Free market?

I’ve been reading quite a lot of articles and comments about the recent Comprehensive Spending Review (CSR) and there is – as you would imagine – a wide variety of different views. What I find quite interesting (to put it politely) are those people with what I think of as right wing (or conservative) views who seem to believe that the state should be smaller and that there should be more of a free market approach to how to provide things in society. The kind of things that I’ve read are along the lines of “get money out of the public sector into the private where it can work to generate wealth”.

What I would really like is for someone to explain (without using the typical rhetoric that uses words like “waste” and “efficiency”) why a smaller state with services being provided through a free market would be better than what we have now. Let me lay out, in general, the reason why I find this free market ideology confusing in certain circumstances. I assume that most people accept that there are some things that should be provided by the public sector. Examples would be the military, policing, etc. There are others, such as education and healthcare, that are probably amongst the kind of things that some would like to see provided by the private sector, rather than by the public sector.

Here’s where I get slightly confused – and hence would like someone to explain the free market ideology to me. If we consider healthcare, it has a total cost of something like £100 billion per year and makes up about 15% of public spending. We could presumably privatise healthcare, reduce public spending by 15%, and return £100 billion back into the marketplace (assuming that we actually do reduce the deficit). Let’s assume that the goal is to continue to provide healthcare for all, but just to do so through the private sector rather than the public. How do we achieve this? To first order, providing healthcare for all must cost about the same whether done through the private or public sector (any efficiency savings will probably be cancelled out by the fact that some profits will have to be made for those who have invested). The cost per person will therefore be about £1500 per year and the cost per family will be something like £5000 – £6000 per year. Currently 50% of jobs in the UK pay £19000 per year or less and 50% of household have income of £25000 per year or less. Given that very little of the £100 billion that is returned to the private sector will go to the lowest earners, how are these people meant to suddenly start paying for healthcare?

One option is that the private sector redistributes wealth so that everyone in employment can afford healthcare. The other is that it is provided directly by employers, although this then begs the questions of what happens to the unemployed and those who are retired. What I want to know is how this is significantly different from what we already have? Roughly £100 billion a year will be spent providing healthcare for people in the UK. This money isn’t going to be available for anything other than providing health coverage, so how does it suddenly generate wealth in the private sector when it supposedly wasn’t when in the public sector?

Possibly my initial assumption is wrong and that those who want a reduced public sector actually do not believe that everyone should get reasonable healthcare. Maybe the idea is that providing health coverage through the private sector would introduce choice. You could choose to have no healthcare, pay very little and get very basic healthcare, or pay a lot and get the best possible healthcare. Presumably this then implies that the unemployed would have no coverage, the lowest earners would only have basic coverage, and only the highest earners could afford coverage similar to what we all get today. If this is what is essentially being suggested by those who support small government, then they are probably correct that the total cost of healthcare will be less than it is today and some money will be consequently available for other, potentially wealth creating, enterprises. What is possibly not recognised, however, is that having a healthy workforce is, in itself, a way of creating wealth (or at least of creating more wealth than a comparable society in which many do not have health coverage).

The third possibility that I can imagine is that those who want small government and more private sector involvement in providing services, really haven’t given it much thought at all and simply believe all the rhetoric that is being thrown around by various conservative thinktanks. You can probably work out that my view, at this stage, is that providing services like healthcare and education through the public sector is preferable to providing it through the private sector. I’m more than happy to accept that some kind of savings could be made and that there may well be inefficiencies in the system, but I’m not – at this stage – convinced that it would be significantly different if it were in the private sector. I am, however, genuinely interested in having someone explain – including all goals and assumptions – why providing certain services through the private sector is preferable to providing it through the public sector.

Quantitative easing

So the results of the Comprehensive Spending Review (CSR) have now been announced and they are -in the my view – very depressing. I was listening to George Osborne on Radio 4 this morning and essentially his argument is that this has to be done (some – myself included – disagree) and that he doesn’t even need to have a plan B as his plan A is what we need to do. What is available, according to Osborne, is the ability of the Bank of England to use monetary stimulus if growth should suffer as a result of the spending cuts.

Essentially – as far as I’m aware – this refers to the process of Quantitative Easing. I’m not an economist and I have to admit that I don’t fully understand this, but what I gather is that this involves the Bank of England essentially creating money (crediting its account) and then using this money to buy various financial products. The idea then is that there is more liquidity in the markets, things can be bought and sold, and money can make its way out into businesses who can then pay salaries and carry on operating.

One consequence of quantitative easing is that it is likely to result in inflation. At first glance this seems fairly obvious as money has simply been added into the economy, without actually increasing the net value of the economy. What £1 can buy should therefore decrease. It’s probably not as simple as that since it presumably depends on the actual values of the products that the Bank of England has bought in order to get the money out into the marketplace. If they are able, reasonably quickly, to resell these products for a value consistent with what they paid for them, they could then remove this money from the marketplace and everything cancels. Presumably the amount of inflation must depend – to a certain extent – on the difference between the actual realisable value of the products bought by the Bank of England and the amount that they paid for these products.

The net effect of quantitative easing is presumably then that there is more money in the marketplace and so products can be bought and sold and salaries can be paid. However, it will probably result in some amount of inflation, so everyone would presumably effectively be taking a pay cut of – possibly – a few percent. The alternative would be to make a few percent of the working population redundant, so quantitative easing does something reasonably positive, since it could be preventing some unemployment. However, it is clearly not progressive in that everyone sees their salary devalued by the same percentage. Since low income workers probably spend almost all of their disposable income, they are probably more affected by this inflation than high earners who can save some fraction of their income and earn interest.

Presumably an alternative to quantitative easing would be simply to increase tax for a few years. It could amount to the same thing since it would be reducing people’s salary by a few percent, and the money raised would make it into the marketplace through public sector projects or by paying public sector workers. It’s presumably a little safer in that the consequences of quantitative easing could be quite unpredictable, and it could be more progressive in that it could be aimed at the higher earners (of course being progressive doesn’t appear to be high on the current government’s agenda). Essentially, the government has chosen to make massive public sectors cuts – rather than raising money through taxation – and the only mechanism they have for stimulating growth (if it is required) could have the same effect as taxation would have had. Still not obvious that the government’s approach is the only one that makes sense, or maybe I’m completely wrong and don’t understand anything.

The “greatest macro-economic mistake in a century”

Interesting article in the Guardian today about David Blanchflower’s views on the upcoming cuts. David Blanchflower was, until recently, a member of the Bank of England’s Monetary Policy Committee and is known for being something of a maverick; regularly voting in the minority.

Essentially Blanchflower thinks the government is making a huge mistake in making cuts of this magnitude and are, in fact, being extremely cowardly. As the title of this post indicates, he has also described the proposed cuts as the “greatest macro-economic mistake in a century”. I hope he’s wrong, but my gut feeling is that he is not. What I think makes perfect sense is his comment that even though you do need to cut the deficit, there is no economic theory that says you have to do it extremely quickly. Why is there an insistence that it has to happen within this government? I’m getting somewhat tired of hearing government ministers insisting that there is no alternative and that it is all the previous government’s fault (although there is some merit to the latter). It’s clear that the longer it takes, the greater our total debt will become. However, if we cut too fast and too deep, we risk another recession, reduced revenues and having to borrow more money anyway.

I notice that Alan Johnson, the new shadow chancellor, has now released his plan for cutting the deficit. He is proposing a combination of cuts and tax rises – aimed primarily at the banking sector. It’s probably a little too late, but I much prefer this to the government’s plan of reducing the deficit mainly through cuts. Firstly, I think that the cuts are going to influence a number of things that are fairly crucial to the UK’s well being. Higher education and research funding being things that influence me directly, but the benefits system and policing are two other areas that may be severely affected. There is a second reason why I think tax rises are justified together with cuts.

A cut of £83 billion is equivalent to 3.3 million people earning an average salary (£25000). I’m not necessarily suggesting that 3.3 million people will lose their jobs, but 10% unemployment is not necessarily unlikely. The cuts also mean that £83 billion has left the UK economy, it hasn’t simply gone back into private industry. Private industry is unlikely to suddenly generate £83 billion in wealth overnight. Private industry is also unlikely to reduce profits and the salaries of those in employment simply to reduce unemployment levels (they can’t really employ more people without finding the money to do so). The unemployed are therefore likely to remain unemployed for quite some time. Combining cuts with tax rises means it’s more likely that we will be able to manage a smooth transition from the public to the private sector. I know the CEOs of major corporation will argue that this will inhibit growth, but I’m not convinced. What is more, essentially insisting that 10% of the working population are forced into unemployment so that the wealthiest can continue to get wealthier seems entirely wrong. That doesn’t really feel as though we’re all making equivalent sacrifices for the future of the UK. I hope the government rethinks its strategy before Wednesday’s CSR announcement, but I doubt it.