Not all government spending is equal
Spending on people generates the most economic growth
Published in the June 30th, 2024, edition of The National.
I’ve written that every pound government spends on healthcare generates £4 of economic activity. This is the multiplier effect, a concept articulated by John Maynard Keynes in his 1935 book, The General Theory of Employment, Interest and Money, and is taught to every economics student.
It measures how much economic activity results from an increase in government spending. If the multiplier is >1, the additional spending stimulated a larger increase in income than the original amount. Conversely, if it’s <1, the additional spending caused income to fall.
Suppose the government spends £1 more on a nurse. After tax, the nurse is left with about 67 pence. If that money is saved in a bank, it won’t generate any economic benefit because banks don’t lend out other people’s savings but create the money they lend out of thin air. And because nearly half of people in the UK have £1,000 or less in savings and a quarter have less than £200, it’s likely the nurse will spend any extra income.
That spending becomes someone else’s income on which tax will be paid. If the nurse buys something in a store, the owner and staff receive income and pay tax on that income and the nurse pays VAT. The people who supplied the goods to the shop also receive income which they then spend and pay tax on, etc. The cycle continues with the amount of the extra £1 of government spending becoming smaller as it works its way through the economy.
Two things have happened. First, the nurse’s extra 67p becomes additional income for many more people. Second, it becomes additional tax revenue for the government since it’s taxed at each stage. But has a politician ever admitted that when government spends more, it also collects more in tax?
New spending can pay for itself out of new taxes paid. But it depends on what the government spends money on. It’s the ‘Guns vs Butter’ model, which describes the tradeoffs governments face in deciding to spend on defence versus social programmes. If it spends more on ‘butter,’ e.g., healthcare, then there’s a significant net gain to the economy. Not only are healthcare workers employed, but the nation’s health improves. If, however, it spends more money on guns, e.g., defence, the multiplier is 0.6. And if the money goes on nuclear weapons, it’s negative. That’s because there’s no ‘market’ for nuclear weapons - the hope is that they’ll never be used. They’re a ‘sunk cost’ that is lost forever to the productive economy.
Yet that sunk cost is rising globally. Spending on nuclear weapons rose 13.4% in 2023. The US led with an 18% annual increase. The UK was second at 17.1%. Recently, Rishi Sunak pledged to increase defence spending to 2.5% of GDP (£75 billion over six years) making the UK the second largest defence spender in NATO. Keir Starmer has made the same pledge.
Empirical evidence shows that when governments spend money to meet their people’s needs for health, education, housing, energy, jobs and transport, the multipliers are significantly >1. This makes intuitive sense but it’s remarkable that the Tories or English Labour haven’t made the connection that spending on one’s people is the best possible investment a government can make.
Instead, the UK government has slashed public spending, worsening inequality and poverty. Public sector employment has fallen from 22% in 2009 to 18% in 2024. And don’t expect any change under English Labour. Rachel Reeves claims that the private sector is the “lifeblood of economic growth”, Wes Streeting says the NHS needs more privatisation, and Kezia Dugdale warns that English Labour may have to scrap free tuition in Scotland.
It comes down to what kind of society we want in Scotland. If we’re happy remaining under Westminster rule, then by all means, let’s stay in the failing UK. But if we believe we should run our own affairs and invest in our people so that they can have a better life, then we have no choice but to terminate the union.