Wednesday, 17 January 2018

Trump's tax cut - short term gain, long term pain for the US economy

By John Ross
To assess the impact of the Trump tax cut on the US economy it is necessary to analyse the interrelation of two processes:
  • The determinants of US economic growth in the medium/long term,
  • The short-term position of the US economy in the current business cycle
Analysing these factors, the impact of the Trump tax cut on the US economy is clear:
  • In the short term the US economy is recovering in its current business cycle from its extremely bad economic performance in 2016, of only 1.5% growth, and the Trump tax cut is likely to boost this upswing
  • The tax cut will increase the US budget deficit, and therefore reduce the level of total US savings, thereby reducing US medium/long term growth – unless the US embarks on large scale foreign borrowing, which would directly contradict Trump’s aim of reducing the US balance of payments deficit.
In summary, the Trump tax cuts will create a pattern for the US economy of ‘short term gain, long term pain'. The rest of this article will analyse the reasons for these processes in terms of the fundamental determinants of US economic growth. A comment on the political consequences of these economic trends is given in the conclusion.
Determinants of US growth
In order to analyse the fundamental factors determining US economic growth in both the short and the medium/long term the correlations between the key structural features of the US economy and the US growth rate are shown in Table 1. This Table shows a clear pattern:
  • in the short term no single fundamental structural factor, except accumulation of inventories, is strongly correlated with US economic growth – and inventory accumulation is a passive factor merely reflecting the acceleration and deceleration of US growth. Leaving aside inventories, over a 1-year period the strongest correlation of a structural factor in US GDP with US growth is the percentage of net investment in US GDP, but this only accounts for 25% of US growth in a one-year period – a weak correlation. In summary, in the purely short term numerous factors – the situation in the business cycle, international trade, even the weather – can significantly affect US growth.
  • However, in the medium/long term there is an extremely strong correlation between structural elements of US GDP and US growth – the strongest positive correlations are shown shaded in grey in Table 1. The strongest correlation can be seen to be that between the percentage of US net fixed investment in the US economy, i.e. gross investment minus capital depreciation, with US GDP growth. This correlation accounts for the majority, 54%, of US growth over a five-year period and over a seven-year period US this correlation accounts for 72% of US growth – an extremely strong correlation.
Fundamental analysis, based on growth accounting, shows that high US next fixed investment causes high US economic growth rates. However, for present purposes of analysing the impact of the US tax cut it is not even necessary to establish this. The extremely strong medium/long term correlation of US net fixed investment with US GDP growth shows that it is impossible over the medium/long term to accelerate US GDP growth without increasing the percentage of net fixed investment in US GDP. Therefore, to analyse medium/long term prospects for the US economy it is necessary to analyse trends in US net fixed investment. This, in turn, directly interrelates with the consequences of the US tax cuts.
Table 1
The short-term position of the US business cycle
Analysing first short-term trends in the US economy this is greatly simplified by the fact that US medium/long term growth rate is among the world’s most predictable. Table 1 shows that over a 5-year period US annual average growth is 2.2%, over a 7-year period 2.1%, and over a 20-year period 2.2%. Only a 10-year period shows significantly different growth, at 1.4%, and this is simply a statistical effect of the huge impact of the international financial crisis of 2008. Given all these measures coincide therefore, annual average US GDP growth over the medium/long term may be taken as slightly above 2%. Given this stable medium/long term growth rate short term US business cycle trends simply show oscillations above and below this medium/long term average.
Table 2
Turning to the present situation of short-term shifts in the US business cycle, Figure 1 confirms that US economic growth in 2016 was extremely slow – only 1.5% for the year as a whole and falling to 1.2% in the second quarter. Given that the US growth rate in 2016 was substantially below its medium/long term average of slightly above 2%, a recovery of US growth was to be expected in 2017 for purely statistical reasons. This has duly occurred, with US year on year growth in the 3rd quarter of 2017 being 2.3% - marginally above the long-term US average.
The Trump tax cut is therefore being injected into an economy which is already recovering from its cyclical downturn in 2016. As the Trump tax cut is not accompanied by any equivalent reduction in US government spending it will therefore significantly increase the US budget deficit - estimates of the final effect of this are that the US budget deficit will increase by at least $1 trillion. A tax reduction which increases the budget deficit, that is which increases US government borrowing, may well increase a short-term recovery which is already occurring.
However, this increased budget deficit, other things being equal, will reduce US total savings – i.e. the sum of household, company and government savings. In the purely short term this fall in the US savings rate will not reduce US growth because, as was already shown, in the short term, i.e. one or two years, net saving and net investment are not closely correlated with US economic growth. Therefore, in the short term, the effect of extra spending arising from increased government borrowing, i.e. extra money flowing to corporations and consumers, may well lead to extra spending boosting already recovering US growth. For this reason, as already noted, in the short term, in 2018, the combination of the cyclical recovery and tax cuts is likely to lead to increase ‘short term gain’.
Figure 1
The medium/long term
However, in the medium/long term, as already noted, key structural features of the US economy, in particular net fixed investment, are extremely highly correlated with US growth. This, therefore, means that over the medium/long term analysing the trend in US net fixed investment gives an extremely clear guide to US economic growth performance.
Necessarily the effect of a greater US budget deficit is to reduce US total savings – other things being equal. As Figure 2 shows the US already passed into almost permanent US budget deficit and government borrowing from the late 1960s onwards – with only a short period of budget surpluses under Clinton. By 2017, although it had recovered from the depths of the international financial crisis, US government borrowing was still 4.0% of GDP even before the Trump tax cut kicks in.
Figure 2
The household and company sectors
In theory, as US total saving is the sum of government, household and company saving, increases in US household and/or company savings could offset a fall in total US saving caused by an increased budget deficit – for example theoretically companies and households benefitting from the tax cut would save their extra income. However, Figure 3 shows, however, that no increase in these other potential sources of US savings was in practice sufficient to overcome the effect of increased US government borrowing resulting from US Federal budget deficits. The result of substantially increased US government borrowing, not offset by trends in the household or company sectors, was therefore to produce a sustained fall in US total savings – that is in US capital creation. US net savings, which had been 13.1% of US Gross National Income (GNI) in the late 1960s, by 2017 had fallen to 1.7% of GNI.
Figure 3
Saving and investment
Turning to the relation between US savings/capital creation and the key chief structural determinant of US economic growth, net fixed investment, it should be recalled that total investment is necessarily equal to total savings. Investment may, however, be financed by either US sources or by borrowing from abroad. Therefore, a reduction in US savings, caused by an increase in the budget deficit due to the tax cuts, necessarily means that US total investment must fall unless an equal foreign source of savings can be found.
US presidents from Reagan to Obama were indeed prepared to use foreign borrowing to offset the decline in US savings - as Figure 4 shows. In the 3rd quarter of 1979, shortly before Regan came to office, the US was actually a net international lender of 1.0% of GNI. However, under Reagan the US embarked on massive international borrowing, this reaching a peak of 3.3% of GNI during his presidency. After a brief decline under George H W Bush, US foreign borrowing then expanded further under Clinton and George W Bush - reaching a peak of 6.1% of GNI in 2005. The shock of the international financial crisis then forced a reduction in US international borrowing, but it still stood at 2.6% of GNI in 2017.
Figure 4
Nevertheless. despite this very large increase in US foreign borrowing Figure 5 shows that this insufficient to entirely offset the decline in US savings and maintain the previous US level of net fixed investment. US net fixed investment fell from 10.5% of GDP in 1978, shortly before Reagan came to office, to a low of 1.7% of GDP in 2010 immediately following the onset of the international financial crisis. US net fixed investment has since recovered to 3.9% of GDP but this remains far below its previous peak level.
Given the extremely strong correlation between US net fixed investment and US economic growth which was already analysed this sharp fall of US net fixed investment necessarily greatly reduces US economic growth.
Figure 5
The slowdown in US growth
Given the close correlation of US net fixed investment with the US growth rate, the necessary result of this sharp fall in US net fixed investment was therefore also a progressive slowdown in the US economy shown in Figure 6.
Taking a 20-year moving average, to eliminate any short-term effects of business cycles, US annual average economic growth has fallen from 4.4% in 1969, to 4.1% in 1978, to 3.5% in 2003, to 2.2% in 2017. The extremely close correlation of the percentage of US net fixed investment in GDP with the US medium/long term growth rates already analysed means that the Trump administration cannot significantly accelerate US economic growth without increasing the percentage of net fixed investment in US GDP.
Figure 6
The choices tracing TrumpThe fundamental determinants of US economic growth therefore clearly show the choices facing the Trump administration which result from the tax cut.
By carrying out a tax cut unaccompanied by any government expenditure reductions the Trump administrations is lowering the level of US domestic savings. This in turn necessarily means a reduction in US investment unless an alternative source of savings can be found.
As previously analysed previous US presidents from Reagan to Obama partially offset this decline in US savings by large scale foreign borrowing. But this large scale foreign borrowing necessarily has consequences for the US balance of payments and therefore for Trump’s pledge to reduce the US trade deficit. 
  • The current account of every country’s balance of payments is necessarily equal to the capital account of the balance of payments with the sign reversed – i.e. an increase in foreign borrowing must necessarily be accompanied by an exactly equivalent worsening of the current account balance of payments. Whereas previous US Presidents were prepared to accept a deterioration in the US balance of trade as the necessary price to pay for large scale foreign borrowing Trump made it a central pledge to reduce the US trade deficit – the chief component of the US balance of payments deficit. But it is arithmetically impossible for there to be an increase in US foreign borrowing without there being a worsening in the US balance of payments deficit – that is, in practice, without there being a worsening of the US trade deficit. The Trump administration is therefore faced with only one of two choices:
  • If Trump sticks to the target of reducing the US trade deficit then the US cannot undertake significantly increased foreign borrowing, net fixed investment will therefore remain low, and US economic growth cannot significantly increase in the medium/long term.
If the US increases foreign borrowing, in order to increase the level of US investment, then this will necessarily mean an increase in the US balance of payments deficit – and therefore the Trump administration will be forced to abandon its central pledge of reducing the US trade deficit.
Contradictions of Trump’s policyIt is therefore clear that by its tax cut the Trump administration therefore places itself in an internally contradictory position in which it is impossible to simultaneously meet two of its stated goals: 
  • If the US does not increase foreign borrowing it cannot increase its level of fixed investment and therefore the US cannot significantly increase its growth rate – which was one of Trump’s key campaign pledges.
  • If the US does significantly increase foreign borrowing, in order to increase its level of fixed investment and therefore increase its medium/long term growth rate, the Trump administration cannot achieve its goal of reducing the US balance of payments deficit – on the contrary the US balance of payments deficit will increase.
If it should be argued that the Trump administration can find a way out of this contradiction by, for example, increasing the level of Innovation in the US economy this, unfortunately, rests on a misunderstanding. First, the close correlation between US net fixed investment and US economic growth shows that other factors are not powerful enough to compensate for a lack of net fixed investment. Second, the factual data shows that while a combination of innovation and fixed investment is extremely powerful in raising US productivity and growth, innovation unaccompanied by fixed investment does not significantly raise US productivity – for a detailed analysis of the US factual data see "Reality & myth of the US 'internet revolution'"
Other analyses
While the above analysis is made in terms of analysing the fundamental determinants of US growth it is also worth considering other analyses.
The IMF arrives at a fundamentally similar analysis to the above in its latest international projections – predicting a short-term increase in US growth in 2017-2018 but without any medium/long term increase in the US growth rate. Figure 7 shows more precisely that the IMF projects US 2.2% GDP growth in 2017, and 2.3% in 2018, before a decline to 1.9% in 2019, 1.8% in 2020, and 1.7% in 2021 and 2022. Overall the IMF projects annual average US growth in 2016-2022 of 1.9% - which is actually marginally below the average annual medium/long term US growth rate of slightly above 2%. Given the stability of US medium/long term growth, therefore, while the present author would agree with the IMF’s projected general pattern for the US economy, i.e. higher growth in 2017-2018 followed by a slowdown, he considers that US growth will possibly be slightly higher than the 1.9% annual average indicated by the IMF.
Gavyn Davies, former chief economist of Goldman Sachs, who runs one of the world’s most sophisticated ‘now casting models’, similarly concludes that while the pattern of faster US growth in 2017-2018 followed by slowdown is correct he predicts average US growth remaining just above 2%.
Figure 7
Lawrence Summers former US Treasury secretary has the same analysis. He characterises the increase in US growth in 2017-2018 as a ‘sugar high’ – the equivalent of the purely temporary short-term boost in human energy caused by taking a large dose of sugar. His analysis, given the self-explanatory title the: ‘US economy faces a painful comedown from its “sugar high”’ is that: ‘The tax-cut legislation now in committee on Capitol Hill exacerbates every important problem it claims to address, most importantly by leaving the federal government with an entirely inadequate revenue base. The bipartisan Simpson-Bowles budget commission concluded that the federal government needed a revenue base equal to 21 per cent of gross domestic product. In contrast, the tax cut legislation now under consideration would leave the federal government with a revenue basis of 17 per cent of GDP — a difference that works out to $1tn a year within the budget window.
‘This will further starve already inadequate levels of public investment in infrastructure, human capital and science. It will probably mean further cuts in safety net programmes, causing more people to fall behind. And because it will also mean higher deficits and capital costs, it will probably crowd out as much private investment as it stimulates.’
Finally, while the focus of this article is the economic prospects for the US, it is worth noting certain key US domestic and geopolitical trends which follow from this.
Under normal circumstances it would be expected that the relatively more rapid growth of the US economy to be expected in 2017-2018 would lead to favourable approval ratings for a US President. However, in addition to other purely political factors, opinion polls in the US show strong popular disapproval of the proposed tax cuts due to their being considered to be particularly favourable to the rich – polls show up to 58% of the US population disapproving of the tax proposals with only 37% approval. Overall a survey of US opinion polls on 16 December found 58% of US voters disapproving of Trump’s record as President and only 36% approving. It remains to be seen if the economic recovery likely to continue in 2018 will increase President Trump’s approval rating before the fact that the US medium/long term growth rate has not accelerated becomes clear. However, it is clear that a situation of continuing low US medium/long term growth will continue the present situation of instability in US domestic politics.
The reduction of the US savings level due to the increased budget deficit due to the tax cuts also has geopolitical implications. If the Trump administration turns to large scale foreign borrowing to try to increase US investment levels, and therefore accelerate growth, this will necessarily lead to a larger trade deficit. As this would clearly be contrary to one of Trump’s central campaign pledges it will lead to temptations to blame other countries for what are in fact difficulties created by the consequences of the tax cut – China may be a target of this. If, however, the US does not turn to foreign borrowing to boost investment and growth levels then US economic growth will not increase – which may also lead to seeking foreign scapegoats. In summary, the fact that the tax cut will not produce a significant acceleration in US growth, other than in the purely short term recovery in 2017-2018, may increase the temptation of the US to inaccurately blame other countries for what are in fact self-created economic problems exacerbated by the increase in the budget deficit.
In conclusion, the consequences of the US tax cut are therefore clear. They may be easily understood both in terms of the economic fundamentals considered and by those of other analysts including the IMF. The tax cut, by increasing the US budget deficit, will produce a ‘short term gain and long-term pain’, a ‘sugar high’ to use the term of Lawrence Summers. It will further boost a US recovery which is already taking place for statistical reasons in 2017-2018 but at the expense of undermining the US savings level and therefore the ability of the US economy to finance the investment which the data shows to be crucial for any significant increase in the US growth rate.
China’s economic policy, and that of other countries, must therefore be prepared both for the ‘short term gain’ of the US tax cut of 2017-2018 and for the ‘long term pain’, that is the low average US growth rate, that will be caused by the increase in the US budget deficit.
* * *
This article previously was published at Learning from China and originally appeared in Chinese at Sina Finance Opinion Leaders

Tuesday, 16 January 2018

Jeremy Corbyn is right. Carillion should be a watershed moment.

By Tom O’Leary

The collapse of Carillion was wholly made in Britain, although it has negative consequences internationally. Much of the coverage surrounding the failed outsourcing company focuses on its ailing business in Canada and the Middle East. This is a red herring. In its last-ever full year annual report and accounts (pdf) approximately three-quarters of the business revenues were generated in the UK (74% of the total, amounting over £3.8 billion).

The truth is Carillion has gone bust, putting vital public services and thousands of jobs at risk, because it and its component companies grew fat during the first phase of neoliberal economic policy and could not cope with the more recent phase, austerity.

The immediate cause of the collapse is a failed acquisition spree since the crisis began. This is highlighted by the fact that revenues were barely changed between 2010 (pdf) and 2016 at just over £5 billion and net assets actually shrank, even before the latest collapse to zero.

Yet the underlying cause is the disastrous relationship successive governments have had with the private sector. Whether the Thatcher/Major/Blair governments believed the nonsense they spouted about the superior efficiency of the private sector is immaterial. Only the wilfully ignorant could ignore the litany of failed privatisations and the extortion of PFI contracts that followed that followed their policies. The real purpose of Thatcherite economic policy, which has become widely known as neoliberalism, was precisely to hand state resources and revenues to the private sector.

Carillion, and the companies it acquired, expanded rapidly as it was fattened on the force-feeding of outsourcing, privatisations and PFI. Carillion’s ‘business model’ was to acquire as many of these companies as possible that benefited from public sector hand-outs and increasingly to hide the debt incurred in off-balance sheet special purpose vehicles.

The model came crashing down because of austerity. The main reason revenues are flat between 2010 and 2016 is that the Tories (and the Coalition before them) slashed public sector investment in roads, rail, ports and housing, and took an axe to real current spending, in areas such as education services, the NHS, the justice, system, and so on. The pace of new privatisations and PFI since 2010 was not enough to top up the bucket with a big hole marked austerity.

Where now?

Clearly, no tears should be shed for the private sector shareholders who continued to receive hefty dividends even when Carillion started to make losses. The directors continued to pay themselves hefty salaries and bonuses even as the company floundered. Some will be paid still.

It is those reliant on public services, that is the overwhelming majority of society who face even higher bills and lower living standards as a result of the collapse. The workforce will face job losses, and pensioners will be concerned about their futures. Mostly, this will be without the support of a union, as Carillion was viciously anti-union.

There must be no bail-out of the failed Carillion company. If possible, the directors and their advisers and auditors should be investigated to determine whether they are in breach of company law. Company law must change too. Directors must have a financial liability for this type of failure, including compulsory claw-back of salaries and bonuses, as well as liability for pension scheme failure. Auditors, lawyers and accountancy firms too must be held to account. A windfall levy should also be considered on all past and current holders of PFI contracts in order to fund the inevitable losses, with a view to driving PFI out of the public sector altogether.

The vital public service contracts for staffing prisons, cleaning hospitals and providing school meals and so on, should be taken back into public hands, the natural home for the provision of public goods. Similarly, construction activity must not be halted, the infrastructure deficit and housing shortages are already too great. The Carillion workforce and tens of thousands of workers in ancillary companies can be incorporated into new direct labour organisations.

The claim by George Osborne and Tory mayor of the West Midlands Andy Street that it was government failure to use ‘small and mid-sized firms’ in its contracts is ridiculous. The scale of these contracts is beyond the scope of these firms. Carillion used the familiar, monopolistic approach of buying up mid-sized rivals, which is a general tendency of private sector operations.

Above all, the fallacy that the private sector is intrinsically a more efficient provider of goods and services should die with Carillion. This cannot be true as the private sector is obliged to make a profit and the public sector is not. This is a failure of outsourcing, PFI and privatisation. They should all die with Carillion, and under a Corbyn-led Labour government that process can begin.

Monday, 4 December 2017

Longest slump on record – official

By Tom O’Leary

The latest official forecasts for the UK economy show the longest slump on record. But there is official silence on the cause of the crisis, signalling no intention to change course to end it.
Instead, the Office for Budget Responsibility (OBR), the UK Treasury and Chancellor Philip Hammond all hint that slashing growth forecasts over the medium-term is somehow connected to the weakness of productivity growth and this in turn is in vaguely related to the weakness of investment. 

Officially, the weakness of UK productivity growth remains a mystery or a ‘puzzle’. In reality, the UK is just one of the more extreme examples of a phenomenon across the Western economies of weak productivity growth. 

In all cases, the cause is the weakness of Investment which determines weak productivity, and the UK is among the weakest because its investment has been among the weakest. The claim that it is instead caused by ‘measurement problems’ of the service sector or other imponderables is belied by the fact that a large service sector is common to all Western economies, yet the UK has badly lagged behind even the G7 average growth in productivity since the Great Recession. Productivity is weak in the G7 because investment is weak, and both are weaker still in the UK.

UK Great Stagnation

The Great Depression of the 1930s lasted less than 3 years but was only definitively ended by the war boom in 1940, ten years later. The Long Depression at the end of the 19th century lasted 12 years. According to the official OBR forecasts the Great Stagnation in the UK will last at least 17 years, with living standards failing to recover their 2008 level until at least 2025. 

The current crisis is an unprecedented duration of weakness. On reasonable assumptions from the Resolution Foundation, real average earnings will not recovery their 2008 level until 2025. At the same time Government departmental spending will on average have fallen by 16% in real terms between 2010 and 2022. It also forecasts that the current outright decline in living standards will last longer than the fall in the recession, 19 quarters versus 17 quarters. Claims that ‘austerity has ended’ are utterly foolish. 

The consequences of such a prolonged depression will be severe. They are already beginning to accumulate. The OBR forecasts for per capita GDP and especially the level of debt would have been worse, except that longevity is beginning to decline. This is almost unprecedented in an advanced industrialised economy in peacetime. Further deterioration is almost inevitable, at least under current policy.

Einstein’s definition of madness

In the Budget, Hammond did suggest that low productivity was linked to low investment. He went further, “The key to raising the wages of British workers is raising investment – public and private. And Mr Deputy Speaker, we are investing in Britain’s future.”

This should all represent progress. Except the last part of that statement is untrue. The Tory government intends to cut public sector investment further.

The level of public sector net investment reached 3.4% of GDP during the crisis under Labour and was instrumental in supporting a recovery. The Tories slashed public investment to 1.7% of GDP in 2013/14 and has only recovered to 2% since. Hammond intends to cut it close to its low-point in the next Financial Year to just 1.8% of GDP and barely increase it subsequently. See Chart 1 below.

Chart 1. UK Public Sector Net Investment as Percentage of GDP, 2000 to 2023
It is important to recall, Hammond and the official forecasters are close to acknowledging that weak investment causes weak productivity growth, and that this in turn lowers the growth of wages and living standards. But the Tories intend to do nothing to reverse the weakness of investment.

As many analysts have pointed out, the big set-piece of the Budget in tackling the housing crisis will encourage no new home building and simply drive up house prices. This is at a cost of £3.2 billion, when 40,000 new genuinely affordable homes could have been built. The Tories have boosted demand for housing without boosting investment. The textbook response is higher prices (or in this case, softening the possible house price fall).

It is a serious mistake to believe the Tory leadership are stupid. Theirs is not primarily a failure of diagnosis. The intention is not to address a crisis whose proximate cause they accept; the lack of investment.

The intention of the austerity policy is to transfer incomes from poor to rich, from workers to companies. The policy’s ultimate aim is to boost profits. This is why, from the Tories’ perspective, the state cannot interfere in the economy by investing on its own account, as this would remove sections of the economy from private sector profitability altogether. The thrust of policy is the opposite, to privatise as much of the economy as possible. In the footnotes to the OBR documents, it seems as if the government intends to sell off its remaining shares in RBS at a huge loss to the public sector, for precisely this reason. The NHS, education, rail and other sectors are all being opened to the private sector.

Labour’s alternative

Under John McDonnell and Jeremy Corbyn, Labour has entirely the correct framework of borrowing for Investment, not for current or day-to-day spending. The latter can be met and even increased substantially by increased taxation. 

This follows from the fundamentally correct point that only Investment can add to the productive capacity of the economy. Consumption cannot. Therefore only Investment can sustain growth. Borrowing (and incurring debt and debt interest) for spending without a return was a factor in the Western government’s inability to deal with the end of the post-World War II boom in the 1970s. At the same time, Western governments were divesting assets (privatisation) that had been rescued through nationalisation after World War II.

Rather than make the state more responsible for Investment, the Western governments instead chose to slash current spending, led by Thatcher and Reagan. The verdict is clear. In the 38 years since Thatcher first came to office the economy has grown by 126%. The same accumulated change in growth took place in the preceding 26 years. 

Labour’s current economic framework is a sharp break from that past. In effect, to spur recovery, Labour is willing to make inroads into the private sector’s domain by increasing state investment.

However, the question is now posed of what will be the appropriate level of that investment, in light of the official expectations that weak productivity means a permanently lower rate of growth, something more like 1.5% than 2.25%.

One factor in the response is Labour’s own fiscal rules. According to the OBR, at some point in the next few years borrowing for current or day to spending will end, possibly in 2019. Table 1. below shows the forecasts for Public Sector Net Borrowing and Public Sector Net Investment over the next few years.

Table 1. UK Public Sector Net Investment and Net Borrowing, 2016/17 to 2022/23, £bn
Source: OBR

The same trends are shown in Chart 2 below. Pubic Investment is forecast to exceed public borrowing at some point in the next few years.

Chart 2. Public sector net Borrowing & Net Investment, £bn, 2016/17 to 20222/23
Given how realistically downbeat the OBR now is, and assuming unchanged government policy, only an outright recession could push the cross-over point for public investment and borrowing into the very far future. This means day-to-day or current government spending at some point in the next few years will be more than covered by government taxation and other revenues.

A crucial difference is that Labour would maintain and increase government Investment for growth in living standards. The Tory stated plan is to eliminate borrowing altogether.

At the last election, Labour’s costings manifesto outlined £48.6 billion in taxation and other revenue-raising measures. According to the OBR, it will also a have further £21 billion in 2020 in headroom to increase current spending without having to borrow. To address the real damage to public services and pay, as well as to maintain and build political support for a radical government of the left, then most if not all of this £70 billion spending is likely to be needed.

Therefore at some point all of the new government borrowing will be for investment. The Labour fiscal framework already includes a ‘knock-out’ option, where borrowing on all items of government outlays can be increased if interest rates remain close to zero, which provides flexibility in the face of a recession.

But in light of the official acceptance that growth will now be ‘permanently’ lower, at least lower over the foreseeable future there is room for reconsideration of the borrowing targets for investment. The National Investment Bank and Infrastructure Commission should both have as their mission statement the ‘permanent’ raising of the productive capacity of the economy.

This may well require going beyond the current commitment to borrow £25 billion in additional funds over each of the next 10 years to fund investment. Even if the private sector matches this increase, there will still be a requirement for prolonged rate of much higher Investment to return even to the previous growth path.

The Tories are likely to bequeath Labour an exceptionally weak economy. Labour’s fiscal framework already allows the correct focus on government Investment. At the same time, the effects of severe austerity and Labour’s own tax plans already mean there is will soon be plenty of scope to increase government Consumption (current spending) without increasing borrowing. But to deal with the severity of the Great Stagnation under current official forecasts, much greater increased in borrowing for Investment may be needed.

Saturday, 25 November 2017

John McDonnell is right, borrowing for investment does pay for itself

By Michael Burke

The manufactured furore surrounding John McDonnell in the wake of the Budget has a clear purpose. It is designed to distract attention from probably the grimmest set of forecasts delivered in a Budget in the modern era and to deflect criticism from the Tory government. 

This is not solely an anti-Labour, pro-Tory propaganda campaign. Contrary to widespread assertions, austerity is not coming to an end and is being deepened. Seven years of falling living standards are not over. The Institute for Fiscal Studies (IFS), very far from being a left-wing thinktank, says that living standards will be lower in 2023 than they were in 2008.

This is a doubling down on the failed policy of austerity. It is therefore important for all supporters of austerity to shift attention from the repetition of a policy that has already failed.

Borrowing to invest

The immediate focus of the criticism of Labour plans was the absence of a specified level of interest of government debt arising from Labour’s borrowing. This is perhaps one of the weakest grounds to attack.

This is because Labour’s Fiscal Responsibility Framework is committed to borrowing solely for investment, and balancing current or day-to-day spending on items such as health and education with current revenues which is mainly taxation. 

As a result, all of Labour’s borrowing would have a return. The combined effect of borrowing at low interest rates and investing with much higher rates of return is a net boost government finances, which can be used to increase Investment further. The level of government deficits and debt will fall automatically as taxation revenues grow along with increased economic activity.

Currently, government borrowing over any time period (or debt ‘maturities’ in the jargon) costs less than 2%. This is below the level of inflation, which alone means that the borrowing makes sense. Yet, at the same, the returns to commercial investment are on average around 12%. Any government, or business, which can borrow at such low interest rates for such high investment returns would be foolish to pass up this opportunity. It is reckless and extreme that the Tories have passed up this opportunity.

Of course, no-one can possibly know what the level of interest rates will be in a few years’ time. But the official forecasts from the Office of Budget Responsibility (OBR) suggest only a minimal increase on government borrowing costs (the yields on UK government bonds, or ‘gilts’) over the medium-term.

This is shown in Chart 1 below, with the green line in Chart 3.10 representing the latest forecasts of long-term borrowing costs. These barely move above 2% over the medium-term.

Chart 1. OBR Expectations of UK Interest Rates
In financial markets there is a calculation used to highlight where interest rates are expected to be in a given number of years’ time. Currently, using this calculation of the difference between 10year gilt yields and 20year gilt yields implies a market expectation that in 10 years’ time, 10year interest rates will be 2.3%. None of these forecasts can be relied on for pinpoint accuracy. Instead, they are shown to illustrate the point that it is reasonable to assume that government borrowing costs remain subdued for some time to come.

Rates and growth

The fundamental point is that when economies grow strong and especially when there is a risk of inflation, all long-term interest rates tend to rise. If the economy is performing strongly, then the pressure on Labour to borrow for investment when it comes to office subsides to some extent. But that is not what any serious commentator, the OBR, IFS or Resolution Foundation thinks is likely.

Instead, government interest rates fell sharply in response to the grim Budget outlook. This should be read as a ‘market signal’ that borrowing for investment should increase. Bond markets could absorb a lot more borrowing before gilt yields were pushed back up even to their very low pre-Budget levels.

The commitment of the Fiscal Responsibility Framework means it is easy to gauge whether the borrowing is sustainable. The decisive criteria is whether the return on the borrowing exceeds the cost of borrowing. As noted above, the average commercial return on investment in the UK is around 12%, a large multiple of the current cost of borrowing. Only if the cost of borrowing rose above that level would it become unsustainable. This seems unlikely in the foreseeable future.

In reality, the net returns to government from the same investment as the private sector are actually significantly higher. To take a clear example, a private developer who builds homes might get a return of 10-12%. But the same returns are available to government for the same project, while the cost are lower. This is because in the course of construction, income tax and National Insurance is paid by builders and other workers (and there is a return on their consumption too via VAT). This is a return to government which is simply not available to the private sector. 

So, John McDonnell is right, and his critics are wrong. Borrowing for investment not only makes sense, it more than pays for itself.

Wednesday, 8 November 2017

O Portugal: a esquerda no governo

Por Tom O’leary

A polemica recente sobre a politica económica no Portugal é muito importante porque tem importância para todos os grupos anti austeridades da esquerda. Os grupos da esquerda têm alcançado algo único no período atual, em que o governo do Portugal é o único que opera para terminar a austeridade. Nos termos mais generais, isto é o objetivo para o governo possível de Corbyn na Inglaterra, também deveria ser o objetivo para a esquerda completa da Europa, então precisa de observar o governo do Portugal. 

O periodista que e famoso na Inglaterra que se chama Owen Jones começou a polemica com uma afirmação verdadeira que a experiência portuguesa demostra que a austeridade nunca era necessária. As políticas que sustentam o crescimento económico são mais preferidas e também causam uma redução do déficit publico entre outras vantagens. Uma variedade de pessoas criticou Jones incluindo Jolyon Maugham, um comentarista de Twitter que publicou muitos tuítes que apoiam completamente as ações da União Europeia com respeito ao Portugal.

 O tuíte é um modelo de brevidade, contem ao menos três errores em menos de 140 caracteres e, mais importante, os credores do Portugal foram resgatados pela UE, não o país. O governo do Portugal ainda tem as dívidas dessa época que pioraram devida ao programa da austeridade que as acompanharam. Se pode culpar a comissão da União Europeia, o Fundo Monetário Internacional, o Banco Central Europeu, os políticos portugueses (alguns do Partido Socialista que agora estão na coalizão da esquerda), as agências de notação de riscos de crédito, os bancos domésticos e internacionais, e claro, os credores. Como o partido politico da Inglaterra, os ‘Liberal Democrats’, Maugham não só defende a adesão à UE, senão também a austeridade que a UE perpetua.

A recuperação do Portugal não vem por causa da imposição do programa da austeridade, mas apesar das políticas da austeridade. Mas os questiones mais importantes para a esquerda agora são como a recuperação económica pode ser alcançada e pode ser mantida.

O desempenho económico

O FMI prevê um crescimento do PIB real de 2,1% no ano de 2017, o que pode ser a taxa mais forte desde a começa da crise em 2008. Mas a taxa de crescimento foi de 2,8% na primeira metade de 2017 comparada ao mesmo período em 2016, o que ultrapassa a UE ou a média da zona euro. Não há dúvida que o crescimento económico tem acelerado desde a coalizão entre os democratas socais e os partidos extremas da esquerda em 2015 e isto continua.

O crescimento do PIB do Portugal, ano por ano
Fonte: Eurostat

A primeira conclusão deveria ser que a terminação da austeridade não cause desastres. De fato, tem causado um crescimento acelerando e uma redução nos deficits públicos do setor publico. A segunda conclusão é que o governo da esquerda pode terminar austeridade apesar da UE e ainda a zona europa ao menos nas limitas certas.

O crescimento é limitado pela acumulação do capital, que é o crescimento nos meios de produção. Desde a coalizão da esquerda, o nível do investimento (a Formação Brutal de Capital Fixo) subiu 7,7% (dados pelo segundo quarto de 2017 já não é disponível). Durante o mesmo período, PIB real subiu ao menos da metade dessa taxa. Por isso o investimento causou o crescimento económico.

O governo contribuiu ao aumento no investimento, mas a contribuição mais grande proveram do setor privado. Os lucros previstos são o fator principal dos investimentos privados então é provável que as medidas do governo português para aumentar o consumo e o seu incremento modesto dos investimentos causaram o acréscimo dos níveis previstos do lucro. Em breve, as medidas de incentivo têm estimuladas a economia portuguesa.

É mais preferido e mais efetivo que a austeridade, mas não é sustentável para o futuro. O aumento ao consumo não se sustenta por um crescimento dos salários e das rendas. Eurostat reporta que a proporção das poupanças caseiras tem mergulhada. Essas cifras se-pode ver na tabela seguinte.

A proporção das poupanças caseiras, %:
Fonte: Eurostat

Essa redução nas poupanças caseiras e os níveis do consumo atual (causado pelo investimento do setor privado) não são sustentáveis. Os salários reais estão em queda e em certo ponto, sem o crescimento real nos salários e nas rendas, as casas vão limitar seus gastos.

Para sustentar a recuperação económica e aumentar os salários reais, o crescimento do investimento deveria aumentar por maneira sustentável. É improvável que o setor privado vai fornecer o investimento se os gastos dos consumadores fraquejem. Então, o governo tem de procurar maneiras no que pode aumentar o investimento do setor publico.

Sem mais conhecimento da economia portuguesa não é possível para produzir um plano para o investimento do setor publico. Não obstante, há uma variedade das fontes potenciais para fundos que incluem:
  • O numero de corporações que são públicos que podem aumentar seu investimento (usando as reservas ou os empréstimos novos
  • Os pedidos para a comissão europeia para acelerar/aumentar seu programa dos gastos do capital
  • A nova infraestrutura e outros projetos que o Banco Europeu de Investimento custeia
  • Os novos impostos para os super-ricos e as companhias grandes para pagar os investimentos
  • A remoção dos subsídios para os negócios para criar fundos para o investimento public
  • Quando é possível, empréstimos adicionais pelo governo
A escala do investimento que é necessário é muita grande. Em 2000 a Formação Bruta de Capital Fixo como uma proporção do PIB subiu 28%, mas agora representa quase metade dessa. Entretanto todos os passos nesta direção asseguram que a recuperação tem uma base mais sustentável.

O governo português da esquerda demostrou que existe um alternativo à austeridade, mas os incentivos não funcionam de longo prazo. Para sustentar a recuperação e mostrar que o alternativo à austeridade é o investimento, necessita-se os medias mais fortes.

Este artigo é uma modificação do artigo que originalmente apareceu em inglês.