Tuesday, 22 January 2013

Productivity Crisis in the British Economy

By Michael Burke

The Office for National Statistics reports that productivity has fallen again the 3rd quarter of 2012, the fifth consecutive quarterly decline in productivity.

Figure 1

13 01 22 Figure 1

The fall in productivity is a function of rising hours worked and stagnant output. In the last 5 quarters output as risen by just 0.6% while hours worked have risen by 3.4%. Falling productivity is extremely unusual coming out of recession, as firms usually begin increasing output long before they increase hiring or hours. It has sparked a widespread debate on the ‘baffling productivity puzzle’. On this measure, this is the worst performance of all recessions since the 1990s.

Figure 2

13 01 22 Figure 2

A trend fall in productivity would have very serious negative consequences for long-term growth prospects. While the effect of austerity policies is to transfer incomes from labour and the poor to capital and the rich, a decline in output per hours worked would reduce the overall level of national income, or require an increase in hours worked simply to avoid economic contraction.

But the decline in productivity may be less mysterious than is widely suggested. George Osborne promised to preside over a ‘march of the makers’ but as Fig.2 below shows services output has been a gently rising incline. It is manufacturing output that has fallen.

Figure 3

13 01 22 Figure 3

Productivity, in terms of output per hour worked is significantly higher in the manufacturing and production sectors than in the services sector. The decline in manufacturing output would tend to lower the total productivity of the whole economy. In addition, energy extraction has a far higher productivity rate than manufacturing or the economy as whole, 12 times greater. Energy extraction has fallen by 7.9% over the last 5 quarters.

However manufacturing has been in a long-term decline. Even when all components of production are taken together, manufacturing, energy, utilities and construction account for less than 23% of all output in the British economy. The relative fall in manufacturing output cannot account for the fall in productivity for economy as whole.

Hoarding Capital

SEB has consistently argued that the source of the current crisis is the investment ‘strike’ by firms. The refusal of firms to invest accounts for the entirety of the fall in output since the recession. But this has a corollary, which points to how the crisis might be resolved. Firms have been hoarding capital, not investing. This increase in the savings of the corporate sector could provide the resources to fund an increase in investment.

In a normally functioning market economy private firms borrow to invest. But hoarding capital means the corporate sector has reduced its borrowing and increased its net savings. The chart in Fig.4 below shows the net savings of the non-financial corporate sectors, that is firms except banks and financial institutions. The corporate sector has been saving throughout the crisis. In fact, this saving is the counterpart of the refusal to invest is the cause of the crisis.

Figure 4

13 01 22 Figure 4

The ONS reports that one-third of all private sector firms are maintaining higher levels of employment than they needed in order to meet production. Firms who refuse to invest are holding onto to workers in expectation of an upturn, although employment is increasingly part-time and casualised. Real wages have also fallen continuously since 2008. Labour is becoming cheaper and more instantaneously disposable.

Reducing the outlays on employment, by firing workers or placing them on short-time is clearly easier and less risky than reversing an outlay on major capital investment. Firms can also fund higher levels of net employment because of capital-hoarding. But clearly this is not sustainable and firms’ savings may already be falling. Without a sustained upturn in output, the risk must be that unemployment will rise sharply or that real wages and full-time employment will fall further. The fall in productivity highlights the central importance of the investment strike.

Sunday, 20 January 2013

China has to deal with near stagnation in developed economies in 2013

By John Ross

A key issue for China’s economic policy in 2013 is to correctly assess the growth dynamic, or more precisely its weakness, within the US, Europe and Japan. The practical importance of this issue was rammed home by 2012’s experience. At the beginning of last year China projected a 10% export increase, which was only possible if the developed economies significantly expanded. This did not occur. The US experienced modest growth, around two percent, but Europe and Japan slipped into economic downturn. China consequently failed to achieve its 10% export growth target.

Failure to correctly assess export prospects, overestimation of the degree of growth in the advanced economies, in turn negatively affected China’s overall economy policy. As external demand was lower than expected the degree of domestic economic stimulus required was underestimated, China’s overall economic growth was consequently weak by its own standards in the first part of 2012 – the annual increase in industrial production falling to 8.9% in August and GDP growth declining to 7.4% in the 3rd quarter. More rapid growth only revived after a rather too delayed domestic stimulus launched from the summer.

For economic perspectives it is therefore important to be clear from the outset that 2013 will be another depressed year in the developed economies. The US economy should continue to grow, but at a low rate by historical standards. It is already possible to predict growth will be negligible in the European Union and probably Japan – although there some results may be produced by the latter’s new government’s stimulus policies. Overall China will therefore face a difficult trade situation. Domestic demand will be all important.

The difficult prospect for the developed economies, and therefore for China’s trade with them, is clearly revealed by analyzing their investment situations. It is sometimes mistakenly believed that because consumption is a larger proportion of an economy than investment it is the former which determines whether an economy grows or contracts. This is an arithmetical error. Consumption is a larger percentage of the economy than investment but it is also comparatively stable – particularly when ‘Keynesian’ counter cyclical policies are operated . Fluctuations in investment are much larger than those in consumption and therefore determine growth prospects.

For example in the US during the ‘Great Recession’ after 2007 the maximum decline in US household consumption was 3.4% while US government consumption did not fall at all. But the maximum decline in US fixed investment was 26.4%. In money terms, the maximum decline in US household consumption during the US Great Recession was $313 billion in inflation adjusted terms. But the maximum fall in fixed investment was $558 billion, or more than three quarters greater. Econometrics shows over 50% of economic growth in an advanced economy is accounted for by changes in capital investment.

Looking at the advanced economies entering 2013 reveals a clear picture. In all three major advanced economic centers investment has not even recovered to pre-financial crisis levels and recent indicators are negative. Taking these three main economic centers in turn:

· In the US, private fixed investment peaked as long ago as the 1st quarter of 2006 - over six years ago. In the 3rd quarter of 2012 its was 16.2% below its peak. In the last quarter US residential investment recovered slightly, but from a state of semi-collapse – US residential investment is 52.7% below its peak. US non-residential investment declined in the last quarter.

· In the EU fixed investment in the 3rd quarter of 2012 was 17.3% below its pre-crisis peak and has been falling for the last five quarters.

· In Japan the peak of investment was in 1991 – fixed investment in Japan has been falling for an astonishing 21 years. After a temporary boost from reconstruction following the earthquake and tsunami Japan’s fixed investment turned down again in the 3rd quarter.

Japan’s new government is putting forward a moderate size stimulus package – although given the long term depression in Japan’s economy it remains to be seen how effective this will be. However in the US and Europe no such programs are being advanced. Without a substantial recovery in investment strong growth in the advanced economies is impossible in 2013.

The impact of this on China is clear. Not only are the advanced economies stagnant but their trade performance is worse than their growth. In October, the latest month for which aggregated data is available, imports into developed economies were 6.4% below pre-crisis peaks and had been falling since January. Only the rise of imports into developing economies, which are now 22.3% higher than before the financial crisis, stopped China’s export difficulties being greater. To give precise trends, in inflation adjusted terms Japan’s imports were 2.6% below pre-crisis levels, the US 5.2% below and the Euro area 9.7% below. In contrast imports by Latin America were up 13.5%, by Africa and the Middle East by 24.7% and by developing Asian economies by 25.8%.

While import trends by developing economies are encouraging, half China’s exports still go to developed economies. China’s exports to developing economies are insufficient to fully offset the depressed conditions in the US, Europe and Japan.

China will therefore continue to suffer negative headwinds from the situation in the advanced economies in 2013. Import growth by developing economies will partially but not fully offset negative trade trends in advanced economies. Domestic demand will be decisive.

So far China’ moderate investment led stimulus launched in summer 2012 has been sufficient to speed up economic growth. Hopefully this will be enough and a further stimulus to domestic demand will not be required. Current projections of China’s growth for 2013 of 8.0%-8.5% are satisfactory in present international economic circumstances. But given the situation in the developed economies surprises in 2013 are more likely to on the downside than the upside. At least some contingency planning for a further boost to domestic demand, if required, may be required.

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The article originally appeared in Shanghai Daily.

Monday, 14 January 2013

20 Years of Lost Output

By Michael Burke
The Office for National Statistics (ONS) reported the latest data on industrial production as: ‘Production rose by 0.3% between October and November. Within production mining and quarrying rose by 8.7%’.
Both statements are factually correct. But this is very far from an accurate presentation of the data. Economic data provide the main navigation data for conducting economic policy. The ONS’ reporting of the latest production data invites us to admire the view while we are heading for the rocks.
The index of industrial production (IP) for November rose to 97.3 in November, from 97.1 in October. In September it was 97.9. The chart below shows the index of industrial production from 1992 to the most recent data.
Figure 1
13 01 14 Figure 1 Industrial production
The base date for measuring output is 2009 when the IP was set at 100. This means that in each of the last 3 months industrial production has been below the level seen in 2009, which was the deepest recession in Britain since the 1930s.
Prior to George Osborne’s Comprehensive Spending Review in October 2010 the IP index for in the 2nd quarter of 2010 stood at 102.7. In the following Budget he promised a ‘march of the makers’. Yet economic policy has overseen a complete reversal of the modest rebound in activity under Labour after it adopted a stimulus programme. Output has fallen by 5.3% from the 2nd quarter of 2010 and is now 1.8% below the low-point recorded in the recession.
The startling fact is that, as the chart shows the last time industrial production was lower than the most recent reading was in May 1992.
According the National Institute of Economic and Social Research GDP shrank by 0.3% in the final quarter of 2012. There will be much discussion about the unprecedented ‘triple-dip’ recession that the Tory-led Coalition has presided over. The criticism is entirely justified.
But the medium-term picture is even more grave. The British economy has slumped to levels of output last seen 20 years ago, at the depth of the ERM crisis. That too was another failed Tory experiment in the necessary ‘disciplines’ to curb wage growth and so restore profits.
This is a chronic failure of economic policy. A radical reorientation is required to halt the crisis.

Wednesday, 9 January 2013

China's economy speeds up

By John Ross

China's economy in 2012 was "a tale of two halves": In the first six months slowdown, even a feeling of developing crisis; in the second half recovery and accelerating growth. The story therefore had a happy ending. But it is worth noting what went wrong in the first half, and how it was corrected in the second, as this contains lessons for the future.

The initial problem in early 2012 was simple. China's economic policy makers underestimated the problems in the developed economies. China's official prediction of 10 percent export increase in 2012 could not be achieved without significant growth in developed markets. This did not materialize – the US economy grew slowly while Japan and the EU's fell into a new decline. Consequently, as is now officially stated, 2012's export target will not be achieved.

This itself was not an extremely serious error. It is impossible in economics, due to the enormous number of variables involved, to make precisely accurate predictions, only orders of magnitude can be accurately predicted. The undershoot in export growth in 2012 will not be enormous. To compensate for international demand being weaker than predicted China required a domestic economic stimulus. It was here that a much more serious problem initially arose.

Early in 2012 the World Bank produced a report arguing that China's state should "get out" of the economy – something clearly going against a new state stimulus program. Supporters of such neo-liberal policies in China, for example Lang Xianping, launched a campaign arguing that a stimulus program was futile and that China faced terrible economic depression. Western authors such as Nouriel Roubini advanced less extreme versions of the same analysis.

Such "the state must get out of the economy" neo-liberal policies have produced economic disaster where they have been pursued in countries as diverse as Europe, Latin America and Russia. I warned in this column in March that such policies would damage China's economy.

By summer 2012 the damaging consequences of state failure to intervene were clear. In May annual fixed asset investment growth fell to 20.1 percent, the lowest level for a decade. In August the yearly increase in industrial production declined to 8.9 percent, from 11.4 percent in January. In the same month industrial company profit fell 6.2 percent year on year. A sense of malaise, even elements of crisis, was evident during the first half of the year under the impact of policies which reflected neo-liberal opposition to state intervention.

Fortunately from mid-year policy changed, creating the happy economic ending to the year. In late May Premier Wen Jiabao announced growth must receive more support. An infrastructure investment program that grew to US$157 billion was launched. Theoretical support to the new stimulus was given by former World Bank Chief Economist and Vice President Lin Yifu – who specifically stressed an investment based stimulus package was preferable to a consumer based one.

These policies meant the state "getting back" into the economy – not in the sense of trying to administer it, but in that of setting the overall investment level. Such policies are familiar in either Chinese economic analysis stemming from Deng Xiaoping or Western ones coming from accurate reading of Keynes. Premier Wen Jiabao also turned the economic tables, explicitly justifying not only the 2012 stimulus but the earlier one in response to the 2008 financial crisis.

The stimulus package launched in mid-2012 was rightly of a much smaller scale than 2008's. In 2008 the world economy plunged downwards in the greatest economic decline since 1929. A huge stimulus was necessary to guard against downturn on such a scale – particularly under conditions where not only was there severe existing global recession but also further downside risks. The 2008 scale of stimulus, US$586 billion, was to guarantee China's economy was not dragged into global downturn.

But in 2012 there was stagnation, not sharp decline, in the advanced economies. China's required stimulus was therefore much smaller – a program on 2008's scale would have been highly undesirable in overheating the economy in these different circumstances. The announced infrastructure stimulus in 2012 was approximately one third of 2008's. But the state was "stepping into" the economy on an appropriate scale.

The correctness of these policies was shown rapidly. By November the investment decline had reversed – the annual increase in fixed asset investment rising to 20.7 percent. The same month year on year industrial production accelerated to 10.1 percent. Industrial company profits began to grow – rising to a 20.5 percent yearly increase in October and 22.8 percent in November. Profits growth in October and November was so strong that it turned the 1.8 percent yearly decline in January-September into a 3.0 percent increase in January-November. While GDP growth for the 4th quarter 2012 will not be available until later it would be highly astonishing, given these trends, if it were not higher than the 3rd quarter of 2012's 7.4 percent.

What are the conclusions, and what are 2013's perspectives? It showed, as always, the disastrous consequences of neo-liberal opposition to appropriate state intervention in the economy. A moderate problem facing China, lower than anticipated growth in developed economies, and consequently somewhat slower than anticipated export growth, became a significant crisis due to opposition to appropriate state intervention. However once policies were corrected, and appropriate investment stimulus policy measures adopted, all the advantages of China's economic structure came into play. Within a few months China's economy was recovering with an impetus that is strong enough that it will clearly continue into 2013.

China's difference to Western economies is that once the appropriate economic policy response is decided it has structures to deliver it. The Chinese state has sufficient levers that it can set an overall investment level in the way that Deng Xiaoping or Keynes considered necessary. This created rapid economic recovery in the second half of 2012. In contrast the Western economies have no structures to set the overall investment level. The latter remains purely in private hands – something Keynes explicitly warned would create crisis.

In the Western economies, to attempt to reverse the decline in fixed investment which is the core of the Great Recession, governments are reduced to running huge, ultimately unsustainable, budget deficits or flooding the economy with money – symbolized by the various quantitative easing programs in the US and hyperexpansionary monetary policies now followed by the European Central Bank and Japan's central bank. These have failed both to reverse the investment decline in developed economies while threatening other states in the global economy with inflation and currency fluctuations due to this excessive monetary expansion. China's policies ensure its own investment does not decline, thereby generating economic growth, while not pumping excessive monetary stimulus into the global economy.

Provided the policies which brought China's economy success in the second half of 2012 are continued, its economy's prospects for 2013 are clear. China's economy in the 2nd half of 2012 was on an upward trajectory shown clearly by upward shifts in profitability. As this was still growing it will clearly continue into the first half of 2013. Projections of accelerated growth for the first half of 2013, compared to 2012, therefore appear well founded.

During the course of 2013 external conditions will have to be reviewed to see if the existing domestic stimulus is sufficient – theoretically the domestic stimulus could be reduced if export conditions significantly improve, or it could be accelerated further if external conditions deteriorate. But 2013's basic dynamic is that China will grow much more rapidly than other major economies, due to its structural strength and its much superior mechanisms for dealing with economic downturns which 2012 again demonstrated.

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This article originally appeared on China.org.cn.