Thursday, 26 May 2016

US productivity declines


By Michael Burke

US productivity is set to decline for the first time in three decades, according to forecasts from the influential business research organisation the Conference Board. The level of productivity, which is the amount produced per hour of labour, is decisive for living standards. It is extremely difficult to increase the living standards of the mass of the population without increasing productivity, and impossible to do so on a sustained basis. The Conference Board is forecasting US productivity will decline in 2016.

The Financial Times quotes Bart van Ark, the Conference Board’s chief economist saying, “Last year it looked like we were entering into a productivity crisis: now we are right in it”. Fig.1 is the Conference Board chart reproduced from the FT. Rising productivity has been a feature of the US economy since the crisis of the early 1980s.

Fig. 1 Conference Board changes in US productivity -via FT
 

But the chart also shows US productivity growth has been exceptionally weak in the recovery phase since the 2008 crisis. This weakness or outright falls in productivity is a generalised feature of the advanced industrialised economies since the crisis.

The cause is easily identified. Weak productivity growth is associated with weak investment growth. Outright falls in productivity have followed declines in investment. This is the pattern evident in the US economy. Fig.2 below shows Federal Reserve Board of St Louis data on the level of real investment (Gross Fixed Capital Formation) in the US economy, which is falling.
 
Fig.2 Level of real Investment (Gross Fixed Capital Formation) in US
 
The level of productivity is expected to fall after the level of investment has already fallen. In effect, more workers will be attempting to produce goods and services with fewer machines to hand. As a result the level of that output per hour worked will decline. It is possible, for a period, to make the existing level of productive capacity work harder. But this simply accelerates the deterioration and dilapidation of that capital stock (its ‘wear and tear’) so the rate of consumption of capital exceeds the rate of investment. Net investment falls and with it the productive capacity of the economy as a whole.

Two further points are worth noting. First, the level of investment in the US economy never recovered its pre-recession peak and is now turning lower. The economic outlook is deteriorating as a result, not improving as the policy makers of the Federal Reserve Board seem to believe

Secondly, the chart clearly demonstrates that this was an investment-led downturn in the US economy. As the US led the whole world into crisis, therefore it is reasonable to state that the Great Recession was caused by the US investment decline. In the chart above the shaded area represents the period of the recession itself. Evidently investment declined long before the recession began. In fact, it was two years later that recession began, as investment peaked in the 1st quarter of 2006. As the financial crisis of 2007-2008 also followed the investment decline, the millions of words written in support of the idea that it was the financial crisis which caused the recession are factually wrong. It was the fall in investment which caused both the financial crisis and the recession.

Turning to the UK economy, a cottage industry has grown up attempting to obscure the fundamental forces driving the decline in productivity here. SEB has shown that it is the decline in investment, leading to a decline in the net capital stock which has caused the crisis of productivity here, and that all other explanations are spurious. In the words of the FT report, the UK may simply be the ‘canary in the coalmine’, its productivity decline a harbinger of what may happen to the Western economies generally.

Tuesday, 24 May 2016

The State of the Economy

By Michael Burke

800 people packed into a recent ‘State of the Economy’ conference hosted by Shadow Chancellor John McDonnell to discuss economic trends and economic policy. This was in addition to the series of lectures that John McDonnell is hosting, with workshops at the conference allowing a more wide-ranging discussion and debate. In addition to important speeches by McDonnell himself and Jeremy Corbyn, there was a very valuable contribution from Ha Joon Chang, along the lines of his recent article in the Guardian.

SEB hopes to post videos and other material from the conference as they becomes available. Here is John McDonnell’s speech that opened the conference (video).

The piece below is based on a Powerpoint presentation at one of the workshops by the present author.

***

The UK economy remains in crisis, in contrast to the assertions of George Osborne and the supporters of austerity. The chart below compares the current slump to the Great Depression in this country and to the slump that followed the onslaught of Thatcherism (Fig.1).

Fig.1 Depressions Compared

At the end of the 1st quarter in 2016 the current crisis was 8 years old, approaching a ‘lost decade’. As the chart shows the current crisis is much worse than either the Great Depression or under Thatcher. SEB previously suggested that this slump would be “twice as bad as Thatcher”, and this judgement has proved correct.

There is no suggestion that the course of this slump will necessarily follow the earlier periods. Major events or external factors intervened. The Great Depression ended with rearmament for World War II. The Thatcher experiment was boosted by the huge windfall from North Sea oil, although the Tories created another recession after the consumption splurge of the ‘Lawson Boom.’

There can be no crystal ball about the trajectory of the economy, but it is possible to identify the key internal dynamics which determine growth. This slump and its predecessors were all led by a crisis of investment. At the same time, it is impossible for an economy to grow sustainably over the medium-term if it has a low and/or falling level of investment. This characterises the current crisis in the economy (Fig.2).
 
Fig.2 Change in GDP and its components since the crisis began
 
The economy overall remains close to stagnation, so that average living standards cannot rise. But the modest increase in GDP since the crisis is almost entirely driven by rising consumption. The combined increase in household and government consumption amounts to £84.3bn. But the rise in investment is just £5.8bn. Since the crisis the proportion of investment has amounted to just 5% of GDP. As this is below the rate of capital consumption (capital used up in production, or which dilapidates), the stock of capital in the British economy is falling. As a result the capacity for future increases in output is declining. At the same time, an inevitable consequence of growth which relies almost entirely on consumption while net investment falls is a rising trade deficit. The trade gap has widened once more to record levels even during a period of stagnation.

The key factor in this investment-led crisis is the weakness of business investment (Fig.3). There has been no recovery at all in business investment and it remains below its pre-crisis level, even though both GDP and consumption have recovered. As the chart shows, the fall in business investment preceded the decline in GDP and led the whole downturn. Business investment as a proportion of GDP has declined markedly over the period and is now falling once more in outright terms. ‘Demand’, by which is meant consumption, has not led growth.
 
Fig.3 Weakness of UK Business Investment
Source: ONS
Over time, Britain and the other advanced industrialised economies have increasingly adopted the US model of economic growth, particularly from the 1980s onwards (Fig.4). This is a model based on rising consumption as a proportion of GDP and consequently a declining proportion of GDP directed towards investment.

However, the consequence of this is plain. As consumption has risen as a proportion of GDP, the growth rate of consumption has slowed sharply. This apparent paradox relates to the sources of growth. Investment is a key input into economic growth while consumption is not. So, as consumption claims an ever-greater share of GDP and investment a diminishing share, the growth rate of the whole economy slows. Consumption then slows with it.

By contrast economies with a high and/or rising proportion of GDP directed to investment will produce higher rates of GDP growth and consumption can grow more rapidly. But this is not the US or Western model.
 
Fig.4 US Consumption share in GDP and consumption growth
 
The same trends are evident in the British economy (Fig 5.). The proportion of consumption and the growth rate of consumption in the UK are inversely correlated. As the proportion of consumption in the economy rises, the growth rate of consumption falls, and vice versa.

The US-led Western model of growth can be summarised as ‘shop till you drop’ and consumers frequently do. Slow growth economies produce flat or falling real incomes and consumption is

increasingly financed by debt, until the point at which the debt becomes unsustainable.
 
Fig.5 UK Consumption share in GDP and consumption growth
 
This fundamental economic context demonstrates why the fiscal framework set out by John McDonnell is correct. The commitment to borrow only for investment provides the optimal basis for sustainably higher rates of growth. The claims that this is austerity-lite or similar to failed Labour policies of the past are misplaced or disingenuous.

The crucial difference lies less in the specific fiscal rules than in the economic context. The entire theme of the State of the Economy conference was the need to substantially increase investment. Previous governments cut investment and adopted Tory spending plans. In those circumstances, it is only possible to balance the current spending budget by applying a brake to it. The level of government spending as a proportion of GDP was on average lower in the New Labour years than under Thatcher.

By contrast, if investment is increased the economy will grow more rapidly and consequently tax revenues will grow more rapidly. It is also likely that social welfare payments will fall as more people are in better-paid work. Both of these revenue and expenditure headings are in the Government current spending account. Increased investment will cut the current spending deficit.

The scale of problem requires this break from past economic orthodoxy in Britain. The depth of the crisis means that traditional ‘demand management’ and muddling through will not work. It may even be that ‘People’s Quantitative Easing’, that is money creation for investment purposes, is necessary.

The general rule is that the greater the increase in investment the faster the economy can sustainably grow and the more rapidly the deficit on current spending will decline, which is the basis for Labour’s economic plans. There is no sign that anything else is likely to rescue the British economy.

Thursday, 12 May 2016

Slowdown is made in Downing Street

By Michael Burke

It is now customary for George Osborne to blame all the ills of the British economy either on overseas economic weakness or more recently the ‘uncertainty’ over the Brexit debate. This is nonsense. The renewed economic stagnation is directly related to the policies the Tories have pursued.

The three most widely discussed symptoms of the renewed stagnation are the decline in retail sales, the widening of the trade gap and the fall in production. Of these the fall in production is the most important.  

This point may require explanation, primarily because the strength of the neoliberal counter-revolution in economics has tended to drag all other schools of thought in its direction. As a result, there is widespread confusion on these matters as if to suggest that consumption, or wages, or some other factor can lead the economy.

Marx argued (in Grundrisse and elsewhere) that,
“The conclusion we reach is not that production, distribution, exchange and consumption are identical, but that they all form the members of a totality, distinctions within a unity. Production predominates not only over itself…..but over the other moments as well. The process always returns to production to begin anew. That exchange and consumption cannot be predominant is self-evident.”
It is self-evident that exchange and consumption cannot be predominant for the simple reason that it is impossible to exchange or consume a good or service before it has been produced. It is sometimes suggested that this is only true of pre-monetary economies. An individual or a whole economy can borrow so that the level of consumption rises beyond their share of what has been distributed to them after production. Very true. But since the money borrowed has to be paid back plus interest, the borrowing amounts to a claim on future production.

Production-trade-retail sales

This fundamental point applies to analysis of the current state of the British economy. Production and manufacturing are both in recession, that is at least two consecutive quarters of declines. The trade gap has widened to record levels. But retail sales have only just begun to falter by recording falls in February and March.

Osborne and others want to claim this is a result of Brexit ‘uncertainty’. But if British-based companies were cutting back on investment this would be reflected in lower import demand for investment goods. If British consumers’ greater uncertainty led to lower consumption, then this should be reflected in lower imports of consumer goods. In both cases the trade gap would narrow.  

At the same time, there has been no crisis of ‘demand’ in the British economy, if by that is meant under-consumption. Retail sales have been far stronger than either production or exports since the recession. This is shown in Fig.1 below.

Fig. 1 Consumer demand versus output
  
Retail sales, which are primarily the key discretionary part of household consumption, have risen modestly since the beginning of the recession, up 6.5%. But output is now in its third recession in 8 years and has fallen back towards levels last seen in the depth of the Great Recession itself. It has fallen by 10%. Quite logically, if production in Britain is falling but consumption is rising, then the trade gap must grow.

To be clear, there is the same broad pattern when total consumption is taken into account, that is household discretionary and non-discretionary consumption plus government consumption. Like the rest of the economy Government has increased consumption and cut investment. The totals for consumption and investment are shown in Fig.2 below.

Fig. 2 UK Consumption and Investment
 
It is not the case there is no growth in consumption in the British economy. It is growing at a modest pace. But investment is effectively unchanged over 8 years, up by just 2%. This is the crucial weakness of the British economy, which is an extreme case of the general malaise afflicting the advanced industrialised economies.

This in turn accounts for the widening trade gap. Producers based in Britain are losing market share globally and domestically. As the world economy is not far from stagnation this leads to falling output. In addition, as the growth of consumption in Britain is greater than most competitor economies, which Osborne claims as a sign of success, this leads to the growth of imports outstripping the growth of exports by some distance. This cannot be solved by devaluation. This has already been tried and failed. The pound is still 16% lower against a basket of major currencies than it was prior to the recession.

It is investment which is the source of the falling levels out output and the widening trade gap. In addition, household income growth has been weak and real wage growth almost non-existent over a prolonged period. Therefore the rise in consumption has been achieved by a rundown of savings/increase in borrowing by households. The household savings ratio has fallen to a new all-time low of 3.8% (Fig.3 below).
 
Fig. 3 Household savings ratio
 
Of course, wages cannot sustainably rise if production is falling. The squeeze on profits if businesses cannot force down wages means profits are cut and output cuts follow. This is what has happened in the steel industry, for example. Rising wages requires rising output. That can only be sustained by increasing investment.

Osbornomics and its followers

There have been two distinct phases to the Tory offensive. The first was to cut government spending, both current spending on services and capital investment. But, as both of these cause economic downturn, then government spending on social security (or other items like working tax credits) tends to rise. This is widely understood as austerity.

The second phase was purely for electoral advantage and began in earnest in the March 2013 Budget. This promoted private consumption, most obviously with policies such as ‘Help to Buy’ and other schemes. This was combined with a halt to new cuts in current spending while continuing to cut public investment. 

It is this sequence of policies combined which has brought about the current crisis. The austerity policy led to a renewed downturn in the economy and a widening public sector deficit. The austerity mark II policy led to an unsustainable rise in consumption. It also led to inflation of asset prices, especially the damaging rise in house prices. In textbook fashion, ‘demand’ for housing was increased with extra funds, without any increase in supply, that is investment in new housing.

All of those, however well-meaning who now argue for further measures to boost ‘demand’ (meaning consumption) would simply repeat Osborne’s highly damaging policy in a new form. This is the case with Adair Turner’s call for monetary financing to boost nominal demand, known as ‘helicopter money’ (pdf).

There is nothing intrinsically wrong with money creation. It is especially useful in extreme cases where the economy is slowing sharply and/or there is a risk of sustained deflation; prolonged falls in the price level. But we have already shown that the British economy is not suffering a deficiency of ‘demand’. It is once more in crisis because there is still a slump in investment.

If instead monetary measures are used primarily to boost consumption there will be a re-run in some new form of Osbornomics. This relates to a fundamental economic law. The greater proportion of output devoted to investment the higher the growth rate of the economy (and ultimately the sustainable rise in the level of consumption). The greater proportion of output devoted to consumption the slower the growth rate of the economy (and the same negative consequences for the level of consumption). You can’t shop your way to prosperity, as British consumers can once more testify.   

Monetary and fiscal measures should be aimed boosting investment. This would raise output and produce high-skill, high-wage jobs. This is in fact exactly what Jeremy Corbyn and John McDonnell have proposed. It is the sustainable way of out of renewed crisis.

Tuesday, 19 April 2016

RIP ‘All in it together’, buried in Panama

By Michael Burke

This Tory government, its economic and social policies and its financial scandals almost seem designed to provide illustrations of fundamental economic truths. “The history of all hitherto existing society is the history of class struggles”, famously wrote Marx and Engels in the Manifesto of the Communist Party. The Panama scandal reveals the big lie that austerity is about deficit reduction and the false mantra that ‘we are all in it together’. The entirety of government policy is an attack by one class on all its subordinates.

Whenever some Tory Minister or another announces another damaging economic policy or wholly regressive social policy and attempts to justify this in terms of a shared burden of adjustment, it can punctured by recalling just one word: Panama. ‘We’re all in it together’ has been fatally wounded.

Tory economic policies and the leaders themselves are often criticised in terms of incompetence or immorality. No doubt that these factors are present. But the same policies now in place have been pursued to different degrees before; public sector spending cuts, cuts to public sector investment, pay cuts, tax increases and benefit cuts for average and low-paid workers, tax cuts for business and the high paid, privatisations, and so on. This was the actual content of Thatcherism although it was cloaked with ‘monetarism’ and again when the pound entered the Exchange Rate Mechanism. The label changed but the policy was the same.

This policy consistency is not accidental. It represents a class interest. As a result the current government cannot be advised or implored to choose different policies. Only militant opposition combined with considered alternatives will work.

Tax haven hub

The focus of the anger has quite rightly been against David Cameron, who called tax avoidance ‘morally repugnant’ when looking for a cheap target in tax-dodging celebrities. But he is also a representative figure of the model of the British economy which his government inherited and which they are recklessly extending.

That economic model places the economy at the centre of an international hub of tax havens, with the City of London as its organisational focal point. Economic policy is aimed at promoting this international role, if necessary at the expense of other sectors of the economy. So, the departing permanent secretary to the Treasury recently told the Financial Times that steel was a ‘lame duck industry’ and should not be bailed out. This assessment clearly does not apply to the finance sector and the banks.

Table 1 below shows the level of bank liabilities (primarily deposits) in selected financial centres. They show the vast level of offshore wealth in tax havens. The data is from the latest quarterly report from the Bank for International Settlements.

Table 1. Bank Liabilities in selected centres, US$ billions
 
The US is no stranger to tax avoidance itself, although to a large extent this is done onshore, through incorporation in Delaware or Nevada. But the UK economy and its dependencies and Overseas Territories have greater bank liabilities combined than the US itself. This is not an exhaustive list, as other territories, including Gibraltar, the British Virgin Isles, Belize and others are engaged in similar schemes.

The efficient management of savings should be a positive contribution to economic prosperity, by directing savings towards the most productive areas for investment. But this is not what is happening. A global system of tax avoidance deprives countries of tax revenues that could be used to for investment or social protection or public goods. This is not just confined to Britain and the biggest victims are the populations of the Less Developed Countries.

Worse, the capital does not lie idle in the banks, offshore companies and hedge funds. It is used for speculation in financial assets, stock markets, commodities and property which further distorts economic activity, and exacerbates inequality.

The current Labour leadership has nothing to do with these rackets and has always opposed their effects. The Labour leadership can only gain from the exposure of these scandals. One of its tasks will be to formulate policies which shift the whole financial sector away from tax-dodging and speculation towards productive investment. That is a major task. But the sums involved are so large that every incremental step has the potential for a huge positive effect.