Politics and Economics

The 2008 Financial Crisis was Primarily a Failure of Socialism.

I’ll argue that the 2008 financial crisis was primarily caused by a failure of a socialist policy and exacerbated by socialist economics.

Mr. Miliband and Mr. Balls of the UK Labour Party believe that the 2008 financial crisis was primarily caused by a failure of capitalism.  To an extent this is true, but then few of us believed that capitalism is a perfect system, just the best system currently available.

But it was not Labour’s lack of regulation of the “casino banks” in the UK that started the economic crisis, although they may have accelerated its effects.  The initial spark was provided by the policy of “sub-prime” lending in the USA.  A policy of which Mr. Miliband and his socialist colleagues would have been proud.

In 1999 President Clinton effectively reversed the Glass-Steagall Act opening the way for the credit unworthy to engage in the property market.   For the Democrats it was positive discrimination; social engineering.   The left had long complained that the property market was allowing the already wealthy and Middle Class to profit from the property market boom.  By allowing the poor and economically unreliable to borrow money and buy their house was considered another blow for equality.  A huge amount of debt built up in a part of the economy that couldn’t afford the interest payments.  When asset prices started to fall many people defaulted on their loans leaving the banks with properties that were worth less than the value of the mortgage debt.

So Sub-prime lending was the spark.  It caused a brief economic downturn in many countries.  However in many left-leaning economies, which borrowed billions to spend on social engineering experiments, it went on to cause a crash.

Let’s be clear about the economic legacy left by the last Labour Government.  The deficit was a whopping £155,000,000,000 in one year!  Whilst I have heard many Labour politicians responsible for this eye-watering number blame it on extra spending required to avert an “world-wide financial crisis” created by bankers, the facts do not support this defence.

It was not a “world-wide” crisis as it affected only countries that ran up huge Government deficits (Greece and the UK being prime examples) or massive private deficits (Ireland).  This includes the US who refused to raise very low tax levels to meet spending obligations, and the EuroZone who cannot put taxes up any higher to match their totally out-of-control spending plans.  Many countries, including Canada, Australia, Saudi Arabia, China, Sweden Germany and much of South East Asia all avoided the worst of the crisis because their spending was more-or-less in line with their tax revenues.  Labour must take its share of the blame with the bankers, as it was them that ran up Government debt.

Also, Labour turned on the spending tap long before the 2008 – 09 financial crisis.

http://www.ifs.org.uk/bns/bn99.pdf (see Fig. 4.1 on page 10)

Labour spending went from 36% of GDP in 1999-2000 to 42% in 2005 -2006 whilst revenue was broadly flat at 37% of GDP over the same period.  Increasing Government deficits is not new and the size of this early deficit was not unusual by historical standards.  But the key difference here is that Labour increased spending and debt during the boom which started at the end of John Major’s government.  We expect Governments to increase spending and deficits during a recession.  This is essential to cover increased unemployment benefits and lower tax revenues and smooth out the economic shocks that inevitably hit the most vulnerable citizens.  However, prudent Governments will then pay down debt during the boom times to allow more future borrowing when the economic cycle inevitable takes a turn for the worse.

Remember that the deficit is given as a percentage of GDP, which is much higher during a boom therefore the deficit is proportionally bigger.  Also, the last boom lasted for a long time, an unprecedented 16 years, allowing massive debt to build up if you were foolish enough to continue to borrow during this time.

The reason that Labour felt they could borrow with impunity, even during a boom, was it believed it had banished “boom and bust” economics.  Gordon Brown famously made this statement in the House of Commons. The world’s finances were linked for the first time by technology and Labour believed the massive global market could spread financial risks. Labour bet the country’s financial health on a belief that asset values would continue to rise, allowing borrowing against those assets.  Finally, Labour selfishly expected our disenfranchised children and grandchildren to pay back the debt sometime in the future, believing this was acceptable because it assumed the economy would be much bigger by then and they could afford it.  This is undemocratic and immoral. The consequence of all this is that Labour foolishly and arrogantly believed there would never be another downturn so could continue to spend above tax receipts.

Labour was wrong on all counts.  The connected global markets did not spread the risk, it spread the contagion, asset prices fell and the economy shrank increasing the debt to income burden.

So because Labour arrogantly believed there would be no more downturns they increased their profligate spending rather than pay down debt.  Consequently, when the financial crisis hit in 2008 there was no more credit available, which left the UK economy unusually exposed.

So, a socialist policy started an economic downturn, which socialist economics turned it into a crash.

Thanks to Labour the incoming coalition government had the unique problems of solving a massive economic slowdown with no ability to borrow more to smooth the worst effects.  They had to reduce spending when there was more need for the extra money.  An impossible task without causing major hardship.

Whether the coalition policies produced the best possible outcome given the disastrous economic hand they were dealt by Labour is difficult to judge.  This remains to be seen and history will be the judge.

Labour’s election prospects do not lie in trying to talk down the coalition economic performance or in justifying its recent economic mismanagement.  To win the next election they must address one key question:  Which party will best manage our new economic reality?

We have over a trillion pounds of debt, which is still rising due to an annual deficit of over 100 billion pounds.  All this must be paid down.  Combining this with an older population (with their large pension and healthcare needs) means we will have no more spare money for at least a generation. We must earn what we want to spend.  We cannot continue to borrow what we spend. Increased taxation can get nowhere near lowering the deficit, let alone the debt.

Massive public spending cuts are inevitable.

Labour must now convince the country that they can move from a party which financially supports in-work welfare benefit and uncontrolled public spending to one which puts financial prudence ahead of its social engineering experiments i.e. manage the country’s massively reduced public spending capacity for the foreseeable future.

The Labour front bench may believe they can do this, but I doubt that their political paymasters (Unite and the GMB unions) or the socialist Labour backbenchers will let them.  They have a social agenda not an economic one. The country may feel that there are other political parties with a longer history and proven innate instincts of supporting a smaller State and lower public spending.

Politics and Economics

There are clear limits to Socialist Economics – and the UK has passed them

In 2012-13 the UK Government is spent  £100,000,000,000 more than it raised in tax.  This is called the Government deficit.  This is less than the £155,000,000,000 deficit in 2009-10  (the last year of the Labour Government) but still unsustainable.  The difference in spending and tax revenue is made up by Government borrowing, which is bloating our £1,400,000,000,000 debt.  Can socialist economics eliminate the deficit, then start to pay down the debt whilst maintaining living standards?

Socialist economic logic:

Socialist economics has a predominantly social agenda not an economic agenda.  Its logic goes something like this:

“I need a certain amount of income to live a decent life therefore I am entitled to have it.

If I’m unable to earn this much myself then somebody else must make up the difference:

1.  My employer must pay me more for my efforts (minimum wage)….or

2.…. my next-door neighbour (who earns more than me) must give me some of their income (intra-generational redistribution of wealth)….or

3.…The Government must borrow more money, give some to me and get my children and grandchildren to pay back the debt (inter-generational redistribution of wealth)…..or

4.   ….a combination of 1,2 and 3.”

How far can we push these policies before they become detrimental to those they are designed to help?

Solution 1.  Minimum wage.

Setting a legal minimum wage can be a good way to ensure that workers have a fairer remuneration for their labour from their employer.  The trick is to put minimum wages at a level that benefits workers but not so high it puts the employer out of business or drives jobs to countries with cheaper labour.  Minimum wages put up the costs to businesses, which must be passed on as increased prices (causing inflation), which must be paid by workers.  Increased prices causes the businesses to be less competitive in global markets (causing unemployment).  There are two significant numbers regarding labour costs: $135 and $12. The first is what the average worker in the West earns per day; the second what the average worker in urban China earns.

What entitles the rich world’s 500 million workers to salaries ten times greater than the 1.1 billion workers in urban bits of the developing world?

(Full, brilliant article is here:    $135 – $12 = the pay gap the West can’t bridge.)

Solution 2.  Intra-generational redistribution of wealth – Taxation.

Western democracies accept that a certain level of wealth redistribution is healthy.  By reducing inequality we can ensure the whole country benefits from the talents of all its people and we enjoy a more peaceful, more harmonious, meritocratic society.  However, we are now paying much more for the increased number of elderly people in our society with their higher pension and healthcare costs.  This leaves less for working age benefits.

Remember in Britain more than half the adult population receive more in benefits than they pay in tax and the top 1% of taxpayers provide 30% of income-tax revenue.  So, the majority are supported by a minority of tax payers – i.e. the “rich” are already contributing.

Let’s try a thought experiment.  If we taxed everybody at 100% of his or her income we would collect very little tax.  Few people would work for no money.  If we set income tax at 0% we would collect no money. Therefore (logically) there is an optimum top tax rate whereby we collect the most tax.  Labour believed this was 40% for all but one month of their 13-year rule.  The current administration thinks it is 45%.  However all agree that taxing too much collects less tax.  We are just arguing about the correct percentage.

So can we squeeze the rich some more? A simple calculation:  Suppose we ask all people earning over £100,000 to pay an additional £30,000 tax per year on top of the tax they currently pay?  Totally ludicrous of course, as most earn little more than £100,000 and couldn’t find it, and those that earn significantly more (the one’s we all really want to tax) can easily move country and pay us no tax at all.  High taxes will also act as a disincentive for rich and talented individuals to come to the country in the first place.  So the constraints on incentives and resulting talent drain would make this whole concept fanciful as a way of raising revenue……but just for the sake of illustration let’s suppose it was possible…..

We have 500,000 people in the UK who earn more than £100,000 so (best case scenario) we’ve raised £15,000,000,000.  We’ve reduced the deficit from £100,000,000,000 per year to £85,000,000,000 per year.  Now what?

Solution 3. Inter-generational redistribution of wealth – Borrowing.

In the UK we have an annual £100,000,000,000 + deficit which is bloating our £1,400,000,000,000 debt.   The current interest payments are greater than the defence budget.   Money paid in interest is money not available for welfare, education, healthcare and investment.   Interest rates charged to countries are based on the risk of not getting back the money you lent.  Highly indebted countries pay higher interest rates to compensate for the extra risk.  This puts up the costs of borrowing even higher.  When the debt gets so big that a country cannot afford the interest payments nobody will lend it more money and its economy collapses – such as happened in Greece.  The UK is close to this debt limit so increased borrowing is no longer an option.

The current economic problems caused by our massive debt are obvious.  Moreover, effectively taxing our children and grandchildren so that we can have a better life now at their future expense is undemocratic and immoral. Taxation should be by consent and they have not voted for it.

There is a limit to how far we can push minimum wages, taxation and borrowing.  We have reached that limit.  We must now live within our means.

Perhaps Socialist economic logic is flawed?

How about:

“I need a certain amount of income to live a decent life therefore I must earn it.”