The impact of fiscal policy

Politicians talk about fiscal policy as if it were a business strategy for the country. But government is nothing like a business. The state doesn't earn anything. Instead, it confiscates its money from people in the form of tax. It's subject to none of the constraints and competition a normal business has to contend with. All fiscal policy means is how the Government taxes us and how it spends the money.

However, like any person or business, governments borrow and spend for two principal reasons: either to produce or to consume. The most obvious form of government consumption is when the state transfers money to people in the form of pensions and benefits. Spending on health and education can also consume money, especially when it fails to deliver improvements. The bottom line is that borrowing to fund this kind of expenditure won't pay for itself. When the cash is spent, it's gone and can only be repaid with higher taxes.

Public investment

Alternatively, when government spends money productively it invests in things like roads, railways, energy generation and communication networks. Investment in capital infrastructure like this is commonly associated with higher economic growth and output. It can help to facilitate trade and promote economic activity in the private sector, where a nation's wealth is created. In other words, borrowing to produce can pay for itself.

The bad news is that we're doing the opposite. Public spending is set to rise by £119 billion between 2008 and 2011. Just 6% of this is associated with capital investment. Another 38% is a result of higher social security bills during recession and the dead money of debt interest. This leaves the remaining 56%, which the Government is willfully borrowing to fund yet more unproductive consumption.

Borrowing to consume means that once the money is spent, we have to borrow more just to stay afloat. No wonder the national debt is getting out of control. We need to get a grip on public spending and start living within our means.

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