Socialist Economic Bulletin

US rate hike benefits banks – no-one else

December 18, 2015 Uncategorized

.659ZUS rate hike benefits banks – no-one else

By Michael Burke
The US central bank the Federal Reserve has raised interest rates for the first time since 2006. The Fed began cutting interest rates in 2008 in response to the Great Recession and the associated financial crisis. On the face of it the timing appears odd, as the US economy has not experienced any robust recovery since the crisis. 2010 was the strongest annual growth rate at 2.5%, which is an extraordinarily tepid rebound from such a sharp recession. 

More recently industrial production has gone back into recession, as shown in Fig. 1 below. Output has fallen for 4 straight months and is 1.2% below its level a year ago in November 2014. Although this is depressed by the fall in energy output, manufacturing as whole is barely stronger, rising just 1% from a year ago.

Fig.1 US Industrial Production In Recession
 
An economic slowdown and falling output might not seem the most appropriate time to raise the level of interest rates. But the level of Fed Funds is not correlated to the growth of industrial production at all, and has frequently moved in the opposition direction to the growth in output as shown in Fig.2 below. 


The Fed has entirely different goals in raising rates in the current period, although it will have to monitor closely the pace of the slowdown. The goal of the Fed is to bolster the attractiveness of the US economy to capital inflows, and within that strengthen the already dominant role of the banks.

One of the features of the current crisis is a widespread mystification of the role of credit and money in the economy. Interest rates are the price of credit, what is charged by the lender to the borrower. A key difficultly for banks in particular arises when interest rates are at or close to zero. If the price of credit generally available is close to zero and is readily available banks will find it extremely difficult to make profits. They will substitute lending for increasingly speculative activity, gambling in the stock markets, in housing, in commodities and so on.

However, there is a central misconception in the Fed’s efforts to ‘normalise’ the interest rate environment and it is a risky strategy. The idea is that raising interest rates will prompt a shift away from speculation towards productive lending for investment. But in aggregate US companies have little need to borrow for investment. This is because their own investment remains lacklustre and so can be funded well within their own resources, that is profits. Fig. 3 below illustrates this point by showing the nominal level of US GDP, company profits (Gross Operating Surplus) and investment (Gross Fixed Capital Formation).

 
Fig.3 GDP, Profits and Investment

From 2000 US GDP has expanded by $7.1 trillion. Profits have risen by $3.3 trillion and yet investment has only risen by $1 trillion. In the period from 2000 to 2014 the profit share of US companies has risen from 37.5% of GDP to 41.2%. At the same time the proportion of GDP devoted to investment has fallen from 23% to 19.5%.
If we take the measure of the investment rate as the proportion of profits devoted to investment, this has fallen from over 60% to little more than 47% over the period. As a result, firms can access their own funds in order to finance productive investment. Yet, as already noted, investment is a declining proportion of US GDP.

Instead, the most likely outcome of higher interest rates is likely to be increased charges to consumers, in the form of credit card debt, auto loans, mortgages and so on. This will effectively be a transfer of incomes from consumers to banks. 

On a global scale the effect is likely to be much worse. As the US Dollar is the sole world reserve currency all international debtors are obliged to borrow in US Dollars. For commodity producers, whose exports are priced in US Dollars the further fall in commodities’ prices reduces national incomes and tends to cause both currency depreciation and capital flight. 

Capital tends to flow towards the US with higher rates. Outside the industrialised countries the so-called ‘emerging markets’ are expected to have seen their first net outflow of capital in 27 years in 2015. For individual countries such as Brazil, Turkey, South Africa and many more the effect of capital flight can be dire.

But there is also a negative impact on the world economy as a whole. Capital flows to the US are to a low investment-high consumption economy. Sucking in capital from the rest of the world to finance US consumption – and bank interest on financing it – will have the effect of slowing world growth even further. It is a high-risk strategy from the Fed, one in which the US is unlikely to be the main casualty.

Corbyn’s election: Rational economics starts here

November 30, 2015 Uncategorized

.186ZCorbyn’s election: Rational economics starts hereThe following piece was originally a presentation to the recent conference of the Labour Assembly Against Austerity. Prof. Chick is one of the foremost Keynesian economists in Britain. 

The argument below may surprise many who regard themselves as ‘Keynesians’ and yet who argue for persistent budget deficits and routinely borrowing to support consumption.

On the contrary, a key point of agreement between Marxists, genuine Keynesians and others, and one that is reflected in the editorial line of SEB, is that investment is decisive for economic growth and that the current crisis is caused by the weakness of investment.

***************************************************

By Victoria Chick

Since the election of Jeremy Corbyn as leader it has become acceptable in the Labour party to challenge the austerity doctrine (Corbyn The Economy in 2020). What a welcome change! Rational economics starts here.

I shall take it as read that everyone in this room holds the following truths to be self-evident:

(1) That austerity is counterproductive if its purpose is to reduce the public debt and 

(2) That its real purpose is to provide a smoke-screen behind which to shrink the state and reward the rich

There is another truth that is less obvious:

That government cannot determine the size of its deficit by its own actions. 

Austerity is not only unpleasant politics; it is bad economics. We need to explain and communicate this fact to the electorate -to demonstrate that we are not the ones who are economically illiterate!

The economics of austerity is based on an inappropriate generalisation from the individual’s budget to the government’s budget. Mr Micawber can control his deficit, but only because he is a small cog in a great machine. Government is a big component of the machine, and other parts react to what it does. Those reactions influence national income, the level of unemployment (and hence benefits) and tax revenue. A cut in expenditure will reduce income by more than the original change in government expenditure (the multiplier, working negatively).

Second, there is the ‘three balances’ identity: (G-T) + (I-S) = M-X
[where G is total Government spending, T is Government revenues, I is investment, S is savings, M is imports and X is exports].

The private sector is just about in balance; the fiscal deficit is almost the mirror image of the international current account deficit. The fiscal deficit cannot be eliminated (should you want to) without eliminating also the international deficit, which almost no-one is talking about (John Mills is an exception).

Alternatives to austerity 

If you really want to eliminate the deficit, the positive response of the economy to government action, the multiplier in the positive direction, needs to be enlisted. In a recent blog, the TUC’s senior economist, Geoff Tily, recalled that Keynes, who was the first to exploit the potential of the multiplier, did not use the phrase ‘deficit spending’ which is so closely associated with his name but rather ‘loan expenditure’. Now since deficits have to be financed by borrowing you might not see any distinction, but the point is that wise, productive loan expenditure pays for itself over time and increases the productivity of the economy. Output and employment rise, the tax take rises, benefit costs fall and we have increased our productive and social capital. Loan expenditure reduces the deficit as the economy recovers. The point is rhetorical, but it is good rhetoric that we need.

Keynes on the budget

Let us look more closely at Keynes’s view of budgetary policy, for it is usually much mis-represented and current discussion of the budget in normal times is still somewhat confused. He distinguished between the ‘ordinary budget’ or current account, and the capital budget or spending ‘below the line’ – a distinction we make today.. The latter was to be used to compensate for failings in private-sector investment. 

‘…periods of deficiency (sic) expenditure should be made the occasion of capital development until our economy is much more saturated with capital goods than it is at present.’ (J M Keynes, Collected Writings vol XXVII p 320)

This would by itself make the economy more stable:

‘…if the bulk of investment is under public or semi-public control and we go in for a stable long-term programme, serious fluctuations are enormously less likely to occur.’ Ibid. p 326

By contrast the aim should be for the current budget normally to run a surplus,  

‘which should be transferred to the capital Budget, thus gradually replacing dead-weight debt with productive or semi-productive debt…’ ibid. p 277

‘I should not aim at attempting to compensate cyclical fluctuations by means of the ordinary Budget. I should leave this to the capital Budget.’ Ibid p 278

The two budgets serve different purposes:

‘[T]he capital budgeting is a method of maintaining equilibrium; the deficit budgeting is a means to attempt to cure disequilibrium if and when it occurs.’ Ibid, pp 352-3

And capital expenditure ‘has nothing whatever to do with deficit financing’ ibid. p 352 

In other words, deficit financing is for emergencies only – emergencies like the depth of a depression. That lesson was learned and applied after the financial crisis. There is no need to follow the financial crisis with a self-inflicted fiscal crisis. The economy is currently far from peachy but it is not in dire straits. Let us not plunge it into further recession by austerity. Worse, this and the previous government have gone about things in precisely the wrong way, cutting investment rather than current expenditure. Let us instead keep calm and debate where the capital budget should be directed. Intelligent capital spending is more likely to reduce the deficit than austerity.

What kind of capital spending?

As anyone who has read Michael Meacher’s last book knows, there is no shortage of useful things to do. Everyone will have his or her priorities here; but there are some very obvious candidates: green infrastructure, housing. In general, real investment, including investment in those things whose return is hard to measure (education, health, even some infrastructure), and even in things that yield little or no financial return. On this latter point, there is a tremendous PR job to be done, for the mindset is as wrong-headed today as it was in Keynes’s time. He wrote:

‘The nineteenth century carried to extravagant lengths the criterion of what one can call for short “the financial results,” as a test of the advisability of any course of action sponsored by private or by collective action. The whole conduct of life was made into a sort of parody of an accountant’s nightmare. … I spend my time … in trying to persuade my countrymen that the nation as a whole will assuredly be richer if unemployed men and machines are used to build much needed houses than if they are supported in idleness. … 

The same rule of self-destructive financial calculation governs every walk of life. We destroy the beauty of the countryside because the unappropriated splendours of nature have no economic value. We are capable of shutting off the sun and the stars because they do not pay a dividend.’ ‘National self-sufficiency’, The Yale Review, Vol. 22, no. 4 (June 1933), pp. 755-769_

We must face down that dreadful sneer, that government is no good at ‘picking winners’. Is the private sector so good at ‘picking winners’? The banks, for example? Private investment now has virtually dried up, in favour of at best unproductive and at worst pernicious financial speculation. The incentives for private share-holder-owned companies in any case favour far too short a time horizon. As Mariana Mazzucato argues, government’s role is to create and foster markets, not just to rectify their malfunction. That means a courageous state must not flinch; it must be prepared to ‘pick’ what in its best judgement will be winners but knowing that some will be losers – to use the power of its budget to change the direction of our economy to deal with the pressing problems that we face. The private sector will not do that. It wants to return to business as usual. Business as usual is not an option.

Alternative Autumn Statements: Continued Tory Failure Versus Corbynomics

November 25, 2015 Uncategorized

.176ZAlternative Autumn Statements: Continued Tory Failure Versus Corbynomics

By Michael Burke
Having spectacularly failed in his stated goal of eliminating the deficit in the last parliament, George Osborne is repeating his experiment in this one. Both the June 2010 and 2015 Budgets proposed ‘fiscal tightening’ of £37 billion. In the first of these Budgets the main method was cuts in public spending. In the second it is the sole method.

In the latest Autumn Statement this now falls to £36 billion and takes place more slowly after the U-turn on implementing cuts to working tax credits. These are now effectively scheduled to take place more slowly under the guise of ‘reform’ to the Universal Credit system.

The effect of renewed austerity is reasonably predictable. The economy has not grown significantly in the last 5 years. As nominal GDP is approximately 16% higher, so the impact of almost exactly the same nominal cuts will be very similar as from 2010 onwards. Likewise, the starting-point for growth is about the same. In the 3rd quarter of 2010, ahead of that Comprehensive Spending Review the GDP growth rate was 2% and on an upward trajectory from the depth of the recession. In the recent preliminary estimate the growth rate in the 3rd quarter of this year was 2.3% and slowing from 3% following the election boost to the economy, as shown in Fig.1.

Fig.1 GDP Growth Since the Recession
 
The effect of the first round of austerity was to slow the economy to a crawl. Living standards fell and the deficit actually began to rise. GDP growth was 1% in both the 2nd and 4th quarters of 2012 and only lifted above that by the boost from the London Olympics. The economy is set to slow again in 2016 under the impact of austerity and based on past experience may slow towards 1% growth in 2017.

Policy Options

At the time of the March 2015 Budget there were blood-curdling forecasts of the decline of public spending to lower levels than the 1930s. This was entirely a political manoeuvre, a trap designed to get Labour to support unfeasible spending plans and so have nothing positive to offer in the election campaign, which Ed Balls duly jumped into.

In fact, it is the content of government current spending which matters far more than its proportion of GDP. Government spending on education, on health, on childcare and other public goods improves the living standards of the population. An increase in social security payments because of rising joblessness or in-work poverty is necessary but can only partially alleviate falling living standards. There is a world of a difference between current spending that falls because well-paid jobs are being created on a large scale, or falls because the NHS is being cut.

The medium-term history of the British economy is stable or rising Government current spending as a proportion of GDP, as shown in Fig.2. It is the composition of this spending which has adversely altered. To take just one well-known example, the public sector has almost given up on house-building but incurs £25 billion annually in housing benefit payments, which are paid to landlords – enough to build over 160,000 affordable homes. This reflects both slower growth and rising inequality.

Fig.2 Government Current Spending (lhs) & Net Investment (rhs) as a Proportion of GDP
The focus for cuts over the longer run has actually been to public sector net investment. This has been renewed by Osborne. The Blair/Brown government slashed public sector net investment to an all-time low (to meet other, extremely damaging Tory spending plans in 1997 to 2000). But Brown increased public sector net investment to 3.2% of GDP in response to the slump in 2008 and 2009 and this was responsible for the recovery. Osborne has effectively halved this rate of investment.

SEB has previously shown that the private sector followed suit in both cases; increasing or decreasing its own investment rate in response to the rise or fall in public sector investment, with a time lag of 6 months. This is a practical demonstration of what is meant by the phrase state-led investment.

These very different trends in the components of government spending reveal the truth behind the Tory rhetoric of ‘deficit-reduction’, ‘living within our means’ and ‘shrinking the state’. Successive governments, of which this is just the most brutal, have not reduced total current spending as a proportion of GDP and have been content to borrow to fund that spending. They have simply changed its content. Landlords and others, after all, are part of the class of capitalists in whose interests economic policy is formulated.

State spending has not shrunk, but state investment has been savaged. The trend is towards minimal or even zero net public investment. This is because investment creates the means of production. If the public sector invests it owns those means of production. They are not owned by business. To the extent that the state owns the means of production it can direct the level of investment in the economy and its overall trajectory. Private business cannot directly make profits from the means of production it does not own, which explains the contrary drive towards privatisation.

Corbyn & McDonnell are right

The response of the Labour leadership is therefore correct. Prior to Comprehensive Spending Review Shadow Chancellor John McDonnell said his approach could be summed up as “investment, investment, investment”. Firm opposition from the Labour leadership to cuts in working tax credits produced Osborne’s U-turn.

Investment (Gross Fixed Capital Formation) has been in a long-term downtrend in the British economy. It was also specifically responsible for both the recession and for the weakness of the recovery. The long-term investment downtrend is shown in Fig. 3 below, which shows both total investment and Government investment as a proportion of GDP.

Fig.3 Total Investment and Government Investment as proportion of GDP
 
The startling fact revealed by this chart is that it is the slump in Government investment which is primarily responsible for the decline in aggregate investment. Over the entire period the peak to trough decline in total investment has been 26% of GDP to 15% in the recession. The decline in the Government component of that is 7.5% to 0.5%. It is the cut to Government investment which is driving the long-term decline in British investment, responsible for 7% of a total decline of 11%.

As the chart also shows, the decline in investment in the current cycle began in 2006, long before either the financial crisis or the recession itself- and was led by a private sector decline. The rate of investment is decisive for the trajectory of the economy as a whole.

The policy focus must not be on investment in general, with exhortations or bribes to the private sector to invest. This has been tried by Osborne and failed. It must be direct investment by the public sector itself, in housing, transport, infrastructure, renewable energy and education. The private sector will follow.

This is why the proposed Public Investment Bank is so important, supported by measures such as PQE and changes to the tax system to penalise unearnt income such as shareholder dividends while promoting investment. The Public Investment Bank can mop up the idle cash of the large corporations, and direct it for productive investment. Crucially, it also allows the public sector to reap the benefits of that investment, so that it acquires a larger and enduring weight in the economy able to sustainably increase investment over the long-term.

Debating Corbynomics

November 12, 2015 Uncategorized

:1. 

The rate of consumption has risen and the rate of investment has fallen. But the mass of the population is not better off. This is because investment is required to sustain growth, which is the basis for rising living standards.

It may be argued that the rise in consumption is insufficiently strong to spur an increase in investment, and that much stronger growth in consumption would produce more investment by reducing spare capacity. But there is no evidence for this assertion. As profit-maximisation is the goal for producers, it is just as likely in the current period that producers would meet capacity-straining increases in consumption with higher prices.

In fact the entire crisis is characterised by what Keynes dubbed ‘liquidity preference’ and Marx called the hoarding of capital. Firms are investing a low and declining proportion of their profits. More revenues from consumption and more profits are not leading to a revival of investment.

It is a false notion that it is possible to increase living standards over the long-run by prioritising the growth of consumption. The sustained growth of production requires the growth in the means of production, which requires investment. It is only in this way that that is possible to sustainably raise living standards.

Labour Assembly Against Austerity- key discussions for the left

November 6, 2015 Uncategorized

.408ZLabour Assembly Against Austerity- key discussions for the left


By Michael Burke

The Labour Assembly Against Austerity meeting on November 14 is an excellent opportunity to discuss the key economic issues, promote the anti-austerity policies of the Labour leadership and debate the way forward. 

The Labour Party and the left in Britain generally has never before been in a situation where its leadership has been under such sustained and ferocious attack from its opponents. This is because Labour’s new leadership is also something entirely new. It espouses policies which run counter to the austerity offensive, which is the main project of big business and its political representatives. So bringing together all those who want to defend this leadership against right-wing attack, discussing the alternatives to austerity and debating the way forward is vital.

The keynote speaker is the Shadow Chancellor John McDonnell. Along with Jeremy Corbyn and their allies, he has pushed the Tories back on cuts to working tax credits, so much so that it would now be a surprise if at least some concessions were not made. But it should be clear that any gains made through amendments to Osborne’s plans and the Tories’ political difficulties arise because there has been such firm and clear opposition from Labour.

Even if there are certain tactical retreats, it is also clear that the Tories will be relentless in their pursuit of austerity policies. There is no significant section of big business opinion which does not support austerity. Therefore it will be increasingly important for the entire anti-austerity movement and the Labour Party to clarify its economic alternatives and to popularise them among the widest possible layers in society. The debates should be about how to defeat the Tories and their austerity policy, and what the sustainable alternatives should be. As such, the debates will need to be comradely ones aiming to maximise light while minimising heat.

In Britain and in many Western economies in the period since World War II there has been a bastardisation and then the almost complete marginalisation of advanced economic thought. The most important economists are reduced to fortune cookie phrases in the case of Adam Smith’s ‘invisible hand’, completely distorted with reference to Keynes’ ‘digging holes and filling them’ or ignored completely in the case of Marx. Building a movement that is capable of challenging and then defeating the Tory arguments will require a culture of debate and familiarity with these authors and more besides.

SEB has shown that growth is required to raise living standards and that growth itself is primarily determined by the rate of investment. It is because the rate of investment is so low in the British economy that there has been no growth in living standards since the crisis began. The economy has expanded by just £100bn from the 1st quarter of 2008 to the 2nd quarter of 2015, less than 6% in over 7 years. But of this growth £80bn has been the growth of consumption while just £4bn has been a rise in investment. We remain in an investment crisis.

The Labour Assembly Against Austerity meeting will offer the opportunity to hear from leading figures in the Labour Party, the trade unions, campaign organisations and the anti-austerity movement. A series of workshops will allow more detailed debate. Both of these are necessary if the movement as a whole is to continue its momentum and build a clear understanding of the alternative to austerity.

Labour Assembly Against Austerity
10am – 5pm Saturday 14th November
Institute of Education, London WC1H 0AL

Speakers include:
Shadow Chancellor John McDonnell MP
plus
Diane Abbott MP
Lucy Anderson MEP
Michael Burke,

Tories have no answer for slowdown. Corbynomics does.

October 29, 2015 Uncategorized

.232ZTories have no answer for slowdown. Corbynomics does.

By Michael Burke
The British economy is slowing down. In the 3rd quarter of 2015 the economy had expanded by just 2.3% from the same period in 2014. This measure removes the volatility of erratic quarter to quarter movements in GDP.

The most rapid pace of growth in this recovery has been the 3.1% recorded in the 2nd quarter of 2014, which mainly reflected government efforts to stoke consumption (particularly in housing) in the run-up to the election. Since that time the growth rate has progressively slowed. This is shown in Fig.1 below. Despite the severity of the recession, at no point has the growth rate matched the higher levels seen before 2008 to 2009.

Fig.1 UK GDP- Growth is slowing

The slowdown does not mean that a recession is imminent, although this business cycle will come to an end at some point and the global economy is also experiencing some difficulties. The more immediate danger is the effect of government policy and the renewed imposition of austerity policies.

As SEB has previously shown, Austerity Mark II announced in the July 2015 Budget is exactly the same as Austerity Mark I announced in June 2010, a fiscal tightening of £37 billion in both cases. The real effect will be somewhat less this time as the economy has expanded moderately in the interim. Even so, the effect of the first round of austerity was to slow the economic growth rate from a little over 2% year-on-year to 1%. A similar outcome should be expected this time around.

Examining the slowdown

This weakening outlook is the increasing subject of commentary. An article in the Guardian by David Graeber has received a lot of attention. He is a committed opponent of austerity, and all disagreements should always be read in that context. In ‘Britain is heading for another crash: here’s why’ he correctly castigates George Osborne’s economic fallacies, but then supplies a few of his own. As these appear to be widely shared by other progressive economists and opponents of austerity, they are worth debunking.

Graeber argues that any government surplus must entail a private sector deficit. As he correctly states, this is simply an accounting identity and must be true; every borrower requires a saver and vice versa. He goes on to say that the determination to run public sector surpluses is necessarily negative, as it forces the private sector to borrow. He further states that this debt is forced on to those least able to pay it and that this causes recessions, which is often the case.

But in this key passage (using the chart he supplies) he adds, “But if you push all the debt on to those least able to pay, something does eventually have to give. There were three times in recent decades when the government ran a surplus:



Note how each surplus is followed, within a certain number of years, by an equal and opposite recession.”

Note the reason why the surpluses of the private sector do not cause recessions is never explained, nor why we might be entering another recession even though there are still large government deficits.

There are in fact four separate episodes of fiscal surpluses in Britain shown in the chart. Examining them debunks the fallacy that government surpluses cause recessions. The chart used shows the largest surplus of all on the overall fiscal balance in 1948. There was no recession at all until 1974! At the end of the 1960s there was modest surplus, followed by 5 years of continuous growth, and the largest-ever growth rate recorded in a single year, 6.5% real GDP in 1973. The small surplus in 2000 was a result of New Labour sticking to extreme Tory spending plans in the first two years after election in 1997, which was subsequently relaxed. Reasonably strong growth (in British terms) followed and the subsequent crash 8 years later had nothing to do with that surplus. The surplus in the late 1980s was a function of the glut of North Sea oil. This should in fact have been larger, had Government saved this windfall for future investment, as Norway did. Instead, along with Government borrowing it was used to stoke a consumption surge, the ‘Lawson Boom’. The subsequent recession occurred when boom turned to bust. The surplus did not cause the recession – borrowing for consumption while also floating in oil revenues caused an unsustainable boom that inevitably failed.

This argument for permanent fiscal deficits makes no distinction at all between borrowing for investment and borrowing for consumption. The long-run history of the British economy and its decline is in part characterised by the rising rate of Government consumption coupled with a falling rate of Government net investment.

Fig.3 below shows that the strongest rate of growth of GDP in the 1960s was associated with the lowest levels of Government current spending, and vice versa. The higher rates of Government consumption are associated with the slowest levels of growth. The long-term trends are also clear; rising Government spending and declining rates of GDP growth.

Fig.3 UK Public Sector Current Spending Rises As GDP Growth Declines

By contrast, high or rising rates of public sector net investment are associated with high or rising rates of GDP growth (again, in British, not global terms). This is shown in Fig.4 below with public sector net investment as a proportion of GDP alongside the rate of growth of GDP.

Fig.4 UK Public Sector Net Investment, % GDP & GDP Growth
 

Here, although the GDP data is erratic the relationship clearly trends in the opposite direction; as net investment declines so does the GDP growth rate, and vice versa.

In fact there is a significant negative correlation between public sector current spending and GDP growth of -0.41326. By contrast, there is a very small positive correlation between public sector net investment and GDP growth of 0.1281, which rises to 0.21235 if GDP growth is lagged for 3 years (possibly to account for the economic effects of large projects). But in an economy like Britain’s, public sector net investment is usually too small to determine the overall rate of economic growth.

Fig.5 below shows the rate of GDP growth alongside the proportion of total investment (Gross Fixed Capital Formation) in GDP from both the public and private sectors. Even a cursory glance shows the strength of this relationship and the correlation is 0.7721. It is investment which is the primary driver of growth.

Fig. 5 GDP Growth & GFCF as a Proportion of GDP
 

The proportion of GDP devoted to investment (GFCF) is the main determinant of the growth of GDP. But currently the level of public sector net investment is too small to affect the outcome of GDP. At the same time, the level of private sector investment is too weak to support a more robust economic recovery. What can be done?

‘Crowding out’ and Corbynomics

One of the greatest fallacies in modern economics is the notion of ‘crowding out’. This is the assertion that if a level of public sector investment or borrowing is too high then this will prevent the private sector from investing. It particularly came into vogue during the era of privatisations under Reagan and Thatcher and is inscribed in most Western econometric models.

It is a nonsense because it assumes a fixed or steady state economy. But if either the public or the private sector invests in the productive economy, there will be economic growth and so increased funds available for investment.

Over many decades the Western economies have provided ample evidence that the notion of ‘crowding out’ has little basis in fact. Fig. 6 below shows that over the medium-term UK public sector net investment as a proportion of GDP has been cut. In common with most Western economies, the total level of investment as a proportion of GDP has not risen but has actually fallen, although the British case is one of the more extreme examples of both.

Fig.6 GFCF as a proportion of GDP & Public sector net investment as a proportion of GDP

It is clear from the chart that public sector net investment leads investment overall. There is a lagged effect, so that the strongest effect of rising public investment on total investment is registered 5 years later. On this basis the correlation between the two variables rises to 0.6820. Far from public sector investment ‘crowding out’ private sector investment, high and/or rising public sector investment ‘crowds’ it in.

This in turn is a significant part of the answer to the question posed earlier, what is to be done if investment is the main determinant of economic growth, yet public sector net investment is currently too small to effect the outcome of GDP as a whole?

The austerity policy is in part a failed answer to this question. It assumes that if wages and taxes on business are pushed down, businesses will increase the proportion of their profits assigned to investment. This has not occurred.

By contrast, Corbynomics has a very different answer. As high or rising public sector investment crowds in private sector investment, the policy response should be to raise the level of public sector investment in order to raise the total level of investment in the economy. The purpose is to raise the sustainable growth rate of the economy and so improve living standards.

If there are future crises of private sector investment, it may be necessary to raise the level of public sector investment once more. But the answer to the current crisis is to increase public sector net investment to a level where total investment is sufficient to sustain much higher, more sustainable growth.

Currently, the level of investment as a proportion of GDP is 20.6% in the OECD as a whole. In Britain it is 16.9%. An immediate objective should be to raise British levels of investment towards that average, so that competitiveness is not further eroded and living standards do not fall further behind. That is the first step towards addressing the current crisis. Future steps will be discussed in subsequent pieces.
 

Lessons from Ireland for the debate on investment and consumption

October 23, 2015 Uncategorized

Lessons from Ireland for the debate on investment and consumptionThe debate on what spurs economic growth and therefore what policy tools to use is not unique to Britain. As the world economy slows, variations on this debate are taking place in many countries.

A piece on the Irish blog ‘UNITE’s Notes on the Front’ deals with this question from the specific perspective of the current Irish economic and political situation and is written by Michael Burke.

The context is that the general election to the Irish Dáil is less than 12 months away. The current government is a coalition led by the right wing Fine Gael and the Labour Party and has been pursuing austerity policies. But now that an election is in the offing the Coalition has shifted towards boosting consumption in order to get re-elected (much like the coalition government in Britain after 2012). This was the content of the recently announced Budget for 2016.

However, a wide array of forces opposes this agenda. Sinn Féin, some other elected representatives, many in the trade unions and social justice campaigners all argue (with differing emphases) that investment should take precedence. Boosting consumption should be a secondary priority and this should mainly be done by boosting the incomes of the poor and lower paid workers at the expense of the rich and the very highly paid.

There are sound theoretical reasons for this order of priorities, which have been demonstrated by SEB. Moreover, the recent history of the US, which is the Western economic model shows that, as consumption rises as a proportion of GDP economic growth slows and so does the growth rate of consumption. An examination of recent Irish economic history exhibits the same pattern. This is, a high or rising proportion of the economy devoted to investment leads to higher growth, including the growth rate of consumption. A low or falling proportion of investment leads to slower growth, including the growth rate of consumption.

The full piece can be read here.

Corbynomics: winning with policy clarity

October 15, 2015 Uncategorized

Corbynomics: winning with policy clarityBy Michael Burke

Economic policy is central to the survival and eventual victory of the new Labour leadership, even though it is clearly not the only issue. Contrary to the usual Tory media reports, Jeremy Corbyn and his Shadow Chancellor John McDonnell registered an advance with the debate and vote on Osborne’s risible Fiscal Responsibility Charter. That advance came because the correct position of voting against was adopted. As this question will not go away, further advances will require even greater clarity.

The measure of the advance can be summed up in its political aspect with an analysis of the vote. Just 20 Labour MPs rebelled against Labour’s line by abstaining on the Charter. It may be recalled that of the 35 nominations Jeremy Corbyn received from MPs in the leadership contest, only about half of them actually supported him. During that campaign the vast majority of MPs followed the line of abstaining on the Tories massive cuts in the Welfare Bill. Now the overwhelming bulk of the Parliamentary Labour Party has voted against the key Tory legislation of permanently enshrining austerity and ruling out borrowing for investment. This is despite the fact that as recently as May the party’s economic line was ‘fiscal rectitude’, ‘zero-based spending reviews’ and sticking to outlandish Tory spending cuts in the first two years of the Parliament (something the Tories could not do in their own June 2015 Budget).

Politically, the 20 abstainers have isolated themselves within the party (although they will no doubt find regular berths in the BBC studios and lots of column inches in the Murdoch press). Jeremy Corbyn and John McDonnell have led the PLP to a much better economic position by opposing Tory economic policies. As the Tories are committed to austerity and this will be central to the economic debate over the next five years, that leadership will need to keep moving forward.

Exposing Osborne’s fallacies

Labour lost the last election because its economic policies were not credible. There is a concerted effort to distort this factual finding to suggest that Labour was too anti-austerity. Therefore the debate on economic policy is central both to the future direction of Labour policy and its election prospects.

Osborne’s great fallacies, like most distortions of the truth, have some connection to popular understanding otherwise it would be impossible to explain their political power. A central fallacy is to treat all debt as essentially the same, with equally negative consequences. Instead, as

Why borrowing for investment is correct – John McDonnell is right & Osborne is wrong

October 13, 2015 Uncategorized

Why borrowing for investment is correct – John McDonnell is right & Osborne is wrong
By John Ross

An earlier article ‘Why John McDonnell is correct to borrow for investment – an elementary economics lesson for Osborne’ analysed in the ‘family’ and ‘common sense’ vocabulary Osborne likes to present the distinction between state borrowing for investment and state borrowing for current expenditure – a key economic distinction Osborne’s Fiscal Charter deliberately tries to obscure. It also showed how sections of the media deliberately attempt to aid Osborne in this by talking of budget ‘deficits’ and ‘borrowing’ without distinguishing between borrowing for investment and borrowing for consumption.

The following article, an excerpt from a longer analysis of Western responses to the Great Recession, analyses the issue in more formal economic terms. It shows that John McDonnell is very far from being an ‘extremist radical’ in supporting state borrowing for investment. Among those holding the same logical position are fellow ‘extremists’ Ben Bernanke. Larry Summer and Martin Wolf!

* * *

An answer that may be immediately rejected in explaining the failure of response to the Great Recession, and the ‘new mediocre’ slow economic growth following it, was that no Western expert understood the situation. To the contrary, eminent Western economic figures well understood that the problem in the US and other Western economies was that the mechanism translating company income into investment was not functioning adequately, and that the solution was for the state to step in and invest these funds – as in Roosevelt’s 1930s response to the Great Depression. Merely a representative few of those arguing for this response will therefore be quoted – to show the accurate, indeed comprehensive, character of their analyses.

Ben Bernanke, almost immediately he could speak openly after ceasing to be Chair of the US Federal Reserve, called for:

‘a well-structured program of public infrastructure development, which would support growth in the near term by creating jobs and in the longer term by making our economy more productive.’1

Lawrence Summers, former US Treasury Secretary, argued:

‘We may… be in a period of ‘secular stagnation’ in which sluggish growth and output, and employment levels well below potential, might coincide for some time to come with problematically low real interest rates…

‘The… approach… that holds most promise – is a commitment to raising the level of demand at any given level of interest rates… This means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.’2

Martin Wolf, chief economics commentator of the Financial Times, and one of the world’s most influential economic journalists, argued:

‘In brief, the world economy has been generating more savings than businesses wish to use, even at very low interest rates. This is true not just in the US, but also in most significant high-income economies.

‘The glut of savings, then, has become a constraint on current demand. But since it is connected to weak investment, it also implies slow growth of prospective supply…

‘So what is to be done? One response to an excess of desired savings over investment would be even more negative real rates of interest. That is why some economists have argued for higher inflation. But that would be hard to achieve, even if it were politically acceptable….

‘Yet another possibility… supported by many economists (including myself), is to use today’s glut of savings to finance a surge in public investment.

‘The best response… is measures aimed at raising productive private and public investment. Yes, mistakes will be made. But it will be better to risk mistakes than accept the costs of an impoverished future.’3

Wolf analysed this situation in the UK, which faced the same problem as the US, citing similar views by other influential commentators:

‘With real interest rates close to zero… it is impossible to believe that the government cannot find investments to make itself, or investments it can make with the private sector, or private investments whose tail risks it can insure that do not earn more than the real cost of funds. If that were not true, the UK would be finished. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way…

‘This does not even deserve the label primitive. It is simply ridiculous.’

Wolf clearly pointed to the consequences:

‘The results… are not at all ridiculous. They are extremely costly to both the economy and society. Yet, instead of taking advantage of the opportunity of a lifetime to repair and upgrade the capital stock, as Mr Portes [of the UK National Institute for Economic and Social Research] notes: “Public sector net investment – spending on building roads, schools and hospitals – has been cut by about half over the past three years, and will be cut even further over the next two.”’

Wolf concluded, endorsing such analysis:

‘He [Portes] recommends a £30bn investment programme (about 2 per cent of GDP). I would go for far more. Note that the impact on the government’s debt stock would be trivial even if it brought no longer-term gains…

‘the government… is refusing to take advantage of the borrowing opportunities of a lifetime…. It is determined to persist with its course, regardless of the unexpectedly adverse changes in the external environment. The result is likely to be a permanent reduction in the output of the UK.’ 4

Richard Yamarone, of Bloomberg Economics Brief, caustically noted:

‘Instead of adopting an economic solution such as matching idled and unemployed agents (millions of manufacturing and construction workers) with necessary improvements to the electrical grid, dilapidated highways, high-speed trains, outdated bridges, tunnels, ports, and water pipes, America received the political response of extended unemployment benefits and a whopping food stamp programme – safety nets for those who have fallen, not ‘stimulative’ measures.

‘Unlike during the Great Depression, which left a dazzling infrastructure legacy including a swath of bridges, tunnels, highways, art, dams and power generation, the only remnant from the 2007-09 depression is an underemployed labour force, earning a fraction of previous incomes, diminished skill sets and little or no promise for recent college graduates.’5

References

1. Bernanke, B. (2015, April 30). WSJ Editorial Page Watch: The Slow-Growth Fed? Retrieved May 2, 2015, from Brookings: http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/30-wsj-editorial-slow-growth-fed?cid=00900015020089101US0001-05011

2. Summers, L. (2014, January 5). Washington must not settle for secular stagnation. Financial Times.

3. Wolf, M. (2013a, November 19). Why the future looks sluggish. Financial Times.

4. Wolf, M. (2012, May 17). Cameron is consigning the UK to stagnation. Financial Times.

5. Yamarone, R. (2014, January 8). Summers’ remedy is years out of date. Financial Times.John Rosshttps://www.blogger.com/profile/08908982031768337864noreply@blogger.com0