Friday, 27 February 2015

The money exists for investment in Greece

By Michael Burke

The fraught negotiations between the new Greek government and representatives of the EU institutions are likely to be prolonged. They have centred to date on Syriza’s efforts to find room to alleviate some of the worst effects of austerity and address what is called the ‘humanitarian crisis’.

This is entirely justifiable given the depth of the fall in living standards with widespread malnutrition in Greece, a health crisis, hundreds of thousands of homes cut off from electricity supply and other ills.

Policies aimed at income redistribution can help in this key area, so it is entirely correct to attempt to increase tax revenue from the rich in order to ameliorate the effects of poverty on the poor. But any sustainable improvement in living standards must be based on increasing the productive capacity of the economy which requires investment. Any transfer of income will be a one-off effect if income does not grow. Yet the austerity measures imposed by the Troika (EU Commission, European Central Bank and IMF) and the existing burden of debt interest payments prevent the government from investing and provide a further disincentive for the private sector to invest of its own volition.

Domestic sources of investment

There are two key sources of funds that could be tapped for investment; domestic and international.

Domestically the Greek business class claims the highest share of national income in the whole of the OECD. In 2013 (in nominal terms) the Gross Operating Surplus of Greek firms was €102.2bn from a GDP total of €182.4bn. This profit share in GDP of 56% is way in excess of the customary levels in the OECD. By comparison the German profit share in the same year was 39.3%.

A high profit share is not itself directly harmful to growth and prosperity. If firms were investing profits the productive capacity would be rising rapidly and new high-quality and high-paid jobs could easily be created. But the opposite is the case in Greece, which also has the lowest rate of investment as a proportion of GDP in the whole of the OECD. Again in nominal terms investment (Gross Fixed Capital Formation) in Greece in 2013 was just €20.5bn or 11.3% of GDP. By comparison the German proportion of investment was 19.8%.

This is not to hold up the German economic model to be emulated. Like all the Western economies (including Britain) the rate of investment in the German economy has slowed dramatically over several decades, which is the cause of the ‘secular stagnation’ of the Western economies over the same period.

Even so, the disparity in the profit rate and the investment rate is exceptional in Greece. The proportion of uninvested profits in Germany is equivalent to 19.5% of GDP (profits equal to 39.3% of GDP minus an investment level equivalent to 19.8%). This level of uninvested profits is very high by historical standards. But the proportion of uninvested profits in Greece is 44.7% (profits of 56% of GDP minus investment of 11.3%). The nominal level of profits and investment is shown in Fig. 1 below.

Fig.1 Profits and Investment in Greece, 1990 to 2013, €billions (nominal terms)

The charge of indolence and feckless aimed at Greek workers, which is a slur repeated and not solely confined to northern European tabloid newspapers, is entirely misplaced. It is Greek capitalists who refuse to invest a vast proportion of profits who have caused both long-term low productivity growth and the relative crisis. This is true not just on a relative basis but also on a historic one. In 1990 Greek investment was equivalent to 42.8% of profits. In 2013 it was just 11.3%.

International sources of investment

A structural flaw in the Euro Area economy is that it represents an effort to create a single, continental-sized economic entity to compete with the scale of the US and Chinese economies by purely monetary means. The Euro Area has a single exchange rate and single short-term interest rate. But fiscal policy remains overwhelmingly as a national responsibility.

This is a structural flaw as all economic development is uneven. An exchange rate or interest rate policy which may be appropriate to the average will necessarily cause dislocations or worse to economies whose level of development differs significantly from the average. In all other modern economies fiscal transfers occur between regions, usually automatically via common tax and spend systems. In the United States, a federal system of taxation and transfers does not prevent individual states levying their own taxes or making transfer payments (social security, subsidies to farms, etc.). But these federal transfers amount to more than 10% of US GDP.

The EU and the Euro Area have both had fiscal transfers. These have been set through the European Social Fund, the Common Agricultural Policy and others but have usually amounted to little more than 1% of GDP. Disastrously, they have also been cut at a time of crisis, which David Cameron and others boasted as an achievement. The 7-year budgeting round has seen the 2014 to 2020 European Social Fund cut from €961bn to €367bn in nominal terms. The European Regional Development Fund will be €453bn, an increase from €347bn over the preceding period. But this does not compensate for cuts elsewhere and inflation further erodes the total. It is also widely misunderstood that big countries are also recipients of EU funds. Fig.2 below shows for example that Germany received twice as many as ESF funding as Greece over the period 2007 to 2013.

Fig. 2 National Distribution of ESF funding 2007 to 2013, € billions
Source: EU Commission

The cuts to internal transfers have taken place at the worst conjuncture, coinciding with the gravest economic conditions in Europe since the aftermath of World War II. The cuts will accelerate centrifugal tendencies with the EU and unless the trend is reversed they will be key factor in the potential of a break-up of the Euro Area.

While this is a strategic issue, which would need to be addressed by a supplementary budget, there are funds at hand which could immediately be deployed in Greece. One of the many large funding institutions sponsored by the EU is the European Investment Bank (EIB), which has ample scope to increase lending.

As part of a general trend, the EIB has not provided funds for investment that could have alleviated the crisis despite having the financial capacity to do so. Prior to the crisis in 2007 the main components of the EIB’s balance sheet were capital of €35bn and borrowing of €276bn. From this it had made outstanding loans of €285bn. By 2013 the bank’s capital had increased substantially but the growth of its loan portfolio has lagged significantly.

Table1. Key components of EIB’s balance sheet, €bn
Source: Author’s calculations, EIB annual reports and accounts

The EIB is part of an elite group of the world’s most highly-rated borrowers, with a very high capital buffer (own funds) and the explicit guarantee of all the EU governments. As a result it can borrow at extraordinarily cheap interest rates. Maintaining the same ratios as in 2007 and based on the increase in its own funds since it could raise its borrowing to €457bn and its loan portfolio to €472bn.

Given the immediate priority is reviving the Greek economy this could easily be the recipient of the extra €45bn in funds for investment that would become available. A similar pattern applies to the European Bank for Reconstruction and Development, which mainly lends to Eastern Europe (pdf). Since 2011 new investment in projects has fallen by €9bn even though bank capital has increased by €1.7bn. But funds are needed to both develop and integrate the region with the richer West and geographical reasons mean Greece should also be a key destination for that purpose.

Beyond Greece, the subscribing EU countries to both banks can now borrow at exceptionally low interest rates and earn far larger returns from the banks’ investments. Neither the EIB nor EBRD are charitable institutions. The focus for investment would be all the crisis economies of Europe East and West. But these sources of investment could also form part of the overall solution both to the investment crisis and the growing strains on the Euro Area and European Union economies.


There is a pressing need to address the humanitarian crisis in Greece. It remains to be seen how much breathing space Syriza’s fight can win from the EU institutions.

But sustainable growth requires investment. The trend of cutting investment and other transfers within Europe, and cuts to development lending fit with the general austerity policy across Europe of cuts to state investment which are exacerbating the private sector investment strike.

However, this not only deepens the current crisis but threatens to undermine the entire Euro and EU project from within. It is not only the Greek economy which is at stake; it is just the most extreme example of general trends.

Within Greece the key source of funds for investment are the uninvested profits of the business sector. Internationally, EIB and EBRD funds already exist for major infrastructure and other forms of investment. These should be tapped immediately to rescue the Greek economy. And much larger funds could be applied to all the crisis countries of Europe, in a win-win for them and for the key investing countries. The alternative is ongoing crisis and increased risk of Euro break-up.

Monday, 23 February 2015

How the austerity con works

By Michael Burke

‘The Austerity Con’ is the title of a recent article in the London Review of Books. It is written by a leading Keynesian economist Professor Simon-Wren Lewis, who is also a fellow of Merton College, Oxford. The article is available to non-subscribers here. It deserves to be widely read because it contains two important arguments against austerity.

The first argument nails the lie that austerity was necessary because of an immediate crisis of government funding. The second argument exposes the myth that austerity has been responsible for an improvement in government finances. Both of these arguments will be familiar to regular readers of SEB and Prof. Wren-Lewis will give them a far wider airing. Given that averting the crisis in government finances is offered by the supporters of austerity as its main justification, the title of his piece is fully justified.

However there is a difference of view among opponents of austerity about the nature of the current crisis. It is important because it underpins both the overall analytical framework and the suggested policy prescriptions. Prof. Wren-Lewis says, “The place to begin is 2009. By then the full extent of the financial crisis had become apparent.” He goes on, “The financial crisis was leading consumers and firms to spend less and save more. That made sense for individuals, but the problem was that because everyone was doing it, the total amount of demand in the economy was falling. As demand fell, firms produced less, so they reduced their workforce.”

This is not entirely accurate. Demand is comprised of two components, consumption and investment. By taking a step back to 2007 it possible to see more clearly how the crisis arose. Regarding the industrialised countries as whole grouped in the OECD it is possible to see that only one of these experienced a sharp fall. This was investment not consumption.

Fig.1 below shows the level of real GDP and its key components, consumption, investment and net exports. The data is presented in both in constant prices in constant Purchasing Power Parity exchange rates and is itemised in the box below.

Fig. 1 Real OECD GDP and components, US$ PPP trillions, OECD base year

OECD GDP & Components, US$ trillions, PPPs
Source: OECD (data may not sum due to rounding and omissions)

By 2009 the OECD economies as a whole had experienced economic contraction compared to 2007 (the 2008 data is almost identical to 2007). But the direct contribution of falling consumption to the overall economic contraction was non-existent. It had even marginally increased.

The cause of the slump in 2009 was the decline in investment. In round terms GDP in the OECD fell by US$800billion in the two years to 2009 and investment (Gross Fixed Capital Formation) fell by US$1,100 billion. Over the same period, consumption rose fractionally.

It is the case that household consumption fell, just as Wren-Lewis says. But this was more than off-set by the simultaneous rise in government consumption. As he correctly states this was largely because of the operation of what are known in the jargon as ‘automatic stabilisers’. In economies where there exists significant provision of social security and other payments, these tend to rise automatically as unemployment increases along with in-work poverty and other aspects of social deprivation.

Yet taken together the effect of falling household consumption and rising government consumption was a small net increase in total consumption. More important than either a small net rise or fall, what is also clear is that a broadly steady level of consumption was not enough to prevent a sharp fall in investment, which was more than responsible for the entire slump across the OECD.

It is also the case that consumption in the OECD has recovered and now exceeds its pre-recession peak, but investment has not. This is not to say that ordinary households, workers and the poor have not suffered in the crisis. That is true in most countries and is at an extreme in a country such as Greece. But the decline in investment was both the cause of the economic crisis and is responsible for the weakness of the subsequent partial recovery in activity.

Furthermore, recent experience shows that increases in government consumption can at most soften the effects of the downturn (and some cost to government long-term finances, if not the apocalypse conjured up by the supporters of austerity). Rising government consumption during the crisis did not prevent the sharp fall in investment. The slump in investment cannot be corrected by ever more consumption. Consumption has risen since 2009 and is above its pre-recession peak.

The fall in investment was not only responsible for the economic crisis. It was also directly responsible for the deterioration in government finances. Falling investment is a form of saving (unwillingness to spend on investment). As the private sector of the economy increased its savings the public sector was obliged to increase its borrowing which creates the deficits on public finances.

The crisis was not caused and is not perpetuated by a fall in both the components of demand. Only investment fell and it alone has failed to recover. Analysis needs to take account of this key factor, and the policy prescriptions which flow from it. Prof. Wren-Lewis is entirely correct to highlight the ‘Austerity Con’. The biggest con is that the crisis was caused by the public sector, when it was actually caused by the refusal of the private sector to invest. This cannot be addressed by government increasing consumption, or subsidies for consumption. It needs state-led investment.

Monday, 16 February 2015

Fake Anglo-Saxon recoveries are damaging global economy

By Michael Burke

Official economic opinion from the IMF is that the US and the British are the only industrialised economies that are growing strongly and that their growth model should be reproduced generally.

The reality is very different. Both recoveries are the weakest on record and are fuelled by an unsustainable (debt-fuelled) rise in consumption. The international effects of this are negative, acting to provoke further instability in the world economy. The Anglo-Saxon recoveries cannot possibly be widely copied without deepening crises.

First, it is necessary to dispose of the myth that either the US or Britain is enjoying a robust recovery. In sharp recessions there is frequently a large amount of spare capacity in the economy as hours or jobs are cut and factories and offices lie idle or under-used. As a result, recovery from deep recession is often rapid. But that is not the case. Neither the US or British economies has accelerated beyond a 2.75% year-on-year growth rate in the entire recovery period. As a result, they are the weakest recoveries on record.

Fig. 1 below shows the current US recovery phase compared to previous recoveries.
Source: Wall Street Journal

The US recovery is the worst on record as it is also worse than the recovery from the Great Depression. But the performance of the British economy is worse still, significantly slower than any previous recovery phase.

Fig. 2 shows the current British economic recovery compared to previous upturns.
Source: NIESR

Recent trade data also demonstrates the underlying weakness and fragility of even these feeble economic upturns. The US recorded a trade deficit of almost $47bn in December and the British economy had a trade gap of £35bn for 2014 as a whole. These were, in both cases, a return to respective 4-year low-points.

The US trade gap is on a sharply widening trend once more, despite the much lower level of oil imports because of the shale gas boom. In real terms, after accounting for inflation, the US trade deficit excluding oil is at a record, as shown in Fig. 3.

Fig.3 US Monthly and Annual Real Trade Balance, excluding Oil
Source: Census Bureau

As a matter of logic the world cannot emulate an economy where the trade deficit is widening dramatically. The world cannot run a trade deficit with itself. Holding up the Anglo-Saxon recoveries as a model to be followed elsewhere is simply foolish, or overblown rhetoric which has no practical value in policy formulation.

The same increase in effective net overseas borrowing applies to Britain where there are new record deficits on trade balance and on the current account (trade plus current payments overseas, mainly interest and share dividends). In fact the situation is qualitatively more grave for the British economy, for a number of historical and structural reasons which will be examined in a future post. For now it is enough to note that that a very mild British recovery is being funded by record overseas borrowing.
The latest current account deficit is 6% of GDP, an all-time record.

In effect the weak British recovery is being funded by unprecedented borrowing from overseas. Because this has been a continuous process, it has also led to an unprecedented deterioration in Britain’s international investment position. The continuous accumulation of new overseas debts has formed a record level of overseas liabilities, which is shown in Fig. 4 below.

Fig. 4 Britain’s Net International Investment Position as a per cent of GDP
Source: ONS

Both the US and British economies are uncompetitive even at previous exchange rates and are dependent on borrowing from abroad to fund recovery. But the funds they are borrowing from overseas are not being used to fund further economic expansion, via investment. Instead the recoveries in the Western economies are almost exclusively driven by consumption.

This is shown in Fig. 5 below, which shows the real change in both US and British consumption and investment since the recession began to the end of 2014 (Q3 in the case of the UK data). The data is shown in common US$ purchasing power parity exchange rates for comparative purposes.


In real US$ PPP terms the US has increased consumption (combined government consumption and household consumption) by $1,064bn since the recession while investment (Gross Fixed Capital Formation) has increased by just $40bn. In Britain consumption has risen by US$88bn, while investment has increased by just $4bn. This belies any notion that the economies are struggling with the lack of ‘effective demand’. The weakness of the recovery and its dependence on increased overseas indebtedness is due to the virtual absence of growth in investment.

Complete data for the major industrialised countries has yet to be published. But any growth at all for either the Euro Area economy or for Japan is likely to have been almost entirely driven by consumption with investment either flat or contracting once more.

This is placing unbearable pressures on the rest of the world economy, the so-called ‘emerging markets’ and other non-industrialised economies. In part the rise in consumption in the industrialised countries is only possible because prices for basic commodities have fallen sharply. But it is also leading to capital outflow from poorer nations to richer ones, mainly the Anglo-Saxon economies to fund their increased consumption. This outflow of savings is preventing a rise in investment elsewhere, or significantly increasing the costs of that investment. This will both prolong and deepen the global economic crisis.

The industrialised countries as whole led by the US and copied by Britain are consuming, not saving or investing. This produces weak and unsustainable growth in their own countries and is causing a global slowdown and further crises.

Sunday, 1 February 2015

Tsipras versus Cameron: people versus bankers

by Michael Burke

David Cameron became the first elected politician in Europe to criticise the election of the Syriza government in Greece and was quickly followed by George Osborne. This might seem odd as Britain is outside the Eurozone and has limited direct influence over its policies. But the urgent and unrestrained nature of the criticism is very revealing about what is at stake in the anti-austerity struggle and specifically the very different roles being played by the British and Greek governments.

The Syriza government represents the popular will to end austerity. Only the parties of the left increased their vote in the recent election, and that was overwhelmingly to Syriza's benefit with a rise of 9.4%. But entirely new parties and even parties of the traditional right adopted similar anti-austerity rhetoric in an effort to shore up their vote. The election showed the Greek popular majority wants to end austerity.

In Britain the banks have an extraordinarily large weight in the economy. Consequently, this dominance is felt through all areas of political and social life. A recent Global Financial Stability Report from the IMF (pdf) demonstrated the dangerously lop-sided nature of the British economy by focusing on 'shadow banking’, the artificially created networks of companies and vehicles to disguise the real liabilities of the banks. In Britain shadow banking accounts for over 350% of GDP. The next highest exposure of all the industrialised areas or economies is the Eurozone at less than 200% of GDP. The phrase 'too big to fail' is insufficiently grave to convey the threat posed by the outsized level of British bank liabilities.

This explains the sudden and intemperate Tory interventions against the newly-elected Greek government. The British government represents the interests of British big businesses and the most important of these is the banks. The banks have sharply reduced their loans outstanding to Greek borrowers. As Martin Wolf the Financial Times' chief economics commentator explained recently, the banks in general were the key beneficiaries of the bailout, not the Greek economy or its population. Since the €254bn bailout organised by the Troika just €27bn was to support the Greek economy. The rest went to creditors with British, German and Dutch banks at the head of the queue for the taxpayer-funded bailout. But the huge debt is incurred by Greek taxpayers, and so the debt burden is unbearable.

Fig. 1

Recent data from the Bank for International Settlements show that bank loans to Greece have been edging higher again and that British banks have the biggest exposure at $10bn which is equal to the loans from German banks and ahead of US ones at $8bn. The chart below from the Breugel Institute shows the trend in national banks’ lending to Greece.


So there is an immediate concern for the British, German and US politicians who act on behalf on the banks. But Cameron and Osborne are not primarily protecting the immediate interests of British banks, who have already been bailed out of their far bigger failed speculation in Greek assets. They are trying to protect the strategic interests of British banks against popular claims for wider government debt reduction. British banks do have large exposures to countries such as Ireland, Spain, Portugal and others. Their fear is that Syriza represents the turning of the tide where multilateral agencies and their domestic allies can no longer burden the citizens of European countries with more debt in order to bail out failed bankers.

This is why everyone in Europe and beyond fighting austerity has a direct interest in Syriza's success. It has the potential to free Greek society from the impositions of the banks and offer a new model to the whole of Europe. In Britain apart from those receiving huge bank bonuses and their hangers-on no one else benefits from these hugely bloated banks. In general they do not even pay dividends to shareholders. Cutting them down to manageable size by forcing them to take losses on government debt would be everyone else's interest.

There is a particular onus on all those in Britain who want Syriza to succeed or who even simply support the democratic principle that the British government should not attempt to subvert the popular will of another country. We need to get the bankers and their British representatives off the necks of the Greek population.