Monday, 8 August 2011

The Economic Mess - All the Fault of Welfare Spending?

There is quite a long list of people who can legitimately be held to account for the current crisis.   Most people I imagine would put bankers, particularly investment bankers and regulators high on the list.  However it seems that it is welfare spending by governments which is mostly to blame.  At least that is the consensus view of most of the mainstream media.  It is also the determined view of our present nasty Coalition in the UK.  Though of course they blame the previous New Labour government and not themselves.
A typical example of this thinking was to be found in today’s editorial in The Scotsman.  Their leader writer intoned: “The harsh reality is that across America and Europe, huge rises in government and welfare spending have been financed by resort to debt to the point where the ability of government to service and repay these debt obligations has come under question.”  The harsh reality is that this leader writer is talking a load of bunkum.  Let’s try and unpick his or her assertions a bit.
It is true that in many countries there has been a rise in government spending, but it is not true that this rise has been by historical standards huge.  As  Professor George Irvin, Research Associate at SOAS, puts it:  “For thirty years after the war, most major governments carried more debt than they do today. They serviced this easily and eventually reduced the burden because they were able to use fiscal policy to boost and maintain growth.”
What is manifestly untrue is that this rise is primarily down to welfare spending.  While welfare spending will have gone up, this is perfectly natural in an economic downturn.  This is precisely why welfare benefits were introduced in the first place.  To mitigate the damaging effects of downturns or recessions.  What usually goes along with this increase in welfare spending is a sharp downturn in the government’s income, as tax receipts decline due to the downturn.  So the reality is that there has not been a huge rise in welfare spending, but there has been a reduction in government income.
However this downturn in tax returns does not in any way explain the current high levels of government debt.  Here we need to look more closely at where this debt has come from.  And we quickly discover that most of this rising debt has come from the private sector.  Both individuals and companies.  And this private debt of course was financed by our friends in the banking sector, who were more than happy to lend out vast sums of money to all and sundry - no questions asked.  But as soon as the bubble began to burst, well these private banks immediately turned to their governments and begged or bullied them into bailing them out.  Which for some unfathomable reason they all did.  This is what has caused the issue of sovereign debt to raise its ugly head.  In a free market economy, companies, including financial companies that get into trouble are supposed to pay the price of failure.  It is known as market discipline.  And it applies to the shareholders as well.   The companies go bankrupt or get taken over by a competitor at a knockdown price.  And the shareholders lose some or all of their investment.   In extreme cases, where the company is of national importance to the economy, they get nationalized.  Now that is what has effectively happened with the banking system.  Unfortunately for the poor taxpayer, this form of nationalization was designed to protect the shareholders, by keeping the banks afloat.  And to complete the cave in, the management teams that got us into this mess were left in place.  Free to continue to pay themselves huge bonuses.
It is interesting to note that none or little of this gets much of a hearing in the media.  So, in a nutshell, the private sector gets into a critical mess and begs the government to bail out the private banks by taking on more and more debt.  The private sector then blames the government for this rising debt.  Wonderful.

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