Two different levels of economic mismanagement

By Michael Burke

The attempt by the Tory-led government to talk up recovery in the wake of the latest GDP data is entirely predictable. But the gulf between the propaganda and the reality of the British economy is now so wide that stagnation is being redesignated as recovery.

In the first estimate for the 4^th quarter Britain’s GDP grew by 0.7%. This may be updated or revised at a later date. From this supporters of austerity make a series of outlandish or spurious claims about the ‘recovery’.

In fact the British economy has not actually recovered its previous peak before the recession, unlike even the exceptionally weak recoveries elsewhere in the advanced industrialised countries. The Reuters’ chart below shows the performance of those economies since the 1^st quarter of 2008.

Fig. 1 Advanced Economies GDP In the Recession

 Far from being the strongest recoveries the British economy is one of the weaker of the industrialised economies. It has not yet entered a recovery phase, unlike the Germany, the US and Canada. Even now the British economy is weaker than the much-derided French economy.

The economy is no longer contracting. But pretending there is a recovery where none exists is a charade that could only fool the gullible. But there is another level of economic mismanagement altogether with regard to the effects of British economic policy in Ireland.

It has become customary to refer to the crisis countries in Europe as Portugal, Ireland, Greece and Spain. In fact Italy has been hit by a slump much deeper than any of these with the exception of Greece. But the direct and indirect effects of a crisis to destabilise the Italian financial markets, crucially the €2 trillion government bond market would threaten to bring down the entire European financial system.
The performance of the economy in the North of Ireland, where fiscal, monetary and other policies are set to by Westminster, is worse than any of the crisis countries except Greece.

The chart below was first produced by the author for this piece. It shows real Gross Value Added (GVA) for selected OECD economies plus real GVA for ‘Northern Ireland’ in the ONS regional accounts. GVA is the same as GDP except it removes the effects of taxes and subsidies on production. It is used to measure regional accounts as those effects are difficult to allocate regionally.

Fig. 2 Percentage Change in Real GVA in Selected OECD Economies & in Northern Ireland

In the chart there are effectively four broad groupings. Sweden, the US and Germany have been the most successful of these selected OECD economies. But even Sweden has increased its GVA in real terms by only 4.7% over a 5-year period. This might be regarded as crawling from the wreckage.

The next grouping includes France and the Euro Area where growth has been less than 1% in either direction around zero. This is effectively stagnation. As it probably encompasses the entire OECD the overall situation in the industrialised economies should be characterised as the Great Stagnation.

The third grouping includes the laggard economies of Portugal, Britain, Spain and the Republic of Ireland, where real GVA has each fallen by around 3% over the period. In effect these are economies where output is well below its prior peak and recovery remains elusive.

Finally there are economies where the crisis has been an outright disaster. Taking Italy alone, there have been sharper recessions in Western Europe in the post-World War II period. But none was so severe that there was still a 6.6% fall in output more than 5 years later. Greece has experienced the most severe slump of any OECD economy in the post-WWII period. The performance of the NI economy sits between these two. This is a qualitatively worse level of economic performance even than in Portugal, Britain, Spain and Ireland.

World Bank sees a ‘turning-point’ in world economy

By Michael Burke

The World Bank has recently released its updated forecasts for the world economy. Two key features of the forecasts have received the greatest attention. The first is that the World Bank describes the overall trend in the world economy as at a ‘turning-point’ and secondly that this is led by a recovery in the advanced industrialised countries, or High Income Countries in the World Bank’s categorisation.

In terms of the forecasts, global GDP growth is expected to advance from 2.4% in 2013 to 3.2% this year rising to 3.4% in 2015 and 3.5% in 2016. Within that the Developing Economies are expected to grow by 5.3% in 2014, accelerating to 5.5% and 5.7% in 2015 and 2016 having grown an estimated 4.8% in 2013. But the bigger contribution to global growth is expected to come from the High Income Countries (HICs) which grew by just 1.3% in 2013 (estimated) rising to 2.2% in 2014 and 2.4% in both the following years.

So global growth is only ‘led by’ the HICs in the sense that the modest acceleration in projected growth is from the low base of 2013, a rise from 1.3% to 2.4%. By contrast the Developing Economies as a whole are expected to accelerate from 4.8% in 2013 to 5.7% in 2016, a rise of 0.9%. As a result the growth gap between these two key categories of the global economy narrows from 3.5% to 3.3%, on World Bank forecasts.

Over the medium-term the compound effect of growth differentials of this magnitude is very large. If a 3.3% differential in growth were maintained over 25 years, the Developing Economies would double in size relative to the HICs.

Turning to the performance of the HICs alone, the chart below shows World Bank data for their gross savings and investment (Gross Fixed Capital Formation) as a proportion of GDP (left-hand side). The growth of GDP is the grey line shown on the right-hand side.

What is clear is that all three variables are in a downtrend. That is, both the cyclical high-points and low-points become progressively lower over time. The slump in activity in 2008 and 2009 is the exception not the rule. The rule is a steady downtrend in activity.

Savings are the basis for investment. Of course savings can be supplemented by borrowing but as both the interest and principal on debt must be repaid at some point, debt can only serve to reschedule the time when savings are used for investment.

It is the declining proportion of GDP devoted to investment which is the primary determinant of the slowdown in GDP growth. All output is either consumed or it can be saved for investment purposes. It is only with the accumulation of capital through investment that economic activity can expand.

GDP growth in the industrialised countries is in a long-term downtrend because economic activity is determined by the declining rates of savings and investment. The ‘turning-point’ for the HICs may only be growth is no longer falling. But it is not in an uptrend.

Developing Economies’ Turmoil

However it is also notable that from the mid-1970s to the late 1990s investment exceeded the gross savings of the HICs. This can only arise by the HICs drawing on the savings of other countries and using them for investment. The last great wave of savings flowing from the Developing Economies to the HICs (primarily the US) was in 1997 and 1998, through the Asian financial crisis. Since that time savings and investment have been almost identical.

The World Bank among others highlights the risk that talk of a recovery in the industrialised economies will combine with reduced money-creation (‘tapering’ by the US Federal Reserve) to place some of the Developing Economies in severe difficulties. Some Developing Economies have low savings levels and are highly dependent on inflows of foreign capital to finance overseas debts or trade deficits, or both. The risk is that savings flowing into New York, London and other financial centres from the high savings economies (mainly in Asia) will stay there and not be recycled to the Developing Economies that require them. Financial markets have already identified a hit-list of potential casualties.

The graphic below from the Financial Times highlights some of those economies. The currencies of Indonesia, South Africa and Turkey have all fallen by approximately 20% versus the US Dollar in the last year. Other countries on this list include Brazil, India, Chile, Hungary and Poland.

The financial market speculators and the FT may not be proved correct. Certainly some countries listed have ample foreign exchange reserves to meet external funding needs for quite some time. It is also possible that they could come to some bilateral arrangements with high-savings economies who might choose to invest directly in these economies. Of these high-savings economies China is the most important.

Even so it is noteworthy that chaos and dislocation has already begun in some Developing Economies because of developments in the indistrialised countries led by the US. The HICs have a feeble economic recovery that does not threaten to break out of the long-term downtrend. But the weakness of savings and investment in the industrialised economies is so marked that any upturn comes at the expense of growth and living standards in some Developing Economies.

The ‘turning-point’ that the World Bank speaks of is unlikely to be a return to robust growth in the industrialised economies. The greater risk is that it is actually a new round of turmoil for many of the Developing Economies.

How bad will it get?

By Michael Burke

Chancellor George Osborne has recently been promoting two ideas. One is that a recovery is under way and the other is that further cuts in government spending are needed, up to £25bn.

The contradictory nature of those two statements tells us something important about the nature of the current recovery and the actual content of economic policy. It is clear that however weak the current recovery is, the overwhelming bulk of the population will not benefit from it. Austerity policies have always been aimed at transferring incomes from labour and the poor to capital and the rich. So for example, a VAT increase was said to be necessary to cut the deficit yet was simultaneously implemented with a cut in the corporation tax rate which reduced government revenues by almost exactly the same amount.

The popular shorthand for this is a recovery solely for the 1%. The class content is clear. The policy is designed to boost capital at the expense of labour and its allies.

Austerity is not at all designed to boost total economic output, in which capital might be one of the beneficiaries. The reason is simple. In the ordinary course of events an economic downturn or slump leads to a fall in profits far greater than the fall in output. A simple recovery in output could entrench that for a prolonged period.

So, the owners of a car firm sell cars worth £1,000 million in a year. Their main costs are all the inputs of labour, capital and raw materials amounting to £800 million. But these largely to tend to stay the same or even continue to rise a little when the downturn occurs. Suppose sales fall by 10% to £900 million. Input costs are unaltered in aggregate. Now profits are only £100 million and previously they were £200 million. On a 10% decline in sales, profits have fallen by 50%. Profits fall faster than output.

From the owners’ perspective the danger is that over the next period everything, sales and input costs all rise at the same rate. If so, once they have more or less recovered to £990 million in sales (an increase of 10%) the costs of labour, capital and raw materials will have risen in parallel by 10% to £880 million. Where the profit margin was previously 20% now it will be just 11%. Austerity policies are designed to avoid this permanent and unacceptable decline in the profit rate by pushing costs lower (or increasing unpaid labour though zero hours contracts, unpaid overtime, reduced pension benefits, etc.).

There is no shortage of capital to invest. SEB has previously shown that British firms are sitting on a cash mountain as are firms in nearly all the Western economies. But it is imperative from their perspective to permanently lower costs, most especially labour costs before resuming investment.

To date this project has met with only limited success. Profits, as measured by the Gross Operating Surplus of firms is £14bn lower than in the first 3 quarters of 2008 when the slump began.

This explains the weakness of the recovery as firms continue their investment strike. The NIESR chart below will be familiar to many readers. It shows the current slump in relation to the most severe recessions of the 20^th century. Although not as severe as the Great Depression the current crisis has lasted considerably longer. All prior slumps had led to a recovery after 4 years (48 months). By contrast the current downturn remains 2% below its pre-recession peak. It will be at last 6 years before there is a recovery of the previous level of output.

Source: NIESR

It may be useful to delve further back in history for comparison. Between 1879 and 1893 the British economy grew by just under 13% in what has become known as the Long Depression. Even if growth in the 4^th quarter of 2013 was reasonably strong, for the year as whole GDP would be 2.5% below the level of 2007 a full 6 years later.

The current cycle is compared to the Long Depression in the chart below. For the time being, even this comparison is not encouraging as the current slump is currently more severe.

There can be no suggestion that any previous recession can be mechanically extrapolated in order to suggest the path from the current crisis. But the comparisons do provide a context for the both the severity and duration of the current slump. They also belie any nonsense from the supporters of austerity about the strength of the current recovery.

The recovery itself remains dependent on a revival in investment. This is not the same as an upturn in ‘demand’, which is comprised of both consumption and investment. Household consumption has almost completely recovered its prior peak and government consumption is at a new high. The fall in investment more than accounts for the entire fall in GDP. The fall in business investment alone (not including government or household investment) exceeds the fall in output.

This is also true historically. After contraction the British economy crawled along at a snail’s pace for a further decade in the Long Depression. It only began to grow robustly from 1894 onwards. Through most of the Long Depression investment continued to decline. It was only when investment recovered its pre-recession peak in 1894 that the economy began to grow robustly. This relationship between growth and investment during the recession and recovery of the Long Depression is shown in the chart below.

The structure of the British economy is very different now and so too is its weight and role in the world economy. Then increased exploitation of a growing colonial empire combined with increased military spending were key components of the recovery. Britain’s relative economic decline since then means that option is closed.

Even with increased imperial exploitation it required a full recovery in investment to end of the Long Depression. Unless and until there is a full and robust investment recovery the British economy is set to remain in an Osborne-recovery, weak and solely for the 1%.

Fairytales from the OBR, nightmare for the population

By Michael Burke

The Office for Budget Responsibility (OBR) has come under fire from across the political spectrum following publication of its latest report accompanying the Chancellor’s Autumn Statement.

The economics editor of the Financial Times Chris Giles says there ‘is not a shred of credibility’ to the OBR forecast that the unemployment rate will fall to 7.1% at the beginning of 2014 and stay there for over a year. As the Bank of England has identified 7% unemployment as the threshold for possible interest rate increases, without much conviction. But there is clearly a political merit to forecasting 7%-plus unemployment, if no logic. It certainly saves George Osborne from having to explain why interest rates could rise even before the economy has recovered its pre-recession level.

Among opponents of austerity, the anti-poverty and tax campaigner Richard Murphy says the OBR’s assumptions resemble George Osborne’s ‘wish list to Santa’. James Meadway at the new economics foundation argues that both the OBR and Osborne will not reveal the true dynamic at work in the recovery which is rising consumer debt and the reflation of a property price bubble centred on London.

The OBR admits it has a poor forecasting record. This is hardly surprising given that it uses the Treasury model of the economy. In all the arcane debate about ‘multipliers’ (the cumulative economic effects of government spending) a central truth tends to be obscured. The highest multiplier admitted in the Treasury/OBR model is just 1. This implies that no area of government spending can add to growth at all. Since the private sector has no magic wand to render its own investment in bridges, housing, railways or education more productive than government, then logically it is impossible for the economy to grow at all. The long-term decline of the British economy has been given an official rationale.

However an examination of the OBR forecasts is revealing about the real dynamic at work in the economy.

How bad will it get?

According to the OBR over the next 5 years jobs and wages will grow and the unemployment rate will fall. These central forecasts are shown in Table 1 below (excerpted from the OBR’s Table 3.5 of OBR data here).

Table 1. Inflation, employment, wages and unemployment

Source: OBR

Consequently average earnings (the growth of wages and salaries divided by the number of employees) will stagnate or even fall in real terms. Measured against the CPI the OBR forecasts average earnings will return to 2011 levels only at some point in 2016. Measured against the RPI, which takes housing costs into account, real wages never recover over the forecast period.

Even this scenario seems unlikely. In a stunning reversal of both pre-recession trends and the entire aim of austerity, the OBR is forecasting is that the lion’s share of the recovery will go to labour, not to capital. Table 2 below shows the distribution of the growth in nominal GDP over the next 5 years (table attached to Chart 3.20 of OBR data).

Table 2. Nominal GDP growth and its components (% contribution)

Source: OBR

Labour’s share of national income has been declining on a trend basis since the 1970s. The purpose of austerity is to reverse the natural fall in profits from a recession as sales fall but cost are unchanged or even rise (including the cost of labour). Yet the OBR’s forecast of flat or falling real wages is based on labour maintaining its share of national income or even increasing it.

Chart 1.

Perhaps the most outlandish forecast of all is reserved for the rise in business investment. The fall in business investment during the slump has now exceeded the entire fall in GDP. As government and other sectors have also cut their investment this means that total investment has now fallen far further than aggregate GDP. GDP has fallen by £40bn since the 1st quarter of 2008, business investment is £42bn lower and total investment has fallen by £61bn.

It is also accepted that the primary source of the OBR’s repeated over-optimistic forecasts have been its projections for rising business investment that have failed to materialise. Yet once again the OBR is projecting a rise in the expenditure of firms in plant, machinery, building, transport equipment, and so on.

Previously, SEB has shown that the investment rate (investment as a proportion of profits) of British firms has declined markedly over several decades. The OBR forecasts that profits as a proportion of GDP will peak in the second half of next year at close to current levels and that they will then gradually decline. Despite this, according to the OBR, business investment will rise dramatically at the same time, from a new low of 7.6% of GDP in the 3^rd quarter of 2013 to over 10% of GDP by the beginning of 2019.

These trends and the OBR forecasts are shown in the Chart 2 below.

Chart 2.

Source: OBR, author’s calculations

Economic forecasting is always uncertain. But the notion that businesses will substantially increase their rate of investment while profits trend lower is fanciful. Businesses do not invest because it is socially necessary or even because the economy is growing. GDP has been rising since mid-2009 and business investment has been falling. In a market economy investment is driven by the return on it, which is profits.

In reality there are only two main trajectories for the economy while austerity remains in place. The first possibility is that the OBR’s assumptions about flat or falling real wages prove wrong and wages are driven down much further to boost profits. In that circumstance investment can rise if profits rise first. The alternative is the current pattern, where neither profits nor investment have recovered and a snail-like recovery takes place driven by increased borrowing to finance consumption.

There is a third variant, which breaks from austerity. This would see the state leading an investment based-recovery using its own resources and those of the private sector to boost growth and productivity, create well-paid jobs and so allow the sustainable funding of a decent social security system.

Unfortunately, without this radical change in policy, the fairytales from the OBR are likely to be a nightmare for the overwhelming majority of the population.

A milestone reached in the British slump

By Michael Burke

The release of the second estimate of GDP in the 3^rd quarter of 2013 marks an important milestone in the current slump. The fall in investment has for long been the driving force of the current crisis and in fact preceded it. As in many other countries investment (Gross Fixed Capital Formation) in Britain began to fall before the recession began. It also statistically accounts for the recession as the fall in investment is larger than the total fall in GDP.

With the publication of the latest GDP data it is now the case that the decline in business investment alone more than accounts for the entire slump in GDP in the current crisis. It is always possible that the data could be revised substantially with the release of the third estimate in the National Accounts data (and could be revised later). But the most recent data show that the total fall in GDP since the 1^st quarter of 2008 to the 3^rd quarter of 2013 is £40bn. Over the same period the total decline in investment (GFCF) is £61bn. This includes investment by firms, by government and by private households. But it is firms that play a dominant role in the British economy and its level of investment.

The decline in business investment now amounts to £42bn and exceeds the total decline in GDP of £40bn. These are shown in Chart1 below.

Chart1

The fact that the decline in both business investment and total investment can exceed the decline in GDP is accounted for by the fact that other components of growth have increased. Again, the data is subject to revision in the final release (on 20 December). But both government consumption spending and net exports have increased. The change GDP and its main components since the 1^st quarter of 2008 are shown in Chart 2 below.

Chart 2

Taken together the change in government and household consumption combined since the recession began is effectively zero. Household consumption has fallen by £15bn and government consumption, has risen by £16bn. Government consumption is the component of GDP which has grown most over the period.

Zero growth in consumption is hardly to be commended. Yet it is much stronger than the performance of GDP in aggregate. This belies any notion that weak demand is driving the slump. There are a series of variants of this idea, that the economy lacks ‘effective demand’ or is suffering from ‘under-consumption’ and so on.

The driving force of the slump remains the fall in investment, led by the fall in business investment. The fall in business investment alone more than accounts for the entirety of the prolonged crisis. Government could act to offset this by investing on its own account, if necessary drawing on the resources of the private sector to do so. Instead, the Coalition cut public sector investment by £6bn after Labour increased it modestly.

It is still the case that increased public sector investment is the only viable means of resolving the crisis that doesn’t lead to further misery for the majority of the population.