Can government spending really help the recovery

It is the turn of the Labour Party to have their conference this week and opposition parties generally have a free hit at the government.

The Shadow Chancellor, Ed Balls, used his speech to suggest that the government should spend more money (£4 billion) on building new houses and giving a tax break to first time house buyers to try and boost economic activity.

This is standard Keynesian stuff. The government spends more money to boost Aggregate Demand. The multiplier effect then raises national income and employment by even more than that. Balls claims it will 'kick start' the economy.

It's good politics, but not really believable as economic policy. The government is already spending far more than it raises (around £170 billion) to boost Aggregate Demand. Although using government spending on construction keeps a lot of the spending local at first the multiplier is very low (maybe 1.25?) and so it might raise GDP by £5billion if its new money.

The biggest hole in the Balls argument is how it would be funded. According to him Labour would use the money raised from the auction of 4G licences by the mobile phone companies. That money has already been earmarked for use so actually it would be financed by more borrowing.

The argument about how much to stimulate the economy will go on for ever. See what you think of the Balls plan.

The Independent report the policy proposal here

Chinese have been reading the Development textbooks

One of the pieces of advice given to Less Developed Countries (LDC's) by the 'First World' in the 1960's was to invest in 'leading sectors'. This was based on the view that certain sectors have high second round effects and so a high multiplier value.

While this advice was largely ineffective, and in many cases disastrous, the idea of government intervention and 'unbalanced growth' to kick start under developed economies has remained in the literature. Clearly the Chinese have read about it as they now wish to invest in British infrastructure in order to help boost economic growth.

The Chinese are, of course, acting in their own best interests. They need Europe to grow so they can buy more Chinese goods. They also need somewhere to invest their considerable wealth. They have established 'sovereign wealth funds' to do this, a very sensible move as China cannot possibly use all the profits currently earned by their exports.

There are several ideas to explore here. Will there really be a big multiplier effect as a result of the proposed new investment? Is this the golden goose the Public Private Partnership programme has been looking for (it has totally failed to attract significant private funds for nearly ten years)? Are sovereign wealth funds a good idea? And of course how long has China considered the UK an LDC?

Whatever the answers it is clear that old copies of Todaro have a ready market in China.

The BBC cover the story here