Are the Tories spending or saving?

On the front page of today's FT is the headline: "Osborne warns of big spending cuts to come".

But in a speech yesterday, he announced 10 measures that should be implemented in the Budget to "kickstart a green recovery". Just his first measure alone - £6,500 energy-efficiency entitlement voucher for every home in Britain - would cost (given that there are around 25 million homes in Britain) over £160 billion. Others of the 10 announced measures would also cost billions of pounds.

That will help reduce the government deficit.

But according to George, the measures will "only" cost £30 billion, "without adding a penny to the national debt".

Three questions:

A. Is the impact positive so long as the government doesn't pay directly?

Before we drill into the fantasy of that costing, let's consider for a moment what it would mean, even if it were true. Is £30 billion harmful if spent directly by government but beneficial if spent by the private sector in response to government incentives?

Let's take that first case, of paying for energy-efficiency measures.

Whether paid for by direct grant or by entitlement funded by energy and finance companies, people would not be as careful about how they spent the money as they would be if they were spending their own. The enormous surge in demand created by this sort of mechanism would drive up the cost of buying and installing the energy-efficiency measures. To the extent that the measures were effective, they would reduce demand, and therefore reduce prices. Lower prices and more efficient houses would tempt people to increase their comfort levels - a well-known economic effect, known as the rebound effect - which would result in domestic energy-consumption settling at a level higher than would be implied by the simplistic assumption that demand would fall by the theoretical, technical contribution of the improvements.

The net effect is that, however paid for, you only get a fraction of the benefit that you expected from the theoretical potential of this sort of proposal. Costs tend to be higher and savings lower than expected. And they weren't expecting much benefit in the first place: £160/year saving on energy bills from an investment of £6,500 is a simple payback period of 40 years and a discounted payback of...  never. Some of the houses won't last that long, let alone the equipment.

If the government simply offered to pay £6,500 towards energy-efficiency upgrades for every house, they would have to raise the money in tax, borrowings, or "quantitative easing" to pay for it. Hopefully, I don't need to explain why all of these would have a strong negative impact on the economy, but I'll post a comment below, just in case.

But would it be any better if the money didn't come from the government? 

In the Tory model, the money is lent by an energy or finance company, effectively mortgaged against the house (the debt goes with the property, which isn't very different to saying that the balance of the debt is repayable when the property is sold, but the value is passed on to the new owner because of the enhancement to the value of the house). Someone has to find the money to lend in the first place, which either takes cash out of other parts of the economy (equivalent to taxation or borrowing), or provides the basis of issue of new credit, resulting in expansion of the broad money supply (equivalent to quantitative easing).

This is a real sub-prime mortgage, because we know from the start that the projected savings are less than the money needed to repay the loan, even spread over a long period. This is effectively state-sponsored mortgage-equity withdrawal, for a purpose that everyone knows is sub-prime. Not only does it push households further into debt, reducing their ability to buy other products that might have given them and the economy a better return, but it provides a drain on the household's resources for many years to come, extending the negative effect into the never-never.

There is no such thing as free money, or painless spending. The Tory way of funding this is marginally better than direct government funding, because the need to recoup the cost from savings provides a spur to efficient behaviour. But this is a marginal difference. All the other negative impacts, of diverting money from more productive to less productive resources, creating a bubble in one sector and a burden on others, are just as great whether it is funded directly by government or indirectly by government fiat.

B. Are the calculations reasonable?

George gets to his figure of £30 billion by allowing £20 billion for these energy-efficiency measures, £5 billion for a high-speed rail link, £3 billion for the 3 carbon-capture and storage demonstration projects, and £2 billion for a roll-out of domestic smart meters. The costs of the other measures are not included, but this is deliberate, because:

"These illustrative figures are deliberately conservative: policies to introduce feed in tariffs, a national electric vehicle recharging network, build an electricity internet, construct an offshore DC cable network and develop marine energy parks will stimulate significant further private sector investment."

In other words, the cost will be higher, but it's not a cost, it's a benefit, because this is "private sector investment" that has been "stimulated" by creating economic distortions to encourage people to do what they otherwise would not choose to do. The higher this figure goes, the greater the stimulus, presumably. Why didn't we think of this before? Our economic woes can be solved by George working out what business ought to do, creating incentives to make them do it, and then waiting for the benefits of the stimulated investment to roll in.

It's the broken-window fallacy again. George has forgotten that the money that is thus diverted would otherwise have been used elsewhere. This is not stimulus, it is diversion. It may be justified if the social benefits outweigh the costs, but it cannot be treated as a gross benefit.

Anyway, what about the figures themselves?

There is a large discrepancy between George's estimate of £20 billion as the cost of the energy-efficiency measures, and the simple calculation of multiplying the entitlement per household (£6,500) by the number of households (25 million) to get a total of £162.5 billion.

The justification for George's figure is that, although every household is entitled to spend this amount, in practice, 1 million households will spend an average of £2,000 per household every year for ten years. No explanation is given for this assumption. We aren't getting, as is implied, £6,500 of improvements to every household for our £20 billion. We are getting £2,000 of improvements to 40% of households (and no improvements to the rest) for our £20 billion.

The paper appears to say that £6,500 of energy-efficient investment yields £160/year of savings, but does not tell us how much savings we could expect from the £2,000 of investments that they budgeted for. Let's be generous and say that the £2,000 will go to the investments that give the most bang for the buck, and allow for £100/year of savings. We can do a fairly simple demonstration of the net effect of these investments, to show that the cash-flow impact on our economy will be negative for the first ten years, with £20 billion pounds of spending yielding £5.5 billion pounds of savings, and thereafter providing a £1 billion annual benefit (ignoring the above reservations).

Cash-flow negative for the first ten years, and a minimal return over a long lifetime.

And this is a stimulus?

C.  Is this really all private-sector investment, without cost to the taxpayer?

One may wonder where the £20 billion of private-sector money for energy-efficiency will come from, and whether energy and financial companies have that amount of excess cash sitting around waiting to be loaned out to clearly loss-making investments, or whether the government would have to at least loosen regulations on capital adequacy, if not funnel some money their way. But let's take that at face-value.

George's claim is that the 10 measures would all be implemented "without adding a penny to the national debt". Of course, one could push up government spending without increasing the national debt, by increasing taxes or printing money, but the clear implication of his speach is that this is a free lunch - we get lots of private sector investment in government goodies without the public sector having to provide anything other than the incentives. Except, when one looks at the details...

The £5 billion of private-sector investment in a new high-speed rail link is "in conjunction with government funding". Of course it is. £5 billion isn't remotely enough for this project. But this won't add to government debt. Presumably the money will be found from the budget somewhere, although the paper is not specific. And if something else is cut, or borrowing is raised to pay for something whose budget would otherwise be cut because the money had gone to this project instead, we won't be able to call that an increase in national debt caused by this project.

The £3 billion of private-sector investment in carbon-captured coal-fired power stations (notice it's for the power-stations, not for the carbon capture part) will be "made possible by government carbon capture and storage projects and networks, funded from the proceeds of the EU ETS." Because (I suppose) the Labour government had missed the revenue stream that would arise from EU-ETS auctions and had left the money just floating around, unallocated in their budgets.

Energy companies will be incentivized to install a national network of electric-car recharging points "by designating electric vehicle recharging points as regulated assets". Aren't lots of us going to have "regulated assets" in our homes, then? Will we have to hand control of the socket in the garage to one of the licensed oligoplists to charge us for use of the regulated facility? So we generate private-sector investment by gratuitously placing a government-created barrier to individual freedom. Well, so long as that doesn't show up on the government's books, that's fine then.

Energy companies will likewise be incentivized to "invest in the creation of an electricity internet", though we don't know how. If they would have done it voluntarily, the Tories can hardly claim credit for it. If they need to be forced or incentivized to do it, someone will have to pay for that, and it's going to be either taxpayers or customers.

"The Government should make it easier for companies to borrow money to invest in green technologies by providing government guarantees for bank loans to environmental technology companies, as part of our proposed National Loans Guarantee Scheme." If the Government guarantees loans, doesn't that mean that the Government carries the liability? That sounds remarkably like increasing the national debt.

"The government should instigate a network of large scale Marine Energy Parks around Britain’s shoreline." That's going to be free is it? Or will the existing incentives be sufficient to provide the necessary support, in which case what are you claiming credit for? For making them all locate in the same place, rather in the place that is most suitable for each of them. Well done.

"Require the National Grid to construct a new network of under-sea Direct Current (DC) cables, which will run like bootlaces down each side of the British coastline, allowing offshore renewable developments to access the electricity grid." OK, so the National Grid will spend the money, not the government, but why will NG spend the money on this hugely expensive project that no one has yet judged viable? They are a regulated industry, and even if they were, you couldn't serious oblige a private company to do something uneconomic without compensating them. So NG will be enabled to recoup their costs and a reasonable operating profit from this scheme. Who will pay for that? Again, taxpayers or customers, through subsidy or energy bills. Do we really care whether the money went via the Government? Money taken from us for these sorts of schemes is effectively taxation, and has all the same economic impacts, whether or not the Government take a cut. For instance, if it increases our costs of living, we will spend less on other goods, which will mean less tax raised on those goods, which means less government revenue from other sources.

* * * * *

Now, repeat after me, George. THERE IS NO SUCH THING AS A FREE LUNCH. The winners you pick may or may not be losers, but please don't pretend you can get lots of money spent on things that wouldn't have been built if you hadn't mandated it, and it not have an impact on the economy, of similar magnitude whether or not the intervention involved the money being filtered through the government's hands.

And if you want people to use less of something, don't throw money at technology that helps people use it more efficiently, without increasing its price. Some people (quite a lot, from experience) will use the improved efficiency to consume as much as they did before but make it go further. After all, it won't cost them any more, and if you have reduced demand (and therefore price) at all, it will probably cost them less. If you want people to consume less of something, there is only one effective way to do it: MAKE IT MORE EXPENSIVE.