Francis Maude, despite not even being a Cabinet Minister has sparked two political crises in a week, the latest becoming a national crisis.
By saying to everyone ‘fill a jerry can in your garage’ with a petrol hauliers strike coming he has caused massive queues at petrol stations, prompting the very shortages he feared several days before the strike was due to begin. As well as dire warnings from the fire brigade that by filling metal jerry cans you could blow yourself up – which one poor dear lady did. What is even more galling is that being in charge of the COBRA emergency planning arrangements he must have known that petrol stations only have a few days supply and all it takes is a panic for them to run dry. Worst of all Maude is in charge of the Nudge unit in cabinet – the Behavioural insights team. Nudge Nudge Panic Panic.
There are several economic lessons this teaches us. All on how the ‘tighten your belt’ of neo-con economics is flawed. Why?
The term often used is ‘housewife economics’ – a term with sexist overtones but good provenance. After all Thatcher used her analogy of the housewife keeping within her budget and even more tellingly Andrea Merkel
One should simply have asked a Swabian housewife,” “She would have told us her worldly wisdom: in the long run, you can’t live beyond your means.”
Swabia is a region where its highland residents are so ‘careful’ with money they don’t even buy potatoes.
The idea being that a government must run its budget like a housewife (or house-husband).
But a country and a national budget and debt arnt like that. If we were Robinson Crusoe on a desert island it would, a favourite subject for neo-con economists, but of course we buy and sell with other people. The economy is a social activity comprising the interactions of billions of people. If you reduce it to the actions of one household you make big mistakes, it is a fallacy of composition.
If it was just me filling a jerry can it would be fine, it would be available for me to use as I see fit at any time. But if everyone fills it on the same day the stations run dry. Now consider as if the petrol was money and the jerry can was a personal savings account. If we save alone its fine, individually we dont make much difference. But what if we all saved large parts of our income all at once? The amount of money in circulation falls, and if money isn’t spent then goods are not produced to supply them and we get unemployment. This is known as the ‘paradox of thrift’ and its consequences was one of Keynes great insights. It is a paradox because what is good for one person is not good if lots of people do the same. Its a counterintuitive and very powerful idea.
Now imagine the petrol station was a bank, of the more modern kind that extends credit at will as long as it knows in the future it will get it back. This works so long as you dont have every one arriving on the same day to draw out their balance, just as the petrol station runs dry the bank runs out of money. Now imagine again that the bank has a run of bad debts. There is a risk it could be taking in less money than it loans out, so of course it lessens loans. But a rumour gets out and people withdraw their cash. Other banks to which the bank loans money to also withdraw their credit to protect their own position if the bank goes belly up, so banks around the world have less and less to loan out. Hence we get a credit crunch or as Keynes described it a liquidity trap.
Of course it is more complicated than that. Our savings don’t just sit in idle balances these days they are put to work by banks. But if everyone saves where do they go? The answer of course is abroad. We get international financial services. Rather as you might at first expect this this money lost to UK PLC it is money gained, as the paying off of the loan is a profit source an income stream for the bank in the future. It all works fine so long as debts dont go bad. Then we get a shortfall in income and the profits on that income dont flow back into the economy through wages, dividends and spending. In other words we have an economic downturn. As Keynes follower Minsky showed it is this cycle of credit that drives the economic cycle.
The prime minister said (or his draft speech did before it was ridiculed) in his conference speech last year that like the government was doing everyone should ‘pay off their credit card’ . But as the above shows if everyone did the credit card companies and the banks that own them would go bust.
The economy is not like a household. It is more like a game of monopoly, competition for resources and the money flowing back to the bank.
The way to get it moving again is to add some fuel, not austerity which is just like petrol rationing.
Corrected: Thanks to Neil W for correcting me on rules of Monopoly :)