Another Edinburgh is Possible

Brian Robertson (Edinburgh City Council Unite rep, writing in a personal capacity) makes the case for public services

Public Services are the bedrock of our society. Generally, and amongst other things, they are purposed to ensure that:

people are safe and healthy
businesses are enabled to thrive
people can find decent, gainful and secure employment
decent education is available to all
those who may be less able are protected and supported

The Public Sector (e.g. Local and National Government, NHS and some industries) exists to serve and provide services to the public. Variously services may be: law making and upholding, defence of the country, health services, housing, transport (inc infrastructure like roads, airports, railways etc), education, care and support for people, waste and cleansing, and many other services, goods and infrastructures that enable society, the economy and communities to thrive. The public sector creates, develops, administers, operates and maintains the public service infrastructure that keeps the country going.

The UK Public Sector employed 5.51 million people (16.7% of UK workforce) in June 2020. This compares to 6.1 million employees (around 20% of workforce) in 2010 and 7.3 million employees (around 30% of workforce) in 1979.

Currently in the UK the Public Sector takes up around 35% of the economy, measured by the share of Public spending to GDP. UK Public Spending has fluctuated over the past 50 years (30% to 45% GDP) but averages over the period to around 35%. Public spending as a share of GDP has, in the past 100 or so years, only twice exceeded 50% of GDP (both a result of war spending).

The CoViD-19 pandemic has exposed many frailties in the UK Public Sector such as:

the difficulties the NHS has experienced in providing its usual level of service whilst dealing with the pandemic
the PPE stock and supply crisis
the crisis in adult social care
the inability to provide a working track and trace (Test and Protect) system

Whilst even a fully pandemic prepared Public Sector may not have been able to save our society, communities, families and economy from the worst ravages of this pandemic it is reasonable to assume that a better prepared public sector would be able to put in place the measures that would help save lives, support our communities and brace our economy. Thus, it seems reasonable that the Public Sector should be expanded and public spending increased in order to ensure that the country is better prepared for crises.

Some economists and political voices argue that an enhanced Public Sector is neither financially nor economically appropriate as expansion “crowds out” employment in the private sector and the cost of such expansion would simply increase public spending therefore borrowing and debt. Also, that increased government borrowing tends to increase inflation. However, these arguments are countered by different economic arguments themselves notwithstanding the various social arguments for effective Public Services.

Crowding in or crowding out

The “crowding out” argument centres around the idea that Public Sector investment reduces private sector investment and profits, partially due to increased interest rates. If private sector investments and profits are reduced, then the overall government tax take is also reduced. Additionally, it holds a notion that pay and conditions are better than those in the private sector therefore prospective employees will be more attracted to Public Sector employment thereby reducing productivity and potentially increasing unemployment in the economy as the public sector is not wealth generating.

However, many economists argue a “crowding in” theory that broadly states that, especially in a recession, increased government spending will stimulate economic growth. Furthermore, there is considerable evidence that increased government borrowing coincides with reduced inflation and interest rates.

A further element of economic argument that debunks the “crowding out” theory is that there is just no evidence that Public Sector pay and conditions are better than those in the private sector (quite the contrary). Historically, the Public Sector has provided good, secure employment for people when the private sector has been unable to. The significance of the latter point cannot be lost as the Public Sector and Public Spending have, in hard economic times, effectively rescued the economy through investments in Public Services and the people who deliver these.

Quantitative Easing and inflation

Quantitative Easing (QE, sometimes considered as “printing money”) is a means of stimulating economic demand used by a country’s central bank and government. It mainly involves the central bank creating an account which it uses to purchase financial products (Gilts, Bonds etc). The account exists in negative balance until the bank sells its purchases and balances the account. Sometimes the government will borrow through this process with the central bank. Around 45% (£895 billion) of UK Government debt (total = £2.1 trillion) is currently held (in Sterling backed Gilts) by the Bank of England. A curiosity of this process is that the UK Government must pay interest on its debt to the Bank of England but, under indemnity, the Bank of England must return this interest to the UK Government (Treasury).

Inflation is essentially a measure of rising prices. It can encourage growth if low and steady but also be damaging to the economy, especially if it fluctuates wildly as this creates uncertainty. Deflation (negative inflation) causes prices to drop meaning sellers will want to rid themselves of stock quickly, but buyers prefer to wait for the price to drop. Hyperinflation (extreme) causes prices to rise quicker than people can earn, often doubling on a daily or weekly basis, and whilst it is rare has proven disastrous for countries that have experienced this.

From November 2009 to July 2012 the UK government borrowed £375 billion to bail out financial markets and institutions stricken by the banking crisis of 2008/9. The first tranche of this borrowing (£200 billion) occurred in November 2009 when inflation was at 1.9%, by January 2010 inflation was at 3.5%. However, inflation was already on an upward trend from its low of 1.1% in September of that year. The second tranche (£175 billion) occurred in July 2012 when inflation was at 2.6%, by September inflation was at 2.2% and was on a plateau, with no major shifts, that lasted until October 2013 from May 2012.

A further fiscal stimulus of this type occurred in August 2016 when the government borrowed £170 billion to ease the potential pain of Brexit. At that time inflation was at 0.6% which would increase to 0.9% in October that year. However, once again, inflation was already on an upward trajectory from an all time low of -0.1% in September 2015 that would peak at 3.1% in November 2017. Currently inflation stands at 0.7% despite massive UK government borrowing (to fund CoViD-19 interventions) of £450 billion since March 2020.

The UK government and the Bank of England, along with many governments and central banks across the world, set an inflation target of 2% as being the optimum inflation rate at which stable and sustainable economic growth occurs. Key reasons for this are to avoid damaging fluctuations which discourage investment, deflation which discourages consumer spending and high inflation which reduces spending power. All these factors risk high unemployment which again is damaging for the economy.

Borrowing is bad

The notion that government borrowing increases inflation is not clearly evidenced and is debateable at best. However, there exists a school of thought that maintains government borrowing itself is bad simply because the debt keeps piling up and we pass this debt on to our children. The simple substance of this argument is that equated with people’s domestic circumstances wherein borrowing to finance a house or other rare and expensive purchase is fine as long as the debt can be paid off within a reasonable period but continuing borrowing and, thereby, living beyond ones means is risky and potentially disastrous. The more complicated argument relates to the supply of money itself and that, in order to maintain inflation at appropriate levels, the amount of money in the economy must be kept within appropriate parameters.

The first argument is plainly and simply a myth as governments do not operate the same as a household. How many households can print their own money? How many households can borrow large sums over 50 or more years then borrow again for another 50 years to pay off the original sum? Furthermore, when governments borrow over these large periods of time the effects of inflation can be to halve or even quarter the spending value of the sum eventually repaid. A deeper analysis of this latter point may be helpful.

Say I borrowed £100,000 at a fixed interest rate of 5% over 100 years to buy a house valued at £100,000 but did not repay any capital, only the annual interest of £5000. I’d be paying £500,000 in interest only and still have to repay £100,000 after 100 years. Therefore, the house has cost me £600,000. However, if house price inflation runs at 2.5% pa, by the end of the mortgage term (100 years) my house would be worth well over £1 million. Also, by around the 30^th year of my mortgage my house value would be increasing annually by more than the £5000 I am paying in interest, so my house then makes more than it costs.

Imagine also that I own the bank that gave me the mortgage and that I am the sole customer and the sole beneficiary of the bank’s profits (my mortgage interest payments). This would mean that the 100 year relationship between me, my bank and my house has netted me around £1 million minus the original £100,000 mortgage which I conjured up from nowhere anyway.

The above example is the reason why household finances should never be used to explain state finances. First of all, most of us do not own a bank that can lend us money. Secondly, households do not possess the longevity to realise the benefits of this type of borrowing. Finally, the risks of investing (and borrowing) in this way precludes the vast majority of us as we do not have control over economic levers (e.g. taxation, inflation, interest rates) as governments and central banks do.

One potential outcome of the state inflation target of 2% is that the price paid for any commodity doubles around every 25 or so years. Meaning that a pint of lager bought in an Edinburgh pub in 2020 and costing £5 would likely have cost £2.50 before the millennium. This also means that a sum of money borrowed 20-25 years ago, with no repayments or interest, would be halved in real terms if repaid today. Looking at this another way, if I had borrowed a sum equal to half my salary 25 years ago I would only have to use quarter of my salary to repay that sum today.

The other part of the argument against borrowing overlaps with inflation as it holds the expectancy that having more money in the economy encourages inflation. This argument has some validity as there are many examples across the world and across time where governments have attempted to borrow and spend their way out of a crisis only to find themselves in an economic disaster.

Zimbabwe 2008 experienced monthly hyperinflation of 79 billion percent meant that prices doubled every day and stability was only to be found in global currencies (e.g. dollars, pounds, Euros). The crisis may have been partially caused by the government printing money to pay salaries and loans, but the result was widespread shortages of food, fuel and medicine.
Hungary 1946 experienced hyperinflation measured in trillions of percentage points that meant that prices doubled almost twice a day. Largely caused by the country’s inability to recover from the Great Depression being exacerbated by WW2 the government’s attempt to print (money) its way out of a crisis resulted in the currency being worthless.

Whilst the types of hyper inflation experienced in some countries may have been caused, at least partially, by government borrowing it is fallacious to equate government borrowing with damaging inflation.

Firstly, as previously mentioned, the Bank of England’s inflation target is 2% per annum and, by comparison the Zimbabwean inflation was 79 billion percent every month. UK inflation means that prices will double every 20 to 25 years whereas the extreme examples above had prices doubling daily. The UK is not, and is nowhere near, the circumstances where high inflation could cause major economic and social problems.

Secondly, whilst UK government debt has increased to over £2 trillion and now amounts, cumulatively, to more than 100% of (annual) GDP less than half of this (£895 billion) is a result of QE and the bulk of the debt has been on the UK balance sheet many years (e.g. 2012 figures show £1.4 trillion debt). Government responses to the coronavirus pandemic have caused some £450 billion to be borrowed using QE methods but £445 billion was borrowed in the same way to support financial markets and institutions affected by either Brexit or the banking crisis and a further £1 trillion plus of debt has remained on the UK balance sheet without causing inflation to accelerate.

Thirdly, of the £895 million borrowing that is attributable to QE £445 billion has been in the economy for several years. The highest inflation rate experienced by the UK over the 10 years of QE has been 5% (October 2011), by comparison inflation was 8.2% in May 1991 and was even higher I decades before. Therefore, the link between inflation, government borrowing and QE may be real, theoretical or simply wrong. Alternatively, it may be that the UK’s fiscal and monetary controls are such that the UK avoids high inflation despite having more and more money in the economy. Regardless, there is evidence that controlled and reasonable increase in the money supply does not negatively affect inflation.

Finally, if the monetary theory of increasing money supply increasing inflation is correct and the Bank of England inflation target of 2% is desirable then as inflation is currently 0.7% increasing public expenditure may help the Bank of England to introduce more money into the economy (through QE) thus achieve the inflation target.

A footnote to this statement, with a reminder that the CoViD-19 pandemic is frequently recognised as a war, may be helpful. The two world wars of the last century caused the UK Government to increase public spending to over 50% of GDP during and slightly beyond these war years. Two or three years after each of these wars public spending returned to a norm of 30% to 40% GDP. Even during the decades of massive Public Sector expansion (including council housing, NHS, public education, social security etc) from 1948 to 1979 public spending rarely moved above 40% GDP and remained stable around 35% over this period. Additionally, the UK finally discharged its WW2 debt on December 31, 2006 (a borrowing period of approximately 50 years).

Sources

Inflation target:

https://www.bankofengland.co.uk/monetary-policy/inflation

https://www.thebalance.com/inflation-targeting-definition-how-it-works-3305854

https://www.ft.com/content/b1a11156-910f-11e9-aea1-2b1d33ac3271

Hyperinflation:

https://www.cnbc.com/2011/02/14/The-Worst-Hyperinflation-Situations-of-All-Time.html

QE:

https://www.bankofengland.co.uk/monetary-policy/quantitative-easing

Inflation over time:

https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23

Public Sector Employment: