Friday, 29 April 2011

The IMF's prediction China will overtake the US to become the world's largest economy in 2016 – chart

This is a link to the chart showing the IMF’s widely discussed prediction that the size of China’s GDP will overtake the US in 2016 in Purchasing Power Parity (PPP) terms.

The chart is interactive. By ticking the boxes on the left-hand side, readers can make their own comparisons. Amongst other comparisons we found interesting; China surpassed the combined economic size of Germany, France, Britain and Italy in 2010; India surpassed all these countries individually in 2006, Brazil in 2011 will have surpassed all those countries individually except Germany.

Thursday, 28 April 2011

British Economic Stagnation Caused By Tory Policies

By Michael Burke

The preliminary estimate of the UK’s 1st quarter GDP showed a rise of 0.5% which exactly matched the rate of contraction in the previous quarter. Consequently over the latest six months the economy has stagnated, registering no growth at all over the period. This follows a 12-month period in which the economy expanded by 2.8%.

A number of right-wing commentators, including the Adam Smith Institute have expressed their disbelief at the data. Yet the 0.5% rise was in line with the consensus estimate by economists and, while there may well be revisions to the data in later releases, the average revision over the last five years has been negligible. This refusal to accept reality is a function of adopting an economic framework that does not correspond to reality.

The initial release focuses solely on output measures of growth – income and expenditure measures will follow in May and June. But it is clear from the output data alone that the government policy of cutting investment has been decisive in the stagnation.

When the Tory-led coalition took office the economic recovery was expanding. In mid-2010 the economy expanded by 1.8%. Of this increase 0.3% was accounted for by a rise in manufacturing, which was mainly a function of the pick-up in world trade and the depreciation of the pound. But the biggest contributors to growth were all government-related. Current Government spending on services such as health and education directly contributed 0.2% of that growth. The state-supported finance sector contributed another 0.5% and the construction sector contributed 0.6%. SEB has previously shown that government construction spending both before and during that period led an increase in private sector investment. Therefore both directly and indirectly, government activity contributed 1.3% of 1.8% growth in mid-2010.

But the effect of Tory led coalition policy has been to reverse that increased government spending. Contrary to those who cannot accept reality, government activity has three effects on GDP; directly, through its own spending; indirectly as its activity causes the private sector to alter its own spending, and an ‘induced’ effect as sectors of the economy not directly related to government activity are affected by changes in spending (for example, consumer spending by workers in firms that supply to government).

When the further date releases are published, it will be possible to analyse this dynamic in greater detail. But it is already clear that government investment fell after the June 2010 Budget and just three months later the economy began to contract. A key area was the fall in government construction spending. The latest data show public construction investment falling by between 13% and 19% from a year ago, depending on the secto. While increased government activity has a triple benefit to the economy, this cut in spending will have had a threefold negative effect on economic activity.

The 1st quarter 2011 data mark three years since the recession began. This should be a period of robust and above trend growth. Instead government policy has produced stagnation. The chart below shows the change in economic activity from the peak prior to recessions.

Figure 1

11 04 28 UK

In this business cycle it is now 36 months since the recession began and the latest data leave the economy still 3.5% below its prior peak. The only cycle where activity was lower at this point was in the Great Depression of the 1930s (-5.2%). The current cycle is more severe than the next sharpest recession, under Thatcher in the early 1980s, when output was 2.8% lower than the peak level after three years.

In both the downturn of the 1930s and that of the 1980s output was back to its previous peak after four years. This is just one year away in the current cycle and to match that now the economy will have to grow by 3.5% over the next 12 months – which would represent a wholly extraordinary acceleration from present stagnation. Even the Office for Budget Responsibility, whose remit seems to include rosy forecasts, is only forecasting growth at half that rate this year. Anything below 3.5% means that this business slump will exceed even that of the Great Depression, at least in duration although not in severity.

Another deeply worrying aspect of the data is that the economic stagnation arises from £9.4bn in fiscal tightening in the Financial Year just ended, £5.5bn of which was spending cuts. The government plans £41bn of fiscal tightening in the 12 month period beginning in April. New Labour had planned £26bn of fiscal tightening this FY, £14bn of which was spending cuts. Continued support for slower, slightly shallower cuts is not tenable given the evident negative impact of much smaller cuts so far.

There is always the possibility of unforeseen events, perhaps a collapse in the currency or a build-up in unwanted inventories either of which might statistically boost GDP without altering the underlying picture of extreme weakness. But outside of these quirks it seems that the best that can be hoped for is a prolonged economic stagnation. A policy-induced return to recession, a ‘double-dip’ cannot be ruled out. It seems certain that employment will fall once more and tax revenues decline. Both of which will lead to a widening of the public sector deficit, contrary to the claims of the government and its supporters. Instead of these, seriously rescuing the economy, creating employment and reducing the deficit will all require a complete change of policy.

Wednesday, 27 April 2011

Poland Escapes Recession By Public Investment

By Gavin Rae

Prior to being elected Poland's Prime Minister in 2007, Donald Tusk declared that he wanted to repeat the ‘Irish economic miracle’ in Poland. As Tusk comes to the end of his first term in office, he can claim that an ‘economic miracle’ of sorts has actually occurred. Poland has been the only EU country to have avoided an economic recession since the outbreak of the global financial crisis. However, this relative economic success has been made possible by carrying through policies that are diametrically opposed to those being implemented in Ireland. Furthermore this is now being threatened by attempts to carry through austerity policies similar to those currently being introduced by the Irish government.

It is not the case that Poland has not suffered an economic downturn during the international financial crisis. GDP growth slowed from 6.8% in 2007 to 1.2% in 2009, before growing by more than 4% in 2010. Unemployment has risen again above 13%, with around 25% of young people now jobless. The budget deficit has risen to nearly 8% of GDP and public debt is edging towards 55% of GDP. With social inequalities widening, inflation rising faster than wage growth and public services deteriorating, Poland is far from meeting the ideas of an island of economic stability propagated by Tusk and his Citizens’ Platform (PO) government.

Yet the fact that the Polish economy has continued to expand has lessened the negative effects of the economic crisis. Why has the Polish economy continued to grow? Poland was fortunate not to have experienced a banking crisis similar to that in many other countries and entered the crisis with a relatively low level of private debt. However, the major reason for Poland avoiding negative growth has been that it has managed to increase public investment at a time when private investment has slumped.

Socialist Economic Bulletin has consistently pointed out that the global economic crisis has primarily been driven by a collapse in fixed investment, which has accounted for around 96% of the fall in GDP in the OECD area. The economic contraction has tended to be deepest and most prolonged in those countries where fixed investment has fallen the most; and the greatest success has been achieved in countries which took measures to sustain or increase fixed investment - most notably China. Such an understanding fits the case of the Polish economy.

One result of the financial crisis was a collapse of private investment in Poland. In 2010 private investment declined by 7.4% in relation to 2009 and by 20% compared to 2008. In June 2010, the overall year-to-year fall in private investment was 17.7% - declining, for example, by 20.8% in construction and 15.6% in purchases of machines, tools and vehicles. This decline in private investment has been spurred by a sharp fall in Foreign Direct Investment.

Although Poland is less reliant on FDI than some of the smaller ‘financialised’ economies in Central-Eastern Europe (most notably the Baltic States) it has still suffered a large decline in private capital inflows. Net inflows of FDI fell in Poland from €16.7bn in 2007 to €8.4bn in 2009 and then down to €5.5bn in 2010.

While private investment has slumped in Poland, public sector investment has taken up the slack. Poland has had the good fortune to have entered the financial crisis at a time when it is eligible to receive large direct transfers from the EU. In the 2007-13 EU budget, Poland has been allocated up to €67bn in structural and cohesion funds, which is almost equal to the government’s total revenue in 2010. It has become the largest single receiver of EU funds – gaining, by February 2010, a net sum of around €21.4bn. Furthermore, over 1.4 million Polish farmers have obtained agricultural subsidies adding up to €5.3bn (in 2009 the total figure was €2.98bn, rising to more than €3bn in 2010.) The Polish government estimates that around half of the country's growth in 2009 was directly created by investments, jointly financed by the EU. A total sum of 18bn zloty was spent on building roads, bridges and sewage works in 2009, growing to around 25bn zloty in 2010.

Leaving aside the qualitative aspect of this investment – with the government spending far more on roads than railways for example – its positive impact on the Polish economy is undoubted. A recent report from the European Commission into the role of public investment in Poland underlines this. It points out how the significant increase in public investment - following Poland's accession into the EU - helped to smooth the economic downturn during the crisis and that increasing the extensive use of EU funds as a means to invest in the country's infrastructure would now help to support its recovery. The report also points out that while public investment has increased significantly over the past few years (rising from 3.5% to 4.5% of GDP between 2005 and 2008) this was from an initially very low level of capital expenditure. There had been no investment into the country's infrastructure (such as transport) throughout the ‘post-communist’ transition prior to EU accession, with funds designated to maintaining a steadily degrading infrastructure.

It is interesting to look at a graph provided in the report that shows the relationship between public investment and economic growth in Poland. As we can see, the recovery in public spending helped to pull Poland out of the recession it had entered at the beginning of the transition. Then from the late 1990s (during the term of a right-wing coalition government) public investment fell sharply helping to significantly slow the pace of economic growth. Public investment then began to grow rapidly around 2005, soaring above its pre-EU accession level. Contrary to the ideologues - that have dominated public debate in Poland - economic growth has increased when the government has invested more and slowed when its investment has reduced.

Figure 1

11 04 26 Poland

The maintenance of positive economic growth through public investment is threatened by political attempts to rein in spending. These come both domestically from the Polish government and externally from the European Union. In order for a national government to receive EU funds for any investment project, it must first provide at least 15% of its overall cost. It is therefore essential that the Polish government commits as large amount of its own funds as possible in order to gain the optimum amount of EU money available for investment from the present EU budget – which runs until 2013. However, there is increasing pressure for Poland to reduce its spending and comply with other European austerity programmes.

Written into Poland’s public finance law are a number of ‘safety thresholds’. If public debt exceeds 55% of GDP, then the government would need to reduce the debt to GDP ratio; and if it goes above 60% then according to the constitution the next year’s budget must be balanced. Also, Poland is obliged to meet the Maastricht criteria by 2012 and has - for example - committed itself to bringing down its budget deficit to below 3% of GDP by next year. It has also voluntarily signed up to the so-called ‘competitiveness pact’ proposed by the German and French governments for the eurozone. The proposed pact aims to draw up a set of commitments that are more ambitious and binding than those already agreed to by the EU member states. Amongst the pact's proposals are maintaining public debt below 60% and the budget deficit below 3% of GDP; reducing the tax burden for companies and linking the retirement age to life expectancy.

The Polish government has already laid out a series of spending cuts and regressive tax rises that it will introduce if public debt crosses 55% of GDP (presently public debt equals around 53%). A partial reform of the privatised pension system (which has been met with scorn by international financial institutions as it effectively nationalises part of the private pension scheme) has helped to ease the public finances. However, the government has also announced a series of public spending cuts, raised VAT to 23% and importantly is seeking to force local governments to decrease their spending.

From the beginning of 2011 all local governments have been compelled to balance their income and current expenditures. In this way the PO central government is attempting to pass the responsibility of cutting spending onto local governments. Local governments have been at the forefront of gaining access to EU funds, leading investment projects in the country's infrastructure and carrying through the preparations for the EURO 2012 football championships.

The longer term ability of Poland to continue its course of public investment driven growth will be largely determined by the shape of the next EU budget that comes into force in 2014 and runs till 2020. Already divisions around the shape of this budget are emerging – with David Cameron continuing his role as an advocate of austerity in Brussels. The richer EU countries are actively trying to reduce the amount that they pay into the EU’s budget, with the UK attempting at the end of 2010 to form a coalition of net-payer countries with the aim of reducing this budget from the current 1.13% of EU GDP to 0.85% - i.e. by €250bn.

After the collapse of ‘Communism’ there was a prolonged phase of de-industrialisation and de-investment in the Polish economy and its infrastructure. Simultaneously the richer Western European economies benefited by buying up and dominating large sectors of the Polish and CEE economies, having new access to expanded markets for their goods and gaining a new pool of cheap and well-skilled labour. It is only during the past few years that this has partially been reversed and some investment in the country’s infrastructure has begun. This is woefully inadequate – leaving out large areas of the country’s neglected industry and services – but has still allowed the economy to grow during a period of global recession. The greatest impediment to growth in Poland would be the curtailment of this public investment.

Wednesday, 13 April 2011

Debt deals ravage Ireland and Greece's economies – Portugal’s package to have the same result?

By John Ross

The full scale of the economic declines in Ireland and Greece, under the impact of the debt agreements and consequent contractionary fiscal policies agreed by their governments, is shown in Figure 1 below. This illustrates the change in GDP, since the peak of the previous business cycle, in the so called ‘PIGS’ economies (Portugal, Ireland, Greece, Spain) compared to Germany and France.

GDP in Greece has fallen by 8.9% since its peak. In Ireland the decline is 14.6%. Both countries saw GDP in the 4th quarter of 2010 fall to its lowest level in the recession – i.e. no recovery had begun. In contrast GDP in Germany is 1.4% below its peak and in France 1.6% below - in both economies recovery has been taking place for seven quarters, since the 1st quarter of 2009.

Figure 1

11 04 13 PIGS

Considering Portugal, the latest country to apply for an EU economic package, it is clear that to date its economy has more closely followed the performance of France and Germany than Greece or Ireland.

Portugal has also outperformed Spain. In the 4th quarter of 2010 Portugal’s GDP was 2.0% below its peak level compared to Spain’s decline of 4.3%.

Furthermore until the 4th quarter of 2010 Portugal’s GDP had been recovering.

Based on the experience of Ireland and Greece, and basic economic analysis. the imposition of a fiscally contractionary debt agreement on Portugal, after its request for an agreement with the EU, will lead to sharp economic decline.

The deep economic contraction in Greece and Ireland has already made it more difficult for them to repay their debts according to the terms agreed. The problem in both economies is not liquidity but their balance sheets. The debt to GDP ratio in Greece, for example, is 140% of GDP. In Ireland exposure to bank bail outs is several times GDP.

The rationale for the loans organised by the EU for Ireland and Greece would be that their economies would grow and therefore make possible repayment of the loans at a future date. In fact the severe economic decline resulting from the contractionary fiscal policies makes this implausible. Figure 1 therefore also indicates the likely consequences if such policy spreads to Portugal.

The depth of the recessions in Ireland and Greece therefore confirms that the EU package to be developed for Portugal is likely to contribute to worsening the consequences of the EU debt situation rather than alleviating it.

* * *

This article originally appeared on the blog Key Trends in Globalisation.

Thursday, 7 April 2011

The attack on the NHS

By Michael Burke

The first major domestic political initiative by the Tory-led Coalition since the TUC’s March 27 demonstration has to been to call a pause in the implementation of its plans for the NHS. The government’s unpopularity is likely to deepen over the next period as the combination of spending cuts and tax increases in the Financial Year (FY) just ended amounts to £9.4bn compared to £41bn in the FY just begun. The TUC-led manifestation of opposition to the governments cuts agenda has prompted the government rethink. How thorough a ‘reorientation’ that becomes will in part be a function of the degree of continued mobilisation against the cuts. But it is clear campaigning and demonstrating does have an effect.

The attack on the NHS is on two fronts. First, despite assertions that the NHS is ‘safe in our hands’ and that spending on it was being ‘ring-fenced’, it is now widely understood that real cuts are taking place, even if government speakers insist on calling them £20bn of ‘efficiency savings’. Secondly, the fundamental character of the HNS is being altered, with the Tories seeking the maximum possible role for the private sector. This scope of that role is only circumscribed by the political situation - and this is what they have now paused to reassess.

NHS Cuts

In assessing the degree of cuts to the NHS budget in real terms three factors need to be taken into account:

  • Government data are presented in nominal (cash) terms, not real terms

  • Therefore the level of inflation needs to be included in calculations - and this is usually greater in medical equipment, drugs, etc., than in economy-wide inflation

  • The population is both growing and ageing, which means that real medical spending would have to increase simply in order to keep with the natural rise in demand
With those factors in mind, it is clear that government cuts are deep in real terms. From the Comprehensive Spending Review of October 2010 to the ‘Resource Departmental Expenditure Limits are shown in Table 1 below (Table A.9, p.85).

Table 1

11 04 07 NHS Table 1

To take the current FY, spending is set to rise by 2.0% compared to the spending in FY 2010/11, even though RPI inflation is currently running at 5.5%. In fact, the total level of spending on the same measure under the last Labour government in the FY 2009/10 was £103bn (Treasury, Budget 2010, Table 2.2, p.43). By the end of the current FY this government will have been in office for just under two years. Over that time spending on the NHS will have risen from £103bn to just £105.9bn, or 2.8%. According to the Office of Budget Responsibility, RPI inflation will have risen by a cumulative 10% over the same period (OBR, Economic and Fiscal Outlook, March 2011, Table 4.3, p.95). This represents a decline in real spending of 7.2% in just two years.

This continues so that over five years nominal NHS spending is projected to rise from £103bn to £114.4bn, or fractionally over 11%. At the same time, the OBR projects that inflation will have risen by 22%, representing a real decline of 11%.

According to the OECD health spending tends to increase internationally by around 1.5% per year over the long run, because of growing and ageing populations as well as the higher inflation rate of medical processes. If that long-run international pattern applies to Britain overt the 5-year period, the additional real spending required would increase by 7.7%.

The Tory-led cuts to the NHS are therefore nearly 19% in real terms compared to normal trends over the lifetime of this Parliament.

NHS Restructuring

The cuts in real spending on health will have disastrous outcomes. They will also be difficult to achieve because cutting spending on preventive treatments and minor procedures will tend to have the effect of significantly increasing the health bill on major procedures. As a result, health outcomes will actually deteriorate more rapidly than the headline data suggest. By definition, the most vulnerable will suffer as a result.

Much more than the real cuts in spending, which are not fully appreciated, the government has drawn fire for its plans to restructure the health service. It is intended that the Primary Care Trusts (PCTs) will be abolished and replaced with consortia of GPs to commission medical services, with much talk of local devolution of decision-making. As elsewhere the reactionary utopia of patients (or students) becoming ‘customers’ who choose their service-provider gives way to the reality that it is the professional entity which does the choosing (GPs, school governors, etc).

PCTs themselves are a New Labour half-way house, designed to continually introduce private sector providers among the rosters of legitimate ‘NHS’ service providers – indeed they were obliged to do so. But this piecemeal privatisation of health services- while maintaining the NHS brand – is insufficient for the Tory-led government. It intends a wholesale transfer of provision to the private sector, and a variety of mechanisms may be deployed.

These include insisting the GP consortia allocate to the lowest bidder, or rewarding them financially for doing so. The option of removing the NHS from British and EU competition law is also considered, which allows ‘social providers’ to be excluded from lowest-bidder regulations. Any of these would have the effect of allowing the private sector firms to provide services in only the most routine and simple procedures- but remove the equivalent funds from the NHS which would increasingly struggle to cope with more complex, difficult procedures or chronic conditions. The costs of the public sector would rise and be increasingly unable to cope against a backdrop of continuous and deep real cuts. The private sector could increasingly win a greater proportion of formerly NHS provision, leaving it to wither.

The Inefficient Private Sector

Figure 1 below is taken from the OECD’s ‘Health At A Glance’ 2010. It shows the per capita health spending for the OECD countries in comparable US$ Purchasing Power Parity terms.

Figure 1

NHS Figure 1
Health spending in Britain is already way below the average of its peer group in the richest OECD economies. Tory cuts will take it to below the OECD average as a whole.

The chart also shows that in general, as the proportion of private spending on healthcare rises, so does the overall cost. The US has the highest proportion of private provision and its total healthcare costs are off the chart - even although 45 million Americans have no healthcare insurance, compared to the universal system for the NHS. For 2007 (latest data) the US spent 16% of GDP on healthcare, whereas Britain spent 8.4% (OECD, 2009). Yet there is the same ratio of health workers in the workforce and life expectancy at birth is higher in Britain.

The private sector is more inefficient than the public sector in the provision of health care. At every level of input, a private system requires an additional level of profit to be extracted. Because the government has cut first and begun privatisation second, one of the effects is the PCTs are currently abandoning private firms – because they are more costly than the NHS! The government intends to investigate this breach of the right to profit.

The aim of government policy is not better healthcare, or even more efficient, less costly healthcare. It is to boost the profits of the private sector by displacing the more efficient public sector.

Campaigners to preserve the NHS and make it more responsive to the needs of patients have already caused a pause in the programme. They should know that maintaining their campaigns can force either a more profound rethink, or hugely increase the political price paid by this government for this policy.

Saturday, 2 April 2011

How the Tories sabotaged the economic upturn

By Michael Burke

The latest economic data confirms the contraction in Britain’s 4th quarter GDP with only a marginal upward revision to a fall of 0.5% compared to the 0.6% previously reported. Even according to statisticians from the Office for National Statistics (ONS) the severe weather effect at the end of the year only depressed activity by 0.5% and without it the outturn would still have been zero. This follows four quarters of modest recovery with positive growth, which had seen GDP expand by 2.5%.

Therefore, while snow was responsible for the outright economic contraction at the end of last year, another factor must have been responsible for the downward shift from 2.5% to zero growth.

The Role of Investment

The slump in economic growth is dominated by the collapse in investment. In the course of the recession, GDP contracted by £88.6bn. The one year long recovery clawed back £32bn of that lost output, to leave it £56.6bn below its previous peak. The renewed contraction in the 4th quarter of 2010 of £6.2bn means that output is now £62.8bn, or still 70% of the total fall, below its peak level.The role of fixed investment (Gross Fixed Capital Formation, or GFCF) has been decisive in the decline. Within the recession, the decline in GFCF accounted for £43.6bn or nearly half of the total decline in GDP. But taking the recession and recovery together the decline in GFCF accounts for £31.5bn, or 56% of the total in lost output. The decline in investment has once more led the way, accounting for over 60% of the contraction in the 4th quarter,£3.8bn of £6.2bn. For the whole period from the recession to date and including the 4th quarter contraction, the slump in investment accounts for £35.4bn of a total in lost output of £62.8bn – that is, 56% of the total decline.

The Role of Government & Private Sector

Investment has two sources, the government and the private sector. Although ONS does not present the data in this way it is possible to construct the differing effects of these two sources on the trends in investment (Table F of the ONS release).

In the course of the recession the Labour government attempted to offset its effects by increasing its own investment. According to the Office for Budget Responsibility (OBR) in 2009, government investment rose by 16.9% while business investment fell by 18.9%. There was also a follow-through in 2010 as Labour was in office until May, some contracts take time to complete etc. The OBR estimated a 4.4% increase in government investment in 2010.1

Turning to the ONS data allows a more precise calculation of the role of the two sectors on investment. Here government investment indicates the general government GFCF as well as that of public corporations, while the private sector GFCF comprises business investment along with private sector investment in dwellings and existing buildings.

Government investment rose by £9.9bn during the recession. It rose further until Labour left office, to £11.2bn. Under the Tory-led coalition it has since fallen by £4.2bn.

If GFCF has been falling total and the government component has been rising, it follows that the private sector is entirely responsible for the fall in investment – and that this fall is greater than the decline in investment as a whole. In the recession, the fall in private sector investment was £52.9bn. This is 60% of the entire fall in GDP in the recession. Because private sector investment has grown even more slowly than GDP during the recovery, it has acted as a further drag on growth. From the pre-recession peak to the end of the recovery phase in the 3rd quarter of 2010 private sector investment fell by £39.7bn, or over 70% of the total decline in output. Investment fell by £3.8bn again in the 4th quarter, which is once more the bulk of the decline in total output during the quarter, which amounted to £6.2bn. Private sector investment fell by £2.1bn in the 4th quarter, so that it now stands £41.8bn below the pre-recession peak. The decline in private investment is responsible for exactly two-thirds of the total loss of output.

The dominant characteristic of the current slump is therefore a private sector ‘investment strike’, which accounts for two-thirds of lost output. The Labour government attempted to counterbalance this strike by a moderate increase in its own investment. Not only did this offset some of the worst effects of the recession, but it finally encouraged the private sector to briefly increase its own investment. In the three quarters from the end of 2009 to the 3rd quarter of 2010, private sector investment rose by £16.6bn, and was itself responsible for two-thirds of the recovery during those 3 quarters. The private sector was encouraged to increase its own investment in response to the persistent rise in government investment.

SEB has previously shown in a more detailed analysis of construction investment how the public sector led the way for the much larger increases in private sector investment. Conversely, a recent survey for the Institute for Chartered Accountants in England and Wales (ICAEW) shows that 45% of all firms expect their turnover to fall as a result of government spending cuts - up from 21% who already report falling turnover. The detail of the survey is set out in the Table below.

11 04 02 Table 1

While economic ideologues talk about ‘Expansionary Fiscal Contraction’ or the ‘private sector taking up the slack’, it has been left to accountants to show how the relationship between the public and private sectors actually works. It is clear that the cuts will have a negative impact on the prospects of the private sector. But the survey also shows the dynamic effect of reduced public sector inputs on the output of the different parts of the private sector, as a ‘ripple effect’ with first those firms supplying directly to government being hit first, then those firms who only indirectly supply to government (is whose own customers are direct suppliers to government), and finally but increasingly those firms who have no obvious relationship to government at all but whose business will suffer from the general economic downtrend, including consumer demand and demand for business services.

The Consequences of ‘Austerity’ Policy

The role of government has been decisive in determining the trends in the economy. In the course of the recession and subsequent recovery, total government spending, including its contribution to GFCF rose by £18.1bn, and so was directly responsible for more than half the recovery of £32bn. As already shown, it was also responsible for inducing the brief recovery in private sector investment which itself accounted for two-thirds of the recovery during its 3 quarters of expansion.

Reversing the rise in government investment has produced a renewed downturn in economic activity. But it should be pointed out that the government will find it much more difficult to reverse the upward trends in its own current spending. As governments in Athens, Lisbon and Dublin are demonstrating, cuts to welfare entitlements will not reduce welfare spending if the numbers on welfare are rising at a greater rate than entitlements are being slashed.

In relation to unemployment, the same ICAEW survey cited above shows that 47% of the private sector have already reduced the number of permanent staff because of the impact on their businesses caused by the cuts, and 36% have reduced the numbers of temporary or contract staff (which is also leading to a growing casualisation of work for those in work).

The current economic downturn was deeper than the recession under Major in the early 1990s or the Thatcher recession of the early 1980s. Output fell by 6.4% in 2008/09, while it fell by only 2.5% in 1990/91 and 4.6% in 1980/81. The recovery has also been slower now, as Figure 1 below shows.

11 04 04 Figure 1

However, the outcomes of the different recessions in terms of unemployment have been markedly different. From Table 2 below it can be seen that, although the most recent downturn was much more severe than either the Thatcher or Major recessions, the fall in employment was markedly less. This is despite the fact that, as already noted, the recovery is also weaker.

11 04 02 Table 2

One chilling statistic within these comparative data is that at Thatcher’s election in 1979 total employment in the British economy stood at 24,716,000 jobs and that level was not regained until the 1st quarter of 1998, during Labour’s first term.

These comparisons are relevant because employment is falling once more due to the coalition’s growth-damaging policies. The numbers in employment have been falling since August 2010, and this trend is likely to accelerate in both the public and private sectors under the impact of government policy.

Given the link between growth and government finances, which are highly sensitive to taxation receipts, it s no surprise that a similar pattern is evident in relation to the public sector deficit. While Labour’s increased spending was producing a moderate recovery, the public sector deficit fell. The Treasury had projected the public sector deficit as high as £178bn in the financial year (FY) about to end. However, up to January of this year the 12-month rolling total for the deficit had fallen to £141bn, and it had been falling for exactly one year on this measure. This positive trend was reversed in February this year, mirroring the renewed deterioration in the economy, with a small time lag. In February the 12-month rolling total for the deficit rose to £143.3bn. The OBR now forecasts it will be £145.9bn in the current FY.

In a damning indictment of government policy the OBR is also now forecasting significantly higher deficits in subsequent years (Table 4.27) than it did in either the June 2010 Budget or following the Comprehensive Spending Review in November. Compared to June, when the economy was undergoing a government investment-led recovery, the OBR is now forecasting cumulatively worse public sector deficits over the period to 2015/16. Of this, the overwhelming majority of the projected worse outcome is due to the lower growth the OBR is now forecasting (Table 4.25).

The failures of the Tory-led Coalition

It is mistake to view these economic changes, lower growth, lower employment and higher borrowing as anything other than the natural consequences of the policy which has been adopted. Many of the collective authors of these policies have read Keynes, some of them have even read Marx too. They are surely all aware of what happened when the same policies were pursued under the cloak of monetarism and the ‘disciplins of the Exchange Rate Mechanism’ at an overvalued exchange rate in the 1980s and 1990s.

But ‘lowering the public sector deficit’ now is no more the real goal of government policy than controlling the supply of money was under Thatcher. The deficit is rising once more, and is projected to increase compared to previous projections. A government solely committed to this end would change policy.

Nor is this an ‘ideological’ government in the sense that an adherence to a smaller state overrides all other objectives. Actual, rather than budgeted military spending is suddenly increasing as the projection of state power over the oilfields of Libya is now very important.

To grasp the dynamic of government policy it is necessary to understand what this policy is actually achieving. In a capitalist economy this means addressing what is happening to the shares of capital and to labour. Close proxies for these are provided in the ONS’s accounts by ‘the ‘Gross Operating Surplus’ (GoS) of firms and the ‘Compensation of Employees’ (CoE) – which are respectively broadly akin to profit and wages (although there are some important differences).

In recessions, profits fall faster than wages. For example a firm sells widgets for £3 million and pays £1.8m in wages. Its gross profits, before any taxes are levied, are £1.2mn. But suppose demand contracts by 5%. Total sales have declined to £2.85m. If wages are unchanged, the widget makers’ profits have fallen to £1.05mn. In this case a 5% decline in the economy has led to a 12.5% fall in profits. From this dynamic comes the push to drive up profits via lowering wages, cutting workers, removing regulations on business and lowering their taxes. Businesses have enacted the first of these two policies and the government has enacted the second two. There is also the government hope that lower wages in the public sector combined with lower benefits will push wages lower in the private sector. Mainstream economists have a name for this, the ‘demonstration effect’.

Taking only the data for the 4th quarter of 2010 compared to the previous year, the compensation of employees rose by 2.1% while the profits (GoS) of private on-financial corporations rose by 12.7%. In addition, ‘other income’, the income of the professionally self-employed and rental income on property rose by 9.9%. Only the profits of the private financial corporations fell, by 28.1%, which is why they insist they must be bailed out by taxpayers. Given that inflation rose by 2.7% in the year, this means that real wages fell 0.6% over the period, while ‘other income’ rose by 7.2% and non-financial profits rose by 10%.

This then is the real ‘achievement’ of the Tory-led coalition. Since the low-point of the recession, just 40% of the increase in value created has accrued to labour while 60% has accrued to capital. But it still leaves the renewed growth in capital below its pre-recession levels so there will be more to come.

But, so far as the Tory-led coalition is concerned, it is doing the right thing ‘sticking to Plan A’. Plan A is the restoration of profits by transferring incomes from labour to capital. However, we shall see in the immediate period ahead whether even this goal can be met. The downturn in the economy at the end of last year was the result of £9.4bn in spending cuts and tax increases. This FY that total will rise to £41bn. Unemployment and the deficit will certainly rise as a result. It is not clear that either GDP or even profits will grow.

Britain in 2011 will provide a testing ground for what is the real goal of a reactionary economic policy – to drive up profits while cutting living standards. If not then, given the character of the government, even more cuts, lower wages, lower services, lower benefits, greater deregulation and privatisations will be the policy.

1. OBR, Economic and fiscal outlook 2011, Table 1.1