China won't have a hard landing - because it is not a capitalist economy

By John Ross

Some US hedge funds, echoed by parts of the international media, are currently trotting out the perennially inaccurate myth that China's economy is about to suffer a "hard landing." This invariably incorrect prediction has been periodically repeated for decades since China launched economic reforms in 1978. The claim then was that by failing to privatize companies, not adopting what became known as "shock therapy" in Russia and Eastern Europe, China condemned itself to stagnation. Instead in 1978-2015, China experienced average annual 9.6 percent GDP growth - the fastest by a major economy in human history.

Making these claims particularly vocally has been Kyle Bass' Hayman Capital Management, who has been taking positions summarized by the Wall Street Journal, "Hayman Capital's portfolio is … expected to pay off if the yuan and Hong Kong dollar depreciate over the next three years - a bet with billions of dollars on the line, including borrowed money." "'… this is much larger than the [US] subprime crisis,' said Bass, who believes the yuan could fall as much as 40%." 

If Bass sticks to these positions, he will lose a fortune as analyzed below.

George Soros similarly recently claimed, "A [China] hard-landing is practically unavoidable." Soros has a disastrous record of investing in Russia and China - having lost approximately $1 billion in Russia's Svyazinvest telecommunications company.

Hedge fund managers speculating on RMB devaluation are self-evidently unreliable sources given that they have a financial interest in spreading "doom." Therefore, before showing the fundamental reason such views invariable turn out to be wrong, similar media errors can be noted. 

In 2002, Gordon Chang was promoted by the Western media as a "China expert" for writing a book The Coming Collapse of China which concluded, "A half-decade ago the leaders of the People's Republic had real choices. Today they do not... They have run out of time." Well over a decade later, China had not collapsed - but Chang has continued appearing on Bloomberg TV as a "China expert." 

In June 2002, The Economist produced a China supplement "A Dragon out of Puff" analyzing, "the economy still relies primarily on domestic engines of growth, which are sputtering. Growth … has relied heavily on massive government spending … the government's debt is rising fast … this is a financial crisis in the making … In the coming decade, therefore, China seems set to become more unstable." In fact, China then experienced the decade of the fastest growth ever by a major economy.

Such claims regarding a "China hard landing" are invariably false because they violate any serious sense of proportion. Take current claims on RMB devaluation, in January CNBC news claimed, "China is playing a dangerous game with its currency, moves that could send the global economy into recession. China's control-minded central bank allowed the biggest fall in the yuan in five months on Thursday."

In reality, the fall in the RMB's exchange rate against the dollar has been small compared to other major currencies. From January 2012 to March 2016, the dollar's trade weight rate soared 23 percent - the euro fell against the dollar by 18 percent, the yen by 24 percent, and RMB only 5 percent. From the RMB's peak dollar exchange rate in January 2014 to March 2016, the RMB fell against the dollar by 8 percent, the yen by 10 percent and the euro by 21 percent. 

Similar "intellectual shoddiness" was Bloomberg's recent claim China's economy was in a crisis paralleling Greece. "Chinese policy makers … have exhausted whatever magical powers they had been using to keep their economy aloft … the world … has had a few years to contemplate a Greek exit from the euro. But if the world's biggest trading nation suddenly hit a wall, it would be a catastrophe of a different order, wreaking havoc on economies near and far." Comparing Greece, whose economy shrank 26 percent in 2007-2014, with China whose economy expanded 81 percent in the same period, is bluntly ridiculous. 

The most fundamental reason claims that China will suffer a "hard landing" invariably turn out to be false is because they do not understand the consequences of the fact China is not a capitalist country. "Hard landings" occur in such economies because all major companies are privately owned and the state therefore has no ability to stop the investment collapses which cause "hard landings." 

During the post 2007 "Great Recession," US household consumption fell by 3 percent but private investment by 23 percent - the US "hard landing" was dominated by the investment decline.

Following 1990, Japan suffered a "hard landing" of a quarter century of less than 1 percent annual average GDP growth. However, in 1990-2013 Japan's household consumption rose by 31 percent. But Japan's fixed investment fell by 16 percent - the severity of Japan's stagnation therefore was exclusively due to its investment fall.

In contrast to the US and Japan's investment decline, creating true "hard landings," in 2007-14 China's fixed investment rose by 105 percent creating economic growth of 81 percent. This was possible because China possesses a large State sector which can be used to raise investment if the government needs to take anti-recessionary measures. Most fundamentally, China hasn't and doesn't suffer "hard landings" because it is a socialist not a capitalist economy.

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This article originally appeared, under the title 'China doomsayers misunderstand how socialist economies work' at Global Times.

Crisis remains an investment crisis

By Michael Burke
Prior to the recent G20 meeting leading international economic bodies such as the IMF and the OECD made tentative calls for increased investment, although this was often confused with increased spending. This is a belated or partial recognition of the real source of the crisis in the advanced industrialised countries. In terms of actual changes to policy it seems to have made no impact at the G20 whatsoever.

As the world economy is once more slowing and there are again a series of spurious explanations offered for this, it is worth revisiting the actual causes of the ongoing crisis which first became widely apparent in 2007. In this piece the advanced industrialised countries as a whole will be the reference point, using aggregate data for the OECD. But each individual economy within the OECD simply provides its own unique combination of these common factors, including Britain.

If one word can summarise the entire crisis in the advanced industrialised countries it is: Investment. The fall in Investment preceded the fall in GDP. It was also the largest component of the fall in GDP and it is the sole component which has failed to recover.

These points are illustrated in Fig.1 below, which shows real GDP, Final Consumption and Investment (Gross Fixed capital Formation, GFCF) for the OECD as a whole, using US$ Purchasing Power Parities.

Fig.1

Investment (GFCF) first fell in the OECD in 2008. Both GDP and Final Consumption Expenditure continued to increase and only fell for the first time in 2009. Falling Investment caused the crisis. On a full-year basis the total decline in Investment was 13% from its pre-recession high to the low-point of the recession in 2009. By comparison GDP fell by 3.5% and Consumption fell by 0.3%. The fall in Investment was far greater in proportional terms than GDP or Consumption.

Even though Investment is a far smaller proportion of GDP than Consumption in the OECD, its decline in monetary terms was far greater. From the pre-recession peak to the low-point of the recession Investment fell by US$1.3 trillion (in PPP terms). Consumption fell by US$ 0.03 trillion, or US$30bn, and barely constitutes a blip in the chart above. The fall in Investment was the largest component of the crisis.

Since the trough of the recession in 2009 real GDP has recovered by US$3.95 trillion. In 2014 GDP was US.55 trillion larger than its peak in 2008. Consumption is stronger. It has increased by US$2.17 trillion since 2009 and is now US$2.26 trillion above its pre-recession peak. By contrast Investment has recovered by only US.94 trillion from 2009 to 2014 and it remains US.37 trillion below its 2007 peak, or US$366 billion. The economic crisis in the OECD remains an investment crisis.

Consumption requires Investment
Economics should be the study and practise of achieving the greatest sustainable material well-being of the whole of society. For most of humanity this still revolves around the struggle for food, shelter and clothing. In the advanced industrialised countries, the required quality of those necessities has increased alongside the desire for good health services, education, welfare, access to recreation and leisure, and so on. Unfortunately, for material reasons a great deal of confusion surrounds that goal and the methods to achieve it. 

The (inverted Say’s Law) argument that increased Consumption will lead to increased Investment has evidently not materialised in the current crisis. As noted above, Consumption has increased but Investment has not. This was also the case in the Long Depression at the end of the 19th century as well as in the Great Depression of the 1930s. In both cases Investment continued to stagnate or fall despite a rise in Consumption. Currently we are in a phase of what Marx called the hoarding of capital. Keynes used the terms liquidity preference.

The reason is simple. The advanced industrialised countries are capitalist economies. Capitalism does not exist to satisfy human needs, or the desire for material well-being. It is not driven by ‘demand’. It is driven by profit. Under circumstances where Consumption has recovered, but profitability, or anticipated profitability has not, then Investment will not increase. This characterises the current situation in the OECD economies.

All Consumption of any good or service must be preceded by its production. Any attempt to increase Consumption without increased production simply leads to the creation of debt, a claim on future production. It is unsustainable. The current downturn in the British economy arises because household debt and overseas indebtedness have both increased to unsustainable levels. 

There are two principal methods of increasing production. One is to just get more people into work and/or make them work longer hours for less, or some combination of the two. The other is to increase the productivity of labour through increased Investment, either in the amount or quality of the means of production or through the increased skills of the workforce. The former cannot lead to rising living standards as it relies on working longer for less, and is the path Britain has chosen over the past period. The second method, the increased productivity of labour requires Investment.

Therefore, in order to raise living standards and to sustainably improve both the quality and quantity of goods and services generally available (including housing, health care, education, welfare and so on), it is necessary to increase Investment. Increased Consumption first requires increased Investment.

Levels, ratios and proportions
The Consumption of goods and services is a measure of the material well-being of the population. Yet, there are two main uses of all output, it can either be consumed or invested. So, if it were possible to sustainably increase the level of Consumption by reducing the proportion of the economy directed to Investment and increasing the proportion devoted to Consumption, then the level of Investment should be reduced to a minimum or even zero. In reality, the opposite is the case. The greater the proportion of the economy devoted to Investment, the faster the rise in sustainable Consumption.

Taking just the OECD data cited above, in the period from 2007 to 2014 investment as a proportion of GDP fell to 20.5% from 22.5% in the period 2000 to 2007. Consequently the proportion of GDP devoted to Consumption rose. Yet the level of Consumption increased by a cumulative 18.6% in the earlier period and has increased by just 6.4% in the same 7-period since the recession. The level of Consumption rose more rapidly when it was a smaller proportion of GDP.

This seems to be paradox, in that a falling proportion of Consumption in GDP leads to its faster growth rate. It is extremely important, since the population naturally does not care what proportion of the economy it is consuming, only that its material well-being is rising. But there is no paradox if it is understood that there is no such thing as a Consumption-led economy. On the other hand, as Investment increases the means of production, then the economy as whole can expand with rising Investment. From this expansion of GDP it is possible to increase the level of Consumption.

This is why the economic policy framework outlined by Jeremy Corbyn and John McDonnell recently is so important, because it is correct. There is a clear emphasis on borrowing for investment, and that the current or day-to-day budget will be in balance over the business cycle. The National Investment Bank will be the principal vehicle for the investment. This amounts to the public sector having a greater role in the investment function, thereby leading to stronger growth. It is primarily from this source of rising activity that the current budget will be brought into balance as tax revenues increase and social welfare outlays related to poverty and underemployment decline. Over time the entire austerity could be reversed and living standards raised.

It is George Osborne’s refusal to invest, indeed his ridiculous ban on productive investment that will deepen the crisis. The new framework from the labour leadership begins to offer a way out of perpetual crisis and austerity.

Labour now getting it right on economic policy framework

By Michael Burke
Below is a series of short extracts from recent speeches or articles by Jeremy Corbyn and John McDonnell. They amount to the beginnings of a major campaign to reorient the economic debate in Britain along the correct lines.

Together they are based on the correct economic framework that investment is the decisive driver of economic growth and prosperity. As a result it is logical, as Socialist Economic Bulletin has repeatedly argued, to borrow for investment and to prioritise the creation of a National Investment Bank to focus on infrastructure and other investment. This in turn leads to a correct position on the budget deficit – there should be borrowing for investment but consumption over the business cycle should be financed out of taxation (i.e. over the business cycle there should be borrowing for investment but not current expenditure).

This clear distinction between investment and current expenditure stands in sharp contrast to the parallel errors of both George Osborne and confused self-styled ‘Keynesians’. Osborne would try to rule out Government borrowing for either investment or consumption - but actually he cuts investment and encourages households to take on debt to fund consumption. The self-styled ‘Keynesians’, who have nothing in common with Keynes (or Marx), would borrow permanently for Government consumption – a long term unsustainable position which leads to the lowering of the percentage of investment in GDP, and therefore over time both a slower growth rate and a slower rate of increase in consumption. In both cases borrowing for consumption leads to ever slower growth – or in current circumstances it produces very slow growth. Because it was the wrong economics the self-styled ‘Keynesians’ failure to distinguish investment and consumption undermined Labour’s economic creditability, while Osborne’s failure to make the distinction, thereby banning borrowing for investment, undermines his credibility both with most serious economic commentators, companies and trade union.

Jeremy Corbyn and John McDonnell have set out the outline of a correct framework for economic policy. Jeremy Corbyn’s full speech can be read here.

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Jeremy Corbyn: “Labour’s alternative will put investment first. We will only borrow to invest over the business cycle.

We will put public investment in science, technology and the green industries of the future front and centre stage.

Only by driving up investment will we achieve the higher productivity we need to guarantee rising living standards for all.

We want to see the reindustrialisation of Britain for the digital age driven by a national investment bank as a motor of economic modernisation based on investment in infrastructure, transport, housing and technology. That provides a solid return."

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John McDonnell: “We need to begin by underlining our commitment to bringing the government’s day-to-day spending into balance.

We know the importance of borrowing for investment, which lays the foundations for future economic prosperity.

Few things are more urgent than delivering the infrastructure our economy is crying out for, infrastructure which pays for itself by expanding economic activity and raising tax revenues.'

The full piece can be read here

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John McDonnell: “Winning back economic credibility is the most important fight in a generation. Step by step we need to demonstrate that of course we can manage government budgeting effectively. This isn’t about accepting cuts but making sure our income from taxation and economic growth matches our spending. It also means recognising the importance of borrowing for investment, which lays the foundations for future economic prosperity. Investment in our infrastructure pays for itself by expanding economic activity and raising tax revenues.'

The full piece can be read here.

The mystery surrounding the ‘productivity puzzle’

By Michael Burke
The latest official data show how far the UK economy is lagging behind other industrialised economies in terms of productivity, in this case output per hour worked. There is too a long-standing discussion amongst economists in Britain about the so-called ‘productivity puzzle’. There is a genuine crisis of productivity in Britain. But in reality there is no productivity puzzle at all. It is easily explained by the weakness of investment. In particular, the recent fall in in the stock of capital in the British economy explains the almost unprecedented decline in UK productivity.

Currently, debate in Britain is dominated by the possibility of ‘Brexit’. This is an error. Under current circumstances, whether Britain is in or out of the EU is a trivial matter in economic terms compared to the crisis of productivity. This is because, contrary to George Osborne (and those on the left who are confused and echo him) it is not possible for consumption, or wages to lead economic recovery. Sustainable increases in consumption require sustainable increases in output. Unless that is achieved by more people simply working longer hours, then it must come via increased productivity. Without it, living standards will fall. This will be the case in or out of the EU.

Yet the latest ONS data show that productivity is falling. It also shows how far the UK economy lags behind other industrialised economies. Fig.1 below shows the relative productivity performance of the UK economy versus the other countries of the G7. According to the ONS, UK GDP per hour worked in 2014 was lower than the rest of the G7 average by 18%. Within that, it was lower than both the US and France by 31% and lower than Germany by 36%. The sole G7 economy whose productivity is lower than the UK’s is Japan, which has been stagnating for 25 years.

Fig. 1 Productivity Trends in the G7 Economies

 

 

This relative weakness is not confined to most of the G7. According to the ONS, UK productivity also lags that of Spain by 5%, Ireland by 30%, Belgium by 34% and the Netherlands by 45%.

 

The effects are twofold. If UK productivity is stagnating or falling, so will living standards. If relative productivity is declining the British economy will be less able to sell goods abroad, and its domestic industries will increasingly collapse through under-competitiveness. This is what is currently happening to the steel industry, for example.

 

The ‘productivity puzzle’

 

The purpose of all analysis or commentary should be to illuminate what is otherwise hidden or obscure. But economics differs fundamentally from the natural sciences in this key respect. No physicist has an interest in obscuring or denying the fundamental laws of physics, or in basing analysis on anything other than fundamental laws (although there is a strong interest in revising or reassessing them in light of new data).

 

However, in economics there are vested interests at work, social classes, whose enrichment or otherwise depends on economic outcomes. Therefore there is a very great material incentive to falsify or obscure the fundamental forces at work in the economy. This is why the fall in productivity has been a ‘puzzle’. Analysts and commentators have a false understanding of the fundamental laws of economics and attempt to fit empirical facts such as falling productivity into that false framework.

The official discussion of the crisis in productivity began with the Office of National Statistics (ONS) in 2012 and was later taken up by the Bank of England and many others. The timing was not coincidental as what had been a very weak recovery in productivity started to go into reverse from 2012 onwards. Productivity actually fell. This was by the worst performance for productivity of all recessions in the post-World War II era. It is almost unprecedented coming out of recession as Fig.2 below shows.

 

Fig.2 Productivity (output per hour) trends following recessions

Source: ONS

 

The argument has been advanced that the crisis in productivity reflects the changing composition of output, with the decline of relatively high productivity sectors and the increase of low productivity ones. Specifically, it is said that the decline of North Sea oil output, as well as the crisis in financial services have depressed productivity while the allegedly low level of public sector productivity has the same effect. Using ONS data is it easy to refute these claims (Table 1 below).

 

Table 1

* Workforce jobs figures, benchmarked to Labour Force Survey totals

Source: ONS

 

North Sea oil output (under Mining & quarrying) is the most productive sector of the economy, with output per hour worked 12 times greater than for the economy as a whole. It fell 7.3% during the recession, slightly more than the economy as a whole (since revised upwards). But as it accounts for just 2.7% of all output, arithmetically it cannot be responsible for the weakness of productivity as whole

 

The output of the finance sector is a very large component of the British economy, whose measured productivity level is approximately half as great as the economy as a whole. But its output fell slightly less than that of the economy, so its decline cannot be responsible for the productivity crisis.

 

The public sector is also widely held to be a low productivity sector, although measuring outputs from sectors such as health or education is done at market prices, which almost certainly undervalues them. The output of this sector initially rose during the recession, which is natural to cope with a rising population. But the total economy productivity crisis persisted after the recession and deepened from 2012 onwards. The combined output of the civil service, health and education sectors have all risen since then by a combined 5.4% between 2009 and 2012, according to ONS data. At the same time the public sector workforce has shrunk by 8.9% because of the austerity policy. There has therefore been a significant increase in public sector productivity, outstripping all other sectors of the economy.

The productivity crisis is not caused by the changing composition of output. It is a crisis of the private sector and embraces all sectors.

 

Much of the confusion on the source of the productivity crisis arises from an incorrect economic framework. One of the clearest expressions of this misunderstanding is as follows:

 

“Ever since the industrial revolution, economic growth has rested on the firm foundation of better use of buildings and machines and improvements in the level of output for every hour worked.” Chris Giles, Economics Editor of the Financial Times, Solving the productivity puzzle is key to government finances

This is the view that Total Factor Productivity (TFP) “the better use of building and machinery….” is the driving force behind economic growth. But this proposition is ridiculous when set in this historical context. The driving force behind economic growth is not that better use has been made of buildings and machines since the industrial revolution, but that there have been vastly more buildings, machines and other contributors to the productive capacity of the economy since that time. According to Bank of England data (Three centuries of economic data) from 1850 to 2000 the accumulation of productive capital has been twice as fast as the growth in output. This is entirely in line with the analysis of Adam Smith and Marx, who respectively argued that the ‘rise in stock’ or the ‘rising organic composition of capital’ exceeds the growth rate of output itself.

 

It is also not possible to explain the uniquely poor performance of UK productivity by reference to TFP or ‘better use of buildings and machinery’, as in a modern economy businesses based in Britain could simply learn those techniques and/or buy the technology from overseas to make better use of their existing stock of productive capital.

 

The reason for the calamitous decline in UK productivity is because it has been reducing the existing stock of capital in the economy.

 

Scrapping productive capacity

 

It is extremely rare for the level of productive capital to decline. The Bank of England data noted above records only two instances since 1850 in Britain when the capital stock fell, the first two years of World War I and in the Great Depression.

More usually, the capital stock grows. Indeed it is this drive to accumulate capital for the purpose of realising profits that gives capitalism its dynamic force and its capacity to raise the material level of society. However, all capitalist economies are determined by the realisation of profit, not by the accumulation of productive capacity for its own sake, or to raise the material level of society. Profit is the raison d'être. As a result, if profits are declining, or by scrapping unprofitable plant or machinery profits will increase, it is quite usual for productive capacity to be scrapped. Individual firms do this on a continuous basis. In exceptional periods there may be circumstances when capital in aggregate is being scrapped. This characterises the current period (Fig.3).

 

Fig. 3 UK Capital Stock Index

 

The close correlation between the trend in capital stock and the level of productivity is shown in Fig.4 below. In fact the level of capital stock leads the productivity level by one year, so that the capital stock first fell in 2011 and the first recorded fall in productivity was in 2012.

 

Fig. 4 Capital Stock & Productivity

Furthermore, this outright decline in the stock of capital is unique to the UK economy in the G7 currently. Among the economies for which there is data, since 2010 the US capital stock has risen by 4.1%. In Germany it has increasd by 2% and in France by 1.9%. Italy has increased by just 0.6%, and so is effectively unchanged. But in Britain it has fallen by 2.1%.

 

The relationship between the level of productive capital and the level of productivity is clear across the industrialised economies. If other factors are unchanged, the higher the stock of capital, the greater the level of productivity. This can be illustrated in Fig.5 below, which shows the trends in the capital stock in selected G7 economies.

 

Fig.5 Trends in Capital Stock in Selected G7 Economies

This is almost a mirror image of the trends in productivity shown in Fig. 1 above. Changes in productivity track changes in the productive forces of the economy, led by the stock of capital. Over this period, the US has both the largest increase in capital stock and the greatest increase in productivity. The UK, which had previously been a relatively strong performer both in terms of the growth in productivity and the growth in capital stock, is now the sole economy shown where both productivity and the capital stock are falling.

 

Conclusion

 

There is no mystery around the ‘productivity puzzle’. It is a function of the weakness of UK investment in both absolute and relative terms. The decline in productivity is preceded 1 year by a decline in the capital stock. This declining capital stock is itself an extremely rare event. According to Bank of England data it has only occurred twice previously in Britain since 1850.

 

The puzzle arises only because there is a mystification of the driving forces behind productivity growth and economic growth in general. In the first instance, after the division of labour, growth is driven by the amount and quality of capital in productive in use in the economy.

 

In the UK productive capacity is being scrapped. This is not because there is no unsatisfied demand in the UK economy. On the contrary, there is both a scarcity of necessities, such as in housing and healthcare and other areas, as well as a large trade deficit. The productive capacity is being scrapped because its owners cannot make profits, or do not anticipate sufficient profits in a situation of growing competition and sluggish growth in consumption, for example in the steel industry. To survive and prosper, the owners of the UK steel industry would have to leap towards the front of global productivity or technical quality through very large scale investment and they are unwilling or unable to do so.

 

A reduction in the stock of capital is one way in which capital can overcome declining profitability. Marx identified some of the others as increasing the working day, which is happening in the UK and US but not elsewhere. Other factors which can offset falling profitability are a reduction in the cost of capital goods (the means of production), a reduction of (real) wages, increasing the division of labour through the growth of foreign trade or by boosting profits through increased financial speculation.

 

Many of these factors are at work in a number of countries. But Britain is the only G7 country where the capital stock is actually falling. The other OECD economies where the capital stock has fallen are Denmark, Greece and Slovenia. It is possible Britain may be a harbinger of more general international trends.

 

For now though, this weakness puts the British economy in a uniquely vulnerable position in the global slowdown. So it is no exaggeration to say that under current circumstances the need for state-led investment to rescue the economy and living standards from renewed crisis is more acute in Britain than elsehwere in the G7 economies. When John McDonnell says, “our mantra is investment, investment, investment,” this is exactly what is required to stave off renewed economic weakness.

 

Labour's economic alternative to the budget should centre on a National Investment Bank

By Michael Burke and John Ross

Introduction

Labour is now carrying out extremely effective campaigning against Tory policies – on tax credits, on the sweetheart Google taxation deal, in support of the junior doctors and pinning the responsibility for the crisis in the NHS squarely on the Tories. This excellent work needs to continue and be strengthened.

But in the forthcoming budget Labour must also set out the framework for a comprehensive macro-economic alternative to Osborne’s austerity. This article argues why the centre piece of this should be to reinforce the existing pledge to increase infrastructure investment with the establishment of a National Investment Bank.

Osborne left swimming naked as the economic tide goes out

In a famous phrase the American billionaire investor Warren Buffet said of the economy: "when the tide goes out… you discover who's been swimming naked." Chancellor George Osborne fits this phrase perfectly. As the world economy slows, with consequent turmoil on financial markets, it is demonstrated that the Chancellor’s claims of ‘economic success’ are entirely bluff.

What Osborne has done in the last six years is to go on an international borrowing binge which failed to correct the basic imbalances and weaknesses in the British economy and he has left it dangerously unprepared for and exposed to the current slowdown in the world economy. Osborne ensured that the average British citizen, and even more the poorest members of society and those who rely on the NHS, pay the price for his failure to confront the key issues in the British economy. His real policy was exemplified in the sweetheart deal for Google, the recreation of the ‘bonus culture’ in banks, in contrast to the attack on the NHS and his attempt to ram through cuts in tax credits. This is the real context for Osborne’s coming Budget.

Instead of the further attacks on living standards and profligate international borrowing the appropriate macro-economic policy framework for Labour would focus on two things.

· First, to address Britain’s chronic investment shortage – only by increasing investment can living standards sustainably rise.

· Second, to prepare contingency measures in the event that the current slowdown worsens.

In contrast to Osborne’s attack on living standards and profligate international borrowing, Labour’s policy of productive investment, led by the creation of a National Investment Bank (NIB), should begin to tackle the basic imbalances in the British economy. The NIB will finance the economic growth that will lead to both rising wages and rebuilding social services, and will prepare Britain for the new international choppy waters it is entering.

In short people will be ‘better off with Labour’.

Osborne’s reckless international borrowing

The key current trends in the global and British economic situation are clear.

The world economy is slowing and Britain is not excluded from this – puncturing Osborne’s claim of ‘economic success’. In line with these economic realities the World Bank has cut its growth forecasts for the leading economies and the Bank of England has cut its growth forecast for the British economy. The British economy has in fact been slowing for some time with 3% growth in mid-2014 declining to 1.9% at the end of last year.

But Figure 1 shows the real basis of even the temporary upturn of British growth – Osborne’s rapidly growing international borrowing which leaves Britain exposed to the new worsening of the international economy.

When Osborne became Chancellor in May 2010, i.e. during the 2^nd quarter of 2010, Britain’s rate of net overseas borrowing was an annualised £31.2 billion. By the 3^rd quarter of 2015, the latest available data, it was an annualised £70.9 billion. As a percentage of GDP overseas borrowing almost doubled from 2.0% of GDP to 3.8%- as shown in Figure 1.

Figure 1

Under Osborne Britain, as shown in Figure 2, has borrowed an extraordinary £340 billion from abroad – equivalent to nearly one fifth of Britain’s current GDP. Far from being ‘prudent’ the Chancellor has simply financed his so called ‘recovery’ by the most unstable form of borrowing – from foreign creditors.

Figure 2

Failure of investment to recover

Yet despite Osborne’s extraordinary rate of foreign borrowing the Chancellor has failed to correct the most fundamental of all imbalances in the British economy, and the key source of its economic problems such as low growth and low productivity increases – its inadequate investment level.

Despite the inevitable severe initial fall in fixed investment under the impact of the international financial crisis, from 19.0% of GDP in 2007 to 15.6% of GDP when the Chancellor came to office, Osborne has ensured that any economic growth which did occur in the cyclical recovery overwhelmingly went into consumption not investing for the future. Between the 2^nd quarter of 2010 when Osborne came to office and the latest data for the 3^rd quarter of 2015 in current price terms three quarters of the recovery in output went into consumption and only a quarter into investment. This failure to invest has left Britain both unable to sustain any prolonged economic expansion and exposed to any international economic downturn.

The real Budget choice

The Chancellor claims that he must impose even greater austerity in the March Budget, due to Britain facing a “dangerous cocktail of new threats”. The reality is that it is Osborne’s own policies, his failure to invest, his large scale international borrowing, which are a particularly dangerous liquor in that concoction.

The reality of this ‘dangerous cocktail’ is that the Chancellor is the barman. The British economy is slowing and unprepared for any international downturn because he recklessly promoted consumption, in particular soaring house prices, in order to get re-elected and it is that short-lived mini-boom financed by foreign borrowing which is inevitably fading.

The failure was inevitable because rising consumption without investment cannot be sustained. It simply leads to more debt or a rundown in savings. A sustainable growth in economic growth and consumption must be based on investment. This hard economic reality is the core of Labour’s alternative for a sustainable economic recovery.

Such investment for sustainable economic recovery is precisely what is lacking under Osborne. Since the beginning of the crisis in the 1^st quarter of 2008 in inflation adjusted terms consumption has risen by £89.3 billion. Over the same period Investment has risen by just £9.3 billion. It is no surprise therefore that in per capita terms GDP has barely risen at all, or that more people are working longer hours for the same real return on pay. It is almost unprecedented for productivity to stagnate during most of a recovery phase but this is what Osbornomics has achieved because investment has remained so weak.

The Chancellor’s policy of austerity weakened the economy and sapped investment further. Under George Osborne the Government cut its own level of investment. The consequence of Osborne’s economic policies was that productivity actually declined from mid-2011 onwards and had only just recovered in time for the General Election. According to the Office of National Statistics (ONS), “UK productivity in 2014 was lower than that of France, Germany and the US by 32-33 percentage points, and lower than that of the rest of the G7 by 20 percentage points.” Both of these are record gaps in productivity with the rest of the G7. Higher living standards and improved productivity depend on higher investment which Osborne demonstratively failed to produce.

Furthermore, the Chancellor’s “fiscal charter” makes the situation worse. Osborne does not understand the difference between borrowing for investment and borrowing for consumption – something every business and every family understands. By lumping all forms of government borrowing together, and rejecting them all, he would ban a family not only from seeking to pay its electricity or food on credit card borrowing, which is a road to ruin, but also from borrowing to buy a house – a totally sensible objective.

If Osborne were a farmer his fiscal charter would rule he should not invest in a tractor – because it involved borrowing!

‘Extremists’ supporting infrastructure investment

Labour should restore sanity to public finances by clearly distinguishing productive capital expenditure, investment, from current expenditure – consumption. Labour should not borrow over the course of the business cycle for current expenditure. But it will borrow for productive investment – thereby laying the basis for economic growth and rising living standards.

In reality at present particularly favourable conditions exist to borrow for infrastructure spending at extremely historically favourable rates which will boost the productivity of the British economy– as writers such as Martin Wolf, chief economics commentator of the Financial Times and figures such as former US Treasury Secretary Lawrence Summers, have rightly emphasised. Indeed, the words Martin Wolf wrote in the Financial Times on 13 February 2014 require no alteration:

“Does the UK have a sensible strategy for recovery? Just recall: the last time it [the UK] tried the credit-expansion route to growth, it ended up in a huge financial crisis. Why should it rationally expect a different outcome this time?...

An expansion of private borrowing to buy ever more expensive houses is deemed good, but an expansion of government borrowing, to build roads or railways, is not. Privately created credit-backed money is thought sound, while government-created money is not. None of this makes much sense.”¹

Or if the chief economics commentator of the Financial Times is a too ‘hard left’ extremist for the Chancellor perhaps he will listen to the words of his former US counterpart – US Treasury Secretary Lawrence Summers:

“The… approach… that holds most promise –means ending the disastrous trend towards ever less government spending and employment each year – and taking advantage of the current period of economic slack to renew and build up our infrastructure. If the government had invested more over the past five years, our debt burden relative to our incomes would be lower: allowing slackening in the economy has hurt its potential in the long run.”²

Labour’s policy of sustainable investment and a National Investment Bank

Labour’s approach is diametrically opposite to Osborne’s. It has repeatedly set out the case for increased public sector investment – which, through economic growth and the well-known ‘multiplier effect,’ will stimulate and not reduce private investment. Labour has correctly stated it will run a balanced budget on current spending over the business cycle. This means the Government borrowing over the course of the business cycle will be exclusively directed towards investment. The Chancellor’s false fiscal charter failure to distinguish current expenditure and investment will be scrapped. The government will borrow for investment – including by creating a National Investment Bank. But current spending on public services would be met from taxation revenues.

This is correct because it is sustainable. Borrowing for investment in some cases, for example on transport or housing, leads directly to revenue. But above all it leads to economic growth and therefore rising tax revenues. As a result, the Government can finance its borrowing from those rising tax revenues. By contrast, persistently borrowing to fund current or day-to-day spending (frequently, and inaccurately described as ‘Keynesianism’) is unsustainable.

Labour’s approach is to increase investment. This will lead to stronger and more sustainable economic growth. The effect on government revenues is twofold. Tax revenues will rise with increased economic activity. At the same time Government outlays will fall as more people are in work and more of those workers are in higher-skilled, higher paid jobs. As a result, the current budget will actually move towards balance.

This is in contrast to austerity, which is the economic equivalent of applying leeches to a very sick patient. This is the reason the Chancellor will again miss his deficit targets in the current Financial Year, the reason why the deficit rose in 2012 as austerity took hold and the reason why the Chancellor is nowhere near eliminating the deficit as he had boasted in 2010. Austerity attempts to shift government debt and deficits onto the shoulders of ordinary people, and so weakens the economy that businesses reduce investment even further.

National Investment Bank

The centrepiece of Labour’s investment policy is the creation of a National Investment Bank. This will invest in key infrastructure projects, renewable energy, transport, affordable rented housing and education. This would be founded by public sector capital and borrow in the financial markets with the implicit guarantee of the UK Treasury.

As a result it will be able to borrow at close to the extraordinarily low interest rate levels currently available to the Government itself. These interest rate levels represent the financial market appetite to lend to Government. Currently, UK Government bond (gilts) yields are less than 1% for 5 year and 1.5% for 10 years. It can even borrow for 46 years at a yield of MINUS 1% on index-linked (linked to inflation) gilts. This represents the desire of long-term investment vehicles such as pension and insurance funds to invest securely over very long maturities and the absence of instruments to invest in.

In these circumstances a refusal to borrow for investment is economically irresponsible and counterproductive. In addition to the beneficial productive effects for the economy there is a clear ‘signal’ from the market that it wants to lend to government. Once more to quote that key member of the ‘hard left’ Martin Wolf from the Financial Times on 17 May 2012:

“With real interest rates close to zero… it is impossible to believe that the government cannot find investments to make itself, or investments it can make with the private sector, or private investments whose tail risks it can insure that do not earn more than the real cost of funds. If that were not true, the UK would be finished. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way… This does not even deserve the label primitive. It is simply ridiculous.”³

The initial funding for the National Investment Bank, which will play a key role in Labour’s increase in investment, is straightforward. The Government should borrow the capital utilising the opportunity presented by current extremely low interest rates. In more unfavourable circumstances of severe economic downturn Labour would be prepared to use People’s Quantitative Easing, finance created by the Bank of England to finance productive investment as opposed to the bank bailouts it has hitherto been chiefly directed to, but such a policy is not necessary in present circumstances to finance the NIB. Approximately £50 billion should be raised over the course of a parliament to fund the NIB.

This is a substantial amount to fund the initial capital for an infrastructure investment bank. In Germany the equivalent bank is the KfW (originally Kreditanstalt für Wiederaufbau or Reconstruction Credit Institute). The KfW has €21.6 billion of equity capital and total capital (including debt) of €73.4 billion which supports €489 billion in assets (lending to projects). It would take time for the NIB to reach that position, but it shows what is possible.

Crucially, the NIB would be able to use this Government-funded capital to borrow on its own account in the financial markets. Under the arcane rules of Government finances it need not count on the Government’s balance sheet at all, either as borrowing or accumulated debt. As the KfW example shows, it is possible to borrow comfortably around six or seven times the original capital.

Economic Impact

One of the objections to public sector-led investment programmes is that there are no ‘shovel-ready’ projects to invest in – which would itself be a disgrace given Britain’s lack in investment and productivity compared to other countries already noted. But even this argument has collapsed now that the Government has established its own National Infrastructure Commission with a National Infrastructure Plan. No doubt, Labour can set some of its best brains to revising and re-prioritising the Plan in relation to its own economic priorities. But the Plan and the projects are already there. The problem is the Government, because of its essentially exclusive reliance on the private sector, is simply not delivering them on the scale and pace required.

The work of building up the necessary projects for investment, including by the National Investment Bank, could begin immediately and would be well towards the final goal over the lifetime of the parliament. In the first year the NIB could be established and funded, and borrowing begun and projects prioritised for work to begin or increase in the second year. By the end of the current Parliament work could have been under way for a full three years.

In reality, this Government has no intention of following that route. Although it established a minuscule ‘Green investment Bank’ this was a political sop and is being wound up. But Labour could begin the detailed preparatory work now and hit the ground running in 2020. A full four years of productive investment is possible.

In four years a capital programme funded by £50 billion in capital and amounting to £300 billion in total could be well under way. The general economic impact is possible to gauge using the UK Treasury’s own economic modelling. Investment in infrastructure has the effect of raising growth in the short-term and by increasing growth over the long-term through improved productivity. The precise impact varies by sector and by project, but in a range of raising growth by between 1.5 and 1.9 times the initial investment. On average we can say that a £300 billion investment programme will raise GDP by around £500 billion (an approximate average of 1.7 times).

In general, according to UK Treasury models (pdf), every £1 increase in economic output is reflected as a 75 pence improvement in government finances. 50 pence of this arises from increased taxation revenues and 25 pence from lower outlays as poverty reduces and employment grows. Therefore, over time three-quarters of the additional growth produced by the NIB’s investment programme will return to Government in the form of higher tax revenues and lower outlays. This is an improvement of £375 billion (out of £500 billion in increased output) in total government finances over a period of years. Just as the private sector invests for growth and a financial return, so too should the public sector. The difference is that the public sector also enjoys a further financial benefit not available to the private sector; increased taxation revenues and lower social spending outlays.

From these funds, it is possible to increase investment further and to fund the improvement, not the deterioration in public finances. It is possible to upgrade the NHS and improve it, to address the schools shortage and return to free higher education. Social protection can be improved and a decent level of income in retirement provided for all.

The forthcoming Budget will threaten to undermine further the living standards of the overwhelming majority of the population. But it will therefore be an opportunity for Labour to set out a very clear alternative that will begin to reverse that process and raise their living standards. Naturally Labour will have to deal with reversing numerous anti-social policies in the budget but the macro-economic centre piece of its alternative should be the pledge to raise investment, a clear distinction between current and capital expenditure in the budget, and the establishment of a National Investment Bank.

References

1. Wolf, M. (2014, February 13). Hair of the dog risks a bigger hangover for Britain. Retrieved February 20, 2014b, from Financial Times: http://www.ft.com/intl/cms/s/0/1cd67c18-93e6-11e3-a0e1-00144feab7de.html?siteedition=intl#axzz2silAZOQx

2. Summers, L. (2014, January 5). Washington must not settle for secular stagnation. Financial Times.

3.Wolf, M. (2012, May 17). Cameron is consigning the UK to stagnation. Financial Times.