Tuesday, September 21, 2010

Fallacy of composition, Clegg-style

Nick Clegg's conference speech yesterday signed the Liberal Democrats up to that oxymoronic project, growth-friendly fiscal consolidation. Amongst the nonsense Clegg advocates is the economic model for the hard-of-thinking: the economy as a household:

"The problems are there. They are real. And we have to solve them. It’s the same as a family with earnings of £26,000 a year who are spending £32,000 a year. Even though they’re already £40,000 in debt. Imagine if that was you. You’d be crippled by the interest payments. You’d set yourself a budget. And you’d try to spend less. That is what this government is doing."

Where do we start? First, the numbers are wrong: if the British deficit is give or take 12.5%, then the metaphorical family on £26,000 a year would be borrowing £3250, making their annual expenditure 29,250, not £32,000. British national debt is currently around 60% of GDP, making the metaphorical family indebtedness actually £15,600, not £40,000 - and anyway most families under the age of 50 or so owe several times their annual income as mortgages, and are very sensible to do so. If the imaginary family could borrow at well below the rate of inflation, like the government can at the moment, they would be crazy not to take advantage of the opportunity to smooth their consumption through hard times. But that is the least serious problem.

It is not revolutionary new thinking to suggest the analogy of the economy as a household is stupid. But, anyway, here's why (for the umpteenth time) the analogy doesn't work. If we cut our family spending, then we will quickly reduce our family debts - assuming that no-one buying services off us does the same thing. But of course, that assumption doesn't hold: the reason we are in a recession is precisely because others are doing this. So if the family cuts its spending and finds that others do the same, then family income will go down as well as expenditure, leaving the family as indebted as before, or potentially more so. And that is precisely the effect you would expect cuts in government spending to have. This morning's Education Guardian had a paltry 4 pages of jobs in it - cutting family spending will be a breeze, provided a member of the family isn't looking for an academic job. We're in a deep recession because of the collapse of private sector spending; the coalition's answer to this is to add the collapse of public sector spending.

The analogy Clegg should have used is the following: the metaphorical family on £26,000 a year with its debt problems can easily resolve them by cutting off the supply of food and accommodation to the least productive family members. Children and non-working adults could be booted out of the family home, allowing those left to quickly pay down their debts with the money saved.

That's what the coalition has planned. I give it 18 months to change its mind, or the Lib Dems are toast.