Socialist Economic Bulletin

Declining US profits and private investment

Declining US profits and private investmentBy Michael Burke

US corporate profits fell in the first quarter of 2015. This is the second consecutive fall, technically causing a ‘profits recession’. The nominal level of profits of $2014.8bn in Q1 was lower than in Q2 2012. Profits have fallen to 11.4% of GDP, compared to 12.2% at their pre-crisis peak in Q3 2006. The trend in corporate profits is shown in Fig. 1 below.

Fig.1 US Corporate Profits
Source: BEA

The motor force of capitalist economies is the accumulation of capital via profits, as the name suggests. ‘Demand-led’ or ‘wage-led’ economies are a logical impossibility for the simple reason the wages, or demand, or any other comparable variable follow the production process. There can be no wages or demand without prior production.

Falling profits in a recovery is extremely unusual. But this is the third time this has happened during this weak recovery. In effect, because the economy lacks any great momentum, it is easy for external effects to push profits lower. This could be poor weather, a stronger US Dollar, shipping strikes, weak overseas demand, and so on.

But the effect of a sustained fall in profits is simple. Companies exist to realise profits and will stop investing if profits fall. In Fig. 2 below US corporate profits and US private sector fixed investment are shown in nominal terms for the purposes of comparison.

The Great Recession was preceded by a decline in profits and the fall in fixed investment followed with a time lag. This was a classic profits-led recession, which was partly obscured by the speculative frenzy that continued until 2007 (but which is a recurring end-of-cycle phenomenon).

Fig.2 Profits & Private Fixed Investment
Source: BEA

However, until now private sector fixed investment has not suffered a fall in the current expansion despite the preceding short-lived declines in nominal profits. Since the low-point in private investment at the beginning of 2010 there has been an uninterrupted rise in private investment until the final quarter of 2014.

That changed in the first quarter of 2015. Private sector fixed investment fell in Q1 2015. The decline was extremely modest, from $ 2,850bn to $2,841.5bn and could yet be revised away. But there are further causes for concern. In real terms real GDP growth has increased by just €254bn over the last three quarters. At the same the stock of unsold inventories has risen by €257bn. If goods remain unsold, profits cannot be realised and the most obvious course of action is to cut back on production.

Many official and private commentators suggest that the latest weak data is simply a one-off, reflecting extremely poor winter weather in the US. That could prove to be the case. But the combination of rising inventories, falling profits and the new fall in private investment does not point to an improving outlook for the US economy.

What can we expect from renewed austerity?

What can we expect from renewed austerity?By Michael Burke*

The new Tory government will renew its austerity offensive shortly with the publication of an ‘emergency Budget’ on July 8. It is simple to demonstrate that the previous austerity programme caused the economy to grind to a halt (and with it the improvement in government finances).

Supporters of austerity like to claim that austerity led eventually to recovery. But this is logically impossible. A force applied from one direction, the downward pressure on the economy, cannot sequentially have the effect of lifting the economy. Most children learn these cause and effect relationships through play at the ages of 2 to 4, with marbles, wheels and water.

Therefore the actual course of events of the last round of austerity will prove instructive as to what can be expected in the next 5 years. This has important political as well as economic implications.

Anyone tempted to throw in their lot with Tory economic policy, for example among the Labour leadership contenders, will be obliged to defend the impact of Tory austerity. As there is no solid basis for the current ‘recovery’ which is supported by increasing household debt and borrowing from overseas, the inevitable bust will occur. The ‘Barber boom’, the ‘Lawson boom’ both ended with a slump, and the feeble Osborne recovery reproduces them in a worse environment.

According to the IFS the Tory Government plans imply £45bn of ‘fiscal tightening’ in this parliament equivalent to 4.1% of GDP, although we have yet to see the actual plans of the emergency Budget in June. This is approximately equivalent to the fiscal tightening of the last parliament although it is suggested that all of it will be achieved with cuts to public spending rather than in combination with tax increases as previously. The axe will fall heavier this time.

The previous programme of austerity caused a double-dip recession in most sectors of the economy. The economy had been growing at a very modest pace of 2.1% in the 4 quarters before the last Coalition took office. The double-dip recession in production, construction and agriculture is shown in Fig.1 below. Only services continued to grow.

It is notable too that industrial production (including manufacturing plus energy) is still below the level the Coalition government inherited in 2010. No industrialised economy can sustain growth without growth in industrial production, as the label implies.

Fig.1 Most Sectors Experienced A Double-Dip Recession
Source: ONS

In real terms there was no growth in Government consumption spending in both 2010 and 2011. This turned a modest recovery back close towards recession, only saved by the growth of the service sector in 2012 plus the Olympics effect.

We have already seen how austerity caused a sharp renewed slowdown in the economy as a whole. There is no logic to claim that austerity also led to eventual recovery. Instead, as Tory poll ratings plunged after the ‘omnishambles Budget’ and the economy risked falling back into outright recession, Government policy was changed. There were no new Government spending cuts from 2012 onwards. Government consumption was allowed to grow and the austerity offensive was put hold (Fig.2).

Fig.2 Real GDP & Government Consumption

Table1. Real GDP Growth Real Govt Consumption Growth
Source: ONS

The result of increased Government consumption was a modest expansion. Real GDP grew by 2.8% in the pre-election year of 2014. But this was little more than the 2.1% growth achieved in the year prior to the imposition of austerity. Over the 5-year period 2010 to 2014 real GDP growth has averaged just 0.75%. This is exceptionally weak by historical standards and is striking after a sharp recession, when the usual pattern is for a more rapid recovery. GDP growth has only matched the growth of the population so that per capita GDP has stagnated. Under these circumstances living standards cannot rise.

Investment

However, there is no such thing as a consumption-led recovery. It too is a logical impossibility. Economies are dominated by production. As the proportion of GDP devoted to consumption rises, economic growth tends towards zero. The reverse is also true; as the proportion of GDP devoted to investment rises, so GDP growth increases (including the growth of consumption within that).

Without production, the expansion of which relies on investment, consumption can only be increased by further borrowing.

One of the central fallacies of Tory economic ideology is the idea that by shrinking the state the private sector will thrive. As Government is the largest single customer of the private sector goods and services, the opposite is the case. Cutting public spending damages the private sector and exacerbates its weakness.

Cutting public investment has been a central part of austerity and a key way that government spending has fallen overall. The deficit has fallen by damaging future growth.

This has been the effect of the previous round of austerity. The entire crisis was caused by the slump in business investment, which caused unemployment to rise and Government tax revenues to fall (hence the rise in the deficit). The weakness of business investment can be seen as early as 2006 (Fig.3) and in the sharp decline again in 2008.

Fig.3 Business Investment & Government Investment

Source: ONS

Under the Labour Government investment was increased in 2008 and 2009 to offset a crisis caused by this private sector weakness (Building Schools for the Future, bringing forward planned capital infrastructure projects, etc.).

The Coalition slashed Government investment. The effect was predictable. The recovery in private sector investment was halted. It is only in 2014 with a pre-election rise in Government investment did business investment begin to accelerate again.

If the Tory government attempts to close the deficit by cutting its own investment, or acts on the belief that the private sector will deliver better and more investment in public services, then the effect will be the same once more. Business investment will be cut again. There is no ‘productivity puzzle’. Without investment productivity cannot grow and living standards cannot rise.

‘Welfare’

The Tory Government has also announced plans for further cuts in social security. 64% of all households are in receipt of one type of social security benefit or another, over 20 million households. They, we are the majority.

The previous Coalition Government managed to remove somewhere between 1 million and 2 million households from entitlements that were in receipt of small sums. Most of those of working age in receipt of benefits are actually working. Either their pay and/or their hours are too little to subsist on wages alone. A large proportion of these are single parents.

The Tory party and a supportive media have waged a relentless campaign against ‘welfare scroungers’ in ‘benefits Britain’. The reality is that this is the majority, whose general welfare and wellbeing benefits us all. Not only do cuts in entitlement cause enormous hardship to millions, it actually hits everyone economically. ‘Presenteeism’, being at work but not engaged with it through insecurity or concern for childcare of healthcare responsibilities is widespread and on one estimate is said to depress the economy by £15 billion.

Entitlement to benefits is a function of low pay, disability, old age, poverty and excessive rents. Britain has one of the lowest levels of social security protection among richer industrialised economies. Britain spends 0.4% of GDP on unemployment benefits compared to 1% for the OECD average. In contrast, Britain spends 1.5% of GDP on housing benefits where the benefit goes to landlords while the OECD average is just 0.4%.

Table 2. Social Protection Expenditures As A Proportion of GDP %

Source: OECD

A recent report by Shelter shows that the annual subsidy to private landlords amounts to £14bn, which is greater than the planned welfare cuts. The cuts to welfare will cause enormous human misery. Cutting the handout to landlords would remove incentives for buy-to-let and so act as a brake on the upward spiral in rent and property prices.

In the wider picture, the deficit will soon fall to around £85bn annually and below. Handouts to the corporate sector (tax breaks and incentives) amount to £85bn annually. The entire deficit could be removed by ending this corporate welfare without any of the damaging cuts planned. This alone would address the question of the deficit. But for sustainable growth, public sector-led investment is required.

*This is a slightly modified version of a recent presentation for Labour Against Austerity in the House of Commons

Did New Labour spend too much?

Did New Labour spend too much?By Michael Burke

It is not sufficient for big business to have secured an election victory and an overall Parliamentary majority for the Tory Party. It is also necessary to intervene in the Labour Party to ensure that its leadership also conforms to big business interests too. This has currently taken the form of candidates in the leadership contest being asked to declare that Labour ‘spent too much’ in the run-up into the Great Recession. Answering Yes to this question is effectively a loyalty oath to big business interests, a renunciation even of the social democratic vestige of economic policy under New Labour.

The question is economically illiterate. It is taken as axiomatic that if there was a deficit that spending must have been too high. But all deficits are composed of two items; spending and income. In the case of government that income arises mainly in the form of taxes. It does not follow from the existence of a deficit that the culprit must be spending.

The reality is that measured as a proportion of GDP New Labour spent less on average than Margaret Thatcher. This is shown in Fig. 1 below. On average New Labour’s spending amounted to 41.5% of GDP. By comparison, under Thatcher government spending was 44.2%. In relation to the deficit, the taxation levels were also very different. Under New Labour taxation revenues were on average 37.5% of GDP. Under Thatcher taxation revenues amounted to 42.0% of GDP.

Fig.1 Government spending and revenues as a proportion of GDP

The argument that Labour spent too much has no factual basis whatsoever. The loyalty test of renouncing the ‘overspend’ is based on a complete fiction. In fact, because it was in thrall to neoliberal economics, it is clear that New Labour taxed too little.

Under New Labour the main rate of corporation tax on profits was cut from 34% to 28%. ‘Taper relief’ on capital gains was introduced which cut the tax rate on capital gains (CGT) from 40% to 24%. This system was later scrapped and the rate cut to 18% by Alistair Darling. Owners of assets therefore paid a far lower tax rate than the tax on workers’ income. A system was also introduced where, almost uniquely in advanced economies, companies could set off both past losses against corporation tax, and carry back losses to reduced their tax bill too.

None of this led to an increase in productive investment, which was the supposed reason for these huge giveaways to capital. Instead there was a very substantial increase in speculative investment, which did contribute to the crash. On the contrary, investment (Gross Fixed Capital Formation, GFCF) continued its long-term decline, as shown in Fig.2 below.

Fig. 2 Investment decline as a proportion of GDP

The effect of boosting speculative investment is indicated by the growth of housing as a component of the pre-crash British economic expansion. Fig. 3 below shows the level of GFCF and the level of productive investment, that is GFCF omitting housing. This clearly shows that the decline in productive investment was uninterrupted throughout the period of New Labour as well as before and since under the Tories. In this entire period economic policy was neoliberal dominance which meant there was an explicit aim of reducing taxes on business in order to increase investment. The policy was a complete failure.

Fig. 3 Investment and productive (non-housing) investment

The trend towards lower productive investment by the private sector and increased speculative activity was also fostered by the government’s cuts to the level of public sector investment. The data and OBR projections are shown in Fig.4 below. As government is the biggest single purchaser of goods and services in the economy, cutting government investment encourages the private sector to cut its own investment.

It is one of the central myths of neoliberal economics that government investment ‘crowds out’ private sector investment. The opposite was the case; a cut in government investment accompanied declining productive investment by the private sector. By contrast, rhe temporary rise in public sector investment in 2008 and 2009 helped to lift the economy out of recession and was rapidly ended by the last Coalition government.

Fig.4 Public sector investment
Source: OBR

New Labour did not spend too much. It taxed and spent too little, less than Thatcher. Worse, the cuts in taxes for the business sector and the owners of assets did not lead to increased investment. Investment fell and was itself exacerbated by the decline in public sector investment.

Defence of these simple facts has been made an acid test. They are actually the vestiges of social democratic economic policy at the level of the Labour leadership. If it is accepted that Labour ‘spent too much’, big business interests will have rewritten history in its own interests and fundamentally undermined the character of the Labour Party.

Despite Cameron-Crosby’s tactical triumph Tory support will continue to decline

Despite Cameron-Crosby’s tactical triumph Tory support will continue to declineBy John Ross

The 2015 General Election was a stunning Tory tactical success.They won a majority of Parliamentary seats with the second lowest share of the popular vote for any party achieving this in British history – only Tony Blair’s vote in 2005 was smaller. Cameron is the Tory Prime Minister, with a majority in Parliament, with the lowest share of the popular vote in history.The unpopularity of coalition policies was shown in a dramatic 15% fall in the share of the vote for its parties – from 59% to 44% – but the Tories ensured Liberal Democrats suffered 100% of the loss. Lynton Crosby earned every penny of his fees from Cameron.

But despite the tactical triumph did the Tories shift the social forces and underlying trends in British politics? And if they didn’t what will be the consequences?

To analyse this the starting point has to be not opinion polls but real elections – which determine political shifts. Figure 1 chart shows the modern Conservative party’s share of the vote at every election since its first in 1847 after the split of the old Tory Party over the Corn Laws. The story the chart tells is clear. Short term swings are superimposed on an underlying trend of rising Tory support for almost a century until 1931 and then decline for over 80 years.

Figure 1
15 05 09 Tories

This curve is not a statistical oddity but clear social processes produced it. The modern Conservatives originated in the South East of England, outside London, in the mid-nineteenth century. Over nearly a century they rose to become Britain’s dominant party by adding, in chronological order, mass support in North West England, London, the West Midlands and Scotland. Tory decline was the progressive loss first of Scotland, then North West England, then the West Midlands and London. Now the Tories are back in their original rural and South East bastion.

It is certainly possible to misjudge short term swings – the present author mistakenly believed two years ago that Labour would be ahead of the Tories due to the unpopularity of the coalition’s austerity policies. But a still more basic question for the future of British politics is have the Tories reversed their decline? The answer is no.

To see why focus on the post-1931 vote – its downward shifting trend is clear as shown in Figure 2 which shows the descending part of the chart above. This thesis of ‘Tory decline,’ when I first produced the chart of this trend in 1983 at the height of Thatcher’s grip on politics, in my book Thatcher and Friends, was met with disbelief. But it met the test of seven out of the eight next general elections. It is certainly annoying for the author, and much more importantly tragic for the country, that in 2015 it didn’t. But as the chart shows the Tory 36.9% in 2015 doesn’t break the overall descending trendline.

Figure 2

15 05 10 Tory 1931-2015

The underlying social forces that had produced the overall decline continued to operate even in 2015. Tory support in Scotland fell further to 14.7% – in 1945-55 Conservatives had more support in Scotland than England. In the North of England there was a swing to Labour. In the South’s urban bastion, London, Labour won 45 seats to the Tories 27. In contrast, in the South outside London, the Tories won seats from Labour.

The Tories collapsed further back into their South of England and rural heartland. Despite the dramatic 15.2% collapse of Liberal Democratic votes the Tories could only pick up a tiny 0.8% in a winning year – although it is unusual for them to increase at all between election victories.

For future trends Scotland decided the election in a dual sense. First it saw a crushing rush of votes to an SNP to Labour’s left. That was then used to in a scare campaign aimed at persuading English voters into not supporting Labour – for Tory media demonic Scots occupied the place previously occupied by Jews, West Indians, Romanians etc.

It is totally improbable Labour will ever regain Scottish dominance – any Blairite shift by Labour in England will further distance it from a Scotland which found even Ed Miliband too right wing. Scotland in 2015 is the equivalent of two previous tectonic shifts in British politics – 1868 when Irish Home Rule supporters entered parliament and 1900 when Labour did.

If the ‘Tory decline’ thesis is correct the consequences of this are clear. Despite the tactical success Tory support will shift downwards. The last time the Tories ‘cheated’ social forces by astute tactics, in 1992, tensions broke out despite the victory. The political fault lines of Tory decline this time are clear.

Whether to break promises to Scotland on further devolution, whether to adopt the divisive principle of only English MPs voting on English issues?

On the EU Cameron always intended to call for a referendum ‘Yes’ regardless of whether Merkel makes concessions. But not only UKIP but part of the Tories will campaign for exit.

The economic recovery is based on foreign borrowing and much of the worst hardship on social services to come.

If the ‘Tory decline’ analysis is correct Cameron/Crosby’s tactical success will therefore not halt the deepening fall of the party’s support.

Given that in 2015 the Tories engineered a tiny 0.8% increase in their support it is legitimate to demand the ‘Tory decline’ thesis be examined. I believe the facts show this election was a great Tory tactical success but it cannot halt the fundamental trend undermining Tory support. Naturally if the future trends show the opposite, that the Tory increase was not a blip in a descending trend but the beginning of a real upward shift , then ‘Tory decline’ would have to be abandoned.

It probably wasn’t Keynes who said ‘When the facts change, I change my mind, what do you do?’ But whoever did was correct. So far seven general elections out of eight confirmed the analysis of ‘Tory decline.’ The facts of the next five years will be the test again. The social facts show the Tory decline will continue – shaping the most fundamental trends in British politics.John Rosshttps://www.blogger.com/profile/08908982031768337864noreply@blogger.com0

Can the Lib-Dems save Tory Britain?

Can the Lib-Dems save Tory Britain?

By John Ross
By now many pollsters admit they misread the election campaign. As Freddie Sayers, You Gov’s Editor in Chief, put it: ‘Back in February, it was still considered a near-certainty by the media pundits that the Conservatives would end up significantly ahead. Ed Miliband was unconvincing, the economic numbers coming in were all positive, and now the SNP were wiping out Labour in Scotland: the Conservatives themselves felt a certain inevitability about their return to power after May 7th.’
The election campaign has not turned out like that – the Tories have not gained support. But an attempt has been to explain this by short term factors such as Lynton Crosby’s distasteful election tactics or backlash against the Tory media’s attempted character assassination of Ed Miliband. As Peter Kellner summarised this analysis: ‘Tories pay the price of an inept campaign’.
This view is wrong. History, including election campaigns, is ‘natural selection of accidents’. Far more powerful forces than Lynton Crosby, or David Cameron’s inability to accurately name his supposed favourite football term, explain the failure of Tory support to rise.
To show the deep social processes explaining absence of the anticipated Tory surge the graph below shows the Tories percentage of the vote at every general election since the party’s highest ever score –  55.0% in 1931. The graph is breath-taking in the steadiness of its decline.
Already after World War II the peak Tory vote was 49.6% in 1955 – lower than inter-war levels. It fell to 41.9% by 1992 – the last time the Tories won a majority in the House of Commons. By 2010, when they had declined to being the largest party, but without an overall majority of seats, Tory support was  36.1%. Typically each Tory victory was won with a lower percentage of the vote than the one before, each Tory defeat saw the party’s support fall further than the one previously.

This process is produced by clear social trends. The modern Conservatives originated in the South East of England, outside London, in the mid-nineteenth century following the old Tory Party’s split over repeal of the corn laws. Over nearly a century the Conservatives rose to become Britain’s dominant party by adding, in chronological order, mass support in North West England, London, the West Midlands and Scotland – the current Tory rump in Scotland, with one seat, is in a nation where from 1945-55 Tories actually had more support than England! The Tory decline was the progressive loss of first Scotland, then North West England, then the West Midlands and London.  Now the Tories are back in their original South East bastion. 
This trend, based on real elections not polls, was analysed in 1983 in my book Thatcher and Friends and has continued to operate since. It is such powerful forces, operating over more than 80 years, which underlay the failure of Tory support to rise in the election campaign.
Relentless historical Tory decline, of course, does not mean there are no short term shifts. There is a swing factor of slightly under 5% between a Tory victory and a defeat – explained by events nearer the time of an election. But this is superimposed on an underlying erosion of the Tory vote of slightly over 0.2% a year.
Taking these trends, if the Tories were the leading party on 7 May, they would get a bit under 35% of the vote, and if they were the losing party they would get slightly over 30%. The problem is that with a maximum theoretical 35% vote the Tories could not win an overall majority of seats. Failure to analyse longer term social processes caused failure to foresee accurately the course of the election.
Faced with these trends Labour’s policy has shown strategic errors to a higher degree than anticipated. Labour should have understood Tory support could not rise. The key for Labour was therefore to ensure the unity of its moderate left support. Instead relentless minimisation of Labour’s difference with the Tories during the Scottish referendum campaign, the positioning of Labour to the right of the SNP, must count as one of the worst strategic blunders in recent British politics. Without this Ed Miliband could be practicing his victory remarks outside 10 Downing Street. Labour’s ‘steer right’ policy also opened a space for the Greens in England. It is for these reasons that it not impossible the Tories may get a bit over 34% as the largest party, not slightly over 30% as the losing one.
But this does not alter the fundamental trend of Tory decline. Basic social forces, not contingent mistakes, have blocked a rise in Tory support in the election campaign. It is because the Conservatives are incapable of halting their own decline that the paradox is… only the Liberal Democrats can now save Tory Britain!

John Rosshttps://www.blogger.com/profile/08908982031768337864noreply@blogger.com0

Greek myths retold

Greek myths retoldBy Michael Burke

The world economy is not strong and the President of the United States is sufficiently concerned about new shocks to it that he recently met the Greek Finance Minister to urge ‘flexibility on all sides’ in the negotiations between the Syriza-led government and its creditors. US concern is fully justified.

In any attempt to reach agreement it is important both to have an objective assessment of the situation and to understand the perspective of those on the opposite side of the table. In Mythology that blocks progress in Greece Martin Wolf, the chief economics commentator for the Financial Times argues that negotiations to date are dominated by myths. He demolishes some of these key myths in turn: that a Greek exit would make the Eurozone stronger, that it would make Greece stronger, that Greece caused the crisis driven by private sector lending, that there has been no effort by Greeks to repay these debts, that Greece has the capacity to repay them, and that defaulting on the debts necessarily entails leaving the Eurozone.

Together, these provide a useful corrective to the propaganda emanating from the Eurogroup of Finance Ministers and ECB Board members. Some if this is slanderous, in repeating myths about ‘lazy Greeks’ (who have among the longest working hours in Europe). Much of it is delusional, based on the notion that Greece can be forced to pay up, or forced out of the Euro without any negative consequences for the meandering European or the world economy.

Austerity ideology

The genuine belief in a false idea, or a demonstrably false system of ideas constitutes an ideology in the strict meaning of that word. Inconvenient facts are relegated in importance or distorted, and secondary or inconsequential matters are magnified. Logical contortions become the norm.

All these are prevalent in the dominant ideology in economics, which is supplemented by another key weapon, the helpful forecast. In Britain for example, supporters of austerity argued it would not hurt growth and the deficit would fall. Now there is finally a recovery of sorts, they argue austerity worked, ignoring all the preceding five years and the unsustainable nature of the current recovery (and the limited progress in reducing the deficit).

For Greece the much more severe austerity and its consequences means that supporters are still obliged to rely on the helpful forecast to support their case. The Martin Wolf piece includes a chart of IMF data on Greek government debt as a percentage of GDP, which is reproduced in Fig.1 below.
The IMF includes not only data recorded in previous years but its own projections for future years. From a government debt level of 176% of GDP in 2014, the IMF forecasts a fall to 174% this year and 171% in 2016 and much sharper declines in future years. The IMF has also forecast an imminent decline in Greek government debt ever since austerity was first imposed in 2010, which has not materialised.

Fig. 1 Greek Government Debt, % GDP & IMF Projections


However, the most recent data released by the Greek statistical service Elstat shows that Greek government debt rose once more (pdf) at the end of 2014 to stand at €317bn. The total debt was €9bn higher in 2014 than 2013, whereas the IMF forecast is effectively flat. Worse, as the Greek economy is still contracting the debt as a proportion of GDP will be rising sharply, not falling as officially projected.

In the course of 10 years the Greek government debt level has effectively doubled as a proportion of GDP close to 180%. Most of this took place while austerity was being implemented. The unavoidable verdict is that the debt burden is unstainable and that austerity will only increase it.

To date the Syriza-led government has met all its obligations to creditors but this clearly cannot go on for very long. It is possible that it may prefer to default on the ECB, which can in the end simply print the money (as with its Quantiative Easing programme, but from which it currently excludes Greece). 

Defaulting on the IMF is perhaps more politically difficult, as its Board would have to convene a meeting of all shareholders. €3.46bn is due to the ECB on July 20.

But a default is necessary and inevitable. The authors of the Maastricht Treaty thought that anything more than debt level equal to 60% of GDP was dangerous. Then this would provide an appropriate target for Greek debt reduction.

Investment flows

In the Martin Wolf piece he also suggests that debt reduction should occur “after the completion of reforms”. This is mistaken. ‘Reform’ in the context of the negotiations is a synonym for deregulation, privatisation, attacks on workers’ rights and living standards. This has already been tried and failed. It is a myth that too many Greek regulations, or too much state ownership, or workers fighting for better pay and pensions is the cause of the crisis. All those were in place in 2003 and 2004 when real GDP in Greece grew by 6.6% and 5% respectively.

One myth that hardly needs to be dealt with any longer is that the crisis was caused by imbalances within the Eurozone current accounts (the balance of trade plus overseas interest payments). For a period this became a key explanation of the crisis (pdf) in the official ideology. It has been largely abandoned as all the crisis countries have swung into surpluses. Greece now has a current account surplus because imports have slumped and so remains in crisis.

A common feature of the crisis countries is that they were beset by huge inflows of private sector capital seeking returns, primarily through speculation in property and housing. It was when these private sector inflows dried up and reversed that the crisis became apparent. Until austerity was imposed in 2010 the fall in Greek GDP due the recession was almost exactly the same as in Germany or in Britain, a fall of approximately 4.75% in all cases.

The austerity policy and the ratings’ agencies induced panic had the effect of driving capital flows back from the ‘periphery’ to the ‘core’ countries. Ferocious austerity in Greece and the other crisis countries meant that private sector banks withdrew capital and repatriated it to the key banking centres of Europe: Britain, German, the Netherlands and France.

These private sector speculative flows were destabilising in both directions. They caused both the boom and the bust in Greece and elsewhere. A solution based on reviving these flows, with the inducement of ‘reform’ can only end in renewed destabilisation and crisis. The desperation of these private sector investors is demonstrated by the fact that, for most industrialised countries currently (excepting Greece) borrowing rates are close to zero as unutilised capital seeks a return.

Structural adjustment

The Greek economy needs structural adjustment. For the ideologues of austerity this is a synonym for wage cuts. But Greek finance minister Yannis Varoufakis is right, cutting wages even further will have no effect on improving Greek competitiveness in key industries, “we are not going to be competitive with Mercedes-Benz and Toyota, simply because we don’t make cars.”

The structural adjustment needed is to increase the productive capacity of the Greek economy. This requires productive investment on a large scale. Prior to the crisis the EU did provide some transfers of funds for investment, as well as current transfers in the form of the Common Agriculture Policy and other funds (which is why the anti-austerity parties and most voters in the crisis countries are not anti-EU). However, these were on an insufficiently large scale and were in any event overwhelmed by the private sector inflows which were primarily directed towards construction and housing.

Worse, the EU has cut its funding for investment as the crisis has deepened. This has exacerbated the private sector withdrawal of capital and is an important factor in prolonging the crisis. Fig.2 below shows the levels of investment from the EU and the different forms of investment from the private sector, both total investment (Gross Fixed Capital Formation) and productive investment, which excludes housing.

Fig.2 Investment in Greece & Selected Components, % GDP

All types of investment have fallen as a proportion of GDP during the crisis. But it was the EU’s declining contribution which led the way. In addition, the real cuts in investment are flattered in this comparison as GDP itself was falling. In 2006 productive investment from the EU to Greece amounted to €4.7bn. In the depth of the crisis in 2012 it had been cut to €1.6bn.

This is a punitive measure and is entirely contradictory to the objective needs of the Greek economy. All properly functioning single currency areas require significant fiscal transfers in order to be sustainable. This follows from the fact that all regions or countries in a monetary union are subject to very similar monetary conditions (official interest rates, exchange rates, and so on) yet have very different levels of productivity. Those levels of productivity will diverge to a crisis point unless there are sufficient fiscal transfers to compensate. If the fiscal transfers are sufficiently large and well-directed, they can even compress or reverse the divergence in productivity. Currently, the policy of the Troika is to lay siege to the government in Athens in an attempt to starve it into submission.

As a result, the Greek economy is at that crisis point. It requires very large fiscal transfers otherwise it will diverge out of the Eurozone. This is in addition to the requirement for a very substantial debt write-off already noted. Even then, very strong government and supranational measures would be required to direct the inevitable revival of private sector investment that would inevitably follow a large increase in (supranational) public sector investment. The public sector must begin to direct large-scale investment.

Martin Wolf is quite right to attempt to disabuse the ideologues of austerity of their Greek myths. There is no prospect of an end to the crisis without very substantial debt reduction. It is also reckless bravado to claim that only Greece would be hit by a forced exit from the Euro. But even debt reduction is insufficient to end the crisis, and further ‘reforms’ would only deepen it. Very large fiscal transfers to pay for a structural upgrade of the Greek economy are necessary.

The biggest beneficiaries of the EU are the big firms and banks in the leading EU economies. They need to start paying for this benefit or they will lose it.

Tories’ ‘Right to Buy’ housing plan will deepen the housing crisis

Tories’ ‘Right to Buy’ housing plan will deepen the housing crisisBy Michael Burke

The Tory manifesto election pledge to make housing associations sell their homes at a discount and force local authorities to sell off some of their best stock has been widely condemned by the associations themselves and by housing experts. The government has set aside £1 billion to fund the discount available to the new ‘right-to-buy’ owners and will demand that the housing associations build replacement homes, which do not have to meet affordability criteria. The net new money available for homebuilding is therefore just £1 billion.

Using average construction cost estimates from the National Association of Home Builders of £150,000 per home, this equates to just 6,600 homes. Very few or none may be affordable.

The idea of bribing a tiny number of housing association tenants (and some of the few remaining local authority ones) with public money to become owner-occupiers is part of the policy of privilege to bolster the Tory election campaign. But since the majority of these homes tend rapidly to become part of the private rented sector it will also exacerbate the growing inequality and unaffordability of housing.

It does nothing to address the housing shortage in Britain, which is both chronic and in many parts of the country acute. Fig.1 below shows the level of both new ‘social rent’ housing and total affordable homes from 1991 to 2014. It is necessary to include at least these two categories in order to indicate some general trends as the government has changed the definitions of many categories of housing with the effect of obscuring to wider picture.

Fig.1 Social Rent and Total Affordable new homes
To give an indication of how grossly inadequate this is, the number of (loosely-defined) new affordable homes of all types was just under 43,000 last year and compares to 1.368 million households on local authority housing waiting lists in England alone.

The recent peak level for annual new affordable homes was just over 60,000 and was inherited by this government from the previous Labour government. The official projection of new household formation over the next 25 years is an average 210,000 per year (pdf). While not all of these households will want or need social or affordable housing, the majority will. Therefore the current pace of home building is completely inadequate to meet the additional projected demand. It will do nothing to address the backlog on waiting lists and the housing crisis will deepen.

There are many addition costs to the housing crisis simply beyond the extremes of unaffordability. These include the miseries of overcrowded and substandard housing, the increasing transfers of household incomes to landlords and the distortions to wider society, including the workforce. The much-discussed ‘productivity puzzle’ (pdf) is much less baffling when it is noted that under this government the rise in real estate jobs has far outstripped the rise in construction jobs, as shown in Fig. 2 below.

Fig. 2 Change construction and real estate jobs under the current government

Solutions to the housing crisis

Labour has adopted a policy of aiming for 200,000 new homes per year by the end of the next parliament. This would come close to meeting the projected rate of new household formation. This would also have the effect of moderating the rise in house prices. But it would be unlikely to reverse it, especially as the housing shortfall as indicated by local authority waiting lists would have increase to beyond 1.75 million for Britain as a whole in the meantime.

One of the many myths surrounding government policy is that the state is not intervening in the economy. The reality is the opposite. There are innumerable ways in which this government and its predecessors intervene in ‘the markets’, with costs running into the hundreds of billions of pounds. The bank bailout was only the most spectacular example.

In the housing sector this government has intervened repeatedly in order to boost prices without ever boosting the construction of new affordable homes, which has decreased. Perhaps the most notorious of these schemes is the £40 billion ‘Help to Buy’ policy which uses public funds to boost private property prices which were already excessive.

A radical step that the next Labour government could take is to use this same £40 billion guarantee and offer it to local authorities to build new homes. The first 20% of (unlikely) local authorities’ losses on construction of affordable homes could be guaranteed using these funds. At the same time, government could borrow to increase the funds available for construction.

The arithmetic of borrowing to invest in new public affordable housing is simple and compelling. A 5% rental income on a £150,000 home amounts to £625 per month. A 3% yield requires just £375 per month. Yet the government can now borrow at well below even 3%. It would make money on its housing investment, which could be used for investment in other areas, all of which would see the deficit fall as a consequence. Housing affordability (and quality) would improve and job-creation switch from estate agency towards building.

The big losers from a radical policy would be private landlords who no longer benefit from the upward spiral of house prices and the large ‘house builders’, the companies who do not build homes but sit on undeveloped land banks and count the paper profits of the increasing land and home values.

Shifting the burden of the crisis onto workers and the poor

Shifting the burden of the crisis onto workers and the poorBy Michael Burke

There is an old joke, not a very good one, that the definition of a consultant is someone who you pay to tell the time who then asks to borrow your watch. Osbornomics, the specific variant of austerity economics that operates in Britain is similar.

The British economic ‘recovery’ is the centrepiece of the Tory election campaign and has been blessed by the IMF as a model. But the recovery is entirely fake. On some of the most important measures of average living standards the economy has at best stagnated over 5 years, on others they have fallen. The majority of the population has seen their real living standards decrease. The Tory election slogan should be, “You’ll never have it so good again”.

The essential con-trick of Osbornomics can be illustrated in one chart, Fig. 1 below. This shows the household savings ratio, the proportion of savings relative to household incomes.

Fig.1 Household savings ratio

The Tory-led government came to office when the household savings ratio was 10.9%. In the final quarter of 2014 it had fallen to 5.9%. The ‘recovery’ is essentially driven by this fall in household savings, which is equivalent to approximately 3.75% of GDP. But, as already noted real living standards have not been rising. The household sector has been running down savings in order to finance consumption. This is the epitome of British boom-bust cycles since the Second World War, although formerly there was at least some increase in living standards for a period. This promises to be a boom-bust cycle without the preceding boom.

Debt and deficit obsession

The run-down in household savings highlights a key fallacy of government policy, which it claims is focused on reducing government deficits and debt. In Western Europe the entire economic debate is dominated by the distraction of government finances. In most of the rest of the world, and this means overwhelmingly in countries that are growing more strongly than Western Europe or Britain economic policy debate centres on the issues of growth. This is not only true in fast-growing Asia and Africa, but also in the more sluggish Americas, including in the US where growth rates have been stronger than Western Europe since the recession began, and yet remain feeble by historical comparison.

In Britain, to the limited extent that government deficits have been reduced, as the economy has been stagnant government deficit-reduction has relied on increasing borrowing elsewhere, among households. This illustrates a general truth. Savings and lending must equal each other (aside from money stuffed under the mattress or similar hoarding). All borrowing/lending is a transaction which creates both an asset and a liability; a lender and a borrower.

In common with other Western European countries, Britain’s programme to reduce its government deficit has relied on reducing the savings/increasing the borrowing of the household sector. But in the mainstream economics textbooks a normally functioning industrialised economy is supposed to include a household sector that is acting as a net saver (for big purchases, for retirement and so on). It is the business sector which is supposed to borrow to supplement its own profits in order to invest. In fact, it is this process which is mediated through the banks and which its supporters claim is the uniquely positive attribute of capitalism. Relying on falling household savings to finance consumption cannot lead to increased productivity and is inherently unsustainable.

Fig. 2 below shows the saving and borrowing of three key institutional sectors, the government (blue line), private non-financial corporations (PNFCs, red line) and households (green line) from 1997 to 2014.

Fig.2 UK Institutional Sector Accounts

Over a prolonged period and well before the 2008 to 2009 recession businesses (PNFCs) have not been performing their allotted role. Businesses have been savers. The pre-recession boom was financed by a run-down in household savings. As PNFCs started to increase their savings once more at the end of 2006 the government began to borrow. It was only after this period, in late 2008 when the recession had already begun that households sharply reverted to their allotted role and increased their savings once more. Because both the business and the household sector were now significant savers, the government was obliged to increase its borrowing.

The austerity policy attempts to address this imbalance by decreasing the government’s borrowing by cutting its spending and increasing its income. It does this by forcing a reduced saving of households, through raising VAT, cutting social security benefit, cutting disability benefits, public sector pay and pensions and so on. At the same time it has lavished funds on the private sector businesses (cutting corporate taxes, privatisations, and so on) in order to increase their incomes (profits) and eventually to increase their spending and borrowing.

Economically this policy has failed. The government deficit remains stubbornly high and both living standards and GDP are stagnant. Most importantly the austerity to date has failed in its central purpose which is to revive the profitability of British companies, which is the only conceivable basis on which they could be willing to increase investment. Fig.3 below shows the trend in the profit share of UK companies since 1995. At most the policy of austerity has stabilised the decline in profitability and prevented a further fall. But this is very far from a recovery in profits (and even further from a recovery in the profit rate) which would lead to an autonomous rise in private sector investment.

Fig.3 UK Profit share

Austerity back on the agenda

For a combination of economic and political reasons the Coalition government stopped implementing new austerity measures midway through the current Parliament. SEB identified this at the time, and now it has become a rather more commonplace analysis. It was this halt to new austerity measures combined with the effects of Quantitative Easing and other government measures to boost consumption which have led to the unsustainable upturn in economic activity.

But a faltering economy and plunging Tory opinion poll ratings meant that the drive to push down the savings rate of households also had to be suspended. With the government attempting to lower its own borrowing and businesses showing little sign of investing rather than saving profits, the necessary savings had to come from another source. This was the ‘Rest of the World’ (RoW) sector in the national accounts, which is overseas investors.

For ease of presentation borrowing from the RoW was not shown in Fig. 2 above. But given that the savings of both the household and PNFCs sectors have been static in the recent period, it is worth illustrating just the growing dependence on borrowing from overseas and the government deficit in Fig. 4 below.

Fig. 4 Sectoral Accounts; Government borrowing and Rest of World saving

The business expansion before the recession was in part financed by increased overseas borrowing (red line). At the end of 2007 the level of government borrowing in the final quarter was almost exactly equal to the level of savings by the Rest of the World. But the effect of the recession was to decrease consumption financed by borrowing from overseas. In the 2nd quarter of 2011 the level of borrowing from overseas was less than £1bn even though government borrowing in the same quarter was almost £32bn. The savings then were supplied by both the households and PNFCs (as shown in Fig.2).

Since that time the quarterly level of government borrowing has fallen by £13.5bn and the level of borrowing from overseas has increased by approximately £24.5bn. It is this increased borrowing from the RoW which has allowed the government deficit to fall while there has also been a simultaneous modest upturn in investment and consumption.

This is unsustainable. At a certain point the demand for overseas savings exceeds the willingness of overseas investors to lend. The British economy is increasingly dependent on borrowing from overseas and when there is a sudden withdrawal of funds living standards in Britain will fall dramatically once more. Traditionally in Britain this has been accomplished by a ‘balance of payments crisis’ and now more usually relies on a fall in the pound.

It is therefore completely ridiculous for Tory supporters, or the head of the IMF, to claim that Britain’s recovery offers a model. The world cannot increase its borrowing to finance consumption from another planet. It is not even sustainable in Britain.

The requirement to increase private companies’ profitability is the fundamental driving force behind the proposed resumption of austerity after the general election. It is quite possible too that there will be a renewed crisis to accompany it at a certain point, with overseas investors unwilling to continue financing an increase in British consumption, unsupported by an increase in production or investment.

Economic failure, austerity continues

.678ZEconomic failure, austerity continuesBy Michael Burke

The Tory election campaign is based on the claimed success of the government’s economic policy, as the hype around the latest Budget confirms. In reality the Tories’ economic record has been unprecedentedly poor. Their economic policy is not primarily aimed at increasing growth or prosperity but rather at effecting a fundamental change in the economy which entails a very large transfer of incomes from workers and the poor to big business and the rich. This project is very far from complete and is set to continue.

The relative economic performance under the current government is shown in Fig.1 below. Real GDP has grown by an average of 1.65% under austerity policies. This is remarkably poor by comparison. In the 12 months before the current government took office the economy grew by 2%. Austerity lowered growth even from a feeble pace coming out of recession.

For the entire period from 1997 to 2010 the annual average real GDP growth rate was 2.1%. This includes the recession of 2008 to 2009, the deepest slump in activity since the Great Depression. Yet the performance of the economy under Tory austerity has been even worse

Fig.1 Comparative Real GDP Growth

Einstein said repeating an experiment and expecting a different outcome is the definition of madness. Yet the intention is to repeat austerity. This is because the purpose of the austerity of policy is not to induce growth, or even to cut the deficit.

In the crisis profits fell sharply, even in nominal terms. The Gross Operating Surplus (GOS) was £86.2bn in the 1st quarter of 2008 and fell to £79bn in the 2nd quarter of 2009. At the same time the Compensation of Employees (CoE) fell by just £1.5bn (although in real terms both wages and profits fell by far greater amounts). Since that time and to the end of 2014 the GOS has risen by £16bn and the CoE has risen by £32bn. It should be noted that profits fell once more in the final quarter of 2014, as shown in Fig.2 below.

Fig.2 Wages and Profits
CoE on LHS                                                        GOS on RHS

Despite the fierce impositions of austerity it has proven quite difficult to cut wages in nominal terms (although in real terms wages have fallen substantially). New austerity measures were also suspended after 2011 because of the slump in Tory electoral fortunes. Therefore the plan is to resume austerity with renewed intensity immediately after the election. Austerity is aimed at reviving the profit rate and this is nowhere near being accomplished.