The long run starts now!

What should the government do about the disappointing growth in the UK economy? To traditional Keynesians, the answer is obvious: spend, and spend hard. The big problem is not the deficit or the national debt; these will come good if the economy grows and tax revenues rise, and a little bit of inflation wouldn’t do much harm either. That’s how we dealt with the debt we had built up after World War II.

The Coalition Government has taken the opposite view: we need to cut, and cut hard. Unless we can get our debt under control, then markets will lose confidence and we will go the way of Greece, Portugal and Ireland. And by reducing the size of government, we allow room for the private sector to grow.

Both sides of this argument are wrong. Markets are more understanding if there is a good reason for building up debt. But under Labour the government was borrowing even when the economy was booming; when the crash came we had nothing to show for it except a structural deficit. We hadn’t won a war, or radically improved our infrastructure, or ensured that every child could read by the age of six. But we did have some good memories of foreign holidays. So why on earth should markets now believe that borrowing is going to be put to good use?

But the Government is trying. The problem is that the private sector is not doing its bit. Much of this is outside the Government’s control, whether it be Greece induced Euro jitters, or a dysfunctional constitution taking the US to the brink of default. But whatever the reason, for many firms this is not a good time to recruit or invest.

In my view, we need to think about where we want to be in 10 or 20 years time. What sort of Scotland do we want and what policies do we need to take us there? That means it’s not so much the level of government spending as its quality and composition that’s important. We need fewer wars and better trains, less bed blocking and more fibre optic cables; we need a regulatory environment that makes it easy to set up a business, employ young people, and keep the fruits of risk-taking. Crucially for Scotland, we need to address public sector reform. Are we really sure that we are getting good value in the way we organise our schools, hospitals and local services?

The longer view is often politically difficult; but it is economically essential, and much more likely to convince the markets that the UK is a good place to invest in.

The Dracula Effect

Why do we vote for politicians who propose protectionist trade policies when it is not in our interest to do so? In a seminar held by Giacomo Ponzetto at the Universitat Pompeu Fabra this summer a simple answer was proposed to me: we don’t know we’re doing it.

The argument goes like this:
An individual consumer (like you or I) has no incentive to inform themselves of a candidate’s trade policy since their chance of affecting the electoral outcome is effectively zero. Producers on the other hand, regardless of their ability to influence the election result, value information on trade policies because it allows them to forecast prices and make appropriate investments. Producers are in the know and consumers are oblivious.

Politicians will therefore propose protectionist policies since this will boost their popularity amongst producers whilst the uninformed consumer is none the wiser. This is a very interesting theory because it says that producers will be offered protection even without forming a lobby - the mere existence of information in their minds is enough to secure a political favour!

This set up is good for everyone. Except consumers. And unfortunately, consumers make up the majority of ‘everyone’. Producers get a nice little pay-off, politicians get extra votes without sacrificing uninformed consumer support and the consumer unwittingly picks up the bill through higher prices.

So what on earth does this have to do with Dracula?

Exposing a vampire to the harsh light of day is sufficient to reduce him/her to dust. The Dracula Effect says the same will occur to consumer-hostile policies when they are exposed to the harsh light of public attention. If consumers are just as informed as producers, the politician can no longer get away with his furtive bribe and those terrible tariffs turn to dust.

If you’re interested, see Ponzetto’s paper here for empirical evidence on the Dracula Effect

Post written by Stephen Devlin - 3rd year MA (Hons) Economics