Bucket Economics

We would all like to see permanent full employment – a productive job for everyone. When I learnt my economics we thought that the way to achieve this was demand management: if demand in one part of the economy fell, the answer was to raise it in another. As resources drain out of the bucket in one place, then fill it up elsewhere.

This bucket model may look simple but it has been hugely influential (perhaps largely on that account) and has been hailed as the encapsulation of the ideas of John Maynard Keynes. The tidy reformulation of his ideas popularised by John Hicks, himself a Nobel prizewinner, gave weight to the proposition that we could understand equilibrium in the macro-economy and hence manage levels of demand to ensure that it was achieved, balancing monetary demand and unemployment using interest rates and fiscal spending.

Unfortunately, the model left out two crucial aspects, even though both had been noticed by Keynes. One is that public sector activity is not a substitute for the private sector. Keynes saw that it was possible to break out of an underemployment equilibrium with public works, but did not see this as a permanent phenomenon. Yet over time, an increasing role for the public sector has ratcheted up as a result, and each time that cuts are proposed, an immediate defence of ‘our jobs’, understandably, springs up. And the public sector is seen to provide ‘good jobs’ – secure, well pensioned and with good holidays. Much less is made of whether they produce anything at all, certainly whether there are increases in productivity as wages rise. Ratcheting up public sector activity as a proportion in downturns and never reducing it as the economy recovers will never produce any pressure for good economic performance.

The other missing element was any consideration of debt. In rereading Keynes, it essentially comes over that borrowing does not really matter because it reflects a real asset. Recent experience has shown not to be true. Debt has to reflect the ability and willingness both to pay it back and to service the interest due. The failure to do this triggered the debt crisis of 2008 when holders of debt realised they the assets against which the debt was held were essentially worthless. And this crisis morphed into a crisis of sovereign debt when the responsibility for managing this debt passed to governments. It is true that governments can force their citizens to pay – it is called taxation – but if this is difficult then they need to find other governments’ citizens from whom to borrow.

In any of these cases, there are real burdens of interest payments to be carried. The only alternative is to default. This is not that unusual, but it plays merry hell with credit ratings later, as you would expect. It can only be achieved by countries where underlying opportunities are very strong. It is unlikely to work for highly developed nations.

These missing features from the bucket model are dynamic, changing the shape of the bucket as we proceed; they are underweighted by the proponents of continued borrowing to prevent a double dip recession.