Thursday, 26 July 2018

The crisis in the NI economy never really ended

By Tom O’Leary

The latest release of key data for Northern Ireland (NI) has had business organisations wringing their hands about the weakness of the economy. The CBI said the economy "looks to be on the brink of recessionary territory" after the economy contracted in the 1st quarter of 2018. In fact, the economy has contracted in three of the last four quarters. 

But this is not a short-term problem. Over the longer run, it is clear that NI economy has never recovered from the Great Recession. It remains in a crisis.

Chart 1 below shows a comparison of overall growth rates for NI, Scotland, for the UK and for the Irish Republic (RoI). It is reproduced from the Northern Ireland Statistical Research Agency (NISRA).

Chart1. NI, UK, Scotland and RoI Growth

Source: Northern Ireland Statistical Research Agency (NISRA)

The Northern Ireland Composite Economic Indicator (NICEI) is very far from being as authoritative as a measure of GDP. But it is the most advanced measure so far developed, and movements in the Index are likely to be good indicators of the trends in NI output overall. 

The chart shows that the overall level of output in NI has been exceptionally weak even on a comparative basis. This is highlighted in the table below, which shows the level of growth since the low-point of the recessions in the respective countries or regions, as well as the level of growth since the 1st quarter of 2006, the first available data.

Table 1. Changes In Output, %, Q1 2006 to Q1 2018
 *Data to Q4 2017 only
**NICEI, others GDP
Source: NISRA
Even if the data for RoI is disregarded entirely, based on the widely remarked upward distortions to GDP, the comparative performance of the NI economy has been miserable. This is despite the fact that UK-wide and Scottish growth rates have themselves been extremely weak over the period.

[The economy of the RoI has hugely inflated GDP levels, based on the government policy of attracting spurious investment from overseas, which is in reality a tax avoidance scheme. As a result, much economic data is meaningless. However, on one real measure RoI’s total real wages have risen by a very slow 7.4% over the last 10 years. Yet even this miserable level compares favourably to -3.75% for the UK over the same period].

As the Table shows the NI recession lasted 3½ years to 4 years longer than elsewhere. The NI recession only ended in the 2nd half of 2013. The recovery since that low-point has also been minimal. And the level of output in the NI economy still remains more than 4% below its pre-recession peak. The other economies have all recovered, at least to some extent.

Looking wider, most of the EU countries hit hardest by the Great Recession have made some sort of recovery, including Spain and Portugal. Italy is one of the worst-performing major economies in the world. Since the 1st quarter of 2006 the Italian economy has contracted by 2.4%. But the NI economy has been even worse. Only the ravages inflicted on Greece in the interests of its creditors put it in a separate category, having contracted by 21% since the beginning of 2006.

Disastrous public-private partnership

The disastrous performance of the NI economy has two sources, both the private sector and the public sector. As Chart 2 below shows, both the private and the public sectors have contracted since 2007. When the Tories came to office in 2010 they abruptly reversed the growth in the short-term rise in the public sector, which had been promoted in 2009 in response to recession.

Meanwhile, the NI private sector went into recession at the beginning of 2007, probably reflecting its links to and dependence on the private sector in RoI, where the recession began before the recession in the UK.

This highlights the structural problem of the NI economy as a whole. Its natural link is the RoI economy, especially via the private sector in NI. But the public sector in NI remains dependent on the parsimony of the Westminster government, which refuses to invest and insists that the private sector will, without any evidence.

A refusal to invest is hardly unique to NI among the Western economies. The entire OECD economy remains in an investment blight. This characterises the period we are in.

But the NI economy faces a longer-term, structural problem. When NI was created in 1922 it was part of the British Empire, which was still a globally sizeable market, even while it faced with mounting competitive challenges. NI shipping, manufacturing, linen and banking were an important component of the Empire’s output. But the Empire is long gone. Most of those industries in the North have gone with it.

Now, the world has three major economic units, the US, China and the European Union Single Market which together account for roughly 60% of the world economy. NI’s links to the EU Single Market now face severe disruption via Brexit. It will be left as an adjunct of the UK economy, which represents now just 2¼% of world GDP (according to World Bank data), and continues to decline. The latest decline in NI economic activity is a pointer to those strategic difficulties. The NI is suffering a declining participation in the world economy. Brexit will accelerate that.

The private sector in NI has already begun to anticipate the potential effects of Brexit, where the simple size of the UK market means there is only limited rationale to invest, for any enterprise, wherever its ultimate location. The incentive to invest in NI is even more curtailed than for the UK. The Westminster government has exacerbated these trends both through the ill-conceived Brexit policy itself, as well as its own repeated refusal to invest in the NI economy.

Monday, 23 July 2018

Economic lessons from the left governments in Latin America – and a comparison to China

By John Ross


This article is based on Marxist economic theory and macro-economic study of Latin American countries combined with two primary direct experiences:

· The author is a specialist on China’s economy – having written over 200 articles on it, published in English, Chinese, Spanish, Portuguese, French and Russian over a 26-year period.

· He was directly involved in some economic discussion in Venezuela during the period of Chavez, including directly with President Chavez (articles related to this in Spanish and English may be found at

However, the author has insufficient knowledge of the detailed situation in all Latin American countries and this article does not deal with directly political issues. This article therefore only deals with certain key economic issues which can be clearly seen both in the trends in Latin America and in comparison, to Asian countries – particularly China. It is therefore circulated for discussion in the expectation of inevitable criticism and improvement – these are greatly welcome.

The new wave of social struggles in Latin America

Recent events in Latin America entirely refute the claim in the Western media that the right wing was carrying all before it in the continent. Certainly, the right wing in Latin America is strongly coordinated by outside forces, and the left in Latin America does not have the same advantages in easy unification and coordination – despite the great successes and achievements of the ‘pink tide’ at the beginning of the century. But the reality is that both the right and the left have very deep social roots in Latin America and that there will be a prolonged period of struggle between them. To take simply some recent key events.

· The election of the new left President of Mexico, Andrés Manuel López Obrador, popularly known as AMLO, is an important advance for the whole left internationally, especially in the Americas.

· Polls show that in Brazil Lula would win the Presidential election – which is why a fraudulent state policy is being carried out to imprison him and ban him from the election.

· A new economic crisis in Argentina has forced its neo-liberal government to humiliatingly go to the IMF – discrediting it and launching a new round of social struggles.

Confronted with this situation the Latin American right is increasingly using a strategy proposed by the US of ‘lawfare’ – that is the use of an unelected judiciary, which in reality is controlled by the right and the US, to block popular politicians.

The ‘Brazil Wire’ news service carried an excellent description of strategy noting: ‘ The US has launched a new kind of war on Latin America and it’s called “lawfare”: using the local legal system to oust unfriendly but democratically elected politicians while ignoring corruption by their allies on region’s far right.’

This noted the launching of this strategy to deal with the ‘pink tide’ of the election of left wing governments in Latin America: ‘Hillary [Clinton] gave a speech in 2009 in which she said, “having a functioning democracy isn’t enough in Latin America, we have to support these countries to have strong, independent judiciaries.”’

This strategy also drew on the experience of the right wing in Italy, where similar methods were used a decade earlier to install entirely corrupt governments which carried through massive privatisations. There is a direct link of this to the Lava Jato (Car Wash) campaign being used against the left in Brazil: ‘in 2004 Lava Jato’s inquisitor judge Sergio Moro published a paper called “Considerations of Mani Pulite”, his interpretive thesis on the 1990s Italian – with US cooperation – anti-corruption probe which decimated Italy’s political order, in particular its center-left, and paved the way for both the political emergence of Silvio Berlusconi, the most corrupt leader in its history, and a wake of privatizations of its massive public sector nicknamed “the pillage of Italy”. Mani Pulite in particular, its use of the media to whip up public indignation and support of convictions served as the prototype for Moro’s own operation Lava Jato, launched a decade after his paper…. this new intensified order of privatization, all starting with a scam corruption trial causing media indignity and the overthrow of democratically elected governments with social welfare programs, only to be replaced by truly corrupt leaders who sell off all the goods’’

The bias in such right wing campaigns was blatant: ‘two of the former presidential candidates from the conservative PSDB party, which is the main conservative opposition to PT in Brazil and a long time friend of the United States, have been implicated in tens of millions of dollars worth of bribes with audio and video evidence and had all charges thrown out against them, even though you can just go online and see the evidence yourself, whereas ex-president Lula was given a 9.5 year prison sentence for supposedly receiving $200,000 worth of reforms on a luxury apartment that the prosecutors and judges – who are the same people in this investigation – cannot prove that he ever owned or set foot in. There’s no proof. Lula himself recently said in a speech, “the least they could do is give me the deed to this place.” So it is very selective. You don’t see any politicians from the conservative PSDB party going to jail in Brazil over this…

‘there is a general consensus among the majority of the Brazilian people that this is a witch hunt against Lula. The majority of the people consider him to be innocent. 96% of the Brazilian people reject the Coup president Michel Temer. He’s got a 4% approval rating. And I would also say that most people, probably slightly over a 50% majority, believe that Lava Jato is a witch hunt targeting the PT party, that has had disastrous results for the Brazilian economy.’

The aim of this ‘lawfare’ is to prevent left wing politicians running for office who would be elected, or to attempt to block them in general from campaigning on policy within their countries. This anti-democratic ‘lawfare’ has seen:

· Lula blocked from running for president in Brazil – as already analysed.

· In Argentina former left President Cristina Fernández de Kirchner has been charged with treason, a crime punishable by 10 to 25 years in prison. The right-wing government, in office since 2015, was already unpopular before it signed a bailout deal with the IMF and its support is expected to further decline. Kirchner would be a strong candidate for next year’s Presidential election, so the aim is to block her from running.

· On 3 July the National Court of Justice of Ecuador ordered the preventive detention of the country’s former President Rafeal Correa and requested that he is extradited from Belgium where he is currently living.

Confronted with this assault on democracy and social progress the first and unconditional requirement is international solidarity from progressive forces in every country.

The second issue, however, is preparation of the struggles by an analysis of the strengths and weaknesses of the previous ‘pink tide’ in Latin America – the series of left wing governments that were elected across the continent from 2000 onwards.

The strengths of these progressive governments are well known. They bought about a radical reduction in poverty, inequality and increase in popular living standards. This ‘revolution in distribution’ was the common achievement of all of them and a tremendous contribution to progress both in the continent and globally. But objective analysis shows that only in certain cases was this accompanied by a ‘revolution in production’ – that is the ability to protect their economies from the downturn in international commodity prices which started in 2014 as an aftermath of the international financial crisis. It is therefore useful to examine the different experiences and the reasons for them in terms of economic policies. The main economic examples will be analysed in turn.

Political success and economic success – Bolivia and Nicaragua

The most combined experience of both continuing economic and political success, the two of course being interrelated, was in Bolivia and Nicaragua. In both cases the left has retained political power. The economic record of the left governments in these countries is shown in Figure 1

· In Bolivia Evo Morales was elected President in December 2005 and has been re-elected to office ever since. The Bolivian economy has grown in every year since Morales was elected with the total expansion of per capita GDP up to the end of 2017 during his term being 46% with an annual average growth rate of per capita GDP of 3.2%.

· In November 2006 Daniel Ortega was elected President of Nicaragua and has been re-elected to office since. The Nicaraguan economy has grown in every year since Ortega was elected with the exception of 2009 when it was hit by the international financial crisis. The total expansion of per capita GDP up to the end of 2017 during Ortega’s turn in office has been 38% with an annual average growth rate of per capita GDP of 3.0%.

This relatively smooth and substantial economic growth, of course, significantly underpins, and helps explain, the political success of the governments in Bolivia and Nicaragua.
If the reason for this impressive economic success in Bolivia and Nicaragua is examined, its key macro-economic factor is shown in Figure 2 – the significance of this will become even clearer when less successful cases are analysed.

It should be recalled that GDP is divided into two parts:

· Inputs into production, that is investment – in Marxist terminology Department 1 of the economy

· Consumption which, by definition, is not an input into production – Department 2 of the economy in Marxist terms.

As ‘nothing can come from nothing’, only inputs into production can increase economic output. Figure 2 shows how an increasing proportion of the economy devoted to fixed investment underpinned Bolivia and Nicaragua’s economic growth.

· The percentage of fixed investment in Bolivia’s GDP rose from 14.3% to 20.8%.

· The percentage of fixed investment in Nicaragua’s GDP rose from 24.9% to 30.1%.

This high/rising percentage of fixed investment in GDP is in line with the pattern, as will be shown below, of the successful Asian socialist economies such as China.

To summarise, Bolivia and Nicaragua both carried out not only a ‘revolution in distribution’ but also a ‘revolution in production’ – sustained increases in economic growth even when faced with negative trends such as the fallout of the international financial crisis and the decline in commodity prices after 2014. This is a decisive factor underpinning both their economic and political success.

Economic success, political defeat due to betrayal– Ecuador

Ecuador constitutes a special case in Latin America in that the political setback came from treachery from within the camp of the left.

Rafael Correa was elected President in December 2006. He was re-elected President to three terms as president until 2017. His successor, Lenin Moreno, was the nominee of Correa’s party Alianza País. However, in office Moreno subordinated the country to the US. To attempt to block Correa’s support in the country the fraudulent arrest warrant already noted was issued in July 2018.

Despite great economic obstacles in Ecuador, which does not even have its own currency but uses the US dollar, great economic and social progress was made under the Correa government as clearly summarised by the US Center for Economic and Policy Research (CEPR).

· Annual per capita GDP growth during the past decade (2006–16) was 1.5%, as compared to 0.6% over the prior 26 years.

· The poverty rate declined by 38%, and extreme poverty by 47% percent. The reduction in poverty was many times larger than that of the previous decade.

· Inequality fell substantially, as measured by the Gini coefficient (from 0.55 to 0.47).

· The government doubled social spending, as a percentage of GDP, from 4.3% in 2006 to 8.6% in 2016.

· Public investment increased from 4% of GDP in 2006 to 14.8% in 2013, before falling to about 10% of GDP in 2016.

This increase in the proportion of fixed investment in GDP in Ecuador can be seen in Figure 2 above – it rose from 20.9% of GDP in the year before Correa was elected to a peak of 27.6% of GDP in 2013.

In 2015-2016, in addition to problems created by the increase in the exchange rate of the dollar, with no ability to devalue, Ecuador was struck by severe natural disasters such as the eruption of the Cotopaxi volcano and the El Nino phenomenon and, most substantially, the severe earthquake, which killed at least 676 people with over 16,600 injured and which by itself had a negative impact of 0.7% on GDP. This led to the necessity in the short term to devote more of the economy to consumption, in order to maintain the population’s living standards, but there was no confusion on the fundamental strategy of increasing the level of investment in the economy. This simply tactical shift was politically successful in ensuring the election of the candidate of the Alianza País in the 2017 Presidential election.

Overall the development in Ecuador therefore was an economic success but culminating in a political defeat due to treachery by Correa’s successor Lenin Moreno.

Economic inability to deal with the effects of the decline in commodity prices creates political setback – Brazil and Argentina.

Brazil and Argentina were the two biggest countries in Latin America in which the left came to power, before AMLOs recent victory in Mexico – being respectively the largest and fourth most populous countries in the continent, and its largest and third largest economies.

· Lula was elected president of Brazil in October 2002. He was succeeded in 2011 by Dilma Rousseff who won re-election in 2014 until being removed from office by a fraudulent ‘constitutional coup d’etat’ in August 2016 – with Temer becoming president, whose current approval rating is 4%.

· Néstor Kirchner became Argentina’s president in May 2003. He was succeeded by Cristina Fernández de Kirchner who remained in office until the right winger Macri was elected president in December 2015.

The economic dynamics in Brazil and Argentina are shown in Figure 3

· In Brazil, under the left government, the economy grew steadily until 2013. Per capita GDP in 2002-2013 rose by 33%, an annual average 2.6%. However, from 2014-2016 Brazil’s per capita GDP fell sharply by 9%.

· In Argentina per capita GDP grew by 58% from 2002-2011 – an annual average 5.2%. However, after 2011 GDP growth stalled and by 2015 per capita GDP had fallen by 3% compared to 2011.

Such a negative economic trend in the final periods of the left governments in Brazil and Argentina necessarily undermined their support. While they had made a ‘revolution in distribution’ delivering great progress for the population of their countries, they unfortunately did not succeed to make a ‘revolution in production’ – that is the ability to develop an economic policy capable of continuing substantial economic growth when faced with economic difficulties such as the aftermath of the international financial crisis or the fall in commodity prices.
Major political difficulties faced these governments – for example in Brazil the PT did not possess a majority in the legislature and the 1990s had seen many aspects of neo-liberalism institutionalised in the Central Bank and other bodies. Very negative economic circumstances were also inherited by Brazil’s left-wing government in exceptionally high interest rates and an overvalued exchange rate. Nevertheless, confronted with such strong objective difficulties, compared to positive examples in Latin America and the experience of China, it appears there was an insufficiently clear perspective on strategic macroeconomic direction which had negative consequences when the period of high commodity prices came to an end.

Turning to the explanation of the difference between the left wing governments which achieved both economic and political success and Brazil and Argentina, this can be clearly seen by comparing Figure 4 below with Figure 2 above.

· In Brazil the percentage of fixed investment in in GDP did rise significantly from 2003 to 2013 – from 16.6% of GDP in 2003 to 20.9% of GDP in 2013. However, from 2014 onwards it was allowed to fall, dropping to 16.4% of GDP by 2016.

· In Argentina the increase in fixed investment was shorter lived than in Brazil– from 15.1% of GDP in 2002 to 19.5% of GDP in 2007, before falling to 15.8% of GDP in 2015.

Therefore, whereas in Bolivia and Nicaragua, and for most of the period of the left government in Ecuador, the percentage of fixed investment in GDP rose continuously, underpinning economic success, no comparable scale of increase took place in Brazil and Argentina. This meant that Argentina and Brazil were not so capable of resisting the negative economic trends unleashed by the aftermath of the international financial crisis and the fall in commodity prices.

A special case Venezuela – the left in political power but problems in the economy

Venezuela constitutes a special case in Latin America. Chavez was elected president in 1998 and assumed office in February 1999. Initially he faced great opposition from capitalist control of the state oil company PdVSA, the overwhelmingly dominant economic resource in Venezuela, which created great economic difficulties. But the popular uprising of April 2002, to defeat the attempted anti-Chavez coup d’etat, by destroying capitalist control of the army, transferred the centre of state power into the hands of the working class. The working class has retained state power in Venezuela until the present – a great victory. In December 2002-2003 Chavez defeated the management strike in PdVSA – thereby for the first time securing firm control of the country’s most important economic institution.

These victories were followed by rapid economic expansion in Venezuela. Between 2003 and 2008 per capita GDP rose by 52% – an annual average 8.7%. Despite a moderate economic setback in 2008-2010, due to the impact of the international financial crisis, recovery then took place and in 2013 Venezuela’s per capita GDP was still 50% above its 2003 level – an annual average increase over that period of 4.1%. Chavez died in March 2013 and was succeeded by Nicolas Maduro who has remained President until the present.

From 2013 onwards, however, Venezuela’s economy sharply contracted primarily with both a fall in the price of oil and a decline in oil output. By 2017 Venezuela’s per capita GDP was 39% below its level of 2013 and 8% below its level of 2003. This economic contraction, whose social consequences were greatly exaggerated in the Western media, did not prevent the working class retaining power, with Maduro securing re-election in 2018. But it undoubtedly lowered support for the government, with Maduro’s voting falling by 1.3 million between 2013 and 2018. The economic situation in Venezuela was identified by Maduro as a key issue to address. These overall economic dynamics are shown in Figure 5.
Turning to analyse these trends in Venezuela they are greatly affected by the oil price – shown in Figure 6. The key Venezuelan macro-economic variables, fixed investment and saving, are shown in Figure 7.

For most of the period of Chavez presidency Venezuela was sustained by a sharply rising oil price – which rose from $12.2 on 1 February 1999, the date of Chavez inauguration as president, to an all time high of $145.3 on 3 July 2008. There was then a very severe fall during late 2008 and 2009, due to the international financial crisis, but by 29 April 2011 the oil price had recovered to $113.9. It was still $105.7 in July 2014. After that, however, in line with other commodity prices, the oil price fell sharply reaching a minimum of $26.2 on 11 February 2016. It then recovered to over $70 by July 2018. These trends are shown in Figure 6.

The results of the very high oil price during most of the period prior to 2014 was to create a very high level of total savings in Venezuela – total savings are equal to savings by companies, savings by individuals, and saving by the government. This very high oil price created very high company savings – total savings in the Venezuelan economy reached 42% of GDP in 2007.

As investment is financed by savings such a high level of savings would have permitted a very large increase in fixed investment in Venezuela, of the type seen in Bolivia, Nicaragua, or Ecuador – or of the type seen in China as analysed below. But although fixed investment in Venezuela recovered from their extremely low level of 2003 they never reached even the level of 1998. That is, Venezuela was not transforming its savings into fixed investment – as were, in contrast, Bolivia, Nicaragua, Ecuador or China. These trends are shown in Figure 7 – data in an internationally comparable form is only available up to 2013.

Without a high level of investment Venezuela’s economic growth could not be sustained in the face of the downturn in international commodity prices after 2014, and, even more directly damaging, without a high level of investment the rate of production of oil could not be maintained.

Therefore, Venezuela did not follow the successful economic path of Bolivia, Nicaragua, and Ecuador. This economic failure, as already noted, had a negative effect on the situation of the government – despite the overall great political success of retaining state power.


Finally, in addition to noting the positive lessons from Latin America, it is worth making a comparison of these experiences in Latin America with the successful socialist economy in China – as China’s experience and progress is still considerably underestimated in parts of Latin America.

In the almost 40 years since the beginning of China’s economic reform China’s economy has grown every year without exception. Its annual per capita GDP has increased on average by  8.4% a year over the 39-year period from 1978-2017. China experienced no serious economic crisis following the international financial crisis beginning in 2008.

As a result of that growth China has changed itself from a situation where in 1980 every country in Latin America had a higher per capita GDP than China to one in which by 2017 China had a higher per capita GDP than every country in Latin America except Panama, Chile, Uruguay, Argentina, Mexico and Costa Rica – China overtook Brazil in 2016. By 2023, on IMF projections, China’s per capita GDP will also overtake Mexico and Costa Rica.

Translating that into terms of the percentage of the population of Latin America, as Figure 8 shows:

· In 1980 100% of the population of Latin America lived in countries with a higher per capita GDP than China.

· By 2017 only 23% of the population of Latin America lived in countries with a higher per capita GDP than China and 77% lived in countries with a lower per capita GDP than China.

· By 2023, on IMF projections, only 7% of the population of Latin America will live in countries with a higher per capita GDP than China and 93% will live in countries with a lower per capita GDP than China.
To understand the scale of this transformation, however, it must be understood that China is far larger than Latin America – China’s population of China, at 1.4 billion, is more than two times that of the continent of Latin America.

Figure 9 therefore looks at the combined population of China and Latin America and notes the percentage of that combined population with per capita GDPs above and below China’s – that is, in a sense, it treats China as though it were a Latin American country for purposes of comparison. This shows that as recently as 1997 every country in Latin America, and therefore 100% of the population of Latin America, lived in countries with a higher per capita GDP than China. But, as already noted, by 2017 only 23% of the population of Latin America lived in countries with a higher per capita GDP than China and 77% lived in countries with a lower per capita GDP, while by 2023, on IMF projections, only 7% of the population of Latin America will live in countries with a higher per capita GDP than China and 93% will live in countries with a lower per capita GDP. As a result of this development China achieved the fastest increase in living standards of any major country.

In short, due to its economic policy, China has transformed itself from a country poorer than any in Latin America to one with a higher per capita GDP than all except the very richest Latin American countries. In particular it has overtaken Brazil in per capita GDP.
What, therefore, explains this extraordinary economic development in China and how does it interrelate with the lessons from Latin America? Figure 10 shows the similarity of China’s macro-economic development to the most economically successful left run governments in Latin America – Bolivia, Nicaragua and Ecuador. It shows that China’s growth, like theirs, was underpinned by a sustained and considerable increase in fixed investment. The contrast to the failure to raised fixed investment in a sustained way in Brazil, Argentina, and Venezuela is clear.


The lessons of the advance of the left in Latin America from 2000 onwards, during the ‘pink wave’, was one of the most inspiring and progressive in human history. The lives of many millions of people were improved.

It is also a complete myth, spread by the right, that the right wing has swept all before it. On the contrary the continuing success in a number of Latin American governments, the new left victory in Mexico, continuing struggles in Brazil and Argentina and elsewhere show that the left, as well as the right, has deep social roots in Latin America. The fact that the right in Latin America has to resort to ‘lawfare’ is precisely because it believes that if a democratic process were allowed to unfold the left would win.

At the same time, to confront the new round of struggles, it is necessary to draw lessons, both positive and negative, of the previous wave of struggles in Latin America. A key part of that is to draw the economic lessons. Study both of the successful examples in Latin America and of the socialist economy of China is crucial for this.


The above article was originally published here on the Brazilian website Opera Magazine

Monday, 9 July 2018

Misplaced optimism from the Bank of England Governor

By Tom O’Leary

The Bank of England Governor has declared that the UK economic outlook is improving. He may be right in a limited sense. The recorded growth rate of the 1st quarter of just 0.2% may not be as dismal in subsequent quarters. But there is little room in the medium-term outlook for misplaced optimism.

Carney said, “A number of indicators of household spending and sentiment have bounced back strongly from what increasingly appears to have been erratic weakness in Q1. The UK labour market has remained strong, and there is widespread evidence that slack is largely used up. Pay and domestic cost growth have continued to firm broadly as expected. Headline inflation is still expected to rise in the short term because of higher energy prices.”

But this only highlights the misconceptions about the drivers of economic growth and its consequences. The first indicators Carney relies on are Consumption data. But Consumption growth cannot drive economic growth, and is destined to fall back unless production and living standards are rising.
Consumption is a consequence of output, not a contributor to it. The growth in Consumption therefore requires the growth in output. Chart 1 below shows the real GDP growth rate (in blue, on the right-hand scale) alongside the proportion of GDP in real Final Consumption Expenditure (orange, on the left-hand scale).

Chart 1. UK Real GDP Growth and the Proportion of Final Consumption Expenditure in GDP, 1970 to 2016
Over time, in common with most Western economies, in the UK the proportion of GDP directed towards Consumption has grown. The corollary is that the proportion of GDP devoted to Investment has fallen. At the same time, the growth rate of the economy has slowed as the proportion of GDP directed to Consumption has risen and the proportion directed to Investment has fallen.

This apparent correlation between the falling proportion of GDP directed towards Investment is that it is associated with a decline in the growth rate of GDP. Peaks in Consumption are associated with troughs in GDP growth. If we take prolonged periods, such as the build-up to the Great Recession in 2008, this included a rise in the proportion of Consumption in GDP from 81% at the end of the 1990s to a peak of 87.8% in the depth of the recession in 2009.

This impression is confirmed by examining the data statistically. Chart 2 below shows the correlation between GDP growth and the proportion of Final Consumption in GDP. As the chart clearly shows, the correlation is a negative one, with a downward slope. As Final Consumption rises as a proportion of GDP, GDP growth itself slows.

Chart 2. UK Real GDP Growth & Proportion of Final Consumption in GDP, 1970 to 2016
Correlation is not causality. But the data completely belies the notion that economic growth, and the rise in living standards that growth allows, can be driven by rising Consumption over the medium-term.

Instead, the relationship is better understood as the relationship between Consumption and Investment, which both follow output. If output is not consumed, but saved and invested, it lays the basis for further output. However, if all output is consumed, then there is no possibility of increased output, and it will decline over time as capital (the means of production) are themselves consumed in the production process (through wear and tear, dilapidation, and so on). It is the increase in Investment which leads to the development of the means of production, which sustains an increase in production.

On this fundamental point, Carney’s assessment is wrong, even if better quarters ahead are possible in terms of GDP compared to the 1st quarter of 2018. Improving household spending and consumer sentiment cannot sustain increased growth over the medium-term.

The decisive factor is Investment. And here, the outlook is very far ‘bouncing back strongly’. Chart 3 below shows the rate of growth in Investment (Gross Fixed Capital Formation).

Chart 3. UK Growth in Gross Fixed Capital Formation, %
Investment (GFCF) fell in the 1st quarter of this year compared to the 4th quarter of 2017. Measured on the less erratic basis on yearly comparisons, it has been on a declining trend since the 1st quarter of 2014 and is now just 1.5%.

This Investment weakness and lack of growth in productive capacity is the source of Mark Carney’s other concern of rising price pressures. It is the dearth of Investment which is causing capacity constraints, from which he sees rising inflationary pressures. But even that standard interpretation may be misplaced. 

His view that the strength of the labour market is leading to pay pressures is belied by the fact that real earnings growth remains close to zero. The focus on the falling unemployment rate may be misleading, along with the rise in the employment rate, both of which are at levels not seen in a generation or more.

This is because the number of hours worked per week in the economy is stagnating. Chart 4 below shows the total number of hours worked, in millions. The low-point following the recession was 914.4 million hours worked in the 1st quarter of 2010. But it peaked at 1,034.2 million hours in the 2nd quarter of 2017 and has since stagnated.

Chart 4. Total Weekly Hours Worked, millions
Although there are more people in work (and fewer unemployed workers) they are working shorter hours. Therefore total hours worked are not increasing. The growth of part-time working, zero hours contracts and perhaps even shorter time for full-time workers do not reinforce the idea of a labour market that is going to produce much higher wages. 

The lack of Investment means that the significant creation of jobs over the last period is dominated by lower productivity, lower-paid jobs. It is also at the same time leading to genuine capacity constraints. The Bank of England Governor’s optimism is misplaced. Consumer spending cannot sustain stronger growth over the medium-term. So, the weakness of Investment means that a strong recovery from here is highly unlikely.