Friday, 24 April 2015

Greek myths retold

By Michael Burke

The world economy is not strong and the President of the United States is sufficiently concerned about new shocks to it that he recently met the Greek Finance Minister to urge ‘flexibility on all sides’ in the negotiations between the Syriza-led government and its creditors. US concern is fully justified.

In any attempt to reach agreement it is important both to have an objective assessment of the situation and to understand the perspective of those on the opposite side of the table. In Mythology that blocks progress in Greece Martin Wolf, the chief economics commentator for the Financial Times argues that negotiations to date are dominated by myths. He demolishes some of these key myths in turn: that a Greek exit would make the Eurozone stronger, that it would make Greece stronger, that Greece caused the crisis driven by private sector lending, that there has been no effort by Greeks to repay these debts, that Greece has the capacity to repay them, and that defaulting on the debts necessarily entails leaving the Eurozone.

Together, these provide a useful corrective to the propaganda emanating from the Eurogroup of Finance Ministers and ECB Board members. Some if this is slanderous, in repeating myths about ‘lazy Greeks’ (who have among the longest working hours in Europe). Much of it is delusional, based on the notion that Greece can be forced to pay up, or forced out of the Euro without any negative consequences for the meandering European or the world economy.

Austerity ideology

The genuine belief in a false idea, or a demonstrably false system of ideas constitutes an ideology in the strict meaning of that word. Inconvenient facts are relegated in importance or distorted, and secondary or inconsequential matters are magnified. Logical contortions become the norm.

All these are prevalent in the dominant ideology in economics, which is supplemented by another key weapon, the helpful forecast. In Britain for example, supporters of austerity argued it would not hurt growth and the deficit would fall. Now there is finally a recovery of sorts, they argue austerity worked, ignoring all the preceding five years and the unsustainable nature of the current recovery (and the limited progress in reducing the deficit).

For Greece the much more severe austerity and its consequences means that supporters are still obliged to rely on the helpful forecast to support their case. The Martin Wolf piece includes a chart of IMF data on Greek government debt as a percentage of GDP, which is reproduced in Fig.1 below.
The IMF includes not only data recorded in previous years but its own projections for future years. From a government debt level of 176% of GDP in 2014, the IMF forecasts a fall to 174% this year and 171% in 2016 and much sharper declines in future years. The IMF has also forecast an imminent decline in Greek government debt ever since austerity was first imposed in 2010, which has not materialised.

Fig. 1 Greek Government Debt, % GDP & IMF Projections

However, the most recent data released by the Greek statistical service Elstat shows that Greek government debt rose once more (pdf) at the end of 2014 to stand at €317bn. The total debt was €9bn higher in 2014 than 2013, whereas the IMF forecast is effectively flat. Worse, as the Greek economy is still contracting the debt as a proportion of GDP will be rising sharply, not falling as officially projected.

In the course of 10 years the Greek government debt level has effectively doubled as a proportion of GDP close to 180%. Most of this took place while austerity was being implemented. The unavoidable verdict is that the debt burden is unstainable and that austerity will only increase it.

To date the Syriza-led government has met all its obligations to creditors but this clearly cannot go on for very long. It is possible that it may prefer to default on the ECB, which can in the end simply print the money (as with its Quantiative Easing programme, but from which it currently excludes Greece). 

Defaulting on the IMF is perhaps more politically difficult, as its Board would have to convene a meeting of all shareholders. €3.46bn is due to the ECB on July 20.

But a default is necessary and inevitable. The authors of the Maastricht Treaty thought that anything more than debt level equal to 60% of GDP was dangerous. Then this would provide an appropriate target for Greek debt reduction.

Investment flows

In the Martin Wolf piece he also suggests that debt reduction should occur “after the completion of reforms”. This is mistaken. ‘Reform’ in the context of the negotiations is a synonym for deregulation, privatisation, attacks on workers’ rights and living standards. This has already been tried and failed. It is a myth that too many Greek regulations, or too much state ownership, or workers fighting for better pay and pensions is the cause of the crisis. All those were in place in 2003 and 2004 when real GDP in Greece grew by 6.6% and 5% respectively.

One myth that hardly needs to be dealt with any longer is that the crisis was caused by imbalances within the Eurozone current accounts (the balance of trade plus overseas interest payments). For a period this became a key explanation of the crisis (pdf) in the official ideology. It has been largely abandoned as all the crisis countries have swung into surpluses. Greece now has a current account surplus because imports have slumped and so remains in crisis.

A common feature of the crisis countries is that they were beset by huge inflows of private sector capital seeking returns, primarily through speculation in property and housing. It was when these private sector inflows dried up and reversed that the crisis became apparent. Until austerity was imposed in 2010 the fall in Greek GDP due the recession was almost exactly the same as in Germany or in Britain, a fall of approximately 4.75% in all cases.

The austerity policy and the ratings’ agencies induced panic had the effect of driving capital flows back from the ‘periphery’ to the ‘core’ countries. Ferocious austerity in Greece and the other crisis countries meant that private sector banks withdrew capital and repatriated it to the key banking centres of Europe: Britain, German, the Netherlands and France.

These private sector speculative flows were destabilising in both directions. They caused both the boom and the bust in Greece and elsewhere. A solution based on reviving these flows, with the inducement of ‘reform’ can only end in renewed destabilisation and crisis. The desperation of these private sector investors is demonstrated by the fact that, for most industrialised countries currently (excepting Greece) borrowing rates are close to zero as unutilised capital seeks a return.

Structural adjustment

The Greek economy needs structural adjustment. For the ideologues of austerity this is a synonym for wage cuts. But Greek finance minister Yannis Varoufakis is right, cutting wages even further will have no effect on improving Greek competitiveness in key industries, “we are not going to be competitive with Mercedes-Benz and Toyota, simply because we don’t make cars.”

The structural adjustment needed is to increase the productive capacity of the Greek economy. This requires productive investment on a large scale. Prior to the crisis the EU did provide some transfers of funds for investment, as well as current transfers in the form of the Common Agriculture Policy and other funds (which is why the anti-austerity parties and most voters in the crisis countries are not anti-EU). However, these were on an insufficiently large scale and were in any event overwhelmed by the private sector inflows which were primarily directed towards construction and housing.

Worse, the EU has cut its funding for investment as the crisis has deepened. This has exacerbated the private sector withdrawal of capital and is an important factor in prolonging the crisis. Fig.2 below shows the levels of investment from the EU and the different forms of investment from the private sector, both total investment (Gross Fixed Capital Formation) and productive investment, which excludes housing.

Fig.2 Investment in Greece & Selected Components, % GDP

All types of investment have fallen as a proportion of GDP during the crisis. But it was the EU’s declining contribution which led the way. In addition, the real cuts in investment are flattered in this comparison as GDP itself was falling. In 2006 productive investment from the EU to Greece amounted to €4.7bn. In the depth of the crisis in 2012 it had been cut to €1.6bn.

This is a punitive measure and is entirely contradictory to the objective needs of the Greek economy. All properly functioning single currency areas require significant fiscal transfers in order to be sustainable. This follows from the fact that all regions or countries in a monetary union are subject to very similar monetary conditions (official interest rates, exchange rates, and so on) yet have very different levels of productivity. Those levels of productivity will diverge to a crisis point unless there are sufficient fiscal transfers to compensate. If the fiscal transfers are sufficiently large and well-directed, they can even compress or reverse the divergence in productivity. Currently, the policy of the Troika is to lay siege to the government in Athens in an attempt to starve it into submission.

As a result, the Greek economy is at that crisis point. It requires very large fiscal transfers otherwise it will diverge out of the Eurozone. This is in addition to the requirement for a very substantial debt write-off already noted. Even then, very strong government and supranational measures would be required to direct the inevitable revival of private sector investment that would inevitably follow a large increase in (supranational) public sector investment. The public sector must begin to direct large-scale investment.

Martin Wolf is quite right to attempt to disabuse the ideologues of austerity of their Greek myths. There is no prospect of an end to the crisis without very substantial debt reduction. It is also reckless bravado to claim that only Greece would be hit by a forced exit from the Euro. But even debt reduction is insufficient to end the crisis, and further ‘reforms’ would only deepen it. Very large fiscal transfers to pay for a structural upgrade of the Greek economy are necessary.

The biggest beneficiaries of the EU are the big firms and banks in the leading EU economies. They need to start paying for this benefit or they will lose it.

Tuesday, 14 April 2015

Tories' ‘Right to Buy’ housing plan will deepen the housing crisis

By Michael Burke

The Tory manifesto election pledge to make housing associations sell their homes at a discount and force local authorities to sell off some of their best stock has been widely condemned by the associations themselves and by housing experts. The government has set aside £1 billion to fund the discount available to the new ‘right-to-buy’ owners and will demand that the housing associations build replacement homes, which do not have to meet affordability criteria. The net new money available for homebuilding is therefore just £1 billion.

Using average construction cost estimates from the National Association of Home Builders of £150,000 per home, this equates to just 6,600 homes. Very few or none may be affordable.

The idea of bribing a tiny number of housing association tenants (and some of the few remaining local authority ones) with public money to become owner-occupiers is part of the policy of privilege to bolster the Tory election campaign. But since the majority of these homes tend rapidly to become part of the private rented sector it will also exacerbate the growing inequality and unaffordability of housing.

It does nothing to address the housing shortage in Britain, which is both chronic and in many parts of the country acute. Fig.1 below shows the level of both new ‘social rent’ housing and total affordable homes from 1991 to 2014. It is necessary to include at least these two categories in order to indicate some general trends as the government has changed the definitions of many categories of housing with the effect of obscuring to wider picture.

Fig.1 Social Rent and Total Affordable new homes

To give an indication of how grossly inadequate this is, the number of (loosely-defined) new affordable homes of all types was just under 43,000 last year and compares to 1.368 million households on local authority housing waiting lists in England alone.

The recent peak level for annual new affordable homes was just over 60,000 and was inherited by this government from the previous Labour government. The official projection of new household formation over the next 25 years is an average 210,000 per year (pdf). While not all of these households will want or need social or affordable housing, the majority will. Therefore the current pace of home building is completely inadequate to meet the additional projected demand. It will do nothing to address the backlog on waiting lists and the housing crisis will deepen.

There are many addition costs to the housing crisis simply beyond the extremes of unaffordability. These include the miseries of overcrowded and substandard housing, the increasing transfers of household incomes to landlords and the distortions to wider society, including the workforce. The much-discussed ‘productivity puzzle’ (pdf) is much less baffling when it is noted that under this government the rise in real estate jobs has far outstripped the rise in construction jobs, as shown in Fig. 2 below.

Fig. 2 Change construction and real estate jobs under the current government

Solutions to the housing crisis

Labour has adopted a policy of aiming for 200,000 new homes per year by the end of the next parliament. This would come close to meeting the projected rate of new household formation. This would also have the effect of moderating the rise in house prices. But it would be unlikely to reverse it, especially as the housing shortfall as indicated by local authority waiting lists would have increase to beyond 1.75 million for Britain as a whole in the meantime.

One of the many myths surrounding government policy is that the state is not intervening in the economy. The reality is the opposite. There are innumerable ways in which this government and its predecessors intervene in ‘the markets’, with costs running into the hundreds of billions of pounds. The bank bailout was only the most spectacular example.

In the housing sector this government has intervened repeatedly in order to boost prices without ever boosting the construction of new affordable homes, which has decreased. Perhaps the most notorious of these schemes is the £40 billion ‘Help to Buy’ policy which uses public funds to boost private property prices which were already excessive.

A radical step that the next Labour government could take is to use this same £40 billion guarantee and offer it to local authorities to build new homes. The first 20% of (unlikely) local authorities’ losses on construction of affordable homes could be guaranteed using these funds. At the same time, government could borrow to increase the funds available for construction.

The arithmetic of borrowing to invest in new public affordable housing is simple and compelling. A 5% rental income on a £150,000 home amounts to £625 per month. A 3% yield requires just £375 per month. Yet the government can now borrow at well below even 3%. It would make money on its housing investment, which could be used for investment in other areas, all of which would see the deficit fall as a consequence. Housing affordability (and quality) would improve and job-creation switch from estate agency towards building.

The big losers from a radical policy would be private landlords who no longer benefit from the upward spiral of house prices and the large ‘house builders’, the companies who do not build homes but sit on undeveloped land banks and count the paper profits of the increasing land and home values.

Thursday, 2 April 2015

Shifting the burden of the crisis onto workers and the poor

By Michael Burke

There is an old joke, not a very good one, that the definition of a consultant is someone who you pay to tell the time who then asks to borrow your watch. Osbornomics, the specific variant of austerity economics that operates in Britain is similar.

The British economic ‘recovery’ is the centrepiece of the Tory election campaign and has been blessed by the IMF as a model. But the recovery is entirely fake. On some of the most important measures of average living standards the economy has at best stagnated over 5 years, on others they have fallen. The majority of the population has seen their real living standards decrease. The Tory election slogan should be, “You’ll never have it so good again”.

The essential con-trick of Osbornomics can be illustrated in one chart, Fig. 1 below. This shows the household savings ratio, the proportion of savings relative to household incomes.

Fig.1 Household savings ratio

The Tory-led government came to office when the household savings ratio was 10.9%. In the final quarter of 2014 it had fallen to 5.9%. The ‘recovery’ is essentially driven by this fall in household savings, which is equivalent to approximately 3.75% of GDP. But, as already noted real living standards have not been rising. The household sector has been running down savings in order to finance consumption. This is the epitome of British boom-bust cycles since the Second World War, although formerly there was at least some increase in living standards for a period. This promises to be a boom-bust cycle without the preceding boom.

Debt and deficit obsession

The run-down in household savings highlights a key fallacy of government policy, which it claims is focused on reducing government deficits and debt. In Western Europe the entire economic debate is dominated by the distraction of government finances. In most of the rest of the world, and this means overwhelmingly in countries that are growing more strongly than Western Europe or Britain economic policy debate centres on the issues of growth. This is not only true in fast-growing Asia and Africa, but also in the more sluggish Americas, including in the US where growth rates have been stronger than Western Europe since the recession began, and yet remain feeble by historical comparison.

In Britain, to the limited extent that government deficits have been reduced, as the economy has been stagnant government deficit-reduction has relied on increasing borrowing elsewhere, among households. This illustrates a general truth. Savings and lending must equal each other (aside from money stuffed under the mattress or similar hoarding). All borrowing/lending is a transaction which creates both an asset and a liability; a lender and a borrower.

In common with other Western European countries, Britain’s programme to reduce its government deficit has relied on reducing the savings/increasing the borrowing of the household sector. But in the mainstream economics textbooks a normally functioning industrialised economy is supposed to include a household sector that is acting as a net saver (for big purchases, for retirement and so on). It is the business sector which is supposed to borrow to supplement its own profits in order to invest. In fact, it is this process which is mediated through the banks and which its supporters claim is the uniquely positive attribute of capitalism. Relying on falling household savings to finance consumption cannot lead to increased productivity and is inherently unsustainable.

Fig. 2 below shows the saving and borrowing of three key institutional sectors, the government (blue line), private non-financial corporations (PNFCs, red line) and households (green line) from 1997 to 2014.

Fig.2 UK Institutional Sector Accounts

Over a prolonged period and well before the 2008 to 2009 recession businesses (PNFCs) have not been performing their allotted role. Businesses have been savers. The pre-recession boom was financed by a run-down in household savings. As PNFCs started to increase their savings once more at the end of 2006 the government began to borrow. It was only after this period, in late 2008 when the recession had already begun that households sharply reverted to their allotted role and increased their savings once more. Because both the business and the household sector were now significant savers, the government was obliged to increase its borrowing.

The austerity policy attempts to address this imbalance by decreasing the government’s borrowing by cutting its spending and increasing its income. It does this by forcing a reduced saving of households, through raising VAT, cutting social security benefit, cutting disability benefits, public sector pay and pensions and so on. At the same time it has lavished funds on the private sector businesses (cutting corporate taxes, privatisations, and so on) in order to increase their incomes (profits) and eventually to increase their spending and borrowing.

Economically this policy has failed. The government deficit remains stubbornly high and both living standards and GDP are stagnant. Most importantly the austerity to date has failed in its central purpose which is to revive the profitability of British companies, which is the only conceivable basis on which they could be willing to increase investment. Fig.3 below shows the trend in the profit share of UK companies since 1995. At most the policy of austerity has stabilised the decline in profitability and prevented a further fall. But this is very far from a recovery in profits (and even further from a recovery in the profit rate) which would lead to an autonomous rise in private sector investment.

Fig.3 UK Profit share

Austerity back on the agenda

For a combination of economic and political reasons the Coalition government stopped implementing new austerity measures midway through the current Parliament. SEB identified this at the time, and now it has become a rather more commonplace analysis. It was this halt to new austerity measures combined with the effects of Quantitative Easing and other government measures to boost consumption which have led to the unsustainable upturn in economic activity.

But a faltering economy and plunging Tory opinion poll ratings meant that the drive to push down the savings rate of households also had to be suspended. With the government attempting to lower its own borrowing and businesses showing little sign of investing rather than saving profits, the necessary savings had to come from another source. This was the ‘Rest of the World’ (RoW) sector in the national accounts, which is overseas investors.

For ease of presentation borrowing from the RoW was not shown in Fig. 2 above. But given that the savings of both the household and PNFCs sectors have been static in the recent period, it is worth illustrating just the growing dependence on borrowing from overseas and the government deficit in Fig. 4 below.

Fig. 4 Sectoral Accounts; Government borrowing and Rest of World saving

The business expansion before the recession was in part financed by increased overseas borrowing (red line). At the end of 2007 the level of government borrowing in the final quarter was almost exactly equal to the level of savings by the Rest of the World. But the effect of the recession was to decrease consumption financed by borrowing from overseas. In the 2nd quarter of 2011 the level of borrowing from overseas was less than £1bn even though government borrowing in the same quarter was almost £32bn. The savings then were supplied by both the households and PNFCs (as shown in Fig.2).

Since that time the quarterly level of government borrowing has fallen by £13.5bn and the level of borrowing from overseas has increased by approximately £24.5bn. It is this increased borrowing from the RoW which has allowed the government deficit to fall while there has also been a simultaneous modest upturn in investment and consumption.

This is unsustainable. At a certain point the demand for overseas savings exceeds the willingness of overseas investors to lend. The British economy is increasingly dependent on borrowing from overseas and when there is a sudden withdrawal of funds living standards in Britain will fall dramatically once more. Traditionally in Britain this has been accomplished by a ‘balance of payments crisis’ and now more usually relies on a fall in the pound.

It is therefore completely ridiculous for Tory supporters, or the head of the IMF, to claim that Britain’s recovery offers a model. The world cannot increase its borrowing to finance consumption from another planet. It is not even sustainable in Britain.

The requirement to increase private companies’ profitability is the fundamental driving force behind the proposed resumption of austerity after the general election. It is quite possible too that there will be a renewed crisis to accompany it at a certain point, with overseas investors unwilling to continue financing an increase in British consumption, unsupported by an increase in production or investment.