20 Years of Lost Output

.254Z20 Years of Lost OutputBy 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.

China’s economy speeds up

.111ZChina’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.

*   *   *

This article originally appeared on China.org.cn.

The Autumn Statement and Long-Term Austerity

.571ZThe 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.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Investment Slump Greater Than Whole Loss of British GDP

.375ZInvestment 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.
T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Britain’s Export Performance Is Woeful

.317ZBritain’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.
T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Lessons from Japan

.372ZLessons 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.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Ireland’s ‘austerity’ is working – for profits

.457ZIreland’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.
T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com1

The importance of the debate on the IMF’s ‘multipliers’

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.


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.
T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Lloyds Bank Can Fund Investment

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.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

The new recession is directly made in Downing Street

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. T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0