Tuesday 28 May 2013

Coalition Multiplies the Damage


Despite the IMF warning the UK government that its austerity measures are causing significant economic damage, George Osborne today announced a further round of spending cuts. Recently the IMF (International Monetary Fund) posted a paper noting that the British government had significantly underestimated the impact of the ‘Fiscal Multiplier’ which has caused even greater damage to the economy as they have pursued their ‘Austerity’ policies. The thing is I don’t think the Coalition did anything of the kind. I think they knew exactly what they were doing, but since this idea is not simple to understand, they thought they could get away with it.

The multiplier is a complicated and very wordy economic idea, and for that reason this news has largely missed the British public’s attention. However, this is the ‘smoking gun’ that proves that coalition policies are pre-designed to further their ideology of shrinking public services at any cost – and the costs are immense.

 Here I’ll try to take you step-by-step through the reality of what the IMF have said, and the real reasons for and effects of current government policies.

 What is the ‘Fiscal Multiplier’?

Imagine an economy of a government and only four people. One person is a hunter and the other three are unemployed. Right now all we have is a hunter hunting for themselves, and so the other three people are starving.

The government spends £1 training an unemployed person to be a builder, which he receives in wages, so that the economy is now worth £1. He spends the wages on meat, paying his £1 to the hunter. The hunter realises he needs help to hunt the extra animals and so employs one of the other unemployed people to help him hunt, paying them 50p to do so. The hunter has 50p profit which he spends on having a new roof built. From the helper’s 50p wages he spends 25p on the final unemployed person asking him to gather some vegetables, and the other 25p on building a new wall. So now, our economy is no longer worthless and no one is unemployed. The £1 spent by the government has caused much more than £1 of economic activity. The total value of the economy is:

£1 spent by government
£1 spent by the builder on meat
£0.50 spent by the hunter on building a new roof
£0.25 spent by the hunter on vegetables
£0.25 spent by the helper on a new wall
£3 Total economic activity
Thus, the £1 government spending has been increased by the fiscal multiplier of 3 to become £3. No one is now unemployed, and no one is starving. Instead of just having a hunter hunting meat for themselves, we now have more meat, vegetables and buildings.

The Ideology of the Right

Economic growth, is the main economic aim of the government which is why it is such a problem for the government when the media report that the country is in recession (negative economic growth) as this means the economy is shrinking, or as in our earlier example; fewer people working, more people starving and the economy is worth less. However, the government have not told you how they have contributed to low and negative economic growth over the past three years.

Our Coalition government is dominated by Conservatives, who do not believe in government spending to help the economy or its people, and for this reason they have been cutting things. Some of the cuts include £6.2bn within the first 100 days of this government’s reign and have continued for example with plan to reduce spending on the NHS of £20bn by 2015 and £50bn by 2020. For some this is still not enough, with many prominent Tory cabinet members stating that further cuts should be made here.

In total the number of public sector jobs is expected to fall by over one million, but the misery continues for those who are the victims of these policies. If either you become unemployed, or your income is reduced because of these things you cannot expect much of a safety net. The government plan to cut over £23bn per year from the welfare budget meaning those on lower incomes will suffer. Indeed, over 7million working families are expected to see their incomes reduce as a result.

This is the result of having a government dominated by millionaires who do not need these services, and feel no obligation or desire to help those less fortunate than themselves. Think about it, if you have private health insurance would you be worried about the fact that the government has just removed its obligation to treat people’s health concerns equally, if at all. Similarly, if your child attends Eton, why would you be concerned that state schools are being turned into de-humanising exam factories?

Unfortunately though, these cuts (and they go far further than I have described) have a larger impact beyond the direct effects to your services. Austerity itself creates a need for further austerity which means the things we have lost so far are barely the tip of the iceberg.

The Fiscal Multiplier Effect

The UK government estimated that the multiplier effect was 0.5. This means that they thought that for every £1 they cut from the economy, only £0.50 of economic activity would be lost. The paper that I mentioned at the beginning of this article outlines that this was wrong, and states that the multiplier was likely to be 1.5. Some speculate it could even have been as high as 3, meaning that for every £1 cut from government spending £3 of economic activity was lost. This is what has caused the UK’s slow economic growth, and the consequent unemployment, fall in wages and fall in living standards that have accompanied it.

The UK government got it wrong! Or did they? When we consider the multiplier effect in reverse, we have to include the figure that is being cut. So, in our earlier example, the cutting of £1 led to a fall in economic activity of £3 including the money that the government originally spent, so a multiplier of 3. As we have to include the money that the government cut, it is very difficult for the multiplier to be less than 1. E.g.. Government cuts £1 from the economy, even if no further money is lost, the economy still shrinks by £1 because we count government spending in the size of the economy. Therefore, the minimum the multiplier can be is 1. The Coalition were telling us that they were in effect going to cut £1 from the economy, but that the economy would only get smaller by 50p. My A-level students could tell you that this doesn’t make sense!

Admittedly, George Osborne’s lack of economics training could be responsible for his mistake, but how did this get past the other 1,459 treasury employees,  Osborne’s four special advisors who are qualified or the nine members of the Monetary Policy Committee who effectively run our economy from the Bank of England? If you accept that such an obvious flaw cannot have escaped everyone’s attention, then we have to begin looking for other explanations of why this could have happened.

Remember, the incoming Governor of the Bank of England has stated that the UK is an economy in crisis. It has been estimated that the government cuts have contributed to this costing an additional £76bn, and this is a conservative estimate. The entire justification for this programme of cuts was to close the fiscal deficit, and yet because of the “miscalculation” of the multiplier effect, this has not happened. Thus, 4,800 nurses have lost their jobs for no reason, among 25,000 other NHS staff. This phenomenon is not particular to the NHS, as I stated earlier, over 1million public sector jobs are being axed.

The Rationale

Public sector workers are those who have chosen to accept lower pay to work in the interests of the public good. These people are being sacked through no fault of their own, not to do with their performance or their competence but because someone in a Whitehall tower decided it would be better if they weren’t paid by the state.

Why? I hear you scream. I could take you through the history of the Conservative party as an organisation of the financial elite. The land-owning aristocracy and the post Thatcher corporate glitterati. I could discuss how this party stood against the formation of the NHS and the welfare state at its inception and has attacked it ever since. I could talk about the number of Tory MP’s and Peers who stand to profit from the privatisation of the NHS, but it might be much easier just to follow the money…

The money previously earmarked for all of us through the public sector has been used to finance tax cuts for the already wealthy, and for large businesses that often currently do not pay their full taxes anyway. The TUC estimate that £25bn is lost annually from the treasury (more than the entire annual savings that the government expects to make from cuts to the welfare budget) in this manner, and while this is at the lower end of the estimates nothing is being done by the government to prevent it. Similarly nothing is being done to curtail the activities of the banks that gambled our way into this mess in the first place, and these are just a couple of small examples without referencing the estimated £20bn on offer in corporate profits from the widely discredited carve up of the NHS.

The Consequences

Let’s assume that the IMF is now correct in its assumption that the multiplier is 1.5 (Many suspect it is significantly higher than this). For every £1 that is cut from government spending, £1.50 disappears from the economy. As nurses, teachers, police officers and other employees are sacked as part of this policy, not only do we lose our services, but we also lose spending power from the economy.

Unemployed police officers spend an awful lot less on tax, reducing the money coming into the treasury for further spending. They also then claim unemployment benefit, increasing the money going out of the treasury. This means even less money left to pay for our schools, hospitals, fire-brigades and all the rest. It also means that the newly unemployed reduce their consumer spending, they have to spend less on everything including food, cars, entertainment electronics – everything.

This means that businesses suffer as they cannot sell things to people who do not have any money to buy them. Sales fall and as a result, profits fall. This means that business have to cut costs or go out of business. Thus, businesses have to let employees go, meaning that these employees have lower income and can spend less which forces the process to repeat itself, and compounds the entire problem. Sooner or later this lack of spending in the economy and consequent fall in business sales results in those businesses closing down.

Fundamentally, austerity is a policy of the wealthy for the short-term benefit of the wealthy, and everyone else will have to suffer the consequences. Austerity is the economics that can and will cause another great depression, just as it has before. When it does, we will all suffer but it will be the poorest and most vulnerable who will suffer first and suffer most.

We are beginning to see the first signs of this with growing demand for food banks, high unemployment and falling wages, but it’s going to get much, much worse. For every Police Officer, Nurse, Doctor, Fireman, Teacher or other Public employee that Osborne shows the door, not only are you less safe for them not being there but the threat to your job or your business grows.

Austerity is a nasty policy designed to transfer money from the poor to the rich, it is a threat to your job, your standard of living and potentially to your very life!


  1. Depressingly accurate :( thanks for succinct words of wisdom

  2. Thank you for the explaination, at least now I understand a little well, tiny bit more about the 'Fiscal Multiplier'.
    I am very new to all this and I find it all very interesting.
    If someone like me can understand that not to spend and to keep on 'cut cut cutting' is damaging, then why on earth is our Chancellor and Government being so stupid???

  3. Thank You! for explaining it in laymans terms.. Very interesting but very depressing, I wish there was a way to get rid of these bloody lunatics that are running sorry ruining our country.

  4. You have described the 'Multiplier effect' very clearly, and you're right FarmDonkey; it doesn't appear to have been something that has caught the public or media attention, perhaps because it sounds complicated. So thank you very much for the 'dummies guide' style explanation. Now, even I can understand it!

    Given the Multiplier effect, as described above, it does seem rather puzzling, as you suggest, why Austerity measures have been considered the solution to the shrinking economy. In addition, we have all watched the steady demise of the Greek and Spanish economy as they also decided on 'austerity' being the answer to the problem. Clearly, it does not appear to have worked out very well for them.
    Could the Tory government and their rich cronies, with their private health insurance, with their children in private schools, never having experienced the benefits system, really be that greedy, as to completely ignore the needs of the country it's governing? To forego the position of responsibility they have been entrusted to by the voting populace, simply in order to line their own selfish pockets with profits from tax cuts and "carving up the NHS"? I find this conclusion difficult to digest. I could temper this standpoint slightly by suggesting that perhaps the government itself is being controlled by only a handful of unscrupulous individuals who are making the ones in power take the wrong decisions?
    If you're right, and they really are that immoral...then we're all well and truly shafted...'Depression' in every sense of the word.

    twitter: Rapinder@RoadrunnerA

    1. "...perhaps the government itself is being controlled by only a handful of unscrupulous individuals who are making the ones in power take the wrong decisions?"

      Close, very close, but it's worse than that. Those in Government who understand how to manipulate the economy to make large amounts of money for the rich & powerful, are themselves part of that this unscrupulous group. The decisions being made are "wrong" for the country as a whole, but it's the right decision for them. They are far more than a handful.

      I'll explain further in a new tweet.
      Sundancin' Paul, Twitter: @Sundancer_UK

  5. Excellent blog post. Clear, concise and an engaging read. For someone who struggles with the ins and outs of economics, I found this surprisingly accessible. And terrifying of course.

  6. As always, succinct and informative. You're one smart Donkey.

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