Saturday, 12 May 2012

The pasty tax could pay for a £30 billion infrastructure programme: four charts show why history will judge us harshly

When I'm asked in interview or articles to sum up concisely why I think the government should change course on fiscal policy, I usually say something like this:
"with long-term government borrowing as cheap as in living memory, with unemployed workers and plenty of spare capacity and with the UK suffering from both creaking infrastructure and a chronic lack of housing supply, now is the time for government to borrow and invest.  This is not just basic macroeconomics, it is common sense. "

The charts below (click on each to enlarge) try to illustrate this. They show, first, that the economy has now seen essentially no growth at all since the autumn of 2010. Output is still more than 4 percent below its peak in 2008, and probably won't regain that level until sometime in 2014.  This is a far longer period of depressed output than the Great Depression:

[Source: NIESR, using ONS data]

As a result, even on the official forecasts,  unemployment is expected to remain persistently high; over 2.5 million for the next couple of years.  With the official estimate of "structural" unemployment only about 1.6 million, this means that the number of people out of work because of macroeconomic factors - and who could potentially be put back to work by sensible macroeconomic policies - will remain close to a million for that period.

[Source: OBR, March 2012]

Meanwhile, public sector net investment - spending on building roads, schools and hospitals - has been cut by about half over the last three years, and will be cut even further over the next two. Hardly surprising that the construction sector has been a heavy drag on output and jobs recently.  

[Source: OBR, March 2012. Note 2012-13 adjusted for BT pension fund transfer: unadjusted figure is -0.2%]

But, at the same time, the cost to the government of borrowing money - the real interest rate on gilts - is at historically low levels.  Not to put too fine a point on it, the government can borrow money for basically nothing.  This is not a theoretical construct either - these real rates of interest are based on actual market prices for index-linked gilts.  The last index-linked gilt was auctioned at a real yield of less than 0.5%. 

[Source: Bank of England]

What does this mean in practice? It means that if the government were, as I suggest, to fund a £30 billion (2% of GDP) investment programme, and fund it by borrowing through issuing long-term index-linked gilts, the cost to taxpayers - the interest on those gilts - would be something like £150 million a year.  To put this in perspective, it's roughly the revenue the OBR estimates will be raised by the "loophole-closing VAT measures" in the last Budget.  In other words, we could fund a massive job-creating infrastructure programme with the pasty tax.  

Twenty, or fifty, years from now, economic historians will look back at the decisions we are taking now. I cannot imagine that they will be anything but incredulous and horrified that - presented with these charts and figures - policymakers did nothing, international organisations staffed with professional economists encouraged them in their inaction, and commentators and academic economists (thankfully, few in the UK) came up with ever more tortuous justifications.  In Simon Wren-Lewis' words, they will ask  why "a large section of the profession, and the majority of policymakers, appeared to ignore what mainstream macro [and, I would add ,basic common sense] tells us".   Their judgement will be harsh. 


  1. Would a £30bn long term investment programme actually make a significant impact in a country already borrowing £130bn this year and not much less next year and the year after.

    £30bn would just about build you Crossrail or half of the proposed Boris Island new London airport.

    Good things certainly, and would keep a few tens of thousand construction workers off the dole, but a significant impact on the economy or employment ?

    1. And those few tens of thousands of construction workers spend their wages, keeping a few thousand others employed , who spend their wages, who... I think it's called the multiplier.

      I admit I'm hazy on multipliers, but cutting capital expenditure/investment in the face of negative govt borrowing rates seems bizarre.

    2. I don't disagree that this has no impact just about the scale of the impact. The multiplier on construction spending is generally pretty high (1.3 - 2.0) depending on how you measure it.

      But say this £30bn were set aside for HS2 or part of a new London airport it would be money spent over 10-20 years. So in terms of an annual boost to the economy it would be relatively negligible.

      And it would be difficult spending £30bn on infrastructure or even housing much more quickly.

  2. The BIS construction stats say that building one house (construction cost £100k) creates 3.5 person year jobs. So that is 35,000 jobs per £1bn spent, albeit with the proviso that the jobs only last a year. Still, £6bn for 5 years is ~200k jobs.

    That said, the money does have to be repaid at some point.

    1. Spot on Tim...and the alienfromzog. I guess you are putting in a good word whenever and wherever you can.

    2. What would the effect on house prices be of a large government funded house building program and would this further impair private sector bank's balance sheets.

  3. Thanks to Tim for those numbers. Looking at it from the macro perspective, £30 billion is 2% of GDP, so it's definitely not negligible. Wouldn't solve all our problems but could make a big difference.

    On paying it back, the govt can sell very long term index-linked gilts at very low (sub 0.5%) real rates. Eventually these mature, and govt has to pay back (or refinance) the original borrowing, inflation uprated. But that doesn't require any sort of sudden adjustment. The infinite horizon financing requirement is as I set out (ie tiny).

  4. Tim,

    What's the gain to the treasury of 200k jobs? I mean how much unemployment benefit is saved and how much extra income tax? Because when you offset this against the cost, it becomes incredibly cheap for the government to invest in infrastructure in the current circumstances.

    That's quite apart from multipliers and longer-term benefits of keeping people in employment.

  5. What makes you think there will be economic historians in 20 or 50 years? They already look like an endangered species right now...

    "... policymakers did nothing, international organisations staffed with professional economists encouraged them in their inaction, and commentators and academic economists (...) came up with ever more tortuous justifications."

    This is indeed what's happening, and the question is "why"?
    I can only think of incompetence and disregard for the issue, which is quite puzzling, especially from commentators.

  6. Brad DeLong and Larry Summers drag out the math, and show that even with very conservative projections, fiscal stimulus is self-financing in a recession if digging out of the hole early has even a tiny lasting impact into the future:

    The main thrust, from a U.S. perspective, except that the variables aren't very different in the U.K.:


    r < g + τημ/(1 - μτ)

    then we simply cannot do a benefit-cost calculation for expansionary fiscal policy. It is self-financing. There are no costs. No future tax increases are needed to amortize the extra debt, because economic growth does it on its own.

    It is, rather, austerity that requires future tax increases.

    For a multiplier μ = 1.0, a hysteresis shadow-cast-by-the-recession coefficient η = 0.1, a growth rate g = 2.5%/year, and a tax share τ = 1/3, this critical value of r becomes:

    r < 7.5%

    The long-run Treasury borrowing rate needs to be above 7.5%/year in real terms--above 9.5%/year in nominal terms--for fiscal expansion to be a bad deal.

    For a multiplier μ = 0.5, a hysteresis shadow-cast-by-the-recession coefficient η = 0.05, a growth rate g = 2.5%/year, and a tax share τ = 1/3, (6) becomes:

    r < 3.75%

    The long-run Treasury borrowing rate needs to be above 3.75%/year in real terms--above 5.75%/year in nominal terms--for fiscal expansion to be a bad deal.

    Note that this applies only to a depressed economy, and only as long as the monetary authority cannot or will not--but in any case does not--carry out the government's full stabilization policy mission all by itself."

    1. Well since we are all deficit spending, then that's great, the deficits are self-financing.

      All we need to sort out a deficit is to enter a recession, under which conditions "even with very conservative projections" the stimulatory deficit becomes self-financing.

      Except of course it would be even better to spend even more. Larry and his math gives us no upper limit on this.

      In other words the work is useless, since it gives no indication of the optimal level of spending - just "more". Of course if you assume that borrowing to keep people employed has long term economic benefit then you will find that borrowing to keep people employed has no net costs. A six year old could have worked out that one for them. The question is, does it and by how much at what level of spending.

      If you argue that it is all about how "stimulatory" the spending is then we are back to talking about WHAT to do with a budget, rather than whether it should get bigger.

  7. Would you even need the pasty tax? I thought the rule was that if the interest rate was below the growth rate, borrowing was a free lunch. You just roll over the debt perpetually, and the debt to GDP ratio shrinks over time.

    An interest rate of 0.5% must be well below the long-run growth rate. The debt to GDP ratio might rise initially (due to the recession) but it's equally likely that the higher spending would increase the short-run growth rate above 0.5%. So, we only need to worry about the point in the future when the cost of borrowing starts to exceed the growth rate, but by then the burden of the debt will be trivial.

    1. Correct on the debt-GDP ratio, see Simon here:

      Of course the debt still exists and has to be paid, but in relation to output it will shrink. Whether that means we shouldn't worry about it at all is a normative question, again discussed by Simon.

  8. If we borrow an extra £30bn for investment on infrastructure projects that brings no external income to the UK, will the bond markets still subscribe for 0.5% yield? Would the extra borrowing have a negative credit rating impact?

  9. @ Tim Leunig, Why does the money have to be repaid? It just needs to be serviced. The question is what the rates might be on rollover.

    1. So national debt never needs to be repaid.
      So the recurring drain to service it only ever ratchets up.
      Unless growth out-paces debt accumulation.
      Has that been happening lately?

      What is your solution to the problem of debt accumulation outpacing growth?

      It seems the answer is to spend the money more effectively. In which case, why is that framed as an argument for increasing borrowing?

  10. Perhaps instead of pumping £40 billion into the IMF to enforce the same kind of economically destructive self-defeating austerity (via their structural sdjustment conditions) in some of our main European trading partners, thus damaging our export market, that money should have been put into supporting the "real economy" of industry, manufacturing, jobs, training etc?

  11. It interests me that the macro guys making these kinds of arguments tend to look at traditional infrastructure - housing, and such like - rather than moves to restructure our economies away from dependence on cheap hydrocarbons. Assuming environmental scientists are correct in their "peak" projections, this would seem to be the more pressing emergency.

    At some point over the next few years, resource shortages are going to slam us waaaaay too fast for markets to adjust on their own.

    Paul Church.

  12. £15b will pay for fibre-to-the-home broadband for every house and business in the UK, with a bandwidth of 50 to 100Mbps. And it starts delivering benefits in year 1 (as soon as you wire up the first premises), unlike say Crossrail which you can't use until it's opened.

    I suspect the multiplier effect is not as high as building houses (as Tim suggests), but there is a big potential productivity upside if people like Brian Arthur and Erik Brynjolfsson are to be believed on the future course of technology.

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