It's not about money

It's not about money

It’s being reported that the government is looking for ways to tackle the cost of living crisis “without spending any additional taxpayers' money.” This is the sort of nonsense we get if we think of economics as being about money rather than real resources.

Economists have traditionally distinguished between real and nominal activity. When I buy a guitar for example I am getting the skill, effort and materials that went into making it, while I am giving up the time taken to write the articles that earned me the ability to pay for the guitar (or, if you prefer, the ability to buy the things I could have afforded had I not bought the guitar). What’s going on is an exchange of real resources. The price of the guitar is the nominal form this exchange takes.

The cost of living crisis is a real problem, not a nominal one. The fact that wages have not kept pace with inflation means that workers must make real sacrifices. They must either cut their spending now or save less and so forego future consumption. The same is true of benefit recipients and those with cash savings. The choice for many of heating or eating is a real one.

Another real problem is that high prices of oil and gas are a transfer of resources from potentially dynamic parts of the economy – from companies and people that could invest and innovate – to rentiers, who owe their income to owning gas and oil fields. As David Ricardo warned two centuries ago, this sort of transfer can kill off economic growth.

Prices are merely a measure of these real problems, but they are not the issue. How fast I can cycle is determined by the brute reality of my limited strength and fitness, not by how many yards there are in a mile or whether I measure distance in miles or kilometres. Much the same is true in economics: money is just a measure; constraints are real.

All of which means that measures to alleviate these problems must involve shifts of real resources. The proposal to scrap annual MOTs transfers real resources from garages to owners of old cars, for example. The same is true of less absurd proposals. Capping energy prices would prevent a transfer of real resources from customers to utility companies, and a windfall tax would be a transfer from energy companies to whoever benefits from how the government spends its proceeds.

A more complicated case is that of government borrowing to increase demand. When there are unemployed resources this increases the size of the economic pie, meaning there is potentially more for everyone. When there are not, it raises inflation, but this too often entails real resource transfers, to beneficiaries of rising prices from losers – those who lack the bargaining power to ensure their incomes rise as much as prices. (The issue of whether government borrowing is inflationary or not is an empirical one, not a theoretical one.)

One of the downsides of decades of even mild inflation is that all of this is often forgotten, so that non-economists especially think too much about money and not about what underlies it, which is transfers of real things. Money, as 19th century economists knew, can be a veil, a barrier to seeing the truth.

And the truth is that unless there are ways of growing the economic pie then what’s at stake in the cost of living crisis is the question: who wins and who loses? Rishi Sunak has made his choices.

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