The need to clarify the left on budget deficits - confusions of so called 'Keynesianism'

By John Ross

John McDonnell, the new Shadow Chancellor, has created something of a stir by his firm opposition to budget deficits to cover current expenditure – writing ‘let me make it absolutely clear that Labour under Jeremy Corbyn is committed to eliminating the deficit and creating an economy in which we live within our means.’ The so called ‘Keynesian’ left has attempted to make a point of defending budget deficits, presenting this as a hallmark of the left. These latter views are politically damaging because they are economically false. Neither do they derive from Keynes but from the confused views of academic pro-capitalist economics. John McDonnell is entirely correct on this point to oppose borrowing to cover current expenditure over the course of the business cycle.

The following article, originally published as ‘A damaging confusion in Western economics books - which followers of Keynes and Marx should correct’ deals with this issue from a fundamental economic point of view. A more comprehensive treatment of the issue, presented in a less technical fashion, can be found in my article ‘Deng Xiaoping and John Maynard Keynes’.

Hopefully John McDonnell’s firm stance on the budget deficit will help the left to adopt the positions of Keynes and Marx and abandon the confused ideas on budget deficits that were wrongly presented under the name of ‘Keynesianism’.

* * *

Economics textbooks, particularly when discussing Keynes, frequently contain an elementary economic confusion - it should be made explicit this is a confusion in the textbooks and is not stated by Keynes. A typical example may be taken as Mankiw’s Principles of Economics, but numerous other examples could be cited as the confusion is widespread.¹ This elementary economic  confusion is expressed in the following formula

Y = C + I + G + NX

In this widely used formulation Y = GDP, C is private consumption, I is private investment, G is government spending, and NX is net exports. For a closed economy, which can be considered here as trade is not relevant to the issues analysed, this becomes.

Y = C + I + G

From this it is typically argued that if there is a shortfall in private consumption C, private investment I, or both, then this can, or should, be compensated for by an increase in government spending G. This allegedly constitutes a ‘Keynesian’ policy. The fundamental confusion is that there exists no category ‘government spending’ G which is neither consumption nor investment – government spending is necessarily used for either investment or consumption. In short the correct formula is expressed as

Y = C_p + C_g + I_p + I_g

Where C_p is private consumption, C_g is government consumption, I_p is private investment and I_g is government investment.

Keynes himself is clear on the distinction writing:
‘loan expenditure’ is a convenient expression for the net borrowing of public authorities on all accounts, whether on capital account or to meet a budgetary deficit. The one form of loan expenditure operates by increasing investment and the other by increasing the propensity to consume.²

This formula clearly distinguishes C_g and I_g as indicated above_.

For Marxists it should be noted that this distinction is also made clear in Marx’s categorisation of the economy into Department I (investment goods and services) and Department II (consumption goods and services).

The attempt in economics textbooks to introduce a third category G which is neither used for consumption nor investment is a piece of economic nonsense which should be stopped.

A key reason the lack of clarity created by introducing the confused term G is practically economically significant is the consequence for the structure of the economy when is there is unspent private saving, including non-invested company saving – i.e. private saving is not being transformed into private investment, and the government steps in to maintain demand. There are then two possibilities.

• If non-invested private saving is used by the government for investment, that is I_g increases, there is no change in the economy’s overall level of investment – private investment is simply replaced by government investment.
• If, however, the non-invested private savings is instead used by the government to fund consumption, that is C_g increases, then the percentage of consumption in the economy rises and the percentage of investment falls.

The use of an economically confused term G therefore obscures the choice being made for the economy’s overall investment level by whether there is an increase in government investment I_g or an increase in government consumption C_g.

The practical significance of this confusion is that modern econometrics shows that capital investment is the quantitatively most important factor in economic growth. Therefore reducing the proportion of the economy used for investment, other things being equal, will reduce the economic growth rate.

Both economic economic theory and practical results show that in a capitalist economy, not necessarily an economy such as China's, there is greater resistance to government spending on investment than on consumption - as state investment involves an incursion into the means of production, which in a capitalist economy by definition must be predominantly privately owned. This theoretical point is confirmed by the fact that state expenditure on consumption has historically risen as a proportion of GDP in most capitalist economies since the economic period following World War II while state expenditure on investment has in general fallen in the same period.

The acceptance of government expansion of consumption, but opposition to government investment, therefore has the consequence that when so called ‘Keynesian’ methods of running government budget deficits are used, and G rises, what in practice happens is that C_g rises but I_g does not. As the government is transferring non-invested private savings into consumption such so called ‘Keynesian’ intervention therefore has the effect of reducing the economy’s investment level – and therefore reducing the economic growth rate. This process is concealed by using the confused term G instead of its proper components C_g and I_g .

However, as already noted, it should be made clear that this confusion is in textbooks and not in Keynes himself. But followers of Keynes should point out this elementary and damaging confusion contained in many economic textbooks.


Notes
1. Mankiw, Principles of Economics 6th edition p562.

2. Keynes, The General Theory of Employment Interest and Money, MacMillan edition 1983 p128.

Corbynomics and crashes: investment versus speculation

By Michael Burke

Words matter. But in economic discussion as elsewhere they are frequently abused. In economic commentary one of the most frequent falsehoods is to describe speculative activity as investment. Stock market ‘investors’ are in fact engaged in speculative activity. There is no value created by this speculation. The claim made by its apologists that it provides for the efficient allocation of capital to productive enterprises is laughably untrue in light of both recent events and long-run history. In fact, a vast number of studies show that that there is an inverse correlation between the growth rate of an economy and the returns to shareholders in stock market-listed companies.

The chart below is just one example of these studies, Fig. 1. The research from the London Business School and Credit Suisse shows the long-run relationship between real stock market returns and per capital GDP growth. The better the stock market performance, the worse the growth in real GDP per capita. The two variables are inversely correlated.

The Economist found this result ‘puzzling’. But it corresponds to economic theory. The greater the proportion of capital that is diverted towards speculation and away from productive investment, the slower the growth rate will be, and the slower the growth in prosperity (per capita GDP).

Fig.1 Stock market returns and per capita GDP growth

This is exactly what has been happening in all the Western economies over a prolonged period. SEB has previously identified a declining proportion of Western firms’ profits devoted to investment. The uninvested portion of this capital does not disappear. Instead, it is held as cash in banks and the banks themselves use this to fund speculation and share buybacks by companies (which simply omits the banks as intermediaries in the speculation). The effects of this are so marked that some analysts believe ‘financialisation’ is the cause of the current crisis, when instead it is an extreme symptom of the decline in investment and the consequent growth of speculative activity.

Stock market crashes

It is now customary in the Western financial press to routinely ascribe all aspects of the Great Stagnation to some failing in China. So, China’s fractional currency devaluation has been identified as the culprit of the recent stock market plunges, even though the 3% devaluation of the Chinese RMB followed a 55% of the Japanese yen and a 27% decline in the Euro.

The claim that the crashes were caused by China’s currency move has no factual basis. Fig.2 below shows the closing level of the main US stock market index in August. The S&P 500 rose from 2,083 to 2,102 in the 4 days after the RMB’s 3.2% devaluation which finished on August 13 (first arrow).

On August 19 the Federal Open Markets Committee (FOMC) of the US central bank released the minutes of its most recent meeting (second arrow), which was widely interpreted as indicating a strong likelihood that interest rates would be increased in September. The prior closing level for the S&P500 was 2,097 and it fell sharply thereafter. Following speeches by a number of governors of the US Federal reserve (who vote on the FOMC) questioned the need for an increase in rates, and the market has recovered in response. Yet other speeches pointing once more to a rate rise led to stock market falls once more, and so on.

Fig.2 S&P500 Index

But this uncertainty over US rate increases is only the proximate cause of the crashes. This sharp fall is a stock market verdict that it cannot easily absorb higher US interest rates. The current valuations for the stock market are based on official short-term interest rates of 0.25% and a dividend yield on S&P500 stocks of 2.24%. Even if rates were only doubled to 0.5% the level of the stock market becomes much less attactive. If rates were to rise towards 2%, the risky stock market’s dividend yield looks extemely unattractive compared to risk-free short-term interest rates.

There is a spearate matter that the US economy does not look robust enough to absorb any significantly higher interest rates, but this hardly concerns stock market speculators. Fig. 3 below shows the pace of growth in US industrial production versus the same month a year ago. Production has slowed for a year and is down to a snail’s pace in the last 3 months, averaging less than 1.4% from the same period a year ago. The latest data show that the US economy is experiencing only modest growth, with GDP in the 2^nd quarter just 2.6% higher than a year ago.

Fig.3 Growth In US Industrial Production

Despite the widespread hype about the British economy, the equivalent data on industrial production is growth of 1.5% for the latest 3 months compared to a year ago. For the Eurozone it is 1.2%. In China, industrial production has grown by 6.3% in the latest 3 months compared to the same period a year ago.

Corbynomics and crashes

Since 2010 the major central banks of the US, Japan, and the Eurozone have created US$4.5 trillion, Yen 200 trillion and €1.1 trillion in their respective Quantitative Easing programmes. The Bank of England has added £375bn of its own. Over the same period short-term official interest rates have been at or close to zero. Long-term interest rates have also plummeted. This has not led to a revival of investment in the advanced industrialised economies. After the short-lived stimulus in some Western economies to end the 2008-2009 slump, total fixed investment (Gross Fixed Capital Formation) has slowed to a crawl in the OECD as a whole, as shown in Fig.4 below.

Fig. 4 OECD GFCF, % change 1996 to 2013

Yet over the same period the main stock market indices in the OECD economies have soared. The stock markets and real GDP are inversely correlated. The S&P500 index has effectively doubled since 2011. The Eurofirst 300 has risen by 55%, the Nikkei 225 in Japan has risen by 125% (boosted by currency devaluation) and the FTSE100 has risen by 25% (a poorer performance held back by the predominance of weak international oil and mining stocks). Data for 2014 is not yet available but the total cumulative increased on OECD GFCF from 2011 may not have reached 10%.

Corbynomics is the policy of attempting to address an investment crisis with an increase in investment. Its critics repeatedly claim that this policy will cause financial turmoil. In light of recent events this assertion ought to cause a wry smile. At the very least, the most powerful central banks in the world have to reassess their intentions on policy simply because of the wild gyrations in the stock markets. These have been accompanied by further large movements in global currency exchange rates.

The reason stock markets are so febrile, and policy so easily blown off course is that a bubble is being created in financial assets because of the combination of monetary creation, ultra-low interest rates and weak investment. Capital that could be directed towards increasing the productive capacity of the economy is instead being used to finance speculation; the worst of both worlds. This policy has caused inflation in financial assets such stock markets, in house prices and (previously) in commodities prices. But continued economic stagnation means that deflation is now the greater risk in the OECD economies at the level of consumer prices.

Corbynomics addresses those risks because its aim is to raise the level of investment in the economy. By increasing the productive capacity of the economy through investment-led growth it overcomes the weakness of the economy. By redirecting the flow of capital from speculation towards investment, it deflates the speculative bubble. So, to take an obvious example, by building new homes it provides housing and employment while deflating the house price bubble.

The root of the objection to Corbynomics is the insistence that the private sector, private capital must be allowed to dominate the economy in its own interests. But the current Western economic model is a combination of shopping and speculation, leading to stagnation. Corbynomics is the antidote to these; prosperity through investment-led growth.

No China’s economy is not going to crash – why China has the world’s strongest macro-economic structure

By John Ross

A great deal of highly inaccurate material is currently appearing in the Western media about the ‘crisis’ of China’s economy – an economy growing three times as fast as the US or Europe. This follows a long tradition of similarly inaccurate ‘crash’ material on China symbolised by Gordon Chang’s 2002 book ‘The Coming Collapse of China’.

The fundamental error of such analyses is that they do not understand why China has the world’s strongest macro-economic structure. This structure means that even if China encounters individual problems, such as the fluctuations in the share market or the current relative slowdown in industrial production, which are inevitable periodically, it possesses far stronger mechanisms to correct these than any Western economy. This article is adapted from one published in Chinese by the present author in Global Times analysing the greater strength of China’s macro-economic structure compared to either that of the West or the old ‘Soviet’ model. The original occasion of the article was the next steps in the development of China’s next 13th Five Year Plan. The analysis, however, equally explains the errors of material currently appear in the Western media.

*   *   *

In October a Plenary Session of China’s Communist Party (CPC) Central Committee will discuss China’s next five-year-plan. This provides a suitable opportunity to examine the reasons for China’s more rapid economic development than both the Western economies and the old Soviet system.

Taking first the facts which must be explained, China’s 37 years of ‘Reform and Opening Up’ since 1978 achieved the fastest improvement in living standards in a major country in human history. From 1978 to the latest available data real annual average inflation adjusted Chinese household consumption rose 7.7%. Annual average total consumption, including education and health, rose 8.0%. China’s average 9.8% economic growth was history’s most rapid.

As China’s ‘socialist market economy’ achieved this unmatched improvement in human living conditions it is this system which must be analysed. Its difference to both the Western and Soviet models explains why China’s economic development is more rapid than either.

China’s is a ‘socialist market economy’ – not a ‘market economy’ as is sometimes imprecisely stated utilising terminology which obscures the structural difference between China’s and Western economies.

The word ‘socialist’ derives from ‘socialised’ – large scale and socially interconnected. China’s economic structure differs from the Western in state ownership of China’s largest companies - those engaged in the most ‘socialised’ production. But simultaneously the largest part of China’s economy, as in every country, is not so large scale, socially interconnected - or state owned. China has billionaires and tens of millions of small and medium companies while China’s agriculture is based on small household farms. However the interrelation of China’s state and private companies fundamentally differs both from the West’s ‘mixed economy’ and the old Soviet system.

In a Western ‘mixed economy’ the private sector dominates. In contrast in China the CPC’s Central Committee in November 2013 explicitly reaffirmed: ‘We must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector.’

But China’s economic structure also differs fundamentally from the old Soviet model in which the private sector was tiny – with even agriculture and local shops state run. Even in Marxist theory there was no justification for Soviet state ownership of small scale, that is non-socialised, companies and such ownership demotivated those working in them, crippling economic efficiency.

This different economic structure of China and the former USSR necessarily determines the different nature of their ‘five-year plans’. As the Soviet economy was essentially entirely state owned the state took even small economic decisions, setting tens of thousands of prices and outputs – it was an ‘administered’ economy.

The majority of China’s economy is not state owned, and China’s five-year plan sets only a few key macro-economic targets – overall growth rate, guidance on investment and consumption, industrial priorities etc. Within these parameters market mechanisms operate and are used to guide the economy. This is the precise sense in which Deng Xiaoping could state: ‘there is no fundamental contradiction between socialism and a market economy’ and ‘if we combine a planned economy with a market economy, we shall … speed up economic growth.’

But China’s macro-economic structure also explains its more rapid economic growth than the West, and avoidance of crises such as the post-2008 ‘Great Recession.’

Western dominance by private companies means no automatic mechanism ensures companies invest even when profitability is high. For example US company operating surpluses rose from 20% of its economy in 1980 to 26% in 2013, while simultaneously private fixed investment fell from 19% to 15%. As Larry Fink, the head of BlackRock, the world’s largest asset manager noted: ‘More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders . . . while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.’ The US government can appeal for greater private investment but it lacks any mechanism to enforce this. Such falling investment culminated in the US ‘Great Recession.’

Western economists such as Keynes foresaw such dangers, noting: ‘the duty of ordering the current volume of investment cannot safely be left in private hands’ and that it was instead necessary to aim at: ‘a socially controlled rate of investment.’ But the Western privately dominated economy has no mechanisms to control its investment level.

In contrast, if required, China’s state owned sector can be instructed to raise or lower investment. As the Wall Street Journal noted: ‘Most economies can pull two levers to bolster growth: fiscal and monetary. China has a third option. The National Development and Reform Commission can accelerate the flow of investment.’ China therefore possesses far stronger anti-crisis mechanisms than the West.

China’s five year plans, by setting certain key economic parameters but within these using market mechanisms, explains the superiority of China’s economy to both Soviet and Western systems – and therefore China’s economic outperformance of both.

The counter-attack on Corbynomics

By Michael Burke

The economic policies of Jeremy Corbyn have come under widespread criticism. This exceeds the level of scrutiny of his policies; many of his critics do not seem to have troubled themselves to read his key policy document. It also be far exceeds the level of scrutiny devoted to any of his leadership rivals.

This is not surprising. All major sections of big business in Britain and in the western economies as a whole are committed to austerity policies. The economic consensus in favour of austerity arises not from economics textbooks or any appraisal of economic history, even recent history such as the stagnation from 2010 to 2012 and the rise in the deficit that resulted. Austerity is the consensus because it represents the interests of these dominant sections of the economy and therefore society.

This explains the assault on Corbynomics, which we should expect to intensify if he wins the leadership of the Labour Party.

Therefore it is important to address these arguments. The BBC’s economics editor Robert Peston, led the way and was closely followed by the Financial Times’ economics editor Chris Giles. Academics have weighed in, with one characteristic contribution from John Van Reenen at the LSE. There are important nuances between these and other critics of Corbynomics but they have common central arguments. All summaries are reductive and readers are encouraged to review these pieces themselves. But the central argument is this:

· the British economy is dependent on foreign capital inflows
· instructions from government to the Bank of England undermine the Bank’s independence
· the flow of international capital on which Britain depends will halt as investors take fright
· as a result, the currency will fall an interest rates will rise
· this will cause inflation and reduce investment, the very opposite of Corbynomics’ aim
· And, the existing £375bn in Quantitative Easing cannot be used as an example as this may be temporary and almost solely focused on the purchase of government bonds (gilts)

It is noteworthy that the critique begins with capital flows and rests on the absolute power of financial markets to set exchange rates and interest rates. These are real and powerful forces and cannot be ignored. But the dominance of finance capital in British society is so great it influences opinion so that the argument ‘There Is No Alternative’ appears to have great weight. The weight of this argument would be lesser in countries such as Germany, or Sweden, or even the US.

There is no denying the British economy is increasingly dependent on inflows of overseas capital, setting new lows last year. This is not simply or even primarily the chronic UK trade deficit, which has persistently oscillated around 2% of GDP in recent. As Fig.1 below shows it is the sharp deterioration in the primary income account which has caused a sharp and unsustainable rise in the current account deficit. It has swung from small surplus in mid-2013 to a deficit of 3% or more of GDP in recent quarters.

Fig. 1 Current account balance, % GDP & components

Source: ONS

The primary income account and its components is shown in Fig.2 below. There are two key points to be highlighted. The first is the very large and persistent deficit on portfolio investment, ranging between 5% and 10% of GDP. This is a net outflow of capital representing the far greater propensity of British capital to invest overseas because of higher returns.

But this persistence means that portfolio investment outflows are not responsible for the recent sharp deterioration in the primary investment account and therefore in the current account as a whole. The balance of Direct Investment has swung from a surplus to a deficit and accounts for the deterioration in the external accounts. This has taken place while corporate taxes have been cut and while the last government was claiming that ‘Britain was open for business’.

Fig.2 Primary income account and components

Source: ONS

It is a remarkable fact that the government’s repeated assertions that its policies are promoting growth and investment are rarely challenged although they are so clearly false. George Osborne has repeatedly asserted that his policies are successfully promoting investment. Specifically he and his supporters have argued that the cut in Corporate Tax rates from 28% to 18% is and will promote Foreign Direct Investment. Fig.3 below shows that FDI inflows have been declining over the medium-term, even while corporate taxes have been cut and ‘business-friendly’ policies have been adopted.

Fig.3 Net FDI Inflows and components

Source: ONS

It is no accident that the sharp deterioration in the external accounts occurred in mid-2013. As SEB has shown elsewhere the Coalition government halted new austerity measures and even slightly increased government spending in order to get re-elected. Borrowing, particularly for housing and other consumption was encouraged. Unless government borrowing was to increase, or were to companies face higher taxes, then the increase in borrowing had to be sourced from overseas.

In order to get re-elected the government encouraged an unsustainable borrowing binge. It now proposes to deal with this crisis with renewed austerity, which will cause an economic crisis. Overseas investors have a diminishing appetite for investment in Britain because it is a slow-growth, low-investment economy. Low British investment levels become self-reinforcing.

The entire criticism of Corbynomics can be shown to be a case of what Freudian psychoanalysts term projection. It is the current policy which has dramatically increased the dependence of the British economy on overseas capital inflows. And the only remedy offered is renewed austerity. This is simply ‘TINA’ (there is no alternative) purportedly from the perspective of the all-powerful dealing room floors of the City.

One of the weakest points of the critique is that it rests on the outlandish proposition that the Bank of England retains credibility. The independent Bank has presided over the biggest ever financial crash in Britain and the longest recession. Throughout most of 2008 the MPC was discussing the need to raise interest rates, even as the economy had already begun its biggest slump since the 1930s. The Bank’s record on growth since independence has been markedly worse than the rest of the post-WWII period. It has also persistently missed its own inflation target. It has a spectacularly bad forecasting record for growth and inflation even in the short-term. It is even questionable how independent the Bank is on decisive matters as the bank bailout of 2008 was clearly a government plan, with Bank officials still delivering speeches about ‘moral hazard’ (pdf).

The superiority of Corbynomics

The weakness of his opponents arguments do not by themselves mean that Corbynomics can succeed. But this has been dealt with in a previous post.

Instead, it is important to state why Corbynomics is superior to the alternative, based on economic fundamentals. The critics argue that government intervention may have been a necessary evil at the time of the banking crisis (and unsurprisingly acceptable to bankers) but that government intervention in the real economy is unacceptable.

This turns economic reality on its head. The returns to productive investment in the economy are far higher than government bond yields. The rate of return for UK companies is currently around 12%, and never fell below 8% even in the depth of the recession as shown in Fig.4 below.

Fig.4 Net rate of return to Private Non-Financial Corporations, %

Source; ONS

By contrast the British government can borrow at extraordinarily low rates to fund investment, as shown in Fig.5 below. At the time of writing the yield on 10 year UK gilts is 1.8% which is a fraction of the rate of return on private investment.

Fig. 5 UK 10 year gilt yields

Source: Bank of England

The objection raised at this point (see Peston in particular) is that there are no projects or sectors where such returns are additionally available, otherwise the private sector would be investing in them. But this criticism is misplaced and only serves to highlight the innate superiority of state-led investment over that of the private sector.

On exactly the same investment, the returns available to the public sector are higher.

To demonstrate this, take the obvious case of housebuilding. Private builders estimate an average construction cost per home of £100,000 in Britain, and a sale price of £175,000 to cover their fees, borrowing costs and of course profits (National Association of Home Builders estimates).

Yet government can build exactly the same home at exactly the same price. It will naturally have far lower borrowing costs than any private sector company. But it is the returns to government which are massively higher. This is because government obtains tax revenues which of course are unrecoverable by any private sector developer. This will be both income taxes on all labour employed, plus tax revenues on all consumption financed by that income, and all other consequential taxes. There is also a benefit to government finances from the increase in economic activity arising from lower social security payments.

The UK Treasury estimates that for every £1 increase in economic activity there will be a 75p boost to government finances, 50p in tax revenues and 25p in lower social security payments*. As a result the net cost of home construction is just £25,000 (after all returns are included) while it now has an asset with market price of £175,000. Employment and a home have bene created and a genuinely affordable rent is easily possible.

The superiority of the public sector is even greater in a strategic sense. Government can direct investment to the most-needed or most productive sectors of the economy, energy, transport, infrastructure and education, in addition to housing in a coordinated fashion. The vastly greater returns to the government means that it is not even the main direct beneficiary of the investment. It is private firms who benefit most, at least in a direct sense, from investment in transport, education, infrastructure and so on. But the key condition is that they not be lowed to act as a brake on investment, as they are currently.

The trading response of financial operators is entirely predictable. Irrespective of their political views their purpose is to make money. The dire warnings against the 2009 Labour stimulus Budget that interest rates would soar was actually followed by a sharp fall in interest rates. Investors were more likely to get their money back from a government whose economy was growing rather than contracting. (The political response maybe another matter, but that is a separate discussion on the levers a radical government would have to use).

Government investment in the productive sectors of the economy yields very high returns, much higher than the interest payable on government debt. Corbynomics has offered a range of options to achieve that increase in investment. All of them are preferable to current policies because they can work.


*Treasury Working Paper No.5, Public Finances and the Cycle http://webarchive.nationalarchives.gov.uk/20100407010852/http://www.hm-treasury.gov.uk/prebud_pbr08_publicfinances.htm The author is grateful to the office of Caroline Lucas MP who managed to locate this paper. It seemed to have been buried away under the Coalition government.

Why Corbynomics can succeed

By Michael Burke

The debate surrounding Labour’s leadership contest is being marred by name-calling and red-baiting. Perhaps this is inevitable but it is regrettable. Britain remains in an economic crisis, which has now entered its eighth year. A more productive course would be to discuss how to end it.

A marker of that crisis is that per capita GDP is still below where it was before the crisis began in 2008, as shown in Fig. 1 below. This remains the weakest recovery on record and the year-on-year growth rate has slowed from 3% to 2.6%. This follows a period from the end of 2012 onwards when no new austerity measures were imposed. Renewed austerity on the same scale as in 2010 to 2012 means there is likely to be a similar slowdown.

Fig.1 Per Capita GDP

The Tory strategy is more of the same, which one commentator called a Captain Bligh policy, “the floggings will continue until morale improves”. This policy is supported by virtually all the mainstream press. Unfortunately, it is also supported by 3 of the 4 candidates for Labour’s leadership. They abstained on the Tory Welfare Bill the centrepiece of the government’s latest Budget. Only Jeremy Corbyn stands on a clear anti-austerity platform. His economic policy can be found here (pdf).

Longest-ever crisis

No-one alive today has ever experienced in a longer economic crisis in Britain. The nearest comparison for the length of the current British economic crisis was at the end of the nineteenth century and the Long Depression. As per capita GDP has not recovered it is extremely difficult for median average living standards to rise. On the contrary, the austerity policy serves to work in the opposite direction by transferring incomes and wealth from poor and middle-income layers to the rich and from labour to big business. So, the latest Budget included a further cut in the Corporation Tax rate to 18% while cutting £12 billion in social protection to the most vulnerable in society.

The Tory policy is straightforward. These transfers of income known as austerity will continue until the business sector is making sufficient profits for it to resume investment. The crisis will be paid for by increasing the rate of exploitation. The austerity mark II of the latest Budget is not because there is still a public sector deficit, as this will fall as it does everywhere even if there is moderate nominal GDP growth. Renewed austerity is necessary because business is not yet willing to fund an investment-led recovery.

The level of investment in the British economy was £295 billion in 2014, exactly the same as the pre-crisis level of 2007. But the economy is actually larger 4.2% larger (keeping pace with population growth, but no more than that). Therefore investment is declining as a proportion of GDP. Consumption, not investment is leading very weak growth and this is not sustainable.

Yet the profit level has also recovered and accounted for 37% of GDP in 2014, compared to 36.1% in 2007. So the Tory policy is not working. Profits have increased by 6.8% in real terms since 2007, but investment is unchanged. Fig.2 below shows the official estimate of the profit rate in the non-financial sector versus the proportion of GDP devoted to business investment. These are strikingly indifferent results for 5 years of austerity policies. The profit rate has only barely returned to its pre-crisis level and is well below profitability prior to this century. The same is true for business investment. Both of these are a recipe for continued slow growth.

Fig.2 Profit rate and business investment

The profits recovery has been greater than the investment rebound. As a result, the extremely high level of uninvested profits has actually grown. The level of uninvested profits in the British economy was £355 billion in 2014, compared to £261 billion in 2007. This is the main brake on a robust and sustainable recovery. Andy Haldane, chief economist of the Bank of England says that firms are ‘eating themselves’ by refusing to invest and instead paying out ever-greater proportions of profits in shareholder dividends. This has been a recurring theme in SEB, and we might add the enormous increase in managerial pay and bonuses which are also a factor. The remainder is deposited in the banks, where it fuels ongoing speculation in financial assets, stocks, housing and commodities.
Unfortunately, it is this Tory strategy that 3 of the 4 contenders for the Labour leadership have endorsed. They have no principle difference with the centrepiece of Tory strategy, cuts to social protection ‘welfare’, privatisations and cuts to corporation tax. The recovery from crisis will be funded by workers and the poor.

This is an extremist economic policy. In the first phase of the leadership campaign it began with an attack on public spending of the Blair and Brown years, placing the candidates not only to the right of New Labour but to the Tories of the time, who effectively endorsed New Labour spending.
Economically, it also places those candidates to the right of Thatcher, who both spent and taxed more than New Labour as a proportion of GDP. It is perhaps worth recalling that main rates of taxation were significantly less regressive even when Thatcher left office in 1990 than they are under the current government (and that many of them were made more regressive by New Labour).

Table 1 Main Taxation Rates- Thatcher versus current

Source: HMRC

This wholesale adoption of the key planks of an economic policy of a government to the right of Thatcher has been compounded by the refusal to oppose the Tory policy of cutting £12 billion from the ‘welfare’ bill. This is widely understood as a direct attack on the living standards of the poorest and most vulnerable and will directly increase child poverty. The Institute of Fiscal Studies, which is not a hot-bed or radicalism but simply uses the Treasury’s own model of the distributional impacts of Budgetary measures, was explicit in arguing that the Budget would increase child poverty.

Yet these measures were not opposed by the Labour frontbench or by 3 of the 4 candidates for leadership. Even the Blairites used to boast that they had reduced child poverty. It is more than a rhetorical question, but also a vital political one to ask if the Labour Party supports increasing child poverty, what is it for?

Corbynomics

Jeremy Corbyn is the only candidate who is not proposing extremist economics. His policy aims to promote growth through increased public investment, funded by progressive reform of the current taxation system, and attacking the abuses of the £93 billion in annual payments for ‘corporate welfare’ in subsidies, bribes and incentives to the private sector.

At the same time he opposes any attempt to make workers and the poor pay for the crisis and rightly argues that the deficit would close naturally with stronger growth. This poses a different way out of the crisis than the one supported by the Tories and the Labour frontbench. His campaign and platform corresponds to a mood inside the Labour Party and wider society. The Tories only won 24% of the electorate's vote in May because only a minority supports their policy. Labour got fewer votes because it had no alternative.

It used to be the case in the period of economic expansion before the crisis, that to some extent ‘a rising tide lifted all boats’. Even if the labour share of national income declined continuously from the 1980s under all governments, at least living standards for the majority in work were rising. That is no longer the case. The entire austerity policy means that there will be no rise in living standards for the majority until big business sees fit to invest once more. That is, only after having made workers and the poor pay for the crisis and a renewed fall in living standards.

It is this policy which the Labour Party frontbench has signed up to. It is a shock to many in Labour that the verbal commitment to match Tory spending is a real one, even when that means supporting an increase in child poverty. Many are quite rightly revolted by it.

By contrast, Jeremy Corbyn’s economic plan is a moderate, logical and fair one. Big business has the resources to fund the investment the economy needs and as they refuse to invest on a sufficient scale, government will use some of their resources in the interests of society as a whole. Workers and the poor should not pay for a crisis they did not cause. Jeremy Corbyn’s plan for state-led investment offers a way out of the crisis.