Business Life: Macromaths
First published in Business Life, February 2009
I was recently invited onto a prestigious radio program to debate a provocative idea: perhaps we should stop giving money to charity and instead spend it on the high street to stimulate the economy. I declined.
This is one of those economic ideas that sounds plausible as long as you don’t think too hard about it. The numbers simply don’t add up. Economists are concerned that the recession may consist of a fall in economic growth from about three per cent to zero growth or below. But according to the Johns Hopkins Comparative Nonprofit Sector Project, the British give less than one per cent of their income to charity, far less than a three or four per cent drop in economic output. Economic stimulus is one thing, magic is another.
Not only is the idea daft in practice, it doesn’t even work in theory. Charities spend money too. They buy equipment, rent and maintain offices, and employ staff. There is absolutely no reason that the economy should be stimulated more by shopping than by giving money to a charity and letting the charity shop instead. (I’ll admit that some charities spend a lot of their cash overseas, but the same is true of many high street retailers, whose supplies are often produced abroad.)
Perhaps we put too much faith in the idea that all the economy needs in a recession is a bit of “stimulation”. Sadly, things are rarely so simple. Think of the government “fiscal stimulus” so much in vogue across the world as the recession tightened its grip at the end of the last year. The popular understanding of a fiscal stimulus is that the government cuts taxes, and the grateful citizenry spends the windfall.
That can indeed happen, but it is easy to forget that if government spending doesn’t change, then tax cuts today mean a rise in government borrowing and tax rises tomorrow. In other words, the government is borrowing money in our name and giving us the proceeds; but we’ll have to foot the eventual bill.
Should we really spend more under those circumstances? After all, one logical response would be for taxpayers to save the money (or use it to pay off debt) in readiness for the day when taxes rise and the government asks for the money back.
Economists call this idea “Ricardian equivalence” – an idea dating back two centuries to classical economist David Ricardo – which means that government taxes and government borrowing are roughly equivalent. The taxpayer always picks up the tab in the end.
In the credit crunch, a fiscal stimulus may work after all, for one simple reason: some consumers desperately want to borrow money but the banks won’t lend it to them. But that is not what we usually have in mind when we think of the free lunch that our governments are cooking up for us all.