Tag Archives: public finances

The magic money tree

On Question Time this weekend, Theresa May was confronted by a nurse whose pay has been squeezed under the Coalition and Conservative governments. Her response to the nurse’s complaints was that “there isn’t a magic money tree that we can shake that suddenly provides for everything that people want”. Theresa May is of course right. There is, as far as we know, not a magic money tree. However, I fear that as an explanation for why nurses can’t have a pay rise, her statement is lacking.

That is not to say that there is no link between magic money trees and nurses’ pay. If there were indeed a magic money tree, then its harvest could surely be used to pay nurses more[1]. The absence of such a tree is a necessary condition for it being impossible to pay nurses more – but it is not sufficient. The reason for this is that there are types of money that are not magical and do not grow on trees. In failing to address the availability of this more mundane form of money, Theresa May has, not for the first time, not really answered the question.

A more charitable interpretation of Theresa May’s statement is that she is trying to argue that we can’t afford to increase government spending above current levels. Government spending is financed by taxes or debt, which must be repaid from future taxes, so the ability of a government to afford a given level of spending is dependent on its ability to raise taxes. One reason that some developing countries struggle to fund public services such as health care is that they have weak public institutions and so can’t raise taxes very effectively. The UK and most other rich countries are much better at collecting taxes and have larger public sectors. But their scope for public spending is not unlimited, for two reasons: high taxes and a large public sector might have a distortionary effect on the economy, discouraging economic activity and squeezing out the private sector; or democratic processes might limit the size of the state by voting out governments that raise taxes.

This is all very complicated and hotly disputed, but one way to understand whether the UK could conceivable have higher public spending is to look at how we compare to other countries. The chart below (based on OECD data) compares public spending as a share of GDP with GDP per capita, for all OECD countries where data is available[2].

On both measures, we are roughly in the middle. GDP per capita in the UK is about the same as Japan, France and Finland, higher than Spain and Italy, and a fair bit lower than most other Western European countries. Public spending (as a share of GDP) is lower than in most Western European Countries, but higher than Japan, Australia or the US.

It is also fairly clear that, as far as this dataset goes, there is no relationship between the two variables. Sweden, Austria and Denmark have much higher public spending than the UK, but this doesn’t stop them having much higher economic output. On the other hand, Australia and the US manage higher economic output with lower public spending. It seems that (within the range of this chart) pretty much any combination is possible. Of course, this doesn’t prove that higher taxes wouldn’t be bad for the UK economy. Perhaps our economy is so fragile that it would be crippled by any tax rises. But if you are going to argue this you are going to have to convince me that it is impossible for us to achieve what much of the rest of Western Europe can.

The political question is more difficult to analyse. Yes, other countries have larger public sectors, but they also have different political cultures. Perhaps the British are fundamentally different to our European neighbours and would simply not stand for the tax rises that are required to finance better health care and pay rises for nurses. Perhaps we are and will always remain a low tax country.

I don’t have a strong opinion on the optimal size of government, but I do wish we could have an honest debate about it. When someone says “we can’t afford it”, we need to be clear that this is nonsense. What they are really saying is that they do not think that we should raise the taxes required to pay for it. This is a debate that we need to have, but saying “we can’t afford it” is not the way to go about it.

The phrase “magic money tree” is even worse: it is designed to ridicule the suggestion that public spending should be increased. A nurse asking for a pay rise is as stupid as someone who believes that money grows on magical trees. Repeating this phrase whenever anyone suggests spending public money on something is not only nonsensical but frankly offensive.

 


[1] This statement is not the main point of this post and I don’t want to hear from any macro-economists about the inflationary effects of magic money trees.

[2] Excluding Ireland and Luxembourg, whose results are heavily distorted by their role as tax havens.

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Austerity and Brexit in England

Ever since the UK voted to leave the EU, there has been a steady stream of articles and analysis trying to figure out why. Clearly there is more than one answer: different people voted for Brexit for different reasons. Nonetheless there are some patterns. By analysing the vote share by local authority, the Resolution Foundation found that areas with higher employment rates, larger student populations, more people with degrees and higher social cohesion were more likely to vote remain. Areas with more old people, more homeowners and those that have only recently seen an increase in immigration were more likely to vote leave.

But one possibility has proved controversial: was austerity partly responsible? Chris Dillow thinks it’s possible. Austerity contributed to stagnant incomes, which may have increased resentment towards “elites”, and to a decline in public services which the leave campaign blamed on immigration. Chris’ thesis received a bit of stick on Twitter from Giles Wilkes and Rupert Harrison.

In one sense, they have a point. The Resolution Foundation’s analysis looked at how average incomes in different areas were related to the share of votes for leave. While the level of income was important, recent changes were not, suggesting that the income effect isn’t related to austerity. But in another way Chris might be right. Stagnating incomes may be an indirect effect of austerity, but a rather more direct effect (which is not included in the Resolution Foundation’s analysis) is the deterioration in public services.

Austerity has led to cuts in many public services, but local councils – who take out the bins, run the libraries and provide social care – have been hit particularly hard. Local government spending power[i] in England fell by nearly 15% in real terms between 2011/12 and 2015/16, but the impact wasn’t felt equally in all parts of the country. Areas that collect a lot of council tax relative to their total spending got off lightly – Surrey’s spending power fell by less than 5% in real terms – while those that rely heavily on central government grants have been hammered – Liverpool City Council’s spending power fell by nearly 23%.

Big drops in spending power mean closing libraries, fewer bin collections and cuts to social care. It seems plausible that in areas where public services have deteriorated further, the argument that immigrants are overwhelming these services – as championed by the Faragist wing of the leave campaign – may have more traction.

The chart below shows how changes in spending power in local authorities in England[ii] between 2011/12 and 2015/16 are related to the share of votes cast for leave.

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England

You might look at this and think there is no clear correlation – but the distribution is far from random. It looks to me like there are two things going on: a negative correlation for most areas, plus a cluster at the bottom left that seems to behave differently. There are no prizes for guessing where most of these outliers are located: they are London boroughs.

The next chart shows the same data with inner (blue) and outer (red) London boroughs highlighted. London voted differently to the rest of the country. Inner London (and some “outer London” boroughs such as Newham) saw big cuts in local government spending, but voted overwhelmingly for remain.

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England
Blue dots are inner London boroughs, red dots outer London

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England

Not all London boroughs followed this pattern. Havering had a relatively small drop in local government spending, but voted heavily for leave. This shows the limitations of using “London boroughs” as a sociological grouping. Havering is the most easterly London borough and surrounded on three sides by Essex. It is just a half hour’s drive from Newham, but a very different place.

Just as not all of London followed a “London-like” voting pattern, not all other areas followed an “unLondon” voting pattern. If we exclude London from the chart, there are still a few stray dots hanging around in that bottom left area – areas that, like many parts of London, voted remain despite large council cuts. Again, there are no prizes for guessing where these places are: successful cities like Liverpool, Manchester, Bristol and Brighton.

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England excluding London

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in England excluding London

So it seems that we can divide England up into two groups: “London-like” areas, which include most London boroughs and some other successful cities; and “unLondon”, which is everyone else. Many London-like areas have seen big cuts to local services and still voted remain. But when we look only at unLondon[iii], we see a different pattern: areas with bigger cuts to local services cast a greater proportion of votes for leave.

On the basis of this, it seems quite plausible[iv] that austerity was one of the drivers of the Brexit vote – but this effect was mediated by cuts to local services, rather than stagnating incomes.

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in unLondon

Change in local government spending power (horizontal axis) versus share of votes case for leave, upper-tier local authorities in unLondon


[i] Calculating trends in council funding is tricky, because responsibilities of councils change year-to-year. When responsibilities are added, extra money might be attached to them but this doesn’t ease the pressure on other services. Luckily, the Department for Communities and Local Government publishesspending powerestimates which (for any two adjacent years) try to take account of these changes. By cumulating the year-on-year changes, and adjusting for inflation, we can get a reasonable estimate of the changes over time in funding for local services.

[ii] The data are for upper-tier authorities. For two-tier areas (the shire counties) the spending power of the districts within each county has been included to make the figures comparable with unitary authorities.

[iii] For the purposes of this analysis, only Liverpool, Manchester, Brighton and Bristol have been excluded from unLondon, since they are the most obvious outliers.

[iv] There are two important caveats here. First, to believe in this correlation, you have to believe that the London/unLondon split makes sense and isn’t just a convenient choice to generate a spurious correlation. For me, the story works, but you will make up your own mind. Second, this analysis only looks at one variable, so it’s possible that the pattern is actually driven by something else, such as difference in average incomes. The Resolution Foundation’s work deals with this problem by including a wide range of variables – but nothing on cuts to local services. I’d like to see them add this to their analysis.

How to draw public finances

Here’s a chart from the OBR that I really don’t like:

Total public sector spending and receipts (OBR)

The OBR's chart showing UK government spending and receipts

I don’t mean to attack the OBR here, which I think generally does decent work. I’ve seen this sort of chart reproduced by all sorts of otherwise reputable people. But it is horribly misleading. It’s not that there is anything wrong in the chart. It’s just that the way it’s constructed and the patterns that jump out at you feed a narrative that is both wrong and pervasive.

Try looking at the chart without reading any of the text. What do you see? A blue line and a yellow line that jump around a lot but sort of follow each other; and two points where the blue line shoots up. And what’s that blue thing that shoots up? Public spending.

Except public spending didn’t actually shoot up. These two points are the biggest recessions in modern history, and while recessions do lead to increased spending thanks to automatic stabilisers, they mainly lead to lower GDP. That’s kind of the definition of a recession.

The chart shows the ratios of spending and receipts to GDP. In many situations this is the best way to think about spending and receipts, but in this case it leads to a visual representation of the right data that tells the wrong story. The blue line shoots up even though spending doesn’t; and the yellow line stays the same even though tax receipts have collapsed.

This may sound obvious and, of course, the people who make these charts know all of this. But when the government and large sections of the media are pushing a narrative that public sector spending was and is out of control, communicating the facts clearly is important.

So how could we do this better? Something along these lines would be a good start:

UK public finances and GDP

A better way to draw the UK's public finances

This chart shows spending, receipts and GDP in real terms (13/14 prices), as well as total public debt as a share of GDP[i]. This shows three important things about the recent financial crisis that we can’t easily get from the OBR chart.

  1. Although spending rose a bit relative to trend when the financial crisis hit, the much more pronounced effect was that receipts collapsed. This was a more important cause of the deficit.
  2. The reason for the collapse in receipts was a collapse in GDP. Receipts broadly follow GDP, since government policy pretty much directly sets what proportion of total output is collected in taxes. Spending policy (at least in the short term) is set in pounds, so it doesn’t follow GDP as closely.
  3. Public debt was a lower proportion of GDP on the eve of the financial crisis than it was a decade earlier when Labour came to power.

This stuff is all pretty basic, but this narrative is largely missing from the mainstream media and instead confined to economics blogs. Maybe this is because of media bias or ignorance. But maybe it’s also partly because we aren’t doing a good enough job of presenting the data that we have.

[i] As I said, it’s usually a good thing to think about public finances as a share of GDP, except when it’s not.