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Government spending, profits & capitalism

Summary:
Simon Clarke, Chief Secretary to the Treasury, says there has been “something of a philosophical shift” in Tory attitudes to public spending. Which poses the question: why? I’m not sure it is the result of high-falutin and rigorous debate. Instead, I’d suggest something else. To see it, let’s start from the perspective that philosophy follows interests and that the Tory party is emergently intelligent: whilst any individual seems cognitively limited, the party itself has a formidable genius. If these premises are correct, we have a ready explanation for this “philosophical shift”. It’s that the health of capitalism, for now at least, requires big government. This is true in several ways. I’ll focus on just one – that big government spending is necessary to support profits. To see my

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Simon Clarke, Chief Secretary to the Treasury, says there has been “something of a philosophical shift” in Tory attitudes to public spending. Which poses the question: why?

I’m not sure it is the result of high-falutin and rigorous debate. Instead, I’d suggest something else. To see it, let’s start from the perspective that philosophy follows interests and that the Tory party is emergently intelligent: whilst any individual seems cognitively limited, the party itself has a formidable genius.

If these premises are correct, we have a ready explanation for this “philosophical shift”. It’s that the health of capitalism, for now at least, requires big government. This is true in several ways. I’ll focus on just one – that big government spending is necessary to support profits.

To see my point, recall basic national accounts identities. These tell us that GDP is the sum of consumer spending (C), government spending (G), investment (I) and net exports (NX). It’s also the sum of incomes: profits (P), wages (W), other incomes such as those of the self-employed (O), and taxes on production (T). Rearranging these gives us an expression for profits:

P = (C – W) + (I – O) + (G – T) + NX

This just tells us about the circular flow of income. It says that higher wages don’t necessarily cut profits if workers spend those wages. And it tells us that capital spending is good for aggregate profits, as one firm’s outlays are another’s orders. And so on.

This Is an identity, but it helps organize our thinking.

The lockdown of shops and pubs last year forced us to spend less and save more; the household savings rate, which had for years wobbled between 5 and 10% shot above 20%. And even now it’s above 10%. C – W has therefore nosedived (as indeed has investment as projects have been put on hold). Our identity tells us that, on its own, this would have caused a massive drop in corporate profits.

But we saw no such fall, because the government acted. Increased public spending supported the economy and hence profits. We credit such spending with protecting jobs. Which it did: in the absence of such spending, firms would have slashed employment in an effort to protect profits. The point is that capitalism required higher government spending. The “philosophical shift” to big government was therefore necessary to sustain profits. Profcpart

My chart summarizes this, by showing the counterparts in my equation. You can see that in 2020 the C – W element collapsed and G – T rose, the net effect of which was to actually slightly raise the share of profits in GDP.

And here’s the problem: will we return to the pre-pandemic world in which C – W supported profits?

The OBR forecasts (shown in my chart) suggest that we will to a large extent. If foresees the savings ratio falling below 5% by 2024. That would mean a rise in C – W which would tend to support profits even if G – T falls.

This, however, is far from certain. The fact that retail sales have fallen since their post-lockdown bounce in April suggests we’re a long way from our old spendthrift ways. Some of us have fallen into more frugal habits. Others might need to rebuild the savings they ran down last year as their hours and jobs were cut.

Hence the need to avoid large cuts in public spending. Imposing these at a time when the prospects for consumer spending are still uncertain (and capital spending too) would jeopardize profits. Instinctively – emergently – the Tories grasp this. Hence their “philosophical shift.”

But note something else about my chart. It shows that the government sector has for years been a big counterpart to profits, even more so during recessions. In fact, apart from a brief spell in the late 80s, it has far outweighed investment counterpart. This was not always the case. In fact, in the 60s the investment counterpart was bigger.

Now, I stress I’m only talking identities here. Perhaps if the government were to shrink significantly, capital spending would surge and so we’d see sustained profits and a small state. This did not, however, occur during the austerity of the 2010s, perhaps because of what Ben Bernanke way back in 2005 called the “dearth of domestic investment opportunities.” The Tories can be forgiven for not wanting to take this risk. There’s a good reason why there are so few libertarians among business lobbyists.

There is, therefore, perhaps a simple and powerful reason (or certainly justification) for the Tories’ conversion to bigger government: it is what capitalism requires.

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