Labour’s Universal Free School Meals Policy, for primary schools, funded by adding VAT on private school fees was generally well received. Those that opposed it, generally, did not see it as an economic policy and it perhaps reveals a limited understanding of how a nation’s economy work. So in this blog, I want to outline how our economy works. It is brief, so it may be a little crude in places. On the whole, though, I feel I offer a succinct explanation of the model.
No, don’t go anywhere! It’s worth reading. Really it is.
The recipe for happiness, according to Dickens’ Mr Micawber, is through fiscal prudence:
Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery (Dickens, David Copperfield, 1850).
It’s simple isn’t it? And if you follow these rules then you will be happy.
It follows then that the same rules apply to a national economy. Income £721 billion (from national and local taxation for 2017), annual expenditure £720 billion result happiness, annual expenditure £784 billion (all government spending for 2017), result misery.
Oh dear! No wonder there is so much misery about. We are in deficit to the tune of £63 billion. Surely, it follows then, that we have to make savings and cut back or increase taxation.
While this is the narrative that is perpetuated in the media and by government, it is not the way the national economy works.
A national economy is not like a household with incomes and expenditure. A household has money going in and going out again. A national economy does not have money going in and out of it, in the same way. The national economy includes all the money that is in its own currency. Some may get saved up, some my go abroad. But the only place that money is going to be spent is in the national economy, even if that activity is overseas.
The national currency is introduced into the economy through government spending. There is no other way of creating currency. The way in which currency is introduced by the treasury is by spending on health, education, defence and welfare, for example. The government either credits the accounts of public-sector organisations or gives contracts to private companies to provide goods and services.
A government’s currency is an IOU. The reason these IOUs have value is that the government expects us to pay taxes in the national currency. The government will not accept anything other than its national currency. We accept it as salaries and shops accept it because, essentially, we have to pay our taxes in the national currency.
Before a government can raise any tax it has to spend. It has to introduce IOUs into the economy. This year, in the UK, it will be £784 billion.
If we apply the Micawber principle and cut spending to try and get it down to £721 billion, you would expect tax revenue to reduce. The reason it doesn’t is because people and organisations increase their borrowing. Much growth in the economy in the last few years has been a result of consumer spending funded by private debt. Individuals and businesses (the private sector) have to borrow from commercial banks to help fund a reduction in public spending. Or they have to use up their savings. The government’s cuts in spending mean that public sector deficit is transferred to private sector debt.
Cutting public spending leads to a reduction in spending on things like health, education and welfare. We have to make decisions about what to spend limited resources on. We have to prioritise spending. This is austerity.
Austerity increases the amount of private debt, with households and businesses borrowing from commercial banks and lenders who profit from the process. Currency entering the system as a result of government spending becomes unevenly distributed. With the lenders and those with capital accumulating further, while the rest become poorer and indebted. It trickles up rather than down.
The accumulation of currency at the wealthier end of the private sector ends up in the banks. The treasury and Bank of England have to create bonds in order to buy back this currency to maintain interest rates. This is what the national debt is, it is not what we think it is. It is private sector-accumulation of currency.
A regressive taxation, one where the more wealthy pay a smaller proportion of their income and wealth in tax, than the less wealthy, adds to inequality. It also increases accumulation at the top end and adds to the national debt.
We need a progressive taxation, one that increases the proportion of tax paid by those at the top end and gives more income to those on lower incomes. I am not going to go through the benefits of universal welfare here. Abi Wilkinson offers an excellent explanation here in The Guardian. Kevan Bartle’s blog about Universal Free School Meals argues the benefits of this policy excellently, too. The important point is that this policy should be seen as an economic policy and not an educational policy.
The austerity programme (it has actually been with us since the mid 1970s, to a lesser or greater degree) is system that allows finance unrestrained access to our economy. Politically, by drawing on Mr Micawber, a consensus has been established amongst the electorate. Consequently, we find our public services starved of funding. But the Mr Micawber doesn’t work on a national scale and if applied, like it has been done, it leads to growing inequality.
The government can increase public spending. Additional spending, more currency entering our economy, increased pay, better working conditions for teachers, more investment in research and development. And the currency that enters the economy does not just remain in schools, it is spent in the private sector. More wages, more spending in the economy, more tax revenues. It will not increase the deficit, but it will mean more money going to the less well off (including most public-sector workers e.g. teachers).
That national debt will come down if we have a more progressive taxation system, discouraging the accumulation of currency, and so the treasury does not have to issue bonds to maintain interest rates.
We, like the US and many countries in Europe, need an end to austerity, an end to deficit reduction. We need to increase public spending and we need progressive taxation. Labour’s simple policy is the latter. It is a very good policy proposal. More of this please.
Further reading and information
You can read previous blog posts:
More information about Modern Monetary Theory on this page:
The following books are useful background and all readable: