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Those govt cuts - slasher horror or history-changing brilliance?

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Throughout its history the NHS has had an average 4 per cent increase above ordinary inflation, because medical and pharmaceutical costs rise faster.

Ah, now, we know what that is, that's Baumol's Cost Disease. Average wages are determined by the average productivity in an economy. It's a lot more difficult to increase productivity in labour-intensive services than it is in manufacturing: therefore we expect services to rise in price relative to manufactures over time. The NHS will have a higher inflation rate than the rest of the economy. Do note what happens eventually - we get to Douglas Adams' the Shoe Event: the NHS has swallowed the rest of the economy and we all make our living by taking in each others' hernias.

Marxist markets?

We therefore rather need to do something to try to increase this productivity. Specifically, we want to improve total factor productivity (TFP – the jargon way of saying we want to get more out for the same resources put in). We've only really found one consistent way of doing this: markets.

Serious economists suggest that the Soviet Union, in its entire history, did not manage to improve total factor productivity at all. The same point turns up in Mikhail Gorbachev's memoirs and other serious economists suggest it was the same for all of the planned, non-market economies.

It may even be true that the short-term result will be profits for buddies but as Bob Solow (yet another, serious, Nobel-winning economist) has pointed out, 80 per cent of the increase in production in the 20th century, in those market economies, came from increases in TFP.

The use of markets rather than planning might only crank out a 1 or 2 per cent per year increase in productivity, but think of what compounding over the decades does to that.

It's not necessary to have the “you're poor so you die” sort of markets either: Germany, France, innumerable countries, have the “the government will pay for most or all of it” markets, with different suppliers, charitable, non-profit, for-profit, all scrambling to get a slice of that cash. It's the scrambling that seems to do the trick after all.

So yes, this last bit is ideological, but that's because the British left has a very strange, Marxist almost, attitude towards markets. They're not just, as Brad DeLong points out, methods for the extraction of that surplus which rightfully belongs to the labourers: they are also information, incentive and asset-allocation devices.

But of course, what everyone really wants to know is, well, Tim, will the cuts work? Are we about to be ushered into the sunlit uplands of permanent economic growth, falling debt levels and a miraculous escape from a second Great Depression? Sorry to disappoint, but I haven't a clue: and nor, contrary to public statements, has anyone else, economist or not. While there's a lot of public spluttering going on, everyone recognises that it might work, also that it might not. The odds and probabilities change depending on who is talking, there cannot be an absolute insistence one way or the other.

Those Nobel Laureates will let us know, just like the politicians and us journalists, oooh, sometime in 2015. ®

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