‘Economics in One Lesson’ should be in Nick Clegg's red box

The three main themes of Nick Clegg's speech on Friday were as follows:

1. We should have investment-led growth and not debt-led growth.
2. We should have growth balanced around the regions.
3. We should not have growth based on financial services.

Professor Geoffrey Wood used to write a column for Economic Affairs entitled ‘Economic Fallacies Exposed’. This speech could have kept him going for a few volumes. Firstly, financial services...

I can certainly understand that Nick Clegg might see certain practices as artificially encouraging certain types of financial services (having the government bail-out banks for example). We should deal with those problems at root. It would be much better, however, if politicians went round exploding the myth that financial services are ‘soft’ and do not add value to the economy than suggesting that growth should not be based around them. Imagine life without financial services. Simple tasks such as reducing the risk of outliving your money (buying an annuity); buying a book from Amazon; buying a house and paying for it over 30 years; putting aside 10% of your income each year so that it can provide you with an income 40 years later, in retirement, would become impossible. Each reader of this blog probably has some savings that are diversified around a huge range of potential investment projects as a result of the economic utility that comes from the financial services industry. Indeed, you only have to look at countries where, for one reason or another, a viable financial services industry does not exist to see the abject misery its absence causes.

But, can we have too much of a good thing? This might be the case if there is artificial encouragement for the sector to grow, but it is hardly likely that, given the huge regulatory costs we impose on the financial services industry, we are in that position yet. Maybe some financial services are socially useless as Adair Turner suggests. However, if you look under the skin of the financial products that are produced, there is more to them than meets the eye and I would not trust government to choose which were and which were not socially useful. 

In any case, we also export so much by way of financial services: there is far more danger of undermining our comparative advantage than there is of producing too much by way of financial services. Fortunately, we do not have joined-up government so it was not difficult to find the figures: Vince Cable's quango, UK Trade and Investment, proudly announced a £42billion net trade surplus in financial services for 2009. What this means is that there is £42billion of teddy bears, light bulbs, toys and cars we can import and do not have to make at home as a result of our exports of financial services. Perhaps Nick Clegg would prefer all our actuaries, accountants and financiers to be stuffing teddy bears at home rather than selling financial services abroad.

It seems that Nick Clegg will achieve his objective of balanced growth around the regions if he has his way on financial services. If we prevent the financial services sector from exploiting its comparative advantage then the south east and London may well end up looking like the north east - we will certainly be better balanced. But, more seriously, we are not going to become better balanced until the state withdraws from the slow growing regions and that was certainly not on Nick Clegg's agenda in his speech. The state, and its national pay bargaining and overwhelming presence in some parts of the country, is using the resources that could be put to other economic ends.

And what about ‘investment not debt’. It is quite difficult to invest without borrowing and getting into debt (ignoring the distinction between debt and equity finance). If people do borrow to invest then that borrowing can be funded from overseas or it can be funded domestically: it does not much matter which. Investment therefore requires debt. People may be borrowing for consumption, of course, but, given the great wall of savings from Asia, the British were bound to be borrowing from citizens of Asian countries. If Nick Clegg and I were the only two citizens in the world and he wanted to consume only 50% of his income, no doubt I would go into debt to him as I could borrow at such a low interest rate given his preference for consumption later over consumption now.

There are certainly some interesting issues here (and some complex ones too). Should the government have been a net borrower during the early twenty-first century? Should we learn lessons from China and reason that our welfare state may be inhibiting domestic saving? Are distortions in the Chinese economy leading to saving there being higher than is optimal? Fair enough, the government is addressing the first, but it is ignoring the second. Our government cannot do much about the third. However, it is worrying that Nick Clegg does not seem to realise that if a nation such as China is a net saving nation then it is going to have a trade surplus and other countries are going to have deficits. Eventually such situations must rectify themselves.

Someone should stick a copy of Economics in One Lesson in Nick Clegg's Red Box - we have a few spare in the IEA storeroom: there is a great thirst for it from the young future political leaders and intellectual thinkers who pass through our door.

Clegg's speech seems to have been a response to the idea that the government 'does not have a plan for growth'. Whether it does or not is immaterial - what is 'unseen' here is that it is not the duty of governments to attempt to create economic growth. It is the duty of governments to protect private property rights and provide genuine public goods (defence and law). The question is not whether the government has a 'growth plan' but why on earth people believe it ought to have one in the first place!? This is especially true as government measures of economic growth based on C+I+G are entirely fraudulent. It is not for Nick Clegg or anyone else to decide by fiat what shape the economy should take - that can only rationally be decided by markets operating freely and without inducements or distortions created by government which includes government control of the money supply, discriminatory and high rates of tax, trade barriers, subsidies, labour market regulation, price floors, restrictions on land use, control of the education system and so on and so on. Government is subject to limitations on knowledge which mean it cannot know what is the most efficient means to allocate resources because utility is subjective and because the market mechanism allows a process of discovering this to occur. And even if it could know, government does not act without interest as public choice theory shows - it is open to capture by special interests which impose their will on others by coercion. Any government 'plan' for growth should, therefore, be about removing government distortions, not further distorting behaviour according to the particular preferences of this or that set of special interests, which, let's face it is merely an ill-advised attempt to correct a pre-existing set of government induced-failures! What struck me as most absurd, however, is the internal contradictions of Clegg's speech. If we do not want growth based on debt, why is the Central Bank running negative interest rates which incentivises debt and destroys savings? If we don't want growth based on financial services, why is the government creating and facilitating the creation of vast amounts of fiat money? Lastly, the means to achieve 'balanced' regional growth is for government to allow proper regional competition to occur by taking away policies like a national minimum wage and national pay bargaining which overprices labour in the regions and to stop vast transfer payments between the UK's regions which have clearly failed to deliver any benefits and depress growth for both payees and recipients. In short, we need to let the economy - or rather free actors within it - decide what shape it ought to take. The idea that government - with all it's flaws, inefficiencies and its inherent lack of knowledge - should decide what the economy should be is nothing short of insanity, or worse, socialism.

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