July 2016

The Corbyn Government and the private sector

The Corbyn Government and the private sectorBy Tom O’Leary
There has been a furious and ill-informed reaction to comments by Jeremy Corbyn and John McDonnell regarding the pharmaceuticals industry. This follows a renunciation of Corbynomics by the well-known blogger Richard Murphy. Both cases illustrate widespread confusion on the left and on the centre of British politics about the economy and its driving forces. Confusion is never helpful, and may be highly damaging and so it should be ended.

The central problems of British politics are that the Tory Party believes it understands the fundamentals of economic policy and that many on the Labour side share this high opinion the Tories hold of themselves. The fact is that the Tory Party has been in office for the overwhelming majority of the last 150 years in which time Britain has experienced a continuous relative economic decline without precedent in the modern era.

The Tory notion, that as business runs the economy then whatever business wants must be good for the economy, has been maintained throughout this decline and is even used as a justification for it. It is claimed that alternative policies would have been worse despite the mass of evidence provided by other countries who have experienced an enormous advance in their relative economic weight in the world economy over the same period. In economics, the Tories forget nothing and have learned nothing. It is not possible to offer economic solutions to the current crisis by mimicking them, as many in the Parliamentary Labour Party wish to do.

Corbynomics in government

The purpose of a political party is not to strike a pose or make propaganda but to wield power in support of the interests it serves. Jeremy Corbyn and John McDonnell reject the failed Tory nostrums of austerity, under-investment and chronic decline. In the economic sphere their aim is to achieve office in order to boost the living standards of the population, address key threats such as climate change and inequality and to ensure that the overwhelming majority of the population enjoy a far greater share of the wealth they create.

The context for this programme is that the private sector is the dominant component of the economy in Britain and will be for the foreseeable future. But the foolish Tory/Labour right notion that everything the private sector wants should be delivered is blatantly false in the era of the Panama Papers, Mike Ashley and Philip Green.

Instead a sober assessment is required of the strengths and failings of the private sector and government intervention should obviously be designed to strengthen the former and correct the latter. Overall, the current crisis was caused by the failure of the private sector to invest and has been extended by their continued refusal to organise an investment recovery.

There is a list of industries in Britain that have completely failed to deliver the necessary level of investment. There is a homebuilders’ sector which builds no homes, an energy sector which is keener on pollution through fracking than investing in renewables and which has led to power shortages being officially predicted this winter, and a set of railway companies which couldn’t run a whelk stall despite receiving a bigger government subsidy than British Rail. Crucially, Britain now has the highest level of charges for higher education in the world and yet a below-average attainment of a Master’s degree or above in the OECD.

The essential approach to these industries is that the private sector has failed to invest so that the public sector must. In some cases this means (re)nationalisation. But in all cases it means that the public sector regulates the level of investment at a much higher level and that the benefits or returns on this investment must also accrue to the public sector in order to be sustainable. This means the government or local authorities and others building homes. It means the state investing in renewable energy and energy storage and levying the energy sector companies to contribute to that. It means taking over the train operating companies and boosting investment via Network Rail. In education it means scrapping fees and raising the universities’ budgets so that they can increase their level of R&D and investment.

There is a separate category of profitable industries, many of whom employ large and well-paid workforces. These include banking and financial services, the military sector and pharma. There are others. Even here spectacular failure is possible so that nationalisation is unavoidable, such as Lloyds and RBS banks or potentially a large chunk of Rolls Royce. But in all cases the role of a radical government of the left is to harness those industries for productive use. This includes directing them towards useful new activities and ending subsidies and tax breaks for useless or harmful activities, using public purchasing, tax changes, regulatory measures and legislation to promote useful investment and deter damaging activities. To take just one very simple example, George Osborne cut tax credits for business investment in 2011 to in order to fund a cut in the rate of Corporation Tax. This is a net benefit to companies that do not invest at the expense of those who do, and should of course be reversed.

Harnessing these industries for productive use means banking becomes a channel for investment not speculation, the defence industry shifts into civilian use technologies such as industrial hardware, scientific research, civilian marine, aerospace and satellite production and so on. For pharma this means shifting R&D from ultra-expensive questionable palliative and non-essential drugs towards effective generic drugs and drugs to tackle the big global killers, malaria, heart disease, HIV/AIDs and so on which are currently neglected. In this way pharma is subordinated to the NHS and global health needs. For each of these industries there will also be strong benefits through government increasing its own funding for investment.

A third group of industries are mainly in the retail or service sectors, everything from real estate activity, to the leisure industries to personal services such hairdressing and high street shops. This group also increasingly includes functions such as social care and others formerly carried out by the public sector which have been outsourced to the private sector. Many, not all, of these are low-paid jobs. The role of government is to ensure that they are properly regulated, both in terms of staff and in terms of their customers. The National Minimum Wage, the fight for pay and job equality for women, black people and others and all forms of worker protection should be rigorously enforced across all sectors, but these are the sectors which include the most egregious employer offenders. Childcare needs to be placed on a well-funded collective enterprise, not a ramshackle and over-priced home industry as is currently the case.

Across all sectors the principles are to use whatever is the most effective lever to increase the level of the investment in the economy and ensure that the benefits of that are shared more equally among the overwhelming majority of the population. People’s Quantitative Easing, a National Investment Bank and regional offshoots, increased borrowing for investment all means to achieve that end. The state must aim to regulate the level of investment in the economy and that level must be much higher than currently. This is the road out of the crisis.

Norway, Switzerland or Albania?

Norway, Switzerland or Albania?By Tom O’Leary

The Brexit referendum campaign was dominated by assertions that the UK economy could benefit from access to or participation in the EU single market while opting out of the conditions on Freedom of Movement for workers. These assertions are false. This was continued during the strange Tory leadership contest, which had more casualties than debates, and has been repeated by the new Prime Minister and some of her key allies. This is a reactionary myth, with the potential to do great harm to the economy.
The former Justice Secretary and chair of the official Leave campaign Michael Gove dropped a bombshell in the Brexit campaign that not only would the UK be leaving the EU, which was on the ballot, but that a Leave vote meant we would be departing the single market too, which was not on the ballot. Gove made this highly damaging pledge because he followed the logic of the two official campaigns, which had been fought primarily on the terrain of anti-immigration. He understood that there was no realistic possibility of restricting Freedom of Movement (FoM) for workers while remaining inside the single market. 
Like Farage, Gove was effectively choosing impoverishment and lower immigration over prosperity and higher immigration. It was largely dismissed with derision, as Gove said the model would not be Norway’s or Switzerland’s relations with the EU, but those of Albania. All three countries are outside the EU. But Switzerland and Norway are part of the single market whereas Albania is not. Switzerland and Norway both have to accept all the conditions of access to the single market including Freedom of Movement (and pay far higher per capital contributions to the EU Budget than the UK does).
Elsewhere, confusion on the relationship between the single market and Freedom of Movement continues to dominate public discussion on this topic post-referendum. It is also in danger of infecting the debate inside the labour movement. For both reasons, it is necessary to set out the correct position:
  •  Under current circumstances and for the foreseeable future membership of the EU single market is crucial to the prosperity of the UK economy; living standards will fall outside it
  • The Freedom of Movement is a fundamental pillar of the single market, not an add-on or trade-off with it
  • In both cases, the single market and its Freedom of Movement component raise living standards in this country greater than they would otherwise be
  • The notion that it is possible to negotiate with the EU to access the single market while restricting Freedom of Movement (FoM) is false. It is unacceptable to the EU as a whole.

The nature of a market
A market allows the exchange of commodities. Any capitalist economy is a market on a grander scale, a series of interlocking markets. This exchange allows for what Adam Smith called the division of labour. Marx’s more precise term was the socialisation of production. This is the most powerful force in economic development. Adam Smith’s ‘Wealth of Nations’ was devoted to the outworkings of the division of labour. For Marx, the socialisation of production is the economic base of socialism.
To illustrate this point, no-one reading this piece on a laptop or a phone built that laptop or phone themselves. In a modern economy even the technology we have come to take for granted relies on a vast array of inputs of basic goods, different stages in the production process and an army of hundreds of thousands of workers to produce those goods, to develop, refine, market, transport, sell and service them and their various components. This army and this production process takes place across continents. Adam Smith argued it would take an enormous time for a single labourer to create just one pin from scratch. It would take an eternity to create a laptop from one individual’s labour.
Of course, the exchange of commodities in the market is unequal. The owners of the means of production can claim for themselves a huge proportion of the value created by the labour of others (which is one of the arguments for the common ownership of the means of production). But the benefits of the division of labour/socialisation of production cannot take place at all without the exchange that a market allows.
So too is the exchange between countries unequal. Many economies, most of them former colonies were unable to develop domestic industry before the whole world was already dominated by huge multinational enterprises. They often need to restrict access to their markets in order to develop domestic industry. This is a trade-off as costs are higher and technology necessarily poorer. But it is entirely legitimate for an oppressed country to take this detour so that is can later enter the world market. Britain is not an oppressed country.
In both cases, the optimal rate of development is ultimately produced by fully participating in the division of labour/socialisation of production. But because markets allocate resources on the basis of profit, not human needs, the optimal rate of development of the economy is when the market is allowed to fly freely within the iron cage of the state.
Continental-sized economies
The superiority of the capitalist system over its predecessors lay largely in its ability to harness the productive capacity of the whole economy and raise it up to a higher level. This was initiated on the basis of the nation-state, which necessitated in most countries sweeping away feudal domains, princes and kings, as well as their laws and restrictions on all the factors of production to create a single market. Those factors of production are goods, capital and labour. But as soon as feudalism was overthrown and supplanted by capitalism, most classically in the case of the Britain, production began to penetrate overseas markets. Capitalism necessarily created modern nations and immediately began to operate internationally.
In the modern era, entire economies are being organised on a continental basis and integrating into the world economy through that medium. The growth rate of trade within those continents is growing far faster than their external trade. North America, China and the EU are continental-sized economies. India may soon join them and it is to be hoped that so too will Latin America and Africa.
Irrespective of it size, to develop the potential of any market there must be free movement, distribution and exchange of commodities within that market. One of those commodities is labour. It would be impossible to imagine, say, a properly functioning market to build houses where bricks, wood, slates and so on could be freely exchanged, and builders were free to borrow to pay for them, but labour was excluded. The whole economy includes all sectors and construction serves here as just one illustrative sector. Freedom of movement of labour is integral to the optimal function of any market.
The EU Single Market
It is widely understood that the EU single market is vital to the maintenance of living standards in the UK. Even most of the Leave campaign leaders still want access to the single market. The greatest vulnerability in the current crisis is unlikely to be trade, even though new tariffs are likely to raise prices and cut exports to a certain degree. The bigger negative response is likely to be felt in terms of investment.
All large-scale firms operating internationally, wherever they are located, achieve market position and dominance by directing their activities towards the largest possible market, the UK’s vote to retreat from the EU will deter some proportion of large-scale investment, either by firms based in Britain or firms who might otherwise have invested here. Unless there were radically different economic policies where the state directs the bulk of investment, which is not on off in a country like Britain, then any economy dependent mainly on private investment will suffer outside the single market.
The EU and all its major component economies and political parties are committed to the operation of the single market including the Freedom of Movement. However they rationalise this, it derives from an understanding that they too would suffer economically if the single market were broken up. They are committed to FoM as an integral part of the single market for the same reason. Quite literally, it is only Little Englandism which opposes free movement.
Therefore the notion that effective membership of the single market can be achieved while restricting free movement of workers is a fantasy. It is a reactionary fantasy because it implies that FoM is a negative factor, unlike the movement of goods, capital and firms. Michael Gove recognised the unreality of being in the single market and promising to cut immigration, and so opted for the Albanian model. The EU cannot adopt that model, or allow others to while accessing the single market. Every train, lorry, car and van crossing borders would need to be opened to check whether the driver and passengers had the right to reside in the country.
Now that the Tory party has done its blood-letting, at least for now, its Brexit negotiations will be obliged to return to the real world.
It is imperative that the Labour Party stands for policies that will raise the living standards of the population. In that context, this means committing to membership of the single market and of course the free movement of movement of workers that makes it possible.  

Theory of under-consumption cannot explain the current crisis

Theory of under-consumption cannot explain the current crisisBy Michael Burke

Incorrect ideas usually reflect a one-sidedness or distorted analysis of a problem, reflecting one or a limited series of factors rather than encompassing the totality of all important factors, their proper weight and their inter-connection. So, the theorists of the Medieval church who insisted that the Sun and the planets revolved around the Earth could point every morning to the dawn and every evening to the sunset. The Earth was the centre of the Universe. Famously, what they could not explain is why Jupiter’s moons revolved around Jupiter or later, more prosaically, why a tall ship disappears gradually beyond the horizon, its tallest mast disappearing last. The theory explained one phenomenon but could not withstand new evidence.

The theory of under-consumption is espoused across a variety of schools of thought, in mainstream economics as well as by some of those describing themselves as either Keynesians or Marxists. It bears the same relation to scientific analysis as the ideas of the Medieval church do to astronomy. This is meant in a strict sense. Under-consumption can be used explain one or more phenomena, but cannot explain an all-encompassing crisis such as the current slump. It does not stand up to the evidence.

In a ‘normal’ or average business cycle downturn it might appear that some combination of household or government spending, or private sector investment or exports start to fall more or less simultaneously and GDP as a whole weakens. (Very often, behind the apparent widespread downturn is the leading role of falling business investment, but that can be set aside here). Some change in fiscal or monetary policy, increased government spending, lower interest rates, or a lower currency and so on may off-set the slump, ‘demand’ recovers and expansion resumes across all sectors of the economy.

But under-consumption cannot explain this crisis (or severe downturns in general). This is shown in a stylised account of the current crisis of the British economy using annual data. Fig.1 below shows the level of GDP, Consumption and Investment in real terms from 2007 to 2015. The data table is shown below for clarity.

The pre-recession peak of activity was in 2007. From that point to the low-point of the slump in 2009 GDP fell by £77 billion. Over the same period Consumption fell by £29 billion and Investment fell by £50 billion. Even though Investment is a far smaller component of total expenditure it fell by far more than Consumption. It was an Investment-led slump.

UK Real GDP, Consumption and Investment, £mn

The period since has been the weakest economic recovery on record. Annual GDP only surpassed the 2007 level in 2013. Over that time GDP rose by £34 billion while Consumption rose by £20 billion. But Investment was still the main brake on the recovery, down £31 billion from its peak level.

The most recent data to 2015 show GDP has increasd by £124 billion from 2007. Consumption has risen by £92 billion. But Investment has not recovered, being less than £1 billion higher in 2015 than in 2007. Worse, Investment has begun to contract once more in the latest two quarters. Therefore a GDP increase of £124 billion and a Consumption increase of £92 billion has led to zero increase in Investment, which is now declining.

Consumption has risen in the UK economy since the slump. But Investment has not. The theory of under-consumption, with the policy prescription that boosting Consumption will itself lead to a recovery in Investment has been demonstrated as false. The same pattern is true in the US and the Eurozone economies. Consumption is higher but Investment is flat or lower.

This is because private sector Investment is not determined by the level of Consumption but by profitablity. Without a rise in profits, private investment will not rise. Therefore it falls to the public sector to Invest, or wait until the private sector businesses graciously deign to invest once they see fit, perhaps destroying existing factories and offices and jobs first in order to recover profitability.

All theory is supposed to be able to explain the world. The theory of under-consumption cannot explain the world and the actual performance of the most advanced industrialised economies since the crisis. The theory is demonstrably false and should be junked.

Tory economic policy: “Welcome to Slumsville”

Tory economic policy: “Welcome to Slumsville”By Michael Burke

In what is probably a desperate attempt to stay politically relevant Chancellor George Osborne has announced a ‘5-point plan’ the centre-piece of which is an undated intention to cut the Corporation Tax rate to 15%. This is justified in terms of attracting investment to off-set the shock of the Brexit referendum outcome. It will do nothing of the sort. The effect will be to reduce further the funds available for public sector investment. As this deepens the investment crisis of the UK economy Osborne’s claim that this cut signifies that ‘Britain is open for business’ is false. Instead it indicates ‘welcome to a low tax, low investment Slumsville’.

Emergency measures to boost investment are almost certainly needed in the wake of the Brexit vote. Private sector investment was already in recession (two quarters of contraction) before the vote. As investment is the most volatile component of output it is likely that the first and most damaging effect of the shock will be further sharp reductions in private sector investment. But it is a myth that investment increases with reductions in Corporation Tax, as proved by Britain’s own recent history

SEB has previously shown that repeated cuts to the level of Corporate Tax (on profits) have not led to an increase investment at all. This is illustrated in Fig.1 below which shows the level of the CT rate and business investment as a proportion of GDP.

Fig.1 UK Corporate Tax Rate and Business Investment, % GDP

The highest levels of business investment in this period were when the CT rate was at 30%, close to its highs. After the slump business investment staged a weak recovery from 2009 onwards while the tax rate was unchanged. But repeated cuts to the tax on profits under Tory governments saw business investment stall. As noted above business investment has begun to contract once more even while the CT rate is at its low.

This should not be surprising. Business investment is driven by returns or profits. If Company X makes profits of £1 million and pays a 30% CT rate then the net profits will be £700,000 and it may be attractive to invest further. But if the same Company X makes profits of £500,000 and pays just a 20% CT rate of its net profits are just £400,000. This may be too low to attract investment.

Private investment is driven by returns not tax rates. Otherwise, Bulgaria, with a 10% CT rate would be one of the high investment economies in Europe with commensurately high living standards and Germany with a 29.65% CT rate would be one of the low investment economies with low living standards. The opposite is the case.

But the effect of the CT rate cut is worse than neutral. The UK Treasury works with the assumption that each 1% cut in the CT rate reduced Government revenues by £2 billion. Table 1 below shows the level of CT revenues by year.

Table 1. Corporate Tax revenues 2006 to 2015, £bn
Source: ONS
In 2006 the CT rate was 30% and the CT revenue was £50.9 billion. Therefore the taxable profits in that year were £169.7bn. In 2015 the CT rate was 20% and the CT revenue was £44.9 billion. Therefore the taxable profits in the year were £224.5 billion. Over the period profits rose by £54.8 billion yet the tax revenues from those profits fell by £6 billion.

Just as lower tax rates have failed to lead to any improvement in the level of business investment, restoring the CT rate would not lead to a slump in investment. If the CT rate had been maintained at 30% the revenues on the level of profits recorded in 2015 would have been £67.3 billion, or £22.4 billion more than actually recorded. A 10% cut in the CT rate led a £22.4 billion decline in revenues, slightly worse than but overall in line with the Treasury model.

With these additional Government revenues it would have been possible to fund very extensive public sector investment programmes. These would generate high-skilled and highly-paid jobs, boosting the level of economic activity and productivity. The projects themselves could be taken from the Government’s own National Infrastructure Plan, about which there has been so much publicity and so little activity. Previous experience shows that those parts of the private sector benefiting from increased public sector investment respond with increased investment of their own. This is the road that the Government should now go down in response to the crisis, providing a public sector-led investment response to the crisis. 

But the Tories strive at every turn to reduce the role of the state, even as the banks, the housing association sector and now possibly the social care sector falls into state hands as the private sector atrophies under the crisis. Unfortunately, the Labour right in the person of Alistair Darling signed up to the Osborne fantasy ‘Emergency Budget’, which even Osborne is not so reckless to implement. This signifies complete inability to learn anything from the economic crisis of the last 9 years. 

The only significant political force which understands the need for increased public sector investment in response to the crisis is the Labour leadership under Jeremy Corbyn and John McDonnell. Yet they are under attack, it seems, not despite their correct understanding of the solution to the crisis, but because of it.