For anyone interested in creating an economy that can fund a fairer society, the recent post in Progressive Pulse by Charles Adams is essential reading (The Magic Multiplier Effect). It gives links to two other documents, an explanation by Richard Murphy of multiplier effects (It really is time that people realised most government spending pays for itself) and an analysis of the size of multiplier effects for different types of Government spending (Reeves et al. Does investment in the health sector promote or inhibit economic growth?)
A very simple place to start is to take a £1 coin from your pocket. Where did it come from? (It was made in a plant outside Cardiff.) Did the government borrow money or raise tax in order to make the coin? No, it just switched on a machine. The £1 was effectively created out of thin air. If the government made twice as many £1 coins, would they become worth 50p? No, because of the multiplier effect. As thin air money moves through the economy, the Government gets some or all of it back through tax.
The critical point is that the Government does not SPEND the money it creates out of thin air, it INVESTS it. Depending, among other things, on the multiplier effect, the Government can make good or bad investments. If the multiplier is greater than 1, it is a good investment. The Government gets back more in tax than it paid out. It does not need to raise any extra tax or borrow anything. In fact, it gets extra money for free, which it can use to make new investments. If the multiplier is less than 1, the Government has made a bad investment, it does not get back all the money it paid, and may eventually have to raise taxes or borrow more.
This is a simplistic view from a non-economist, and looks only at cash the Government gets back. Some of the potential value of Government investment would not be monetised, for instance allowing parents more quality time with their children, or providing better public facilities. This case has been argued much better elsewhere. Other “value” is monetised, though this may sometimes do more harm than good. For instance, assisting house purchase without making more housing available simply pushes up prices. It creates imaginary money, which can disappear overnight (as it did in 2008).
It is worth mentioning that when the Government gives a tax break, this is the equivalent of an investment. It judges that in the long run it will get more money by leaving it in the wider economy, rather than collecting the tax and re-investing it. Similarly, by having a higher tax rate for workers than non-workers, the government judges that it is better to take back and re-invest money from workers, because non-workers will use the money more productively. I make no comment on whether these ideas are plausible. Also, by choosing not to create money out of thin air, the Government chooses to forgo investment , and reduces the flow of money through the economy.
The paper by Reeves et al. analyses government spending in 25 EU countries and shows that spending in particular areas – Education, Culture, the Environment and Health – is correlated with a positive fiscal multiplier. It pays for itself. In contrast, spending on defence is correlated with a negative multiplier.
Their analysis provides evidence of a positive benefit in specific areas, but it does not show how the benefit occurs. We need to look at the effects money has on its journey through the economy, how far it travels, and what eventually happens to it.
I am afraid that I am not a real socialist, because I invest in the stock market. Long ago, I would buy a share because an expert wrote how good it was. Now I look instead at certain characteristics of shares. Shares with particular characteristics may do badly, but on average do slightly better. Shares with other characteristics sometimes do brilliantly, but on average do slightly worse. We need to ask what are the characteristics of Government investments that are associated with a particularly good or bad return?
Taking education as an example, some investment in universities goes into paying higher salaries to vice chancellors. It seems fairly unlikely that this investment will give a positive return. If investment in education gives an overall positive return, but some of the investments give a negative return, there must be other investments in education that compensate with a particularly good return.
What are the features in common between good investments in education and good investments in other areas? My impression (backed up with no data or evidence) is that virtually all forms of Conservative Government spending have characteristics that I would associate with a negative investment return. In contrast, Labour policies in many areas should be good investments. However, I am not sure that Labour really understands why they would be good investments, or what would be bad investments, so that they could make a stronger case for more Government spending, and could channel more of that spending into the best investments.
The danger is that in practice a Labour government will invest with a scattergun approach, or according to who shouts loudest, or purely for show, rather than use objective analysis. I also wonder whether even enlightened economists have spent too much time worrying about thin air, and not enough time quantifying the factors that make government spending a good or a bad investment.
Questions for any reader who gets this far: In considering good or bad government investments, which factors are the most important candidates to evaluate? Why do they seem to be important? Can they be made semi-quantitative?