Austerity is on course to be a lot worse

By Michael Burke

The Office for Budget Responsibility (OBR) has produced its latest assessment of the economic crisis and its impact on government finances (pdf here). In common with the UK Treasury the OBR tends to underestimate the impact of austerity policies and consequently has a persistently over-optimistic outlook for the British economy. This is no surprise as the OBR uses the Treasury economic model.
Even so the detailed analysis by the OBR is very valuable as it reflects official thinking on the economy and on economic policy. This view will continue to be shared by the OBR and Treasury beyond the next election.

A key conclusion of the latest report is the assessment that austerity policies are set to continue for some time to come. The chart below shows the OBR’s assessment of the austerity policies and their composition from 2008/09 with projections until 2018/19. The policy measures of government spending cuts and tax change changes are expressed as a percentage of GDP.

Fig.1

Source: OBR

The OBR persists in projecting the effects of Labour policy over the entire period even though the Coalition has been in office since May 2010. Labour’s austerity measures (announced by Alistair Darling in March 2010) are shown in purple. The additional measures introduced by the Coalition in June 2010 are shown in green. The further measures after that time (beginning with the Austumn Statement in 2010 and March 2011 Budget) are shown in orange.

Currently we are approximately midway through the Financial Year 2014/2015, when the fiscal tightening rises from 5.1% of GDP to 5.6% of GDP. So the current fiscal tightening is approxumately 5.35% of GDP. By 2018/19 the OBR projects the entire austerity policy will reach 10.3% per annum.
In effect we are currently only half way through the austerity programme.

At the TUC, Geoff Tily points out that that the entire OBR analysis is based on an incorrect framework (adopted from the Treasury). This framework assumes that austerity reduces the deficit while doing little damage to the economy. Yet the OBR’s own data show this assumption is incorrect.

The data below is extracted from the OBR’s Chart 1.3 in its latest report. It shows the level of Total Managed Expenditure versus Current Receipts as a proportion of GDP during the entire period of the crisis to date.

Fig.2  Expenditure & Receipts, % GDP

Source: OBR

Since FY 2008/09 expenditure has fallen by just 0.6% while receipts have also fallen by 0.2% of GDP. The OBR forecasts that this will improve imminently, but forecasts of that type have been made ever since the OBR was established. The latest data for the current Financial Year actually show the deficit widening once more. The effect of austerity policies is to produce the weakest recovery on record while the reduction in the deficit has been minuscule. If 5% or more fiscal tightening has been required to reduce the deficit by just 0.4%, the OBR projections of further policy measures shown in Fig. 1 are likely to be a significant underestimate.

A continuation of austerity policies is unlikely to produce a different outcome. Unless there is a radical break with OBR/Treasury thinking, austerity is set to get a lot worse.

Austerity killed off improving productivity. Investment is needed to revive it

By Michael Burke

Supporters of government austerity measures have been quick to claim that recent revisions to GDP growth show a much shallower recession and much stronger recovery than previously thought. These claims are factually incorrect. The Office for National Statistics (ONS) accurately summarised the effect of its revisions as follows,

“Although the downturn in 2008-2009 was shallower than previously estimated and subsequent growth stronger, the broad picture of the economy is unaltered. It remains the case that the UK experienced the deepest recession since ONS records began in 1948 and the subsequent recovery has also been the slowest.”

The current situation for the British economy is characterised by an exceptionally weak recovery. The actual increase in output is minimal, much worse than any previous recovery. The very slow improvement in GDP is a product of more people working longer hours for less pay.

In the most recent reassessment of the data, the ONS noted the continuing exceptional crisis of productivity (the amount produced per hour of work). This is shown in Fig.1 below. The dotted line shows the previous trend growth in productivity. The unbroken light blue line shows the previous ONS data and the dark blue line shows the most recent revision.

Fig.1 Output Per Hour and trend

Source: ONS

It should be noted that productivity had been growing very moderately from the end of 2009 until the Coalition’s austerity policies began to take effect at the beginning of 2011. There has been no recovery since.

This is far worse than any previous recovery, as shown in Fig.2 . It is unprecedented in Britain for productivity to be lower than the pre-recession peak 6 years previously. But that is what the previous estimate (unbroken black line) shows. The more recent revision (broken black line) is slightly better but is unlikely to alter the main trend.

Fig.2 Output Per Hour, comparisons with previous recovery periods

Source: ONS

In the average of previous recessions and recoveries, productivity was 16.3% higher 6 years after the recession began. The complete data for the current slump is yet to be published. But if it is still below the pre-recession level (as seems likely) then the gap between the current trend in produtivity and the recovery from previous recessions could be in the order of 17% or 18%. There is also no sign of improvement.

If output per hour does not increase it is exceptionally difficult for average pay to increase. That would require a sharp rise in labour’s share of output, which is extremely rare when output is not expanding. This is the cause of the wage crisis in the British economy.

In a market economy there are also great difficulties in raising social expenditure when there is no growth in productivity. In any event is impossible to both raise wages and increase spending in education, health, transport, housing and so on if there is no increase in output per hour.

The cause of the productivity crisis is no puzzle. Just as a heavy load can be lifted much more quickly by machinery than by hand, productivity increases with the amount and sophistication of the capital machinery that is used. Cutting back on that equipment, by refusing to invest and/or letting existing machinery dilapidate will reduce output per hour. This is what has happened in Britain and many other western economies.

The argument that all that is required is increased demand is false. The final up-to-date data for the British economy will certainly show that demand, both household and government consumption have recovered since the recession. But investment has not. Increasing consumption by reducing investment is the road to impoverishment.

Private firms do not exist to satisfy demand, but to accumulate profits. Currently they remain uncertain about profits, and there is growing opposition to increased private investment.

But government has no such constraints. It can invest because the investment is necessary and reap returns not available to the private sector in the form of increased tax revenues and lower social security payments. State-led investment is needed before the crisis can be ended.

Austerity is the cause of the crisis in France. Investment can end it

By Michael Burke

The French economy is in a grave crisis, much worse even than the sluggish growth of the OECD countries and almost as bad as Britain. In the 6 years since the beginning of the crisis the OECD economy as a whole has grown by just 4.5%. Over the same period the French economy has grown by just 1.2%. This is closer to the British economy, which was still 0.6% lower than when the recession began. The data is shown in Fig. 1 below.

Fig.1 Real GDP in OECD, Britain and France, Q1 2008 to Q1 2014

Source: OECD

Supporters of the Tory government’s austerity policy have bizarrely attempted to congratulate themselves on the recovery in Britain as the following quarter finally saw the British economy exceed is previous peak. But 0.2% growth in over 6 years is the worst performance since the Great Depression.

Similarly, there is an absurd attempt to portray the situation positively in Britain because it is better than the crisis in France. This is both factually incorrect (in the 2^nd quarter of 2014 the French economy was 1.2% above its pre-recession peak) and meaningless. However bad the sitation in France, this would make no-one in Britain better off.

Investment Strike

In reality, the cause of the crisis in France has the same source as the crisis in the OECD as a whole and in the British economy. It is the fall in productive investment (Gross Fixed Capital Formation) which accounts for both the severity of the initial recession and the prolonged character of the following stagnation.

The various trajectories of each economy have also been determined primarily by the chages in investment (GFCF). Initially the crisis in France was much less severe than the in the OECD as a whole because the fall in investment was less sharp. By contrast, investment fell further in Britain and the recession was sharper than in either France or the OECD. However, the recovery in French investment stalled in mid-2012 almost immediately after Hollande won the Presidential eelction and began to apply austerity policies.

By contrast, OECD investment has been painfully slow to recover. But it has been on an upward trend since the 3^rd quarter of 2009, which accounts for the steady crawl out of recession. In Britain the ludicrous zig-zags of government austerity policy killed off a weak recovery in 2010. But large government subsidies to reflate a housing bubble have had the effect of increasing consumption and house building from its all-time low from the end of 2012. These trends are show in Fig. 2 below.

Fig.2 Real GFCF in OECD, France, UK, Q1 2008 to Q2 2014

Source: OECD

The French Crisis

There are two key indicators of the role of the slump in investment as the cause of economic crisis in France. These are the performance of investment relative to other components of the national accounts and investment relative to its previous trend.

Investment in France began falling once more when the Hollande government began implementing austerity policies. Prior to that point, the right-wing Sarkozy administration had talked about the need for austerity, but was generally keeping these measures in reserve in the hope of getting re-elected (similar to the Tory government from mid-2012 onwards, with a similar lack of success likely).

Fig.3 below shows the real performance of France’s GDP and its components from the beginning of the crisis to the 2^nd quarter of 2014. In aggregate GDP is almost €21bn higher than it was in the 1^st quarter of 2008. Investment (GFCF) is the only component of GDP which remains significantly below its pre-crisis level. Consumption by both the private sector and of government is higher. The problem of the French economy is not primarily a crisis of ‘aggregate demand’. It is investment, not consumption which is the brake on a genuine recovery.

Private consumption is over €31bn higher and government consumption is strongest of all at over €44bn higher. This also belies the idea that austerity is aimed at reducing government spending. Pro-business parties are far less concerned about increasing government spending if this is directed towards consumption. They are opposed to an increase in government investment, which interferes with the dominant role of the private sector in the ownership of the means of production. Despite much talk about the ‘bloated state sector’ in France government investment is actually a smaller proportion of the total than in the Anglo-Saxon countries of the US and UK (just 15.3% of the total in the most recent 2011 data).

Investment is now €37.5bn lower than its pre-crisis peak. It has fallen from 20.4% of GDP to 18.2%. Only net exports are also negative, but the decline is much less significant with a fall of just €2.6bn. The performance of real GDP and its components is shown below.

Fig. 3 France Real GDP & Components, Q1 2008 to Q2 2014

Source: OECD

The trend decline in investment is equally stark. Investment has fallen by 9.9% in a little over 6 years since the crisis began. In the comparable period prior to the crisis investment had expanded by 18.9%. If this prior trend growth rate of investment had been maintained, it would now be €109bn higher. This would directly add 6% to GDP even before any productivity effects from higher investment are taken into account. GDP and the investment trend are shown in the Fig. 4 below.

Fig.4 Real GDP & GFCF Trend, Q3 2000 to Q2 2014

Source: OECD

The resources for investment

If there were no idle resources in the economy it would be necessary to constrain consumption in order to finance investment. But that is not the case currently. In common with most OECD economies (including Britain) the profits of French firms have been recovering.

In nominal terms the profit level (Gross Operating Surplus) peaked at €668bn in 2008. But after a slump in 2009 profits have turned slowly higher and finally recovered (in nominal terms, not taking account of inflation) to €674bn in 2013. But investment has continued to fall and is now €17bn lower than in 2008. The investment ratio (investment as a proportion of profits) has therefore declined.

This is the culmination of a long-term trend. Fig.5 below shows the nominal level of profits and the investment for the French economy over the last 40 years. At the beginning of the period the investment ratio was approximately two-thirds. In 2013 investment was €395bn compared to profits of €674bn, an investment ratio of just 58.6%. Simply restoring the former investment ratio would increase the level of investment by approximately €40bn. Instead, the level of uninvested profits continues to grow.

Fig.5 France Profits & Investment, 1974 to 2013, €bn

Source: OECD

France is not in crisis because of the Euro. The main features of the crisis are the same as in Britain, which maintains its own currency. Nor is it true that the crisis of the French economy is caused by a bloated state sector. On the contrary, government investment as a proportion of total investment is now lower in France than in either the US or UK.

This is actually a key part of the problem. The crisis is accounted for by the fall in investment. The private sector is on an investment strike. This is exacerbated by the cuts in the government’s own level of investment.
The resources exist to resolve the crisis throught state-led investment. This can be funded by using uninvested profits of the private sector. A certain proportion of this can be done indirectly via government borrowing, especially as borrowing costs for 10 years are just 1.25%. It can also be done directly, directing the state-owned enterprises and the the commercial banks to increase investment, as well as other measures.

Three charts to explain why most people are getting poorer

By Michael Burke

Most people in Britain are getting poorer. For obvious reasons, the government and supporters of austerity would prefer not to discuss this fact.

Yet in the strained language of the Labour right, there has also been a clamour for Ed Miliband to ‘change the narrative’ on the economy by no longer talking about the cost of living crisis. This is based on the completely false notion that that the economic recovery under way will inevitably produce higher living standards. This fails to understand the content and purpose of current economic policy. It is also based on a refusal to face facts.

Some of the key facts on the cost of living crisis are glaringly obvious. The chart below shows the change in regular average pay as well as the change in total pay including bonuses. Also included is the change in consumer price inflation.

Chart 1. Change in regular pay, pay including bonuses and CPI inflation, %

Source: ONS

Under four years of the Tory-led Coalition, regular pay has fallen by 5.25%. This real decline in pay is understated in two ways. The first is that the CPI is a narrow measure of prices. In particular it excludes housing costs. Broader measures of inflation have tended to be higher over the last four years. In addition, only the pay of employees is captured by these average wage data. Anyone forced to work in self-employment, casual or other work without a regualr wage is not included in the data. These categories, along with part-time workers, have formed the bulk of the jobs growth over the last period, which has been a key factor in depressing wages generally. A broader, more accuarate picture of average wages would show a picture that is much worse.

It also seems as if the fall in living standards on this measure is unprecedented. The chart below is via Ed Conway, economics editor of Sky TV, who regularly provides very useful economic data. It shows the cumulative fall in real wages over a 5-year period.

Chart 2. Cumulative fall in real wages over a 5-Year Period, % Change

This shows real wages contracting by 7.6% over that time period. Real wages have not fallen so sharply since records began in 1864, not even in the Great Depression of the 1930s. As we have already seen, there is also no end in sight. Wages continue to fall behind inflation.

This is the key fact which underpins the ongoing cost of living crisis. But it is not confined to the issue of wages. Of a total British population of 64 million on latest estimates, only 30.6 million are in work. The rest, the majority of the population, are mainly comprised of young people, the elderly, the unemployed and economically inactive. They too have tended to experience a fall in living standards as social security entitlements and public services have been cut. They are often at the sharpest end of the cost of living crisis.

Austerity At Work

An obvious question arises, if the economy is recovering in real terms how is it that real wages have fallen so sharply? The answer is twofold. First, the population is growing, so that GDP per capita remains significantly below its 2008 level, before the recession.

But the content of austerity is to transfer incomes from labour and the poor (such as wages, or the benefits of social security as well as public spending) to capital and the rich (in the form of profits, tax breaks, tax cuts, privatisations, and so on). The aim is not to lead to stagnation, which is a consequence of the investment strike by firms. The aim of austerity policy is to boost the returns to capital. Under conditions of stagnation, this can only be achieved by reducing wages and the transfer payments to workers and the poor.

This can be seen directly even in the form of incomes and prosperity. The chart below is via Chris Williamson, chief economic at economic survey and analysis firm Markit. It shows expectations of household finances over the next 12 months by income bracket. In effect, the higher income households tend to be more optimistic on average about their living standards, while the poorer are more pessimistic. The poor are getting poorer. Among the rich, the lion’s share of the recovery is claimed by the ultra-wealthy, the owners of capital, landlords and so on.

Chart 3. Household incomes and optimism on household finances

The Tory Party sees no reason to change these trends of the economic policy that led to them. They would carry out more of the same, renewing the austerity offensive that has been soft-pedalled ever since the poll ratings plummeted in 2012.

Labour is currently debating economic policy. Evidently, it would be wholly counterproductive to abandon the focus on the cost of living crisis now, which is already the deepest on record and is continuing. Yet the scale of this crisis also means that any policy is appropriate to the magnitude of the crisis. SEB has previously outlined some of the measures that could be taken. All proposals and policies need to be assessed in light of the extremely grave economic crisis that Labour will inherit in 2015.

Hoarding cash while refusing to invest

By Michael Burke

The world’s largest companies are hoarding cash and cutting productive investment at the same time. The Financial Times reports a survey from one leading ratings’ agency, Standard & Poor’s, which shows that the 2,000 largest private firms globally are sitting on a cash mountain of $4.5 trillion, which is approximately double the size of Britain’s annual GDP.

Yet capital expenditure, or ‘capex’ by those firms fell by 1% in 2013 and is projected to fall by 0.5% this year. But this does not presage an upturn. Steeper declines in productive investment are projected by those firms in both 2015 and 2016. Taken together, if these projections materialise the actual and projected falls in capex over the 4 years from 2013 to 2016 will approach the calamitous fall in productive investment seen at the depth of the recession in 2009. This is shown in the FT’s chart below.

Chart 1. Real Capital Expenditure by 2000 leading firms

SEB has previously argued that companies are not prevented from investing by lack of access to capital or similar factors. They are sitting on a cash mountain. The same is true of British firms. There is plenty of money left, but firms refuse to invest it.

This is because private firms are not concerned with growth, either GDP growth or the growth of their own productive capacity. They are primarily driven by the growth of their own profits, or preserving them. Where that is not possible, where new capex will not meet an expected level of return, no new investments will be made.

The survey findings are reinforced by recent research from investment bank Morgan Stanly, which focused on the US economy. It argued that there were two reasons to expect little improvement in productive investment. One is that the US economy is far below using all the existing manufacturing capacity currently available, so has little need to add new fixed capital. The second reason is that shareholders tend to oppose heavy commitments to new, large-scale investment. Managements that do not invest are rewarded by shareholders, while those that do are punished (lower share ratings, lower financial rewards for managers and ultimately, loss of job if the investment turns sour).

Contrary to mainstream economics, this indicates that the interests of shareholders are not ultimately aligned with those of society as a whole. Instead the interests of shareholders frequently stand opposed to an increase in productive investment, which is the key mechanism for raising productivity and living standards.
Or, as another investment bank shows, the greater the long-run returns to shareholders, the lower the growth rate of GDP, and vice versa. The chart below is from CSFB and has previously been used by SEB. It shows the relationship between average shareholder returns and average GDP growth over a number of countries from 1900 to 2013. GDP growth is strongest where the returns to shareholders are lowest, and vice versa.

Chart 2. Shareholder returns and GDP growth for selected countries, 1900 to 2013

This has clear and direct implications for economic policy. The Tory-led government has attempted to encourage private sector investment with a series of inducements, bribes, subsidies, privatisations and so on. But it has not worked.

In the latest GDP data for the 1^st quarter of 2014, business investment in the British economy remains £25bn below its previous peak level in the 1^st quarter of 2008, even though GDP as a whole is £10bn below its previous peak. Total investment, which includes the government and the household sectors is now £49bn below its previous peak. The fall in investment accounts for the stagnation of the British economy and the main investment deficit originates in the business sector. The trend in business investment is shown in the chart below.

Chart 3 Real Business Investment, Q1 2006 to Q1 2014, £bn

A continuation of the same policy is unlikely to yield different results. Instead a radical, reforming Labour government could direct investment itself, using the available resources. Even the current government has recently ‘fined’ Network Rail for to failing to meet its targets and will use the proceeds to upgrade wifi on the rail network, that is to engage in productive investment on a very small scale.

The same logic on a vastly greater scale could be applied to the problems of declining energy capacity and the need to de-carbonise the economy. Fines running into billions could be legally applied to the privatised energy companies if they fail to meet new legislative targets on investment in renewables and energy efficiency. The proceeds can then be used for direct state investment.

These and other methods could be applied to a series of key sectors, banking, energy, transport, health, education, infrastructure and so on. If the private companies still refuse to invest, government can use the fines to invest directly itself. In fact there are any number of methods of achieving the same objective. But, as the surveys and analysis from the financial sector show, the private sector currently has no intention of leading an investment recovery as profits have not yet recovered. So the state must lead an investment recovery.