Saturday, 26 June 2010

Twice As Bad As Thatcher

by Michael Burke

The Budget set out by the new ConDem government will indeed be worse than the Thatcherism which inspired it. It has been widely criticised in main media outlets for its unfairness, even in the Daily Telegraph. Nick Clegg squirmed beside David Cameron as he admitted to a woman firefighter in a TV audience that the freezes to pay and benefits were real cuts.

The openly class warfare character of the Budget is the cause of establishment concern. Cutting public sector pay and jobs, cutting services as well as disability and housing benefits, while hiking VAT are a direct assault on the incomes and living standards of those on average incomes, workers and the poor. Doing this simultaneously with cutting the progressive Council tax, reducing employer’s National Insurance, raising the threshold to £5 million for Capital Gains Tax and reducing the corporate tax rate towards 24% demonstrates who are the beneficiaries - businesses, high-earners and the wealthy.

This series of tax cuts also belies the idea that the paramount objective is to reduce the deficit. By FY 2014/15 these cuts, a transfer of wealth to business and the rich, will amount to £10.1bn annually. By contrast the hike in VAT alone will yield £13.5bn. By that time the reduction to benefits will amount £30bn per annum (all data from the Budget 2010 Redbook unless otherwise stated). Public sector pay will increase below inflation for those under £21,000 a year and be frozen completely for those above, a cut mounting to £3.3bn annually. More is threatened from a review by John Hutton, Blairite former minister for work and pensions.

This is a reordering of society and is neither intended to nor is likely to achieve deficit-reduction.

Attacks Compared


The comparison with the experience of Thatcherism is a useful one. After 10 years in office the first Thatcherites had reduced total managed expenditure (TME) by 5.9% of GDP, or by £83bn in contemporary prices. The coalition’s aim is to reduce TME by 7.7% of GDP in 6 years, a real cut of £108bn. Even this understates the case since there are already cuts being enacted in this year of £8.9bn, for a total of £117bn.

But there is an important point glossed over in the official presentation of the Budget, which is that TME includes debt interest payments, which are clearly not government spending that provides services or creates jobs. These interest payments rise sharply over that 6-year period, by £36.6bn, so that the actual cuts to services, benefits, pay and jobs will be £145bn, or 10.3% of GDP. By contrast, Thatcher’s annual debt interest payments fell, by today’s equivalent of £17bn, which we will examine below. So her real cuts to government spending therefore amounted to 4.7% of GDP or £66bn in current terms over 10 years. Osborne, Cameron, Clegg and Cable are planning cuts of £145bn or 10.3% of GDP over 6 years. This is more than twice the real cuts of the first Thacherites, and will feel even worse. No wonder the Financial Times believes the Budget is ‘risky’.

Further Lessons of Thatcherism


Tax cuts for business and the rich destroy any claim that the overriding priority is deficit-reduction. But history also demonstrates that cutting spending will not reduce the deficit. SEB has previously shown that Thatcher inherited a deficit of £8.75bn and produced average deficits of £9.00bn over the next 5 years. Similarly, the total debt level rose from £98bn to £157bn. The only reason that interest payments were finally lowered, was a result of the recovery later in the 1980s. Meanwhile, the deterioration in government finances during the first five years would have been much worse without the surge in government revenues from North Sea oil, which was an unforeseen bonanza.

In the chart below government revenues from North Sea oil are shown as a proportion of GDP, with Treasury forecasts for the next five years. An underlying measure of the government budget balance is also shown, which is the budget balance with the effects of the oil revenues removed. This underlying deficit initially rose under Thatcher, from 2.6% of GDP in the year before she took office to 2.8% and then 3.0% of GDP in the following 2 years. Surpluses were recorded in FYs 1982-84 before falling back into deficit once more. Throughout the entire period the economy generally and government finances in particular benefited from North Sea oil revenues, which were equivalent to 3.2% of GDP in the Financial Year (FY) 1984/85. This will not be repeated in this period.

Figure 1


10 06 26 SEB Budgeet Chart 1



Effects of Government Spending


Since government spending is both a component of GDP and a part forms a component of gross fixed capital formation (investment) in the national accounts, it is easy to see how reducing it depresses activity directly. But it also depresses private sector activity indirectly. This is because the output of all sectors of the economy requires the inputs of other sectors. Government output relies on the inputs of the private sector.

The table below is taken from the official analysis of the Input-Output tables from the ONS . The columns show the total output for each of the broad government sectors shown. These are always 1 because the purpose of the table is to show the relative impact on other sectors arising from 1 unit of output. So, £1bn of government output in education, healthcare and social work requires an input of £6mn in agriculture, £5mn in mining, £120mn in manufacturing and so on. It also requires £486mn in inputs from private firms operating in the same sector. The total demand of those other outputs and government output combined is £1.854bn, and 1.854 is the multiplier attached to this sector.

Table 1


10 06 26 SEB Budgeet Table 1



Osborne & co. hope that the private sector will fill the gap left by the decline of public expenditure by increasing its own output and investment. The scale of the government and their own impact is one factor which makes this very unlikely. With an average multiplier across the public sector just below 1.8, his cuts of £145bn will reduce demand by £260bn, over 18% of GDP. The total contribution to GDP from all production, construction and service sectors of the economy has amounted to just 3.5% over the last five years.

The policy of the Thatcherites, old and new, is to ‘crowd in’ private sector activity. Access to service is determined by profit-maximisation and is then a function of income or wealth and consequently both the scope of services declines and their prices rise. This is illustrated by the fact that the NHS is a universal system at a cost of 8.3% of GDP, whereas 45million Americans do not have health care coverage and yet it consumes 16.3% of GDP. But for the Thatcherites an important goal for themselves would be achieved. Profit can be extracted from an area which had previously been in the public sector.

The existence of these multipliers also explains why cuts do not narrow the deficit, as Thatcher showed and the Dublin government amongst others is currently proving . While increased government spending in education, health and social work leads to increased total demand 1.854 times greater than the initial output, decreased government spending leads to a reduction in total demand by the same multiple. And it is this lower level of output which both depresses tax revenues and pushes up welfare-related spending as unemployment and impoverishment rise. As SEB has pointed out previously , the long-standing Treasury estimates is that of every rise/fall in output 75% is registered as a change in government finances, 50% tax revenues and 25% change in government spending (Treasury, Public Finances and the Cycle, Treasury Economic Working Paper No.5, November 2008 ).

So, a £1bn fall in output leads to a £750mn deterioration in government finances. But we have already seen that, without an increase in private sector investment and output, a cut in government spending of £1bn will lead to a fall of £1.8bn in total demand. The damage to government finances arising from the total fall in demand is 75% of£1.8bn. This is £1.35bn. This damage is greater than the initial cut of £1bn and therefore widens the deficit.

The same process works in reverse. A £1bn investment by government leads to £1.8bn rise in total demand, and a £1.35bn improvement in government finances follows. This is a net return of £350mn which could be used for further investment or to erode the deficit.

Why Do They Do It?


The argument that government investment can restore both economic activity and narrow the deficit will not be unfamiliar to readers of SEB, and it is becoming a little less rare in the wider economic debate. But the question is posed, why would policymakers set out to damage the economy in this way? Further, why would a government that clearly represents the interests of business and the rich, more accurately the capitalist class as a whole, be willing to sacrifice large chunks of that class, many of whom will be bankrupted by these extraordinarily large cuts?

There isn’t space here to develop a rounded response to those questions. But the chart below illustrates the main theme. It is taken from the Bank of England’s latest Quarterly Bulletin and shows labour’s share of national income over time.

Chart 2


10 06 26 Chart 2

Labour’s share rises during recessions. This is not because pay or jobs increase- the opposite is the case. It is, as the Bank of England puts it, because the fall in labour income is less rapid than the fall in profits’ share of national income arising from the fall in output. It is the overriding aim of this government, even more than its predecessors, to ensure this trend is discontinued. It does this not by promoting growth as there is no guarantee that the profits’ share of national income will rise. Instead, it sets about an assault on the wages and social wages of all workers, and cuts taxes for businesses. By this means it can aid the resumption of the long-run trend rise in the profit share. This is what the new chief of the Office of Budget Responsibility and seasoned Thatcherite Alan Budd described as engineering a ‘crisis of capitalism which re-recreated a reserve army of labour and has allowed the capitalists to make high profits ever since’

Osborne said in his Budget Statement that reducing corporate tax rates to 24% would advertise that Britain was ‘Open for Business’. The advert is a Primark one. Dublin and Reykjavik have the two lowest corporate tax rates in the OECD, while the weighted average is 35%. It advertises that Britain will be a low-tax, low-wage, low-growth, low-skill and low-investment economy, and is a part of programme that will deter significant large-scale investment. As one commentator at the time described 1980s Thatcherism ‘Welcome to Slumsville’.

The duty to oppose such a policy both on the grounds of social justice and economic rationality is self-evident.

Tuesday, 15 June 2010

Fake independence of the 'Office for Budget Responsibility'

by Michael Burke

The appointment of Professor Alan Budd to head the new Office for Budget Responsibility (OBR) is something of an old-boys’ reunion. Both he and David Cameron were advising Norman Lamont and at his side when Sterling was bundled out of the European Exchange Rate Mechanism in 1992. This is a sharp reminder of both the Thatcherite credentials of the new government, as well as its lack of economic competence.

As has been pointed out elsewhere, the idea that this is a politically independent body is belied by the fact that Budd has been performing this role for over a year for the Conservative Party and helped to formulate its attacks on the Labour government. Now he and his officials will be paid for by taxpayers, rather than by the Conservative party, where the expense properly lies. The outcome had been predetermined, with David Cameron having previously announced that the fiscal situation is much worse than the previous government admitted.

'Independent' Forecasts


The OBR’s remit is supposedly to formulate an ‘independent’ forecast for growth and for government finances. However, it will simply be using the Treasury’s existing econometric model of the British economy. This is already the case for Chancellors, who then decide which estimate of growth to use within a range produced by the Treasury. Given its political formation it is wholly unsurprising that Budd’s team has arrived at significantly lower growth forecasts than those contained in the last Budget. GDP growth is expected now to be just 1.3% this year, and an average 2.7% over the 4 following years, barely deviating from that central point. Clearly, the ConDem coalition hopes that all future governments will be similarly hamstrung in formulating taxation and spending policy by a Thatcherite body posing as an independent authority.

Statistically, the OBR projection is one of the least likely scenarios, given both the volatility of GDP growth and the existence of the business cycle. It is characteristic of the failings of the Treasury model itself, which often correctly summarises the relationship between different sectors of the economy – but is incapable of anticipating their dynamic. This is highlighted in the chart below, taken from the Institute for Fiscal Studies. The broken green lines are the Treasury’s forecasts of public borrowing as a percentage of GDP, while the uninterrupted black line is the actual level of that borrowing.

Chart 1


10 06 15 OBR Chart 1


Budd was chief economic adviser to the Treasury in the period 1991-97. As the chart shows, with few exceptions the entire period was characterised by errors of understanding of the path of government borrowing. This is not about the failings of one man, although in others it might induce a greater degree of humility regarding forecasting ability than is currently on display. Instead, the failings of that period were repeatedly made before and subsequently. In effect, the Treasury model which is constantly updated and is being used now by the OBR, fails to capture the cyclical movements in the economy almost entirely. In effect, it is dominated by the idea that economies always return to ‘equilibrium’ in the short-term because of the ingenious workings of the market. So, the green lines assume equilibrium or a return to equilibrium, when much larger, long-term economic trends are at work.

Structural Deficits

The one exception orthodox economics makes to this article of faith in equilibrium is when it repeatedly discovers a ‘structural deficit’ in government finances. This is supposed to be an estimate of the underlying deficit, once the immediate effects of the deficit are removed. It is also known in the jargon as the ‘cyclically-adjusted budget balance’, which simply means the budget balance once the effects of the business cycle are discounted. For some reason in dominant economic thinking, the structural deficit alone is not corrected by the alchemy of the markets, but always requires swingeing cuts in government spending.

Budd & Co. have 'discovered' exceptionally high levels for the structural deficits, even while their own forecasts for the both the total deficit and borrowing are lower than in Alistair Darling’s last Budget. These lower forecasts arise because taxes have improved owing to the modest rebound in economic activity to date, partly spurred on by increased government spending in the 2009 Budget, as SEB has repeatedly highlighted. (It is also shameful that Darling deliberately understated this improvement by £7bn, which could have been used to stimulate the economy further and which might have changed the election outcome to Labour’s benefit ).

The table below is taken from the OBR’s Pre-Budget Report. The key data are contained in the bottom two rows, which show their estimates of the cyclically adjusted deficit and borrowing. The latter is significantly higher because of accumulating debt interest payments.

Table 1

10 06 15 OBR Table 1


It is this ‘structural deficit’ which George Osborne states it is his priority to tackle and which the OBR says is 5.3% of GDP this year, or £75bn. This is greater than the £60bn level of cuts already suggested- even taking into account some of the cuts already planned.

Rewriting the Past, Not Forecasting the Future


But the structural deficit is a fiction. We have already seen that it purports to be an objective assessment of an underlying deficit, in effect a measure of the gap between government spending and revenues with the effects of the business cycle removed. But no authoritative international or domestic body argued that Britain had a significant structural deficit prior to the Great Recession, although they all argue it now. But if it were truly structural it would surely have been visible before the recession, and not simply a function of it.

In the chart below we show two different sets of estimates and forecasts from the EU Commission for the ‘cyclically-adjusted budget balance’ as a proportion of GDP, as well as GDP itself. The EU Commission is a body whose economic outlook is dominated by neo-liberalism, aka Thatcherism. But, unlike some other neo-liberal supranational institutions, it is bold enough to publish its own forecasts and estimates in a regular cross-country format, which makes large-scale and timely comparisons relatively easy.

Chart 2


10 06 15 OBR Chart 2


There are two key points to note. The first is that, even though it is claimed that the estimates of the deficit are structural in nature, removing the effects of the business cycle, they are in fact closely correlated to the business cycle itself. The disastrous widening of the ‘structural deficit’ takes place in the midst of the recession and its aftermath. This is true of all countries surveyed by the EU, and insofar as is known, for all international bodies and their forecasts or estimates.

The second crucial fact is that there is some rewriting of history taking place. In the 2006 estimates and forecasts (the shorter, red line) the 2005 structural deficit was estimated to be 3.2% of GDP, yet by the time of the 2010 estimates this has inexplicably risen to 4.0% of GDP. The same applies to 2006, which rises from 2.7% of GDP in 2006 to 3.5% of GDP in 2010, and so on. In scientific terms, this is known ‘fitting’ the data to the theory. It is dishonest. It is not because new evidence has come to light about tax revenues or spending in 2005, but in order to build a case for a bloated ‘structural deficit’ in 2010 and 2011, and of course a policy of cuts to public spending to rectify it.

For Britain’s neo-liberals, the Thatcherites who are back in charge, it is easy to understand why a falsification of history is important. It simultaneously absolves them of their role in previous economic debacles and sets up the ideological mechanisms for a repeat performance. This is a farcical repetition of economic policymaking- but with dire consequences.

As the Financial Times's economics has suggested, identifying either the ‘structural deficit’, or estimating the impact of changes to government spending are intensely political acts, and can also be an iterative process, one that is returned to time and again because, ‘ if cutting public spending reduces growth, which in turn cuts tax revenues, borrowing still falls short of the chancellor’s fiscal goals and this requires further cuts in public spending etc.’

Wednesday, 9 June 2010

An Ugly Punch & Judy Show, Britain’s New Fiscal Policy

by Michael Burke

George Osborne’s latest announcement on the need to reduce the public sector deficit included suggestions that departmental budgets would be cut by up to 20% by measures including abolishing planned increases in free school meals’ provision as well as cuts to pensions and welfare payments. But even this announcement was almost overshadowed by a report from the Fitch credit ratings’ agency that called for a ‘more ambitious deficit-reduction plan’ to ‘underpin market confidence’.

This is widely taken to mean that the ConDem coalition should accelerate its planned spending cuts. It was seized on by Osborne in support of his own extreme measures.

This is an ugly Punch & Judy show now familiar to the ordinary population, workers and the poor in Hungary, Ireland, Germany, Greece, Spain, Portugal and elsewhere. Either an international agency or the national government will declare there is a crisis of government finances and offer no solution to it. This cry of imminent fiscal disaster is then taken up in the financial markets, the press and other media and is echoed by the ratings’ agencies. At that point either the international body or the national government will announce that the markets/ratings agencies are demanding spending cuts. It is a show where the population are repeatedly clubbed.

The ratings’ agencies themselves play a further role in this - accepting the governments’ unwillingness either to stimulate growth through investment or to use tax increases rather than spending cuts.

But in the latest British case this pantomime is even more transparent than usual. As can be seen in Figure 1 below Fitch outlines its projected paths for the budget deficit depending on a 1% difference in annual GDP growth. Fitch chooses to project the deficit based on the possibility of consistently lower 1% growth over a 4-year period. But the same process would work in reverse. A 1% higher growth would reduce the projections for the deficit by same amount. In this way, at the end of the period Financial Year (FY) 2014/2015 the deficit would be just over 2% of GDP.

Figure 1

2010 06 09 Figure 1

And this awful pantomime is continuing - with the ratings’ agencies, Fitch included, now citing the austerity measures taken in countries such as Greece, Spain and Portugal as a reason to downgrade their debt, on the logical grounds that lower tax revenues will follow and therefore meeting interest payments will become more onerous. Yet the downgrades themselves undermine government bond markets further and so the clubbing of the population is renewed.

Investment Leads To Growth

Faced with this farce it is vital to realise that government spending is both a component of GDP and a catalyst for private sector activity. In Britain the cuts programme is already having a detrimental impact on growth before they have barely begun. Building contractors are laying off workers now because of the cut in the schools' building programme. And the British Retail Consortium warns of the damage done to shops sales if the much-touted and wholly regressive rise in VAT takes place.

These are practical demonstrations of the fact that these cuts will not produce a balanced budget as every cut reduces growth in both the public and private sectors and the taxes that flow from it. By contrast, for example, a small increase in higher education spending increases the employment rate for graduates - providing government with a huge return in the form of both higher income tax revenues and lower welfare payments.

Learning Lessons

Cameron’s recent invitation to Thatcher to tea at No.10 may have been a nod to the right wing of his party, but he should have factually quizzed here on how her deficit-reduction efforts turned out. Just like Thatcher, Cameron-Clegg will find that their cuts lead to a widening deficit.

In the Financial Year (FY) 1978/79 before Thatcher took office, and itself a year of economic turmoil, public borrowing was £8.75bn. In the next five years it was successively £8.6bn, £11.5bn, £6.0bn, £8.5bn and £10.5bn - an average £9.0bn. And that was with a bonanza from North Sea oil, which will not recur this time. Simultaneously public sector net debt rose from £98bn to £157bn over the same five year period.

The present economic disaster in Ireland

Prior to the election, George Osborne repeatedly argued that Britain should follow the example of the fellow Thatcherites in the Dublin government and slash spending. Fiscal tightening on the scale of Ireland in 2009 would be equivalent, in comparative GDP terms, to £90bn in Britain. But the Tories admiration for Ireland’s 'slash and burn' has become an embarrassment as the latter now has a 14% unemployment rate despite the return of mass emigration, and the budget deficit has doubled to the highest in the European Union, at 14.3% of GDP, despite Ireland having started the recession with a budget surplus

The fake parallel to Canada

So the Tory hunt has been on for an example of successful fiscal tightening. With no contemporary European success stories to boast of, and no well-known ones from the 1930s either, the Chancellor now promotes Canada’s fiscal tightening of the early 1990s as his model. The very obscurity of the example, and the fact that it does not relate to any of the really large economies such as the US, Germany, Japan, France, the UK etc. is itself a testimony to its rarity. It is true that in this arbitrarily selected case fiscal tightening did lead, eventually, to a lower deficit - but due to factors that are completely absent in Britain.

First, simultaneously with Canada's tightening, the US was undergoing a huge boom - and the US accounts for 85% of Canada’s trade. Second Canada embarked on encouraging large-scale immigration - which particularly attracted wealthy Hong Kong Chinese. No such windfall, or policy is likely for Britain this time around.

Even then the Canadian case was accompanied by a 15% fall in the value of the Canadian Dollar and growth averaged just 1.7% over 5 years - and even this was entirely due to net exports as the domestic economy was in permanent recession. Because of this unemployment averaged 10.4% and government debt actually increased from 50% of GDP to 70% of GDP!

The lessons of the real world show it is impossible to see cuts as a way to prosperity and to lower debt. A genuine economic recovery is a pre-requisite for deficit-reduction. Government investment is required to spur that recovery.

Friday, 4 June 2010

Parasite threatens host, the impact of the European bank bail-out

by Michael Burke

The stated purpose of the enormous €750bn bailout package announced by the European Union was to stabilise financial markets and halt the slide of all Euro-denominated financial assets including the currency. Although the initial reaction was to boost financial markets both in Europe and beyond, the relief was short-lived. Geek long-term interest rates are climbing back up to 8 per cent, leading European stock markets have lost between 5 and 6 per cent of their value since the announcement was made and the Euro fell from over 1.28 versus the US Dollar to under 1.22 in just three weeks.

This negative reaction is a repeat of the response to the earlier ‘rescue package’ of €120bn, which then prompted the much larger €750bn announcement. Ostensibly, the bailout is supposed to rescue Greece. Yet there is not a single cent in the package which will be aimed at reviving the Greek or any other economy. Instead, the bail-out is to provide a guarantee against a debt default by Greece and other European crisis-hit economies. It is therefore entirely a bail-out for holders of Greek government debt. According to the Bank for International Settlements (BIS), at the end of 2009 total foreign claims on all Greek entities amounted to US$217bn, of which US$193bn was held by European banks. The major European banks are the holders of Greek debt and the recipients of its interest payments. So the bail-out is to their benefit, ensuring the continuity of interest payments and capital repayment to them. Since taxpayers’ funds are being used to bailout these banks holding Greek debt, the €750bn is in effect an international version of the national bank bailouts which have created massive population opposition across the world.

Simultaneously Greece and other countries are saddled with ever-greater debt burdens – that is their obligations to other EU member states, the European Central Bank (ECB) and the IMF. Worse, Greece, Spain, Portugal and Italy and have been arm-twisted into adopting fiscal contraction, involving huge cuts to public spending, services, welfare payments and job losses. These are among the most severe fiscal tightening packages by industrialised countries in the post-WWII period (in Greece, the fiscal tightening is equivalent to 11 per cent of GDP). Latin America in the 1980s provides some comparison. According to the FT’s chief economics commentator Martin Wolf, ‘Greece is being asked to do what Latin America did in the 1980s. That led to a lost decade, the beneficiaries being foreign creditors. Moreover, as creditors are now paid to escape, who will replace them?’ The failure of the initial package was foretold by Argentina’s President Cristina Fernandez, which has some bitter experience from the economic crisis and debt default of 2001.

In Europe only the 1930s provides the precedent of such deep and widespread measures that have now been adopted. The austerity policy failed then and worsened the Great Depression.

The authors of the austerity programmes have no explanation as to why an austerity package supposedly designed to reassure financial markets has led to the opposite. This is because the effect of fiscal austerity measures has been disastrous for the minority of European economies that have adopted them. Services, welfare, incomes and pay have all been slashed. Because of this, the taxes which governments rely on to service their debts have also plunged, and actually led to wider deficits. Feeding the parasitical bank shareholders is killing these economies.

The verdict from the Standard & Poor’s (S&P) ratings agency is clear. S&P sparked the latest episode in the crisis by downgrading both Portugal and Greece, in effect arguing that the risk of defaulting on their debts has increased. In relation to Spain’s downgrade it argues that the new factor is slower growth caused by austerity measures.

That is, because fiscal contraction is disastrous economically, it also increases both the budget deficits and the interest rates on government debt. The Fitch ratings’ agency echoed this view in its downgrade of Spain.

Core Versus Periphery


Fiscal austerity measures have only been forced on a minority of European governments. Previously, the Spanish Socialist government had resisted demands for bigger cuts, arguing they would be damaging and counter-productive. By contrast, what remains the majority of EU economies, as well as non-EU economies such as the US, China and Japan, did the opposite and adopted fiscal stimulus to restore the economy, and the tax revenues which it generates - with varying degrees of success. In Britain, the 2009 Budget was a stimulative one which softened the recession and actually lowered projections for the deficit. Unfortunately, the stimulus was not repeated in the 2010 Budget.

The big European powers, the ECB and IMF have forced on the weaker EU countries a policy which is the opposite of their own, successful stimulus measures. Fiscal contraction has also been applied across the board in Eastern Europe. High levels of government borrowing in some of these countries and the proportion of that debt in foreign hands (mainly Europe’s banks), increased their vulnerability. That was certainly the case for Greece. But that is not an explanation for which countries have had fiscal austerity forced on them.

The table below shows the level of government debt in the Euro Area economies, as well as the proportion of that debt held overseas. It is taken from the ECB’s latest Financial Stability Review.

Table 1


10 06 03 Table 1

Greece does have the highest proportion of government debt held overseas - hence ist vulnerability to international pressures. But Belgium has the highest level of government debt, yet no signs there of external pressures and threats of an engulfing crisis. Further, Spain has both one of the lowest levels of government debt and one of the lowest proportions of government debt held overseas, much lower than Germany, France, the Netherlands, Belgium and Austria, who comprise the so-called ‘core Europe’ group.

The difference between the so-called core group and those who have had austerity forced on them is the relative weight of their banking sectors. The banks of Germany, France, the Netherlands, Belgium and Austria have net external assets of $1,780bn according to BIS data. This rises to $2,058bn if Luxembourg is included. By contrast the Mediterranean group of Italy, Spain, Portugal and Greece, has net external liabilities of $417bn. (The Netherlands’ membership of the core group is a partial anomaly as it has net liabilities. But the sheer size of its banking sector, almost the same as Italy and Spain combined, buys the ticket).

The bail-out is aimed at restoring the balance sheets of Europe’s ‘core’ banks, all of it funded by European and other taxpayers. The periphery are being written off, on the basis that their banks are already net debtors. Neither the €120bn was ever enough to bail out Greece nor was the €750bn enough to cover all the Mediterranean country debt. But then they are not the intended recipients. Instead the latter sum does correspond almost exactly to the potential write-down of all the Euro Area banks’ loans and debts, which the ECB’s December 2009 Financial Stability Review estimated to be €740bn.This estimate has subsequently been lowered, but was the best estimate at the time of the May 8-9 bail-out agreement. At the same time, the ECB announced it would buy European government debt and other bonds from the banks, even though European governments are themselves prevented from doing so, and the ECB’s statutes appear to rule it out. That decision is now facing a legal challenge in the German Constitutional Court.

Role of the IMF


In announcing the IMF’s participation in the bail-out of Europe’s core banks, its Managing Director Dominique Strauss-Kahn said, ‘The Greek government should be commended for committing to an historic course of action that will give this proud nation a chance of rising above its current troubles and securing a better future for the Greek people.'

Verbiage aside, the role of the IMF is a wholly pernicious one. The focus is its traditional one of urging deregulation, low wages and taxes and privatisation with a particular emphasis on those sectors which will benefit US capitalism, telecoms, insurance and above all banking. It specifically rules out any ‘restructuring’ of government debt, which would involve bondholders having to accept a discount on the value of their government debt, even though it has recently been possible to buy these debts in the market at 60 per cent of their face value.

It is widely argued that the crisis for Europe as a whole and the peripheral Euro Area economies in particular is simply a function of a burst housing bubble. But Figure 1 below, from the ECB's Financial Stability Review, shows that housing is the lesser component of the much larger decline in gross fixed capital formation. Both housing and other forms of investment are required for social need and to revive activity. The cause of the crisis remains a private investment strike.

Figure 1

10 06 03 Figure 1

This is highlighted by Figure 2 below showing EU Commission data and foreasts for GDP and investment in the Euro Area. Declining investment has been the driving force of the European recession, falling by 13.6 per cent while the contraction in GDP has been 4.1 per cent. Investment is forecast to contract further in 2010, projected to rise by a miserable 1.8 per cent in 2011. There can be no robust or sustained recovery until investment recovers. The transfer of huge amounts of capital from taxpayers and the poor to the banks will only postpone that investment recovery further.

Figure 2

10 06 03 Euro Area GDP GDFCF

With governments hamstrung by austerity packages and depressed tax revenues, restructuring is an option which may prove unavoidable in any event, just as it was in Latin America. Better by far to include it in an overall package of stimulating growth, cutting military spending and taxing the rich. The European Commission forecasts that the Euro Area will grow by less than one per cent in 2010 and little more than that in 2011, with investment continuing to decline. A stimulus package focused on increasing public investment would restore growth and halt job losses, and so revive tax revenues. Otherwise, the Euro Area will continue to lurch from on crisis to the next .

Tuesday, 1 June 2010

£6bn in ConDem Cuts, A Toxic Remedy

by Michael Burke

The ConDem coalition government has broken two promises in its first moves on economic policy. In the election campaign the LibDems' Vince Cable repeatedly argued it would be too soon to cut government spending, given the fragility of the recovery. The Tories argued that they could find an early £6bn in spending cuts by efficiency savings alone. Instead, the government have begun with immediate cuts of £6.25bn which impact directly on services, investment and jobs. It is clear that the compound effect created by this coalition is more toxic even than its individual components.

The government has provided headline numbers for some government departments, and some pointers to specific programmes. These are shown in the graphic from the Financial Times below. The full detail of the cuts will not be made clear until the June 22 Budget.

One of the most damaging decisions already taken is the announcement of a freeze on public sector hiring. The Chartered Institute for Personnel Development estimates that this could mean 50,000 job losses this year alone. Services will deteriorate rapidly as job-leavers and retirees are not replaced. Youth unemployment, already at 1 million, will increase further as a direct result.

Local authority budgets will be another of the biggest casualties, with hugely inadequate spending on housing cut even further. This would be disastrous in all the major cities which already suffer a huge shortage of decent affordable housing. Construction, especially for social housing is precisely an area where private investment has collapsed and one third of a million jobs have been lost in the sector in the course of the recession. Labour-led councils and all those who oppose the cuts should press hard against this deeply unpopular measure. The local authority housing budget is actually a significant net contributor to central government finances through council rents and asset sales. Both of these revenues should be used instead to create new, decent social housing.

Disastrously, capital spending will be cut at a time when investment is still falling, and these cuts will target transport and infrastructure spending - even flood management defences. The first two are also precisely the areas hardest hit by the investment strike in the private sector. The coalitions aim is clearly to withdraw government investment in areas where private investment is already weakest. This is the crass notion of 'crowding in' private investment by withdrawing public spending. It will only exacerbate deeply negative current trends in these key sectors of the economy.

This issue also highlight the economic damage of the overall cuts package, which will serve to widen the deficit. This is precisely what is currently occurring in Greece and Ireland - and of course when Thatcher did this in the 1980s the deficit rose as the economy and tax revenues slumped.However, what has been introduced so far is only the tip of an iceberg. The June Budget and September Spending Review will all see much larger cuts. The Institute for Fiscal Studies says the cuts may be up to £60bn in total over the next few years. It is reported that George Osborne has been seeking to learn lessons from the Dublin government, where devastating 'austerity measures to reassure financial markets' have been adopted. If so, one such supposed propaganda lesson is to exaggerate the initial level of cuts, and then seek the approval of a grateful nation when the cuts come in somewhat lower.

This lesson is a false one. The ‘gratitude’ of the population in Ireland is expressed in the lowest opinion poll ratings for the ruling Fianna Fail party since its foundation over 80 years ago and the obliteration of its coalition partners the Greens. The cuts packages have been worse than initially stated, as the deficit has predictably continued to widen. And the financial markets, seeing tax revenues plunge are so far from reassured that long-term interest rates are the second-highest in the EU, behind only Greece, having been one of the lowest.




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