The new recession is directly made in Downing Street

By Michael Burke

The final release for UK GDP in the 2^nd quarter of 2012 showed a small upward revision to recorded growth. But this still showed a contraction of 0.4% of GDP for a third consecutive decline. Real GDP is now 1% below the level recorded in the 3^rd quarter of 2011.

Previously SEB has shown that the driving force behind the recession has been the decline in investment (Gross Fixed Capital Formation, GFCF). That remains the case. In aggregate real GDP has declined by £60bn since the peak level of activity in 2008. Investment has contracted by £50bn.

Only the decline in household consumption comes close to making such a negative impact on GDP, falling by £42bn. In contrast the other main categories of GDP have risen. Government current spending has risen by £13bn while net exports have risen by £14bn. The latter is overwhelmingly due to the slump in import demand as exports have risen by less than £3bn over the period. GDP and its main components are shown in Chart 1 below.

Chart 1

The private sector was the source of this decline in investment, as the Labour Budget of 2009/2010 temporarily increased public investment. The incoming Coalition immediately brought that to a halt. What is now striking is that the decline in investment is now led by the contraction in public investment. In fact the whole of the ‘double-dip recession’ of three consecutive quarters of falling GDP is accounted for by the sharp fall in public investment.

This is shown in chart 2 below. This is the same format as the previous chart but it covers the time period from when the Coalition came into office. In addition it separates the two sources of investment, public and private. The data for these are taken from Schedule F of the latest  quarterly national accounts.

Chart 2

Over the period of the Tory led-coalition’s time in office the economy has contracted by £5.6bn. But the main driving force is no longer the investment strike of the private sector. It is the sharp contraction in public investment which has fallen by £11.2bn, almost twice the fall in GDP. Private investment has actually increased by £4bn over the same period.

It is noteworthy that household spending has also fallen by an amount greater than the fall in GDP, down by £8.6bn and reflects the effects of ‘austerity’, the cuts in welfare and other payments, the public sector wage freeze and the decline in real wages because of high inflation. Off-setting these to some extent have been the rise in government current spending and the increase in net exports.

In a very direct sense the latest contraction in the British economy is a function of government policy.

It is a recession made in Downing Street.

Improving Yields and Destroying the Environment

By Michael Burke

A short but very interesting item was recently broadcast on Radio 4’s Today programme. A recording of the programme can be replayed here where a summary is also available.

The report highlighted a disaster in the production of corn, wheat and soya beans in the US. This was not because of the widespread recent drought, but an additional man-made disaster which may have longer-lasting impact.

In effect, large US farmers have been encouraged to adopt genetically modified strains of the seed varieties for these different crops. The specific form of GM was resistance to extremely powerful weedkiller, which was then used exhaustively.

But giant ragweeds have developed resistance to that weedkiller just as many campaigners had suggested. Now 2,4-D a new chemical will be deployed that last saw widespread use in the rice fields and jungles of South-East Asia as part of Agent Orange. Formerly, it had been used as in Vietnam part of the campaign to destroy foliage and crops. Now, it will be used in the US to destroy all vegetable life including weeds, except for the seeds once more genetically modified to withstand it.

It seems almost incredible, but the response of vast agrichemical companies like Dow and Monsanto is to develop even more highly resistant seed strains. At the same time, at US insistence, consumers are not allowed to know whether they are purchasing goods made of GM products.

This intensification of both the efforts to increase yields at all costs and the hoodwinking and fraud perpetrated on consumers are likely to intensify in the current crisis. The crisis is characterised by a slump in investment. In effect, firms stop investing when they cannot be sure of making a profit. As a result, measures to increase productivity and schemes that amount to reckless fraud or endangerment (of consumers or the environment) are likely to increase in an effort to increase profits.

Marx put it this way, “If the rate of profit falls, on the one hand we see exertions by capital, in that the individual capitalist drives down the individual value of his own particular commodities below their average social value, by using better methods, etc, and thus makes a surplus profit at the given price; on the other hand we have swindling and general promotion of swindling, through desperate attempts in the way of new methods of production, new capital investment and new adventures, to secure some kind of extra profit, which will be independent of the general average and superior to it”.

Mass unemployment and lower pay are key consequences of the current refusal to invest, but so too are the growth in reckless schemes involving swindling and environmental depredation.

Germany's recovery Is faltering

By Michael Burke

Germany is widely regarded as the motor of the European economy. GDP grew by just 0.3% in the 2^nd quarter of 2012 and is barely 1% higher than a year ago. The German statistical agency Destasis speak of a continuing export-led recovery. But that is not strictly correct. German exports are rising. But because imports are rising faster, net exports have subtracted from growth.
Table 1 below shows the real change in GDP between 2008 when the recession began and the 2^nd quarter of 2012.

Table 1

Taken in isolation, Germany’s exports are indeed the single biggest contributor to its growth. But imports have grown at a significantly greater pace – they are up 12.1% over the period, compared to 9.5% for exports. As a result, net exports have subtracted from growth. Both, however, have grown faster than GDP itself, which has risen by 1.7% compared to the peak before the crisis. As a result Germany has become an even more open economy and trade accounts for over 48% of GDP.

The single largest net contributor to Germany’s growth has been household consumption, which more than accounts for the entire rise in GDP. Household consumption has risen by 3.8% since 2008. Increased government spending has also been a significant contributor to growth over the period and has risen even more rapidly – rising by 8.1%. Aside from net exports, investment (GFCF, Gross Fixed Capital Formation) has also been a drag on growth. This is the only component of GDP which is still lower than in 2008 and so is acting as the main brake on recovery.

Trends In Growth

A rise in household consumption is in fact characteristic of all the so-called core countries of the Euro Area. Along with Germany, Austria, Belgium, Finland, France and Luxembourg all have a level of household consumption that is now higher than before the recession, although this trend is by far the most pronounced in Germany. The exception is The Netherlands, where household consumption has fallen.

Turning to the source of this strength in household consumption, Table 2 shows the main categories of GDP alongside the changes in both the Gross Operating Surplus of firms and the Compensation of Employees. Since these latter two are only provided in nominal terms and on a calendar year basis, the entire set of data is presented in the same way to the end of 2011.

Table 2

The source of the rise in household spending is readily identifiable. The rise in spending of €98bn is almost exactly equal to the rise in the Compensation of Employees of €97bn. It seems likely that this willingness to consume is underpinned by the rise in government spending as well as the fall in the unemployment rate to 6.8 per cent - which is lower than at the onset of the recession.

Germany has therefore experienced a mild recovery based not on export growth but primarily on rising household consumption assisted by rising government spending. While this is a much stronger performance than either Britain or the crisis-hit countries of the Euro Area it is not sustainable over the medium-term and there are already signs that growth is slowing to a crawl. Trends in unemployment, which had supported consumption, have gone into reverse with unemployment rising for 5 straight months.

German Chancellor Merkel recently took half the Cabinet and a host of business leaders to China in order to cement the growing trade relationships between the two countries. Oddly, the overwhelming clamour from Western economists and commentators is that China’s economy should become more like that of Germany, driven primarily by household consumption rather than investment.

Instead, the current trends in the German economy show that it needs to become more like China, where investment plays the leading role in spurring growth. The alternative is for the German future to look more like the recent past of the crisis economies in the Euro Area where slowdown has been followed by stagnation followed by economic contraction.

Why More ‘Austerity’ Is On the Way

By Michael Burke
The latest monthly public borrowing data, which show a large deficit in government finances, have widely been hailed as a ‘surprise’. However, SEB has previously pointed out that the deficit has been widening over the prior six months, so that the latest shortfall in government finances is simply the continuation of an established trend.
More fundamentally, it does not require very sophisticated economic analysis to assume that a renewed contraction in the economy will lead to both higher government spending and lower government tax receipts. Despite higher prices, the nominal level of taxation receipts has fallen since the beginning of 2012, and expenditures have risen. At the very least, the borrowing data should put paid to all the chatter that the GDP data showing economic contraction is somehow wrong . Of course, the GDP data is subject to revision, like almost all economic releases including the data on public borrowing. But it is in practice inconceivable that the economy could be expanding while a significant shortfall appears in government finances. In that sense, government borrowing data are some of the most reliable of all, as they represent real expenditure made and income directly received by the government, rather than survey evidence and estimates of activity in the private sector.

International Experience
If there is any genuine ‘surprise’ from the widening in the budget deficit it is a product of an entirely incorrect framework that assumes that the state is an obstacle to economic prosperity and that removing it will boost output. In fact, the performance of the British economy and government finances in response to ‘austerity’ supports the opposite contention; which is that the state should be the leading force in an economy because it is more efficient than the private sector in developing economic growth. Reducing the weight of the state in the economy therefore damages economic activity.
But anyone who has followed the trajectory of the crisis-hit European economies in the recent period would not at all be surprised by the outcome in Britain. In every case where severe ‘austerity’ measures have been put in place, economic activity has contracted. This has also usually been accompanied by no significant improvement in projections for government finances, and in some cases a deterioration. The table below shows the EU Commission estimates and forecasts for the budget deficits in selected EU economies. It should be stressed that these are the EU Commission’s forecasts (in the Spring 2012 Euro Area Economic Forecasts), and have in the past been subject to negative revisions.

Table 1

Policy Response
The response to economic contraction and renewed widening in government budget deficits in the crisis countries of the EU is also instructive. In none of these cases has there been a reversal of policy, so allowing growth and therefore an improvement in government finances. Greece and Portugal largely had austerity foisted on them by the Troika of the EU, IMF and ECB. Spain, like Britain, initially had a mildly stimulative policy carried out by governments of the left, PSOE and the Labour Party respectively. However, while this partly reversed the slump it was wholly insufficient to provide economic recovery and they then switched to ‘austerity’ policies. This appeared to the electorate like an inconsistent and illogical zigzag on economic policy and ushered in parties of the right even more committed to an attack on the living standards of workers and the poor.
Ireland was a different case, as its ruling circles are wholly committed to the interests of foreign capital and their domestic agents (in this case, the speculators of Allied Irish Bank and its manly foreign bondholders). Therefore, without any external political impositions, the Irish government moved straight to an ‘austerity’ policy of its own. It later fell into the clutches of the Troika simply because this policy had utterly failed. The Troika then loaded the Irish state with even more debt in order to extend the policy.
Britain is unlikely to be any different and ‘austerity’ will be deepened. Reports of the latest deficit widening had headlines such as ‘Surprise deficit raises risk of more austerity , and ‘Tax slump threatens to set off new wave of cuts’ .
Even prior to the UK borrowing data, a series of business calls had been raised for further cuts in welfare payments in order to provide investment subsidies for firms. The Institute of Directors, the CBI and the British Chambers of Commerce have all been plugging deregulation and tax ‘reform’ as well spending cuts. This is actually an agenda for lower employment rights, safety and environmental standards, as well as tax cuts for corporations at the expense of labour and the poor. That is, a deepening of ‘austerity’.

Rationale of Policy
Rhetorically, it is possible to speak of the classic definition of the ‘madness’ of current policy in Einstein’s sense; repeating an experiment and expecting a different outcome. But in truth the dynamic of current policy is not irrational at all. Just as in the rest of Europe, policy is not aimed at restoring growth at all, or even reducing the deficit, despite government claims to the contrary.
In any capitalist economy investment falls not because there is insufficient demand - the 1.8 million households on waiting lists for social housing in England could testify to that. Investment falls because capital cannot be invested for a sufficient profit. In Britain investment (Gross Fixed Capital Formation) began to decline in the 1^st quarter of 2008, one quarter before GDP began to contract. It led the economy into recession and now accounts for 80 per cent of the total loss in output.
The purpose of current ‘austerity’ policy is to restore profits. Seen from the point of view of capital, there are two main current economic problems. The first is to reverse the adverse change in the profit share which takes place during recessions. The second is to create conditions allowing an increase in the profit rate.
1.In a recession the profit share falls. Company A produces goods which it sells for £1mn. It has wage costs of £0.5mn and other variable costs (raw material, energy, etc.) of £0.2mn. The surplus generated is £0.3mn. But in a recession it can only sell goods for £0.8mn as some are left unsold and some others offered at a discount. The costs of raw materials are almost entirely outside their hands. Faced with the same wages and raw material costs, the surplus falls to £0.1mn. This is exactly what has happened in the British economy since 2008. In nominal terms the compensation of employees had risen from £773bn to £816bn. Of course, in real terms, after inflation, there has been a marked decline in wages but in official data the distribution of incomes is presented only in nominal terms. But the gross operating surplus (GOS) of firms (akin to the surplus identified above) has risen from £503bn to just £508bn over the same period. Again, in real terms there has been a marked fall in the surplus. Crucially, the nominal rise in compensation has been greater than the rise in the surplus. Capital’s share in national income has declined as a result.
If Company A can lay off workers or cut overtime and maintain output it will do so in order to restore profits. But the complexity of the production process may not allow a significant reduction in wages with unchanged output. There is also the concern that a rival firm might increase its output and win market share from Company A, or even hire the workers it has trained. Instead, Company A will benefit if government can find a way to cut wages, say, by increasing the numbers of people unemployed in an attempt to force down wages, or cutting non-wage benefits to force those in work to work longer for less.
2.The cause of deep recessions is a decline in investment. Individually, firms are unwilling to resume investment until they can be much more certain of making adequate profits. In aggregate, they hoard capital and refuse to invest it. To make a profit Company A must deploy capital. This is in the form of both its costs of employment, raw materials and other input costs, as well as its costs of plant, machinery and so on. The rate of profit is the surplus extracted as a proportion of this total capital employed.
Frequently, boom precedes recession. This is not become economics is some kind of morality tale about excess, but because the boom includes an unusually high level of investment. In Britain, ‘unusually high’ is still weak by international standards but it meant the level of investment rose by 15 per cent in the four years to 2005, and by the same proportion again in the two years to 2007. This latter increase in the capital stock (plant, machinery, etc) took place while wages were growing but was not accompanied by an equivalent rise in the growth of the surplus. In fact, investment rose at a faster rate than the surplus. Since the profit rate is the ratio of the surplus versus total capital employed (both fixed capital and variable capital) and the surplus rose at a slower rate than investment, it follows that the profit rate fell.
But Company A is operating in a recession and sales are not rising and it cannot do anything about the costs of its plant and equipment. It is also at the mercy of market forces in terms of input costs such as raw materials. To restore the profit rate therefore requires a reduction in wages.
Anything which indirectly supports the level of wages such as benefit entitlements, unionisation, national pay bargaining, employment rights and so, must all come under attack to achieve this. Meanwhile, it will demand from government both that corporate tax rates must be cut and that the government provides work, or at least subsidies to it in order to boost sales and increase retained (after tax)profits.
This is the content of all ‘austerity’ policies. It is why they will continue even while growth is at best stagnant and the deficit rises once more. Policy is not aimed deficit reduction or still less economic well-being via growth. The aim of policy is restore and raise profits. It is why these policies will not only continue but deepen in the face of both economic contraction and a rising deficit.
The alternative remains large-scale state investment which will produce economic recovery. Firms wishing to survive will be obliged to participate in the recovery by investing on their own account, even at the lower profit rate.
Both resisting the impositions of further austerity and demanding the state lead the recovery through investment are the subject of a struggle between classes. Effectively it is a struggle about which major class will be forced to pay for resolving the crisis.

Questions and answers: Why investment not cuts is key

The debate on the alternatives to the current failed economic policy of the government has intensified. The renewed downturn in Europe, a British government Budget whose cut in the 50p tax rate underlined the class interests it represents and the slip back into ‘double-dip’ recession have all heightened interest in alternatives to ‘austerity’.

Socialist Economic Bulletin has consistently argued that the appropriate response to the current crisis is investment, not cuts. A number of readers have expressed interest in a Frequently Asked Questions, addressing some of the main points of this. These are set out below.

What do you mean by investment?

What we mean by investment is investment in machinery, transport, technology, housing and hospitals and similar things. This is not the speculation, sometimes wrongly called ‘investment’, which is often spoken of in relation to the stock market and other financial instruments.

All economic output is either consumed or set aside in the form of savings by households, companies or the government. This saving can sit idle in a bank, be used for speculation, or used for investment in building houses, infrastructure, transport links, education, health care, and so on. It is this latter type of investment which creates prosperity and jobs as well as improving productivity. It is what is meant by the term investment.

From a socialist point of view, investment is about ‘the means of production’. The question of who controls the means of production and how they are developed is the most important issue in the economy. Most of the time this issue appears abstract, but in a big economic crisis such as the present the question of who will control, or set the policy of the means of production, is an immediate issue.

Why has the question of investment become so important currently?

The fall in investment (gross fixed capital formation) in the OECD group of industrialised countries from 2007 to 2010 was approximately US$963bn in real terms. This is vastly more than the total decline in GDP, which was US$220bn. This was because other components of GDP, such as household or government spending as well as net exports to the rest of the world all rose. In order to reverse the slump, there must be a recovery in investment.

Is the same true for Britain?

It was. Until the Tory-led government came to office the decline in investment was the biggest contributor to the British recession and accounted for approximately 80 per cent of the decline in GDP. Declining investment also led the recession, beginning to fall before the economy as a whole contracted.

How has the recession changed since the Tory led coalition took office?

On the same basis as the OECD as a whole (US$ at Purchasing Power Parity), the decline in investment now accounts for the entirety of the British recession. The difference is that it has been joined and then overtaken by the decline in household spending. This is a result of government policy, where wage freezes, the VAT hike, benefit cuts and job losses have combined with higher inflation to push real incomes down. As a result household spending has also fallen. To get out of the recession therefore means that both people’s incomes, which determine consumption, and investment must be increased.

If there’s no money left, how can investment be increased?

There’s plenty of money left! If wages are held down and yet prices (for food, energy, rent, transport costs, etc.) are rising this means that the share of national income of companies or landlords or transport operators will all rise. Their share of national income is profits. But companies are refusing to invest this profit.
Where they can, companies are holding down wages and hiking prices but in general are refusing to invest.

As a result, they are sitting on a cash mountain (held in the banks) of around £750bn. Capital is plentiful. Currently it is in the hands of those who refuse to invest it. This refusal has led the economy into a double dip recession. The only way to reverse this is to raise people’s income, which means to stimulate consumption, and at the same time to embark on a major investment programme.

But is that enough?

It is more than enough to deal with the scale of the current problem. To restore all the lost output since the recession would require just £67bn. To restore the British economy to trend growth, so that it would seem as if the recession had never happened, would require approximately £225bn. Both of these totals are just a fraction of the cash holding of the corporate sector.

How could this cash mountain be accessed?

Government policy could easily claim it, through a variety of levies, windfall taxes and surcharges. The funds are already held mainly in British banks (as companies become increasingly concerned about holding them in overseas banks) and could be directed for investment purposes. RBS and Lloyds-TSB are already owned by the state and all deposit-taking banks operating in Britain can only do so because the deposits are guaranteed by the state. A substantial part of this investment should be launched directly by the state in housing, transport and other sectors. As regards private companies, a simple instruction could be issued that the banks must provide investment (cheap loans) to all the areas needed.

What are those areas?

The priorities would be investment in housing, in transport (especially much more energy efficient rail), in infrastructure (hi-speed broadband, non-carbon energy generation, port facilities, and so on), as well as
in education at all levels. These are the areas which have seen the biggest falls in investment during the recession, and yet have potentially the biggest returns on investment.

But once the bridge is built, or new broadband supplied, isn’t the money gone?

All the money spent has very large multiplier effects. This means the money continues to circulate in the economy long after the initial expenditure. In addition, there are very large boosts to productivity, making it possible to establish or expand businesses and services. The CBI now accepts that the average multiplier for large infrastructure projects is 2.84:1, meaning that for every £1bn initially invested, the economy is boosted by £2.84bn.

There has been a lot of recent talk from the CBI and others on the need for investment. Isn’t this the same as SEB’s policy?

No. The CBI and others represent the business interests that have participated in the investment strike which is the cause of the crisis. Now, because demand generally is falling once more (investment, household spending, government consumption and exports) they are suddenly concerned about current and future profits. They have also benefitted from lower wages and falling corporate tax rates. Yet they continue to refuse to invest.

Instead, they demand that they be given further subsides, handouts and guarantees (even guaranteed profits in the case of the nuclear industry) in the hope they will graciously deign to invest at some point in the future when profits are certain.

Worse, they also demand further cuts in wages and employment rights, and further cuts in government spending on welfare. This is indefensible morally but it also runs counter to the needs of the economy as whole, where falling household incomes is now also driving the recession.

But wouldn’t those business subsidies be worth it, if it led to a recovery?

Private businesses are driven by profit, and in aggregate they will make no large scale investments without an increase in profitability. As this is a generalised crisis in the industrialised countries, autonomous large scale private sector investment can be ruled out because no sufficiently large recovery of profits is in sight.

Therefore all attempts to bribe private businesses to invest, such as the government’s ‘credit easing’ are likely to prove extremely costly or fail, or both.

Then how can investment recover?

The state is not driven by profit and so has the capacity to make rational economic decisions, based on what is required to optimise sustainable economic activity. The mechanisms for the state to access the private sector’s cash hoard have already been identified. It is a relatively simple matter to achieve it.

If this were so simple, why hasn’t it been done already?

In Keynesian terms, this would amount to a ‘somewhat comprehensive socialisation of investment’. The state would be taking over functions that have been ceded to the private sector, such as house building, and would derive the surplus generated by it in the form of rent.

It would begin to reverse the decades of privatisations begun in earnest under Thatcher. In Marxist terms it would mean some portion of the means of production passing from private to public ownership. This is not therefore acceptable to the current owners, and the political forces which support them.

But surely this is Utopian, talking about the state taking over the means of production?

Across the world, the efficacy of all stimulus or bailout measures was in direct proportion to the involvement of the state, which is why China’s investment stimulus was the most successful of all. Even in the US currently, it is the state-owned agencies Freddie Mac and Fannie Mae which are keeping the housing market going as private banks have exited the US housing market. All across the world, including Britain, it was the state which supported the failing private sector banking system. It is the state, in the form of EU subventions, which is funding rapid recovery in the Baltic states and which allowed Poland to avoid recession altogether.

The state is a more efficient provider of many large scale goods and services. If its weight in the economy overall is sufficiently great it can also have the levers to regulate the level of investment, which is decisive for continued prosperity.

What about other alternatives, like taxing the rich?

Britain is a very unequal society, made more so by the Tory-led coalition’s policies of reduction in real wages and cuts in welfare entitlements. A more redistributive tax system, and closing tax loopholes to pay for it, would be beneficial. But tax increases alone are not sufficient for reviving the economy. In the last financial year the public sector deficit was over £124bn. Even the most ardent supporters of increasing taxes do not suggest that the full armoury of tax increases could match this total.

Other schemes, based on further monetary interventions or quantitative easing, or increased wages, while all useful in themselves, do not address the central issue that significantly increased investment is required to revive the economy and that the only agent that can lead an investment recovery is the state.


A leaflet version of this article Questions and answers can be downloaded here.