Wednesday, 12 December 2012

The Autumn Statement and Long-Term Austerity

By Michael Burke

George Osborne’s Autumn Statement brings home the stark reality that on current policy settings economic stagnation and ‘austerity’ will be a permanent feature of the British economy for many years to come.

The Office for Budget responsibility (OBR) has a hopelessly over-optimistic track record in forecasting GDP growth. Fig.1 shows the actual outturn on GDP compared to its forecasts. In 2010 a recovery of all the output lost in the recession was two years away, according to the OBR. Now it is still two years away.

Figure 1
12 12 10 Autumn Chart 1


The updated forecast may also prove to be overly optimistic. The OBR uses the UK Treasury’s model of the economy. In 2010 it forecast that investment (Gross Fixed Capital Formation) would lead the recovery, rising by 11.5% between 2010 and 2012. In fact it is the only component of GDP which has fallen over that period, down by 2.8% to the 3rd quarter of 2012.

Since the OBR was established by the Coalition government real GDP has risen by just £27bn. As SEB has previously shown that was largely a function of the momentum established by increased spending under Labour in 2009. Since Osborne’s first Autumn Statement in 2010 the economy has grown by just £8.2bn and excluding the Olympics’ effect in the 3rd quarter of it has actually contracted by £5.6bn.

Fig.2 shows the change in real GDP and its components since the OBR was established in 2010. GDP over the period rose by £27bn. All other main components of GDP also rose, although the rise in household consumption limped to an increase of just £2.6bn. But the fall in investment has been the main brake on activity falling by £6bn over the period.

Figure 2
12 12 10 Autumn Chart 2

This highlights the essential fallacy of official economic models shared by the Treasury, the OBR and others. The private sector was said to respond to lower government spending by increased spending of its own. The opposite has been the case. Faced with government cuts the private sector cut back on its own investment (and pushed up government current spending in the process as poverty and underemployment rose).

Therefore the government’s insistence on continuing ‘austerity’ not only for the rest of this parliament but also out to at least 2018 will not produce a different result. Economic stagnation and ‘austerity’ are set to become embedded in the economy over the next period, for at least a decade since the recession began.

Osborne has already challenged Labour to continue and deepen the cuts well into the next parliament. But only a decisive break with Tory cuts will produce a different result. Reversing the cuts and growing the economy through investment is required. In light of the private sector strike only the state has the capacity to do that. Enacting slower, shallower cuts will produce only a somewhat less stagnant economy and both poverty and the public deficit which grow more slowly.

How the Cuts Work

On the right of the Tory party John Redwood consistently argues that there are no cuts as government spending continues to rise in cash terms. Very few misrepresentations consist of a complete fiction but instead rely much more on a large distortion of the truth by disregarding key elements of it. The Redwood argument is typical.

Cash spending is rising because of three factors. It includes rising interest payments on government debt, not on services, welfare or public sector pay. Secondly it includes increases in the numbers entitled to welfare payments because of the stagnation caused by government policy. Thirdly unchanged nominal spending includes the effects of inflation. Once inflation is taken into account real government spending is falling.

This is an important point. The process of ‘fiscal consolidation’ is frequently accounted in a cumulative way for this reason. If a benefit is frozen in cash terms (or held below the rate of inflation) over a prolonged period the effect of the cuts deepens over time as inflation continues to rise. There are a few benefits which have been cut outright and scandalously these include benefits for people with disabilities, support for childcare and the education maintenance allowance and housing benefit for poorer households.

But the overwhelming majority of cuts are based on freezes or sub-inflation rises in benefits. These have now been increasingly back-loaded to the next parliament as the table in Fig. 3 shows, taken from the Autumn Statement. Osborne’s plans increasingly rely on fiscal consolidation in the next parliament. In addition to those tabled here there are nearly £19bn in further cuts which have already been outlined for the two further years to 2018.

Figure 3


12 12 10 Autumn Chart 3

If Labour is elected but does not reverse these plans it will be implementing cuts much greater in 2015/16 than the cuts that were implemented in 2011/12. The real effect of the cuts will be more than three times greater. To give one example, pegging the new Universal Credit to a rise of just 1% is expected to save £640mn in 2014/15, but to save more than £2.2bn in the two following years. Of course, this supposed saving is in reality only a measure of how much these benefits will be cut. As incomes of the poor are cut, spending is cut by an equal amount. This would otherwise circulate in the economy and largely return as government tax revenues. It is also planned that government investment will be cut even further to a level barely above the rate of depreciation.

Whichever party or combination of parties is elected in 2015 it can expect only long-term austerity and economic stagnation unless it is willing to break decisively with current failed policy.

Monday, 10 December 2012

Investment Slump Greater Than Whole Loss of British GDP


By Michael Burke

The latest estimate for Britain’s GDP growth in the 3rd quarter of 2012 left the initial estimate unchanged with growth of 1% in the quarter.

Boosted by a series of special factors to do with the prior Jubilee holiday, the Olympics and other events, most forecasts suggest that this will give way to much slower growth in the 4th quarter. There are even forecasts that there will be a ‘triple-dip’ with growth contracting once more at the end of the year. In reality the overall situation is better characterised as stagnation, with growth fluctuating around zero.

The source of the current crisis is becoming ever more apparent. As the chart in Fig.1 below shows GDP has fallen by £47bn in real terms from its peak in the 1st quarter of 2008 to the 3rd quarter of 2012. Over the same period investment (Gross Fixed Capital Formation) has fallen by £49bn. That is to say the fall in investment is now greater than the entire fall in economic activity.

Of the other components of GDP only the fall in household consumption comes close to matching the negative impact of declining investment. Consumption fell by £37bn over the same period.

Figure 1
12 12 10 Chart 1


By contrast government current spending rose by £14.7bn over the period, while net exports rose by £29.3bn. The rise in net exports is almost wholly attributable to a slump in imports as exports have barely increased. Imports have fallen by £19.1bn.

Without the detail provided in the third and final estimate of GDP it is not possible to determine the source of the slump in investment. It is possible that the public or private sector which is responsible. But SEB has previously shown that the entire second recession was caused by the decline in public sector investment and this is in line with the stated plans of the Coalition government to sharply reduce its own investment.

This highlights an important point. Governments across the OECD have increased their current spending in the crisis. According to the OECD government current spending is up from 19% of GDP on average to 22%. This covers government expenditure on areas such as pensions, unemployment and incapacity-related benefits, health, housing supports and other social policy areas. In some cases the efforts to limit these outlays have been severe, but the growth of unemployment and poverty has automatically pushed them higher.

However OECD governments have tended to sharply reduce government investment. In Britain and elsewhere this is highly damaging to growth and therefore has a negative impact on government finances. But growth and improving government finances are not the aim of ‘austerity’ policies. Their aim is to restore the profit rate of the private sector and removing government from productive areas of the economy is a step towards that.

Thursday, 29 November 2012

Britain's Export Performance Is Woeful


By Michael Burke

A number of commentators have recently called for a currency devaluation as a way to revive the British economy and outgoing bank of England Governor Mervyn King has described a recent very modest rise in the value of Sterling as ‘unwelcome’.

These calls tend to ignore the fact that Britain has already had very substantial devaluation. As the Bank of England chart shown in Fig. 1 below shows the decline in the pound’s exchange rate index (ERI) from 2008 onwards. The ERI fall was nearly 30%, with a slightly larger fall against the US Dollar and a less pronounced fall versus the Euro. The recovery in the currency’s exchange rate has only been a partial one.

Figure 1


12 11 29 Chart 1


There are usually two main effects arsing from a sharp currency devaluation. One is to increase the price of all imported goods which cause inflation. This is what happened and the British economy was the only major economy to experience both a sharp economic downturn and a rapid rise in inflation during the crisis. The other usual effect of currency depreciation is to cheapen the price of exports in foreign currency terms, and so provide a boost to exports and the growth and jobs that depend on them. But following that devaluation exports have barely grown in volume terms.

Figure 2

12 11 29 Chart 2


From their pre-recession peak exports fell by 11.3% to their low-point. They have since recovered but were still 0.8% below that peak in the 2nd quarter of 2012. Since George Osborne announced the ‘march of the makers’ as the theme of his first budget in 2010 export volumes have actually fallen by 0.4%. This is possibly the only time in British history where there has been a very substantial currency depreciation and no recorded improvement in export performance.

This is a remarkably bad performance given that world trade has expanded since the recession of 2008 to 2009, according to the World Trade Organisation, by 13.8% in 2010 and by 5% in 2011. It is also a remarkably poor performance even compared to sluggish major trading partners. Fig. 3 below shows export volumes compared to both the US and the Euro Area. Euro Area export volumes are now 3.6% above their pre-recession peak while US exports have increased by 8.3%.

Figure 3

12 11 29 Chart 3


Of course, these are not the strongest performers. As a group, Newly Industrialising Countries’ exports have risen by approximately 50% over the same period according to WTO data.

There are numerous reasons for the exceptionally poor export performance of the British exports over the recent period. Patterns of trade are highly dependent on the weak export markets of the industrialised countries, financial services played a disproportionate part in the exports of services during the upturn, exporters responded to the devaluation by raising prices rather than winning market share, and so on. But all of these can be essentially reduced to the current problem of not producing enough goods or services that the rest of the world needs to buy. To correct that requires investment.

Given that the private sector remains on an investment strike, the government could respond as a minimum by investing in high-speed rail links, improved port facilities, super-fast broadband and through investing in education by scrapping fees and bringing back EMA. It could also remove the restrictions on visas including student visas so as to increase trade and educational ‘exports’. A government committed to creating hi-tech jobs would invest directly in carbon-reduction and renewable technologies for which there are very large and growing export markets. But that would all require a very different type of government.

Thursday, 22 November 2012

Lessons from Japan

By Michael Burke

Japanese GDP contracted by an annualised 3.5% in the 3rd quarter of 2012. This annualised rate means that GDP fell by 0.9% in the quarter compared to the 2nd quarter. The Japanese economy had barely found its footing after the onset of the global economic crisis when it was hit by the devastating earthquake, tsunami and nuclear disaster at Fukishima. Government support for recovery has already ended.

The natural disasters are specific to Japan. But each economy is a unique combination of global economic developments and Japan remains the world’s third largest economy. Therefore developments in Japan have a direct impact in the global economy and illuminate those general trends. For example the halt to Japanese production caused by the disaster led to disruption of output in British and other European factories. There may also be wider lessons to be learnt from the Japanese economy and how economic policy responded to the crisis.

At the turn of this century it was already commonplace to speak of a ‘lost decade’ for Japan as the economy had barely grown since the collapse of the combined property and stock market bubble in 1989. But since the beginning of 2000 to the 3rd quarter of 2012 the Japanese economy has grown by just 8.5% in over 12 years. This is an annual average real growth rate of 0.7%. It would have been mediocre growth for the Chinese economy in a single year over the same period. It effectively amounts to two lost decades.

A number of authors have drawn important parallels between Japan at the onset of its crisis and the current situation in many western economies, including the US and Britain. In The Holy Grail of Macroeconomics Richard Koo analyses the Japanese crisis as a ‘balance-sheet recession’, where the debt liabilities of firms have become far greater than their assets. This means that profits are used to pay down debt, not to invest.
The firms themselves are kept afloat often by banks simply foregoing loans as they fall due. This leads to the creation of both ‘zombie’ firms and ‘zombie’ banks, without any ability to grow. This in turn places an enormous burden on government finances, as the state supports consumption by increasing borrowing and acquiring debt.

The main drag on growth over the entire period has been the decline in Japanese investment (Gross Fixed Capital Formation), which has fallen from over 30% of GDP before the crisis to under 20% now (which is still more than countries such as Britain). If investment had just kept pace with the virtually stagnant level of GDP rather than declining GDP would now be over 11% higher.

Figure 1
12 11 22 Japan Fig 1


But this decline took some time to gather pace as the chart in Fig.1 above shows. At a comparable period in the current global crisis, 5 years in to the Japanese crisis of the 1990s investment had fallen by 5.5% from its peak level. By contrast US investment is 16.8% below its peak level. Investment in the Euro Area is 12.8% below its peak. In Britain it is 16% below its peak.

SEB has consistently argued that the state should increase its own level of investment as the necessary response to the crisis and use the growing resources of the private sector to fund that investment. Japan is important in this respect. Many commentators, such as Harvard Professor Robert Barro, have argued that Japan’s frequently announced government investment programmes prove the futility of that idea. However, the chart in Figure2 shows that as Japanese investment has been falling, the government share of that falling total has also been in decline.

Figure 2
12 11 22 Japan Fig 2


The solution of state investment to combat balance sheet recession and a private sector investment strike has not been tried and failed in Japan. It has not been tried at all. Falling government investment has led a generalised investment decline. This has led to economic stagnation and now renewed crisis.

Yet even now its proportion of GDP devoted to investment at 20% is considerably higher than in countries such as the US or Britain which are just 15%. It is unlikely that either economy will be able to grow more strongly than Japan over the medium-term, or to be able to withstand external shocks, unless this rate of investment is increased.

If two lost decades and zombie firms sounds outlandish in relation to Britain it is noteworthy that the latest Bank of England Inflation Report predicted a prolonged period of slow growth ahead, when the current slump is already longer than the Great Depression. The Bank has also led a discussion of an estimated 30% of British firms who are ‘zombies’ able to fund interest payments but not to investment, expand or hire. But with banks unwilling to lend the Bank was oddly silent on the growth of zombie banks in Britain. Like Japan, this is a decisive feature of the current crisis in Britain.

The starting-point for the British economy is not as favourable as that of Japan as it has a lower proportion of GDP devoted to investment. Without increasing the rate of investment there will be even more negative consequences for growth.

Saturday, 10 November 2012

Ireland's 'austerity' is working - for profits

By Michael Burke

The Central Statistical Office (CSO) has produced its latest institutional sector accounts for the Irish economy in 2011. The title would suggest they are among the driest economic data possible - from a long list. In fact they are among the most important data available because they reveal the sources of income for all the main sectors, or classes, operating in Irish society.

This situation in Ireland is not unique and it actually represents a specific combination of general trends that apply in all the capitalist economies. The CSO has simply set these out with unusual clarity.

The chart below shows the profits of non-financial firms operating in the Irish economy (Figure 1), as well as the profit share, that is profits as a proportion of total Gross Value Added (GVA). GVA is the same as GDP, except the effects of subsidies and taxes on production are excluded.

Figure 1
12 11 10 Chart 1


The profit share has been rising since 2008. This is when ‘austerity’ policies were first adopted in Ireland. This is not coincidental. Clearly the purpose of policy is not to foster economic growth. GDP data in Ireland is highly distorted by the activities of overseas multinational corporations operating in
 Ireland who falsely book activity in order to avail themselves of ultra-low corporate tax rates.

Domestic demand (primarily personal consumption, government spending and investment) has fallen continuously for 4½ years and is now 25.6% below its peak in 2007.

The stated aim of policy is to reduce the government budget deficit. However as the separate National Income and Expenditure Accounts for 2011 show from 2008 to 2011 government current receipts have fallen by €6.3bn while current expenditure has risen by just €0.5bn, a total increase in the deficit of a little over €6.8bn despite all the fierce ‘austerity’ measures (Table 21). The current budget deficit is that part of the public sector accounts which ‘austerity’ is supposed to be addressing, yet the deficit on this measure has risen from 2.2% of GDP over that time to 6.7%. Yet this policy will be maintained even though its stated objective is not being achieved.

In fact the total public sector deficit has only stabilized because the government has cut its own investment over the same period, by nearly 60%. This has exacerbated the total decline in investment (Gross Fixed Capital Formation) which has fallen at the same rate. The decline in GFCF significantly exceeds the fall in GDP. Investment has fallen by €23.6bn in the recession, compared to a fall of €14.6bn in GDP.

This hoarding of capital - a refusal to invest - is the source of the recession. A government committed to boosting the profits of the private sector would reduce benefits and pay in the public sector in order to lower private sector wages. This is what mainstream economists refer to as a ‘demonstration effect’ . At the same time the government would reduce its own investments, say in schools, hospitals, housing or transport in order to facilitate private sector investment at a later date. This is the content of current policy.

Investment has declined throughout the crisis, even after profits have begun to recover. The chart below shows the level of investment of non-financial corporations versus GVA, and the relationship between the two which the CSO calls the investment rate.

Figure 2
12 11 10 Chart 2

But another way of expressing the investment rate is as a proportion of total profits. The chart below shows non-financial firms’ profits versus the level of investment. Profits have risen from their low-point of just over €39bn in 2009 to €46.3bn in 2011, close to the peak in 2007. At the same time the level of investment has fallen by €9.4bn (all expressed in nominal terms, not taking inflation into account).

Figure 3
12 11 10 Chart 3

To put this in perspective firms operating in Ireland formerly invested about one-third of their profits before the crisis. Even this investment rate was very low by international standards. In 2011 the investment rate on this measure was that about one-seventh of all profits were invested. This is also below non-financial firms rate of capital consumption, which was €8bn in 2011. They are producing profits but not forming any new capital.

Yet this cause of the crisis points to its own resolution. A €15bn increase in investment would restore all the output lost in the recession. A larger increase would be required to restore the entire loss of investment. The alternative is to allow firms to continue to hoard capital, with all the consequent damage to the economy, living standards and jobs that entails. At some point in the future they are likely to resume investment even on current trends. But that would required an increase in the profit rate and, with the economy stagnating, that could only arise if living standards and wages are driven even lower.

Tuesday, 23 October 2012

The importance of the debate on the IMF's 'multipliers'

By Michael Burke

It is unusual for ‘academic’ research published by the IMF to find its way into popular media. But this has happened to the latest World Economic Outlook where the IMF deals briefly with the issue of ‘multipliers’ that is, the economic impact of changes in government spending.

The short article has caused an usually high level of commentary among economists and commentators because the data suggests that the multipliers are perhaps more than double the level generally implied by official research and forecasts. Nobel Laureate Paul Krugman has commented that the research shows that, ‘the reason for the worsening outlook is that policy makers have gotten the basic economics wrong’. In Britain Chris Giles economic editor of the Financial Times has led a counter-attack by questioning the validity of the research. A string of other commentators have joined the debate on both sides, including a Greek finance minister.

The key point in the IMF research is that the multipliers are much higher than previously thought by leading bodies such as the IMF, OECD and others. ‘The main finding, based on data for 28 economies, is that the multipliers used in generating [IMF] growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2….’ Whereas the IMF’s (and others) own forecasts implied a multiplier of 0.5, the actual multipliers may be in the range of 0.9 to 1.7.

It is useful to assess why this seemingly arcane debate has created such controversy and why that is taking place currently.

Importance of the controversy

Because of the division of labour all changes in production have a wider impact on the economy. Increased output of one sector necessarily requires increased inputs either of labour, or of capital, or of production goods or raw materials, or some combination of all factors. This is not necessarily true of changes in incomes (which might be saved) or even expenditure (which might be met from existing stocks).

There can be no single multiplier effect. The size of the impact of changes in government spending must depend on firstly on the type of change in government spending. At the same time, even where an increase or decrease in government spending has a very large impact in terms of altering output in other sectors, the impact is not infinite. The size of the impact is itself constrained by the existing capacity of the economy. Therefore the largest multiplier effect can be found where government spending requires the greatest degree of inputs from other sectors (that is, where the division of labour is at its highest level) and which increases the productive capacity of the economy as a whole.

As a result, the overwhelmingly majority of research finds that the greatest multiplier is attached to direct increases in government investment. These are usually held to be much higher than inducements to private sector investment (which may simply be saved and from which profits must be deducted). They are also higher than the multipliers attached to consumption (which does not increase the productive capacity of the economy).

In Table 1 below the Office for Budget Responsibility’s (OBR) own estimates of the different multipliers are set out. These were first published in June 2010 and have not been altered. They are characteristic of thinking among most policymakers.

Table 1
12 10 23 Table 1

The OBR has not altered these estimates even though in its latest publication its estimates show GDP will have grown by 3.6 per cent over 3 years compared to their forecast of 7.8 per cent. In addition, the OBR concedes that an assumed average multiplier of 1.3 would fully explain the shortfall in growth compared to its own forecasts. 1.3 is in the middle of the IMF’s 0.9 to 1.7 range.

It is the insistence on unchanged estimates of the multipliers which is most significant, rather than the OBR’s own very poor forecasting record. In particular there is virtually a religious Golden Rule in (semi-) official literature which places the upper limit on all multipliers at 1. A multiplier lower than 1 implies that GDP will be reduced by less than the total change in government spending. Implicitly, the private sector will always respond in the opposite direction, increasing its spending when government reduces its spending, and vice versa.

This is the crux to the whole debate on multipliers. If government spending ‘crowds out’ private spending then it should be avoided as detrimental to total economic activity. At the same time, it is claimed that ‘austerity’ measures will not prove damaging as they will be offset by increased private sector activity. This false logic explains why the OBR forecast a 20.3% rise in business in the last two years while the actual increase has been 2.5%.

It is also extremely rare that the literature acknowledges the multi-year impact of the multipliers. Very little private investment achieves its return within 12 month. The same is true of government investment. The full yield on investment in transport takes place over the life of the railway or bridge, investment in education is returned over the working life of the pupil, and so on.

Essentially, the insistence on 1 as the ceiling for fiscal multipliers and confining them to a single year is to minimise the role of the state in the economy and its capacity to determine the trajectory for the economy as a whole, in both directions.

Timing of the controversy

This is not the first time IMF research has estimated the multipliers at very high levels. Daniel Leigh, one of the co-authors of the latest piece has previously written in a chapter of the IMF World Economic Outlook (‘Will it Hurt?’) that the 5-year multiplier of a cut in government investment when interest rates are close to zero and main trading partners are also cutting is 6.

This finding was almost exactly mirrored in an IMF Working Paper (‘Effects of Fiscal Stimulus in Structural Models’ ) which used its own econometric model and those of six other institutions including the OECD, the US Federal Reserve Bank, the EU Commission, and others. The key finding was that the 5-year impact of an increase in government investment has a multiplier of 5 or more.

Since the latest IMF research is shorter, no more prominent and modestly focuses on 1-year outcomes compared to previously published research, the unusual controversy it has generated must be due to other factors. Almost simultaneously, writing in the Financial Times, ex-US Treasury Secretary and current Harvard Professor Larry Summers highlighted ‘deep differences of opinion.....between the ‘orthodox view’ [which supports austerity]....and the ‘demand support view’ [which pushes for steps o increase demand in the short run]’ (‘The world is stuck in a vicious cycle’).

The deep split within mainstream economics and the controversy over the IMF research are associated with the same trends. Countries which have adopted the ‘orthodox view’ have generally experienced sharp slowdowns and renewed deterioration in government finances. Other countries, such as the US and Germany, which have ‘supported demand’ have experienced mild but slowing recoveries. In the US this has required the maintenance of large budget deficits. While the latter policy has clearly been more effective in restoring growth it is not sustainable over the medium-term. There is little official enthusiasm in either Germany or the US for further measures to support demand. In effect both ‘austerity’ and ‘demand support’ are running out of road.

Across the OECD government spending rose during the crisis in 2009 and 2010. But this was already being reversed by 2011. Belgium, Denmark, Greece and Slovenia were the only counties where total government spending rose as a proportion of GDP in 2011. In every other OECD economy where it was recorded, government spending fell, as was the case in the OECD as a whole. Despite government investment producing the biggest impact on the economy, all the OECD economies cut investment in 2011. The solitary exception was Denmark, where government investment rose fractionally.

The well-known efficacy of increased government investment has not prevented it from being cut in all the major economies. SEB has previously shown that the cut in government investment entirely accounts for the latest recession in Britain. Evidently, even though government investment would restore growth or even improve government finances it cannot be countenanced as it would interfere with the prerogatives of the private sector.

Conclusion

The debate on the size of the multipliers is effectively debate about the role of the state in determining economic activity. The official literature tends to minimise both the scope and the timescale of the impact of changes in government spending. The latest controversy arises because in their different ways both ‘austerity’ and ‘demand-support’ policies are failing.

The alternative is government-led investment. But this has been cut in all the major OECD economies in order to facilitate an increase in the profits of the private sector. The opposite policy is required, one which increases government investment in order to boost growth, jobs and the productive capacity of the economy.

Thursday, 11 October 2012

Lloyds Bank Can Fund Investment

By Michael Burke

A number of media reports suggest there is a dispute between the management of Lloyds Bank and its regulators at the Bank of England and the Financial Services Authority (FSA). The dispute centres on Lloyds’ estimated profits, which one set of City analysts forecasts will be £800 million. Management wants to use the profits to pay out dividends to shareholders. The regulators argue that prospective losses at the bank in future years mean that the profits should be retained, and used to bolster the bank’s capital.

Lloyds Bank is 43% owned by the state following the bail-out in 2009. In common with all deposit taking banks operating in Britain, it can only function because of government guarantees. It also benefits from liquidity provision and Quantitative Easing. Without these Lloyds Bank would collapse. The government is also the major shareholder and therefore has the capacity to determine the policies of the bank.

The attempted payout to shareholders is not the first instance in which bailed out Lloyds has used taxpayers’ funds to benefit either capital or the rich. Over the 3 years to 2011 Lloyds has paid out £1.385 billion in bonuses. It made a big fanfare of clawing back just £2 million in bonuses to former executives.

SEB has previously shown that the driving force behind the recession is the refusal of firms to invest. Capital is being hoarded rather than invested. Non-financial corporations alone currently have £391 billion on deposit at banks that report to the Bank of England. Retaining capital for prudential reasons is clearly preferable to wasting it on shareholders who have little inclination to invest and will simply increase those deposits. But Lloyds Bank adding to the cash hoard and then waiting for its existing loan books to deteriorate under the impact of the economic slump is hardly much preferable.

Instead, new investment would provide a return on investment for state-owned Lloyds and so reduce the risk of another bailout. The regulators could insist that profits cannot be used for either bonuses or shareholder dividends. An instruction from the government as the major shareholder to invest the profits in productive investment, say housing, high-speed broadband or rail would have a number of positive effects. It would boost economic growth and provide jobs. The effect of that would be to reduce the government deficit, without a penny of increased government borrowing.

Monday, 1 October 2012

The new recession is directly made in Downing Street


By Michael Burke

The final release for UK GDP in the 2nd quarter of 2012 showed a small upward revision to recorded growth. But this still showed a contraction of 0.4% of GDP for a third consecutive decline. Real GDP is now 1% below the level recorded in the 3rd quarter of 2011.

Previously SEB has shown that the driving force behind the recession has been the decline in investment (Gross Fixed Capital Formation, GFCF). That remains the case. In aggregate real GDP has declined by £60bn since the peak level of activity in 2008. Investment has contracted by £50bn.

Only the decline in household consumption comes close to making such a negative impact on GDP, falling by £42bn. In contrast the other main categories of GDP have risen. Government current spending has risen by £13bn while net exports have risen by £14bn. The latter is overwhelmingly due to the slump in import demand as exports have risen by less than £3bn over the period. GDP and its main components are shown in Chart 1 below.

Chart 1
12 09 30 Chart 1


The private sector was the source of this decline in investment, as the Labour Budget of 2009/2010 temporarily increased public investment. The incoming Coalition immediately brought that to a halt. What is now striking is that the decline in investment is now led by the contraction in public investment. In fact the whole of the ‘double-dip recession’ of three consecutive quarters of falling GDP is accounted for by the sharp fall in public investment.

This is shown in chart 2 below. This is the same format as the previous chart but it covers the time period from when the Coalition came into office. In addition it separates the two sources of investment, public and private. The data for these are taken from Schedule F of the latest  quarterly national accounts.

Chart 2
12 09 30 Chart 2


Over the period of the Tory led-coalition’s time in office the economy has contracted by £5.6bn. But the main driving force is no longer the investment strike of the private sector. It is the sharp contraction in public investment which has fallen by £11.2bn, almost twice the fall in GDP. Private investment has actually increased by £4bn over the same period.

It is noteworthy that household spending has also fallen by an amount greater than the fall in GDP, down by £8.6bn and reflects the effects of ‘austerity’, the cuts in welfare and other payments, the public sector wage freeze and the decline in real wages because of high inflation. Off-setting these to some extent have been the rise in government current spending and the increase in net exports.

In a very direct sense the latest contraction in the British economy is a function of government policy.

It is a recession made in Downing Street.

Thursday, 20 September 2012

Improving Yields and Destroying the Environment


By Michael Burke

A short but very interesting item was recently broadcast on Radio 4’s Today programme. A recording of the programme can be replayed here where a summary is also available.

The report highlighted a disaster in the production of corn, wheat and soya beans in the US. This was not because of the widespread recent drought, but an additional man-made disaster which may have longer-lasting impact.

In effect, large US farmers have been encouraged to adopt genetically modified strains of the seed varieties for these different crops. The specific form of GM was resistance to extremely powerful weedkiller, which was then used exhaustively.

But giant ragweeds have developed resistance to that weedkiller just as many campaigners had suggested. Now 2,4-D a new chemical will be deployed that last saw widespread use in the rice fields and jungles of South-East Asia as part of Agent Orange. Formerly, it had been used as in Vietnam part of the campaign to destroy foliage and crops. Now, it will be used in the US to destroy all vegetable life including weeds, except for the seeds once more genetically modified to withstand it.

It seems almost incredible, but the response of vast agrichemical companies like Dow and Monsanto is to develop even more highly resistant seed strains. At the same time, at US insistence, consumers are not allowed to know whether they are purchasing goods made of GM products.

This intensification of both the efforts to increase yields at all costs and the hoodwinking and fraud perpetrated on consumers are likely to intensify in the current crisis. The crisis is characterised by a slump in investment. In effect, firms stop investing when they cannot be sure of making a profit. As a result, measures to increase productivity and schemes that amount to reckless fraud or endangerment (of consumers or the environment) are likely to increase in an effort to increase profits.

Marx put it this way, “If the rate of profit falls, on the one hand we see exertions by capital, in that the individual capitalist drives down the individual value of his own particular commodities below their average social value, by using better methods, etc, and thus makes a surplus profit at the given price; on the other hand we have swindling and general promotion of swindling, through desperate attempts in the way of new methods of production, new capital investment and new adventures, to secure some kind of extra profit, which will be independent of the general average and superior to it”.

Mass unemployment and lower pay are key consequences of the current refusal to invest, but so too are the growth in reckless schemes involving swindling and environmental depredation.

Sunday, 16 September 2012

Germany's recovery Is faltering


By Michael Burke

Germany is widely regarded as the motor of the European economy. GDP grew by just 0.3% in the 2nd quarter of 2012 and is barely 1% higher than a year ago. The German statistical agency Destasis speak of a continuing export-led recovery. But that is not strictly correct. German exports are rising. But because imports are rising faster, net exports have subtracted from growth.
Table 1 below shows the real change in GDP between 2008 when the recession began and the 2nd quarter of 2012.

Table 1
12 09 16 Germany Table 1

Taken in isolation, Germany’s exports are indeed the single biggest contributor to its growth. But imports have grown at a significantly greater pace – they are up 12.1% over the period, compared to 9.5% for exports. As a result, net exports have subtracted from growth. Both, however, have grown faster than GDP itself, which has risen by 1.7% compared to the peak before the crisis. As a result Germany has become an even more open economy and trade accounts for over 48% of GDP.

The single largest net contributor to Germany’s growth has been household consumption, which more than accounts for the entire rise in GDP. Household consumption has risen by 3.8% since 2008. Increased government spending has also been a significant contributor to growth over the period and has risen even more rapidly – rising by 8.1%. Aside from net exports, investment (GFCF, Gross Fixed Capital Formation) has also been a drag on growth. This is the only component of GDP which is still lower than in 2008 and so is acting as the main brake on recovery.

Trends In Growth

A rise in household consumption is in fact characteristic of all the so-called core countries of the Euro Area. Along with Germany, Austria, Belgium, Finland, France and Luxembourg all have a level of household consumption that is now higher than before the recession, although this trend is by far the most pronounced in Germany. The exception is The Netherlands, where household consumption has fallen.

Turning to the source of this strength in household consumption, Table 2 shows the main categories of GDP alongside the changes in both the Gross Operating Surplus of firms and the Compensation of Employees. Since these latter two are only provided in nominal terms and on a calendar year basis, the entire set of data is presented in the same way to the end of 2011.

Table 2
12 09 16 Germany Table 2

The source of the rise in household spending is readily identifiable. The rise in spending of €98bn is almost exactly equal to the rise in the Compensation of Employees of €97bn. It seems likely that this willingness to consume is underpinned by the rise in government spending as well as the fall in the unemployment rate to 6.8 per cent - which is lower than at the onset of the recession.

Germany has therefore experienced a mild recovery based not on export growth but primarily on rising household consumption assisted by rising government spending. While this is a much stronger performance than either Britain or the crisis-hit countries of the Euro Area it is not sustainable over the medium-term and there are already signs that growth is slowing to a crawl. Trends in unemployment, which had supported consumption, have gone into reverse with unemployment rising for 5 straight months.

German Chancellor Merkel recently took half the Cabinet and a host of business leaders to China in order to cement the growing trade relationships between the two countries. Oddly, the overwhelming clamour from Western economists and commentators is that China’s economy should become more like that of Germany, driven primarily by household consumption rather than investment.

Instead, the current trends in the German economy show that it needs to become more like China, where investment plays the leading role in spurring growth. The alternative is for the German future to look more like the recent past of the crisis economies in the Euro Area where slowdown has been followed by stagnation followed by economic contraction.

Thursday, 30 August 2012

Why More ‘Austerity’ Is On the Way

By Michael Burke
The latest monthly public borrowing data, which show a large deficit in government finances, have widely been hailed as a ‘surprise’. However, SEB has previously pointed out that the deficit has been widening over the prior six months, so that the latest shortfall in government finances is simply the continuation of an established trend.
More fundamentally, it does not require very sophisticated economic analysis to assume that a renewed contraction in the economy will lead to both higher government spending and lower government tax receipts. Despite higher prices, the nominal level of taxation receipts has fallen since the beginning of 2012, and expenditures have risen. At the very least, the borrowing data should put paid to all the chatter that the GDP data showing economic contraction is somehow wrong . Of course, the GDP data is subject to revision, like almost all economic releases including the data on public borrowing. But it is in practice inconceivable that the economy could be expanding while a significant shortfall appears in government finances. In that sense, government borrowing data are some of the most reliable of all, as they represent real expenditure made and income directly received by the government, rather than survey evidence and estimates of activity in the private sector.

International Experience
If there is any genuine ‘surprise’ from the widening in the budget deficit it is a product of an entirely incorrect framework that assumes that the state is an obstacle to economic prosperity and that removing it will boost output. In fact, the performance of the British economy and government finances in response to ‘austerity’ supports the opposite contention; which is that the state should be the leading force in an economy because it is more efficient than the private sector in developing economic growth. Reducing the weight of the state in the economy therefore damages economic activity.
But anyone who has followed the trajectory of the crisis-hit European economies in the recent period would not at all be surprised by the outcome in Britain. In every case where severe ‘austerity’ measures have been put in place, economic activity has contracted. This has also usually been accompanied by no significant improvement in projections for government finances, and in some cases a deterioration. The table below shows the EU Commission estimates and forecasts for the budget deficits in selected EU economies. It should be stressed that these are the EU Commission’s forecasts (in the Spring 2012 Euro Area Economic Forecasts), and have in the past been subject to negative revisions.
Table 1
12 08 30 Table 1

Policy Response
The response to economic contraction and renewed widening in government budget deficits in the crisis countries of the EU is also instructive. In none of these cases has there been a reversal of policy, so allowing growth and therefore an improvement in government finances. Greece and Portugal largely had austerity foisted on them by the Troika of the EU, IMF and ECB. Spain, like Britain, initially had a mildly stimulative policy carried out by governments of the left, PSOE and the Labour Party respectively. However, while this partly reversed the slump it was wholly insufficient to provide economic recovery and they then switched to ‘austerity’ policies. This appeared to the electorate like an inconsistent and illogical zigzag on economic policy and ushered in parties of the right even more committed to an attack on the living standards of workers and the poor.
Ireland was a different case, as its ruling circles are wholly committed to the interests of foreign capital and their domestic agents (in this case, the speculators of Allied Irish Bank and its manly foreign bondholders). Therefore, without any external political impositions, the Irish government moved straight to an ‘austerity’ policy of its own. It later fell into the clutches of the Troika simply because this policy had utterly failed. The Troika then loaded the Irish state with even more debt in order to extend the policy.
Britain is unlikely to be any different and ‘austerity’ will be deepened. Reports of the latest deficit widening had headlines such as ‘Surprise deficit raises risk of more austerity , and ‘Tax slump threatens to set off new wave of cuts’ .
Even prior to the UK borrowing data, a series of business calls had been raised for further cuts in welfare payments in order to provide investment subsidies for firms. The Institute of Directors, the CBI and the British Chambers of Commerce have all been plugging deregulation and tax ‘reform’ as well spending cuts. This is actually an agenda for lower employment rights, safety and environmental standards, as well as tax cuts for corporations at the expense of labour and the poor. That is, a deepening of ‘austerity’.

Rationale of Policy
Rhetorically, it is possible to speak of the classic definition of the ‘madness’ of current policy in Einstein’s sense; repeating an experiment and expecting a different outcome. But in truth the dynamic of current policy is not irrational at all. Just as in the rest of Europe, policy is not aimed at restoring growth at all, or even reducing the deficit, despite government claims to the contrary.
In any capitalist economy investment falls not because there is insufficient demand - the 1.8 million households on waiting lists for social housing in England could testify to that. Investment falls because capital cannot be invested for a sufficient profit. In Britain investment (Gross Fixed Capital Formation) began to decline in the 1st quarter of 2008, one quarter before GDP began to contract. It led the economy into recession and now accounts for 80 per cent of the total loss in output.
The purpose of current ‘austerity’ policy is to restore profits. Seen from the point of view of capital, there are two main current economic problems. The first is to reverse the adverse change in the profit share which takes place during recessions. The second is to create conditions allowing an increase in the profit rate.
1.In a recession the profit share falls. Company A produces goods which it sells for £1mn. It has wage costs of £0.5mn and other variable costs (raw material, energy, etc.) of £0.2mn. The surplus generated is £0.3mn. But in a recession it can only sell goods for £0.8mn as some are left unsold and some others offered at a discount. The costs of raw materials are almost entirely outside their hands. Faced with the same wages and raw material costs, the surplus falls to £0.1mn. This is exactly what has happened in the British economy since 2008. In nominal terms the compensation of employees had risen from £773bn to £816bn. Of course, in real terms, after inflation, there has been a marked decline in wages but in official data the distribution of incomes is presented only in nominal terms. But the gross operating surplus (GOS) of firms (akin to the surplus identified above) has risen from £503bn to just £508bn over the same period. Again, in real terms there has been a marked fall in the surplus. Crucially, the nominal rise in compensation has been greater than the rise in the surplus. Capital’s share in national income has declined as a result.
If Company A can lay off workers or cut overtime and maintain output it will do so in order to restore profits. But the complexity of the production process may not allow a significant reduction in wages with unchanged output. There is also the concern that a rival firm might increase its output and win market share from Company A, or even hire the workers it has trained. Instead, Company A will benefit if government can find a way to cut wages, say, by increasing the numbers of people unemployed in an attempt to force down wages, or cutting non-wage benefits to force those in work to work longer for less.
2.The cause of deep recessions is a decline in investment. Individually, firms are unwilling to resume investment until they can be much more certain of making adequate profits. In aggregate, they hoard capital and refuse to invest it. To make a profit Company A must deploy capital. This is in the form of both its costs of employment, raw materials and other input costs, as well as its costs of plant, machinery and so on. The rate of profit is the surplus extracted as a proportion of this total capital employed.
Frequently, boom precedes recession. This is not become economics is some kind of morality tale about excess, but because the boom includes an unusually high level of investment. In Britain, ‘unusually high’ is still weak by international standards but it meant the level of investment rose by 15 per cent in the four years to 2005, and by the same proportion again in the two years to 2007. This latter increase in the capital stock (plant, machinery, etc) took place while wages were growing but was not accompanied by an equivalent rise in the growth of the surplus. In fact, investment rose at a faster rate than the surplus. Since the profit rate is the ratio of the surplus versus total capital employed (both fixed capital and variable capital) and the surplus rose at a slower rate than investment, it follows that the profit rate fell.
But Company A is operating in a recession and sales are not rising and it cannot do anything about the costs of its plant and equipment. It is also at the mercy of market forces in terms of input costs such as raw materials. To restore the profit rate therefore requires a reduction in wages.
Anything which indirectly supports the level of wages such as benefit entitlements, unionisation, national pay bargaining, employment rights and so, must all come under attack to achieve this. Meanwhile, it will demand from government both that corporate tax rates must be cut and that the government provides work, or at least subsidies to it in order to boost sales and increase retained (after tax)profits.
This is the content of all ‘austerity’ policies. It is why they will continue even while growth is at best stagnant and the deficit rises once more. Policy is not aimed deficit reduction or still less economic well-being via growth. The aim of policy is restore and raise profits. It is why these policies will not only continue but deepen in the face of both economic contraction and a rising deficit.
The alternative remains large-scale state investment which will produce economic recovery. Firms wishing to survive will be obliged to participate in the recovery by investing on their own account, even at the lower profit rate.
Both resisting the impositions of further austerity and demanding the state lead the recovery through investment are the subject of a struggle between classes. Effectively it is a struggle about which major class will be forced to pay for resolving the crisis.

Tuesday, 28 August 2012

Questions and answers: Why investment not cuts is key

The debate on the alternatives to the current failed economic policy of the government has intensified. The renewed downturn in Europe, a British government Budget whose cut in the 50p tax rate underlined the class interests it represents and the slip back into ‘double-dip’ recession have all heightened interest in alternatives to ‘austerity’.

Socialist Economic Bulletin has consistently argued that the appropriate response to the current crisis is investment, not cuts. A number of readers have expressed interest in a Frequently Asked Questions, addressing some of the main points of this. These are set out below.

What do you mean by investment?


What we mean by investment is investment in machinery, transport, technology, housing and hospitals and similar things. This is not the speculation, sometimes wrongly called ‘investment’, which is often spoken of in relation to the stock market and other financial instruments.

All economic output is either consumed or set aside in the form of savings by households, companies or the government. This saving can sit idle in a bank, be used for speculation, or used for investment in building houses, infrastructure, transport links, education, health care, and so on. It is this latter type of investment which creates prosperity and jobs as well as improving productivity. It is what is meant by the term investment.

From a socialist point of view, investment is about ‘the means of production’. The question of who controls the means of production and how they are developed is the most important issue in the economy. Most of the time this issue appears abstract, but in a big economic crisis such as the present the question of who will control, or set the policy of the means of production, is an immediate issue.

Why has the question of investment become so important currently?


The fall in investment (gross fixed capital formation) in the OECD group of industrialised countries from 2007 to 2010 was approximately US$963bn in real terms. This is vastly more than the total decline in GDP, which was US$220bn. This was because other components of GDP, such as household or government spending as well as net exports to the rest of the world all rose. In order to reverse the slump, there must be a recovery in investment.

Is the same true for Britain?


It was. Until the Tory-led government came to office the decline in investment was the biggest contributor to the British recession and accounted for approximately 80 per cent of the decline in GDP. Declining investment also led the recession, beginning to fall before the economy as a whole contracted.

How has the recession changed since the Tory led coalition took office?


On the same basis as the OECD as a whole (US$ at Purchasing Power Parity), the decline in investment now accounts for the entirety of the British recession. The difference is that it has been joined and then overtaken by the decline in household spending. This is a result of government policy, where wage freezes, the VAT hike, benefit cuts and job losses have combined with higher inflation to push real incomes down. As a result household spending has also fallen. To get out of the recession therefore means that both people’s incomes, which determine consumption, and investment must be increased.

If there’s no money left, how can investment be increased?


There’s plenty of money left! If wages are held down and yet prices (for food, energy, rent, transport costs, etc.) are rising this means that the share of national income of companies or landlords or transport operators will all rise. Their share of national income is profits. But companies are refusing to invest this profit.
Where they can, companies are holding down wages and hiking prices but in general are refusing to invest.

As a result, they are sitting on a cash mountain (held in the banks) of around £750bn. Capital is plentiful. Currently it is in the hands of those who refuse to invest it. This refusal has led the economy into a double dip recession. The only way to reverse this is to raise people’s income, which means to stimulate consumption, and at the same time to embark on a major investment programme.

But is that enough?


It is more than enough to deal with the scale of the current problem. To restore all the lost output since the recession would require just £67bn. To restore the British economy to trend growth, so that it would seem as if the recession had never happened, would require approximately £225bn. Both of these totals are just a fraction of the cash holding of the corporate sector.

How could this cash mountain be accessed?


Government policy could easily claim it, through a variety of levies, windfall taxes and surcharges. The funds are already held mainly in British banks (as companies become increasingly concerned about holding them in overseas banks) and could be directed for investment purposes. RBS and Lloyds-TSB are already owned by the state and all deposit-taking banks operating in Britain can only do so because the deposits are guaranteed by the state. A substantial part of this investment should be launched directly by the state in housing, transport and other sectors. As regards private companies, a simple instruction could be issued that the banks must provide investment (cheap loans) to all the areas needed.

What are those areas?


The priorities would be investment in housing, in transport (especially much more energy efficient rail), in infrastructure (hi-speed broadband, non-carbon energy generation, port facilities, and so on), as well as
in education at all levels. These are the areas which have seen the biggest falls in investment during the recession, and yet have potentially the biggest returns on investment.

But once the bridge is built, or new broadband supplied, isn’t the money gone?

All the money spent has very large multiplier effects. This means the money continues to circulate in the economy long after the initial expenditure. In addition, there are very large boosts to productivity, making it possible to establish or expand businesses and services. The CBI now accepts that the average multiplier for large infrastructure projects is 2.84:1, meaning that for every £1bn initially invested, the economy is boosted by £2.84bn.

There has been a lot of recent talk from the CBI and others on the need for investment. Isn’t this the same as SEB’s policy?

No. The CBI and others represent the business interests that have participated in the investment strike which is the cause of the crisis. Now, because demand generally is falling once more (investment, household spending, government consumption and exports) they are suddenly concerned about current and future profits. They have also benefitted from lower wages and falling corporate tax rates. Yet they continue to refuse to invest.

Instead, they demand that they be given further subsides, handouts and guarantees (even guaranteed profits in the case of the nuclear industry) in the hope they will graciously deign to invest at some point in the future when profits are certain.

Worse, they also demand further cuts in wages and employment rights, and further cuts in government spending on welfare. This is indefensible morally but it also runs counter to the needs of the economy as whole, where falling household incomes is now also driving the recession.

But wouldn’t those business subsidies be worth it, if it led to a recovery?

Private businesses are driven by profit, and in aggregate they will make no large scale investments without an increase in profitability. As this is a generalised crisis in the industrialised countries, autonomous large scale private sector investment can be ruled out because no sufficiently large recovery of profits is in sight.

Therefore all attempts to bribe private businesses to invest, such as the government’s ‘credit easing’ are likely to prove extremely costly or fail, or both.

Then how can investment recover?

The state is not driven by profit and so has the capacity to make rational economic decisions, based on what is required to optimise sustainable economic activity. The mechanisms for the state to access the private sector’s cash hoard have already been identified. It is a relatively simple matter to achieve it.

If this were so simple, why hasn’t it been done already?

In Keynesian terms, this would amount to a ‘somewhat comprehensive socialisation of investment’. The state would be taking over functions that have been ceded to the private sector, such as house building, and would derive the surplus generated by it in the form of rent.

It would begin to reverse the decades of privatisations begun in earnest under Thatcher. In Marxist terms it would mean some portion of the means of production passing from private to public ownership. This is not therefore acceptable to the current owners, and the political forces which support them.

But surely this is Utopian, talking about the state taking over the means of production?

Across the world, the efficacy of all stimulus or bailout measures was in direct proportion to the involvement of the state, which is why China’s investment stimulus was the most successful of all. Even in the US currently, it is the state-owned agencies Freddie Mac and Fannie Mae which are keeping the housing market going as private banks have exited the US housing market. All across the world, including Britain, it was the state which supported the failing private sector banking system. It is the state, in the form of EU subventions, which is funding rapid recovery in the Baltic states and which allowed Poland to avoid recession altogether.

The state is a more efficient provider of many large scale goods and services. If its weight in the economy overall is sufficiently great it can also have the levers to regulate the level of investment, which is decisive for continued prosperity.

What about other alternatives, like taxing the rich?

Britain is a very unequal society, made more so by the Tory-led coalition’s policies of reduction in real wages and cuts in welfare entitlements. A more redistributive tax system, and closing tax loopholes to pay for it, would be beneficial. But tax increases alone are not sufficient for reviving the economy. In the last financial year the public sector deficit was over £124bn. Even the most ardent supporters of increasing taxes do not suggest that the full armoury of tax increases could match this total.

Other schemes, based on further monetary interventions or quantitative easing, or increased wages, while all useful in themselves, do not address the central issue that significantly increased investment is required to revive the economy and that the only agent that can lead an investment recovery is the state.


A leaflet version of this article Questions and answers can be downloaded here.

Saturday, 4 August 2012

The investment strike is one the government would do well to bust

Michael Burke has an excellent new post on the Guardian’s Comment is Free examining UK companies failure to invest and therefore why the state must intervene if the economy is to recover.

12 08 04 Mick Burke CIF

Friday, 3 August 2012

China's economy in the last 10 years has seen the fastest growth in per capita GDP in a major economy in human history

By John Ross

In the last 10 years China's economy has experienced the most rapid growth in per capita GDP in a major economy in human history. In the same period China has seen the most rapid increase in per capita consumption of any major economy. These are the principle findings of my analysis of the last 10 years of China's economic history. This shows those who claimed China's economy faced 'crisis' had no contact with economic reality. The data is in the tables below and my analysis is here.

12 08 03 China's GDP per capita growth
12 08 03 China's Consumption per capita growth
12 08 03 Last 10 years China's econony

Monday, 30 July 2012

The incredible shrinking UK economy - an update

By John Ross
Earlier this year this blog published an article entitled ‘The Incredible Shrinking UK Economy’. It noted: ‘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.’ .
Data at that time was only available up until the end of 2010. Since then the World Bank has updated its data to cover 2011 and the pattern remains the same.
Taking first the situation of the world’s major economies, the G7 and BRICS, this is summarised in Table 1. The comparison made is between the last year before the financial crisis started, 2007, and the last available comprehensive international data – for 2011. As may be seen the $381 billion decline, in current dollar terms, of UK GDP is, without comparison, the worst of any major economy – indeed it is easily the worst in the world. As a percentage of world GDP the UK lost 1.6 percentage points – easily the worst performance of any European economy. The advance of all BRICS economies is also clear from this data.
Table 1
12 07 27 G7 & BRICS

Taking the situation within Europe this is shown in Table 2. As the UK, Ireland, and Iceland are the three economies which have suffered the biggest losses in GDP in dollars during the financial crisis this table may also be taken to show the ‘sin bin’ of world economic performance. The way in which the UK economy has declined in absolute terms far more than any other European economy is again evident.
Table 2
12 07 27 Eurozone
Where does this leave the UK in the world rankings of economies? In terms of current dollar exchange rates. as shown in Table 3, the UK has slid from 5th to 7th position under the impact of the international financial crisis – being overtaken by France and Brazil
Table 3
12 07 27 Current $

However, as is well known, current exchange rates substantially understate the size of developing economies compared to calculations in internationally equivalent prices (Parity Purchasing Powers - PPPs). This is particularly strikingly the case for India which at current exchange rates is only ranked 10th but in terms of PPPs in 2011 overtook Japan to rank as the world's 3rd largest economy . In PPPs the UK has declined from 7th to 9th position – also being overtaken by France and Brazil on this measure.
Table 4
12 07 27 PPPs

The data is therefore clear. In terms of its real international position the decline in the position of the UK is by far the worst of any major economy. There is no reason to change the analysis. In terms of international comparisons the UK’s is truly ‘the incredible shrinking economy’

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

Sunday, 22 July 2012

The UK’s budget deficit is rising not falling

By Michael Burke
The latest public sector borrowing data shows that the UK budget deficit is widening once more. Indeed despite a series of accounting adjustments which obscure the true picture, it is clear that the underlying trend is also towards rising, not falling deficits.

The Office for National Statistics reports that the June public sector borrowing total was £14.4bn, £500 million higher than in the corresponding month in 2011. However monthly data are erratic and subject to significant revision. Taking the data for the first 6 months of this year as a whole is more meaningful and shows that the deficit over that period is £37.3bn.

But this total is flattered by the strange decision relating to the acquisition of the Royal Mail Pension funds ahead of planned privatisation. In effect the government has decided to include the assets of this fund, but not its much greater pension liabilities in its own accounts. This and another smaller transaction lowered government borrowing by £30.3bn. The underlying deficit, excluding these transactions is therefore £67.6bn in the first 6 months of this year.

This compares to a deficit of £60.5bn in the first 6 months of 2011. The deficit is rising, not falling.
Figure 1
12 07 22 Chart

Factors Affecting Borrowing

This deterioration in the deficit places British government finances in a growing band of European economies where sharp cuts in government spending are leading to economic contraction, which in turn produces widening deficits.

This should come as no surprise. As the crisis is effectively an investment strike by capital, spending cuts by government will only lead to a further decline in private investment. The reason this logic has taken some time to work through in Britain is due to a number of factors. These are primarily the zig-zag in government policy, which initially saw an very modest increase in government investment under Labour and so produced a reduction in the deficit. This was compounded by the uniquely high level of inflation during the British slump, which eroded the real value of all government spending.

SEB has previously shown that the very moderate increase in government investment from the 2009 Budget under Labour was the catalyst for a modest economic recovery. Because of the increase in government spending (including allowing welfare payments to rise automatically as unemployment and poverty increased) the Treasury forecast that the deficit would rise to £178bn in the following financial year. In the event, the deficit began to decline and was £158bn for the financial year.

In addition, the effects of economic growth are felt on both sides of government accounts. Expenditure is lower than it would have been because more are in work and the benefits’ bill falls. Revenues are higher because incomes, profits and consumption all raise the level of tax revenues.

It is widely known that government policies have led to economic stagnation. Yet it is only now that the deficit has started to rise. The British economy has grown by just 0.5% in the two years since the Coalition came to office. But in nominal terms, before taking account of inflation, the GDP has increased by 6.1%. This surge in inflation during the slump is highly unusual, placing Britain on a par with countries such as Iceland. Britain has an incredible shrinking economy when measured in international currency terms.

Domestically this is reflected in a surge in inflation. While severely denting the purchasing power of all those on fixed or low-growth incomes, the fiscal effect was to increase nominal government revenues by £56bn over the last 2 years. This compares to annualised nominal growth in GDP of £88bn.

The Treasury’s estimate is that every £1 increase in economic activity will lead to a 50p increase in government revenues. In fact the increase over the last two years has been 64p (£56bn of revenues of £88bn increased output). However, government current spending has also risen by £42.3bn over the same period. This is an inevitable consequence of the savings (i.e refusal to invest) by firms.

This points to the essential fallacy of all ‘austerity’ measures, whether from the Coalition’s frontal assault, or the slightly shallower, slower cuts favoured by current Labour policy. Even nominal growth will largely be reflected in increased government revenues. But spending cuts have the effect of weakening economic activity and so drive up government expenditures.

Even in the narrow terms of reducing the deficit, the only effective prescription is growth. The most effective means of promoting growth, as even the cautious 2009 Labour Budget shows, is for the government to increase investment.

Saturday, 14 July 2012

What the world economy should learn from China


By John Ross
I have a new article at the Guardian's Comment is Free analysing China's economic success both during the international financial crisis and in general since since 1978. It analyses the theoretical bases of China's economic policies in terms of both Chinese and Keynesian economic theory. The article starts:
'Few things better illustrate the difference between the state of China's economy and that of the rest of the world than the fact that its newly announced GDP growth figures of 7.6% were analysed as a "slowdown". In any other major economy this would have been considered blistering growth threatening overheating. Instead, it is clear China has room for further stimulus measures in the second half of the year.
'Indeed, as the international financial crisis has unfolded, there have been few starker contrasts than those between China, the US and the EU. Europe has combined loose monetary policy with little or no stimulus to the productive economy – the "austerity" approach. The result has been that the EU's economy shrank by 2% over four years – the UK's shrank by 4.4%. The US has combined loose monetary policy with a consumer stimulus delivered via the budget deficit. The result? The US economy has grown by 1.2% in four years. India, which followed the US model of a budget deficit delivering a consumer stimulus, saw its growth decline from 9.4% in the first quarter of 2010 to 5.3% in the first quarter of 2012.
'Meanwhile China, which combined expansionary monetary policy with an investment-led stimulus, has experienced more than 9% annual average growth throughout the four years of the financial crisis.'
The rest of the article can be found here.

12 07 14 Comment is Free

Saturday, 16 June 2012

Cancel The Greek Debt


By Michael Burke

The Greek general election on June 17 presents a clear political choice on whether to continue with the ‘austerity’ measures imposed by the Troika of the ECB, EU and IMF which have caused a disastrous economic slump. Greek GDP fell by over 13 per cent between 2007 and 2011 and contracted sharply again in the 1st quarter of 2012. In real terms the compensation of employees has fallen by approximately 15%. The cause of the slump is the investment strike by capital, down nearly 47 per cent since the slump began and accounting for nearly 90% of the entire fall in output.
Yet Greece is just the sharpest expression of the European crisis, which at the very least is likely to see the continent as a whole remain in a depression. This is a Europe-wide crisis and it requires continent-wide solutions.

As the first step, it is necessary to address the claim that the ‘austerity’ measures (which are actually designed to cut wages and non-wage benefits) are necessary to close the deficit in public finances. As EU Commission projections show, the Greek government’s ‘primary balance’ is a deficit of just 1 per cent of GDP (see table below). The primary balance is the balance on government finances once debt interest payments are excluded. The very large total public sector deficit arises because of interest payments amounting to 6.3 per cent of GDP. The EU projection is that the primary deficit will rise to no more than 2 per cent of GDP in 2013.

Table 1
12 06 16 Table 1

Therefore a key component of the Greek crisis could easily be resolved simply by cancelling the debt. The interest payments would no longer be made. This is necessary as it is widely recognised that the debt is unsustainable and a default is inevitable. The EU estimates that the level of public sector is currently over 160 per of GDP. The formula used for assessing debt sustainability is that the real growth rate must exceed the real interest rate multiplied by the debt as a proportion of GDP. More succinctly, government revenues must be growing at a greater rate than the interest payments on existing debt.

Using that formula, if Greece were growing in real terms at 2.4 per cent per year (the average of the 10-year period 1992-2001) then the real interest rate would need to be 1.5 per cent to be sustainable, given the current level of debt. Instead the Greek economy is contracting, at a rate of over 6 per cent a year, and market interest rates are close to 30 per cent.

Previously, the claim was that ordinary citizens in the rest of Europe would suffer through their pension and other funds if there were a cancellation of the debt, or if any Greek government abrogated the debt. Whatever the previous merits of that argument it has been nullified by the exit of most private sector investors from the Greek government bond market. Any private sector investors who remain cannot be ordinary pension funds, as these are not allowed to invest in such high-risk, lowly-rated bonds.

The public sector, through the ECB and through Greek institutions are now the majority holders of Greek government debt. The ECB, as the central bank which stands behind the Euro, cannot possibly go broke as a result of a Greek default; it has unlimited recourse to Euros. It has in any event made significant profits on its previous purchases of Greek government debt.

The main negative impact would be felt on Greek banks who remain holders of their government debt. But these are rapidly heading towards insolvency in any case as the effects of the economic contraction takes hold. Whatever the outcome of the election Greek banks are facing nationalisation at some point As a result there will be a pressing need to recapitalise the banks under public ownership, which is a process that has already begun in Spain under the auspices of the ECB and EU.

Apart from the impact on hedge funds, vulture funds and other speculative vehicles, no disaster follows a Greek default if there is a recapitalisation.

In Britain, the equivalent of US$7.8bn in total Greek debt is held by these speculators. Less than US$3bn is held by British banks or public bodies (mainly the Bank of England). No negative consequences follow from writing this down to zero.

Cancelling the debt would remove one of the huge burdens on the population of Greece. It would not lead to any disastrous financial consequences for the ordinary citizens of the rest of Europe. For those who oppose ‘austerity’ across Europe, cancelling the Greek debt is the main practical contribution that can currently be made in support of those leading that struggle in Greece.