Saturday, 26 March 2011

Osborne’s Budget Is An Admission of Policy Failure

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.

Tuesday, 15 March 2011

The Hutton Report Is An Attack On All Workers

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.


Sunday, 6 March 2011

Structural deficit denial?

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

Tuesday, 1 March 2011

The high stakes in the battle for union rights in Wisconsin

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

11 03 01 Wages

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