The importance of public spending in a recession

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It is compulsory for Labour Party members to illustrate any mention of unemployment with a picture of the Jarrow Marchers.

It is compulsory for Labour Party members to illustrate any mention of unemployment with a picture of the Jarrow Marchers.

With the news today that unemployment may top 2m for the first time since 1997, it’s now clear that the recession is well advanced and that the worst may well not be over.

Over the past 18 months, the widely-held notion that both main parties are “just the same” appears to have been blown wide apart: partially, at first, because of the stark sylistic contract between Brown and Cameron, but latterly because of their very different responses to the recession.

The Tories have been urging tax cuts, lower government spending and less borrowing (public and private), while Labour have been bringing forward planned government spending and trying to encourage private spending to keep the economy going.

If we want the recession to be short and shallow, government spending is an important part of the response – in fact, cutting back spending will actively worsen the recession.

The recession – a real terms contraction of the economy – means that businesses are producing less, and so are using fewer resources (in terms of labour and in terms of capital). We’re now at an articicially low level of production, especially because this recession has been caused by internal failures in specific markets rather than a massive shock to demand – even so, recovery after a recession isn’t costless.

This is in part because of the hysteresis effects of recession, on both labour and capital. When these resources go underused during the downturn, they dont’ just get put aside for later use: machinery gets scrapped, factories get demolished, and workers are made unemployed.

Various theories abound as to why there is a “ratchet” effect on unemployment in paticular after a recession: that workers lose touch with the job market, or become ill and unfit to work, or that there is an “insider-outsider” effect where good jobs are kept by those workers who remain in work, and that remaining jobs are insufficiently well paid to encourage unemployed workers back.

Nevertheless, it appears to happen to both capital and labour, the two inputs into production and growth. And if we don’t want to suffer a massive deadweight loss in our national resources, it’s as well for the government to take the strain for a while.

VoteRedGoGreen

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4 Responses to “The importance of public spending in a recession”

  1. Miller 2.0 Says:

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  2. G20 battle lines « Frank Owen’s Paintbrush Says:

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