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.654ZGeorge Osborne Shows He’s Learnt Nothing from Greece or Ireland

By Michael Burke

The Autumn Statement was widely presented as facing up to harsh realities of slower growth, but with George Osborne offering a series of cunning schemes in order to resolve the crisis .

The stagnation of the British economy is a function of government policy and plans to increase investment by increasing the credit available to smaller firms will founder because they will not invest when they don’t expect to make profits .

SEB has long argued that government needs to increase investment in a series of areas. Surely, the government’s plans to increase investment in infrastructure should be welcome? But the government’s planned increase amounts to less than £3.8bn spread over four years, or less than 0.1% of GDP in each year. In addition, most of the wish list for infrastructure and capital projects is dependent on investment in the private sector. So, George Osborne and Boris Johnson stood outside Battersea power station in London and talks of new tube lines, enterprise zones and 25,000 jobs. Just two days later the private developer central to the project collapsed into receivership.

Worse, the government’s planned increase in capital spending is paid for by taking money from the pockets of the poorest and most vulnerable in society. These will bite much harder in later years, long after the pathetically small planned increased in investment has come to an end. This is shown in the table below, from the Autumn Statement.

Table 1

So, there are total cuts in current spending in 2012/13 of £910mn and total cuts over the next 3 years of £3.8bn, shown as a positive sign in the Treasury bookkeeping method. This is in order to pay for tax cuts (fuel duty) and a projected increase in capital spending. But in the two following years the projected cuts to current spending increase dramatically for a total of over £27bn cuts in all. Although these are mostly unspecified, the itemised cuts include child tax credits, working tax credits, real public sector pay cuts and the breaking of the promise to uphold overseas development aid at 0.7%.

This is a very damaging but much milder version of the same logic that has led Greece and Ireland to disaster – every failure to meet budgetary targets because of the impact of ‘austerity’ is met by further ‘austerity’ measures. But the deficit is and borrowing totals are likely to go higher still as the economy stagnates- or worse. It may only be a matter of time before this same logic produces comparably savage cuts in spending- with the same economic consequences.

Politically, by pre-announcing needed cuts for the next Parliament Osborne hopes to bind all parties to further ‘austerity’ measures. For the LibDems, Danny Alexander has already proved obliging, signing up to Tory cuts of £23bn in the next Parliament. The key question is whether Labour will go down the same path in accepting the need for cuts even when they have demonstrably failed to deliver economic growth or even deficit-reduction. It is the path that leads to Athens and must be resisted.

.913ZDesperate Osborne’s Subsidies to Businesses Won’t Work
By Michael Burke

George Osborne has told the BBC that there will be £40bn in ‘credit easing’ so that small firms can obtain both cheaper and more readily available loans. Osborne has called the scheme a ‘game-changer’. If the funds had the stated impact, of increasing investment by small and medium-sized enterprises (SMEs), then it would certainly provide a significant lift to the economy. £40bn is equivalent to 2.8% of GDP.

The strength of this overblown rhetoric may be judged by the fact that there are widespread reports that the Office for Budget Responsibility is set to slash its growth forecasts for 2012 to just 1% from 2.5% previously.

How is it that significant funds for new investment by business will actually lead to no improvement in the outlook for growth, even on the usually over-optimistic forecasts from the OBR?

There are to be at least two, possibly three funds. The first will be guarantees to increase the availability of credit. The second will be a fund to lower the cost of that credit to SMEs. Since SEB continually argues for increased investment, surely this is a good thing?

Private Sector Failure

Even official forecasts do not assume that growth will significantly improve as a result of this policy. This highlights the fallacy that underlies all current attempts to persuade, cajole, demand or bribe private firms to increase their investment. The fallacy is that those firms are struggling under the burden of insufficient funds to invest. Of course certain individual firms may have such difficulties. But in aggregate that is not the case.

In a previous bulletin SEB showed that in 2010 the total Gross Operating Surplus of the business sector in Britain was £475bn. These are akin to profits. Yet the entire level of investment (Gross Fixed Capital Formation) was just £214bn in 2010. As this includes the investment by both private individuals and government, it is clear that businesses have vast resources already from which they could increase investment.

The chart below shows the decline in total Gross Fixed Capital Formation (GFCF) and corporate sector GFCF. Both these measures of investment began falling one quarter before the recession itself began. The fall in both at their low-point in the 4^th quarter of 2010, of over 20%, is approximately three times as great as the fall in GDP of at 7.1%. Both chronologically and arithmetically the decline in investment, led by declining business investment, led the recession.

Both measures of investment have experienced a small recovery. Business investment began to rise in the 1^st quarter of 2010. This was two quarters after both total investment and GDP began to rise in the 3^rd quarter of 2009.

Private sector investment led the recession. But it cannot lead the recovery. This is demonstrated in the chart below, which shows corporate GFCF and GDP.

The recovery in business investment occurred two quarters after the economy as a whole began to recover. This is because the increase in investment did not depend on the availability of resources, as profits have exceeded investment by some distance throughout the entire crisis.

Corporate investment rises and falls in line with expected returns. The purpose of capital is the preservation or expansion of capital. If the economy is not growing a main motive will be to preserve capital. If the economy is expanding, it will be increase capital through profitable returns on investment.

This is what happened in 2009-10. GDP began to expand in mid-2009 and six months later corporate GFCF began to increase. Precisely the same time lag operated in the reverse situation. Corporate GFCF fell once more in the 1^st quarter of 2011. This was six months after the modest recovery peaked n the 3^rd quarter of 2009.

Public Sector Leadership

The new factor which caused the recovery was the increase in public sector investment (both by general government and the remaining public sector corporations). At its highpoint in the 4^th quarter of 2009, public sector investment was over 20% higher than its pre-recession level.

This led directly to the increase in GDP which in turn eventually prompted the private sector to increase its own investment. The Tory-led Coalition immediately cut public investment on taking office, and six months afterterwards private investment began to contract once more.

Instead of subsidising the private sector to invest, the proven means of achieving that end is for government to increase its own investment. It could divert the support for borrowing costs to agents who are willing to invest, such as local authorities who want to invest in housing, infrastructure, transport and education.

Even on official forecasts the borrowing subsidy to SMEs will not work. But the recent history of the British economy shows that investment by the public sector will have the effect of restoring growth which in turns leads o a revival of corporate investment. Subsidies and bribes to businesses to invest will not work while there is no growth. Increasing, not cutting, the investment of the public sector will lead to recovery.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

.044ZLatest UK GDP data even worse than it looks
By Michael Burke

The latest release for British GDP in the 3^rd quarter was unrevised – but the composition of that growth was awful. GDP rose by 0.5% in the quarter and is just 0.5% higher than a year ago. But analysis of the components of growth suggests the outlook is deteriorating.

Household consumption did not grow at all in the quarter and contracted by 1.5% over the course of the year. Investment (gross fixed capital formation) fell by 0.2% in the quarter and by 1.8% from a year ago. In terms of domestic expenditure only government spending rose in the quarter, up 0.9% on the quarter and 2.9% over the year. This is testimony to the multiplication of ‘austerity’ measures: If unemployment and poverty are increasing at a faster rate even than you cut welfare benefits your total welfare bill will rise.

Taken together UK domestic expenditure rose by £3bn in real terms in the quarter. But inventories rose by £2.9bn at the same time and therefore account for almost the entirety of domestic growth in the quarter. Since GDP rose by just £1.8bn in the 3^rd quarter, the rise in inventories indeed exceeds the growth in GDP as well as accounting for almost the entirety of growth in domestic spending.

Inventory Build-Up

Inventories are a cyclical and erratic component of growth. But a persistent rise in inventories over a number of quarters only occurs if businesses are receiving new orders and are restocking as they become increasingly confident about a sustained upturn. This is sometimes called a voluntary rise in inventories. But this is not at all the situation presently. Domestic demand is stagnant and exports have also fallen in the last two quarters. It seems unlikely that order-books are filling up and businesses becoming more confident about future prospects. In fact the respected Market Purchasing Managers’ Index shows that new orders have been slowing dramatically, as shown in the chart below.

Therefore the current build-up in stocks is likely to be an involuntary. Inventories are most likely rising because sales have not met expectations. If so, businesses will tend to meet new orders by depleting those existing inventories rather than increasing output. At the very least this rise in inventories is unlikely to be repeated over several quarters. The addition to growth in the 3^rd quarter arising from rising inventories is unlikely to be repeated over several quarters.

As we have seen domestic demand would have been close to zero and GDP would have contracted without rising inventories. To avoid that fate in subsequent quarters some other component(s) of growth will have to begin to grow once more. Otherwise the British economy will begin to contract once more.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com1

.209ZProfits and Austerity In the Industrialised Economies
By Michael Burke

A previous SEB article examined the profit rate in the Irish economy which is rising even though the economy continues to contract. Yet at the same time Ireland’s level of investment is falling. Corporate incomes – profits – are rising even though total economic activity is falling. Arithmetically, this can only occur by reducing the income of labour – wages are falling both in absolute terms and as a proportion of total economic activity. It happens that the Irish Department of Finance set this out with some clarity. This is indeed is the thrust of the entire ‘austerity’ policy – a transfer of incomes from labour to capital across the industrialised economies of Europe, as well as in the US and Japan.

Who Is Paying for the Crisis?

The table below shows the Gross Value Added (GVA) of selected economies, and how this is divided between the compensation of employees and the gross operating surplus of the corporate sector. GVA is a measure of all the value created in an economy. It is the same as GDP except that it excludes the impact of taxes and subsidies. With some important qualifications the Compensation of Employees (CoE) is akin to labour’s share of that value added, while the Gross Operating Surplus (GOS) is akin to the level of profits in each economy. This provides an approximate measure of economic activity and its distribution as income: Value-Wages-Profits. In the table blow the profit rate is calculated as the share of GOS in Gross Value Added.

The general tendency has been that the crisis-hit countries have the highest profit rates. This was an important factor in the build-up to the crisis. In nearly all countries the crisis was characterised by reduced investment by the corporate sector, which remains the driving force behind the economic crisis. In these higher profit countries the fall in investment had a greater impact on aggregate demand as the corporate sector takes a bigger share of GVA. In turn, the fall in investment had a bigger negative impact on household incomes, especially through rising unemployment.

Profits and deficits

The profit rates should also be seen in relation to the public sector deficits that have caused so much turmoil. In all cases the public sector deficits are a fraction of the level of profits. In Greece the 2010 deficit was €25bn, in Italy it was €70bn, in Ireland it was €19bn (excluding an extraordinary bank bailout), and so on. The deficits could easily be covered in their entirety simply by extracting a fraction of the profit level from the corporate sector in each country. The same is true of Britain, where the profit level in 2010 was £475bn compared to a deficit of £137bn. (The British profit level is depressed and consequently the profit rate is lower because of the slump in the financial sector – a factor which also applies to a lesser degree in the US and even to France).

Who can pay for the crisis?

There are effectively three destinations for profits. These are investment, which raises future prosperity, or dividends for shareholders which are not invested or huge executive compensation and bonuses, both of which do not. The table below shows the level of profits, the level of public sector borrowing and the level of gross fixed capital formation (investment). In the last column the difference is shown between the level of profits and the level of public borrowing and investment combined.

Table 2 shows that in all cases the current level of both the public sector borrowing and the current level of investment can be funded by the level of profits in each country and in the Euro Area. In most cases there is scope to fund both the deficit and significantly increase the level of investment. But the opposite has been happening.

The struggle over distribution of national income

In most recessions capital’s share of income falls. This is not because wages rise, but because profits fall at a faster rate than the fall in output. What then usually occurs is a struggle by capital to regain its lost share of income. It does this by cutting wages and benefits, by increasing unemployment and by reducing its tax burden – financed by reducing social welfare benefits. This is the content of ‘austerity’ measures.

Figure 1 below shows how this has operated in the Euro Area as a whole. Between 2008 and 2009 GVA in the Euro Area fell by €254. Confirming the idea that profits fall at a faster rate than output, Euro Area profits (GOS) fell by €227bn. Profits fell by over 6%, twice as fast as the fall in output. Wages (CoE) fell by €17bn.

However, this natural tendency for profits to fall at a greater pace than the fall in output is interrupted and diverted by a series of interventions, including rising unemployment, wages and benefit cuts as itemised above. In the period 2009 to 2010 Euro Area GVA rose by €188bn. Of this increase in output €139bn went to profits and just €53bn accrued to wages.

Because of inflation the real level of both wages and profits has fallen sharply – all these data are in nominal terms and do not take account of inflation. The ‘austerity’ offensive to increase the profit share has partly been successful, but the wage share of national income has not undergone any strategic reversal.

This is contrasted with Greece. Greek nominal GVA did not fall in 2009 at all as the Greek recession was shallower than most. GVA fell in 2010 by €6bn. This is shown in chart 2. The massive offensive against Greek workers and the poor means that the natural tendency for profits to fall faster than output has not operated. The level of wages fell by €4.4bn and profits fell by just €1.8bn. The wage share of national income has suffered a reversal.

Readers will be interested to know where Britain stands in relation to these examples, one of them the extreme case of Greece (and previously, Ireland). In 2009 British GVA fell by £38bn, shown in Chart 3 below. This was exceeded by the fall in profits, down £43bn and wages rose by £5bn. The entirety of policy since has been to reverse those trends. GVA rose in 2010 by €40bn. (It should again be stressed that these are nominal data, in real terms output is still over 4% below its peak and real wages have fallen).

As a result of initial ‘austerity’ measures, £18bn of the increase in output has been claimed for profits. But it is widely understood that the real offensive in Britain only began in the new Financial Year, which began in April this year. What is being attempted is a decisive reversal of the wages’ share of national income.

Conclusion

Countries like Greece are experiencing a qualitatively sharper crisis than the European average. There is a high correlation between the likelihood of economies falling into this type of extreme crisis and their exceptionally high level of pre-crisis profits. Because the income of the corporate sector is a much greater factor in the economy, their investment strike hass a proportionately greater impact on total output and/or government finances.

Profits remain exceptionally high, so much so that they could finance the deficit while simultaneously increasing the level of investment.

Under normal working of a market economy the tendency is for profits to fall faster than output. The entire ‘austerity’ policy is to prevent this tendency from operating, and to reverse it by reducing wages even faster than the decline in output. In the Euro Area, to date this has only been achieved in Ireland and Greece.

In Britain, it’s too early to say whether a similar ‘austerity’ drive will achieve the same disastrous results. But it is clearly the aim of government policy to drive up profits even while the economy is stagnating. This can only be achieved by driving down wages.
T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

The relation of profits and ‘austerity’
By Michael Burke

In what may be an important development the Financial Times reports that, in return for accepting much larger ‘haircuts’ (imposed losses on the value of the bonds they own) bondholders are demanding that there must be a growth strategy for Greece.

In a piece headlined ‘Bondholders Demand Greek Growth Plan’ the paper quotes the Managing Director and chief negotiator for the Institute of International Finance, which represents the largest bondholders mainly the banks. The call for a growth plan is not given much substance in the article.

But there is a logic to the demand. Bondholders are most concerned about cash flow from interest payments and the final repayment of debt principal. In all the Euro Area economies where severe ‘austerity’ measures have been applied bond yields have risen – Greece, Ireland, Portugal, Spain and now Italy. This implies that the bondholders’ risk of not receiving those cash flows and principal has risen, and that a higher interest rate is demanded to compensate. ‘Austerity’, a generalised attack on the living standards of the overwhelming majority, has failed to provide reassurance to bondholders that they will get all the bond repayments. Instead, the reduction in incomes and economic crisis that has followed has increased the risks that the governments will default. If it proves to be the case now that the bondholders are demanding not more austerity, but growth, this would reflect the accurate judgment on their part that the risk of default has increased because of massive cuts in government spending. It is a demand that the European governments provide funds to Greece to help the economy recover, not impose more cuts.

Can ‘Austerity’ Work?

Of course the bondholders, mainly the banks but also increasingly other parasites such as hedge funds and ‘vulture funds’, had no qualms about massive assaults on pay, jobs, pensions, services and welfare benefits while they thought it improved their own prospects of being repaid by EU governments. But even at an earlier stage it was clear to some that cuts in government spending would not work. This is shown in the actions of the credit ratings’ agencies – who effectively represent the interests of the bondholders – and have repeatedly campaigned for large cuts in government spending, only then to downgrade countries such as Greece, Ireland, Portugal and Spain because of the negative economic impact of those same cuts.

By now it is increasingly clear in the case of Greece that any further cuts will be equally counter-productive in restoring the growth required to service debt. But the IMF, ECB and EU Commission are holding up another example of how their impositions can be made to work – Ireland. The ‘Troika’ argue that successive Irish governments (the current coalition of the rightist Fine Gael and Irish Labour Party having replaced the populist right of Fianna Fail) have stuck to the measures agreed, that growth has resumed and that therefore the deficit is falling.

In fact, the previous government imposed cuts in 2008 and before any international agency demanded them. The current government is set to announce its own first Budget, which will also impose greater cuts than demanded by the Troika. It is also widely understood, if not by the Troika, that Irish GDP is artificially inflated by the activities of (mainly) US multinationals booking activity and profits in Ireland to avail of its ultra-low corporate taxes. This has seen GDP rise in the latest two quarters. But domestic demand fell again by 1.1% in the 2^nd quarter of this year, a 3 ½ year-long slump collapse and is now 24.8% below its level at the end of 2008. According to the IMF the Dublin government’s deficit will be 10.3% of GDP this year, having been 7.3% before the cuts began to bite in 2008.

Even so, the Troika are increasingly determined that the deficit will decline and prove their case. They point to the fact that, excluding enormous bank bailouts equivalent to over 20% of GDP last year, borrowing fell from €23.5bn in 2009 to €19.3bn in 2010, an improvement of €4.2bn. Yet this is simply because the value of bonds redeemed in 2010 was €4bn lower. Otherwise there is no underlying improvement in the level of borrowing at all.

But there is an important difference with Greece. Following big tax increase Athens’ taxation revenues have fallen by 4.2%in the first 9 months of this year whereas Dublin’s tax revenues are 8.4% higher reflecting the imposition of new income taxes. The key difference is that Ireland was a much more prosperous country than Greece prior to the crisis. Per capita incomes were 50% higher, even adjusted for Purchasing Power Parities. Therefore, while the cuts have certainly had a negative impact on Irish growth, and the domestic economy continues to contract, the level of impoverishment of the entire economy is not in the same category as Greece, where even bondholders may now accept that further cuts are counter-productive. Instead, the impact of the cuts in Ireland might be said to be Greece in slow-motion.

Who Benefits?

The new caution in imposing further cuts in Greece is the worry of the loan-shark that the borrower may go bankrupt. But while there is still blood that can be squeezed in countries like Ireland cuts remain the sole policy agenda. The effect of this policy is clear from the recent publication of the sectoral accounts for the Irish economy.

This is shown in the chart below, which shows that as Gross Value Added continues to decline, profits have started to recover and therefore the profits’ share of national income has increased.

According to the Central Statistical Office (CSO), ‘The operating surplus or profits of non-financial corporations (NFCs) increased from €35.2bn in 2009 to €37.8bn in 2010. The other main component of value added is compensation of employees or wages and salaries which declined from €37.3bn in2009 to €34.9bn in 2010. Therefore the improved profit share relates more to a decline in payroll costs for these corporations rather than to an increase in overall value added.’
Yet this increase in the incomes of the corporate sector, wholly achieved by reducing wages, has not led to an increase in investment. It has led to the opposite, as the chart below shows.

In the words of the CSO, ‘Expressing gross fixed capital formation as a percentage of gross value added gives the investment rate. Gross value added is largely unchanged between 2009 and 2010 while investment fell from €7.5bn to €5.8bn in the same period resulting in a fall in the investment rate between 2009 and 2010.’

But there is also another way of expressing the investment rate – investment as a proportion of corporate incomes, or profits. On this measure, the investment rate has fallen by €1.9bn even as profits have increased by €2.9bn, by reducing wages by €4.9bn. The total investment rate has fallen on this measure from 21.3% to 15.3%.

From the point of the view of the economy as a whole, this transfer of incomes has been disastrous. The corporate sector has €32bn in unspent (uninvested) income from profits. But the household sector – which spends more than 90% of its income – has had its income reduced.

The thrust of policy is not to produce an economic recovery. It is to produce a recovery in profitability. In this, it has been a qualified success. The absolute level of profits has recovered from its low and the profit share of output has also increased to more than 50%, even if profits have not recovered their previous peak. The intention is clearly to achieve that goal at the expense of wages.

In Ireland it has become commonplace to suggest that, while all sorts of investment projects and welfare provision are desirable, ‘there is no money left’. On the contrary, the €32bn level of uninvested profits in 2010 alone is almost exactly equal to the entire reduction in GDP in the recession which began in 2008, €34bn.

This is the thrust of the entire ‘austerity’ policy across Europe, the transfer of incomes from labour to capital in order to increase profitability. In a subsequent blog SEB will examine the effective of this policy in the leading European economies, including Britain.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com1

GDP Data Show UK Stagnation Is Home Grown & Due to Government PolicyBy Michael Burke

Publication of the latest estimate of GDP data shows that the recession was much sharper than previously thought. The revision shows that GDP contracted by 7.1% rather than the 6.4% previously estimated. The recovery which began in the 3^rd quarter of 2009 was also slightly stronger than previously estimated, the economy expanding by 2.8% until the 3^rd quarter of 2010. From that time onwards the economy has stagnated completely, with zero growth in the three  quarters since. The result is that the British economy is 4.4% below its peak level before the recession, which is now estimated to have begun in the 2^nd quarter of 2008.

George Osborne and other Tories as well as their supporters in the media are now promoting the idea that the stagnation of the British economy is a function of the turmoil in the Eurozone economy and financial markets. The main channel for economic weakness in the Eurozone to be expressed in British economic activity is via exports. But the British economy has not grown over the last 9 months – while the first dip in exports has occurred only in the latest quarter. This is highlighted in the chart below, which shows the level of total domestic expenditure versus exports. Domestic demand began to contract as soon as the current government took office. Evidently, the stalling of British economy has not been caused by the turmoil in the Eurozone.

In fact the opposite is the case. The British economy comprises 14.5% of the entire EU economy, in OECD terms approximately $2trn of a total $13.8trn (in Purchasing Power Parities). Yet even before the latest downward revisions to GDP by the Office of National Statistics are included, the OECD data show that the entire loss in EU GDP was $355bn, of which British economic weakness is 21.4% of the total, equivalent to $76bn. As the chart below shows, the British economy has been a brake on the Eurozone economy, not vice versa.

Stagnation

Returning to the ONS release, the total loss of output since the UK recession began is £65.2bn. The total loss of investment (Gross Fixed Capital Formation) over the same period was £43.3bn, that is almost precisely two-thirds of the entire recession. But the latest data also represent a turning point. The total loss in household consumption during the recession was larger at £51bn, over three-quarters of the total contraction in the economy. The fall in household consumption began to outstrip decline in investment in the 1^st quarter of this year.

This loss in consumption has therefore not been the catalyst of recession. The decline in investment preceded the recession by 6 months. Declining investment was the driving force of the recession. But it does indicate that there is a new and significant and pressure on household spending in the British recession. Other components of the national accounts have risen over the same period, notably government current consumption and net exports.

It is also no longer the case that the private sector fall in investment exceeds the total decline in investment. Previously, this had been the case as government investment had risen. As a result the fall in private sector investment had amounted to 80% of the total lost output through the course of the recession. Now the decline in private sector investment amounts to £36.5bn – 56% of the total decline in output.
But government investment is now falling. In total, government investment has fallen since the recession began, down £6.8bn. But this is entirely a function of the current government’s policy. Since the Tory-led government took office, government investment has fallen by £12.2bn, more than reversing the very modest rise in investment of the previous Labour government. The direct effect of the government decision to reduce investment is to cut GDP by 0.9%.

Recovery Derailed

These are only the direct effects of declining government investment. It is now commonplace to speak of a continuous recession from the 1st quarter of 2008. Cameron and Osborne routinely speak of their dire inheritance from the Labour government. The actual inheritance of the Tory dominated government was actually an economic recovery underway, which after the latest revisions is now stronger and longer than previously estimated. The economic recovery lasted 5 quarters and GDP expanded by 2.8%, whereas previously it was estimated at 4 quarters long and a recovery of 2.5%.

The Labour government did not begin to increase investment until the 4^th quarter of 2008. From that time until the new government took office government investment rose by £27.2bn. But this had an indirect effect primarily by encouraging private sector investment so that the economy expanded by £38.7bn in total.
On the same ratio the current government’s decision to reduce its own investment will have led to a total decline in output of £17.4bn, or 1.3% of GDP.

Conclusion

The UK economic stagnation is a home-grown one due to the policies of the present government. It began before there were any negative effects from the Eurozone’s turmoil. It is primarily a function of the government decision to reduce its own investment. The British economy is stagnating because of policy made in Downing Street and nowhere else.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Economic downturn in the UK now twice as bad as in the Eurozone due to government deficit cutting
By John Ross

One of the more factually inaccurate pictures being spread by supporters of the policies of the present UK government – with its priority to budget deficit reduction – is that UK economic performance during the financial crisis is superior to that of the evidently crisis hit Eurozone. A typical version of this appears in an article on 3 October in the Daily Telegraph by its international business editor Ambrose Evans-Pritchard.

Evans-Pritchard states: ‘My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse [the Eurozone] by foolish elites.’ Presumably Evans-Pritchard’s sympathy goes to the inhabitants of the Eurozone, rather than his own country the UK, because he believes the UK has been doing better than the Eurozone.

The factual situation is the exact opposite of the impression presented by Evans-Pritchard. Judged by economic performance, the average citizen of the UK far more needs Evans-Pritchard’s sympathy than the average citizen of the Eurozone – i.e. the UK’s economic performance during the financial crisis is much worse than that of the Eurozone. This may be seen in Figure 1 – which shows UK GDP compared to that of the Eurozone since the peak of pre-financial crisis output. Comparison is straightforward as in both the Eurozone and the UK the peak of the previous business cycle was in the 1st quarter of 2008.

By the 2nd quarter of 2011, that is 14 quarters after the peak of the previous cycle, Eurozone GDP was 2.0 per cent below its previous peak level whereas UK GDP was 3.9 per cent below its previous peak – i.e. UK economic performance was almost twice as bad as that of the Eurozone.

Equally striking is the clear way in which present government’s policies made UK economic performance worse than in the Eurozone. It may be seen from Figure 1 that while the initial decline in UK GDP was greater than in the Eurozone – the greatest decline in UK GDP being 6.4 per cent registered in the 3rd quarter of 2009, compared to a maximum Eurozone drop of 5.5 per cent in the 2nd quarter of 2009 – recovery in the UK was also initially more rapid. This may be clearly seen in Figure 2, which shows year on year GDP changes.

The UK and the Eurozone reached their 1st quarter 2008 peaks with almost exactly the same economic momentum behind them – 1.9 per cent growth in the previous year in the UK and 2.0 per cent in the Eurozone. However by the 3rd quarter of 2010, the one immediately following the departure of the  previous government, UK GDP was rising at 2.5 per cent compared to 2.0 per cent in the Eurozone. Eurozone recovery subsequently slowed somewhat to 1.6 per cent by the 2nd quarter of 2011.

However UK GDP growth under the new government, which gave priority to budget deficit reduction, dropped astonishingly, by more than two thirds, from 2.5 per cent to 0.7%. Under the new government the year on year growth of UK GDP therefore fell from being higher than that of the Eurozone to being less than half that of the Eurozone!

The present author is not a supporter of the present constitution of the Euro. On the contrary I predicted the current events unfolding in Greece and other countries in advance due to fundamental weakness in the design of the Euro. Writing in 1996, i.e. fifteen years ago:’ [the Treaty of] Maastricht’s proposals are … disastrous. It proposes to create the most fundamental features of a common state — a single currency and a central bank. But it does not create any state budget which can deal with the huge regional and sectoral implications of this. The process that would unfold with the creation of a single currency by this method may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join.There will be sharply deepening regional imbalances and inequalities.’There is evidently no reason to revise that analysis.
It is therefore all the more striking that UK economic performance is actually worse than in the Eurozone. And a substantial reason it is worse is clearly due to the policies of the present government with their priority to budget deficit reduction.

In any discussion of the relative economic performance of the Eurozone and the UK two fundamental facts must be held in mind against unsubstantiated myths:

• UK economic performance during the financial crisis is substantially worse, almost twice as bad, as that of the Eurozone.
• And the reason it is that bad is because the present government, through its priority to cutting the budget deficit, reduced the UK’s rate of economic recovery from substantially above that of the Eurozone to less than half that of the Eurozone.

This factual situation evidently has a more general economic significance than merely for the UK and the Eurozone. For reasons dealt with frequently on this blog a policy of simply running budget deficits is inadequate to deal with the consequences of the present financial crisis as it does not tackle its driving force – the decline in investment. But under conditions of private sector weakness any rapid reduction in the budget deficit will lead to rapid economic slowdown or contraction. This is sharply illustrated by the fact that the UK government, by such policies, has reduced the UK’s rate of economic recovery to less than half that of the openly crisis struck Eurozone.

Other countries thinking of embarking on immediate deficit reduction policies, such as those advocated by the Republicans in the US, should look at the UK and draw the appropriate negative conclusions. Do not be totally distracted by financial fireworks: the policies of the present UK government are so bad they have produced an economic recovery which is only half that of the Eurozone!

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This article originally appeared on Key Trends in Globalisation.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Move towards some sensible ideas from Samuel Brittan
By Michael Burke

The Financial Times’ veteran economics commentator Samuel Brittan has recently argued for the state’s holdings in the banks to be used as the basis for creating a new state bank focused on productive investment.

Echoing calls from Adam Posen, he argues that the disastrous fall in both the money supply and bank lending needs to be corrected by decisive state action. Posen is perhaps the sole member of the current Bank of England Monetary Policy Committee who understands the gravity of the current situation and is not constrained by official orthodoxy in seeking remedies l.

These are similar ideas as those outlined in the recent pamphlet, ‘A Brighter Economic Vision for Britain. Brittan says his own proposal, ‘…is to use the state-owned banks as the nucleus of Mr Posen’s proposed state lending bank for small and medium enterprises. Who knows what obstacles well-paid lawyers could think up? But in principle this could start next week. The main thing needed would be a Treasury directive to these banks to replace profit maximisation with a requirement to promote economic recovery.’

One reason for the renewed slump in the share price of leading British banks is their exposure to the sovereign debt crisis. Yet Lloyds-TSB Bank, for example has seen the price of its shares fall from 74p at the time of the government’s share-buying programme to 34p as at the close of trading on September 23. This compare to the collapse of RBS’ share price to 22p compared to the government purchase price of 52p – despite the fact that (aside from the US and Britain) Lloyds has no significant exposures to sovereign debt markets at all.

This highlights the fact that the main driver of the slump in banks’ shares is not primarily the debt crisis, severe though that it is. The share prices have collapsed because of economic weakness and the deterioration in the banks’ existing loan book, personal, business, mortgage and other loans.

Therefore it is possible to differ with Brittan’s analysis in two respects. First, the banks’ refusal to lend is driving both the fall in profits and the share price on which it rests. They are not ‘maximising profits’ but hoarding capital in order to preserve it. A government instruction to lend is the only way to break the lending and investment strike. Secondly, it is a widespread misconception that small and medium-sized enterprises (SMEs) are the key to growth. In reality, outside the personal services sector they mainly provide inputs to much larger firms. Bundling up loans to SMEs will not create the investment demand for smaller firms’ output. The largest firms show no intention of increasing their own investment – which is what is required.

Instead, only government can break the log-jam by initiating investment in housing, in infrastructure, in transport and in education. The private sector would benefit. These contracts would mainly be awarded to large firms but they tend to sub-contract or purchase inputs from SMEs and individuals. It is this process which creates employment at the SMEs.

But this is a disagreement only about the nature and direction of the required policy. The basic thrust of the Brittan analysis is correct. Bank lending and money supply are collapsing along with the banks’ share prices. The banks contain the resources to correct the slump, yet refuse to do so. They are in public ownership. All that is required is a government instruction to fund the large-scale investment that is required to produce a recovery.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Eurozone rescue packages will continue to fail until they deal with the central issue in Europe’s recession
By John Ross

The international financial system is passing through the agony of a new round of the Eurozone debt crisis for the simple reason that European governments, like that in the US, refuse to deal with the core of the economic recession in Europe for reasons of economic dogma.

Anyone who looks at the economic data for the Eurozone without wearing ideological blinkers can see the situation at once – it is charted in Figure 1. The Eurozone recession is due to a collapse in fixed investment. Taking OECD data, at inflation adjusted prices and fixed parity purchasing powers (PPPs), then between the last quarter before the recession, the 1st quarter of 2008, and the 2nd quarter of 2011 Eurozone GDP fell by $204bn. But private consumption declined by only $29bn while the net trade balance increased by $32bn and government consumption rose by $91bn.

However fixed investment fell by $290bn – i.e. the recession in the Eurozone was wholly due to the fixed investment decline

Equally evidently, due to its scale, until this fall in investment is reversed it will take a prolonged period for the recession to be overcome. Therefore to restore growth, which by now is generally realised is the core to turning round the budget deficit problem, the fixed investment decline must be overcome.

Nor is there anything mysterious about how to do this – the state has entirely adequate means. To take the most decisive international case China made the core of its stimulus package direct state investment particularly aimed at infrastructure and housing – the result being that China’s economy has grown by over thirty per cent in three years.

Europe and the US clearly do not have the scale of state sector, nor the political willingness, to act on the scale China did. But US history shows that even without proceeding to a socialist scale of measures direct state intervention on investment is entirely possible.

Roosevelt expanded US state investment from 3.4% of GDP to 5.0% between 1933 and 1936 (data from US Bureau of Economic Analysis Table 1.5.5). Jason Scott Smith, in his study of New Deal public spending, summarises such investment as including 480 airports, 78,000 bridges, 572,000 miles of highway – which, in addition to its immediate effect in stimulating demand, reinforced the productive position of the US economy. Roosevelt, it is superfluous to point out, was neither a socialist nor a communist (despite claims to the contrary by the US right!).

Quarterly, up to date, data is regrettably not available on what is occurring across the Eurozone for state investment, but it is available for the US and there is no reason to suppose, with  current policies, that the situation in Europe is any better. Between the peak of the previous US business cycle, in the 4th quarter of 2007, and the 2nd quarter of 2011 US private fixed investment fell from 15.8% of GDP to 12.2% – i.e. a decline of 3.6% of GDP. Yet in the same period US state investment did not compensate but also fell marginally – from 3.3% of GDP to 3.2% of GDP. Therefore while Roosevelt expanded the weight of US state investment current US administrations have been letting it fall.

Instead of directly addressing the core issue of the investment fall European administrations are either attempting to stimulate it indirectly – which, as it is ineffective, has led to fiscal/sovereign debt crises, or are acting via expansion of the money supply – which, in a situation whereby companies and households are paying down debt, is merely the famous ‘pushing on a piece of string’.
The most favourable outcome of such a situation is that eventually the debt will be paid down, but only after several years of stagnation. The less favourable variant, of course, is that the banking system breaks under the strain and renewed recession is further propelled by fiscal cutbacks. All these problems simply arise from the fact that, under the rubric of the dogma ‘private equals good, state equals bad’, European governments refuse to use the state tools available to deal with the investment fall which is at the core of the Eurozone recession.

Some European politicians are now beginning to call for state measures to increase investment, UK Business Secretary Vince Cable being one. But the action they envisage so far is inadequate to deal with the scale of the investment fall.

China’s economy, which does not have such ideological inhibitions, will continue to expand while the Eurozone remains relatively stagnant for a significant period – and as long as economic stagnation continues there will be no resolving of the Eurozone debt crisis.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

A Brighter Economic Future For BritainBy Michael Burke

‘A Brighter Economic Future for Britain’ is the title of a new pamphlet co-written by the present author and Professors George Irvin and John Weeks. In the Guardian we set out the rationale for the publication:

‘The UK depression has already lasted three years, and NIESR argues that is likely to last five years or more – longer than that of 1930s.

Yet economic debate is dominated by counterproductive attempts to reduce the deficit through cuts in public spending, which are now the single most important cause of the depression.’

The full article can be read here.

In an argument that will be familiar to regular readers of SEB, the pamphlet argues that public spending cuts are counter-productive both in terms of reviving growth and in reducing the public sector deficit. This is because the deficit itself is primarily a product of the depression.

Further the underlying cause of the depression is a private sector investment decline, which by the end of the 1^st quarter of 2011 accounted for 80% of the total lost output since the economy began to contract 3 years earlier – that, is £44.9bn of a total of £56.3bn.

Therefore breaking that investment strike is a pre-requisite to any sustained recovery. By investing in areas such as housing, transport, infrastructure and education, the government can lead an economic recovery that meets acute economic needs and reverses the rise in joblessness.

The pamphlet puts forward two related solutions to the crisis- the creation of a state-owned Investment Bank and using the excess capital at the state-owned banks to fund the needed investment.

Importantly, this analysis is beginning to win political support. In welcoming the attempt to turn the debate towards an investment-led recovery Jon Trickett MP argues in a foreword to the pamphlet,

‘Collapsing investment hits current growth and long-term productivity…..Working on the premise that we must tackle investment and long-term competitiveness the authors argue that one way forward which would increase demand in the economy, and raise both employment and productivity, would be to take action now to address this issue…..The pamphlet sets out one idea from the authors to tackle this collapse investment; a National Investment Bank, using the government’s majority stake in Lloyds-TSB and RBS…..There are those who would argue that this would indeed be poetic justice.’

The continued economic stagnation in Britain and some other leading economies will force a reconsideration of policy even among the architects of the current crisis and their supporters. In Britain , though, a Tory economic ‘Plan B’ is likely to include privatisation, deregulation as well as attacks on social protections such as maternity/paternity leave, pensions and an abuse of youth ‘training’ programmes to provide unpaid labour. But none of this will alter the basic problem that private firms are sitting on hoards of cash that they refuse to invest, while also leading to further impoverishment for the overwhelming majority of the population.

Likewise, since at least the ‘worse than Thatcher’ New Labour Budget of 2010 there are many now on the opposition benches who fundamentally agree with the ‘austerity’ policy. They merely advocate slower, shallower, more anguished cuts. But as the economy has already stalled under the impact of less severe cuts than they would now be implementing, the Labour supporters of cuts are also obliged to look for a ‘Plan B’. Whether they move towards Osborne, or in the direction of state investment to generate recovery remains to be seen.

In any event, as the pamphlet argues there can be no suggestion of a sustained recovery without replacing the policy of cuts with a government-led investment recovery.

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