Frequently, and with some validity, business people lambast economists for knowing nothing about the real world. They claim that economists dwell in ivory towers and just don’t get it. Some economists may well live in ivory towers but those of us who work for ourselves and employ people and try to make a living in the private sector are not as removed as the business people might think. In fact, we are business people. Yet the point is valid, as theoretical models of the economy do sometimes seem removed from reality.
However, the criticism can work the opposite way. Just because you run a business does not mean you understand how the economy works.
And when business people weigh into public debates about the economy, their pronouncements can vary from the vaguely embarrassing to the downright wrong. We are seeing this in the economics of the fiscal treaty debate.
Despite knowing nothing — or at least very little — about how the economy works, why is it that some business people speak with utter confidence on economics yet they get the basics wrong?
A business is not the same as an economy. An economy is myriad businesses and lots of other bits too that are not businesses, but may be customers of businesses.
Let’s just address the most basic proposition of the business people about the fiscal deficit and what the country needs to do to right itself. The favourite line of all business people is that the Government needs to balance its books.
If we can just balance our books, through cutting spending and raising taxes, all would be grand. Let’s just examine whether this is actually true.
The Government also borrows the language of the business person when it says that it is imperative that it balances its books.
There is no problem with both the Government and the private sector balancing their books — as long as they don’t do it at the same time. Doing it at the same time, as we are trying to do, destroys the economy.
Some propositions, which sound absolutely reasonable, when teased out a bit don’t make any sense.
It sounds perfectly reasonable to suggest that free-spending teenagers should learn the value of thrift. If you have teenage children, you might regularly tell them not to spend so much. You may threaten to cut off the supply of your cash to them. You might often tell them to go out and get a job. Or you might suggest that they save more.
So you tell them to reduce spending or increase savings. Do you ever urge them to reduce their income?
I didn’t think so.
Now consider the following. What is good for the individual might not be good for the collective. When you start to save to balance your books, that is good for you. But if everyone stops spending in order to balance everyone’s books at the same time, that is not good for everyone.
The reason is not hard to grasp. It is the paradox of aggregation. It begins with one of the basic rules of economics, which is that the vast majority of employed Irish people are employed in the domestic sector. This means that we buy and sell stuff to one another. This implies a golden rule, which many business people fail to grasp: your spending is my income and my spending is your income.
And then one more rule holds, which is that my income is the font of my savings. If my savings are the barometer of my prudential housekeeping, I need to have income out of which to save. But if I have no income because you are not spending, then I have no savings. And if I have no income and therefore no spending power, then ultimately you have no income and so on.
This is the paradox of aggregation: what is good for the individual is not necessarily good for the collective. This leads to another paradox, the paradox of thrift. The paradox of thrift means if we save at different times and spend at different times, then we can keep the income and spending channel open. But if we all save at the same time, then no one has income and we all suffer.
This distinction between the individual and the collective goes to the heart of macroeconomics and it shows why the business world view, which is looking at one balance sheet, is not that clever when it comes to looking at millions of balance sheets.
Now think of the fiscal treaty. The fiscal treaty says that the governments of all European countries should balance their books simultaneously, which sounds reasonable.
But now look at the fact that, with the exception of Germany, economic activity in every European country is weakening, and yesterday the OECD downgraded growth forecasts for all countries bar Germany. Slowing growth is a reflection of the private sector stopping spending and trying to balance our books.
But if we are saving and the Government is forced by law to save too, who will spend? And if no one spends, what happens to everyone’s income? And if everyone’s income is falling, what happens to austerity targets, which are expressed in terms of debt to income? As debt is expressed as a percentage of income, and income is falling while debt is fixed, it means the ratio is getting bigger rather than smaller.
Now let’s go from the teenage kids to my 10-year-old, who is learning fractions. Once he grasps the idea of a numerator and a denominator, he can maybe tell the business person what happens when the numerator is getting smaller faster than the denominator.
The denominator is the bit of the fraction below the line. The fraction gets bigger. So if the numerator (income) is getting smaller faster than the debt (the denominator), the fraction is getting bigger and you are missing your targets.
A recession is actually too much saving. I know it sounds strange, but that’s what it is.
The fiscal treaty will therefore deepen the European recession, which is the result of too much private sector saving as people are scared about their future employment and income prospects, so they save.
This is why austerity without debt forgiveness can’t work. School kids could figure this out. It also explains why what is good for the individual is not necessarily good for the collective and explains why everyone saving at the same time is good for no one.
This is why the fiscal treaty is Kamikaze economics for most of Europe, it is designed to suit the Germans’ short-term political interests and has nothing to do with macroeconomics as we know it.
As for the business people, they are right about economists sometimes. But other times they should stick to accountancy; economics uses a different part of the brain.
Good morning David, Effective essay in bridging macroeconomics to financial management. Most people in their heart of hearts would acknowledge, if asked, would agree with your thesis. However, Ireland, Italy and others need to regain competitiveness and this can only be achieved through lower government incomes (or costs) as lower government effective income drives prices of labour, services and goods down. This is good as lower costs will render Ireland more competitive versus all. As well, lower spending forces the State out of sectors in the economy and everyday life where the private and non-for-profit sectors can deliver at lower… Read more »
I think there is a difference in views between Business views as represented by IBEC and those on the ground with small mid size domestic businesses. But I agree fully when people talk on behalf of business they do see an economy as company p & L and Balance Sheet and that is fundamentally wrong. That is why IBEC have not made a right call any time recently from Benchmarking to now.
The problem to solve is the German politics. Is this likely or even possible?
subscribe.
I am begining to think the entire EU is in a longer term Kamikaze drive. Youth unemployment in several countries is reaching critical levels. Especially amongst urban males, who are most liable to wreck things the most. The entire policy framework is failing. For the sake of comparison, Europe should be looking at how the Asians coped with the 1998 liquidity, asset crash, banking crisis. The entire political establishment has contructed a role for itself in protecting those who resource the political system with resources, at the expense of those who resource the state system. The entire system is dysfunctional.… Read more »
The EU is trying to regulate a sense of responsibility into the subjects, while at the same time promising the subjects that Europe will take responsibility, and at the same time making sure that the EU will never be made responsible. The word that strikes fear into the EU, from top to bottom -> responsibility. Plenty of response, and no understanding of responsibility. Everybody is convinced that somebody else will accept responsibility. This is adolescent, and it at the heart of the Europe’s intellectual culture of denial. Construct loads of fairytales, with fairytale endings and then believe in it. It… Read more »
Excellent article. Especially in the light of this organised campaign by the government to round up establishment figures from the world of business (and worse still – sports people,musicians and celebrities) under this “Alliance for Ireland” banner urging us to vote for this new treaty – something they cant possibly comprehend.
+1 Adam re Deco – He should have his own newspaper column.
Deco’s comments are the first ones I read on this site.
At the heart of this matter is the mistaken belief that balancing budgets equals structural change. It is a real accountants approach and hence is obviously the advise being proffered by the big four. However anyone that has ever worked in change management will know you need to carry out your structural changes first and then look to balance your budgets over the mid to long term. If Spain were for instance to achieve audit book compliance without any impact on the huge unemployment, it just creates social upheavel and the certainty that the books are only balanced in the… Read more »
No offence Gizzy, but “Change management” sounds like one those awful buzzwords spouted by someone infused with (to paraphrase Deco) “The Morally and intellectually bankrupt IRISH concept of management.
No thanks.
Housekeeper economics might work for business and housekeepers and like housekeepers businesses want a full larder before they holiday Angela Markel needs to holiday with next’s month mortgage money otherwise business owners in the west will not be able to buy the hottest BMW and Angela’s larder will empty but austerity is relative thing and if it continues the Chinese will be seeing lots of made in Europe (Germany ) stickers on their goods this may be a subtext of German austerity and like the Chinese now we may not be able to afford our own goods. David! Henry ford… Read more »
David said “A recession is actually too much saving. I know it sounds strange, but that’s what it is”.
I don’t accept that, doesn’t increased savings lead to more Capital formation for business?
Isn’t savings just delayed spending?
The good news is that a precedent has been set in the Lisbon treaty so if a yes vote is carried we can all ways have a second referendum the instability treaty Mark 2
I’m fairly sure debt should be the numerator and income the denominator, you have it the other way around. To express debt as a % of income it should be (Debt/Income) X 100, not (Income/Debt)! Your point is valid though. “So if the numerator (income) is getting smaller faster than the debt (the denominator), the fraction is getting bigger and you are missing your targets.” Wrong! 1. if the numerator gets smaller faster than denominator, the fraction get smaller, not bigger. 2. you should have debt as numerator and income as denominator, which would validate your point that reducing income… Read more »
The treaty is not a final step. It is part of the process of baby steps to full fiscal union.
Excellent piece David. A much more technical look at this issue covered in this paper that makes very solid point. I don’t want to be too cruel but I suspect you were watching the Frontline the other night with some emminent business people. “…What Ireland has not signed up to however, is a regime whereby the overall net benefit of a single currency entity flows disproportionately within that entity. Once this sort of “rent-seeking” begins within the EZ, smaller nations like Ireland will always suffer at the hands of economically more powerful countries like Germany or France.” It seems to… Read more »
Sorry forgot to post link to that article I just referred to…
http://www.acassconsult.com/attachments/File/Acass_Economic_Monitor_-_February_2012.pdf
good article but i think the numerator and denominator in the debt/gdp discussion got mixed up!
“A recession is actually too much saving. I know it sounds strange, but that’s what it is”
Can we get that in flashing neon lights floating across every parliament in Europe?
Who was the hysterical woman on Vincent Browne last night? Joan Burton’s sister?
The calibre of Irish public debate is truly frightening and the clips featuring Enda Kenny were “OMG!”. I still can not fathom why the people voted for him.
Well, I do. But that is equally frightening.
I have difficulties with this line or argument. The argument is that it is up to the state, and people, to maintain demand during downturns, but increasing it’s levels of debt. This is full of all sorts of implied assumptions. For a start, since it never comes with any form of qualification, it assumes that it will work for all economies, what ever their situation. For an economy that has been increasing it’s total debt levels, every year, for decades, it is unlikely that simply increasing them further will have any different effect. This really is an instance of Einstein’s… Read more »
Hello David. What would happen if we vote no to the Treaty and we need funding from the ESM at the end of the year. Do you see the EU panicking and renegotiating our debt in order to facilitate a second vote for yes before the year end? Is this the game of poker you are referring to?
Hi David,
There is possibly a total Irish savings sum of 100-300 billion euro (from what I hear). How can this be mobilised to change the nonsense we’re mired in? GF
A few years ago, I traded in the auld banger for a new Renault during the scrappage scheme. David seems to be saying that it would be good for the economy if I, and others like me, used whatever money I’d saved since then, to trade in the Renault, and get a brand new 2012 plate. If we all were to do it, the savings glut would be freed up, and the economy would take off. Thing is, when I bought the Renault, where did the money go? Well apart from the dealers and importers cut, the rest of the… Read more »
There are of course situations in which borrow and spend would work: For example, if we copied the post war German or Japanese model of directed development. Another would be to copy the ideas behind the results of the US ‘Sputnik scare’ (http://en.wikipedia.org/wiki/Sputnik_crisis) – the funding of science and engineering students and courses. As a direct result, by the early-mid 1960s the US was full of recently graduates in bewildering array of state-of-the-art science and engineering disciplines. Both of these used carrot and stick approaches. In modern terms this would include taxing property speculation to death, making emigration for recent… Read more »
Thank you David +1, Deco +1, and Lord Jimbo +1 for light on the subject of income, spending and macroeconomics. There are several elements that need resolution. 1 – Government Spending to be not greater than Government Income. 2 – The Irish Currency to have the ability to regulate itself 1 – Spending less than you earn, it seems right on a microeconomic level. It helps me at the end of my month. But I am sure I understand the consequences of taking such a guideline to the Government finances? If the Minister for Finance set out a Budget (and… Read more »
It is possible to achieve the correct levels of saving and spending in an economy at the same time. It is possible to stimulate the economy without creating any new debt. It is possible to shrink the deficit and balance the books without austerity. It is possible to have a sustainable economic model which ends the cycle of booms and busts, of stimulus and then austerity. What is required is creative thinking, not creative accounting.
Here’s how – https://sites.google.com/site/equitablesovereignfund/
Follow us on Twitter @TheESF
While the fact is clear that cutting government spending is further damaging our economy, the fact is not clear that doing so is worse than increasing borrowing to increase government spending. We have a very inefficient use of public money in this country and it is not sustainable, any effort to cut our cloth to fit our table is necessary and welcome so long as the most vulnerable are the most protected from such an exercise. The negative aggregate effect of course cannot be denied so would it be best to cut current spending to balance the books asap but… Read more »
Alot of “business” people in Ireland realise that their business does not have much of a chance without government payola and although preaching fiscal rectitude are really motivate by the immediate benefit of government fiscal excess. Prices in many markets in which the state is a large customer are artificially suspended as a result of government excess, the sustainable business’s are those who are not dependent directly or indirectly on government excess, to be fair Michael O’leary is operating one and yet he appears to advocate a yes vote.
So what is the source of all the income and spending? How does Ireland or the EU create money, this video made me think about it.
– A small portion by the Treasury (3%)
– By far the majority by Commercial Banks (97%)
http://www.youtube.com/watch?v=d3mfkD6Ky5o&feature=player_embedded
Here is a video explaining some small print in the ESM that none of the YES crowd are mentioning. On #VINB last night Ganley tried to explain to the YES people that there will not be enough money in the ESM to save all the Banks in Europe ( the fund starts at €700b of which we have to fork out €11b based on our population and then the ESM will have the LEGAL POWER to force all the governments in Europe to TOP UP (No Limit) the fund ANYTIME the fund managers(immune from prosecution)decide and we have the luxury… Read more »
“Let’s just address the most basic proposition of the business people about the fiscal deficit and what the country needs to do to right itself. The favourite line of all business people is that the Government needs to balance its books” Confusing and lacking punch sir. Took three readings to get the point. You are maybe tired but your senitments are honourable. I would put it like this … Let’s home in on the wisdom of ‘business people’ offering ‘budgetary advice’ to the Irish government in the aftermath of the upcoming Stability (Austerity) Treaty referendum. Running a country involves far… Read more »
The one thing that bothers me about this whole fiscal treaty is this. Spending other peoples money is what politicians do. It’s all they know… well, that and teaching kids. Redistributing our money is how they survive in their careers. And now they’re asking us to limit their spending. It’s all very strange.
“If we can just balance our books, through cutting spending and raising taxes, all would be grand. Let’s just examine whether this is actually true.” I don’t know what business circle you’re associated with, but most business people that I know are fully aware that balancing the books is not an answer to our problems. All are fully aware of the concept of anti-cyclical investment or stimulus as it’s commonly called. The problem is that there is already a stimulus in play, in the form of borrowings for excessive public sector pay, but most of it is finding its way… Read more »
[…] a budget deficit is not necessarily a bad thing and, as David McWilliams points out in this piece: if everyone and everything is balancing their budget at the same time, that’s a recipe for […]
Couldn’t leave this article without posting. The idea that business thinking doesn’t go with macroeconomic thinking is something I have been saying (in my own head) for the last few years. In recessions, businesses cut wages, cut jobs, cut costs, all in the name of getting back on good terms. For a single business, that is fine in that it works for them to keep the business afloat. What the business people seem to ignore is that, this action of “austerity” on the business, while it greatly improves efficiency, leaves former workers looking for jobs elsewhere and a lower total… Read more »
“my income is the font of my savings”
As in beer font. Or are we talking Times New Roman or Arial bold
I prefer the thought of a beer font filling my jerry can until the tap runs well dry pal
I’m going back to Houston …
Joe Higgins TD Socialist Party/United Left Alliance said: “Its a threat a day now by the Government and proponents of the ‘Yes’ Campaign for the Austerity Treaty. The Minister for Finance using an opinion of the NTMA about not being able to borrow in the money markets and by business organisation IBEC threatening higher electricity and gas bills are the two latest threats. It is reprehensible that the right of the Irish people to vote freely is traduced in such a crude manner. As I said in the Dail this morning on the Order of Business, just about the only… Read more »
How much money is wasted in this country.
How much money are we over charged every day .
How many are over payed,now add all this to who ruined this country FF,LAB FG these three should unite into one party.
I left out the greens because they are the only ones to be got rid of so far.
When I read the above I feel sick ,if this was the uk how many. Would be in prison by now..we might be in recession but rip of Ireland is alive and well.
[…] […]
European situation spinning out of control: Why we need “Plan B” now. Money will disappear so we need a Credit System. Monetarism will actually vanish. The “Austrians” are really agitated. Of course DMcW is right, but when does anyone try Kamikazi? When certain defeat is inevitable as the historic reference clearly shows. Remember the films of pilots taking a last Saki, never to be seen again? Sepuku is a better motif – rip ones self apart to prove loyalty to the Samurai. Roman “falling on the sword pales by comparison. I think Ireland does not have this tradition – some… Read more »
David your article is classical Keynesian thinking but I am afraid it is too late in this cycle of excessive debt to apply any more stimulus. When debt levels are low stimulus does have a strong effect on an economy but with the current levels of unsustainable debt, not just in Europe, but throughout the world such stimulus will have little if any effect. We are gone well past the stage of a “liquidity trap” and are now at the stage of an “insolvency trap” which no amount of new liquidity is going to solve. The main European banks are… Read more »
“A recession is actually too much saving. I know it sounds strange, but that’s what it is.” well a boom is too much debt! enslavement by the globalist banksters. The world economy is being destroyed by design by the elites. VOTE NO as I believe David is also advocating (thanks!), but not for the same reason Too many people are dependent on “money” magic-ed into existence out of thin air by the globalist bankers. They are Satanic, and voting Yes is making a pact with the devil. It’s time for people to stand on their own 2 feet and wean… Read more »
Buying metal or stones is buying things and the money spent to buy stuff goes where. For the average person gold is not useful practical try go to a local shop to buy a pint of milk with a ounce gold in your leather satchel (man bag) but yes I think that if money is used for transactions then that money should exist and even when borrowing money to pay for a HOME that money should exist and should be seen and physical handed to the vendor, speculation can then not exist. The money we owe never existed and nor… Read more »
A recession is too much saving as David puts it. This is true. It can feel like there’s less money during a recession because people save rather than spend. However, as well as this there actually is less money during a recession. The reason for this is once you repay a loan to a bank the money doesn’t exist anymore. It may sound strange but as you repay your mortgage, your current account balance goes down, and no-one else’s goes up. In this way banks delete money through loan repayments. Hence reducing debts to the banks may sound like a… Read more »
I don’t think that the fiscal treaty matters much in the grand scale of the European crisis . How much longer can the Euro hold together ? When Greece goes or is kicked out the markets attention will turn to Spain , Italy , Portugal and Ireland . France is not looking to hot either . http://www.cnn.com/2012/05/21/opinion/frum-euro-crisis/index.html They say Spain to both too big to fail and too big to save . There is a scarey piece in that CNN article about How Spain was second only to the US in Securitizating debt ? Who owns that debt now ?… Read more »
“Just because you run a business does not mean you understand how the economy works.” Or you may understand how the political economy works, all too well. Business at the top of the pyramid, is very different from business at street level. I heard the head of the Dublin Chamber of Commerce debate the head of the Irish Commercial Tenants Association recently. John Corcoran of ICTA is a shop keeper on the ground floor of the real economy of wealth production, and delivery of services. The other fellow was a director of Greencore. Greencore: formerly the Irish Sugar Company, which… Read more »
Perhaps Enda and the boys have an inkling of this and have gone “kamikaze” spare. A “treaty” will not stop this, like all the bailouts so far. The Euro Is Crumbling; British Empire Prepares War-Style Measures May 24, 2012 (LPAC)–While the G-8 meeting on May 18 19 and the Eurozone heads-of-state summit on May 23 were piously promising to prevent Greece from exiting the euro-zone, quiet war-style preparations were already underway by the British to deal with the exact opposite situation: the financial tidal wave that will be unleashed across Europe when Greece is either forced, or chooses, to quit… Read more »
Landbank CEO: “The Euro Was a Big Mistake From The Start” May 24, 2012 (EIRNS)–In an interview with the Sueddeutsche Zeitung today, Ludwig Poullain (92), eminence grise of traditional banking in Germany and former CEO of Westdeutsche Landesbank, said the question is not even whether the collapse of the euro can no longer be prevented: “Rather, was the introduction of the euro a not big mistake? After all, it was designed as a factor of integration. And now, it has had the exact opposite effect. Is there a European identity any longer?” Poullain adds that he not only thinks the… Read more »
Here is the latest article from Frédéric Lordon who belongs to a group in France know as the ‘ aghast economists’,:
http://blog.mondediplo.net/2012-05-24-Euro-terminus
It’s in French and again Google translation is hopeless.