Enlightenment time?

The economic debate is coalescing increasingly into two camps: those who think that the Government can prevent a further economic correction through deep spending cuts, and those who think that the Government can prevent a further correction through continued deficit spending. On This Week, Will Hutton just described the two camps respectively as Catholics and Protestants. As the British government is implementing a (roughly) Catholic programme, it is likely that the failure of this programme to prevent a correction will be interpreted by much of the media, academia and the population as evidence that the Protestants were right. Conversely, Catholics will point to the failure of Obama's essentially Protestant programme as evidence that they were right. Both sides will pay attention only to the evidence that suits their views. Neither side will consider that they may both be wrong.

Why are there so few atheists and agnostics in this debate? Maybe there is no God, maybe economic imbalances can reach a point where corrections are both necessary and inevitable, and maybe governments promising to prevent them only make matters worse in the long run, whichever creed they follow.

Our intellectual establishment (dominated by the Oxbridge prelacy) is ranged as powerfully against such heresy as the religious establishment was once ranged against those who placed reason above faith. Without the fear of eternal damnation, the promise of perpetual bliss, and the immutability of an order prescribed by a higher power, how were the clerical and aristocratic hierarchies to maintain their authority? And without the promise that they can make things better than they would be without intervention, how is our intellectual establishment to persuade us to keep listening, voting and paying for their arrogant yet ignorant prognostications?

Things didn't turn out too bad when we allowed reason to supersede faith. Authority did not collapse, but became based more on merit and less on position. There turned out to be other foundations of morality than simply having (often delphic or contradictory) rules handed down from above. Technology and our standard of living improved more quickly. People might find similar benefits resulted from apostatisation of the government-deity.

The atheist alternative

I want to put on record my atheism. I believe that the economic outcome of this budget and this government's policies will be significantly worse than their central projections, and indeed probably worse than the worst case that they envisage. But I also believe that the alternative course of continued government profligacy would have been even worse. Their failure will provide no justification for a reversal of policy in the direction of greater government interventionism, though very likely that will be the intellectual conclusion and political effect.

We need some fundamental corrections, which so far have been prevented from occurring. Profits will have to fall substantially, and with them equity values. Property prices need to fall in real terms by at least half (along with writing down existing debts, so people can afford to live on lower wages). Wages will have to fall significantly further, relative to the cost of the goods they buy (because we are simply poorer than the credit bubble made it appear, and uncompetitive with increasingly competitive developing world countries). Unprofitable commercial assets will have to be put to more productive use by allowing their owners to go bust if they don't find a better use themselves. Government spending, borrowing and taxation need to fall by significantly more than planned even in this budget, even though it seems highly unlikely that the spending cuts proposed but not set out in the budget will actually be achieved. (That means government simply not doing many things it does, rather than trying to do them more efficiently, and not ring-fencing any part of spending from cuts).

Think of it this way. A healthy economy does not have interest rates (on gilts and savings) as low as they currently are (negative in real terms, and well below the "originary rate" that reflects the normal time-preference for jam today over jam tomorrow). If an economy is growing, people can get better returns on their money without significantly greater risk by investing it in other ways than buying government debt. So governments have to pay more interest on their debt (higher yields on gilts) to persuade people to buy their debt. That means higher interest rates generally. And if the economy is growing strongly, the government can't print the money to pay for its debts (and keep interest rates low) without causing serious inflation problems (which push up interest rates).

So we'll be able to spot a genuine recovery, rather than the fake we've got now, by the arrival of higher interest rates (so long as they owe more to growth than to inflation). But as the only thing that is stopping our massively over-leveraged individuals and organisations from going bust is exceptionally low interest rates, and as we have done nothing to reduce our combined levels of indebtedness (and indeed cling obdurately to asset over-valuation in the misguided belief that it is somehow helpful to our economic wellbeing), the first sign of an interest-rate increase as a result of a strengthening economy will bring the recovery shuddering to a halt. People (probably including central banks) will retreat to buying government debt at low yields again, and governments will be under pressure again to use that money to substitute for the private spending that can't return so long as our debts (private and public) remain as heavy as they are. And that spending will further delay the necessary correction that would allow a sustainable, private-sector-led recovery, instead further increasing our overall indebtedness (see Japan for a model).

The only way out of this conundrum is to encourage, rather than inhibit, the recognition and writing-off of bad debts, along with a collapse in asset prices (property, equity. etc) so that we don't simply follow bad debts with more bad debts. We need the full-blown recession - equity and property prices through the floor, mass bankruptcies of individuals and organisations - both for the purpose of Schumpeterian creative destruction, and to create the circumstances in which recovery does not kill itself.

Don't forget the "micro" environment

We also need to get rid of the micro-economic inhibitors, as well as the macro-economic problems. The budget indicated that the Government is aware of the issue, but hasn't a clue how to solve it.

They know that the tax and benefit system creates strong disincentives to work. Yet through their increased means-testing of benefits and changes to the tax system, they dramatically increased (more than fivefold to 1.7 million, see p.69 of the Budget red book) the number of people who keep less than 30p of any extra pounds that they earn.

They know that they need to encourage small businesses, which are the engine of innovation, employment and recovery. Yet their targeted incentives perpetuate the "sovereign risk" (or "policy uncertainty") that deters investment by all but those companies big enough to think that they can influence policy to their advantage. Their National Insurance exemption for the first ten employees of new companies outside the South and East of England means that any company that has already been established, or that an entrepreneur was considering establishing in the South and East, has to expect to compete with new businesses outside that area who have an artificial labour-cost advantage. But anyone thinking of setting up a new company outside the South and East to take advantage of this benefit faces the risk that what government giveth, government usually taketh away, or at least fiddles with to the advantage of some and disadvantage of others. 20 years of increasing industrial policy, interventionism and sovereign risk, combined with higher taxes, greater burdens of responsibility placed on senior management, the collusion of government in allowing the extension of the market powers of the Vertically-Integrated Large Enterprises (corporatism, for short), and the increasing significance of public-sector buyers with monopsony powers, provide plenty of deterrent for entrepreneurs to put their money at risk in commercial ventures. The only thing that can really encourage sustainable businesses (i.e. ones not dependent on hand-outs) to proliferate wherever is most suitable is for politicians to abjure industrial policy and targeted intervention, so that investors can have confidence that the only risks they have to consider are the normal commercial ones, and not the imponderable risks of political calculation.

They know that we can't afford all our pension commitments, but instead of simply removing the incentive to retire at 65, leaving it to the choice of the individual and their employer, they make it difficult for people not to work longer, whether or not they are still fit and whether or not they have a job. They load the cost of terminating employment at the age of 65 on to the employers (who will now have to pay redundancy if the employee is no longer fit for the job at 65). They do nothing to help youth unemployment by encouraging people to stay in their jobs for longer, rather than simply removing disincentives to flexibility. And they bequeath an even greater problem to future decades through their "triple-lock" indexing mechanism for the basic state pension.

There are ways of adjusting the "micro" incentives to encourage work and make us more competitive with the developing world (I am thinking particularly of the Basic Income plus Flat Tax idea), but something as radical as that would be heresy to both Catholics and Protestants. They want to stick to arguments within the conceptual boundaries laid down by their faiths. It is easier to argue about the nature of the sacrament than to question the whole concept.