees. The total cost of an employee is not only their salary but all the overhead associated with a workplace as well as provisions for pensions, health and other benefits.
It is common to estimate a multiplier factor of x 3.5 to be applied to basic salary levels in order to arrive at a total ‘employee cost’ overhead. There are around 6 million public sector employees in the UK compared to 23 million employed in the private sector; clearly this is far too many government employees representing some 20% of the working population for the size of the economy.
Some would argue that ‘Big Government’ needs many people to run it; just so, but I, together with many others, will argue for a much reduced government model allowing private enterprise to do what it does best without undue interference from government with its often attendant negative outcomes.
Governments naturally grow exponentially unless politicians and the executive act decisively to manage it, especially the expansion of jobs. A serious, apolitical, non-partisan, approach to this leviathan of government could swiftly reduce the 20% to a more reasonable 15% without the people of Britain noticing any significant difference in service delivery.
You can do the math and see the savings on salaries alone going a long way to balance the UK budget. However, balancing the budget in this way, it will be argued, would have dire effects on unemployment costs and so the problem comes down to the principle of employer versus employee relationships and finding enough ‘work’ for all the working-age people to do rather than ‘make-work’ jobs in government.
This subject will be discussed more fully in Chapter 10 about National Economies and how a complete reappraisal and restructure of government services is required with the objective of making for much smaller government going forward.
Government taxation methods and policy
Fiscal policy is the use of the government budget to influence economic activity; it deals with the raising of taxation and the ways it is spent. When our politicians (policy-makers and lawmakers) seek to influence the economy, they have two ways to act: through monetary policy and by fiscal policy.
We have already seen how central banks use monetary policy by indirectly controlling the money supply through adjustments to interest rates, bank reserve requirements, and the purchase and sale of government securities and foreign exchange. On the other hand, governments influence the economy by changing the level and types of taxes, the extent and composition of spending, and the degree and form of borrowing.
The value of all final goods and services produced in the economy, the GDP, is calculated by adding four key sources of national income together according to the formula:
GDP = C + I + G + NX:
- Overall national spending or demand, that is, private consumption (C),
- private investment (I),
- purchases of goods and services by the government (G),
- exports minus imports (net exports, NX).
Fiscal policy that increases overall demand directly through an increase in government spending is typically called expansionary; it is contractionary if it reduces demand through lower spending.
In the short term governments may focus on expanding spending or cutting taxes to stimulate an ailing economy, or reduce spending and raise taxes to combat rising inflation and ‘cool’ down an expanding economy. In any event the goal is to maintain a reasonably stable economic environment that is steadily growing.
These targets apply to most countries but the application varies depending on the special circumstances of each nation. The desire to reduce poverty might lead a low-income country to tilt spending toward primary health care, whereas in an advanced economy, pension reforms might target growing long-term costs related to an aging population, as we find in Britain today.
Differing fiscal policies are influenced by the type of economic theories adopted from time to time. Economies evolve through cycles and economists often differ on what ‘economic levers to pull’ at any one time. Politicians are constantly ‘experimenting’ by what might appear as ‘tinkering’ with various taxes, welfare subsidies or making changes to the structure of government services.
For example, a favourite policy of Mrs Thatcher’s government in the 1980s was the ‘so called ‘Private Public Partnership’; this called for public services joining with private enterprise to form a joint venture but with a profit motive. It was a way to ‘commercialise’ national services by selling off large chunks of publicly owned assets to large corporations and allowing them to be managed as profit-making businesses.
Unfortunately not all national services are suitable for this type of treatment and several failures caused subsequent governments to rethink the policy. Unfortunately the action stopped at ‘re-thinking’ and there is scant evidence of any reversals except of course in the banking sector some of which, in any case, was forced into government ownership as a result of the 2008 crisis.
I am sure you are able to think of several examples through personal experiences. Network Rail, Water Utilities, Electricity companies and even the vast departments of Work, Pensions and Environment have all been affected by privatisation in one way or another.
The net result has been an inordinate rise in costs and therefore price increases for many of these services as I am sure we have all witnessed. There is a case to consider taking important utilities, housing and vital transport hubs back into public ownership with subsidies to moderate the end cost to the customer. It is, of course, economic heresy at this stage of UK national development but it is fairly certain that significant changes in this direction will have to be made as a response to the crippling effects of the global crisis.
Government response to financial crisis
The 2008 crisis hurt most economies causing financial sector difficulties and flagging confidence disrupting private consumption, investment, and international trade; all of which adversely affect national output (GDP).
Governments responded by trying to stimulate economic activity through new discretionary spending targets, reductions in some taxes, subsidies and increased public works programs because these actions help to soften the effects of an economic downturn. However, stimulus may take time and be difficult to design, troublesome to implement effectively and hard to reverse when a recovery begins.
The correct response ultimately depends on the fiscal flexibility a government has for new spending initiatives or tax cuts. Governments face a trade-off in deciding between targeting stimulus to the poor, where the likelihood of full spending and a strong economic effect is higher; funding capital investments, which may create jobs and help bolster longer-term growth; or providing tax cuts that may encourage firms to take on more workers or buy new capital equipment. In practice, governments try to take a “balanced” approach with measures in all of these areas to some degree or another.
Fiscal deficits and public debt ratios (the ratio of debt to GDP as discussed earlier) have expanded sharply in many countries because of the crisis. Financial support and guarantees to banks, financial institutions and industrial sectors have added to concerns about the deterioration of government finances.
Countries can afford to run moderate fiscal deficits for extended periods of time supported by domestic and international financial players remaining convinced of the government’s ability to meet their present and future debt obligations. Deficits that grow too large and linger too long may, however, undermine that confidence.
A collapse in financial markets causes a high degree of fear to enter the global arena and for money to flow quickly and in large quantities into what investors call ‘safe havens’ such as the US dollar and US Treasury bonds. These events cause distortions in the normal operation of markets where the forces of supply and demand are compromised, prices become unrealistic and the flows of goods and services are interrupted.
To be continued next Saturday
Obama stopped keeping a Budget, then the CBO gave up on Audits, and the Banksters and NeoCons pissed off the BRICS who sold almost all their Treasuries, which were bought with US Treasury printed dollars; almost all new US Treasuries are now bought by the Treasury. All the rules for Macro Economics for the USA went into the toilet and we are on borrowed time until inflation kills US too. Reports and Words are now just a Smoke Screen (curtain) TPTB hide behind.