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Big government is back or growing?

Jean-Pierre Dumas

Tuesday, September 5, 2023

Big government is back or growing? The Keynesian culture is seeping in everywhere (including this paper). The idea is simple: we have greater needs (social, green, old age, etc.), we need more spending, therefore more deficit (the FT journalists seem not to have made up their minds; more deficit or more tax or both?)

1. The Keynesian ideology

· It is agreed that budget deficit is necessary in the event of a recession (recession means that economic growth is negative), the Keynesians take their argument to the limit. Since economic growth is insufficient (relative to our idea of what it should be, call it potential growth), we need permanent budget deficits. “Economic growth will probably not be strong enough to bring them down and far from cutting spending, many governments are enthusiastically increasing it”. The Keynesian theory, fiscal deficit in case of recession has morphed into the socialist ideology, always more expenditure to accommodate infinite needs.

· If you raise public spending, it is difficult to go back, the ratchet effect. In the wonder world of macroeconomic textbooks (which is limited to micromanaging the cycle through fiscal and monetary policy), there is a recession, the government pushes a button (increase spending more than revenue and the deficit will bring higher growth through the multiplier effect). Keynesians don't understand the ratchet effect. If the government increases spending, it is very difficult to reduce it afterwards.

· In most cases, the increase in expenditure (in the real world, not the textbook wonder world) is not due to public investment, but very often to an increase in recurrent expenditure (wages and salaries for additional civil servants, subsidies for products, for pensions, for enterprises, social expenditure due to ageing, etc.). It is almost impossible to reduce them, as they are by definition recurrent. This is particularly true in countries like France, where expenditure cannot be reduced (entrenched benefits "avantages acquis"), the number of civil servants cannot be reduced, their salaries can only be increased (never enough), the public subsidy for public pensions can only be increased for demographic and political reasons, and so on.

· If you cannot (or will not) reduce spending (for obvious political reasons), then increase growth. And we come back to proposition 1 (vicious circle). The only Keynesian prescription to increase growth is a budget deficit (read M. Krugman, O. Blanchard, S. Kelton, T. Piketty, etc.). Economic growth has nothing to do with fiscal policy, but with microeconomic policies, which are slow and painful.

2. Limit to deficit

· Today there are at least three limits to permanent Keynesian fiscal and monetary policy. a) The huge fiscal deficits of 2020 and 2021 in the US and Europe, financed by QE, are the main cause of inflation. If you want to reduce inflation, you need to stop QE and reduce the fiscal deficit (indirectly financed by monetary financing). b) The second limit is the increase in public debt. You cannot have a permanently high budget deficit while reducing the debt-to-GDP ratio (Blanchard's two ideas that budget deficits promote growth (in real terms) and that the interest rate will be permanently below the growth rate (r-g negative) are wrong ( If the primary deficit is above r-g, the debt ratio rises. c) In countries with a high tax ratio, there is a limit to tax increases (the public expenditure and tax ratios by country are missing from the graph).

· Since we cannot or will not cut spending, the authors (E. Agyemang & C. Giles) switch gears and argue for more taxes. Some countries have a tax code that is biased in favour of the rich, there are rich people asking for more taxes... well, this is not the case everywhere. And whatever Mr Piketty and Mr Saint-Amans (of the OECD) say, the revenue ratio for France amounts to 53% of GDP in 2022 (source: IMF/WEO, April 2023). The French may not be enjoying the "flavour of the day" from Mr Saint-Amans. When the French Socialist government introduced a tax on wealth, there was an exodus of entrepreneurs from France, not a strong incentive to re-industrialise the country.

If we need to raise spendings to meet new needs, then countries with high public expenditure ratios (not mentioned in this article) should consider to reduce useless or less important expenses.

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