Wednesday, 26 March 2014

Who Is The Chancellor Trying To Kid?

As I've explained before on this Blog, the notion of linking a CEO's pay to a company's market value is not a very reliable measure of the CEO's performance. Suppose a CEO receives a £2 bonus for every £200 increase in the market value of the company. That would be a more watertight system if the CEO was responsible for every pound of that £200. But that's not the case; a CEO of an oil company, an energy company, a steel company, or a timber company is not responsible for the fluctuations in the global demand for those raw materials, nor the global supply, nor the price of other raw materials linked to the production of the products. Consequently, a CEO who claimed he was responsible for his Timber company's 300% increase in market value would be being very flexible with the truth.

Anyone who understands economics would know this. I think George Osborne understands at least the basics of economics - which means he also probably understands that many of his claims of success in the recent Budget are also as specious as those of our aforementioned Timber company's CEO.

When George Osborne talks about his successes in relation to economic growth and lower unemployment (his two favourites) he is simply listing facts that are largely beyond his control and taking credit for them. Increased economic growth and increased employment are going on while George Osborne is chancellor, but they are going on in spite of his being chancellor not because of it. To take credit for this is to commit a fallacy called the cum hoc ergo propter hoc fallacy, which is a with event x therefore y causative fallacy.

I'm sure George Osborne knows how little Chancellors actually control the economy - so in taking credit for events that are beyond his causal power he must hope that enough people won't notice and will give him largely underserved credit. Also, let's not forget - taking credit for success stories gives them the ability to blame the opposition for unsuccessful outcomes in their past legacies.

In recent decades, the three principal causes for the UK's economic growth have been:

1) The flexibility of our market economy and the embracing of free market trade.

That was largely thanks to Margaret Thatcher's government and their pro-privatisation and deregulation reforms, as well as dealing with stultifying unions choking the British economy and inefficient British businesses that were being artificially propped up.

2) The prudent use of interest rates to manage demand at a domestic level.

That was due in no small part to our no longer being subservient to the Exchange Rate Mechanism.

3) The increased demand (and prices) for the knowledge-based services we provided throughout the world in a transition away from such large-scale manufacturing.

This was due to globalisation and the ability to capitalise on specialisation. Incidentally, when UK folk lament the loss of manufactured goods in this country, they often overlook the fact that we are still huge manufacturers - it's just that our production is not so much about goods anymore, it is much more service-oriented.

Once the Thatcher reforms were in place, and once we escaped the thrall of the ERM (both Conservative initiatives), future Chancellors like George Osborne were set up with a large box of cigars.

With that in mind we return back to George Osborne's Budget. The economy is getting better, but economies do - they fluctuate, largely independent of Osborne's initiatives. Here's an analogy. At the moment I feel really ill - I have a sore throat, I'm full of cold and I am continually coughing. Suppose I tell George Osborne that I'm going to take a couple of weeks off work and have lots of rest. Osborne says "No, that won't make you better - have some of my magic baked beans, they will make you feel better". I take them every day, but I still decide the rest will do me good. In a week or so I begin to feel better, and on seeing the improvement George Osborne tells me that it was my taking the magic beans that made me better, not the rest. Just as anyone who understands sore throats, colds and coughs knows that the rest would have made me better anyway without the beans - anyone who understands economies understands that global demand and global supply at both short-term and long-term levels are the decider of economies, not Chancellors. Chancellors do not exactly do 'nothing', but they also should understand that the national well-being is largely beyond their scope.

The same is true of employment - governments don't do 'nothing' - but they don't have much of a long-term effect on employment. It is easy to temporarily lower the unemployment level (apprenticeships and renaming statuses are two good ways), but if demand exceeds supply in the labour market, the successes will fluctuate and usually be short-lived.

The next time you see a politician taking credit for economic growth, be sure to scoff. And remember that exclaiming a strong causal link between the state of the economy and the performance of the government has a two-way effect - you can attempt to take unjust credit for good outcomes when you're in government, but you can also attempt to discredit previous governments by laying all the bad outcomes at their door. I'd advise that both should be undertaken with very sober judgement.  

* Photo courtesy of