Socialist Economic Bulletin

The incredible shrinking UK economy

2012-01-15T08:56:00.003Z

By John Ross

The magnitude of the blow suffered by the UK economy since the beginning of the financial crisis is very considerably minimized by not presenting it in terms of a common international yardstick. Gauged by decline in GDP, using a common international purchasing measure, dollars, no other economy in the world has shrunk even remotely as much as the UK (Figure 1 and Table 1).

As most countries produce only annualized GDP data it will be necessary to wait before a comprehensive global comparison can be made for 2011. However it is clear no substantial growth in dollar terms took place in the UK economy during that year – GDP at national current prices rose only 1.4 per cent between the 1^st and 3^rd quarters and the change in the pound’s exchange rate against the dollar during the year was a marginal 0.3 per cent. Therefore there will have been no significant recovery from the UK data set out in Table 1 below, and the gap between the UK and other European economies, which form the next worst performing major group, is too great to have been qualitatively affected by changes in the Euro’s exchange rate – the Euro declined against the pound by only 3.3 per cent in 2011.

Table 1 shows that the fall in UK GDP in 2007-2010 was $562 billion compared to the next worst performing national economy, Italy, with a decline of $65 billion – i.e. the decline in UK GDP in the common measuring yardstick of dollars was more than eight times that of the next worst performing national economy. Table 1 shows the 10 national economies suffering the greatest declines in dollar GDP.

It is also extremely striking that the UK’s decline was more than two and a half times that of the entire Eurozone. The UK accounted for a somewhat astonishing 77 per cent of the EU's decline.

Table 1

Figure 1

Expressed in percentage terms the situation is no better. of all economies for which World Bank data is available only Iceland, with a decline in dollar GDP of 38.4 per cent, suffered a worst percentage fall than the UK - even bail out economy Ireland, with a fall of 18.4 per cent, outperformed the UK economy.

Two trends intersected for the UK's performance to be so much worse than that of any other economy. First, contrary to the government's anti-European rhetoric, UK economic performance in constant price national currency terms has been significantly worse than the Eurozone during the financial crisis (Figure 2). Up to the latest available data, for the 3rd quarter of 2011, UK GDP was still 3.6 per cent below its pre-financial crisis peak compared to the Eurozone's 1.7 per cent below. Second, between the beginning of 2008 and the beginning of 2012, the pound's exchange rate has fallen by 21.0 per cent against the dollar compared to the Euro's 11.4 per cent drop in the same period. The multiplicative effect of the severity of the relative drop in constant price GDP and the fall in the pound's exchange rate accounts for the unequalled decline in UK GDP in dollars.

Figure 2

As at present the UK economy shows no substantial sign of recovery, the present UK government, which maintains a steadfastly ostrich like attitude towards Europe in particular, and most other countries in general, may argue that a measure in terms of dollars at current exchange rates is irrelevant – the UK currency is the pound and what counts is constant price shifts. Such an argument is false and an attempt to disguise the true scale of the decline of the UK economy.

The internationally unmatched decline in UK dollar GDP is a huge fall in real international purchasing ability. The far higher than targeted inflation in the UK during the last two years, which has substantially eroded the population's living standards, is itself in part a reflecton of the decline in the UK's exchange rate and consequent raising of import prices. In short, the decline in the international purchasing power of the UK's economy translates into a direct fall in real incomes. The decline in the UKs ranking among world economies in terms of GDP, being recently overtaken by Brazil, statistically reflects the same process .

It may also be seen that the government's claim that the UK is outperforming Europe and the Eurozone is entirely without foundation even in constant price national currency terms. But when measured in terms of real international comparisons, i.e. in dollars, the UK's performance is incomparably worse than Europe's.

It appears extremely unlikely that the UK's economy will escape from this circle of decline in the next period. The austerity policies pursued by the present UK government have substantially slowed the economic recovery that was taking place in 2009 and the first part of 2010 - between the 3rd quarter of 2010 and the 3rd quarter of 2011 the UK economy grew by only 0.5 per cent. The opposition Labour Party has recently also endorsed essentially the same austerity policies which have failed not only in the UK but in other European economies, such as Greece and Ireland, where they have been pursued.

Even if any partial recovery takes place, for example by some increase in the exchange rate of the pound against the Euro, the sheer magnitude of the decline in the UK economy makes it implausible that this could be on a scale sufficient to reverse the fall in its relative international position.

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This article originally appeared on Key Trends in Globalisation.

UK stagnation turns to risk of double-dip recession

2011-12-30T09:22:00.001Z

By Michael Burke

The Construction Products Association (CPA) is forecasting a ‘double-dip’ UK recession for the construction industry in 2012 and compares the latest slump to that of 10 years ago - the last Tory recession under Major when 600,000 construction industry jobs were lost. The CPA is well-placed to judge the near-term outlook as it comprises all the main suppliers to the construction industry.

For most of 2011 the majority of commentary on the British economy veered between expectations of a strong boom and, more recently projections for a double-dip recession. The reality was more prosaic - with the economy stagnating, growing by just 0.5% over the latest 12-month period.

This is because most commentators ignored the actual cause of the prior recovery and the key factor which would reverse it. SEB has previously shown how the recovery was caused by the increase in government spending, both current spending (mainly increased welfare payments but also the Labour government’s cut in VAT) and increased government investment (Building Schools for the Future, etc.).

Reversal of Government Spending

The renewed economic stagnation arises because both parts of government spending have now been cut. Welfare benefits have been cut, which is disastrous for many recipients but also undermines household consumption as does the hike in VAT. Household consumption is the biggest single category of GDP. The policies that supported household consumption added 1.2% to GDP growth during the recovery and until Labour left office. In the period since the Tories took office the decline in household consumption has reduced GDP by 0.6%. Similarly government investment increased under Labour and directly added 0.8% to GDP over the course of the recession. Government investment fell immediately the Tory-led Coalition took office and has subtracted 1.0% from GDP over that period.

Taken together the combined effects of Labour’s increased spending added 1.8% to GDP, while the policies of this government have subtracted 1.6% from GDP.

Effects of Changing Fiscal Stance

The March 2011 Budget detailed a ‘fiscal tightening’, that is tax increases (except for companies) and spending cuts amounting to £41bn. By the 3^rd quarter approximately half of that tightening will have taken place as it is 6 months into the Financial Year. £41bn is approximately equivalent to 2.7% of GDP. The previous recovery saw the economy expand by 2.8% over 5 quarters. Therefore the direct effect of the fiscal tightening currently under way is to remove growth almost entirely from the economy, hence stagnation.

Unfortunately the extent of the damage does not end there. The fiscal tightening is only half-complete this year and yet there is already stagnation. This is because each sector of the economy is connected to the other. So, declining government spending in the form of firing public sector workers will lead to falling household consumption, and both will affect business investment.

Since each economic sector responds variably to a change in another sector’s activity, and often with a time lag, it is impossible to assign a precisely distributed causal effect of a change in fiscal policy. But we have noted above that Labour’s increased spending of 1.8% of GDP led to a recovery which added 2.8% to GDP. This demonstrates the way the state can lead economic activity in total. This is what Keynes called the ‘multiplier effect’ as the private sector responds to increased government spending. In this case the multiplier is 1.56 (the ratio of 2.8% to increased spending equal to 1.8% of GDP).

In reality the multiplier is probably considerably higher as there is a pronounced time lag while the business sector responds to changes in government spending. SEB has previously shown that private sector investment has consistently risen or fallen 6 months after changes in output. So, the private sector continued to invest for 6 months after the Coalition took office, and this was in response to the increased spending by the Labour government.

Therefore, without taking account of other factors such as net exports or an unwanted build-up of inventories, the direct and indirect impact of the current government’s cuts should be multiplied by 1.56. This would subtract 4.2% from GDP and almost certainly lead to renewed economic contraction. The government also plans £61bn of fiscal tightening in the next Financial Year, beginning in April.

Construction Investment

The construction sector is highly responsive to the business cycle as it relies on a high level of current investment. The CPA estimate that it is headed for a double-dip recession is therefore highly significant. This will sharpen the already acute shortage of affordable homes, either to buy or rent at a time when 300,000 construction workers have already been made unemployed. Local authorities throughout Britain are desperate for funds to build new homes, from which they could derive an income way above the cost of borrowing even with affordable rents. Instead of providing funds to them, George Osborne has provided £40bn in ‘credit easing’ to small and medium sized enterprises. They will not build homes, provide decent affordable housing and employ workers with these funds.

But the State could because it is a vastly more efficient provider of large-scale housing as well as infrastructure projects. The government and its supporters like to promote the falsehood that ‘there is no money left’. But £40bn of loans to local authorities and public bodies could go a long way to easing the housing crisis. It would also go some way to averting the likelihood of a double dip recession.

From the government’s perspective the only stumbling-block is that it would remove the main responsibility for construction from the hands of the private sector and place it in the hands of the public sector. This is of course what happened to most of the shareholder-held banking sector in Britain during the last crisis. It seems that nationalisation is only permissible when bondholders and shareholders are being rescued. But it is not allowed if it is to rescue the unemployed, those paying extortionate rents for substandard homes or even the economy as a whole.

When British thieves and French thieves fall out - the Anglo-French governmental dispute in perspective

2011-12-22T13:40:00.002Z

By Michael Burke

The French and British authorities are engaged in a war of words over which country will be first to be downgraded by the credit ratings agencies. At least the hostilities are purely verbal - these ‘heroes’ of Tripoli are prepared to use other methods when the odds are overwhelmingly in their favour.

The immediate cause of the dispute was initially the remarks of French central bank governor Noyer. In response to the threat from Standard & Poor’s (S&P), one of the credit ratings agencies, that France would be downgraded, he argued that Britain should be downgraded first because its economic fundamentals are worse than those of France.

The remarks caused predictable uproar in Britain. Even the leadership of the LibDems, the main representatives of the pro-EU business class in Britain discovered its nationalist roots and criticised the remarks. But Noyer argued that, ‘they [S&P] should start by downgrading Britain which has more deficits, as much debt, more inflation, less growth than us and where credit is slumping’. Essentially, Noyer is correct on the relative ‘fundamentals’. But this focus on the ‘fundamentals’ also demonstrates a shared and thorough misunderstanding of the nature of the crisis.

The table below shows the relative levels for each of the indicators specified by Noyer. The estimates are taken from the EU Commission Autumn forecasts.

Table 1

It is clear that the Noyer observations are correct. The British government’s credit rating is also under threat as the economy weakens. Yet France’s downgrade seems likely to happen even sooner. More importantly, the French government is currently paying over one per cent more for 10 year government debt than the UK so that its effective market rating is already lower than Britain’s. This is despite the lower deficit, lower inflation and higher growth in France.

This demonstrates that Noyer is looking in the wrong place for the determinants of bond yields. Bond yields are not primarily determined by the nominal level even of important economic variables. Ultimately the price of any given financial market asset is determined by the real level of savings that are directed towards it. In countries such as Britain, the US and Japan the very high level of corporate savings must ultimately be held in some financial asset, and in the current circumstances of weak or stagnant growth government bonds have looked far more attractive than their only main alternative, which is stocks. 10 year debt yields are currently below 2% in the US and below 1% in Japan. This is true even though government debt and deficit levels are even higher in the US and Japan than either France or Britain. UK companies cannot invest in financial instruments in another currency without exposing themselves to exchange rate risk.

For investors in French government bonds the situation is different. There is an easy alternative - German government bonds also denominated in Euros. The rising premium on French yields represents the increased perceived risk of the Euro breaking up, in which case investors prefer to hold the debt of the strongest economy in the Euro Area.

The key relevant ‘fundamental’ for the Eurozone is that investors may choose between different governments’ credits. That is, there is a market mechanism for redirecting savings towards one country - and there is no fiscal mechanism to transfer savings in the opposite direction. Just as in other Eurozone economies, bond yields started to rise in France as soon as ‘austerity’ measures were introduced. Investors based in the Euro have greater prospects of being repaid if they invest in government bonds where the economy will grow, not stagnate or decline.

French and British Both Wrong

The growth outlook is sharply deteriorating in both France and Britain. In the Spring Forecast the EU Commission was projecting 2% growth for both Britain and France in 2012. In the Autumn Forecast the Commission is forecasting just 0.6% growth. Both governments are pursuing ‘austerity’ policies which are clearly not working.

They have both also invested an enormous political capital in the maintenance of the AAA rating for their government debt and argued that their policies would reduce their budget deficits. As we have seen, both governments debt ratings are likely to be downgraded in 2012. And both countries are projected to have a deficit in 2013 which, five years after the recession began, is still double the level it was in 2007, before downturn began.

The failure of their policies has led not to a re-think, but in both cases to blaming foreigners. The unwillingness to correct a failed policy is the cause of the diversionary war of words between the two governments.

The most ridiculous aspect of their policy is that both governments claim that their policy is driven by the demands of financial markets. Yet the government bond markets are sending a very clear signal. Long-term interest rates are either at the current inflation rate as in France, or below it in Britain. They are so low because businesses are saving, not investing. Businesses feel more confident lending to the government than investing on their own account. But both governments insist on cutting spending. If that leads to renewed recession the effect will be to cut further the level of savings in the economy - and bond yields may start to rise.

Corporate savings are being lent to the governments at exceptionally low interest rates. This glut of corporate savings could be used to invest for recovery. Since businesses themselves refuse to do this, only the state can end the company investment strike.

EU Summit Is Another Failure for ‘Austerity’

2011-12-12T07:14:00.003Z

By Michael Burke

The outcome of the EU summit has widely been hailed in the British media as a triumph for David Cameron. It is rare that a complete rupture and isolation in multi-party negotiations is regarded as a triumph – but this is a function of the dominant and still growing xenophobia of the British press.

The EU Commission will now impose further spending cuts and rules to enforce deficit limits across the whole of the EU. David Cameron did not oppose these measures because they lead to public spending cuts- he is cutting public spending by a greater proportion of GDP than any major country which has not been in receipt of EU/IMF funds for its creditors.

Cameron’s stated objective was a defence of the interests of the City of London. There is a question mark over whether he has even be able to achieve that. Angela Knight, former Tory MP and chief spokesperson for the British Bankers Association guardedly told The Times that she hoped that City’s interests would not be harmed by Britain’s isolation.

Holding Back the Tide

‘Let all men know how empty and powerless is the power of kings’. So said King Canute in demonstrating to sycophantic courtiers the impossibility of instructing the advancing tidewaters to retreat. But it seems that the thinking of the EU Commission has retreated behind even that of Dark Age monarchs.

In response to the economic, fiscal and balance of payments crises in Europe, the EU summit in Brussels agreed to issue a series of regulations- to prevent these crises being manifest at the level of government deficits. A new rule that so-called structural deficits will not exceed 0.5% of GDP has been introduced . The EU Commission will be given prior oversight of the national Budgets. Given the impossibility of factually establishing the level of the structural deficit (which depends on extremely approximate estimates of potential output) then the combination is a recipe for complete control by the EU Commission - the economic geniuses who have led Greece and Ireland to disaster.

While it is impossible to precisely quantify the structural deficit it is practically impossible to determine the level of the government deficit simply by controlling spending. This is because the deficit reflects the gap between government spending and income. Government incomes are overwhelmingly taxation revenues and these are determined by the spending of consumers and the spending of businesses (primarily investment).

To achieve the precise control over its own income, as demanded by the new agreement, the European governments would have to determine the incomes and spending of both other main sectors of the economy, consumers and businesses. And, in a currency union it would also have to ensure that the overseas sector was not a significant net lender or borrower (through large trade or current account deficits/surpluses). Otherwise, if the other domestic sectors remained in broad balance, a large trade deficit could only result in a large government deficit.

This is show in Figure 1 below. The chart shows the sectoral balances in leading EU economies and the EU as well as the change between 2006 and 2009. The chart is taken from the Financial Times and is based on OECD data.

Figure 1

Simple national accounting identities mean that the increased savings of one sector of the economy must be reflected in the increased deficit of another. In all cases the balances shown below, the government balance (the public sector deficit/surplus), the private sector balances (the savings/consumption of the private sector) and the overseas sector (the current account balance) sums to zero, as they must.

Within each national economy of the EU it is impossible to legislate for the deficit of the public sector without determining the savings, consumption and investment decisions of all other sectors of the economy.

It is also entirely impossible in a single currency area for all other economies to maintain government balances if one or more key countries have large current account surpluses, as is presently the case with Germany and others. Other countries must then run current account deficits and to simultaneously maintain a government balance they are faced with two unacceptable alternatives. They must either hugely increase household savings even though incomes are declining; that is, household spending must fall even faster than incomes. Alternatively, businesses must reduce investment to well below the level of its income, which could only lead to a further reduction in competitiveness and a renewed widening of the current account deficit. This is the downward spiral that countries like Greece have already entered.

The Tory Position

David Cameron did not object to any of this because he is a champion of increased government spending, or a defender of the welfare state. Nor has his government shown any appreciation of the fact that reduced government spending will also reduce the incomes of other sectors of the economy.

Instead, his objection was to the threat to the City’s ability to siphon off funds from other businesses in Europe. He may not have been successful even in that limited aim. Ed Miliband writing in the Evening Standard argued that Cameron was ‘a prisoner of the Tory Right’ and had isolated himself and Britain from the continuing evolution of policy in Europe.

While willing the other EU national leaders to act decisively to halt the crisis, Cameron himself acted to prevent that happening. Defending the sectional interest of the City and relying on some of the most backward political forces in Britain, Cameron has finally crossed a line that even Thatcher only threatened to do. There will be no benefit to the British economy from this decision and the consequences could prove extremely negative. If, for example, overseas multinationals decide they want a base in the EU, will they choose semi-detached Britain or one of the other 26 countries who continue to have a common regulatory regime? If the British economy suffers as a result, it should be remembered this was done to benefit the City of London and to appease the Tory Eurosceptics and Union Jack-wavers.

George Osborne Shows He’s Learnt Nothing from Greece or Ireland

2011-12-05T06:33:00.001Z

By Michael Burke

The Autumn Statement was widely presented as facing up to harsh realities of slower growth, but with George Osborne offering a series of cunning schemes in order to resolve the crisis .

The stagnation of the British economy is a function of government policy and plans to increase investment by increasing the credit available to smaller firms will founder because they will not invest when they don’t expect to make profits .

SEB has long argued that government needs to increase investment in a series of areas. Surely, the government’s plans to increase investment in infrastructure should be welcome? But the government’s planned increase amounts to less than £3.8bn spread over four years, or less than 0.1% of GDP in each year. In addition, most of the wish list for infrastructure and capital projects is dependent on investment in the private sector. So, George Osborne and Boris Johnson stood outside Battersea power station in London and talks of new tube lines, enterprise zones and 25,000 jobs. Just two days later the private developer central to the project collapsed into receivership.

Worse, the government’s planned increase in capital spending is paid for by taking money from the pockets of the poorest and most vulnerable in society. These will bite much harder in later years, long after the pathetically small planned increased in investment has come to an end. This is shown in the table below, from the Autumn Statement.

Table 1

So, there are total cuts in current spending in 2012/13 of £910mn and total cuts over the next 3 years of £3.8bn, shown as a positive sign in the Treasury bookkeeping method. This is in order to pay for tax cuts (fuel duty) and a projected increase in capital spending. But in the two following years the projected cuts to current spending increase dramatically for a total of over £27bn cuts in all. Although these are mostly unspecified, the itemised cuts include child tax credits, working tax credits, real public sector pay cuts and the breaking of the promise to uphold overseas development aid at 0.7%.

This is a very damaging but much milder version of the same logic that has led Greece and Ireland to disaster - every failure to meet budgetary targets because of the impact of ‘austerity’ is met by further ‘austerity’ measures. But the deficit is and borrowing totals are likely to go higher still as the economy stagnates- or worse. It may only be a matter of time before this same logic produces comparably savage cuts in spending- with the same economic consequences.

Politically, by pre-announcing needed cuts for the next Parliament Osborne hopes to bind all parties to further ‘austerity’ measures. For the LibDems, Danny Alexander has already proved obliging, signing up to Tory cuts of £23bn in the next Parliament. The key question is whether Labour will go down the same path in accepting the need for cuts even when they have demonstrably failed to deliver economic growth or even deficit-reduction. It is the path that leads to Athens and must be resisted.

Desperate Osborne's Subsidies to Businesses Won't Work

2011-11-28T07:59:00.001Z

By Michael Burke

George Osborne has told the BBC that there will be £40bn in ‘credit easing’ so that small firms can obtain both cheaper and more readily available loans. Osborne has called the scheme a ‘game-changer’. If the funds had the stated impact, of increasing investment by small and medium-sized enterprises (SMEs), then it would certainly provide a significant lift to the economy. £40bn is equivalent to 2.8% of GDP.

The strength of this overblown rhetoric may be judged by the fact that there are widespread reports that the Office for Budget Responsibility is set to slash its growth forecasts for 2012 to just 1% from 2.5% previously.

How is it that significant funds for new investment by business will actually lead to no improvement in the outlook for growth, even on the usually over-optimistic forecasts from the OBR?

There are to be at least two, possibly three funds. The first will be guarantees to increase the availability of credit. The second will be a fund to lower the cost of that credit to SMEs. Since SEB continually argues for increased investment, surely this is a good thing?

Private Sector Failure

Even official forecasts do not assume that growth will significantly improve as a result of this policy. This highlights the fallacy that underlies all current attempts to persuade, cajole, demand or bribe private firms to increase their investment. The fallacy is that those firms are struggling under the burden of insufficient funds to invest. Of course certain individual firms may have such difficulties. But in aggregate that is not the case.

In a previous bulletin SEB showed that in 2010 the total Gross Operating Surplus of the business sector in Britain was £475bn. These are akin to profits. Yet the entire level of investment (Gross Fixed Capital Formation) was just £214bn in 2010. As this includes the investment by both private individuals and government, it is clear that businesses have vast resources already from which they could increase investment.

The chart below shows the decline in total Gross Fixed Capital Formation (GFCF) and corporate sector GFCF. Both these measures of investment began falling one quarter before the recession itself began. The fall in both at their low-point in the 4^th quarter of 2010, of over 20%, is approximately three times as great as the fall in GDP of at 7.1%. Both chronologically and arithmetically the decline in investment, led by declining business investment, led the recession.

Figure 1

Both measures of investment have experienced a small recovery. Business investment began to rise in the 1^st quarter of 2010. This was two quarters after both total investment and GDP began to rise in the 3^rd quarter of 2009.

Private sector investment led the recession. But it cannot lead the recovery. This is demonstrated in the chart below, which shows corporate GFCF and GDP.

Figure 2

The recovery in business investment occurred two quarters after the economy as a whole began to recover. This is because the increase in investment did not depend on the availability of resources, as profits have exceeded investment by some distance throughout the entire crisis.

Corporate investment rises and falls in line with expected returns. The purpose of capital is the preservation or expansion of capital. If the economy is not growing a main motive will be to preserve capital. If the economy is expanding, it will be increase capital through profitable returns on investment.

This is what happened in 2009-10. GDP began to expand in mid-2009 and six months later corporate GFCF began to increase. Precisely the same time lag operated in the reverse situation. Corporate GFCF fell once more in the 1^st quarter of 2011. This was six months after the modest recovery peaked n the 3^rd quarter of 2009.

Public Sector Leadership

The new factor which caused the recovery was the increase in public sector investment (both by general government and the remaining public sector corporations). At its highpoint in the 4^th quarter of 2009, public sector investment was over 20% higher than its pre-recession level.

This led directly to the increase in GDP which in turn eventually prompted the private sector to increase its own investment. The Tory-led Coalition immediately cut public investment on taking office, and six months afterterwards private investment began to contract once more.

Instead of subsidising the private sector to invest, the proven means of achieving that end is for government to increase its own investment. It could divert the support for borrowing costs to agents who are willing to invest, such as local authorities who want to invest in housing, infrastructure, transport and education.

Even on official forecasts the borrowing subsidy to SMEs will not work. But the recent history of the British economy shows that investment by the public sector will have the effect of restoring growth which in turns leads o a revival of corporate investment. Subsidies and bribes to businesses to invest will not work while there is no growth. Increasing, not cutting, the investment of the public sector will lead to recovery.

Latest UK GDP data even worse than it looks

2011-11-27T13:07:00.001Z

By Michael Burke

The latest release for British GDP in the 3^rd quarter was unrevised – but the composition of that growth was awful. GDP rose by 0.5% in the quarter and is just 0.5% higher than a year ago. But analysis of the components of growth suggests the outlook is deteriorating.

Household consumption did not grow at all in the quarter and contracted by 1.5% over the course of the year. Investment (gross fixed capital formation) fell by 0.2% in the quarter and by 1.8% from a year ago. In terms of domestic expenditure only government spending rose in the quarter, up 0.9% on the quarter and 2.9% over the year. This is testimony to the multiplication of ‘austerity’ measures: If unemployment and poverty are increasing at a faster rate even than you cut welfare benefits your total welfare bill will rise.

Taken together UK domestic expenditure rose by £3bn in real terms in the quarter. But inventories rose by £2.9bn at the same time and therefore account for almost the entirety of domestic growth in the quarter. Since GDP rose by just £1.8bn in the 3^rd quarter, the rise in inventories indeed exceeds the growth in GDP as well as accounting for almost the entirety of growth in domestic spending.

Inventory Build-Up

Inventories are a cyclical and erratic component of growth. But a persistent rise in inventories over a number of quarters only occurs if businesses are receiving new orders and are restocking as they become increasingly confident about a sustained upturn. This is sometimes called a voluntary rise in inventories. But this is not at all the situation presently. Domestic demand is stagnant and exports have also fallen in the last two quarters. It seems unlikely that order-books are filling up and businesses becoming more confident about future prospects. In fact the respected Market Purchasing Managers’ Index shows that new orders have been slowing dramatically, as shown in the chart below.

Figure 1 – PMI New Orders, National & London

Therefore the current build-up in stocks is likely to be an involuntary. Inventories are most likely rising because sales have not met expectations. If so, businesses will tend to meet new orders by depleting those existing inventories rather than increasing output. At the very least this rise in inventories is unlikely to be repeated over several quarters. The addition to growth in the 3^rd quarter arising from rising inventories is unlikely to be repeated over several quarters.

As we have seen domestic demand would have been close to zero and GDP would have contracted without rising inventories. To avoid that fate in subsequent quarters some other component(s) of growth will have to begin to grow once more. Otherwise the British economy will begin to contract once more.

Profits and Austerity In the Industrialised Economies

2011-11-14T08:06:00.001Z

By Michael Burke

A previous SEB article examined the profit rate in the Irish economy which is rising even though the economy continues to contract. Yet at the same time Ireland’s level of investment is falling. Corporate incomes – profits - are rising even though total economic activity is falling. Arithmetically, this can only occur by reducing the income of labour - wages are falling both in absolute terms and as a proportion of total economic activity. It happens that the Irish Department of Finance set this out with some clarity. This is indeed is the thrust of the entire ‘austerity’ policy – a transfer of incomes from labour to capital across the industrialised economies of Europe, as well as in the US and Japan.

Who Is Paying for the Crisis?

The table below shows the Gross Value Added (GVA) of selected economies, and how this is divided between the compensation of employees and the gross operating surplus of the corporate sector. GVA is a measure of all the value created in an economy. It is the same as GDP except that it excludes the impact of taxes and subsidies. With some important qualifications the Compensation of Employees (CoE) is akin to labour’s share of that value added, while the Gross Operating Surplus (GOS) is akin to the level of profits in each economy. This provides an approximate measure of economic activity and its distribution as income: Value-Wages-Profits. In the table blow the profit rate is calculated as the share of GOS in Gross Value Added.

Table 1. GVA, Compensation of Employees, Gross Operating Surplus and the Profit Rate, €bn in 2010 (unless otherwise stated)

The general tendency has been that the crisis-hit countries have the highest profit rates. This was an important factor in the build-up to the crisis. In nearly all countries the crisis was characterised by reduced investment by the corporate sector, which remains the driving force behind the economic crisis. In these higher profit countries the fall in investment had a greater impact on aggregate demand as the corporate sector takes a bigger share of GVA. In turn, the fall in investment had a bigger negative impact on household incomes, especially through rising unemployment.

Profits and deficits

The profit rates should also be seen in relation to the public sector deficits that have caused so much turmoil. In all cases the public sector deficits are a fraction of the level of profits. In Greece the 2010 deficit was €25bn, in Italy it was €70bn, in Ireland it was €19bn (excluding an extraordinary bank bailout), and so on. The deficits could easily be covered in their entirety simply by extracting a fraction of the profit level from the corporate sector in each country. The same is true of Britain, where the profit level in 2010 was £475bn compared to a deficit of £137bn. (The British profit level is depressed and consequently the profit rate is lower because of the slump in the financial sector – a factor which also applies to a lesser degree in the US and even to France).

Who can pay for the crisis?

There are effectively three destinations for profits. These are investment, which raises future prosperity, or dividends for shareholders which are not invested or huge executive compensation and bonuses, both of which do not. The table below shows the level of profits, the level of public sector borrowing and the level of gross fixed capital formation (investment). In the last column the difference is shown between the level of profits and the level of public borrowing and investment combined.

Table 2. Gross Operating Surplus, Public Sector Borrowing and Investment, €bn in 2010 (unless otherwise stated)

Table 2 shows that in all cases the current level of both the public sector borrowing and the current level of investment can be funded by the level of profits in each country and in the Euro Area. In most cases there is scope to fund both the deficit and significantly increase the level of investment. But the opposite has been happening.

The struggle over distribution of national income

In most recessions capital’s share of income falls. This is not because wages rise, but because profits fall at a faster rate than the fall in output. What then usually occurs is a struggle by capital to regain its lost share of income. It does this by cutting wages and benefits, by increasing unemployment and by reducing its tax burden - financed by reducing social welfare benefits. This is the content of ‘austerity’ measures.

Figure 1 below shows how this has operated in the Euro Area as a whole. Between 2008 and 2009 GVA in the Euro Area fell by €254. Confirming the idea that profits fall at a faster rate than output, Euro Area profits (GOS) fell by €227bn. Profits fell by over 6%, twice as fast as the fall in output. Wages (CoE) fell by €17bn.

Figure 1

However, this natural tendency for profits to fall at a greater pace than the fall in output is interrupted and diverted by a series of interventions, including rising unemployment, wages and benefit cuts as itemised above. In the period 2009 to 2010 Euro Area GVA rose by €188bn. Of this increase in output €139bn went to profits and just €53bn accrued to wages.

Because of inflation the real level of both wages and profits has fallen sharply – all these data are in nominal terms and do not take account of inflation. The ‘austerity’ offensive to increase the profit share has partly been successful, but the wage share of national income has not undergone any strategic reversal.

This is contrasted with Greece. Greek nominal GVA did not fall in 2009 at all as the Greek recession was shallower than most. GVA fell in 2010 by €6bn. This is shown in chart 2. The massive offensive against Greek workers and the poor means that the natural tendency for profits to fall faster than output has not operated. The level of wages fell by €4.4bn and profits fell by just €1.8bn. The wage share of national income has suffered a reversal.

Figure 2

Readers will be interested to know where Britain stands in relation to these examples, one of them the extreme case of Greece (and previously, Ireland). In 2009 British GVA fell by £38bn, shown in Chart 3 below. This was exceeded by the fall in profits, down £43bn and wages rose by £5bn. The entirety of policy since has been to reverse those trends. GVA rose in 2010 by €40bn. (It should again be stressed that these are nominal data, in real terms output is still over 4% below its peak and real wages have fallen).

Figure 3

As a result of initial ‘austerity’ measures, £18bn of the increase in output has been claimed for profits. But it is widely understood that the real offensive in Britain only began in the new Financial Year, which began in April this year. What is being attempted is a decisive reversal of the wages’ share of national income.

Conclusion

Countries like Greece are experiencing a qualitatively sharper crisis than the European average. There is a high correlation between the likelihood of economies falling into this type of extreme crisis and their exceptionally high level of pre-crisis profits. Because the income of the corporate sector is a much greater factor in the economy, their investment strike hass a proportionately greater impact on total output and/or government finances.

Profits remain exceptionally high, so much so that they could finance the deficit while simultaneously increasing the level of investment.

Under normal working of a market economy the tendency is for profits to fall faster than output. The entire ‘austerity’ policy is to prevent this tendency from operating, and to reverse it by reducing wages even faster than the decline in output. In the Euro Area, to date this has only been achieved in Ireland and Greece.

In Britain, it’s too early to say whether a similar ‘austerity’ drive will achieve the same disastrous results. But it is clearly the aim of government policy to drive up profits even while the economy is stagnating. This can only be achieved by driving down wages.

The relation of profits and 'austerity'

2011-10-25T08:22:00.001+01:00

By Michael Burke

In what may be an important development the Financial Times reports that, in return for accepting much larger ‘haircuts’ (imposed losses on the value of the bonds they own) bondholders are demanding that there must be a growth strategy for Greece.

In a piece headlined ‘Bondholders Demand Greek Growth Plan’ the paper quotes the Managing Director and chief negotiator for the Institute of International Finance, which represents the largest bondholders mainly the banks. The call for a growth plan is not given much substance in the article.

But there is a logic to the demand. Bondholders are most concerned about cash flow from interest payments and the final repayment of debt principal. In all the Euro Area economies where severe ‘austerity’ measures have been applied bond yields have risen - Greece, Ireland, Portugal, Spain and now Italy. This implies that the bondholders’ risk of not receiving those cash flows and principal has risen, and that a higher interest rate is demanded to compensate. ‘Austerity’, a generalised attack on the living standards of the overwhelming majority, has failed to provide reassurance to bondholders that they will get all the bond repayments. Instead, the reduction in incomes and economic crisis that has followed has increased the risks that the governments will default. If it proves to be the case now that the bondholders are demanding not more austerity, but growth, this would reflect the accurate judgment on their part that the risk of default has increased because of massive cuts in government spending. It is a demand that the European governments provide funds to Greece to help the economy recover, not impose more cuts.

Can ‘Austerity’ Work?

Of course the bondholders, mainly the banks but also increasingly other parasites such as hedge funds and ‘vulture funds’, had no qualms about massive assaults on pay, jobs, pensions, services and welfare benefits while they thought it improved their own prospects of being repaid by EU governments. But even at an earlier stage it was clear to some that cuts in government spending would not work. This is shown in the actions of the credit ratings’ agencies – who effectively represent the interests of the bondholders – and have repeatedly campaigned for large cuts in government spending, only then to downgrade countries such as Greece, Ireland, Portugal and Spain because of the negative economic impact of those same cuts.

By now it is increasingly clear in the case of Greece that any further cuts will be equally counter-productive in restoring the growth required to service debt. But the IMF, ECB and EU Commission are holding up another example of how their impositions can be made to work - Ireland. The ‘Troika’ argue that successive Irish governments (the current coalition of the rightist Fine Gael and Irish Labour Party having replaced the populist right of Fianna Fail) have stuck to the measures agreed, that growth has resumed and that therefore the deficit is falling.

In fact, the previous government imposed cuts in 2008 and before any international agency demanded them. The current government is set to announce its own first Budget, which will also impose greater cuts than demanded by the Troika. It is also widely understood, if not by the Troika, that Irish GDP is artificially inflated by the activities of (mainly) US multinationals booking activity and profits in Ireland to avail of its ultra-low corporate taxes. This has seen GDP rise in the latest two quarters. But domestic demand fell again by 1.1% in the 2^nd quarter of this year, a 3 ½ year-long slump collapse and is now 24.8% below its level at the end of 2008. According to the IMF the Dublin government’s deficit will be 10.3% of GDP this year, having been 7.3% before the cuts began to bite in 2008.

Even so, the Troika are increasingly determined that the deficit will decline and prove their case. They point to the fact that, excluding enormous bank bailouts equivalent to over 20% of GDP last year, borrowing fell from €23.5bn in 2009 to €19.3bn in 2010, an improvement of €4.2bn. Yet this is simply because the value of bonds redeemed in 2010 was €4bn lower. Otherwise there is no underlying improvement in the level of borrowing at all.

But there is an important difference with Greece. Following big tax increase Athens’ taxation revenues have fallen by 4.2%in the first 9 months of this year whereas Dublin’s tax revenues are 8.4% higher reflecting the imposition of new income taxes. The key difference is that Ireland was a much more prosperous country than Greece prior to the crisis. Per capita incomes were 50% higher, even adjusted for Purchasing Power Parities. Therefore, while the cuts have certainly had a negative impact on Irish growth, and the domestic economy continues to contract, the level of impoverishment of the entire economy is not in the same category as Greece, where even bondholders may now accept that further cuts are counter-productive. Instead, the impact of the cuts in Ireland might be said to be Greece in slow-motion.

Who Benefits?

The new caution in imposing further cuts in Greece is the worry of the loan-shark that the borrower may go bankrupt. But while there is still blood that can be squeezed in countries like Ireland cuts remain the sole policy agenda. The effect of this policy is clear from the recent publication of the sectoral accounts for the Irish economy.

This is shown in the chart below, which shows that as Gross Value Added continues to decline, profits have started to recover and therefore the profits’ share of national income has increased.

Figure 1

According to the Central Statistical Office (CSO), ‘The operating surplus or profits of non-financial corporations (NFCs) increased from €35.2bn in 2009 to €37.8bn in 2010. The other main component of value added is compensation of employees or wages and salaries which declined from €37.3bn in2009 to €34.9bn in 2010. Therefore the improved profit share relates more to a decline in payroll costs for these corporations rather than to an increase in overall value added.’
Yet this increase in the incomes of the corporate sector, wholly achieved by reducing wages, has not led to an increase in investment. It has led to the opposite, as the chart below shows.

Figure 2

In the words of the CSO, ‘Expressing gross fixed capital formation as a percentage of gross value added gives the investment rate. Gross value added is largely unchanged between 2009 and 2010 while investment fell from €7.5bn to €5.8bn in the same period resulting in a fall in the investment rate between 2009 and 2010.’

But there is also another way of expressing the investment rate - investment as a proportion of corporate incomes, or profits. On this measure, the investment rate has fallen by €1.9bn even as profits have increased by €2.9bn, by reducing wages by €4.9bn. The total investment rate has fallen on this measure from 21.3% to 15.3%.

From the point of the view of the economy as a whole, this transfer of incomes has been disastrous. The corporate sector has €32bn in unspent (uninvested) income from profits. But the household sector – which spends more than 90% of its income – has had its income reduced.

The thrust of policy is not to produce an economic recovery. It is to produce a recovery in profitability. In this, it has been a qualified success. The absolute level of profits has recovered from its low and the profit share of output has also increased to more than 50%, even if profits have not recovered their previous peak. The intention is clearly to achieve that goal at the expense of wages.

In Ireland it has become commonplace to suggest that, while all sorts of investment projects and welfare provision are desirable, ‘there is no money left’. On the contrary, the €32bn level of uninvested profits in 2010 alone is almost exactly equal to the entire reduction in GDP in the recession which began in 2008, €34bn.

This is the thrust of the entire ‘austerity’ policy across Europe, the transfer of incomes from labour to capital in order to increase profitability. In a subsequent blog SEB will examine the effective of this policy in the leading European economies, including Britain.

GDP Data Show UK Stagnation Is Home Grown & Due to Government Policy

2011-10-09T11:44:00.003+01:00

By Michael Burke

Publication of the latest estimate of GDP data shows that the recession was much sharper than previously thought. The revision shows that GDP contracted by 7.1% rather than the 6.4% previously estimated. The recovery which began in the 3^rd quarter of 2009 was also slightly stronger than previously estimated, the economy expanding by 2.8% until the 3^rd quarter of 2010. From that time onwards the economy has stagnated completely, with zero growth in the three quarters since. The result is that the British economy is 4.4% below its peak level before the recession, which is now estimated to have begun in the 2^nd quarter of 2008.

George Osborne and other Tories as well as their supporters in the media are now promoting the idea that the stagnation of the British economy is a function of the turmoil in the Eurozone economy and financial markets. The main channel for economic weakness in the Eurozone to be expressed in British economic activity is via exports. But the British economy has not grown over the last 9 months - while the first dip in exports has occurred only in the latest quarter. This is highlighted in the chart below, which shows the level of total domestic expenditure versus exports. Domestic demand began to contract as soon as the current government took office. Evidently, the stalling of British economy has not been caused by the turmoil in the Eurozone.

Chart 1

In fact the opposite is the case. The British economy comprises 14.5% of the entire EU economy, in OECD terms approximately $2trn of a total $13.8trn (in Purchasing Power Parities). Yet even before the latest downward revisions to GDP by the Office of National Statistics are included, the OECD data show that the entire loss in EU GDP was $355bn, of which British economic weakness is 21.4% of the total, equivalent to $76bn. As the chart below shows, the British economy has been a brake on the Eurozone economy, not vice versa.

Chart 2

Stagnation

Returning to the ONS release, the total loss of output since the UK recession began is £65.2bn. The total loss of investment (Gross Fixed Capital Formation) over the same period was £43.3bn, that is almost precisely two-thirds of the entire recession. But the latest data also represent a turning point. The total loss in household consumption during the recession was larger at £51bn, over three-quarters of the total contraction in the economy. The fall in household consumption began to outstrip decline in investment in the 1^st quarter of this year.

This loss in consumption has therefore not been the catalyst of recession. The decline in investment preceded the recession by 6 months. Declining investment was the driving force of the recession. But it does indicate that there is a new and significant and pressure on household spending in the British recession. Other components of the national accounts have risen over the same period, notably government current consumption and net exports.

It is also no longer the case that the private sector fall in investment exceeds the total decline in investment. Previously, this had been the case as government investment had risen. As a result the fall in private sector investment had amounted to 80% of the total lost output through the course of the recession. Now the decline in private sector investment amounts to £36.5bn - 56% of the total decline in output.
But government investment is now falling. In total, government investment has fallen since the recession began, down £6.8bn. But this is entirely a function of the current government’s policy. Since the Tory-led government took office, government investment has fallen by £12.2bn, more than reversing the very modest rise in investment of the previous Labour government. The direct effect of the government decision to reduce investment is to cut GDP by 0.9%.

Recovery Derailed

These are only the direct effects of declining government investment. It is now commonplace to speak of a continuous recession from the 1st quarter of 2008. Cameron and Osborne routinely speak of their dire inheritance from the Labour government. The actual inheritance of the Tory dominated government was actually an economic recovery underway, which after the latest revisions is now stronger and longer than previously estimated. The economic recovery lasted 5 quarters and GDP expanded by 2.8%, whereas previously it was estimated at 4 quarters long and a recovery of 2.5%.

The Labour government did not begin to increase investment until the 4^th quarter of 2008. From that time until the new government took office government investment rose by £27.2bn. But this had an indirect effect primarily by encouraging private sector investment so that the economy expanded by £38.7bn in total.
On the same ratio the current government’s decision to reduce its own investment will have led to a total decline in output of £17.4bn, or 1.3% of GDP.

Conclusion

The UK economic stagnation is a home-grown one due to the policies of the present government. It began before there were any negative effects from the Eurozone’s turmoil. It is primarily a function of the government decision to reduce its own investment. The British economy is stagnating because of policy made in Downing Street and nowhere else.

Economic downturn in the UK now twice as bad as in the Eurozone due to government deficit cutting

2011-10-03T15:54:00.003+01:00

By John Ross

One of the more factually inaccurate pictures being spread by supporters of the policies of the present UK government - with its priority to budget deficit reduction - is that UK economic performance during the financial crisis is superior to that of the evidently crisis hit Eurozone. A typical version of this appears in an article on 3 October in the Daily Telegraph by its international business editor Ambrose Evans-Pritchard.

Evans-Pritchard states: ‘My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse [the Eurozone] by foolish elites.’ Presumably Evans-Pritchard's sympathy goes to the inhabitants of the Eurozone, rather than his own country the UK, because he believes the UK has been doing better than the Eurozone.

The factual situation is the exact opposite of the impression presented by Evans-Pritchard. Judged by economic performance, the average citizen of the UK far more needs Evans-Pritchard’s sympathy than the average citizen of the Eurozone - i.e. the UK’s economic performance during the financial crisis is much worse than that of the Eurozone. This may be seen in Figure 1 – which shows UK GDP compared to that of the Eurozone since the peak of pre-financial crisis output. Comparison is straightforward as in both the Eurozone and the UK the peak of the previous business cycle was in the 1st quarter of 2008.

By the 2nd quarter of 2011, that is 14 quarters after the peak of the previous cycle, Eurozone GDP was 2.0 per cent below its previous peak level whereas UK GDP was 3.9 per cent below its previous peak - i.e. UK economic performance was almost twice as bad as that of the Eurozone.

Figure 1

Equally striking is the clear way in which present government’s policies made UK economic performance worse than in the Eurozone. It may be seen from Figure 1 that while the initial decline in UK GDP was greater than in the Eurozone - the greatest decline in UK GDP being 6.4 per cent registered in the 3rd quarter of 2009, compared to a maximum Eurozone drop of 5.5 per cent in the 2nd quarter of 2009 - recovery in the UK was also initially more rapid. This may be clearly seen in Figure 2, which shows year on year GDP changes.

The UK and the Eurozone reached their 1st quarter 2008 peaks with almost exactly the same economic momentum behind them – 1.9 per cent growth in the previous year in the UK and 2.0 per cent in the Eurozone. However by the 3rd quarter of 2010, the one immediately following the departure of the previous government, UK GDP was rising at 2.5 per cent compared to 2.0 per cent in the Eurozone. Eurozone recovery subsequently slowed somewhat to 1.6 per cent by the 2nd quarter of 2011.

However UK GDP growth under the new government, which gave priority to budget deficit reduction, dropped astonishingly, by more than two thirds, from 2.5 per cent to 0.7%. Under the new government the year on year growth of UK GDP therefore fell from being higher than that of the Eurozone to being less than half that of the Eurozone!

Figure 2

The present author is not a supporter of the present constitution of the Euro. On the contrary I predicted the current events unfolding in Greece and other countries in advance due to fundamental weakness in the design of the Euro. Writing in 1996, i.e. fifteen years ago:’ [the Treaty of] Maastricht’s proposals are … disastrous. It proposes to create the most fundamental features of a common state — a single currency and a central bank. But it does not create any state budget which can deal with the huge regional and sectoral implications of this. The process that would unfold with the creation of a single currency by this method may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join.There will be sharply deepening regional imbalances and inequalities.’There is evidently no reason to revise that analysis.
It is therefore all the more striking that UK economic performance is actually worse than in the Eurozone. And a substantial reason it is worse is clearly due to the policies of the present government with their priority to budget deficit reduction.

In any discussion of the relative economic performance of the Eurozone and the UK two fundamental facts must be held in mind against unsubstantiated myths:

UK economic performance during the financial crisis is substantially worse, almost twice as bad, as that of the Eurozone.
And the reason it is that bad is because the present government, through its priority to cutting the budget deficit, reduced the UK’s rate of economic recovery from substantially above that of the Eurozone to less than half that of the Eurozone.

This factual situation evidently has a more general economic significance than merely for the UK and the Eurozone. For reasons dealt with frequently on this blog a policy of simply running budget deficits is inadequate to deal with the consequences of the present financial crisis as it does not tackle its driving force - the decline in investment. But under conditions of private sector weakness any rapid reduction in the budget deficit will lead to rapid economic slowdown or contraction. This is sharply illustrated by the fact that the UK government, by such policies, has reduced the UK's rate of economic recovery to less than half that of the openly crisis struck Eurozone.

Other countries thinking of embarking on immediate deficit reduction policies, such as those advocated by the Republicans in the US, should look at the UK and draw the appropriate negative conclusions. Do not be totally distracted by financial fireworks: the policies of the present UK government are so bad they have produced an economic recovery which is only half that of the Eurozone!

* * *
This article originally appeared on Key Trends in Globalisation.

Move towards some sensible ideas from Samuel Brittan

2011-09-24T15:59:00.000+01:00

By Michael Burke

The Financial Times’ veteran economics commentator Samuel Brittan has recently argued for the state’s holdings in the banks to be used as the basis for creating a new state bank focused on productive investment.

Echoing calls from Adam Posen, he argues that the disastrous fall in both the money supply and bank lending needs to be corrected by decisive state action. Posen is perhaps the sole member of the current Bank of England Monetary Policy Committee who understands the gravity of the current situation and is not constrained by official orthodoxy in seeking remedies l.

These are similar ideas as those outlined in the recent pamphlet, ‘A Brighter Economic Vision for Britain. Brittan says his own proposal, ‘...is to use the state-owned banks as the nucleus of Mr Posen’s proposed state lending bank for small and medium enterprises. Who knows what obstacles well-paid lawyers could think up? But in principle this could start next week. The main thing needed would be a Treasury directive to these banks to replace profit maximisation with a requirement to promote economic recovery.’

One reason for the renewed slump in the share price of leading British banks is their exposure to the sovereign debt crisis. Yet Lloyds-TSB Bank, for example has seen the price of its shares fall from 74p at the time of the government’s share-buying programme to 34p as at the close of trading on September 23. This compare to the collapse of RBS’ share price to 22p compared to the government purchase price of 52p – despite the fact that (aside from the US and Britain) Lloyds has no significant exposures to sovereign debt markets at all.

This highlights the fact that the main driver of the slump in banks’ shares is not primarily the debt crisis, severe though that it is. The share prices have collapsed because of economic weakness and the deterioration in the banks’ existing loan book, personal, business, mortgage and other loans.

Therefore it is possible to differ with Brittan’s analysis in two respects. First, the banks’ refusal to lend is driving both the fall in profits and the share price on which it rests. They are not ‘maximising profits’ but hoarding capital in order to preserve it. A government instruction to lend is the only way to break the lending and investment strike. Secondly, it is a widespread misconception that small and medium-sized enterprises (SMEs) are the key to growth. In reality, outside the personal services sector they mainly provide inputs to much larger firms. Bundling up loans to SMEs will not create the investment demand for smaller firms’ output. The largest firms show no intention of increasing their own investment – which is what is required.

Instead, only government can break the log-jam by initiating investment in housing, in infrastructure, in transport and in education. The private sector would benefit. These contracts would mainly be awarded to large firms but they tend to sub-contract or purchase inputs from SMEs and individuals. It is this process which creates employment at the SMEs.

But this is a disagreement only about the nature and direction of the required policy. The basic thrust of the Brittan analysis is correct. Bank lending and money supply are collapsing along with the banks’ share prices. The banks contain the resources to correct the slump, yet refuse to do so. They are in public ownership. All that is required is a government instruction to fund the large-scale investment that is required to produce a recovery.

Eurozone rescue packages will continue to fail until they deal with the central issue in Europe's recession

2011-09-18T13:32:00.001+01:00

By John Ross

The international financial system is passing through the agony of a new round of the Eurozone debt crisis for the simple reason that European governments, like that in the US, refuse to deal with the core of the economic recession in Europe for reasons of economic dogma.

Anyone who looks at the economic data for the Eurozone without wearing ideological blinkers can see the situation at once – it is charted in Figure 1. The Eurozone recession is due to a collapse in fixed investment. Taking OECD data, at inflation adjusted prices and fixed parity purchasing powers (PPPs), then between the last quarter before the recession, the 1st quarter of 2008, and the 2nd quarter of 2011 Eurozone GDP fell by $204bn. But private consumption declined by only $29bn while the net trade balance increased by $32bn and government consumption rose by $91bn.

However fixed investment fell by $290bn – i.e. the recession in the Eurozone was wholly due to the fixed investment decline

Figure 1

Equally evidently, due to its scale, until this fall in investment is reversed it will take a prolonged period for the recession to be overcome. Therefore to restore growth, which by now is generally realised is the core to turning round the budget deficit problem, the fixed investment decline must be overcome.

Nor is there anything mysterious about how to do this – the state has entirely adequate means. To take the most decisive international case China made the core of its stimulus package direct state investment particularly aimed at infrastructure and housing – the result being that China’s economy has grown by over thirty per cent in three years.

Europe and the US clearly do not have the scale of state sector, nor the political willingness, to act on the scale China did. But US history shows that even without proceeding to a socialist scale of measures direct state intervention on investment is entirely possible.

Roosevelt expanded US state investment from 3.4% of GDP to 5.0% between 1933 and 1936 (data from US Bureau of Economic Analysis Table 1.5.5). Jason Scott Smith, in his study of New Deal public spending, summarises such investment as including 480 airports, 78,000 bridges, 572,000 miles of highway - which, in addition to its immediate effect in stimulating demand, reinforced the productive position of the US economy. Roosevelt, it is superfluous to point out, was neither a socialist nor a communist (despite claims to the contrary by the US right!).

Quarterly, up to date, data is regrettably not available on what is occurring across the Eurozone for state investment, but it is available for the US and there is no reason to suppose, with current policies, that the situation in Europe is any better. Between the peak of the previous US business cycle, in the 4th quarter of 2007, and the 2nd quarter of 2011 US private fixed investment fell from 15.8% of GDP to 12.2% - i.e. a decline of 3.6% of GDP. Yet in the same period US state investment did not compensate but also fell marginally – from 3.3% of GDP to 3.2% of GDP. Therefore while Roosevelt expanded the weight of US state investment current US administrations have been letting it fall.

Instead of directly addressing the core issue of the investment fall European administrations are either attempting to stimulate it indirectly – which, as it is ineffective, has led to fiscal/sovereign debt crises, or are acting via expansion of the money supply – which, in a situation whereby companies and households are paying down debt, is merely the famous ‘pushing on a piece of string’.
The most favourable outcome of such a situation is that eventually the debt will be paid down, but only after several years of stagnation. The less favourable variant, of course, is that the banking system breaks under the strain and renewed recession is further propelled by fiscal cutbacks. All these problems simply arise from the fact that, under the rubric of the dogma ‘private equals good, state equals bad’, European governments refuse to use the state tools available to deal with the investment fall which is at the core of the Eurozone recession.

Some European politicians are now beginning to call for state measures to increase investment, UK Business Secretary Vince Cable being one. But the action they envisage so far is inadequate to deal with the scale of the investment fall.

China's economy, which does not have such ideological inhibitions, will continue to expand while the Eurozone remains relatively stagnant for a significant period - and as long as economic stagnation continues there will be no resolving of the Eurozone debt crisis.

A Brighter Economic Future For Britain

2011-09-05T12:09:00.000+01:00

By Michael Burke

‘A Brighter Economic Future for Britain’ is the title of a new pamphlet co-written by the present author and Professors George Irvin and John Weeks. In the Guardian we set out the rationale for the publication:

‘The UK depression has already lasted three years, and NIESR argues that is likely to last five years or more – longer than that of 1930s.

Yet economic debate is dominated by counterproductive attempts to reduce the deficit through cuts in public spending, which are now the single most important cause of the depression.’

The full article can be read here.

In an argument that will be familiar to regular readers of SEB, the pamphlet argues that public spending cuts are counter-productive both in terms of reviving growth and in reducing the public sector deficit. This is because the deficit itself is primarily a product of the depression.

Further the underlying cause of the depression is a private sector investment decline, which by the end of the 1^st quarter of 2011 accounted for 80% of the total lost output since the economy began to contract 3 years earlier – that, is £44.9bn of a total of £56.3bn.

Therefore breaking that investment strike is a pre-requisite to any sustained recovery. By investing in areas such as housing, transport, infrastructure and education, the government can lead an economic recovery that meets acute economic needs and reverses the rise in joblessness.

The pamphlet puts forward two related solutions to the crisis- the creation of a state-owned Investment Bank and using the excess capital at the state-owned banks to fund the needed investment.

Importantly, this analysis is beginning to win political support. In welcoming the attempt to turn the debate towards an investment-led recovery Jon Trickett MP argues in a foreword to the pamphlet,

‘Collapsing investment hits current growth and long-term productivity.....Working on the premise that we must tackle investment and long-term competitiveness the authors argue that one way forward which would increase demand in the economy, and raise both employment and productivity, would be to take action now to address this issue.....The pamphlet sets out one idea from the authors to tackle this collapse investment; a National Investment Bank, using the government’s majority stake in Lloyds-TSB and RBS.....There are those who would argue that this would indeed be poetic justice.’

The continued economic stagnation in Britain and some other leading economies will force a reconsideration of policy even among the architects of the current crisis and their supporters. In Britain , though, a Tory economic ‘Plan B’ is likely to include privatisation, deregulation as well as attacks on social protections such as maternity/paternity leave, pensions and an abuse of youth ‘training’ programmes to provide unpaid labour. But none of this will alter the basic problem that private firms are sitting on hoards of cash that they refuse to invest, while also leading to further impoverishment for the overwhelming majority of the population.

Likewise, since at least the ‘worse than Thatcher’ New Labour Budget of 2010 there are many now on the opposition benches who fundamentally agree with the ‘austerity’ policy. They merely advocate slower, shallower, more anguished cuts. But as the economy has already stalled under the impact of less severe cuts than they would now be implementing, the Labour supporters of cuts are also obliged to look for a ‘Plan B’. Whether they move towards Osborne, or in the direction of state investment to generate recovery remains to be seen.

In any event, as the pamphlet argues there can be no suggestion of a sustained recovery without replacing the policy of cuts with a government-led investment recovery.

Social Unrest and Government Policy

2011-08-17T18:03:00.003+01:00

By Michael Burke

There’s a very good piece on LabourList titled ‘Who Didn’t Predict a Riot?’ It lists many of the bodies or leading individuals who warned that deep cuts to public spending would lead to social unrest and violence. The short piece is worth reading in full, but here is a (far from exhaustive) list of those who did predict riots and civil disturbances because of the policies of the Tory-led government:

Derek Barnett, president of the Police Superintendents' Association
The Commissioner of the Metropolitan Police
Karen Ward, senior economist at HSBC
The Governor of the Bank of England
The Archbishop of Canterbury
Nick Clegg, and not least,
Youth workers in some of the affected areas

The latter prediction was made in response to the closure of most of the youth clubs in Haringey, but all the warnings were made in an assessment of the impact of the cuts.

The disturbances were therefore not only a predictable cause of the government’s policies, they were predicted by a broad array of specialists and commentators, many of whom are not particularly hostile to the government (and one is a leading member of it). Based on historical experience, not least the effects of Thatcher’s cuts in the early 1980s, it was inevitable that riots and other disturbances would follow as a consequence of government policy. The list is a bit long and comprehensive for the Tories to dismiss them all as excusing rioting – although doubtless that won’t stop them.

Analysis from the Guardian has shown that, while rioting and looting include many layers of society and has many motivations, the striking fact is that of those currently charged with offences, 41% live in the most deprived 10% of areas in England. This too is predictable. As bodies such as the Institute for Fiscal Studies have pointed out, the poorest have been hardest hit by the cuts. Therefore, just as it is inevitable that deep cuts to public spending will lead to social unrest, those most harmed by the cuts, or at least some living in those communities will be at the forefront of that unrest. Latest analysis from the TUC shows that in some of the riot-affected areas there are 20 jobskeekers for every job vacancy.

Of course, even in the most deprived areas, the majority of people do not riot, still fewer engage in looting or approve of it. But opinion polls also show that while most think the police responded well to the riots (despite widespread media criticism of them) most also believe that David Cameron, Theresa May and Boris Johnson did not respond well to the riots.

Strikingly, while a majority of between 8% and 10% believe that government policies on welfare, education and law and order will make matters worse, double that level, 20% believe that government economic policies will have the same effect. A net 23% also oppose the cuts to police budgets.

Although opinion polls only ever represent a snapshot, and views expressed are often contradictory, this set of opinions reflects a fundamental truth. Government policies are not only impoverishing the majority, they have predictably led to violent social unrest. The continuation of these policies will only exacerbate those trends.

Tory policies are making the overwhelming majority worse off while also making their neighbourhoods and town centres less safe.

Economic Crisis Is Cause of Deficits, Not Vice Versa

2011-08-16T13:57:00.002+01:00

By Michael Burke

SEB has repeatedly argued that it is the economic crisis which has caused the rise in government budget deficits, not vice versa. This view is reinforced by the recent gyrations in global financial markets. .

This issue is crucial for the debate on economic policy, as understanding the real factual situation clearly leads to promoting growth as the means to tackle the deficits. By contrast, an analysis which suggests that it is the increase in government spending which has caused the economic slowdown can simply be addressed by cutting that spending.

The latter is the policy pursued by the Tory-led Coalition. It has strong ideological support across the media, including the BBC. It is not at all based on the facts. Before the Great Recession began in 2008 the public sector deficit in the UK economy was 2.7% of GDP. It rose to nearly 4 times that level in 2010 at 10.4% of GDP. The same is true across the Euro Area as a whole, where the deficit was a negligible 0.7% of GDP in 2007, and rose to 6% last year.¹ The same pattern is evident in the US where the deficit rose from 2.8% to 10% of GDP, and in Japan from 2.4% to 9.7%. The public sector deficits in all cases rose under the impact of the recession and the varied efforts of governments to offset its effects. There is a very useful dissection of the sources of the US deficit here from Professor John Weeks . In the US as elsewhere, the deficit is driven by the fall in both income and corporate tax revenues, and a rise in unemployment benefit payments as the jobless total rose.

The recent turmoil in financial markets arises because of the accumulating evidence of a renewed slowdown in economic activity, including both in the US and Europe. But this has not prevented the widespread assertion that the turmoil was caused by the European debt crisis. This is to compound the initial error, which also views the world through the wrong end of the telescope and holds that deficits are causing the slowdown.

A characteristic example of this incorrect assertion comes from the BBC’s business editor Robert Peston. On August 7 Peston wrote: ‘Although bankers say the downgrading of America’s credit rating was unwelcome, their more pressing worry is the rising price Italy has to pay to borrow - the rising price of Italian government debt’. Italy is extremely important, as it is both the third largest economy in the Euro Area and has the largest level of outstanding government debt. But the yields on Italian government debt had peaked on August 4, and as the chart below shows fell continuously through the following week.

Figure 1 Italian government debt yields

Bond prices rose for all EU governments and their yields fell as the ECB bought €22bn in EU government debt. This is a welcome departure from the ECB, and represents a further small step in the direction of EU-wide solution to the crisis rather than further attacks on ‘peripheral’ economies. It is also likely to be insufficient given the scale of the deficits and existing debts in the Euro Area. But it is clear from the chart that the continued turmoil in stock markets is not driven by EU bond markets - they had stabilised.

At the time of writing, most major stock markets are falling once more in reaction to the weak German GDP for the 2^nd quarter, up just 0.1% in the quarter. By contrast government bond prices are rising and yields falling - in the case of Germany and the US to new record lows . And bond yields for the crisis-hit European countries are now back at levels last seen a month ago, before the EU summit on Greece.

The same cannot be said for stock markets. The chart below shows the performance of leading stock markets. All the major stock indices of the US, Germany, France and Britain are nursing losses in the range of 5-10% - the exception is the Shanghai Composite Index which has recovered all the recent lost ground.

Figure 2 Major Stock Market Indices

There is a clear message from the divergent paths of major financial markets in recent days. Stocks have fallen and bonds have risen because growth is weakening once more. The markets have taken fright not from public sector deficits, which remain large - yet bond yields are falling. They have taken fright from slowing economic activity. Financial markets are not clamouring for spending cuts, VAT hikes and job losses. The remedy they seek is the one that is necessary for the economy- a return to growth.

Notes

1. Eurostat, Euro Area Spring Forecasts 2011,

More than three years without full economic recovery in the developed economies - the latest GDP figures in context

2011-08-16T13:41:00.001+01:00

By John Ross

The publication of the European Union (EU) and German 2nd quarter GDP figures, following those for the US and Japan, completes the data regarding the state of the business recovery in the main developed economies. The picture is completely clear – Figure 1:

By the 2nd quarter of 2011 none of the major regions among the developed economies has recovered their peak level of GDP more than three years after the high point of the previous business cycle.

US GDP is 0.4% below its peak level in the the 4th quarter of 2007.

EU GDP is 1.8% below its peak level in the 1st quarter of 2008.

Japan’s GDP is 6.0% below its peak level in the 1st quarter of 2008 – Japan’s data is of course affected by the earthquake and tsunami.

Overall, taking the period as a whole, this represents over three years of net negative growth in the developed economies. The key economic issue is not the possibility of a double dip recession, which the media is speculating on, but this extremely low growth rate even without one.

For comparison it may be noted that China’s economy has grown by over 30% in this same three year period.

Figure 1

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

What lies behind the renewed international economic crisis - and what policies are required to deal with it?

2011-08-11T11:08:00.005+01:00

By John Ross

Given the onset of a renewed round of the international financial crisis it is useful to draw together its various elements in an analysis of its overall determinants, its course, and the policies necessary to deal with it. This is the aim of this article.

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For the second time in three years almost all parts of the world economy are being shaken by a renewed financial and economic crisis. The most important immediate drivers of this are not Standard and Poor's downgrading the US's credit rating, or political struggles between President Obama and Republicans in Congress, but weak US economic recovery, Europe's widening debt crises, the consequent $8 trillion loses on international share markets by 9 August with knock on effects on balance sheets and spending, the continuing decline of US house prices and a new developing crisis of the banking system.

Reasons for the open reappearance of crisis

The reason severe crisis has reappeared, and what determines its dynamic, is the failure of US and European government policies to resolve the issues which created 2008's financial collapse. The policies pursued since then, which were adapted to deal with much more minor economic events than the ones which occurred, postponed the unwinding of the crisis without removing its underlying causes. As a result the focus of the crisis changed but it was not resolved.

The immediate cause of the financial crash of 2008 was an unsustainable build-up of US private sector debt – this debt being accumulated due to the attempt to maintain the growth of the US economy and to ensure political stability by sustaining US living standards. By the 4th quarter of 2007, the peak of US economic expansion, total US household, private non-financial company, and government debt was 218 per cent of US GDP – Figure 1. That the fundamental debt build up was private, and not government, is shown by the fact that household and non-financial company debt was equivalent to 168 per cent of GDP compared to 51 per cent of GDP for government debt - i.e. private debt was more than three times as large as government debt.

Figure 1

Interest rate increases introduced leading to 2008, in order to deal with inflation, resulted in the inability of the US private sector to finance this debt burden. The US sub-prime mortgage crisis was simply the weakest link in the overall excessive US private debt.

In 2008 the inability of the US private sector to meet its debt obligations, with consequent falls in asset values, initially in housing and then in shares and other financial instruments, destroyed US financial institutions’ balance sheets. The US financial sector overall became insolvent. Therefore a stronger and more centralized financial instrument, the US state, had to step in to rescue the private financial system - with a similar process occurring in other countries. The new crisis has broken out because of the risk that the tools available to the US and European states themselves will be insufficient to restore stability.

Transfer of private sector debt into the public sector

The debt data clearly show the process of transfer of the original excessive US private debt into the public sector – the changes in US debt since the peak of the previous business cycle are shown in Figure 2.

Following the onset of the US economic downturn in 2008, the overall US debt burden rose, reaching 247 per cent of GDP in the 3rd quarter of 2009 – these changes reflecting the decline in US GDP as well as increasing debt. Since then up to the 1^st quarter of 2011, the latest available data, US debt fell only marginally to 243 per cent of US GDP - still 26 percentage points above pre-recession levels.

However the internal structure of US debt shifted. US private sector debt peaked at 180 per cent of GDP in the 2nd quarter of 2009. It then fell to 163 per cent of GDP – still 5 percentage points above its pre-recession level. But any recent decline in private sector debt has been almost entirely offset by increases in government debt created by budget deficits exceeding 10 per cent of GDP.

Figure 2

The US therefore simply ‘nationalized’ its debt problem – replacing private with public debt. The mechanisms by which this occurred were the indirect consequences of the financial crisis, with recession increasing welfare payments and reducing tax receipts, as well as transfer of funds to the private sector in bank bailouts and similar measures.

John Mauldin and Jonathan Tepper therefore put it correctly in their book Endgame: ‘Debt is moving from consumer and household balance sheets to the government. While the debt supercycle was about the unsustainable rise of debt in the private sector, endgame is the crisis we will see in the public sector debt.’ (p25)

In short, although the US crisis may currently appear in the form of a government deficit and debt issue, the origins of the problem lay in the private sector and the government debt issue is the consequence of nationalization of private sector debt.

The European debt crisis

Europe followed a similar path to the US but with some countries, e.g. Greece and Italy, building up large public sector debts alongside the private ones in Spain and other states. Europe’s situation is structurally more potentially threatening than the US as the Federal Reserve has greater resources than the European Central Bank and the US state is able to react in a more centralized way than the decentred structure created by the different states of the European Union.

The European Central Bank simply does not have sufficient resources to be able to deal with a spread of the debt crisis into the larger EU economies such as Spain and Italy. Given the exposure of European banks to national state debt the spreading of the European sovereign state crisis to major economies therefore has the potential to bring down the European banking system. For this reason there have been rising European interbank lending rates, reflecting banks decreasing willingness to lend to each other, extremely high rates for bank insurance in a number of countries, and sharply falling bank share prices in both Europe and the US.

Kenneth Rogoff, author of the notable quantitative study of debt crises This Time is Different, and former chief economist of the IMF, accurately summarized the situation in the financial sector as follows:

‘Securitization, structured finance, and other innovations have so interwoven the financial system’s various players that it is essentially impossible to restructure one financial institution at a time. System-wide solutions are needed… the financial system remains on government respirators… in the US, UK, the euro zone, and many other countries today.

‘Most of the world’s largest banks are essentially insolvent, and depend on continuing government aid and loans to keep them afloat. Many banks have already acknowledged their open-ended losses in residential mortgages. As the recession deepens, however, bank balance sheets will be hammered further by a wave of defaults in commercial real estate, credit cards, private equity, and hedge funds. As governments try to avoid outright nationalization of banks, they will find themselves being forced to carry out second and third recapitalizations.

‘Even the extravagant bailout of financial giant Citigroup, in which the US government has poured in $45 billion of capital and backstopped losses on over $300 billion in bad loans, may ultimately prove inadequate.’

Political struggles are the symptom of the renewed crisis and not its cause

Given the scale of the debt situation none of the means used for tackling the debt problem in the US and Europe can avoid severe economic pain. The political fighting which has broken out is simply over how this pain should be shared. The political struggles which have occurred, for example between President Obama and Republicans in Congress, or between Germany’s government and other European states, are therefore not the cause of the renewed economic crisis but its result. Analysing the different responses however leads directly to the issue of the necessary policies to deal with the financial and economic crisis.

The necessity to run budget deficits

The most ideologically right wing forces - the US Tea Party and those in Europe sharing the views of the British Conservatives - advocate limiting the public debt build up by radically reducing government spending. This is linked to a theory that the state is ‘crowding out’ the private sector. This entire analysis is false. Because of its ideological blinkers it fails to see that the origin of the crisis lay in the private sector debt. It is also extremely dangerous in terms of economic policy.

The main transmission belt from excessive debt into recession is the fall in private investment. As may be seen in Figure 3 the entire decline in GDP in the G7 economies between the 1^st quarter of 2008, the peak of the previous business cycle, and the 1^st quarter of 2011, the latest available data, was accounted for by the decline in fixed investment. In fixed price parity purchasing powers (PPPs) the decline in G7 GDP was $381 billion and the decline in fixed investment was $591 billion – the decline in fixed investment can be greater than the decline in GDP as it is offset by increases in household and government consumption.

Figure 3

The theory of ‘crowding out’ argues that resources used to finance the budget deficit would be used to generate economic expansion if released to the private sector – for example US financial analyst John Mauldin argues ‘increasing government debt crowds out the necessary savings for private investment, which is the real factor in increasing productivity.’ (Endgame p59)

But reducing budget deficits by cutting public spending cannot create an economic way out in present conditions. Reducing budget deficits cuts demand. But resources released to the private sector are used to pay down debt, so private spending will not increase sufficiently to compensate for the fall in public spending. Total demand will fall, increasing recessionary pressure.

In short, it is vital in the short term to maintain budget deficit spending, including by targeting maintaining or expanding consumption – state spending on investment is analysed below. Attempts to immediately reduce budget deficits must be strongly resisted. Countries facing an economic slowdown should run, or increase, budget deficits to compensate for the shortfall of private sector demand.

Richard Koo, in his important books Balance Sheet Recession and The Holy Grail of Macroeconomics, has dealt with this correctly in analysing the experience of the decades long fight against the consequences of over-indebtedness in Japan. As Koo noted:

‘What sets Japan’s Great Recession apart from the U.S. Great Depression is that Japanese GDP stayed above bubble peak levels in both nominal and real terms despite the loss of corporate demand worth 20 per cent of GDP and national wealth worth ¥1,500 trillion… The financial deficit of the government sector mounted sharply, leaving in its wake the national debt we face today. But it was precisely because of these expenditures that Japan was able to sustain GDP at above peak-bubble losses despite the drastic shifts in corporate behavior and a loss of national wealth equivalent to three years of GDP. Government spending played a critical role in supporting the economy…

‘Japan was left with a large national debt. But if the government had not responded with this kind of stimulus, GDP would have fallen to between one-half and one-third of its peak – and that is an optimistic scenario. U.S. GNP shrank by 46 per cent after falling asset prices destroyed wealth worth a year’s worth of 1929 GNP during the Great Depression, and the situation in Japan could easily have been much worse. This outcome was avoided only because the government decided early on to administer fiscal stimulus and continue it over many years…

‘In summary, the private sector felt obliged… to pay down debt… Disastrous consequences were avoided only because the government took the opposite course of action. By administering fiscal stimulus, which was also the right thing to do, the government succeeded in preventing a catastrophic decline in the nation’s standard of living despite the economic crisis.’ (The Holy Grail of Macroeconomics p22-25)

Naturally the form the budget deficit takes is itself extremely important. Government spending on those on average and low incomes, and on investment, is not only socially more just but is far more effective as a stimulus than tax cuts for the best-off – who save, rather than spend, a higher proportion of their income. Equally spending on investment is far more effective in expanding the economy that military spending – which does not add to productive capacity. But overall it is necessary to fight moves by fiscal conservatives to reduce the budget deficit in the short term. As an immediate response to the financial crisis countries facing the threat of economic downturn should run or maintain stimulus packages funded, if necessary, by budget deficits.

Budget deficit and the medium term

While budget deficits with a large component targeted at maintaining consumption are immediately vital to prevent short term economic decline they are not sufficient, faced with deep economic problems, to relaunch substantial growth because they do not deal with the most fundamental issue driving the downturn – the investment fall. This is in addition to the fact that few countries have Japan’s financial strength, which enabled it to sustain a very large budget deficit over a long period. For most countries large budget deficits can be run in the short term but are financially unsustainable in the medium term.

A policy of running large budget deficits is often inaccurately described as a 'Keynesian' one - inaccurately as Keynes own central concern was factors affecting investment and not budget deficits.¹ Paul Krugman in the New York Times, for example, regularly but wrongly argues that the budget deficit is both the most central issue in economic policy and the core of Keynes views. US economist Paul Davidson similarly claims in The Keynes Solution: ‘Anything that increases spending on goods and services increases the profitability of business firms and the hiring of workers.’ (p54) But this is false - for example, an increase in spending on goods and services accompanied by cost increases may lead profits to fall.

However, even if profit did increase due to increases in demand, companies may not reverse the cuts in investment that are the core of the recession. Keynes pointed out that to generate investment a price must be paid to overcome ‘liquidity preference’ - the advantages of holding assets in cash and other liquid forms. In circumstances of high uncertainty, such as at present, the cost of overcoming liquidity preference may be prohibitive and therefore it will prevent investment taking place even if such investment would yield a positive profit.

Low interest rates necessary but not sufficient

Even more fundamental than liquidity preference in the present situation is that, given excessive indebtedness, companies use resources to repay debt, that is to build up their balance sheets, and not to invest even if demand increases. Therefore stimulating demand by budget deficits may prevent worse declines in production but does not produce significant output increases.

In such conditions low interest rates are also insufficient as an economic policy to provide a way out. Low interest rates are necessary to prevent interest payments becoming unsupportable and to remove a block to borrowing for investment. But they do not lead to investment under conditions where companies are intent on paying down debt and have no intention of borrowing for investment.

International redistribution of debt

As any solution to the present situation must involve medium term debt reduction a number of states are seeking to achieve this at the expense of other countries even without formal defaults on debt payments. In particular the US, via falls in the exchange rate of the dollar, reduces the real value of its debt at the expense of countries which hold dollar assets. Such policies however clearly only aid one country at the expense of others, effectively redistributing the debt without reducing the overall debt burden.

Inflation is not a relatively harmless solution

It is important to remove an illusion currently being suggested that inflation would be a relatively painless and non-harmful way to reduce debt. The idea behind this is that while the monetary volume of debt, its nominal value, would remain the same its real size would be reduced. Kenneth Rogoff, for example, has argued this:

‘It is time for the world’s major central banks to acknowledge that a sudden burst of moderate inflation would be extremely helpful in unwinding today’s epic debt morass…. Moderate inflation in the short run – say, 6% for two years – would not clear the books. But it would significantly ameliorate the problems, making other steps less costly and more effective. ‘

Similarly the British economist Will Hutton has argued:

‘As the IMF's chief economist, Olivier Blanchard, has suggested, if the options are public and private default, continuing bank weakness, economic stagnation (perhaps depression), or inflation, then the least bad option is to accept inflation, but to manage it within bounds.

‘Since inflation will happen anyway as governments seek the least bad way out, the choice in reality is whether to accept and manage it or not. Once debt is at a sustainable level and growth has resumed, then the world's financial system can be redesigned to avoid a repeat, and price stability restored.

‘This is the truth that cannot speak its name: as a senior financial policy official told me, even to raise it at home or abroad merely as an issue for debate is to invite universal disapproval. But truth must be faced. Britain should provide a lead – both for its own economic fortunes and to set the new international standard. As a minimum it should announce a new programme of quantitative easing, in effect printing money; insist the Bank of England uses the money it prints to buy the broadest range of private debt; and immediately replace the 2% inflation target with a target for the growth of money GDP – so getting Britain off the hook of its unpayable private debts.’²

However someone will have to suffer the loss in real resources created by the inflation. Usually this is the majority of the population as the rate of increase of incomes fall behind the rate of inflation. Politically a policy of lowering debt by inflation is therefore likely to be drastically unpopular for whoever implements it.

Furthermore economically inflation, striking at the majority of the population by reducing living standards, will actually cut consumption – which strengthens recessionary tendencies. Inflation also does not deal with the issue of increasing investment – the fall in which drove the recession. In short inflation is not a solution either politically or economically to a crisis of the depth which currently exists.

Indirect means of stimulating investment

If the way out is turned to, the necessary policies cannot be separated from the analysis of the depth of the crisis.

If the current economic crisis were of small or moderate dimensions then it could indeed be tackled by increases in budget deficits which primarily raised or maintained consumption. Such deficits would increase demand while liquidity preference, lack of profitability and debt levels would be insufficient to prevent companies responding to the increase in demand by raising investment - therefore substantial economic recovery would occur. This, however, has clearly not occurred in the crisis since 2008 despite large budget deficits being run.

Given budget deficits have been insufficient, attempts are also made to raise investment by extremely low interest rates and by seeking to reduce liquidity preference – the latter being a key goal of the talk regarding the need to ‘restore confidence’. These measures have also clearly not succeeded.

Confronted with this impasse more logical economic commentators are therefore beginning to address the need to raise investment. Such discussion currently primarily centres on advocating indirect means such as tax breaks. For example Joseph Stiglitz recently argued:

‘those worried about the shortage of policy instruments are partially correct. Bad monetary policy got us into this mess but it cannot get us out. Even if the inflation hawks at the Federal Reserve can be subdued, a third bout of quantitative easing will be even less effective than QE2. Even that probably did more to contribute to bubbles in emerging markets, while not leading to much additional lending or investment at home.

‘The Fed’s announcement that it will keep the target federal funds rate near zero for the next two years does convey its sense of despair about the economy’s plight. But, even if it succeeds in stopping, at least temporarily, the slide in equity prices, it won’t provide the basis of recovery: it is not high interest rates that have been keeping the economy down. Corporations are awash with cash, but the banks have not been lending to the small and medium-sized firms… The Fed and Treasury have failed miserably in getting this lending restarted, which would do more to rekindle growth than extending low interest rates though 2015.

‘But the real answer, at least for countries such as the US that can borrow at low rates, is simple: use the money to make high-return investments. This will both promote growth and generate tax revenues, lowering debt to gross domestic product ratios in the medium term and increasing debt sustainability. Even given the same budget situation, restructuring spending and taxes towards growth – by lowering payroll taxes, increasing taxes on the rich, as well as lowering taxes for corporations that invest and raising them on those that do not – can improve debt sustainability.'

By identifying raising investment as the key target Stiglitz does address the central dynamic of the recession. But the issue is once again quantitative and related to the depth of the crisis. Will measures such as tax breaks be sufficient to raise investment if they are added to other policies such as running budget deficits and low interest rates? If the economic crisis is not deep they will suffice. If the economic crisis, and the necessity to pay down debt, is stronger then indirect measures to target investment, such as tax breaks, will not be sufficient.

The current indications, given the scale of the economic problems and debt burden, is that indirect means to stimulate investment by policies such as tax breaks will be insufficient to relaunch substantial economic growth.

Direct means of raising investment

The most decisive way to overcome the current situation flows from the above trends. Its practical effectiveness was shown by its use by China in its successful 2008 stimulus package, which was followed by over 30 per cent GDP growth in three years. Keynes also analysed and advised it. This is that the state must overcome the reality or threat of a fall in investment by itself undertaking and organizing investment. Keynes noted this in The General Theory of Employment, Interest and Money: ‘It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.’ (p378)

Such an analysis flowed from Keynes practical experience regarding the relation between the depth of economic crisis and lack of sufficient efficacy of other economic instruments: 'Only experience… can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment… I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest… I expect to see the State… taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital… will be too great to be offset by any practicable changes in the rate of interest.' (p164) Therefore: ‘‘I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.’ (p320)

Keynes naturally did not advocate an administered economy. But he therefore explicitly argued in the General Theory that the state should have the ability to intervene sufficiently to determine overall investment levels.Keynes also noted that this 'somewhat comprehensive socialisation of investment' and 'the duty of ordering the current volume of investment' did not mean the elimination of the private sector, but socialised investment operating together with a private sector: 'This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative… apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest there is no more need to socialise economic life than there was before…. The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government.' (p378)

The country which most approximates to this economic system is China. China, of course, describes its economy in a different way and using Marxist terminology. China defines itself as passing through ‘the primary stage of socialism’ and its overall system as ‘socialism with Chinese characteristics’. However it is not the important question whether China’s definition of its own system should be accepted, or whether its economy should instead be regarded as conforming in important features to the system described by Keynes in the General Theory of Employment, Interest and Money. What is important is understanding how such an economic system works and to note that China has been able to run the world’s largest stimulus package without an unsustainable budget deficit, and why its macroeconomic policy has come through the international financial crisis more successfully than the US and Europe – and why China’s economic system has generated, during the last thirty years, the most rapid economic growth of any major economy in the world.

China’s economy

The difference between China and the US and Europe, of course, lies in economic structure. After its 1978 economic reforms China abandoned an administered economy. But it did not abandon the ability of the state to set the overall level of investment, and it maintains a state owned banking system which is stronger in a crisis than the ones in the US and Europe and which can be instructed to expand lending in order to sustain stimulus packages. China therefore actually implements Keynes point that ‘the duty of ordering the current volume of investment cannot safely be left in private hands.’ That is, a ‘somewhat comprehensive socialization of investment’ does exist in China, not in the sense that the private sector is eliminated, on the contrary China’s private sector is large and dynamic, but in the sense that the state has sufficient levers to determine the overall level of investment. In contrast in the US and Europe the conditions outlined by Keynes do not exist, and the state sector is insufficiently large to deliver an investment-led stimulus.

As a conseuence of these differences China has come through the financial crisis far more successfully than the US or Europe

Implication of the differences

Once again the interaction of these different factors cannot be separated from analysis of the scale of economic crisis itself. China’s economic structure clearly gives it a superiority which has allowed it to avert serious downturns, as shown both in the 1997 Asian debt crisis and in the international financial crisis since 2008, and to maintain very long term rapid economic growth. But how serious the lag in the US and Europe compared to China is depends on how serious the economic crisis is.

If the economic crisis is not deep then gradually time, and greater application of the measures which are available to the US and European economies – budget deficits, low interest rates, tax breaks for investment – will overcome the investment decline. China will still grow more rapidly, but the US and Europe will also resume growth. If the crisis is deep then only adoption of full scale Chinese methods of direct state action to implement ‘the duty of ordering the current volume of investment’ would suffice. That, however, would require a huge extension of the state sector of the economy, and therefore greater application of the indirect methods available in the US and Europe will be tried first.

One clear implication, of course, is that in all these different circumstances China continue to will grow much more rapidly than the US and Europe even if the latter escape a 'double dip' recession.

Conclusion

The realistic conclusions which follow from the present renewal of the international financial crisis, in terms of both analysis and the required policy response, are therefore clear:

The International financial crisis has recurred because the economic policies to deal with the 2008 crash in the US and Europe did not remove its underlying cause - excessive debt build up in an attempt to sustain US economic growth and living standards. The post-2008 policies failed because they were designed to deal with much less serious economic events than the ones which unfolded.

The effect of the policies pursued after 2008 has been to nationalize large part of the debt that originated in the private sector. Therefore, in most cases, and in particular in the US, even if the crisis reappears around state finances the actual origins of the problem lay in the private sector debt.

The strategic failure to overcome the debt crisis creates strong pressure to a renewed crisis of the banking system.

The debt crisis transmits itself into the real economy above all though a collapse in investment – taking the G7, the entire decline in GDP is due to the fall in fixed investment.

In the short term it is necessary to deal with the crisis by continuing to run budget deficits, and countries that have not done so may well need to introduce budget deficit spending. China is an exception because its economic structure allows it to run large stimulus packages without budget deficits due to its ability to directly stimulate investment. Only a handful of other countries, however, have a state sector large enough to fund and run such investment programmes and therefore other economies will have to run budget deficits in the short/medium term. However while budget deficits are necessary to avoid sharp economic decline the experience of the last three years has shown that the economic crisis is too deep for budget deficits by themselves to stimulate significant growth because they do target the core of the recession, the investment decline.

Very low interest rates must be maintained in order to lighten the burden of interest payments on the overextended debt, and to remove an obstacle to investment. However, once again the experience of the last three years has shown that the economic crisis is too deep for low interest rates themselves to relaunch investment and substantial economic growth.

China possesses the advantage that it can directly stimulate investment. In other countries there is also a growing realisation that the core transmission of the economic problem lies in investment falls. But without a sufficiently large state sector most other countries do not have the means to directly launch investment. Therefore indirect methods such as tax incentives for investment and similar measures are being proposed. It remains to be seen in practice, if these are introduced, whether they are effective. Given the depth of the crisis the probability is that even if such measures are introduced they will not be enough to sufficiently overcome the low investment level. Consequently growth will continue to be very slow in the US and Europe even if a new recession can be avoided.

The world economy will therefore see a further period in which China’s economy will grow rapidly while the US and Europe remain at best relatively stagnant.

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This article originally appeared on Key Trends in Globalisation.

Notes

1. See Ross, J. ‘Deng Xiaoping and John Maynard Keynes’. Soundings Winter 2010.

2. The British newspaper The Observer made the same call:

‘The only alternative to default is inflation – governments printing money to get out of the corner they, their banks and their citizens are in. The question facing policymakers in the years ahead will be which of the unpalatable options they confront – economic stagnation, public and private default together with endemic bank weakness, or uncontrolled or managed inflation – they are going to choose…

‘The British government's policies are locked in the same impotent stasis as the rest of the world's – battening down the hatches, cutting public spending and borrowing, and refusing to accept realities. The government should declare independence. It should abandon the suffocating 2% inflation target and replace it with a target for the total volume of spending in the economy. It should prepare to stimulate the economy with more quantitative easing – in effect printing money – using the proceeds to lend directly to public agencies and departments prepared to lift capital spending.’

The financial crash and macro-economic policy - why the US and Europe have budget crises and China does not

2011-08-06T17:41:00.001+01:00

By John Ross

The events precipitating the renewed financial crash were the combination of debt crises and confirmation of slow US economic growth. Regarding the former countries were either trying to cut deficits (the US, Greece, Italy, the UK) or feared they will have to bail out those running unsustainable ones (Germany, France). But these large deficits were not accompanied by strong economic growth – although it can be cogently argued that they were necessary to stave off sharp economic downturn.¹

Japan is currently preoccupied with overcoming the consequences of the tsunami and earthquake, but it also will soon have to face the reality that, due to decades of budget deficits, it has the largest government debt as a percentage of GDP of any country – twice that of the US.

In contrast China in 2008 launched the world's largest state stimulus package to counter the international financial crisis. But it is not running any substantial budget deficit - this year it will only be around two per cent of GDP. But China has enjoyed rapid economic growth.

It has been claimed that China is applying ‘Keynesianism’, but if budget deficits were the key issue defining such policies then China is clearly not pursuing ‘Keynesianism’ at all.

Actually, the core of Keynes’ analysis did not lie in advocating budget deficits, and in some ways China has a policy which more corresponds to his views than that pursued in the US and Europe. This is is briefly outlined below. But before dealing with this it is illuminating to contrast the nature of the economic policies pursued by the US and Europe in the last three years on the one hand, and by China on the other, and to analyse why the latter was able to launch such a large stimulus package without a significant budget deficit.

The actual core of the Great Recession

The core of the difference between the policies pursued in the US and Europe on the one hand, and that followed in China on the other, requires understanding what actually occurred during the 'Great Recession' after 2008. A more extensive analysis has been given elsewhere but to summarise in the US and Europe the Great Recession was dominated by an investment collapse. To take the largest example, in the 2nd quarter of 2011 US GDP was still $56 billion below its 4th quarter of 2007 peak. However all major components of US GDP except fixed investment were already above their previous peak levels – inventories were $37 billion above, government consumption $51 billion above, personal consumption $66 billion above, and net exports $159 billion above. But US private fixed investment was $388 billion below its 4th quarter 2007 level. The entire decline in US GDP was therefore due to the fixed investment fall. These changes are shown in Figure 1. A similar pattern exists in almost every major developed country.

Figure 1

This investment fall, by driving and maintaining the downturn, produced a decline in personal and company income and therefore a fall in tax revenue – the latter being the primary reason for budget deficits. The crucial issue, both for economic development and to close the budget deficit, is therefore how to relaunch growth.

China's situation was different and explains why it ran no significant budget deficit. China abandoned administrative running of its economy with the economic reforms beginning in 1978, but it still has a sufficiently large state sector that this could be, and was, instructed to increase investment. As the key banks are state owned they could be instructed to increase lending to companies – in the US the opposite occurred and lending to companies fell sharply. The rapid economic growth initially generated by China's state companies in turn stimulated the private sector.

The result, during the crucial period 2008-2009, is shown in Figure 2. Instead of China's investment falling it rose by $420bn. Consequently there was no recession. Under the impact of the increase in jobs and incomes created by the stimulus package, China's household expenditure also rose by $160bn. Therefore despite the combined effect of a fall in net exports and inventories of $160bn China's GDP in 2009 rose by $440bn.

As there was no recession there was no fall in tax revenue and no major budget deficit. As this process continued, by 2011 China's GDP had increased by over 30 per cent, $2.3bn in current price terms, compared to pre-crisis level. In contrast by the 2nd quarter of 2011 US GDP was still 0.4 per cent below its 2007 peak level.

Figure 2

In the US and Europe the budget deficits were increased by government attempts to restart growth. China could instruct its state companies to invest and its state banks to lend, but the state sector in the US and Europe is too small for this to be effective. Only indirect means, such as quantitative easing (printing money) and budget deficits were available as policy tools. Both proved ineffective in restarting rapid growth. But the latter policy worsened the deficits. China, due to the rapid growth resulting from the investment stimulus, had no significant budget deficit.

Relative scale of economic problems in the US, Europe and China

Naturally the above does not mean China escaped all economic problems - particularly food price inflation, but these are not on the same scale as the budget deficit crises gripping the US and Europe.

Nor do such developments mean China does not face economic policy choices. It is impossible to judge the size of a stimulus package perfectly in advance. The crucial thing in 2008, confronted with the worst economic crisis for eighty years, was to act rapidly and forcefully to head off downturn. This was achieved.

Indeed, so successful was the stimulus that by the 2nd quarter of 2010 China's GDP growth was 11.9 per cent – well above the average 9.9 per cent since its economic reforms began and unsustainably high. Also, despite the government's efforts, it is always impossible to prevent some part of a stimulus spilling into unintended areas - creating a too high rate of increase in China's house prices.

In summer 2010 world food price inflation also began. China suffered from this less than other comparable BRIC countries – Brazil, India and Russia. But countering these price rises required monetary tightening and slowing the economy

Finally, a medium term problem must be tackled. It is impossible to implement a huge lending increase, under conditions of international economic downturn, without some increase in bad loans. When China's government launched the 2008 stimulus package it anticipated this by making banks increase provisions for bad loans and stating they would have to raise extra capital. The government's calculation was simply that large scale economic growth resulting from its policies would generate more than sufficient resources to deal with any bad loans problem of the type now appearing in municipal debt – i.e. far more would be gained than lost. With more than 30 per cent growth in three years China's economy has easily enough resources to deal with bad loans.

In short China's economic structure does not produce perfection – which only exists in heaven. But the problems it faces are far smaller than the budget deficit and debt crises in Europe and the US.

China's economy grew by more than 30 per cent in three years while Europe and the US remain below their peak levels of output. It is therefore easy to see which policy has been more successful.

Keynes and Chinese descriptions of China’s economic system

How is such an economic system as that operating in China to be described? China itself, of course, uses Marxist terminology – it describes itself as passing through ‘the primary stage of socialism’ and its overall system as ‘socialism with Chinese characteristics’. However there is another, more familiar in the West, way of looking at it.²

Keynes in the General Theory of Interest, Employment and Money evidently did not advocate an administered economy.³ But he did explicitly argue that the state would have to intervene sufficiently to determine the overall level of investment: ‘I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.’ (p320)

Keynes, as is well known, attached great weight to changes in the rate of interest in affecting the investment level. But he did not believe these would be sufficient by themselves: 'Only experience… can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment… I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest… I expect to see the State… taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital… will be too great to be offset by any practicable changes in the rate of interest.' (p164)

This led Keynes to the conclusion: 'It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.' (p378)

Keynes noted that 'somewhat comprehensive socialisation of investment' and 'the duty of ordering the current volume of investment' did not mean the elimination of the private sector, but socialised investment operating together with a private sector: 'This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative… apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest there is no more need to socialise economic life than there was before…. The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government.' (p378)

It does not seem the most interesting question whether we should accept China’s definition of its own system, or whether its economy instead should be regarded as conforming in important features to the system described by Keynes in the General Theory of Employment, Interest and Money. What is important is understanding how China’s economy actually works, why it has been able to run the world’s largest stimulus package without a budget deficit, and why therefore its macroeconomic policy has come through the international financial crisis more successfully than the US and Europe.

* * *

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

Notes

1. For an analysis of this see Richard Koo’s The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession.

2. A more detailed discussion of these issues can be found in Ross, J. ‘Deng Xiaoping and John Maynard Keynes’. Soundings Winter 2010.

3. All page references are to the 1983 Macmillan edition of the The General Theory of Employment, Interest and Money.

Panic on world markets

2011-08-06T17:38:00.001+01:00

By Michael Burke

International business news and other TV channels are offering a Babel-like interpretation of the current slump in world financial markets. European (including British) stations are reporting the Wall Street-led declines as a response to the continued debt crisis in Europe. But this makes no sense. An EU crisis would have been felt first in EU markets and perhaps not at all in the US - US stocks had been rising over a prolonged period while Europe has been in turmoil. (And, despite what we may think, Greece or Ireland might fall into the sea while causing barely a ripple in the Hang Seng and the other plummeting Asian stock indices).

US channels have no explanation at all for the crisis- and analysis is limited to individual stocks, the scale of losses for investors and a generalised antipathy to Washington.

The Asian networks come closest to identifying the source of the current crisis- which isn't in Europe at all. Their consensus is that markets are plunging because of the slowdown in the US economy.

But, why now? We are repeatedly told that financial markets react instantaneously to new information. The US GDP data for the 2nd quarter of 2011 were truly awful, up just 0.7%. As the BEA annualises quarterly data (multiplies by 4) this means that the US economy grew by under 0.2% from the 1st quarter.

On closer inspection the data were even worse. Large downward revisions to both the prior quarter and further back mean that economy fell by 5% in the recession, and has not recovered that prior peak in activity yet, as had been previously thought. This is the weakest US recovery from recession in the post-WWII period. Yet these data were published last Friday. If they were the immediate cause of the panic, it is a slow motion reaction.

No, the new news is the compromise agreement in Congress on Tuesday to raise the Federal debt ceiling in return for large scale cuts in Federal spending. This can only have one consequence- slower growth. Since the anticipated profits derived from growth drive stock prices, it is natural for stocks to fall when growth prospects are lowered. As Wall Streeters say, the US has just suffered a derating.

The crisis is driven by 'austerity'- US austerity.

EU financial markets are caught in the backwash of this, as slower US growth certainly harms global growth prospects. This is felt most keenly in their weakest link, the sovereign debt markets, since these have assumed all the stresses of the EU economies and financial systems. But we should not expect stock and other markets in Europe to remain unscathed, especially bank stocks.

In particular, as reaction to the latest bailout of Greece's creditors shows, bond markets do not reflect any confidence in these repeated prescriptions. Instead a first bailout of the economy is required, in Greece, Ireland and elsewhere.

There was a fondness before for asserting that Ireland was closer to Boston than Berlin. With the German economy recovering far more robustly than the US, we will hear less of that in the years ahead.

It might be wise instead to focus on the German and other answers to the crisis. This was not just short-term economic stimulus, but long-term productive investment.

For too long this economy has been a weigh-station for US companies counting their profits. Instead of listening to their self-serving advice on economic policy (while following German strictures on fiscal policy) policymakers in Ireland should emulate what works, in Germany, Sweden and most of Asia, investment-led growth initiated and guided by the State.

Not only debt ceiling deal but worsening trade deficit negative for US growth

2011-08-01T18:25:00.000+01:00

By John Ross

Numerous commentators have analysed the negative implications for US growth of the debt deal between President Obama and Republican leaders in the US Congress – this is considered below. But an aspect which should be integrated into analysis is that the drag on growth represented by the cuts in government spending in a debt deal will interact with another negative trend – the widening US trade deficit.

The primary causes of slow growth of the US economy are domestic – above all failure to overcome the severe fall in fixed investment which occurred during the ‘Great Recession’. However a secondary lowering of US growth is being created by its trade position - despite hopes that the decline in the exchange rate of the dollar would boost US net exports.

Instead of assisting US growth the US trade deficit has been widening – i.e. net exports are falling. The US trade balance, having reached a low of $25.5bn in May 2011, increased to $50.2bn in May 2011 - the latest month for which data is available. This is shown in Figure 1. Figure 2 shows the same data expressed as a three month moving average in order to remove the effect of shorter term fluctuations.

As a percentage of GDP, the deficit on US net exports has increased from a low of 3.4 per cent of GDP in the 4th quarter of 2010 to 3.9 per cent of GDP in the 2^nd quarter of 2011 – as shown in Figure 3. Over that period this represents a 0.5 per cent of GDP downward pressure on US growth. It is clear from Figure 3 that the gap is increasing.

Given these trends, at the best US net trade is therefore unlikely to increase US GDP growth and is more likely to reduce it. Any sources of US growth will therefore necessarily have to be domestically generated.

This evidently interacts with a debt ceiling deal. The reduction in projected US government spending in an agreement, others things being equal, will primarily reduce the increase in government and household consumption – the latter through cuts in social spending programmes. With this consequent downward pressure on the growth of consumption, and no boost coming from net exports, significantly higher US economic growth would require a large boost in the only remaining source of demand – investment. But no substantial measures are being taken by the US government to increase either government or private investment.

No boost from net exports, constrained consumption, and no measures to boost investment is simply to break down into components the constraints which now exist on US growth. Given both domestic and international trends, the long term slowing of the US economy previously analysed in greater detail by this blog will continue.

Figure 1

Figure 2

Figure 3

Weakness of the current US economic recovery compared to previous US business cyles

2011-07-31T16:35:00.004+01:00

By John Ross

It has been pointed out that the present US economic recovery is the slowest since World War II. However the precise parameters of this are frequently not analysed nor are they placed in a longer term context. Both are significant as they show not only the cyclical situation but the continuation of a prolonged slowing of the US economy.

As regards the immediate weakness of the present recovery this is shown in Figure 1, which charts the course of US business cycles since 1973. The starting date in each case is the peak of the previous cycle and the numbers along the horizontal axis show the quarters since that peak. Also shown are a 2.6% growth trend line and a 1.6% trend line – these representing, as analysed below, 20 and 10 year moving averages for US GDP growth.

As may be seen not only was the downturn in US GDP in this recession deeper than in any previous one since World War II but recovery is far slower. The previous deepest decline in GDP in any US post-war recession was 3.2% following 1973 and by eight quarters after the previous peak in that cycle US GDP had regained its previous peak level. In the present cycle the maximum fall in GDP was 5.1% and 14 quarters into the cycle US GDP has still not regained its peak level. For comparison in the slowest previous US recovery, that following 1980, by 14 quarters after the peak of the previous business cycle GDP was already 4.9% above its previous peak level, whereas in this recession it is still 0.4% below it. In short this is both the deepest recession and slowest recovery in US post-World War II history by a considerable margin.

Figure 1

Even more significant strategically is the long term slowing of the US economy. This is illustrated in Figure 2, which shows a 20 year moving average for US growth with the latest data being for the 2nd quarter of 2011 – utilising such a long time frame removes the effect of purely cyclical fluctuations. The downward trend of US long term growth is clear. The annual average US GDP growth rate has declined from 4.3% in 1969, to 3.0% in 1990, to 2.6% by the 2nd quarter of 2011.

Figure 2

The current growth rate of the US economy is even lower if a 10 year moving average is considered. This is shown in Figure 3. By the 2nd quarter of 2011 the 10 year moving average of US GDP growth had fallen to 1.6%.

Figure 3

As noted, the 1.6% and 2.6% trend lines in Figure 1 therefore represent average 10 and 20 year growth rates for US GDP. As may be seen the recovery in the present recession is far lower even than these long term averages - which are themselves falls from previous levels.

In short the US economy is progressively slowing not only in cyclical terms but from a long term point of view. The present slow recovery is therefore not at aberration but a part of a long term trend.

Such a deep rooted slowing of the US economy clearly has major implications not only for the United States itself but for the pattern of development of the world economy.

* * *

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

US GDP figures even worse than they look

2011-07-31T16:29:00.005+01:00

By John Ross

The 2nd quarter 2011 US GDP figures, showing annualised growth of 1.3% in that quarter and a newly revised downwards annualised 0.4% in the 1st quarter of 2011, were interpreted as bad. But they are far worse even than they look at first sight.

First, the downward revision to the depth of the recession, to a trough of 5.1% in the 2nd quarter of 2009, means that instead of having already recovered its pre-recession GDP level the US economy remains 0.4% below its peak in the 4th quarter of 2007. This is shown in Figure 1.

Figure 1

Second, as shown in Figures 1, 2 and 3, it is misleading to draw attention to personal consumption expenditure, and its weak annualised 0.1 per cent increase in the 2nd quarter of 2011, as the key feature of the downturn. The really fundamental cause of the US recession is the collapse in fixed investment.

As may be seen from Figure 2, in the 2nd quarter of 2011 US GDP, in 2005 constant prices, was $56 billion below its peak level in the 4th quarter of 2007. However all major components of GDP except for fixed investment were already above their 4th quarter of 2007 levels – private inventories $37 billion above, government consumption $51 billion above, personal consumption $66 billion above, and net exports $159 billion above. However private fixed investment was $342 billion below its 4th quarter 2007 level – i.e. the entire decline in US GDP was due to the fall in fixed investment.

Figure 2

Nor was this decline in fixed investment entirely accounted for by the residential sector – see Figure 3. The overall fixed investment fall was divided essentially half and half between residential and non-residential fixed investment – the decline in residential fixed investment being $199 billion and the decline in non-residential fixed investment being $192 billion.

Figure 3

In short, as this blog has continuously pointed out, the core of the ‘Great Recession’ in the US, as in other countries, is not a decline in consumption but a huge fall in fixed investment. The ‘Great Recession’ is actually ‘The Great Investment Collapse’. Until this reality is grasped, and the policy consequences drawn, US GDP figures are likely to continue to surprise on the downside.

Meanwhile the latest US GDP data is shockingly bad - worse even than the features the official press release and initial press commentary concentrates on.

* * *

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

Boris Johnson economic proposals should have put Londoners before bankers

2011-07-28T12:20:00.001+01:00

Ken Livingstone has a new article taking apart Boris Johnson’s economic proposals, including the Tory Mayor’s call to get rid of the 50% top rate of income tax, on the Guardian's Comment is Free here.

It analyses ‘Boris Johnson's economic proposals, made following weak UK GDP figures this week and centring on cutting the top rate of income tax from 50%, are part of his campaign to be the next Conservative party leader. He is courting the Tory base, including its right wing. Proposing to cut income tax on those earning over £150,000 a year plays well with them…

‘Johnson's proposals… constitute part of his continuing policy of hitting Londoners in their pockets in pursuit of his political ambitions and record of backing bankers – the two coming together in Tory party politics. These proposals, however, are economically incoherent and uncosted…. Johnson's positions, both on tax and on fares, aid the best off. They do not help ordinary Londoners. The mayor should be putting Londoners first – not bankers or his political ambitions.’

BRICS say Greek bailout too soft on the banks

2011-07-28T09:53:00.002+01:00

By Michael Burke

The rapid growth of the so-called BRIC economies (Brazil, Russia, India and China) is providing a global benefit in terms of economic growth. But their increasing weight in the world economy will also provide a growing benefit specifically to all the European economies, and most especially the majority of citizens in the most crisis-hit countries.

The latest example of this arises in relation to the Greek crisis. Because of their more rapid growth the BRIC economies subscription of the funds for the IMF are growing. Their weight in the IMF is growing as a result, where previously the interests of the US have always held sway. It is clear from a report in the Financial Times on July27th that representatives of the BRICs are unhappy with the term of the latest bailout involving Greece. The complaint is twofold - that the austerity measures imposed on Greece are too harsh and the level of losses imposed on the banks is too small.

According to the FT, ‘Paulo Nogueira Batista, who represents Brazil and eight other countries on the IMF’s executive board, said the Greek government’s austerity plan was too tough and the restructuring of Greek debt held by European banks was too small.

“Greece is not having an easy time,” he told the FT. “The mostly European private creditors of Greece have had an easy time.”’

Mr Batista also went on to argue that, while there were suspicions about bias towards European bondholders (EU banks), Christine Lagarde the new IMF MD and former French Finance Minister had the perfect opportunity to dispel such suspicions (by taking a tougher line on bank losses).

Further, the FT reports, ‘Arvind Virmani, the Indian executive director on the board, said the plan dealt with short-term cashflows but left Greece with a large and precarious sovereign debt stock, threatening further defaults.

“I am not convinced [the plan] addresses the basic problem of liquidity versus solvency,” he said, adding the fund had dodged the question for more than a year.’ The clear implication is that Greece requires further debt write-offs if it is to become solvent.

Both men also argued that the size of the IMF loan would be unacceptably large and would not have been made available to a developing country. The obvious implication is that either European taxpayers or bondholders should make a greater contribution- and it was clear that their preference is for the banks to take greater losses.

According to the latest official documents, the debt-reduction for Greece will be €26.1bn, less than 12% of total debt outstanding of €350bn. Clearly, this is a welcome first step but wholly insufficient to bring about solvency. Once all forms of ‘credit enhancement’ (very expensive insurance) on the debt being restructured are paid for, the total estimated debt reduction is actually smaller than the €28bn projected level of Greek privatisation receipts.

As the BRIC representatives say, the cuts are too harsh and the losses for bondholders too small. Politically, as well as economically, the rise of the BRICs is a major benefit. Progressive forces in Europe (including Britain) and elsewhere should increasingly look to them. Not only is it possible to learn from their rapid growth, but it is also very valuable to have them as allies in the interests of the overwhelming majority of the population of Europe, and against the interests of the bankers.

The stats show the Tories make you worse off and less safe

2011-07-27T06:21:00.003+01:00

By Michael Burke

A small but growing number of commentators have analysed the way Tory policies make the average person worse off. New data released on police numbers and crime also show the way Tory cuts are making you less safe.

Even the Tories admit that the recession, which their cuts policies are deepening, will raise the threat of crime. In particular crime is increased by the cuts in welfare benefits – which is what the Tories are concentrating on.

The Times reported (£) on June 29th on the opinion of senior police officers on this coming increase in crime:

“It won’t be an even, upward progress, there will be a ragged line with different patterns in different areas and some crime types shooting up, while others remain level,” one said.

Chief constables and criminologists say that there is usually a gap between the worst of the financial crisis and the impact of austerity on the public before the effects are reflected in crime patterns.

They believe that crime will rise more dramatically as sections of the public feel the impact of public spending cuts, unemployment and, perhaps most significantly, cuts in benefit payments.

As The Times reported (£), some crimes are already going up:

Kenneth Clarke, the justice secretary, told the Commons last week that burglary was one of the crimes that is “rising at the moment”, adding: “It is going up rather alarmingly compared with a year ago.”

Ministers are nervous that rises in property crime herald the long awaited recession crime wave that will worsen if unemployment increases substantially and people have less cash in their pockets…

“There are indications that crime is about to turn. The reason it has not gone up yet is because unemployment has not risen that much,” one minister admitted.

Yet confronted with this rising threat of crime the Tories are actually cutting police numbers. The report (pdf) published by Her Majesty’s Inspectorate of Constabulary (HMIC) on July 21st confirmed there will be 16,200 fewer police officers in the UK as a result of the Tory led government’s cuts.

London – the Tory Mayor makes you less well-off and less safe

This increase in various types of crime is already feeding through into London. After the Tory Mayor of London has made Londoners worse off through his unnecessarily large above-inflation fare increases, the Conservative-led government and the Tory Mayor are additionally making Londoners less safe.

As The Times reported (£):

Burglaries, robberies and muggings are on the rise for the first time in years as fears grow among ministers that the economic downturn is driving up crime.

Figures from Britain’s biggest police force provide the first indication that years of falling crime are coming to an end. The Metropolitan Police has reported big increases in robbery, burglary and motor vehicle crime in the past 12 months…

Robbery, including muggings, pick-pocketing, burglary, shoplifting, theft of bicycles and interfering with motor vehicles increased, the Metropolitan Police report says. Figures show that there were more than one thousand more burglaries last month compared with May last year.

Robberies in the capital jumped by 15 per cent from 3,257 in May last year to 3,749 this May; house burglaries rose by 18.5 per cent from 4,410 to 5,228; and thefts of and from vehicles by 6 per cent to 9,299.

Yet despite this trend the Tory Mayor is pressing ahead with cuts in in police numbers. In the last year police numbers in London were already cut by 926. By 2014 there will be 3,111 fewer Metropolitan Police staff including 1,907 fewer officers, 820 less PCSOs, and 324 less police staff.

Tories – talk and not action on crime

These trends show clearly the picture which always exists: the Tories, whether as the UK government or as the Mayor of London talk a great deal about crime but take actions which increase it – both by deepening the recession and by cutting police numbers.

As Ken Livingstone said about the situation in London:

“Boris Johnson’s cuts mean on average every London borough will lose over 50 police officers. These cuts risk undermining the work which the police and local communities are doing to make our streets safer.

“The Conservative Mayor’s cuts will mean some of the most experienced and able officers losing their jobs, including 300 of the 600 sergeants who manage local police teams.”

The story is the same across Britain and in London: the Tory-led government and the Tory Mayor make you less well-off and less safe.

* * *

This article originally appeared on Left Foot Forward.

British Economic Stagnation

2011-07-26T15:02:00.002+01:00

By Michael Burke

The British economy continues to stagnate. Just over one year after the Tory-led Coalition announced its first Budget the British economy is virtually still in the water. In the preliminary estimate of GDP in the 2^nd quarter growth was just 0.2%. In the three quarters since the Comprehensive Spending Review (CSR) this figure constitutes the sum total of economic growth, i.e. just 0.2% - with the previous 6 months having registered no growth at all.

Tory supporters are sufficiently concerned to have begun he discuss the need for a growth strategy, although the remedies offered are likely to exacerbate the situation, as will be discussed below.

As SEB has previously shown , before the Tory-led government’s policies began to take effect there had been an economic recovery. For comparison, in the three quarters preceding the CSR the economy had grown at a moderate rate of 2.1%. This is in sharp contrast to current performance which now reflects the effects of cuts to public spending and their wider impact on the economy.

In the three quarters since the CSR, the economy has expanded by just £660mn, compared to £26.7bn in the preceding 9 months. No wonder most households and businesses feel poorer and gloomier.

It is possible that the situation may get worse. Economies only respond to policy changes after a certain time lag. In both the phases of recovery and in the subsequent stagnation the economy as whole responded two quarters after significant changes in government spending. Although there was an ‘emergency budget’ in June 2010 and VAT was increased in January 2011, most of the cuts did not take place until the beginning of the Financial Year in April 2011. The depressing effect of those cuts is therefore only beginning to be felt and is likely to increase throughout the rest of this year.

Despite the fact that the recovery began at the end of 2009 GDP output is still 3.9% below its peak level. Other European economies such as Germany and Sweden have already recovered all the output lost in the recession, by taking precisely the opposite course. Growth was stimulated via a series of measures - most effectively by increased government spending. The consequence is their public sector deficits are falling, while in Britain the official forecasts for the deficit are being revised upwards. The reason for this is simply that tax revenues in Britain continue to disappoint as growth remains elusive.

In the Great Depression of the 1930s it took exactly 4 years for the previous level of output to be restored. The 2nd quarter of this year was the beginning of the 4^th year since the recession. It seems extremely unlikely that the economy will grow by close to 4% by the 1^st quarter of 2012. This depression will not be as severe as the Great Depression, but it seems likely to be even longer.

The stagnation of the economy and the damage this is doing to Tory popularity has sparked a debate about the need for growth. Predictably, it ignores that fact that the recovery was fostered by increased government spending, including investment and is being throttled by government spending cuts. Instead, the focus is on tax cuts for corporations and the rich, an end to all carbon reduction policies, a reduction in the minimum wage, abolishing employment laws, privatisation and so on.

This is a recipe for more of the same and, as in other countries, the effect of this huge transfer of incomes from poor to rich would be to depress economic activity even further as well increasing the public sector deficit.

Few of these ideas are likely to find much support outside Tory circles. But one which has is the idea of a corporate tax cut to boost investment. This call ignores two important facts. First, the government is already cutting corporate tax rates from 28% to 23%, yet the private sector’s investment strike continues and accounts for 80% of total lost output. Secondly, the non-financial corporate sector is already sitting on a cash mountain, which is simply financing dividend payments, enormous executive pay and takeovers- that is, everything but investment.

The call for lower corporate taxes obscures a central truth about the current crisis. In any normally functioning market economy the household sector is a net saver, that is it retains a portion of its income and does not consume it immediately. The savings are mainly held in banks. The corporate sector is a normally a net borrower for investment, and borrows from the banks. The government can either be a saver (budget surplus) or borrower (budget deficit). This depends on its own tax and spending policies, but also on what happens in the rest of the economy.

In the chart below, the level of lending or borrowing for these 3 main sectors is shown. Borrowing is a negative number and lending positive. Other important sectors (especially financial corporations and the rest of the world) have been disregarded for the sake of clarity.

Figure 1

What the chart shows is the British non-financial corporate sector has not been performing its designated role over a prolonged period. It has been a net saver. Disregarding the sectors not shown, in general the sum of these three sectors must balance to zero. Saving by one sector must have another sector its borrowing counterpart.

The saving of the corporate sector had two effects. In the first instance corporate savings (achieved through lack of investment and low wages) obliged the household sector to become a net borrower to finance consumption. It also obliged the government to increase its borrowing as the lack of investment depressed taxation revenues. When, at the beginning of 1998, the household sector took fright and returned rapidly to its traditional role of net saver, the government was obliged to sharply increase its own borrowing and the public sector deficit ballooned.

The primary cause of both the unsustainable nature of the prior business expansion and the subsequent recession was the failure of the corporate sector to borrow to invest. Rather than cut their taxes and increase this saving, the whole thrust of policy should be designed to oblige the corporate sector to borrow for investment.

A progressive government policy would be to encourage business investment by increasing the government’s own investment. If necessary, a radical government would simply seize these corporate savings and use them for investment purposes on its own account. But in no case should there be a reduction in the incomes of the household sector via wage cuts and public spending cuts. This only diminishes its ability either to spend or save, and does not create business investment.

The electoral myths of 'blue Labour'

2011-07-26T10:41:00.004+01:00

By John Ross

Recent reports are that the current ‘blue Labour’ is coming apart - with former leading supporters stating they no longer wish to be associated with the project following Maurice Glasman’s widely criticised interview with the Daily Telegraph on immigration. But it is also important to understand that the entire basis of the factual claims by blue Labour were inaccurate.

The name ‘blue Labour’ summarises its analysis. It claims that the politics represented by the colour ‘blue’, that is the Conservative Party, are deeply attractive to those who can or did support Labour. As one analysis by a blue Labour leader put it: ‘Appealing to Lib Dems is all well and good. But we have to start to reach out to the millions of working class former Labour voters who left us for the Tories.’

Unfortunately there is no factual basis for a claim that the fundamental reason for Labour’s decline in support is the attractiveness of the Conservative Party and values it represents. Indeed the facts show the reverse.

There are naturally short term swings at elections, but Labour’s entire strategic net loss of votes over the period since it last came close to enjoying majority support in the electorate, a decline from 47.9% in 1966 to 29.9% in 2010, has been to the Liberal Democrats and other parties – chiefly Scottish and Welsh nationalists. None of this net loss of votes was to the Conservative Party.

Labour

To show clearly the factual trends of Labour support Figure 1 charts the Labour percentage of the vote at all general elections up to 2010.

As can be seen the trend is clear. There are, naturally, many short term fluctuations, but Labour’s support rose until the early 1950s, the absolute peak being reached at 48.8% in 1951. Support remained at a high level until the mid-1960s – with 47.9% of the vote being secured in 1966. After 1966, again of course with short term fluctuations, Labour’s vote fell from its previous level.

Figure 1

It therefore may be accurately said that from 1966 the social/political coalition which had made Labour a force commanding the support of almost half the total electorate progressively came apart. The key strategic issue therefore is where did Labour’s votes go?

To show what happened to Labour’s former support Figure 2 shows the change in the party’s share of the vote after 1966. As may be seen in that period:

Labour’s vote fell by 18.9% .
Liberal/Liberal Democrat votes rose by 14.6%.
Support for parties other than the three major ones rose by 10.2% - this being chiefly the SNP and Plaid Cymru.
The Tory vote, far from rising as it would have if it had attracted electors from Labour, fell by 5.9%

Therefore none of Labour’s net decline in support went to the Conservatives. The facts show, in short, that far from being attractive to Labour votes, the Conservative Party and Conservative values were deeply unattractive. The whole of the loss of Labour votes was to the Liberals/Liberal Democrats and ‘other’ parties – chiefly Scottish and Welsh nationalists.

Figure 2

The Conservative vote

Taking as a starting point for comparison 1966, a peak of Labour’s popularity, furthermore understates the decline of Tory support. Strategically the Conservative vote, naturally with short term fluctuations, has been declining for a prolonged period – as is clear from Figure 3. The post-war Conservative peak was in 1955, at 49.6% and Tory overall support, again inevitably with short term fluctuations, has been declining since.

Figure 3

The Tories failure to win an overall majority at the last general election was therefore not a ‘surprise’. Every Conservative victory since 1955 has seen the Tory vote fall to a lower percentage of the vote than the previous one.

The Conservative Party secured 49.6% of the vote in 1955, 49.4% in 1959, 46.4% in 1970, 43.9% in 1979, 42.4% in 1983, 42.2% in 1987, 41.9% in 1992, and 36.0% in 2010. The average decline of the Tory vote per year between victories is 0.3%.

The Liberal Democrats

Given Tory support was not rising but falling throughout this period the main parties receiving rising support were the Liberal Democrats – as shown in Figure 4, and ‘others’ – chiefly Scottish and Welsh nationalists, as shown in Figure 5

Between 1966 and 2010 support for the Liberals/Liberal Democrats rose by 14.6%. Support for other parties rose by 10.2%

Figure 4

Figure 5

Conclusion

The facts on the erosion of Labour’s former support are therefore clear.

Strategically the Tory party has not shown itself attractive to Labour voters. None of the strategic net loss of support of Labour has gone to the Tories. On the contrary the Tory it is a party whose vote is in long term decline.

The strategic loss of Labour support has been to the Liberal Democrats and Scottish and Welsh nationalists.

Posed in terms of values the conclusion of this is equally clear. Conservative values have not shown themselves attractive to former Labour supporters at all – on the contrary they have shown themselves unattractive. It is Liberal, Democrat and Scottish and Welsh nationalist values that have shown themselves attractive to Labour voters. Therefore, far from moving closer to Tory values, what Labour has to do is to be more attractive to those who have shared the values of Liberal Democrats and Scottish and Welsh nationalists.

Appendix – Percentage of the Vote at General Elections 1931-2010

The vote at general elections is set out in Table 1 below.

Table 1

The Job Losses at Bombardier

2011-07-19T12:37:00.001+01:00

By Michael Burke

It is widely expected that Bombardier’s failure to win the government contract for new Thameslink rolling stock will lead directly to the loss of approximately 1,400 jobs. This will indirectly cause other job losses in the area around the Derby works as well as in related industries. It will also negatively impact government finances.

The contract has been won instead by Siemens. The fact that Siemens is a German company has inevitably led to expressions of chauvinism on the British press, with the Daily Mail in particular focusing on the company’s national base and the Daily Telegraph campaigning that this is an issue of ‘British jobs for British workers.’ .

It is no such thing. It is instead a product of chronic private under-investment, the absence of any policies to promote production or jobs, declining government investment, the effects of privatisation and the dominance of the City in all aspects of policy. In short, it is a product of Thatcherism and New Labour’s refusal to reverse it.

Decline

The knee-jerk response by large sections of British society to any loss of jobs to overseas competitors is to claim that they are being undercut on pay. But investment (and the jobs it creates) does not flow to the lowest paying producer. In Europe, Bulgaria’s average rates of pay are one-seventh those of Germany yet Germany receives more than 500 times Bulgaria’s level of Foreign Direct Investment (FDI). In fact Britain is the biggest recipient of FDI in the world, belying any notion that ‘British jobs’ are lost through the process of international investment ..

In fact it is the failure of British capital to use that vast inflow productively which is the cause of Britain’s relative economic decline and the consequent destruction of jobs. In one sense, Bombardier is simply the latest example of this trend.

Bombardier

An interesting report by the Guardian’s economics leader writer Aditya Chakrobatty highlights how run-down the Bombardier factory and surrounding industrial park were, even before the latest set-back . This is symptomatic of chronic under-investment. A very valuable academic report highlights the reason for this^1[i]. Even compared to the Bombardier operation in Germany, let alone the successful bidder at Siemens, the rate of investment in the British operation was less than 40% of its German counterpart. Further, the proportion of value added consumed by interest payments was three times greater in the British operation.

Government tendering policy compounded these weaknesses. Although the contract remains secret, it is clear that the firms bidding for the work were not simply in the train-building business. The contract stipulated a PFI-style financing arrangement involving maintenance and leasing for 30 years in which, crucially, the bidder would have to arrange the financing for the acquisition of the rolling stock. For a firm already burdened with triple the interest burden, this was an impossible stipulation which added an estimated £700mn in costs to Bombardier’s bid.

This model of PFI-style financing has proved disastrous in all areas, most especially in large-scale transport projects. It is a function of the earlier privatisation of the rail industry including British Rail Engineering Limited, which had produced rolling-stock. The Bombardier plant in Derby is a vestige of that privatisation, having had 5 different owners in the intervening period. It is claimed that PFI deals lower government borrowing and lowers its need to invest. In fact, it inefficiently increases the overall costs of investment and thereby reduces the level of investment itself. Private PFI consortia have features similar to monopolies, and lead to price gouging of the state. In addition, private borrowing costs are always higher than those of government, leading to further costs, which are again borne by the state.

The sole beneficiaries of this adherence to PFI financing are the private consortia members and their financial backers. Since even under the most favourable terms many of these consortia still manage to go bust , the most consistent beneficiary of PFI financing are simply their financial backers among the major banks, who achieve a return irrespective of the failure or otherwise of the project..

Campaign

On July 23^rd unions operating in the Derby works have called a demonstration to campaign against the job losses. They are right to do so. But there can be no concession to the reactionary dead-end of ‘British jobs for British workers’.

German labour costs in the rail equipment sector are almost exactly the same as those in Britain adjusted for the exchange rate, €46,382 compared to £44,081. Siemens won the contract because the various owners of Bombardier did not invest in the company, compounded by government policies which represent the interests of the banks.

The campaign should be directed against the government- a demand to publish the contract to expose how loaded it was, for increased government investment in rail and for an end to PFI-style financing, which benefits the bankers, not the workers.

Notes

1. Knowing what to do? How not to build trains, CRESC Research Report, Manchester Business school.

How To Wreck A Recovery- Tory policy and Q1 GDP Data

2011-07-02T08:59:00.002+01:00

By Michael Burke

The latest publication of the British GDP data for the 1^st quarter of 2011 (Q1 2011) is unrevised - the economy expanded by 0.5% having contracted by 0.5% in Q4 2010.

However the much fuller data provided in this third estimate of growth, as well as revisions to prior quarters, gives a clear picture of the dynamic of the economy. The economy has effectively stagnated since the Tory-led government introduced the Comprehensive Spending Review in October (in fact it has marginally contracted). In the previous four quarters to Q3 2010 the British economy had expanded by 2.5%. By examining the data in detail it is possible to determine the causes of that stagnation.

Cause of Recession

The peak of the last business cycle was in Q1 2008 and the trough of the recession was in Q3 2009. From the beginning of 2008 to that latter date the economy contracted by £88.6bn in real terms, on an annualised basis. Household consumption fell by £41.5bn, one of the biggest percentage declines of the major economies, a drop of 4.9%. In the OECD as a whole the fall in household consumption was a more modest 1.5%.

By contrast government current spending rose by £7.4bn. Net exports also rose entirely as a function of collapsing demand for imports, which fell faster than exports. Combined net exports made a positive contribution to growth of £16.4bn during the recession. But investment (gross fixed capital formation, GFCF) fell by £43bn. Of this decline in investment, the private sector is responsible for £51.1bn, as government investment expanded during the recession by £8.1bn. Therefore of a total decline in GDP £88.6bn the decline in private sector investment accounts for £51.1bn, or 57.7% of the total.

These main aggregates of the national accounts in the recession are shown in figure 1 below.

Figure 1

Despite a recovery that began in Q4 2009 the level of GDP remains well below its peak. At the end of Q1 2011 GDP is still £56.3bn below its previous peak level three years ago in Q1 2008, a shortfall of 4.1%. Household consumption has recovered to some extent so that it is now £36bn below its peak level. Government current expenditure and net exports have both risen, by £13bn and £17.3bn respectively. Investment has resumed its decline in the last two quarters. It is now £36.1bn below its peak, fractionally more than the decline in household consumption. Of this decline in investment, the private sector is responsible for £44.9bn as government investment has risen by £8.8bn. This private sector investment strike accounts for £44.9bn of a total loss of output of ££56.3bn – this is 79.8% of the total.

The main aggregates of the national accounts in from the end of the prior boom to date are shown in Figure 2 below.

Figure 2

Cause of Recovery

As previously stated, recovery began in Q4 2009 and lasted four quarters - the economy expanding by £32.8bn. Consumption rose by £11.7bn, up 1.4%. Net exports did not add to growth, but subtracted from it by £12.6bn. Government current spending rose by £3.8bn. Investment rose by £12.5bn. The private sector contribution to this was £15bn, as government investment has been contracting under the impact of the new government’s policies.

This may have lulled the government and the Office for Budget Responsibility (OBR) into the false idea that that recovery would be driven by investment even as government spending was cut. (The other officially projected component of growth is net exports, but the rise in net exports currently remains entirely a function of the slump in import demand. British exports in Q1 2011 remain below their pre-recession peak despite the sharp rebound in world trade).

The OBR forecast¹ in March this year that private investment would rise by 6.7% this year. Currently it is moving in the opposite direction. In Q1 private sector investment fell 3.8% from the final quarter of last year.

To see why the government and the OBR have been proved wrong in projecting higher private sector investment the dynamic underlying the recovery and subsequent stagnation must be examined.

In Figure 3 the trends in GDP and investment are shown in relation to the end of the expansion in Q1 2008.

Figure 3

As already noted the decline in investment is the driving force behind the recession and the subsequent failure to recover to the previous peak level of output. Private sector investment accounts for 79.8% of that total shortfall. As the chart shows public investment moved in the opposite direction, increasing through 2008 and rising sharply in 2009 and peaking in Q1 2010 - the last quarter of the Labour government.

By the time GDP began to recovery modestly in Q4 2009, public sector investment had risen by an annualised £10.5bn. This was far greater than the initial rise in GDP, which was just £6.1bn higher. Therefore the rise in public sector investment was entirely responsible for the recovery.

Private sector investment did not rise as soon as the economy began to expand. It began to rise only after recovery had begun. Since all private investment is determined by anticipated profits, this inability of the private sector to lead the recovery is no surprise.

However, over the course of 2010 private sector investment was the biggest single contributor to growth rising by £22.3bn. Private sector investment increased as a result of growth fostered by the sharp increase in the level of public sector investment.

But instead of understanding that public sector investment was leading to economic recovery, including stimulating private sector investment, both the Tory-led government and the OBR subscribe to the idea that government spending ‘crowds out’ the private sector and if public spending is cut, private investment will increase. The opposite is the case. Government investment ‘crowds in’ private investment.

The false Tory/OBR idea is also demonstrated by the negative reaction to the subsequent cut in public sector investment. Public sector investment peaked in Q1 2010 where it was 38.4% higher than at the end of the prior business expansion. It began to fall as soon as the Tory-led Coalition took office in Q2 2010. Shortly afterwards, in Q4 2010 GDP began to stagnate. Immediately afterwards, private sector investment began to contract once more.

Technical Issues

For those readers interested in these topics, this next section deals very briefly with some interesting technical issues highlighted by the recent zig-zagging of the British economy- from recession to recovery to stagnation. Other readers can skip straight to the Conclusion.

Leading and lagging indicators: Public investment has clearly behaved as a lead indicator for the economy as a whole. Private investment is a lagging indicator. While public investment rose continuously throughout the recession, the significant increase did not take place until after the March 2009 Budget, when the rate of increase doubled. GDP responded two quarters later, in Q4 2010. Private sector investment responded 3 quarters later by recording its first rise in Q1 2010.

Similarly, public investment began to fall in Q2 2010. GDP contracted two quarters later, in Q4 2010. Private investment fell once more 3 quarters later in Q1 2011.

Multipliers: The OBR concedes a point that is almost unanimous in the literature - that the multiplier effect of government investment is greater than all other types of government spending. However, hamstrung by the notion of ‘crowding out’ and determined to promote it, the OBR’s multiplier for government investment is just 1, meaning that there is no more economic effect than simply the government spending itself². Its multiplier for cuts in welfare is 0.6 and for a VAT hike is 0.35, meaning that both of these have far less than the effect of government cuts or increased spending. Bizarrely, the logic is that private agents, both households and businesses, become more confident because of the cuts, and so offset their effects by increased spending and investment.

The economy’s recent gyrations provide evidence to the contrary. It is impossible to determine the precise effect of increased government investment in stabilising the economy prior to actual recovery. But it has already been shown that a cumulative rise in public investment of £10.5bn led to a rise in private sector investment of £22.3bn. This alone is a multiplier of 2.12. The rise in investment will also have boosted household incomes a well as government income (both via increased tax revenues and lower welfare outlays than otherwise). But, as a minimum, it can be stated that the multiplier from government investment is higher than 2, and is likely to be considerably higher.

Conclusions

The recession was driven by the collapse in private sector investment. The fall in household consumption was also important, much more so than in the OECD as a whole.

The resumed private sector investment strike now accounts for close to 80% of the entire output loss since the recession, and the economy remains more than 4% below its prior peak level.

The government and the OBR promote the notion that cuts to government spending will lead to spending in the private sector from households and businesses. The opposite has been the case. The entire recovery was engendered by the rise in public sector spending and private investment followed later.

The Tory-led government has reversed the rise in public investment through its cuts policy. This has led first to stagnation and now contraction of private investment in Q1 2011. The fall in private and public investment combined more than accounts for the entire slowdown in the British economy in the last two quarters. Tory policies have wrecked the recovery. Only a rise in public investment can revive it.

Notes

1. OBR, March 2011, Economic and Fiscal Outlook

2. Treasury, June 2010 Budget, Table C8.

Greece and other failures of EU bailout packages

2011-07-01T09:16:00.002+01:00

By John Ross

The great majority of serious economic commentators know that the ‘bailout’ package just agreed between the EU and Greece is going to fail. That in the end Greece will be forced into partial default worsening the terms for its creditors. This will, of course, be politely termed ‘rescheduling’, ‘reprofiling’ or some similar phrase in order to attempt to camouflage reality. The camouflage may, however, be so transparent that the ratings agencies will still declare a default. The main discussion is whether it is better for Greece to default immediately or whether the bailout package is a good idea, not because it will work in the end, but because it will postpone the default.

It is therefore useful to understand that all three bailout packages agreed between the EU and its member countries struck by debt crisis are failing in their declared purpose of promoting economic recovery – that is not only in Greece but also in Ireland and Portugal. This is clear from Figure 1, which shows the trend in GDP for these three countries since its peak in the last business cycle.

As may be seen in none of these countries is serious recovery occurring. Attempts to claim it is, for example by making optimistic publicity about the latest quarter’s GDP figures from Ireland, consists of taking data out of context – Ireland’s GDP figures were better only in comparison to the precipitate collapse which had occurred in the previous quarter.

Taking the three countries which have made agreements with the EU the latest available data, for the 1st quarter of 2011, shows:

Greece’s GDP is 9.9% below its peak with an insignificant recovery from the low of 10.0% below.

Portugal had been recovering, but its GDP has turned down in the last two quarters and is now 2.7% below its peak.

Ireland’s GDP is 11.5% below its peak and is the same level as in the 3rd quarter of 2009 – i.e. no net growth has taken place for the last year and a half of austerity packages.

In short no serious recovery has been created by any EU ‘bailout’.

Figure 1

* * *

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

The Greek Crisis

2011-06-23T10:53:00.003+01:00

By Michael Burke

The Greek economic and social crisis continues to unfold. Around it a series of myths have arisen and been perpetuated. It is necessary first to dispose of some of those myths before moving onto a concrete analysis of the situation.

The present author has a piece in the Guardian's Comment Is Free web blog which addresses some of these issues. The present article will deal with rebutting those myths in slightly greater detail before setting out an alternative policy that could both resolve the Greek crisis and reconstitute the European Union and Euro Area on a more stable basis.

Greek Mythology

When the European and international authorities announced over a year ago that there would be a €110bn rescue package for Greece it was claimed that this would be sufficient for the Greek government until at least 2013, at which time the newly-restored health of the Greek economy would allow it to return to international financial markets - especially since it would by then have a far lower borrowing requirement. This rebound in activity would arise from the policies implemented by the Greek government under instruction from the EU/IMF/ECB. On all these fronts, the claims have been shown to be false and the policy a failure.

The EU/IMF/ECB is frequently described as the 'troika'. The troika have produced a conditional emergency lending programme of €12bn because the €110bn is being rapidly consumed. Greece's economy has gone into a tail-spin. GDP in the first quarter of 2011 is 5.5% lower than in the same period in 2010, and the rise in output from the fourth quarter of 2010 is entirely accounted for by a collapse in import demand. As a result the public sector deficit has been on a widening and not a narrowing trend. Because of the troika's policies, the budget deficit has widened to €10.3bn in the first five months of this year, compared to €9.1bn in 2010 before those policies took effect.

It is widely reported that the further emergency funds are required because Greece has missed targets set by the troika. The targets have been missed, but only by a cumulative €1.2bn over five months. Neither this shortfall nor the total €10.3bn deficit level can explain the need for additional funds over and above the €110bn already available.

The capital which was injected has been consumed by the holders of Greek government debt, both short and long-term. As these debt obligations have been redeemed on their due date international investors have simply taken the money. They have not bought any newly issued Greek debt with the proceeds. This redemption of bond holdings has combined with continuing interest payments on the outstanding debts for a total payment to bondholders of over €40bn since the bailout was announced in May last year.

The bailout was therefore one for private creditors - primarily European (including British) and US banks. This was both predicted and predictable, with the FT's chief economics commentator Martin Wolf noting at the time that the impositions on Greece were worse even than those on Argentina, because the private creditors were being paid to exit the market.

Furthermore, it should be noted that, while the budget deficit has not at all driven the need for extra funds, the €1.2bn overshoot is entirely a function of the collapse in tax revenues, not government overspending. In fact spending is €0.7bn lower than the EU/IMF impositions, but tax revenues are also lower by €1.9bn. This too was predicted, including by SEB.

This reality has not prevented widespread media reports that it is the widening public sector deficit which is the cause of the renewed financial crisis , even that this reflects recent overspending, which is factual nonesense.

This latter point is supplemented by the assertion, applauded by sections of the Greek right wing intelligentsia, that the underlying cause of the crisis is a 'bloated public sector'. In fact Greek public spending before the crisis in 2007 was 46.3% of GDP, compared to 46% for the Euro Area as a whole. Greece has among the lowest proportions of public spending on both health and education in the Euro Area, while more than half of the concealed government spending in 2000-2003 was on the military - 5.5% of GDP in total.

Added to all this is the campaign to end any further payments to Greece, with Cameron declaring 'not a penny more' - so joining the charge led by Boris Johnson and George Osborne and including the reactionary nationalist True Finn party, all of whom ignore the small matter that 'Greece' is not the beneficiary of the funds to date. Its creditors are and these include British banks.

To avoid addressing the real dynamics of the situation, the mythology in both Britain and Germany also sinks to reinforcing insulting and wholly untrue stereotypes about the lazy Greeks. In fact, Greeks have the second-longest working hours in the whole of the EU.

Debt Sustainability

Now let us turn to assessing the actual dynamics unfolding in the crisis as well as the likely or preferred policy outcomes.

There is a growing consensus that a debt default by Greece is inevitable. Economists have developed a series of metrics in an attempt to determine where a specific level of debt is sustainable. An influential study from Professors Reinhart and Rogoff is widely quoted that for advanced economies output will slow markedly when the public debt level exceeds 90% of GDP . But this is not substantiated by the post-World War II experience where a host of countries had debt levels for in excess of that. Britain's debt level exceeded 250% yet the growth in GDP in the last 10 years has been little over half that of the 10 years from 1948 onwards.

A more sophisticated and robust measure of debt sustainability is as follows: the real interest rate minus the real growth rate multiplied by the debt/GDP ratio must be lower than the primary budget balance (primary, meaning before debt interest payments are included).

In a less technical formulation of the same proposition; the economy must be able to grow it way out of the debt. However, if total interest payments rise at a faster rate than GDP growth, the debt burden becomes unsustainable.

In the case of Greece currently interest rates (borrowing from the EU/IMF at approximately 6%) exceed the growth rate (-5.5%) by 11.5%. The debt/GDP ratio is 158%, according to Eurostat. This means the interest burden is 18.17 (11.5 multiplied by 1.58) whereas the primary budget balance is forecast by Eurostat to be a deficit of 2.8% of GDP in 2011. The primary surplus would need to rise by 21% of GDP to be sustainable, effectively that government spending would have to be halved without any detrimental effects on the economy or on taxation revenues.

However, the detrimental effects of far more modest cuts- at least compared to this projected level – have already been so great as to overwhelm any supposed 'savings'. There is no reason to suppose that cuts of an even greater magnitude will have any other effect. Yet this is the prescription demanded by the EU/IMF/ECB.

Under these policy settings a Greek default seems inevitable. (Using the same metrics and applying the Eurostat data and forecasts in each case, Irish and Portuguese defaults are also unavoidable, without a change of policy).

A Progressive Approach

On current trends for the year to date, the Greek public sector deficit could reach €24bn. However, in common with nearly all advanced economies the recession itself is caused by a private sector investment strike. Of the €11.8bn fall in output in the two years of recession to 2010 the decline in investment (gross fixed capital formation) accounts for €9.9bn, or 84% of the total. This is not to say that households have not been badly hit, and consumption has fallen by nearly as much, €8.9bn (statistically offset by other factors such as falling import demand). But this is in response to falling incomes, rising unemployment and increasing taxes. The driving force is the investment strike- which actually began prior to the recession and now has fallen by 25.9%, compared to a decline of 6.6% in household consumption.

Since the financial accounts of the main sectors of the economy must balance; businesses, households and government if the former two increase their savings/reduce their consumption, then (excluding the external sector) government is obliged to decrease its own saving/increase its borrowing. As elsewhere, the cause of the increase in the public sector deficit and the recession is the same - the private sector investment strike.

But troika policy has not been focused on addressing this investment shortfall but has instead attempted to correct the public sector deficit via sequestration of the incomes of the household sector both directly (lower wage, tax increases) and indirectly (public spending cuts, reduced welfare payments). The effect has been disastrous because it attacks households' ability to save, a necessary function in any market economy. The more 'austerity' that is heaped upon them the sharper the fall in household incomes, and the greater the propensity to save. Instead, a policy should be pursued which addresses the cause of the economic and fiscal crisis. This should be a policy aimed at increasing investment in the economy.

Increasing investment can be pursued in two ways, through international efforts and domestically.

On the international front, clearly the Greek government cannot borrow in the markets and under the impositions of the troika will not be allowed to borrow from them for investment. Yet the EU has traditionally recognised the need to make capital transfers to poorer regions/countries in order to bolster investment, via cohesion, structural and other Funds. These payments are still being made in Eastern Europe, and account for Poland's ability to escape recession entirely, for example.

The crisis-hit countries of the Euro Area have just become a lot poorer and on current policy settings will become further impoverished. The previous transfer payments were not altruism, but increased the market for goods and services produced in the 'core' economies. At the same time they had the intention of keeping economies together in a single currency area despite their widely different levels of productivity. They prevented repeated rounds of competitive devaluations, which also benefited the core economies.

Therefore, rather than another bailout for private creditors there should be a first bailout for the Greek economy, so that it can be invested productively and growth restored. This should be financed by the core economies, at no greater cost than their intended further bank bailout. Other countries might be willing to participate if there were reasonable investment returns on infrastructure, housing or other investment, perhaps including China.

On the domestic front, there are large resources available in the Greek economy, if only the government chose to access them. In the table below we show the Gross Domestic Product (GDP) for the Greek economy, a measure of output which simply excludes the effects of taxes and subsidies. These are in nominal, not real €.

Nominal GDP & Its Distribution € billion
	2008	2009	2010
GDP	236.9	235.0	230.2
Compensation of Employees	86.3	88.6	83.5
Gross Operating Surplus	124.9	123.7	121.8
Taxes on production (less subsidies)	29.4	26.7	28.4
Source: OECD

There are a number of striking features from the data. First the Gross Operating Surplus (GoS) of firms is vastly in excess of the compensation of employees (CoE), that is akin to capital and labour's relative share of value created. On this measure the GoS is nearly 53% of all value created, compared to just 36.3% for labour, and Greece is by far the most exploitative economy in the Euro Area.

Capital's excessively high share of income combined with an investment strike starves the economy of its lifeblood, while the excessively low compensation share also weakens its effective final demand.

Secondly, the sums are enormous. It should be recalled than the Greek deficit may amount to €24bn in 2011. Yet taxes on production amount to just €28.4bn, even while the GoS is a staggeringly high €121.8bn. Therefore taxes on production could be significantly increased as a decisive contribution to the necessary combination of deficit-reduction and investment.

A Progressive Default

There have been widespread calls for default and even for unilaterally exiting the Euro Area and reintroducing the Drachma. This last policy is in fact especially dangerous to the Greek economy and most of its population (the exception are those whose wealth can be held overseas or whose incomes derive from overseas, such as the shipping billionaires).

Any New Drachma would immediately devalue versus the Euro and thereby increase the local currency value of the existing debt. Since there is no legal mechanism for such an exit it would no doubt be declared illegal by the authorities working for the bigger powers, not just Germany and France but also Britain and the United States. Since they are already insisting on privatisation as the next chapter in the dismemberment of the Greek economy, the 'illegal' exit could be the pretext for the seizure of all manner of Greek assets, including public utilities and state-owned enterprises as 'compensation'.

In addition, Greek banks have accepted deposits in Euros but their key asset would now be in devalued New Drachma so they would immediately be rendered bankrupt. Only a government prepared to protect all the deposits by taking them into public custody, and itself taking control of key assets to forestall their seizure by the foreign powers, could deal with this. Since Mr Papandreou or any likely successor in the foreseeable future is not Fidel Castro, then that is unlikely to happen. Instead, it is Germany, France, Britain and the US who would be in a position to seize assets. Advocating unilaterally leaving the Euro would unleash just such a dynamic.

As already stated, the question of default seems unavoidable. But efforts should be made to avoid a 'disorderly default' which would lead to the same consequences as unilaterally exiting the Euro. It is this type of default being promoted now by Cameron, Osborne, Boris Johnson and others and coincides with the interests of British banks who have exited the Greek government bond market and who feel that they can at least gain a relative advantage from competitors' distress, or may even have a position to profit from a default.

It is possible if, for example, that the ECB retaliates to a default by withdrawing its liquidity provisions to the Greek banks or by refusing once more to accept Greek government bonds as collateral for liquidity provided to other Euro Area banks. This would bankrupt Geek banks, freeze Greece out of international markets for a prolonged period, and require the immediate closing of the deficit. Unless most of the public sector was fired and welfare payments abandoned, the only way to avoid that would oblige the government to introduce a new currency, or quasi-currency.

Comparisons with the Argentinan and Russian defaults are invalid for that reason. These countries had only debt obligations to countries such as the US. Greece, a far smaller economy than either, has Treaty obligations too which can be used against it.

Instead, a programme of investment-led deficit reduction, financed by core economies and Greece's own resources would address the objective requirements of the economy. Under those circumstances, it would make no sense to continue further payments to private creditors, so default (or 'restructuring') is required. In addition, the accumulated debt burden is unsustainable, so all existing holders of Greek government debt would be obliged to take significant losses. If the Maastricht Treaty insists that 60% is the maximum permissible debt/GDP ratio then it can be asserted that the 'haircut' imposed on holders of Greek government debt (which stands at 154% of GDP) must be no less than 61 cents in the Euro, preferably more, for prudence sake.

Job Fears Reinforced

2011-06-10T08:03:00.001+01:00

By Michael Burke

SEB recently wrote that the improvement in Britain’s employment is unlikely to last. This is because jobs growth is a lagging indicator and reflects the previous upturn in activity. As the recovery has ground to a halt in the last 6 months this will in time lead to renewed weakness in jobs.

These fears are reinforced by the latest monthly jobs survey from the Recruitment and Employment Confederation and accountants KPMG. The May data show a further deceleration in jobs growth. The survey has a good track record, with turning-points in the employment data coinciding with turning-points in the survey. The value of the survey is that it is more timely- while REC/KPMG have produced May data, the next employment release from the Office for National Statistics due on June 15 will be for the period to April.

The survey for both full- and part-time jobs is shown in the chart below. Any reading above 50 indicates an expansion in jobs and anything below 50 indicates a contraction. The May reading extends the trend of decelerating employment growth, heading back towards a stagnant jobs market or even worse.

Figure 1

The Tory-led collation has previously attempted to claim the prior improvement in jobs as supporting its contention that the economy will grow even while it cuts public spending and public sector jobs. It is even implied that private jobs have grown because of government cuts. This was wholly dishonest, as all mainstream economics accepts that changes in employment follow changes in activity. Therefore the previous growth of employment reflects the earlier recovery, not this government’s actions. Government spokespersons have since become more circumspect.

Government policy has led to economic stagnation. Both economic theory and the most recent evidence suggest that jobs losses will follow.

Public Versus Private Ownership

2011-06-10T08:01:00.001+01:00

By Michael Burke

Recent political and corporate events have thrown the relative merits of the public and private sectors into sharp relief.

The NHS is the most popular institution in Britain. According to recent research (p.386) by Lord Ashcroft for the Tories the NHS has a 79.8% approval rating - ahead of the BBC’s 66% and 61.8% for the Royal Family (and 43.1% for the Daily Mail, the lowest rating of all). Full details of the poll and voluminous and valuable additional information can be found here

This fact, and the recent mobilisations by the TUC, provides a difficult environment for the Tory-led government’s attempts to significantly reduce real health spending while qualitatively increasing the role of the private sector.

It is further complicated by the financial distress and possible collapse of Southern Cross Britain’s biggest care home provider. Southern Cross has nearly 31,000 residents in its care homes, mostly elderly patients. It is widely described as having reached a financial crisis because it sold its care home properties and leased them back prior to its flotation on the stock market.

However, this misses an essential point. Blackstone, the private equity group, owned both Southern Cross and the vehicle which became its landlord, NHL. Both were loaded with debt by Blackstone the proceeds of which it took for itself. The debt was created in order to strip the assets. Blackstone’s initial investment of $500mn became a payout of $1.5bn.

At risk now are all 31,000 vulnerable residents in the care homes. Many have already been living in atrocious conditions for some time as lack of capital and high debts precluded investment. In 2010 Southern Cross reported it had already 19 homes rated “zero stars”. It has been announced that 3,000 jobs will be cut in an effort to return to profitability- and with it a reduction in the level of care offered to residents.

Efficiency

The private firms that the government wants to run most of the NHS functions under its ‘any willing provider’ rule are not small enterprises, but major corporations such as Blackstone. Their purpose is not the provision of healthcare but the maximisation of profit – and they will reduce jobs and services or even declare bankruptcy when profits fall.

But the argument in favour of the public sector is not confined to these extreme cases of asset-stripping induced crisis. In all the ideological campaign against the NHS a central truth is obscured- the NHS is more efficient than private sector healthcare. This is illustrated in the chart below reproduced from the OECD’s European Health At a Glance 2010.

The chart shows the correlation between spending on health in a number of European countries versus healthy life expectancy at birth. As would be expected, the general rule is that the greater the spending on health the longer the healthy life expectancy in each country. (The R2 corrrelation of 0.33 in the top left hand corner means that higher spending accounts for two-thirds of the difference in life expectancy, as a perfect correlation would be 0.50).

Figure 1

Inevitability there is some variability around the central trend. Some of this will be to do with the stage of economic development and location, such as the Mediterranean countries’ better health outcomes.

But if we examine the Northern European developed economies there are three which are significantly above the correlation line, which means that they have an above-average life expectancy relative to the amount of health spending, and there are three significantly below. The three above the line are Britain, Sweden and Denmark. The three countries below the line are Austria, Germany and Finland.

Therefore, strictly speaking the first group of three countries is much more efficient in its health spending- they achieve above-average outcomes relative to expenditure. This includes the NHS. The second group of three countries is relatively inefficient, achieving worse health outcomes relative to health expenditure.

This is explained by who is spending the money, and what it is being spent on. In Britain, Sweden and Denmark the public sector accounts for an average of 81.6% of all spending on health. In Austria, Germany and Finland the public spending sector funds an average of 75.9% of all healthcare provision.

These are significant sums - with annual public spending in the first group amounting to €2,819 per person, while in the second group it amounts to €2,331 per person (adjusted according to OECD Purchasing Power Parities , Tables 4.1.1 and 4.5.1).

It should be stressed that this is not a function of the first group spending more money - they spend less. The average total spending, both public and private sector spending of the higher longevity countries is €2,920 per person per annum. Total spending in the second group is higher at €3,066 per annum.

Public health spending in these EU countries is clearly more efficient than private health spending.

Furthermore, it is clearly more efficient in terms of treatment and care. The average life expectancy at birth (women and men combined) is exactly the same for both groups at 79.5 years (Table 1.1.1). But the average healthy life years expectancy for the first group is 68.0, while for the second group it is just 56.9, with none above 60 healthy life years. These are enormous differences in tens millions of people’s lives.

Source of Inefficiency

It is well-known that the US healthcare system is almost entirely private. As SEB has previously pointed out, the US system is much more inefficient than the NHS - with the same life expectancy and proportionally the same number of health care professionals, while devoting almost twice as much of GDP to healthcare spending .

A recent explanation for part of this discrepancy comes from The Economist magazine, which has great relevance for the current attack on the NHS from the Tory-led government. It argues that the centralisation of drug approval and purchasing by public bodies is vastly more efficient. The alternative US system means private sector drug producers are spend enormous sums marketing their products to a decentralised multitude of purchasers, equivalent to local GP consortia in this country. These costs are of course passed on, and the drug purchased is frequently the one with the largest marketing budget, not the most effective one. This inefficiency is replicated at every level of input for the private US healthcare system

The principles of public sector relative efficiency apply to the delivery of virtually all public goods, not just health, but also education, housing, transport, infrastructure and services such as post and banking. Marketising and privatising the NHS is not only a threat to the quality of healthcare for millions of people, but a hugely inefficient step backwards.

Fall in unemployment is likely to be temporary

2011-05-23T14:00:00.002+01:00

By Michael Burke

The latest data show a fall in the UK unemployment rate to 7.7% and an increase of 36,000 in the employment total. This is the fifth consecutive quarterly fall in the unemployment rate, which peaked at the end of 2009.

However, even the Tories constrained their boasting about the data, with employment minister Chris Grayling saying only that it “was a step in the right direction”. Neither Cameron nor Osborne made any pronouncement at all on the employment release.

The caution is well-advised. Economists generally regard unemployment as a lagging indicator of activity. That is, unemployment responds after changes in output with a time lag between the two. So it is often the case that unemployment will continue to rise even after a recovery has begun. This is mainly because there is an inevitable delay between a business reaching a decision to hire more workers or open a new factory or shop and the new workers starting their employment.

This is illustrated in the chart below, which shows the unemployment rate (red line) and the year-on-year growth in GDP (blue line). For example following the recession of the early 1980s the unemployment rate carried on rising for another 21/2 years. Similarly, the jobless rate continued to rise for over a year after the end of the recession in the early 1990s.

Figure 1

A number of analysts have noted that the rise in unemployment in this recession has been more muted than in either the Thatcher or the Major recessions - when the unemployment rate rose by 5.6% and 3.2% respectively. The increase in the unemployment rate in this recession was 2.1%, with the Office for National Statistics providing the official assessment that this is particularly striking as the loss of output in this recession of 6.4% is nearly as large as the other two combined (7.1%) .

A crucial difference is politics. The policies of both the Thatcher and Major governments’ were to engineer a rise in the unemployment rate in order to drive wages down and profits up. If there is any doubt on this question, it should be dispelled by this 1 minute video interview with Sir Alan Budd, Thatcher’s chief economic adviser .

By contrast, no Labour government maintaining any link with the unions could hope to set out on the same path and survive. Labour politicians who did adopt these policies such as Ramsay MacDonald and Philip Snowden had to break with Labour to implement them.

It is not surprising that the official analysis of the subdued rise in unemployment in this recession should neglect this determining political factor. But it also overlooks an important aspect of the most recent trends in unemployment.

Crucially, the rise in unemployment from its cyclical floor of 4.8% began in the second half of 2005, nearly three years before the recession began. This is a much longer period than ahead of either the Thatcher or Major recessions, when unemployment began to rise about a year before recession. From mid-2005 onwards overall employment growth failed to keep pace with the natural growth of the workforce over the period. This applied to nearly all categories of employment, including public sector health, education and administration jobs, which grew a little over 2% between mid-2005 and the beginning of the recession in the 2^nd quarter of 2008. This was approximately one-third of the pace required to prevent a rise in unemployment. The three exceptions to this general picture were real estate jobs (but not finance jobs) which grew by 20% over the period and manufacturing and private sector administration jobs, which both saw outright falls in employment.

In short, parts of the private sector were shedding jobs in order to boost profitability. The rest of the private and the public sector were not growing fast enough to absorb these or the natural growth in the workforce. This rise in unemployment was taking place an exceptionally long period before the recession began. This may help to explain why the decline in jobs was more subdued when the recession actually did begin.

The recent improvement in both employment and unemployment simply reflects the lagged effects of last year’s growth. If previous patterns are repeated this improvement may last another quarter or two. But the economy has already begun to stagnate under the weight of Tory cuts and these will be much deeper this year. Therefore the jobless totals are likely to rise once more as government policy takes effect- especially as driving down wages is an aim of policy.

A rational policy based on optimising growth would be set out to reverse these negative trends on a sustained basis, with a goal of full employment. That is the surest way to maximise the well-being of the population, and, not incidentally the best means also of reducing the public sector deficit.

Inflation impoverishes the vast majority

2011-05-18T07:31:00.001+01:00

By Michael Burke

The latest monthly data show the annual pace of UK inflation accelerating to 4.5% in April, using the Consumer Price Index (CPI). The broader measure of inflation in the Retail Price Index (RPI), which also includes housing costs moderated a little, to 5.2% from 5.3% in March.

The impact of these prices increases is severe. At the end of 2010 the annual level of all wage compensation in the UK economy totalled £800bn. In the February data, average weekly earnings grew by just 0.9%. If sustained the decline in real wages would therefore amount to 4.3%.

For comparison if a decline of 4.3% in real wages were directly translated into total employees’ compensation it would amount to a £34bn annual reduction in incomes. This compares to the government’s already enacted tax increases of £3.8bn and spending cuts of £5.5bn in the previous Financial Year (FY) and £20bn in taxes and £22bn in cuts in this FY.

Unlike the cuts, inflation affects all sectors of society, especially those on low or fixed incomes, in addition to those in the public sector who are seeing their pay fall through a wage freeze and increased pension levy.

Usually the group on fixed incomes would include those receiving the state pension. However for reasons of political calculation, the government has chosen to offer a ‘triple-lock’ on pensions, so that pensioners will receive the highest of earnings growth, the RPI or 2.5%. However it was hardly envisaged at inception that this could mean a pensions increase of perhaps 6% just to keep pace with the RPI. Both the June 2010 and March 2011 Budgets assumed that there would be no additional cost to this policy in the current FY. But if the overshoot in inflation is in line with the Bank of England’s latest quarterly Inflation Report, then the cost to the Treasury will be £2.9bn in this year alone – without leaving pensioners any better off.

If the real aim of policy was to reduce the budget deficit reduction, the government approach would be utterly self-defeating. The rise in pensions and other welfare benefits (although most of these have now been switched to a link with the persistently lower CPI) automatically triggered by higher inflation will cause significant increases in net government outlays, even while entitlements are being cut.

Yet government policy is itself largely responsible for the overshoot in inflation. The chart below is taken from the latest official publication for the Office for National Statistics (ONS). In addition to CPI inflation, which is currently at 4.5%, two other measures of inflation are shown. The CPIY measure shows price increases excluding the direct effect of changes to indirect taxation, such as VAT. This is currently rising at a pace of 3%. The CPI-CT measure is the same as CPI but is adjusted as if all taxes were unchanged during the latest 12-month period (for example, excise duty rose on alcohol and tobacco in the March Budget and these are excluded). This is currently rising at a pace of 2.8%.

Figure 1

The Bank of England’s medium-term target is a 2.0% inflation rate with a tolerance zone 1.0% either side of that central aim. A large part of the current overshoot is a direct effect of government policy, which will also have greater indirect effects too. On both the CPIY and CPI-CT measures which exclude the direct effects of government policies, the inflation rate would be within the target range.

This matters primarily because both the latest data and the Bank’s Report have raised expectations that there will be interest rate increases before the end of the year. At the time of writing the interest rate futures market was pricing in two rate hikes by year-end to take official rates up to 1%.

Government hopes for economic recovery are largely pinned on the ability of very low interest rates to support borrowing by companies and especially households while the cuts are pushed through. If the prop of low interest rates is kicked away the economic outlook will deteriorate sharply. Yet it is in the government’s own hands to lower the inflation rate by reversing the rise in VAT. They could also scrap the rules that allow permanent above-inflation prices rises for the privatised utilities and rail companies, which are set to lead to price rises of up to 14% later this year .

At the turn of the year higher inflation led to calls for significant rate increases and a campaign for a higher pound which Osborne and Cameron were keen to lead. Sterling climbed sharply, as Figure 2 below shows.

Figure 2

But that campaign was punctured by publication of the stagnant GDP data for the latest 6 months. Now there is a gradual realisation of how weak the economy is and sterling finds little support from higher prices or the expectation of higher rates, as the chart shows. Instead the talk has shifted to ‘stagflation’ the combination of economic stagnation and rising prices .

That stagflation is even a possibility after one of the most severe economic contractions on record is itself a damning indictment of policy. Recessions should lead to large excess capacity in the economy allowing a rapid rebound without producing price pressures. Now a combination of government spending cuts, chronically weak investment and excessive monetary creation have created the opposite; flat activity and soaring prices.

The opposite policy is required to produce non-inflationary growth, centred on increased government spending and investment.

Problems deepen at Lloyds Bank - but it could be part of the solution

2011-05-05T14:07:00.002+01:00

By Michael Burke

The initial market reaction to the announcement that Lloyds Bank had made a £3.5bn loss in the first quarter of this year was for the share price to fall by nearly 6%. Every British taxpayer has a material interest in Lloyds as the state effectively controls it through a 41% shareholding.

At the time of writing the share price had fallen to a little over 54p per share, whereas the average purchase price by the state was 68p – see Figure 1. Taxpayers are now nursing direct paper losses amounting to nearly £1bn on the share purchases. However this is a tiny fraction of the total costs incurred by the state in bailing out the banks, which has mainly been in the form of providing funds to the stricken banks rather than share purchases.

Figure 1 – Lloyd’s Bank Share Price

According to the Office for National Statistics (ONS) the total debt incurred in ‘financial market interventions’, that is the bank bailout, was £1,335bn, significantly more than the level of state debt incurred via spending and taxation which currently amounts to £903bn.

For all the lurid headlines about both, the debt and the budget deficit actually fell in the last Financial Year (FY) from £156bn to £141bn under the impact of the recovery fostered by Labour’s increased spending - which has now stalled under the Tory cuts. Similarly, the debt level, excluding the bank bailout,t amounts to 59.9% of GDP which is fractionally below the Maastricht Treaty limit and lower than British public debt in every year between 1916 and 1970.

A chunk of Lloyds’ net loss come from a charge of £3.2bn from the miss-selling of payment protection insurance to individuals, many of whom could never have claimed on the insurance. Many other High Street banks are also guilty of the same swindle. Even so, without this charge there would still have been a loss compared to a profit of £721mn in the previous year.

This renewed loss is a product of the banks own current business practise. Income fell 20% as it reduced its assets and curbed its lending. However, losses on its existing loans are increasing (to £2.6bn in the latest quarter) as borrowers continue to struggle and the economy stagnates. In effect this is a policy of hoarding its capital and hoping that something positive will turn up which will improve the existing loan book. However, this is also the policy of all the other banks too and total bank lending to non-financial businesses and individuals has fallen by £74bn in March from a year ago, which was itself £102bn lower than the previous year.

Worse, government policy now exacerbates this trend as it also cuts spending and investment and makes incredible forecasts that something (net exports?, business investment?) will turn up. As a result of capital hoarding and reduced government spending, nothing is turning up.

But Lloyds, in common with the other High Street banks has considerable capacity to increase its lending. SEB has previously shown that the banks are sitting on large capital assets which could be used to increase loans. The Financial Service Authority (FSA) has performed rigorous ‘stress tests’ on all the major banks. The stress test show what would happen to the banks’ balance sheets from a series of events which include a double-dip recession, a rise to 12.5% unemployment, a further 60% fall in house prices and default by one or more European government. Even if all of these events happened simultaneously the FSA estimates that Lloyds Bank would have Tier 1 capital equal to 9.2% of its assets to act as a cushion against losses, compared to 8.0% set as the international standard. Lloyds is actually the weakest of the banks on this measure.

Even so, this implies that Lloyds could increase its lending by 15% and still meet international safety limits for its capital under an extreme economic scenario. The current policy of hoarding capital and accumulating losses is having the opposite effect, the Tier 1 capital ratio fell by 0.2% in the quarter. The bank is becoming more, not less risky as a result .

The opposite approach would be one which benefitted Lloyds shareholders (including the state) and the whole economy. This would be driven by a sharp increase in productive lending, with a positive investment return. Here the role of government is decisive. It could instruct Lloyds to make a sure-fire investment in state-owned housing. The housing shortage in Britain is both chronic and acute, with the lowest number of homes built in 2010 since 1923. 1.8 million households are on council waiting lists and even those who could afford to buy a home cannot find the mortgage financing, where Lloyds has led the way in reducing its lending.

A state-led investment programme in housing, in conjunction with local authorities and financed by state-controlled banks, could produce affordable homes yielding 6% or 7% a year in rents, double the government’s cost of borrowing and so provide a net return to invest further, or to reduce the deficit. Ed Balls has previously called for £6bn investment in 100,000 new affordable homes. This could be done via the State-controlled banks without any increase in borrowing at all. It would also create 750,000 new jobs in a sector decimated by unemployment. 750,000 new jobs would also have a twofold benefit to public finances, much higher tax revenues from both income and consumption and much lower welfare payments.

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

2011-04-29T12:34:00.001+01:00

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.

British Economic Stagnation Caused By Tory Policies

2011-04-28T08:46:00.000+01:00

By Michael Burke

The preliminary estimate of the UK’s 1^st 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 1^st 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

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.

Poland Escapes Recession By Public Investment

2011-04-27T07:45:00.003+01:00

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

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.

http://beyondthetransition.blogspot.com/

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

2011-04-13T13:14:00.001+01:00

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

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.

The attack on the NHS

2011-04-07T09:36:00.003+01:00

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

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

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.

How the Tories sabotaged the economic upturn

2011-04-02T10:53:00.003+01:00

By Michael Burke

The latest economic data confirms the contraction in Britain’s 4^th 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 4^th 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 4^th quarter,£3.8bn of £6.2bn. For the whole period from the recession to date and including the 4^th 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 3^rd 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 4^th 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 4^th 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 3^rd 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.

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.

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.

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 1^st 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 4^th 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

Osborne’s Budget Is An Admission of Policy Failure

2011-03-26T00:36:00.001Z

Michael Burke

Adopting a ‘Budget for Growth’ now is really a tacit admission of failure by the Tory-led coalition. The economy was already growing when they took office. Because of that, two key indicators were falling- unemployment and the deficit.

Now, there is renewed economic weakness. The ‘independent’ Office for Budget Responsibility has continued to cut its forecasts for growth as a result of government policy. In its June 2010 forecasts the OBR projected 2.3% growth this year. That was cut to 2.2% in November and has now been cut again - to just 1.7%. The trend is down because of government economic policy- nothing else; the world economy is performing at least as strongly as the OBR forecast. Despite George Osborne’s claims in the Commons, future British economic growth has also been downgraded, from 2.8% in 2012 to 2.6% and now just 2.5%. This is exceptionally weak growth coming out of a severe recession.

Because of government spending cuts the economy was sent into a tail-spin in final quarter of 2010. This resumed contraction in the economy has inevitably also led to a reversal of the favourable trends in those two indicators. Unemployment is rising once more and the latest data on public finances shows that the year-long downtrend in the deficit has gone into reverse.

Unemployment & the Deficit

The OBR’s forecasts for unemployment have also risen, so unemployment in 2011 and 2012 was originally 8% and 7.6%. Now these have risen to 8.2% and 8.1%. Similarly, deficit forecasts have also risen under the impact of slower growth. Initially OBR had projected a public sector net borrowing requirement of 7.5% and 5.5% of GDP in the next Financial Year (FY) and in FY2011/12. Now these have risen to 7.9% and 6.2%.

This gives the lie to the central claim of government policy - that all these cuts are necessary to reduce the public sector deficit. Their policies have led to a renewed widening of the deficit.

Forecasts

None of this is to say that the OBR is a truly independent body, as it uses the Treasury economic model or to endorse its forecasts. In fact, its forecasting record is poor. First it underestimated the growth of the economy arising from the increase in government spending under Labour, and pushed up its growth forecast by 0.6% for 2010 in November. Then, repeating the same error, it underestimated the negative impact on growth arising the Tory-led coalition’s cuts, and slashed its estimate of 2010 growth back to 1.3%.

Even now, the OBR is on the optimistic side of growth projections. As David Blanchflower has pointed out the OECD forecasts lower growth than the OBR’s 1.7% and 2.5% in 2012, projection instead 1.5% an 2%, as does the CBI (1.8% and 2.3%) while the consensus among private forecasters is 1.8% and 2.1%. Yet the OBR’s forecasts would still make this the weakest recovery from recession since the 1930s.

Budget Measures

The Budget does nothing to alter the negative economic effects of government policy. Osborne described it as ‘fiscally neutral’, that is will have no net impact on the level of government spending or revenue on the economy . This means going ahead with plans for massive spending cuts and tax increases beginning in April that were announced last June and last October in the Budget and the Comprehensive Spending Review.

The downturn was caused by the government’s decision to withdraw £9.4bn from the economy in the financial year just about to end. But its plans to withdraw a further £41bn from the economy this year through spending cuts and tax increases on middle income earners and the poor are unchanged.

This is equivalent to 2.7% of GDP, and requires heroic assumptions about the willingness of the private sector to make up that shortfall. In fact, as the recent survey from the Institute for Chartered Accountants in England and Wales makes clear, the private sector is struggling under the weight of government cuts, with nearly half of firms (47%) reporting lay-offs as a result.

Taxation. The government is cutting corporation taxes and other taxes on businesses. It seems to believe low taxes necessarily attract businesses. That is incorrect, and can in fact store up serious imbalances in the economy. Iceland and Ireland have the lowest taxes in the OECD - and are not an advert for low taxes! Germany has the highest corporate tax rate in the EU – and Europe’s most successful economy. But what the tax cuts do show is that we aren’t all in this together - tax cuts for the wealthy while the poor and middle incomes are clobbered. It also means tax revenues are lowered.
Deregulation. The likelihood is we will only see the full economic picture as supplementary Budget docs are released, but lightening anti-money laundering rules is not a good start. Enterprise Zones were tried and failed under Mrs Thatcher- they simply tend to shift jobs from one location to another at significant cost to the Treasury.
Education The Chancellor trumpeted support for university technical colleges and apprenticeship schemes. But this is the government which has trebled higher education fees and abolished EMA which will be hugely damaging to the requirement to create a highly educated workforce.
Pensions. But the elderly will also suffer. Osborne announced his intention to continuously push the retirement age higher, meaning that some young people yet to enter the workforce may never achieve a decent retirement, especially as pension contributions are set to rise by 3% and there is the threat to implement the Hutton Review into pensions, meaning lower pensions, higher contributions and many pushed out of public sector schemes altogether.
Tax Avoidance. Osborne introduced measures he said would yield £1bn in closing tax loopholes and avoidance of a total of £14bn, yet the HMRC has previously said the total ‘tax gap’ of uncollected taxes was £42bn in the last FY . But even this miserably small effort is a tribute to the campaigning efforts of those in ukuncut and false economy who have done been highlighting Britain’s biggest tax dodgers and campaigning against them.
Fuel stabiliser. Taxes have been increased on oil & gas companies to pay for a cut in the fuel duty stabiliser and fuel duty. But the Tory-led coalition’s increase in VAT raised the price of fuel at the petrol pump by a far greater amount than these cuts, a 3p rise versus a 1p cut. This is a typical Tory con, well practised by Tory Mayor Boris Johnson in London where a freeze in the Council Tax is more than offset by soaring fares.
Raising the Personal Allowance. Raising the personal allowance before income tax paid to £8,015 per annum is billed as a measure to benefit the poor. But this is untrue. The very poorest, including students, the retired, the unemployed and many part-time workers don’t earn enough to get caught in the tax threshold. The real beneficiaries are much higher earners, who enjoy the full benefit of the allowance until they reach the higher earnings’ tax rate.
Green Investment Bank (GIB). It’s welcome that that the funding for the GIB is being increased to £3bn – after the widespread criticism that the original £1bn was pathetically small. But even the new amount is wholly inadequate to the pressing task of carbon-emission reduction and will not be lending to any projects before 2015. It is as if Osborne is determined that no government investment at all take place which might soften the blows he is inflicting on middle-income earners and the poor.

Alternative

The alternative should be clear, and it cannot be slower, shallower, more anguished cuts that many on the Labour front benches still favour. In fact the thankfully unimplemented March 2010 Budget authored by Alistair Darling and Peter Mandelson would have imposed £26bn in spending cuts and tax increases this year, compared to Osborne’s £41bn - somewhat shallower but nearly treble the fiscal tightening seen to date. If Labour is frightened by the reaction in the financial markets to a pro-growth economic policy, it shouldn’t be. As elsewhere, it is this government’s economically damaging policies which have led Moody’s ratings’ agency to question the sovereign credit rating.

The key to economic recovery remains government investment. Business investment fell by 18.8% in 2009 and accounts for three-quarters of the entire decline in GDP. By contrast, government investment rose by 14.1%, while current spending rising by 1%. It was this that laid the basis for the modest economic recovery in late 2009 through 2010, which led to falling unemployment and a falling deficit. This government has hit the brakes hard on investment in 2010 and now is in reverse, with a 12% fall in government investment planned for this year. Inevitably, this is already producing a renewed rise in unemployment and a renewed rise in the public sector deficit.

Low corporate taxes, deregulation and lower public spending are not even designed to restore economic growth and reduce the deficit. As the Wall Street Journal helpfully points out, their true purpose is the reduction in wages in both the private and public sectors, leading to higher profits . A policy based on restarting growth, reducing unemployment and actually reducing the deficit has to begin with the opposite policy to Osborne – that is it has to support investment, not cuts.

The Hutton Report Is An Attack On All Workers

2011-03-15T09:37:00.005Z

By Michael Burke

Millions of workers will have to work longer, make higher pensions contributions and receive lower pensions in retirement, if the recommendations of the Hutton Report are adopted. That the Tory-led coalition is able to turn to a Blairite Labour former minister to build a consensus for this attack is itself a scandal. But the scandal deepens once the report is examined.

It calls for pensions to be related to career-average earnings (dubbed CARE in the Report), rather than final salaries, for increased pension employees’ contributions, for an increase in the retirement age and lower pension entitlements. In addition, it is recommended that a large swathe of private sector workers (both ‘outsourced’ and contract workers) be removed from the Local Government Pension Scheme altogether, despite the fact that these entitlements, like the others have formed part of work contracts.

But not a single of one of these proposals is costed or specified in detailed terms. Instead, the bulk of the 215-page report is devoted to a lengthy argument on the supposed superiority of CARE-based pension over final salary ones. There is no justification for stating this without specifying the level of pensions and the contributions to support them – which is not done.

Instead, the thrust of the Report is aimed at boosting the case for severely reduced pensions, without ever making the case for this. Instead, talk of ‘unprecedented’ rises in longevity since World War II is designed to create an air of crisis. In fact, to take a comparison, life expectancy at birth rose by approximately 30 years in Britain between 1800 and 1840, and has risen by approximately 8 years since WWII. The improvement in longevity, in short, is clearing slowing, if not reaching a plateau but throughout the entire previous historical period pension entitlements were being established or were increasing and not being cut and falling.

This adoption of a scare tactic is fatally undermined by the second chart reproduced in the Hutton Report itself. It shows that the proportion of GDP devoted to public sector pension schemes will fall dramatically in coming years on current policy settings, that is without any of Hutton’s ‘reforms’. The chart is shown below.

Chart 1

The chart is from a commissioned report from the Government Actuary’s Department. This shows that the proportion of GDP devoted to public sector pensions will peak at just 1.9% in the current Financial Year (FY) 2010/11 (ending in April this year) and that it will fall to just 1.4% in FY 2059/60. The fan chart shows a distribution of outcomes by likelihood based on assumption about the growth in productivity, the public sector workforce and longevity. But even in the highest-case scenario, the pensions payout is just over 1.5%, much lower than currently, and in the lowest-case it is a little over 1.2% of GDP.

There is therefore no substance to the claim of a public sector pensions crisis. Assertions that there is a crisis are a fallacy, which are designed to create an atmosphere where cuts to pensions are acceptable.

The Cost of Pensions

Using the Hutton data, the outlay on public sector pensions amounted to under £27bn in the current FY. This is less than the payout on private sector pensions. In the boom years of FY 2007/08, that is before the recession, this private sector pensions payout was £35bn, which was lower than all the combined subsidies offered by the government towards private sector pension, which amounted to £37.6bn Therefore, the entire payout from private sector pensions in that year did not arise from the returns on investment, still less their efficient identification by pension fund managers. Instead, it came directly from taxpayers, with over five million of them in the public sector, and a greater number in the private sector with little or no pension provision themselves. It is the private, not the public sector pension provision which is crisis and in need of subsidy.

This is not an argument against the benefits received by pensioners in the private sector. But, noting the inherent inefficiency of private sector pensions, there is a clear case for bringing them into the public sector, to achieve a more efficient return.

The Hutton Report also shows the annual payout for public sector pensions. This is show in the chart below.

Chart 2

Hutton focuses on the unfairness of the pensions payout, which is undeniable. Higher earners receive a higher proportionate payout than the low-paid, although Hutton’s CARE option is not sure to redress that. But he neglects entirely a glaring point from the data, that a public sector worker has to be in retirement much longer than in public sector employment simply to get their own contributions back. For the higher paid this is 2.5 years longer in retirement and for the low paid this is 3 years in retirement for every year in work. As many public sector workers (teachers health workers, civil servants, social workers, etc.) can spend a working lifetime in public service, many will never even receive their contributions made. Even any moderate increase in contributions will ensure that this applies to the overwhelming majority of public sector workers- they are not a cost to the State, but are subsidising it.

Finally, the ‘cost’ of public sector pensions is a fraction of other items of spending, for example the military budget. This is currently 2.6% of GDP, but as leading economist have noted, this stated total is only a proportion of the hidden costs of British military spending. However, while British military spending produces only destruction and mayhem overseas, and fat bonanzas for corrupt arms’ manufacturers , spending on pensions produces economic well-being, increased demand and smoothed incomes over a lifetime, all of which contribute to the economy. These in turn provide sizeable returns to government as output, demand and profits are all boosted, which all in turn boost tax revenues and lower outlays in areas such as healthcare.

This economic and fiscal benefit of public sector pensions is entirely ignored by Hutton. But it should not be ignored by anyone who wants an economy to grow by placing the wellbeing of its citizens at its core.

Structural deficit denial?

2011-03-06T14:03:00.002Z

By George Irvin

The following article explains what is a ‘structural budget deficit’ and how this concept is misused by those attempting to justify Tory cuts.

* * *

In a recent Guardian piece, George Osborne accused Labour of a ‘reality deficit’ in attacking his deficit reduction plan, since they themselves proposed much the same.[1] Indeed, the notion that Britain must close the ‘structural’ budget gap by some combination of cuts in government spending and tax increases was accepted by Alistair Darling and not merely by Osborne. What’s wrong with Osborne’s argument?

A ‘structural’ deficit is defined as one not associated with recession. The view that the budget gap is mainly structural - as opposed to cyclical - has allowed Mr Osborne to argue that it was Labour’s spending, not the recession, which ‘caused’ the budget gap. In the words of Robert Chote, then Director of the Institute of Fiscal Studies (IFS) and main author of their 2009 Green Budget:

Labour entered the current crisis with one of the largest structural budget deficits in the industrial world and a bigger debt than most OECD countries, having done less to reduce debt and - in particular - borrowing than most since 1997.[2]

It should be added that the IFS, though often characterised in the media as one of Britain’s most influential independent think tanks, played a key role in promoting the notion that Britain’s structural deficit had grown far too large. The Office of Budget Responsibility (OBR), initially under Alan Budd but currently under Chote, has peddled the same argument.[3] But the most pessimistic view of all has come from the Treasury, which has argued that the structural deficit accounts for as much as two-thirds of the total deficit.[^4]

What is the difference between the so-called ‘cyclical’ and ‘structural’ components of the deficit? During a downswing in the business cycle, tax receipts fall and social spending on items such as unemployment benefit increases, thus giving rise to the so-called cyclical component of the deficit. This component is self-liquidating since the opposite happens during the business cycle upswing. So the budget should balance over the cycle as a whole unless -and this is the crux of the matter - there is a further ‘structural deficit’; ie, a gap between current receipts and revenue which remains even when the economy returns to growth with full employment.

At this point, the argument gets a bit more complicated. During a run-of-the-mill recession, the economy may turn down for a period but soon recovers its previous path---the so-called ‘potential output’ path. In a serious and prolonged downturn such as the one we are experiencing in Britain, part of the country’s productive capacity is lost forever, thus permanently shrinking the tax base and reducing the employment and output potential. When this happens, economists have serious difficulty predicting both by how much potential output has fallen, and how long it will take to get back to the (now lower) full-employment non-inflationary growth path, sometimes abbreviated as NAIRU. Moreover, the story is even more complicated if any external inflationary pressure exists since it is claimed the non accelerating rate of unemployment (NAIRU) may be higher than that which prevailed before the recession.

For example, the Treasury and the OBR differ in their respective forecasts of the ‘recovery’ rates of growth the UK will experience between now and 2015. And on the Monetary Policy Committee (MPC), Andrew Sentance has recently argued that firmer action must be taken to combat the inflationary danger, inter alia, because the gap between current output and potential output, or output gap, may be smaller than we think.[5]

Nevertheless, there are serious reasons for believing that the notions of structural deficit, output gap, and NAIRU are all quite shaky. First, NAIRU is notoriously difficult to quantify, particularly at present when inflation is largely imported and wage pressure on prices is negligible.

Secondly, how large is the output gap? If the pre-2008 trend-line for output is taken as the reference point, the gap measured as a share of GDP is currently 11%. But the Treasury now thinks that 6.5% of GDP has been permanently lost, leaving the (reduced) output gap at 4.5%. If Britain’s output, employment and tax base has shrunk that much, it helps explain why the Treasury believes the two-thirds of Britain’s deficit is now structural; ie, the reduction in full capacity output means that Britain can no longer ‘afford’ to spend as much as it could in ‘normal’ times.

Thirdly, the budget (or ‘government savings’) gap cannot be separated analytically speaking from the other national accounting savings identities. For simplicity, assume that the external current account remains constant - in reality, a tenable assumption. For a given level of national income, if the private sector decides to save more (say in order to rebuild its savings), the public sector must spend more by definition. In short, policy makers lack the autonomy to reduce public spending without having an impact on other variables - in particular, the level of national income (as the Irish and Greek cases clearly demonstrate).

Fourthly, the structural deficit argument depends on assuming a fixed structure of revenue. But the tax-revenue response to each percentage point rise in income is not carved in stone; it can be changed through tax reform. In 2010, a study undertaken for Compass indicated that a further £50bn per annum in tax (about 4% of GDP) could be raised merely by raising the tax paid by the top decile group whose overall percentage tax contribution is currently smaller than that of the bottom 10% of households.[6] Indeed, a Tobin tax of only 0.05% would bring in even more.[7]

Finally, the obvious rejoinder to the argument that the structural deficit is higher because potential output (and output gap) is now lower is to call for more public investment directed towards increasing the economy’s output potential. Such investment - say in modernising infrastructure - would have two effects. It would both help to ‘crowd in’ private investment while, through the multiplier effect, raising national income and employment and thus tax receipts.^[8]

Chris Dillow, a columnist for the Investors’ Chronicle, has summed up the case against the structural deficit concept admirably. As he argues, there are some countries with large structural deficits but low debt-to-GDP ratios in which the bond markets still have confidence, while there are others with much smaller structural deficits which the bond markets have turned against;

I fear, then, that the idea of a structural deficit serves a political rather than analytical function. It's a pseudo-scientific concept which serves to legitimate what is in fact a pure judgment call - that borrowing needs cutting. By all means, make this call. Just don't think that talk of a structural deficit helps enlighten us.[^9]

The next time you hear George Osborne reassert the overriding need to eliminate Britain’s structural deficit during this Parliament, ask yourself whether his call is anchored in sound economics or merely in right-wing shrink-the-state ideology.

References

[1] See http://www.guardian.co.uk/commentisfree/2011/feb/28/labour-reality-deficit-ed-balls

2 See http://www.ifs.org.uk/publications/4623

3 See http://socialisteconomicbulletin.blogspot.com/2010/06/fake-independence-of-office-for-budget.html

4 See http://shrvl.com/69SCW

5 See http://www.bankofengland.co.uk/publications/speeches/2011/speech476.pdf

6 See http://clients.squareeye.com/uploads/compass/documents/Compass%20cuts%20WEB.pdf

7 See http://www.guardian.co.uk/commentisfree/2011/mar/02/deficit-cuts-banks-robin-hood-tax?

8 I am grateful to Michael Burke for emphasising this argument.

⁹ See http://shrvl.com/ax6HQ; also http://www.levyinstitute.org/publications /?docid=1258

The high stakes in the battle for union rights in Wisconsin

2011-03-01T17:44:00.002Z

By Michael Burke

There are reports that protestors in Tahrir (Liberation) Square in Cairo are among the worldwide donors of pizza to the protestors in Wisconsin! The protestors have occupied the Capitol Building in an attempt to block passage of a union-busting bill adopted by the State’s Republicans. While the world has been enthralled by the Arab revolution, its militants have provided a practical demonstration of international solidarity.

The struggles in Egypt and Wisconsin are evidently not on the same plane, but they are linked. The global economic and financial crisis which began in 2007 has impacted all countries. In the colonial and semi-colonial world, the daily struggle for food has grown over into a wider uprising against unemployment, economic degradation, autocracy and national humiliation. In the ‘Western’ economies, the defensive struggle against the ‘austerity’ drive includes cuts in public spending, unemployment and falling standards of living. But in both cases it is in response to a determined effort to ensure that is workers and the poor who pay for the crisis- and that capital will restore its fortunes at the expense of labour.

Union-Busting

In Wisconsin Governor Walker is leading an assault on collective-bargaining by all State employees, with no negotiating rights on benefits and pay linked to the consumer price index- challengeable only by State-wide referendum. This is a classic tactic of pitting public workers against those in the private sector, who are themselves experiencing a sharp fall in living standards and watching their publicly-provided services being cut for everything from teachers, to firefighters, police and sanitation.

The US media had overwhelmingly supported the Governor, with the Wall Street Journal recycling the right-wing talkshow epithet ‘Mad Town’ to describe the protests against Walker’s ‘very modest proposals’. Some the media hostility has retreated, though, in the face of opinion polls showing 61% US public opinion approval for the protestors, who have at times numbered just under 100,000, with only the top income earners supporting the measures . Instead, the media has attempted to shift the terrain by portraying the local unions, who have little recent history of militancy, as ‘thwarting the democratic will’ by opposing the recently-elected State legislature. This is an entirely specious argument as it overlooks the small matter than no elected official stood on anything like a union-busting programme in the election.

The unions have already agreed pay and benefit cuts as well as job losses. The further assault by the governor has a different agenda, that of union-busting, and the consequent drop in living standards which would follow from it is what is at stake.

The type of wage reductions that are envisaged have already been achieved in the US private sector. Furthermore during the last significant economic crisis of US capitalism, Ronald Reagan broke the air-traffic controllers’ union PATCO (who had supported his election!). Infamously, the union leaders were arrested, jailed and fined, having been led manacled and bound for the TV news. The union was fined and then broken by decertification. A clear massage was sent to all other unions.

As a result of such methods, In the US private sector union density declined from 30% in the 1960s to 7% currently. Union militancy plummeted. Real weekly earnings fell from $300 in 1979 to $260 in 1996, despite rising economic activity and productivity. Former Federal Reserve Governor Alan Greenspan called the breaking of PATCO Reagan’s ‘most important domestic initiative’. ¹

But the US public sector has remained much more highly unionised - although at a level that is low by international standards. Just under 40% of US public sector workers are unionised. In some states, such as California and New York, that proportion is much higher. The aim is to break US unions in the public sector in order to drive down wages generally across the whole economy. In a familiar story, all this has nothing to do with reducing the US budget deficit- Wisconsin turned down Federal funds for investment in transport and broadband which would have generated new revenues. Already States such as Ohio and Indiana have signalled they will follow suit, and in a complete distortion of reality, a much larger group of Republican-led states describing themselves as the ‘right to work’ states, intend to introduce legislation even further curbing union power.

Not Just Wisconsin

Of course all this has implications not just for the US but in all the Western economies which take their policy lead from it - most especially Britain. While the Financial Times states it regrets the false claim that the union-busting is about saving money, it supports the offensive, likening the US assault on the the public sector unions to Murdoch’s attack on the print unions in the UK and expressing the hope that unions have had their day.

Before Murcoch’s assault on the print unions the Thatcher government’s introduction of severe anti-trade union laws, combined with the defeat of the miners’ strike of 1984-85, devastated trade union membership for a generation. As Chart 1 below shows, labour’s share of national income fell sharply as a result. The Tory-led government in Britain, led by the Tory Mayor of London, have already discussed curbing unions in the public sector and banning strikes. They, and all the reactionary forces in the world such as the tottering Arab regimes, which have faced sporadic strike protests to underpin the uprisings, would only take encouragement if the Wisconsin Governor is successful. Wisconsin may not at present be receiving the same attention as the truly historic events in the Arab countries but it deserves close attention by those who stand for progress left and total support by those who want to defend living standards everywhere.

Chart 1

Notes

1. Separately, Greenspan has argued that Reagan’s great global achievement was the overthrow of the Soviet Union, and the US boom that followed was a result of the capital outflow then from the whole of Eastern Europe. However, since that led to the US bubble, he has since modified this to suggest that the fall of the Berlin Wall led to the bubble

The government and Bank of England set a course to undermine recovery

2011-02-26T08:07:00.002Z

By Michael Burke

This week it was revealed from the minutes of the meetings of the Bank of England’s (BoE) Monetary Policy Committee (MPC) that there is a growing faction in favour of an immediate rise in interest rates. Two days later the revised UK GDP data for the 4^th quarter of 2010 was released showing that the economic contraction had in fact been even sharper than previously estimated – a fall of 0.6% in the quarter. The official statisticians now concede that, while heavy snow exaggerated the decline, the economy would have contracted even without it by falling 0.1%.

The pattern of MPC voting had already shown that two members at the previous meeting had voted for a 0.25% rate rise. This grouping has now hardened and expanded with to one member voting for an immediate rate rise of 0.5% and two others supporting a 0.25% hike. This faction thoroughly misunderstands both the current trends in the British economy as well as having a flawed theoretical framework.

All MPC members will argue that their role is to anticipate trends in the economy and look beyond the immediate data. But for the majority, the MPC members who are drawn from the Bank and the two other proponents of higher rates, this confidence in their own approach seems misplaced.

Short term economic forecasting is always fraught with difficulties. Because economic data is always released after the fact, and policymaking takes place to affect future activity, formulating the appropriate policy has been likened to ‘driving a car while staring in the rear-view mirror’. There is therefore a huge premium placed on any evidence of future activity.

The chart below is compiled from the BoE’s Agent’s report, which compiles survey evidence of the outlook for economy from 700 businesses across all the regions. This report is relied upon by the Bank and others as a forward-looking series of surveys which looks beyond the published economic data.

Figure 1

Gavyn Davies, in his blog in the Financial Times, is among those who relied on this evidence when arguing that the initial GDP estimate was ‘too bad to be true’ and despite the downward revision to GDP he continues to argue that there must be a sharp rebound in activity.

The trouble with relying on these surveys is that, although they purport to be forward-looking data, they are actually lagging indicators – and based on business sentiment, which is hardly immune from government and media efforts to talk up activity. Take a look at the chart. GDP began to contract in early 2008 - before any of the surveys turned negative. And the only one that came close to matching the trough in GDP was retail sales. The evidence therefore shows these surveys are lagging, not leading indicators.
Take another look at the chart. Retail sales have been trending down since mid-2010 and the most up-to-date survey from the CBI (which is not shown in the chart) shows sales plummeting in February. To get back to flat, or zero growth for the latest two quarters combined, GDP in the 1^st quarter of 2011 will have to rise by 0.6%. To get to something like trend growth over the 2 quarters, which is usually held to be 2.25%, GDP in the 1^st quarter of 2011 will have to rise by 1.7% - an extremely unlikely development.

The reason this error can be made in interpretation of the data is probably that it conforms to a preconceived notion - the misplaced idea that growth will rebound sharply, which is itself based on an incorrect theoretical framework. Linked to this is the notion of an ‘Expansionary Fiscal Contraction’ (EFC) – the idea that that an economy can expand even while government spending its cut severely. However, the IMF has examined more than 30 episodes of EFC identified by the original authors of this concept, and found only two where the economy did expand - Denmark from 1983 and Ireland from 1987. ¹

GDP contraction

After the worst recession since the 1930s, the current recovery is also set to be the weakest since that time. This too runs counter to the prevailing orthodoxy which, until relatively recently, held that the sharper the recession the more rapid the rebound.

There is likely to be positive growth recorded in the 1^st quarter of 2011, if only because some activity was held over from the 4^th quarter of last year, especially in sectors such as construction. However, as already noted, merely to achieve zero growth over the two-quarter period would require a rise of 0.6% in 1^st quarter 2011 GDP, while anything like trend growth would require 1.7% growth in the quarter. This is not unprecedented, but in the current environment of reductions in government spending, and flat income growth, it seems highly unlikely.

The greater detail provided by the latest data release shows that the renewed downturn in investment (gross fixed capital formation) accounted for two-thirds of the 0.6% decline in GDP. Precise information will await the final data release, but business investment fell once more in the 4^th quarter and the private sector’s contribution to construction investment is also likely to have been negative. In the data up to the 3^rd quarter of 2010, the private sector’s investment strike was responsible for three-quarters of the recession.

From the perspective of businesses, this is a rational response to the government’s own announced, but as yet unimplemented, programme of spending cuts and tax increases for average incomes and the poor. These cuts will only begin to bite in the 1^st quarter of this year. But the fanfare with which they have been announced means that any private firm dependent on contracts for schools rebuilding, local authority spending, hospital upgrades or in any area of central or local government spending could only expect lower orders. Lay-offs, short-time working and cutbacks in investment are inevitable.

Renewed economic weakness and rising unemployment this year are a function of Tory-led government policy. It seems as if the MPC is set on a course to hike interest rates later this year – and will pile on the misery.

Notes

1. Even considering these two cases in Ireland, the IMF ignores the extremely large subventions from the European Union at that time, an external source of investment which boosted growth dramatically. In the case of Denmark, the present author is not in a position to assess the underlying dynamics, but it should be noted that the Danish fiscal contraction was minuscule compared to current government policy in this county and elsewhere, less than 0.5% of GDP.

Unemployment in Tory recessions

2011-02-17T11:10:00.002Z

By Michael Burke

Unemployment has risen by 44,000 in the latest 3-month period to December and employment has fallen by 68,000. These represent a renewed phase in the recent deterioration in employment, which had been on a very moderate improving trend.

The jobless total rose substantially during the recession. According to the Office for National Statistics (ONS), total employment fell by 600,000 during the six quarters of recession , and continued to fall during the recovery (although ONS does not take into account net job losses in the run-up to the recession) . The unemployment total also continued to rise through the recession and did not peak until it reached 2.506 million in February 2010. Between February and August last year unemployment fell to 2.448 million, a small improvement of 58,000 reflecting the modest recovery that had begun in Q4 2009. However, unemployment has contracted once more and unemployment has since risen back to 2.492 million in the latest data. The recent trends in unemployment are shown in Chart 1 below.

Chart 1

Recessions Compared

In the current recession employment continued to fall until February 2010 so that the total decline in jobs was 763,000 as a result of the recession - 600,000 lost while GDP contracted to September 2009 and another 163,000 in subsequent months. In the two previous recessions under Thatcher and Major, the slump in jobs was much greater even though the fall in output was not nearly so great.

In the table below we show the impact on jobs arising from the last 3 recessions.

Table 1. Impact of Recessions on Changes in Employment

The first point to note is that the total loss of jobs in this slump is much lower than under the two Tory governments - despite the loss in output being almost equivalent to the prior two recessions combined. Second, the change in employment post-recession has been unusually positive in the current period.

Changes in employment and unemployment tend to lag behind changes in output as firms do not immediately begin firing when output falls, and are slow to rehire when it begins to rise. The improvement in employment was in response to the improvement in the economy from the end of 2009 onwards and the assumption that it would continue limiting the destruction of jobs. Third, the renewed downturn in employment represents a break in that trend. In effect, the impact of policy is being brought into line with the previous recessions under Tory governments.

The policy difference in the different recessions is marked. The decline in employment in the latest recession was more muted than in the two preceding recessions. In addition, the resumption of net job creation was much earlier than in the two preceding recessions. The net job losses arising from the recession were therefore much lower, less than 400,000 compared to over 1.6 million in both prior cases. While the misery and waste caused by those 400,000 net job losses could have been avoided with a much bolder policy, there is a qualitative difference in outcomes for jobs between the policies adopted in the latest recession and those adopted by the two previous Tory governments.

Policy Aims

The crucial difference lies in policy, and its aims. In both the 1980s and 1990s, under different guises of ‘monetarism’ and ‘bearing down on inflation’, Tory governments actively pursued a policy of increasing the rate of unemployment. On this occasion the purported reason is deficit-reduction. But the content is the same. Cuts to public spending were combined with changes to the tax regime which favoured business and high income earners. This reduced aggregate demand via driving unemployment higher and average wages lower thereby reducing consumption demand.

In all three cases the private sector had become a net saver via reducing investment. The response of the Thatcher and Major governments was not to increase its own investment, but to parallel the private sector’s investment strike. The aim of this, combined with privatisation of existing industries or state functions, was to increase the output of the private sector even with its investment rate remaining low. The effect of these measures combined to increase the rate of profit. In Marxist terms, this is the capitalist dream, to be able to ‘sell without buying’, that is to increase output without first investing.

The tensions inside the last Labour government arose because many, probably a majority of the Cabinet, led by Peter Mandelson and including Alistair Darling, wanted to emulate this approach. Their parting shot was the March 2010 Budget, described by its official author the Chancellor as ‘worse than Thatcher’. But the fact is that this budget was never implemented by New Labour. Instead, the prior Budget in 2009 increased government spending and investment. It was this that underpinned the recovery and the unusual improvement in employment.

The improvement in employment, like the improvement in the economy (and the reduction in the public sector deficit since) all flow from that policy decision. Had the measures adopted been bolder, their effects on employment, growth and the deficit would have been that much greater. However timidly implemented, this policy does begin to meet the objective needs of the economy as a whole. But it does not meet the imperative to increase profits.

Threat of Higher Rates

It is perhaps a coincidence that the first increases in interest rates following the 1980s and 1990s recession were both precisely 15 quarters after the end of the recession (in July 1984 and September 1994 respectively). The current recovery is only 5 quarters in duration, and yet both Cameron and Osborne have been campaigning for higher rates , even if the contraction in Q4 GDP has made those calls more muted. The campaign is eagerly echoed by City pundits. This is not because this recovery is stronger than its predecessors- it is significantly weaker .

The stated objective of the higher rates policy is to halt the rise in inflation. The latest data show that on the broad Retail Prices Index (RPI) measure inflation is 5.1%. But the effects of increases in indirect taxation have been to raise the price level by 1.6%. The Bank of England Governor Mervyn King, writing to the Chancellor to explain the overshoot refers primarily to the global rise in commodities’ prices as the driver of inflation. It is possible that higher interest rates could curb the growth of imported price inflation by raising the value of Sterling. But the appreciation of the currency could only be short-lived if, as seems likely, a tighter monetary policy acted to dampen growth even further. The official response to higher prices should be a series of administrative measures to lower them, including a reversal of the decision to hike VAT but also in the regulation of utility and transport prices.

At the time of writing, financial market expectations for higher short-term interest rates are approximately that the base rate will be 1.5% by year-end, representing four interest rate hikes of 0.25% each. These expectations have themselves been gyrating wildly, especially as King’s letter to Osborne seemed to imply that hitting the inflation target over the medium-term would require adopting the financial market’s aggressive assumptions on interest rate hikes.

This comes close to outsourcing the normal setting of interest rates from the unelected technocrats of the Monetary Policy Committee directly to the interests of the financial markets themselves, close to the system adopted by the Swiss central bank. This would be a thoroughly regressive step, codifying the City’s dominance over key aspects of policymaking in its own interests – and one not even contemplated by Thatcher or Major.

But it would complement the general thrust of policy, which is an increasingly vicious project to drive down the living standards of the overwhelming majority of society in order to boost the profits of capital, and in Britain its dominant section, the banks.