At the end of the day, economics is all about choice. Or, in the jargon of the economics profession itself, about "opportunity cost"
At the end of the day, economics is all about choice. Or, in the jargon of the economics profession itself, about "opportunity cost". By choosing one course of action, we are intentionally or otherwise avoiding other courses of action. Of course, we don't always like to admit this. Most politicians, for example, like to claim that we can all end up being better off, with no one having to make any serious sacrifices. Yet, in reality, this is a distinctly hollow promise. It's true that economies do expand and, on this basis alone, we end up collectively richer than before. But, if one group in society wants to make rapid gains, this is only likely to happen at the expense of others.
Most of the time, we allow the market to determine our choices. The price mechanism acts as an "invisible hand", allocating resources to where society - or, at least, individuals collectively - value them most. If the price mechanism works efficiently - and, yes, it's a big "if" - we know that buying three more guns will cost us a certain amount of foregone butter. When the price mechanism doesn't work, or where we think the results of the invisible hand are somehow "unfair", governments may step in to "make the world a better place".
Of course, governments come into power for all sorts of reasons. Some fundamentalist regimes may not give two figs for economic well-being. Most governments, though, are judged, at least in part, on the back of perceived economic success (and, let's face it, the capitalist versus communist debate that dominated the 20th century was a story about the relative merits of competing economic systems.)
It's no surprise, then, that many politicians make exaggerated claims about their economic powers. Sometimes, politicians are lucky: circumstances dictate that they can achieve a lot more than might be reasonable to expect. Sometime, though, they get the short straw: circumstances beyond their control leave them doomed to be no more than footnotes in economic history.
Government choices vary. Sometimes, choices have to be made between different groups of existing voters. On other occasions, choices are made between existing and future voters. This distinction is very important. A good way to demonstrate this lies in the varying fiscal experiences of the UK, the US and the eurozone.
Those who follow the eurozone debate closely know very well that most eurozone countries are constrained by the rules of the Stability Pact. Countries have only been able to think about who, today, should be taxed and who, today, should benefit from public spending. The major countries - Germany, France and Italy - have reached the point where they cannot easily increase their government borrowing any further. In effect, this means that fiscal action today involves either taking away from today's voters and giving to tomorrow's (reducing government borrowing, embarking on pension reform) or redistributing the benefits of the public purse between different groups of current voters.
Up until now, neither the UK nor the US have faced the same constraints. Chancellor Gordon Brown has been happy to allow the fiscal position to shift from surplus into deficit. The same has been true of the US Administration. As the left hand chart shows, the budgetary changes in both the UK and the US have been much bigger than those in the eurozone "Big 3".
Of course, both the UK and the US regard the deterioration in their fiscal positions as being no more than temporary, a trick of the economic cycle. When their economies recover, tax revenues will rise and spending commitments will die down, thereby automatically ensuring that fiscal positions will return to broad balance across the economic cycle as a whole.
To date, though, none of us have cared very much about whether this fiscal deterioration is temporary or permanent. There are two reasons for this. First, corporate de-leveraging over the last three years meant that there was no great competition for funds. As a result, interest rates were not driven sky-high by additional government borrowing, thereby pushing the traditional "crowding out" debate off the agenda. Second, by shifting from surplus into deficit, today's voters have gained at the expense of tomorrow's: and, if our debt-fuelled society has taught us anything, we're happy to make these "short-term" choices. Jam today even if we end up in a pickle tomorrow.
This works well only up to a certain point. Either a government will eventually borrow so much that it will bump into its own self-imposed fiscal constraints (in the UK's case, the so-called "golden rule") or the market will impose its own constraints through higher bond yields (arguably, and very tentatively, a process that may already have begun in the US and, hence, for the world as a whole).
With the golden rule now becoming a serious constraint, the Chancellor knows very well that he cannot credibly continue to increase borrowing. He also knows that there's a limit beyond which he cannot go on higher tax revenues. This is partly a problem of forecasting failure. The increase in government revenues in the late 1990s was partly the result of windfall gains associated with the technology boom that, sadly for Mr Brown, have simply not been sustained. So even if he hiked taxes left, right and centre, he would still find himself rather short-changed relative to his earlier revenue expectations.
The combination of the golden rule and the tax shortfall have forced Mr Brown to confront more difficult issues. No longer can he pretend that investment in education, health and transport are almost for free - or, at least, that the cost of this investment can be recouped some years down the road. Instead, he is having to make the difficult choices. Want more education? Better health? Then have fewer civil servants, less bureaucracy, more efficiency.
At this point, though, life gets tough. My right hand chart shows public spending as a share of GDP in the UK, the US, France and Germany since 2000, the year in which the shackles came off public spending in the UK following Labour's earlier commitment to the previous Tory administration's spending plans. Although public spending as a share of GDP is a lot lower in the UK than in other European countries, the UK's rate of increase has been greater in the last three or four years.
The UK's spending increases have, so far, been funded mostly through higher borrowing. If this funding option is now being cut off, the UK government will, first, not be able to increase public spending any further without having to resort to higher taxes and, second, will increasingly have to make different choices between existing spending commitments. In the next year or so, we really will know whether the Chancellor has iron in his soul. It is easy to increase spending in some areas when you don't have to take money away from others. It is a lot more difficult to increase spending in some areas when others directly lose out. The Government doubtless will claim that resistance is futile. We will soon find out, though, whether the Government's choices really can overrule the self-interest of groups within the public sector. Failure to do so will lead us into the fiscal quagmire that has bogged down European policy makers for most of the last 10 years.
Stephen King is managing director of economics at HSBC