Who is to blame for the crisis? Not unions, immigrants or ‘scroungers’

By Michael Burke

A crisis is an objective fact to which there can essentially be only two responses. The cause can be identified and addressed, or some other explanation can be advanced which effectively shifts the blame for the crisis elsewhere. The government and the supporters of austerity are increasingly bent on the second course.

A succession of scapegoats have been offered for the crisis, including perniciously both immigrants and ‘scroungers’, and now unions. However, as these cannot begin to provide an economic explanation for the crisis, the supporters of austerity also persistently claim that the cause of the current crisis is weak exports, effectively blaming foreigners for the British crisis.

The reality is very different. The chart below shows the trend of total domestic expenditure in the course of the present slump. This is the same as GDP minus the changes in both imports and exports. In 2008 and 2009 activity fell sharply and was followed by a mild recovery. But since the Tories began to implement austerity the domestic economy has stagnated.

Fig 1

Since the Tory-led Coalition’s Spending Review of 2010 total domestic expenditure has risen by just £864mn. Statistically, in terms of a £1.5 trillion economy, the change in total domestic expenditure has been zero.

By contrast, GDP has risen by €21bn since the Spending Review, or 1.1% in over 2 ½ years. This is driven by a rise in net exports. Exports have risen by £18.1bn since the Tory-led government began implementing austerity. But imports have fallen by £3.2bn over the same period. Arithmetically lower imports count as a positive contribution to growth, but they actually reflect the weakness of the domestic economy.

These totals are shown in the chart below. It should be clear that since austerity began the domestic economy has not grown at all while net exports have risen by £21.3bn. It is Britain which is a drag on the world economy not vice versa.

Fig. 2

In terms of the components of total domestic expenditure, the fall in investment is entirely responsible for the continued stagnation of the economy. Investment (Gross Fixed Capital Formation) is the only category of the national accounts which has fallen over the period from the 3^rd quarter of 2010 to the 1^st quarter of 2013. Investment has fallen by £25.7bn in that time while government spending has risen by £12bn and household spending has risen by £13.2bn.

Fig. 3 

Far from dealing with the crisis the austerity policy has deepened it. In the preceding slump the decline in investment accounted for most of the fall in GDP, £42bn of a total economic contraction of £45.2bn. Since the imposition of austerity measures investment alone accounts for the slump, as every other component of GDP has risen, government and household spending and net exports.

It remains the case that it is private firms which are driving the slump in investment. But the government’s austerity policy includes a sharp cut in its own investment, which has exacerbated the slump.

Fig. 4

Therefore, far from blaming everyone else it is the government’s own policies which have caused the stagnation. The latest scapegoat is the unions, following on from foreigner, immigrants and ‘scroungers’. But it is the austerity policy which has failed.

This has clear lessons too for the incoming Labour government. Only a policy which addresses the real source of the crisis – the collapse in investment – can hope to resolve the crisis. Otherwise the danger is that economic policy makers are left casting around for scapegoats to distract from the failure of these policies.

It’s even worse than was thought

By Michael Burke
 
The latest GDP release from the Office for National Statistics was accompanied by a set of revisions to previous data. These now show that the downturn was more severe than had previously been estimated and that the British economy is even further away from recovery.

Previously, ONS data had shown that six years into economic slump the economy was still 2.6% below its pre-recession peak in the 1^st quarter of 2008. Now it shows that the economy is actually 3.9% below its peak.

The economy is still £61bn below the peak level. Yet it remains the case that the fall in investment more than accounts for the entirety of the recession, as shown in Fig. 1. Investment (Gross Fixed Capital Formation) has fallen by £68bn. The other main component of GDP which has contracted is household consumption, which is down by £28bn. This demonstrates the effects of falling real wages on living standards. It effectively accounts for half the recession, but it is not as severe as the decline in investment.

By contrast government spending is £20bn higher, despite all the propaganda about the absolute priority of deficit reduction. This is because government policy is not primarily aimed at curbing spending at all, otherwise PFI, Trident and subsidies to corporations would all go. The aim is to boost profits, which means cutting wages, cutting government investment in areas where the private sector can return profits and redirecting the social surplus towards capital.

Fig. 1 

Net exports are also £32bn higher. The government and its supporters are inclined to blame Europe, or foreigners in general for their own failed economic policy. It should be noted that the rise in net exports has very little to do with the increased sale of goods and services overseas. Despite a very large devaluation for Sterling exports are only £6bn higher at the beginning of 2013 than at the beginning of 2008. By far the larger component of the rise in net exports has been the fall in imports, down £26bn over the same period. It seems that both households and firms in Britain are being priced out of world markets. It should be clear from the much greater fall in imports that it is Britain which is a drag on the world economy, not vice versa.

In fact the British economy has been one of the worst performers in the G7, which itself has performed very poorly. As a whole the G7 economy is just 1.1% above its pre-recession peak at the beginning of 2008. The British economy’s performance still 3.9% below its prior peak placing it in the rear of the G7, on a par with Japan and ahead only of Berlusconi’s Italy.

Fig 2

The slump has been followed by stagnation. The effect of the downward revisions to GDP is to increase the gap between the economy’s previous trend rate of growth and its current level. As a result the economy is already nearly 20% below its previous trend rate and even on official forecasts that gap is set to widen over the next period. The economy is about £350bn below its previous trend. This gives a measure of the scale of the crisis facing an incoming Labour government, which cannot be remedied without a commensurate level of investment in the economy.

Fig 3

The Tory-led government has no intention of increasing investment. The much-hyped infrastructure investment plan was entirely fake. As the chart from the Institute for Fiscal Studies reproduced below shows, government investment is being cut.

Fig 4 

The Tories regard the returns available from this investment as belonging to the private sector. The cut to investment is to allow the private firms to invest and so reap the benefits. But there is no evidence that the private sector regards these as sufficiently profitable. As a result the cuts to government investment are simply exacerbating the slump in private investment. A Labour government would need to break this investment strike through a very large increase in government investment.

Why do we have ‘austerity’ and what is the alternative?

By Michael Burke

The national launch of the People’s Assembly Against Austerity is a very welcome development. It brings together a number of the largest unions, anti-cuts group and political forces both inside and outside the Labour Party in opposition to austerity policies.

Many will have been drawn into active opposition to government policies because a single aspect of them, perhaps the cuts in public sector pay and pensions, or social protection for people with disabilities, or the imposition of the bedroom tax or the very high level of unemployment among young black people, or the string of cuts which have driven women out of public sector jobs, facing reduced childcare provision and increasingly bearing the burden of reduced social care.

All of these policies are linked and generally go under the title of ‘austerity’. The term is a little misleading, as it implies that conditions have generally become worse for all. But that is not the case.

Transfer of incomes

One of the first acts of the Coalition government was a simultaneous increase in VAT and a cut in the level of corporation tax. According to the Treasury these amounted to approximately the same (£12bn to £13bn) in terms of revenue. But the VAT hike was disproportionately paid for by the poor and middle income earners, who spend more of their incomes on VAT-able goods. The corporation tax cut was an increase in the net income for firms. Taken together they amount to a transfer of incomes from workers and the poor to capital and the rich, the owners of firms.

This transfer of incomes from labour and the poor to capital and the rich is the essence of austerity policies. It is workers and the poor who are being made to pay for the crisis.

The purpose of austerity

In an economic downturn, profits fall at a greater rate than the fall in output. This is because profits are the surplus of firms after they have paid costs, including fixed costs, and the costs of labour and materials. As the revenue from sales falls but costs are static or do not fall so far then profits are hit. Therefore a key mechanism for restoring profits is to reduce costs, most especially the costs of labour.

This is what happened in the current slump, as shown in Fig.1 below. In nominal terms, before taking account of inflation, between 2008 and 2009 GDP contracted by £39bn and the operating surplus of firms fell by £33bn. Of course, in real terms the fall was more severe in both cases. But the natural outcome is that profits will bear the brunt of the fall in output.

Figure 1

The aim of austerity is to interrupt, divert and reverse this process by cutting wages so that profits can be restored. Cuts to public sector pay have a ‘demonstration effect’, designed to lower the ceiling for pay in the private sector. Cuts to social protection entitlements are meant to force all workers to accept lower pay. These policies are supplemented by privatisations which reintroduce the accumulation of profits into areas of the economy formerly run by the state (NHS, rail, Royal Mail, and so on) and corporate taxes are cut to boost net profits.

This has had an effect. The austerity policy introduced in 2010 has led to a £40bn increase in firms’ operating surplus from their low-point in 2009. But this is not yet a thorough-going reversal. Nominal wages have risen by £43bn over the same period. It should be stressed that these data do not take account of inflation, so that there has been a real fall in living standards but equally only a very limited rise in profits.
Austerity policies have reversed the decline in profits and reduced the wage share of national income. But they have not yet allowed profits to rise so far that firms are once more investing and expecting profits.

The alternative to austerity

The cause of the economic slump remains the slump in investment. In Britain the fall in investment (gross fixed capital formation) more than accounts for the entire fall in GDP. In real terms between the 1^st quarter of 2008 and the 1^st quarter of 2013 GDP fell by £38.7bn while the fall in GFCF is now £50bn (as other components of growth have risen such as government spending and net exports). This is shown in Fig. 2 below.

Figure 2

This is now a combination of the private sector’s refusal to invest alongside government cutting its own investment. It is not possible to have a sustained improvement in economic activity without an increase in investment.

The long-term relative decline of the British economy is driven by the declining rate of investment. In 1970 the ratio of investment to profits was 70%, that is the total level of investment in the economy was equivalent to 70% of firms’ operating surplus. In 2012 this investment ratio had fallen to 42%. As a result, investment has fallen from 19.4% of GDP to just 14.1%.

The declining rate of investment has been a long process. But even as late as 2007 the investment rate was 51% and the rate of investment as a proportion of GDP was 17.7%. As a result of the crisis quantitative change has become a qualitative one.

Figure 3

As the private sector’s refusal to invest is because they cannot be certain of making a profit it falls to the state to invest on its own account. It can make successful large-scale investments which are not profitable to the private sector because uniquely it derives its return from taxation. Any general increase in economic activity will see tax revenues rise and social protection payments automatically fall.

The vast level of uninvested profits is now sitting idle in state-owned banks which failed because they made unprofitable investments. It is simply a matter of political will to tap these vast resources for investment in housing, energy, transport, infrastructure and education. This would lead to economic revival.

The reason it is so fiercely resisted is because it runs counter to the whole thrust of austerity, which is to restore profits. But increasing state-led investment is the only feasible road out of the crisis which does not lead to the further immiseration of the overwhelming majority of the population.

The FT, hedgehogs and the scale of the crisis

By Michael Burke

In analysis of any issue it is crucial to distinguish between factors that are of primary or decisive importance and those that are secondary or lesser matters. This applies to economic analysis as much as other disciplines. There is a vast amount of economic data which is produced by innumerable public and private agencies internationally, and an almost endless number of ways of configuring the data supplied.

The most important issue facing the British economy is how to end the slump. No other issue, employment, incomes, government finances or anything other question can be resolved without it.

Therefore it is extremely important to analyse the trends and prospects for growth in a sober fashion and to focus on the most decisive factors. It is unhelpful or even misleading to focus primarily on secondary matters.

The recent Bank of England Inflation Report contained an assessment of the trends in growth of the British economy. Chris Giles, the economics editor of the Financial Times has provided a very useful chart showing changes in the Bank’s growth forecasts over time. The chart is shown below.

Chart 1

This is described as a ‘hedgehog’ chart because of the various lines indicating the changes to the Bank forecasts over time. Chris Giles highlights the fact that this is the first time since 2007 that the Bank has produced an improved forecast, which raises projected GDP growth from 0.9% to 1.2% in 2013. This is shown on the chart as the difference between the orange and green spikes on the chart.

In reality, the Bank’s forecasting record is an extremely poor one. The November 2007 forecast (the purple line in the chart) was made just a few months before recession began in the 2^nd quarter of 2008. This was the deepest recession since the 1930s. Yet the Bank was not forecasting any contraction in output at all. The various ‘hedgehog’ spikes arise because it has continually forecast a rapid return to growth that did not materialise.

The upward revision to the forecast this year is minimal, comprising just 0.3% of GDP. For many people, and not just supporters of austerity like Chris Giles, there is a hope that this upward revision to forecasts is the beginning of a trend and that there will be a continuous upward revision of forecasts as the outlook improves.

Yet the focus on such a slight revision to the growth outlook seems misplaced, and not just because it could be altered in either direction. Even before the slump the British economy was not growing at a fast pace by international standards. A return to prosperity would imply a rejection of permanently lower growth and a return to the previous trend. Instead the Bank’s forecasts imply a further widening of the gap between the future growth of the economy and its pre-recession trend.

This is the real scale of the economic crisis and the issue which is of primary importance. Currently the gap between the level of output and the economy’s former trend is approximately 16% of GDP.

This gap will continue to widen so that any new government will be faced with a shortfall in output of approximately 20% of GDP. In current prices these are in the region of £250bn to £300bn.

This is a measure of the effects of both recession and austerity. Therefore it is also a measure of the scale of the task facing any new government that wants to end them.

The Deepening European Crisis

By Michael Burke

The economies of the European Union and the Euro Area both contracted in the 1^st quarter of 2013. The renewed contraction in GDP began in mid-2011 and has now run for 18 months on both cases. But, as Chart 1 below shows, the recovery from the depths of the recession in both cases was short-lived and at no point was the previous peak in activity of the 1^st quarter of 2008 recovered. In reality, the European economy has been in a slump which stretches all the way back to the beginning of 2008 and is now entering its sixth consecutive year.

Chart 1

The cause of the crisis remains unaltered. Full data for all the components of GDP in the EU and Euro Area are not yet available. But comprehensive data is published up to the 4^th quarter of 2012. No substantial turn in events took place at the beginning of 2013, simply an extension of previous negative trends.

In that period from the 1^st quarter of 2008 to the 4^th quarter of 2012, GDP in the Euro Area has contracted by €288bn in real terms. In the European Union it has contracted by €310bn. However, if the components of GDP are examined it is clear that the decline in investment more than accounts for the entire fall in GDP in both cases.

Investment (Gross Fixed Capital Formation) has fallen in the Euro Area over the same period by €362bn and fell by €461bn in the EU. In both cases this is far in excess of the total decline in GDP, and is shown in Chart 2 below.

Chart 2

Since the slump in both the EU and the Euro Area is driven by the fall in investment, the slump itself and all its economic symptoms (unemployment, falling real incomes, strained government finances, and so on) cannot be resolved without increasing the level of investment.

This would be impossible if the mantra that ‘there is no money left’ were true. But it is very far from being true. The aim and purpose of capital in a capitalist economy is the accumulation of capital.
Where that cannot be achieved capital will simply remain idle as cash balances accumulating in banks. In the latest monthly report from the ECB the currency and bank deposits of non-financial firms in the Euro Area banking system are €2,073bn and short-term bills are a further €83bn (p.143). They are considerably more when the EU cash deposits of firms in non-Euro Area are added.
The accumulation of these assets has been more or less equivalent to the slump in investment. From the end of 2007 to December 2012 currency, bank deposits and bills held by non-financial financial firms has increased by €350bn in cash terms. The refusal of firms to invest has led to a rise in their cash holdings.

Credit direction

These are assets which could be directed towards productive investment. Firms refuse to do so because they are cannot be confident about returning sufficient  profit. But the European governments could direct these assets into productive lending at both the national and supranational level. Before the era of financial liberalisation credit direction, which is the central bank or other authority directing the commercial banks’ lending, was widespread in industrialised economies.

It cannot be seriously argued that this would interfere with market’s efficient allocation of resources, not after the crisis of 2008 and 2009. The authorities also have numerous levers to ensure that credit is direct towards productive investment in infrastructure, de-carbonisation, transport, housing, education and so on).

The banks operating in Europe can only do so because their deposits are guaranteed by the state. The state also issues banking licenses. The ECB is effectively a state body and supplies all banks with needed liquidity. The authorities could direct credit by altering capital rules to favour state-guaranteed investments. Many banks are also now effectively owned by the state. Only the political will to compel bank lending to the productive sector is lacking.

EIB & EBRD

In addition, both the European Bank for Reconstruction and Development (EBRD) and European Investment Bank (EIB) have increased their net equity in the recent past, but cut their lending just when it would have most beneficial effect. The EBRD’s equity has risen by €133bn since 2010 but its lending has fallen by €89bn (p.5). In 2012 alone the EIB’s lending fell by €8bn even though its own funds increased by €13bn (pp.7 &8).

Taken together a prudent rise in the level of lending to infrastructure and other projects in both Eastern and Western Europe based on previous lending/capital ratios could provide significant funds towards an investment-led recovery.

The question of the Euro

As the crisis in Europe is determined by a refusal of the private sector to invest, and which is compounded by cuts in government investment and the investment of entities like the EBRD and EIB, it follows that only a significant increase in state-related bodies can resolve the crisis.

The latest GDP data show that the crisis is reaching into the ‘core’ of Europe. France and the Netherlands were among the countries whose economies contracted once more. Austria, Belgium and Germany only avoided recession by the narrowest of margins. This is a crisis that is engulfing the whole of Europe.

It is frequently suggested that leaving the Euro would provide a panacea for this crisis. Yet it is self-evident that not all countries can devalue against one another. Further, the argument that devaluation without increased investment will not produce a recovery requires only a one-word proof: Britain. Sterling devalued by approximately 30% in 2008 and 2009, without much of a rebound since. Yet the current account deficit has widened from -0.2% of GDP to 3.6% of GDP over that period.

Returning to earlier data on GDP growth, investment (GFCF) in the Euro Area and EU, we can now add further points on the growth of government spending and net exports. These are shown below for the Euro Area and for the EU economies outside the Euro Area as a separate group. The results are shown in Table 1. below.

Table 1. Key Economic Variable in Europe, Q1 2008 to Q4 2012, €bn

The economies outside the Euro Area have contracted just like those inside the Euro Area. Government current spending has risen in both. But non-Euro countries have not had higher levels of investment. They have, on a net basis, simply gained in terms of net exports.

In this sense, the question of in or out of the Euro is a secondary one, which would not resolve the crisis either way if the investment slump is not addressed. Of course, there is a severe structural crisis in the Euro Area, which the crisis has exposed. The US has built a continental scale economy and so too has China. India appears to be heading in the same direction. The European Union has the potential to create the same.

But the Euro is an attempt to graft a 21^st century monetary unity onto a 19^th century patchwork of small nation states. What is required to supplement a monetary union is a fiscal union. Since that must be democratically controlled that also requires political union. In the United States, which is very far from the EU’s former attachment to the ‘social model’ fiscal transfers vary but generally comprise 12% to 15% of GDP. In the European Union they amount to around one-tenth of that. If the single currency is to be maintained then its principal beneficiaries will need to contribute to its maintenance, led by German capital.