The incredible shrinking UK economy

.536ZThe incredible shrinking UK economy

By John Ross

The magnitude of the blow suffered by the UK economy since the beginning of the financial crisis is very considerably minimized by not presenting it in terms of a common international yardstick. Gauged by decline in GDP, using a common international purchasing measure, dollars, no other economy in the world has shrunk even remotely as much as the UK (Figure 1 and Table 1).

As most countries produce only annualized GDP data it will be necessary to wait before a comprehensive global comparison can be made for 2011. However it is clear no substantial growth in dollar terms took place in the UK economy during that year – GDP at national current prices rose only 1.4 per cent between the 1st and 3rd quarters and the change in the pound’s exchange rate against the dollar during the year was a marginal 0.3 per cent. Therefore there will have been no significant recovery from the UK data set out in Table 1 below, and the gap between the UK and other European economies, which form the next worst performing major group, is too great to have been qualitatively affected by changes in the Euro’s exchange rate – the Euro declined against the pound by only 3.3 per cent in 2011.

Table 1 shows that the fall in UK GDP in 2007-2010 was $562 billion compared to the next worst performing national economy, Italy, with a decline of $65 billion – i.e. the decline in UK GDP in the common measuring yardstick of dollars was more than eight times that of the next worst performing national economy. Table 1 shows the 10 national economies suffering the greatest declines in dollar GDP.

It is also extremely striking that the UK’s decline was more than two and a half times that of the entire Eurozone. The UK accounted for a somewhat astonishing 77 per cent of the EU’s decline.

Table 1

12 01 13 Table 1

Figure 1

12 01 13 UK GDP decline in dollars

Expressed in percentage terms the situation is no better. of all economies for which World Bank data is available only Iceland, with a decline in dollar GDP of 38.4 per cent, suffered a worst percentage fall than the UK – even bail out economy Ireland, with a fall of 18.4 per cent, outperformed the UK economy.

Two trends intersected for the UK’s performance to be so much worse than that of any other economy. First, contrary to the government’s anti-European rhetoric, UK economic performance in constant price national currency terms has been significantly worse than the Eurozone during the financial crisis (Figure 2). Up to the latest available data, for the 3rd quarter of 2011, UK GDP was still 3.6 per cent below its pre-financial crisis peak compared to the Eurozone’s 1.7 per cent below. Second, between the beginning of 2008 and the beginning of 2012, the pound’s exchange rate has fallen by 21.0 per cent against the dollar compared to the Euro’s 11.4 per cent drop in the same period. The multiplicative effect of the severity of the relative drop in constant price GDP and the fall in the pound’s exchange rate accounts for the unequalled decline in UK GDP in dollars.

Figure 2

12 01 14 UK & Eurozone GDP

As at present the UK economy shows no substantial sign of recovery, the present UK government, which maintains a steadfastly ostrich like attitude towards Europe in particular, and most other countries in general, may argue that a measure in terms of dollars at current exchange rates is irrelevant – the UK currency is the pound and what counts is constant price shifts. Such an argument is false and an attempt to disguise the true scale of the decline of the UK economy.

The internationally unmatched decline in UK dollar GDP is a huge fall in real international purchasing ability. The far higher than targeted inflation in the UK during the last two years, which has substantially eroded the population’s living standards, is itself in part a reflecton of the decline in the UK’s exchange rate and consequent raising of import prices. In short, the decline in the international purchasing power of the UK’s economy translates into a direct fall in real incomes. The decline in the UKs ranking among world economies in terms of GDP, being recently overtaken by Brazil, statistically reflects the same process .

It may also be seen that the government’s claim that the UK is outperforming Europe and the Eurozone is entirely without foundation even in constant price national currency terms. But when measured in terms of real international comparisons, i.e. in dollars, the UK’s performance is incomparably worse than Europe’s.

It appears extremely unlikely that the UK’s economy will escape from this circle of decline in the next period. The austerity policies pursued by the present UK government have substantially slowed the economic recovery that was taking place in 2009 and the first part of 2010 – between the 3rd quarter of 2010 and the 3rd quarter of 2011 the UK economy grew by only 0.5 per cent. The opposition Labour Party has recently also endorsed essentially the same austerity policies which have failed not only in the UK but in other European economies, such as Greece and Ireland, where they have been pursued.

Even if any partial recovery takes place, for example by some increase in the exchange rate of the pound against the Euro, the sheer magnitude of the decline in the UK economy makes it implausible that this could be on a scale sufficient to reverse the fall in its relative international position.

* * *

This article originally appeared on Key Trends in Globalisation.

UK stagnation turns to risk of double-dip recession

.479ZUK stagnation turns to risk of double-dip recession

By Michael Burke

The Construction Products Association (CPA) is forecasting a ‘double-dip’ UK recession for the construction industry in 2012 and compares the latest slump to that of 10 years ago – the last Tory recession under Major when 600,000 construction industry jobs were lost. The CPA is well-placed to judge the near-term outlook as it comprises all the main suppliers to the construction industry.

For most of 2011 the majority of commentary on the British economy veered between expectations of a strong boom and, more recently projections for a double-dip recession. The reality was more prosaic – with the economy stagnating, growing by just 0.5% over the latest 12-month period.

This is because most commentators ignored the actual cause of the prior recovery and the key factor which would reverse it. SEB has previously shown how the recovery was caused by the increase in government spending, both current spending (mainly increased welfare payments but also the Labour government’s cut in VAT) and increased government investment (Building Schools for the Future, etc.).

Reversal of Government Spending

The renewed economic stagnation arises because both parts of government spending have now been cut. Welfare benefits have been cut, which is disastrous for many recipients but also undermines household consumption as does the hike in VAT. Household consumption is the biggest single category of GDP. The policies that supported household consumption added 1.2% to GDP growth during the recovery and until Labour left office. In the period since the Tories took office the decline in household consumption has reduced GDP by 0.6%. Similarly government investment increased under Labour and directly added 0.8% to GDP over the course of the recession. Government investment fell immediately the Tory-led Coalition took office and has subtracted 1.0% from GDP over that period.

Taken together the combined effects of Labour’s increased spending added 1.8% to GDP, while the policies of this government have subtracted 1.6% from GDP.

Effects of Changing Fiscal Stance

The March 2011 Budget detailed a ‘fiscal tightening’, that is tax increases (except for companies) and spending cuts amounting to £41bn. By the 3rd quarter approximately half of that tightening will have taken place as it is 6 months into the Financial Year. £41bn is approximately equivalent to 2.7% of GDP. The previous recovery saw the economy expand by 2.8% over 5 quarters. Therefore the direct effect of the fiscal tightening currently under way is to remove growth almost entirely from the economy, hence stagnation.

Unfortunately the extent of the damage does not end there. The fiscal tightening is only half-complete this year and yet there is already stagnation. This is because each sector of the economy is connected to the other. So, declining government spending in the form of firing public sector workers will lead to falling household consumption, and both will affect business investment.

Since each economic sector responds variably to a change in another sector’s activity, and often with a time lag, it is impossible to assign a precisely distributed causal effect of a change in fiscal policy. But we have noted above that Labour’s increased spending of 1.8% of GDP led to a recovery which added 2.8% to GDP. This demonstrates the way the state can lead economic activity in total. This is what Keynes called the ‘multiplier effect’ as the private sector responds to increased government spending. In this case the multiplier is 1.56 (the ratio of 2.8% to increased spending equal to 1.8% of GDP).

In reality the multiplier is probably considerably higher as there is a pronounced time lag while the business sector responds to changes in government spending. SEB has previously shown that private sector investment has consistently risen or fallen 6 months after changes in output. So, the private sector continued to invest for 6 months after the Coalition took office, and this was in response to the increased spending by the Labour government.

Therefore, without taking account of other factors such as net exports or an unwanted build-up of inventories, the direct and indirect impact of the current government’s cuts should be multiplied by 1.56. This would subtract 4.2% from GDP and almost certainly lead to renewed economic contraction. The government also plans £61bn of fiscal tightening in the next Financial Year, beginning in April.

Construction Investment

The construction sector is highly responsive to the business cycle as it relies on a high level of current investment. The CPA estimate that it is headed for a double-dip recession is therefore highly significant. This will sharpen the already acute shortage of affordable homes, either to buy or rent at a time when 300,000 construction workers have already been made unemployed. Local authorities throughout Britain are desperate for funds to build new homes, from which they could derive an income way above the cost of borrowing even with affordable rents. Instead of providing funds to them, George Osborne has provided £40bn in ‘credit easing’ to small and medium sized enterprises. They will not build homes, provide decent affordable housing and employ workers with these funds.

But the State could because it is a vastly more efficient provider of large-scale housing as well as infrastructure projects. The government and its supporters like to promote the falsehood that ‘there is no money left’. But £40bn of loans to local authorities and public bodies could go a long way to easing the housing crisis. It would also go some way to averting the likelihood of a double dip recession.

From the government’s perspective the only stumbling-block is that it would remove the main responsibility for construction from the hands of the private sector and place it in the hands of the public sector. This is of course what happened to most of the shareholder-held banking sector in Britain during the last crisis. It seems that nationalisation is only permissible when bondholders and shareholders are being rescued. But it is not allowed if it is to rescue the unemployed, those paying extortionate rents for substandard homes or even the economy as a whole.

When British thieves and French thieves fall out – the Anglo-French governmental dispute in perspective

.413ZWhen British thieves and French thieves fall out – the Anglo-French governmental dispute in perspective

By Michael Burke

The French and British authorities are engaged in a war of words over which country will be first to be downgraded by the credit ratings agencies. At least the hostilities are purely verbal – these ‘heroes’ of Tripoli are prepared to use other methods when the odds are overwhelmingly in their favour.

The immediate cause of the dispute was initially the remarks of French central bank governor Noyer. In response to the threat from Standard & Poor’s (S&P), one of the credit ratings agencies, that France would be downgraded, he argued that Britain should be downgraded first because its economic fundamentals are worse than those of France.

The remarks caused predictable uproar in Britain. Even the leadership of the LibDems, the main representatives of the pro-EU business class in Britain discovered its nationalist roots and criticised the remarks. But Noyer argued that, ‘they [S&P] should start by downgrading Britain which has more deficits, as much debt, more inflation, less growth than us and where credit is slumping’. Essentially, Noyer is correct on the relative ‘fundamentals’. But this focus on the ‘fundamentals’ also demonstrates a shared and thorough misunderstanding of the nature of the crisis.

The table below shows the relative levels for each of the indicators specified by Noyer. The estimates are taken from the EU Commission Autumn forecasts.

Table 1

11 12 22 Table 1

It is clear that the Noyer observations are correct. The British government’s credit rating is also under threat as the economy weakens. Yet France’s downgrade seems likely to happen even sooner. More importantly, the French government is currently paying over one per cent more for 10 year government debt than the UK so that its effective market rating is already lower than Britain’s. This is despite the lower deficit, lower inflation and higher growth in France.

This demonstrates that Noyer is looking in the wrong place for the determinants of bond yields. Bond yields are not primarily determined by the nominal level even of important economic variables. Ultimately the price of any given financial market asset is determined by the real level of savings that are directed towards it. In countries such as Britain, the US and Japan the very high level of corporate savings must ultimately be held in some financial asset, and in the current circumstances of weak or stagnant growth government bonds have looked far more attractive than their only main alternative, which is stocks. 10 year debt yields are currently below 2% in the US and below 1% in Japan. This is true even though government debt and deficit levels are even higher in the US and Japan than either France or Britain. UK companies cannot invest in financial instruments in another currency without exposing themselves to exchange rate risk.

For investors in French government bonds the situation is different. There is an easy alternative – German government bonds also denominated in Euros. The rising premium on French yields represents the increased perceived risk of the Euro breaking up, in which case investors prefer to hold the debt of the strongest economy in the Euro Area.

The key relevant ‘fundamental’ for the Eurozone is that investors may choose between different governments’ credits. That is, there is a market mechanism for redirecting savings towards one country – and there is no fiscal mechanism to transfer savings in the opposite direction. Just as in other Eurozone economies, bond yields started to rise in France as soon as ‘austerity’ measures were introduced. Investors based in the Euro have greater prospects of being repaid if they invest in government bonds where the economy will grow, not stagnate or decline.

French and British Both Wrong

The growth outlook is sharply deteriorating in both France and Britain. In the Spring Forecast the EU Commission was projecting 2% growth for both Britain and France in 2012. In the Autumn Forecast the Commission is forecasting just 0.6% growth. Both governments are pursuing ‘austerity’ policies which are clearly not working.

They have both also invested an enormous political capital in the maintenance of the AAA rating for their government debt and argued that their policies would reduce their budget deficits. As we have seen, both governments debt ratings are likely to be downgraded in 2012. And both countries are projected to have a deficit in 2013 which, five years after the recession began, is still double the level it was in 2007, before downturn began.

The failure of their policies has led not to a re-think, but in both cases to blaming foreigners. The unwillingness to correct a failed policy is the cause of the diversionary war of words between the two governments.

The most ridiculous aspect of their policy is that both governments claim that their policy is driven by the demands of financial markets. Yet the government bond markets are sending a very clear signal. Long-term interest rates are either at the current inflation rate as in France, or below it in Britain. They are so low because businesses are saving, not investing. Businesses feel more confident lending to the government than investing on their own account. But both governments insist on cutting spending. If that leads to renewed recession the effect will be to cut further the level of savings in the economy – and bond yields may start to rise.

Corporate savings are being lent to the governments at exceptionally low interest rates. This glut of corporate savings could be used to invest for recovery. Since businesses themselves refuse to do this, only the state can end the company investment strike.

EU Summit Is Another Failure for ‘Austerity’

.047ZEU Summit Is Another Failure for ‘Austerity’

By Michael Burke

The outcome of the EU summit has widely been hailed in the British media as a triumph for David Cameron. It is rare that a complete rupture and isolation in multi-party negotiations is regarded as a triumph – but this is a function of the dominant and still growing xenophobia of the British press.

The EU Commission will now impose further spending cuts and rules to enforce deficit limits across the whole of the EU. David Cameron did not oppose these measures because they lead to public spending cuts- he is cutting public spending by a greater proportion of GDP than any major country which has not been in receipt of EU/IMF funds for its creditors.

Cameron’s stated objective was a defence of the interests of the City of London. There is a question mark over whether he has even be able to achieve that. Angela Knight, former Tory MP and chief spokesperson for the British Bankers Association guardedly told The Times that she hoped that City’s interests would not be harmed by Britain’s isolation.

Holding Back the Tide

‘Let all men know how empty and powerless is the power of kings’. So said King Canute in demonstrating to sycophantic courtiers the impossibility of instructing the advancing tidewaters to retreat. But it seems that the thinking of the EU Commission has retreated behind even that of Dark Age monarchs.

In response to the economic, fiscal and balance of payments crises in Europe, the EU summit in Brussels agreed to issue a series of regulations- to prevent these crises being manifest at the level of government deficits. A new rule that so-called structural deficits will not exceed 0.5% of GDP has been introduced . The EU Commission will be given prior oversight of the national Budgets. Given the impossibility of factually establishing the level of the structural deficit (which depends on extremely approximate estimates of potential output) then the combination is a recipe for complete control by the EU Commission – the economic geniuses who have led Greece and Ireland to disaster.

While it is impossible to precisely quantify the structural deficit it is practically impossible to determine the level of the government deficit simply by controlling spending. This is because the deficit reflects the gap between government spending and income. Government incomes are overwhelmingly taxation revenues and these are determined by the spending of consumers and the spending of businesses (primarily investment).

To achieve the precise control over its own income, as demanded by the new agreement, the European governments would have to determine the incomes and spending of both other main sectors of the economy, consumers and businesses. And, in a currency union it would also have to ensure that the overseas sector was not a significant net lender or borrower (through large trade or current account deficits/surpluses). Otherwise, if the other domestic sectors remained in broad balance, a large trade deficit could only result in a large government deficit.

This is show in Figure 1 below. The chart shows the sectoral balances in leading EU economies and the EU as well as the change between 2006 and 2009. The chart is taken from the Financial Times and is based on OECD data.

Figure 1


Simple national accounting identities mean that the increased savings of one sector of the economy must be reflected in the increased deficit of another. In all cases the balances shown below, the government balance (the public sector deficit/surplus), the private sector balances (the savings/consumption of the private sector) and the overseas sector (the current account balance) sums to zero, as they must.

Within each national economy of the EU it is impossible to legislate for the deficit of the public sector without determining the savings, consumption and investment decisions of all other sectors of the economy.

It is also entirely impossible in a single currency area for all other economies to maintain government balances if one or more key countries have large current account surpluses, as is presently the case with Germany and others. Other countries must then run current account deficits and to simultaneously maintain a government balance they are faced with two unacceptable alternatives. They must either hugely increase household savings even though incomes are declining; that is, household spending must fall even faster than incomes. Alternatively, businesses must reduce investment to well below the level of its income, which could only lead to a further reduction in competitiveness and a renewed widening of the current account deficit. This is the downward spiral that countries like Greece have already entered.

The Tory Position

David Cameron did not object to any of this because he is a champion of increased government spending, or a defender of the welfare state. Nor has his government shown any appreciation of the fact that reduced government spending will also reduce the incomes of other sectors of the economy.

Instead, his objection was to the threat to the City’s ability to siphon off funds from other businesses in Europe. He may not have been successful even in that limited aim. Ed Miliband writing in the Evening Standard argued that Cameron was ‘a prisoner of the Tory Right’ and had isolated himself and Britain from the continuing evolution of policy in Europe.

While willing the other EU national leaders to act decisively to halt the crisis, Cameron himself acted to prevent that happening. Defending the sectional interest of the City and relying on some of the most backward political forces in Britain, Cameron has finally crossed a line that even Thatcher only threatened to do. There will be no benefit to the British economy from this decision and the consequences could prove extremely negative. If, for example, overseas multinationals decide they want a base in the EU, will they choose semi-detached Britain or one of the other 26 countries who continue to have a common regulatory regime? If the British economy suffers as a result, it should be remembered this was done to benefit the City of London and to appease the Tory Eurosceptics and Union Jack-wavers.

George Osborne Shows He’s Learnt Nothing from Greece or Ireland

.654ZGeorge Osborne Shows He’s Learnt Nothing from Greece or Ireland

By Michael Burke

The Autumn Statement was widely presented as facing up to harsh realities of slower growth, but with George Osborne offering a series of cunning schemes in order to resolve the crisis .

The stagnation of the British economy is a function of government policy and plans to increase investment by increasing the credit available to smaller firms will founder because they will not invest when they don’t expect to make profits .

SEB has long argued that government needs to increase investment in a series of areas. Surely, the government’s plans to increase investment in infrastructure should be welcome? But the government’s planned increase amounts to less than £3.8bn spread over four years, or less than 0.1% of GDP in each year. In addition, most of the wish list for infrastructure and capital projects is dependent on investment in the private sector. So, George Osborne and Boris Johnson stood outside Battersea power station in London and talks of new tube lines, enterprise zones and 25,000 jobs. Just two days later the private developer central to the project collapsed into receivership.

Worse, the government’s planned increase in capital spending is paid for by taking money from the pockets of the poorest and most vulnerable in society. These will bite much harder in later years, long after the pathetically small planned increased in investment has come to an end. This is shown in the table below, from the Autumn Statement.

Table 1

11 12 05 Table 1


So, there are total cuts in current spending in 2012/13 of £910mn and total cuts over the next 3 years of £3.8bn, shown as a positive sign in the Treasury bookkeeping method. This is in order to pay for tax cuts (fuel duty) and a projected increase in capital spending. But in the two following years the projected cuts to current spending increase dramatically for a total of over £27bn cuts in all. Although these are mostly unspecified, the itemised cuts include child tax credits, working tax credits, real public sector pay cuts and the breaking of the promise to uphold overseas development aid at 0.7%.

This is a very damaging but much milder version of the same logic that has led Greece and Ireland to disaster – every failure to meet budgetary targets because of the impact of ‘austerity’ is met by further ‘austerity’ measures. But the deficit is and borrowing totals are likely to go higher still as the economy stagnates- or worse. It may only be a matter of time before this same logic produces comparably savage cuts in spending- with the same economic consequences.

Politically, by pre-announcing needed cuts for the next Parliament Osborne hopes to bind all parties to further ‘austerity’ measures. For the LibDems, Danny Alexander has already proved obliging, signing up to Tory cuts of £23bn in the next Parliament. The key question is whether Labour will go down the same path in accepting the need for cuts even when they have demonstrably failed to deliver economic growth or even deficit-reduction. It is the path that leads to Athens and must be resisted.

Desperate Osborne’s Subsidies to Businesses Won’t Work

.913ZDesperate Osborne’s Subsidies to Businesses Won’t Work
By Michael Burke

George Osborne has told the BBC that there will be £40bn in ‘credit easing’ so that small firms can obtain both cheaper and more readily available loans. Osborne has called the scheme a ‘game-changer’. If the funds had the stated impact, of increasing investment by small and medium-sized enterprises (SMEs), then it would certainly provide a significant lift to the economy. £40bn is equivalent to 2.8% of GDP.

The strength of this overblown rhetoric may be judged by the fact that there are widespread reports that the Office for Budget Responsibility is set to slash its growth forecasts for 2012 to just 1% from 2.5% previously.

How is it that significant funds for new investment by business will actually lead to no improvement in the outlook for growth, even on the usually over-optimistic forecasts from the OBR?

There are to be at least two, possibly three funds. The first will be guarantees to increase the availability of credit. The second will be a fund to lower the cost of that credit to SMEs. Since SEB continually argues for increased investment, surely this is a good thing?

Private Sector Failure

Even official forecasts do not assume that growth will significantly improve as a result of this policy. This highlights the fallacy that underlies all current attempts to persuade, cajole, demand or bribe private firms to increase their investment. The fallacy is that those firms are struggling under the burden of insufficient funds to invest. Of course certain individual firms may have such difficulties. But in aggregate that is not the case.

In a previous bulletin SEB showed that in 2010 the total Gross Operating Surplus of the business sector in Britain was £475bn. These are akin to profits. Yet the entire level of investment (Gross Fixed Capital Formation) was just £214bn in 2010. As this includes the investment by both private individuals and government, it is clear that businesses have vast resources already from which they could increase investment.

The chart below shows the decline in total Gross Fixed Capital Formation (GFCF) and corporate sector GFCF. Both these measures of investment began falling one quarter before the recession itself began. The fall in both at their low-point in the 4th quarter of 2010, of over 20%, is approximately three times as great as the fall in GDP of at 7.1%. Both chronologically and arithmetically the decline in investment, led by declining business investment, led the recession.

Figure 1

11 11 28 Chart 1

Both measures of investment have experienced a small recovery. Business investment began to rise in the 1st quarter of 2010. This was two quarters after both total investment and GDP began to rise in the 3rd quarter of 2009.

Private sector investment led the recession. But it cannot lead the recovery. This is demonstrated in the chart below, which shows corporate GFCF and GDP.

Figure 2

11 11 28 Chart 2

The recovery in business investment occurred two quarters after the economy as a whole began to recover. This is because the increase in investment did not depend on the availability of resources, as profits have exceeded investment by some distance throughout the entire crisis.

Corporate investment rises and falls in line with expected returns. The purpose of capital is the preservation or expansion of capital. If the economy is not growing a main motive will be to preserve capital. If the economy is expanding, it will be increase capital through profitable returns on investment.

This is what happened in 2009-10. GDP began to expand in mid-2009 and six months later corporate GFCF began to increase. Precisely the same time lag operated in the reverse situation. Corporate GFCF fell once more in the 1st quarter of 2011. This was six months after the modest recovery peaked n the 3rd quarter of 2009.

Public Sector Leadership

The new factor which caused the recovery was the increase in public sector investment (both by general government and the remaining public sector corporations). At its highpoint in the 4th quarter of 2009, public sector investment was over 20% higher than its pre-recession level.

This led directly to the increase in GDP which in turn eventually prompted the private sector to increase its own investment. The Tory-led Coalition immediately cut public investment on taking office, and six months afterterwards private investment began to contract once more.

Instead of subsidising the private sector to invest, the proven means of achieving that end is for government to increase its own investment. It could divert the support for borrowing costs to agents who are willing to invest, such as local authorities who want to invest in housing, infrastructure, transport and education.

Even on official forecasts the borrowing subsidy to SMEs will not work. But the recent history of the British economy shows that investment by the public sector will have the effect of restoring growth which in turns leads o a revival of corporate investment. Subsidies and bribes to businesses to invest will not work while there is no growth. Increasing, not cutting, the investment of the public sector will lead to recovery.T Walker

Latest UK GDP data even worse than it looks

.044ZLatest UK GDP data even worse than it looks
By Michael Burke

The latest release for British GDP in the 3rd quarter was unrevised – but the composition of that growth was awful. GDP rose by 0.5% in the quarter and is just 0.5% higher than a year ago. But analysis of the components of growth suggests the outlook is deteriorating.

Household consumption did not grow at all in the quarter and contracted by 1.5% over the course of the year. Investment (gross fixed capital formation) fell by 0.2% in the quarter and by 1.8% from a year ago. In terms of domestic expenditure only government spending rose in the quarter, up 0.9% on the quarter and 2.9% over the year. This is testimony to the multiplication of ‘austerity’ measures: If unemployment and poverty are increasing at a faster rate even than you cut welfare benefits your total welfare bill will rise.

Taken together UK domestic expenditure rose by £3bn in real terms in the quarter. But inventories rose by £2.9bn at the same time and therefore account for almost the entirety of domestic growth in the quarter. Since GDP rose by just £1.8bn in the 3rd quarter, the rise in inventories indeed exceeds the growth in GDP as well as accounting for almost the entirety of growth in domestic spending.

Inventory Build-Up

Inventories are a cyclical and erratic component of growth. But a persistent rise in inventories over a number of quarters only occurs if businesses are receiving new orders and are restocking as they become increasingly confident about a sustained upturn. This is sometimes called a voluntary rise in inventories. But this is not at all the situation presently. Domestic demand is stagnant and exports have also fallen in the last two quarters. It seems unlikely that order-books are filling up and businesses becoming more confident about future prospects. In fact the respected Market Purchasing Managers’ Index shows that new orders have been slowing dramatically, as shown in the chart below.

Figure 1 – PMI New Orders, National & London
11 11 27 PMI

Therefore the current build-up in stocks is likely to be an involuntary. Inventories are most likely rising because sales have not met expectations. If so, businesses will tend to meet new orders by depleting those existing inventories rather than increasing output. At the very least this rise in inventories is unlikely to be repeated over several quarters. The addition to growth in the 3rd quarter arising from rising inventories is unlikely to be repeated over several quarters.

As we have seen domestic demand would have been close to zero and GDP would have contracted without rising inventories. To avoid that fate in subsequent quarters some other component(s) of growth will have to begin to grow once more. Otherwise the British economy will begin to contract once more.T Walker

Profits and Austerity In the Industrialised Economies

.209ZProfits and Austerity In the Industrialised Economies
By Michael Burke

A previous SEB article examined the profit rate in the Irish economy which is rising even though the economy continues to contract. Yet at the same time Ireland’s level of investment is falling. Corporate incomes – profits – are rising even though total economic activity is falling. Arithmetically, this can only occur by reducing the income of labour – wages are falling both in absolute terms and as a proportion of total economic activity. It happens that the Irish Department of Finance set this out with some clarity. This is indeed is the thrust of the entire ‘austerity’ policy – a transfer of incomes from labour to capital across the industrialised economies of Europe, as well as in the US and Japan.

Who Is Paying for the Crisis?

The table below shows the Gross Value Added (GVA) of selected economies, and how this is divided between the compensation of employees and the gross operating surplus of the corporate sector. GVA is a measure of all the value created in an economy. It is the same as GDP except that it excludes the impact of taxes and subsidies. With some important qualifications the Compensation of Employees (CoE) is akin to labour’s share of that value added, while the Gross Operating Surplus (GOS) is akin to the level of profits in each economy. This provides an approximate measure of economic activity and its distribution as income: Value-Wages-Profits. In the table blow the profit rate is calculated as the share of GOS in Gross Value Added.

Table 1. GVA, Compensation of Employees, Gross Operating Surplus and the Profit Rate, €bn in 2010 (unless otherwise stated)

11 11 13 Table 1

The general tendency has been that the crisis-hit countries have the highest profit rates. This was an important factor in the build-up to the crisis. In nearly all countries the crisis was characterised by reduced investment by the corporate sector, which remains the driving force behind the economic crisis. In these higher profit countries the fall in investment had a greater impact on aggregate demand as the corporate sector takes a bigger share of GVA. In turn, the fall in investment had a bigger negative impact on household incomes, especially through rising unemployment.

Profits and deficits

The profit rates should also be seen in relation to the public sector deficits that have caused so much turmoil. In all cases the public sector deficits are a fraction of the level of profits. In Greece the 2010 deficit was €25bn, in Italy it was €70bn, in Ireland it was €19bn (excluding an extraordinary bank bailout), and so on. The deficits could easily be covered in their entirety simply by extracting a fraction of the profit level from the corporate sector in each country. The same is true of Britain, where the profit level in 2010 was £475bn compared to a deficit of £137bn. (The British profit level is depressed and consequently the profit rate is lower because of the slump in the financial sector – a factor which also applies to a lesser degree in the US and even to France).

Who can pay for the crisis?

There are effectively three destinations for profits. These are investment, which raises future prosperity, or dividends for shareholders which are not invested or huge executive compensation and bonuses, both of which do not. The table below shows the level of profits, the level of public sector borrowing and the level of gross fixed capital formation (investment). In the last column the difference is shown between the level of profits and the level of public borrowing and investment combined.

Table 2. Gross Operating Surplus, Public Sector Borrowing and Investment, €bn in 2010 (unless otherwise stated)

11 11 13 Table 2

Table 2 shows that in all cases the current level of both the public sector borrowing and the current level of investment can be funded by the level of profits in each country and in the Euro Area. In most cases there is scope to fund both the deficit and significantly increase the level of investment. But the opposite has been happening.

The struggle over distribution of national income

In most recessions capital’s share of income falls. This is not because wages rise, but because profits fall at a faster rate than the fall in output. What then usually occurs is a struggle by capital to regain its lost share of income. It does this by cutting wages and benefits, by increasing unemployment and by reducing its tax burden – financed by reducing social welfare benefits. This is the content of ‘austerity’ measures.

Figure 1 below shows how this has operated in the Euro Area as a whole. Between 2008 and 2009 GVA in the Euro Area fell by €254. Confirming the idea that profits fall at a faster rate than output, Euro Area profits (GOS) fell by €227bn. Profits fell by over 6%, twice as fast as the fall in output. Wages (CoE) fell by €17bn.

Figure 1

11 11 13 Figure 1

However, this natural tendency for profits to fall at a greater pace than the fall in output is interrupted and diverted by a series of interventions, including rising unemployment, wages and benefit cuts as itemised above. In the period 2009 to 2010 Euro Area GVA rose by €188bn. Of this increase in output €139bn went to profits and just €53bn accrued to wages.

Because of inflation the real level of both wages and profits has fallen sharply – all these data are in nominal terms and do not take account of inflation. The ‘austerity’ offensive to increase the profit share has partly been successful, but the wage share of national income has not undergone any strategic reversal.

This is contrasted with Greece. Greek nominal GVA did not fall in 2009 at all as the Greek recession was shallower than most. GVA fell in 2010 by €6bn. This is shown in chart 2. The massive offensive against Greek workers and the poor means that the natural tendency for profits to fall faster than output has not operated. The level of wages fell by €4.4bn and profits fell by just €1.8bn. The wage share of national income has suffered a reversal.

Figure 2

11 11 13 Figure 2

Readers will be interested to know where Britain stands in relation to these examples, one of them the extreme case of Greece (and previously, Ireland). In 2009 British GVA fell by £38bn, shown in Chart 3 below. This was exceeded by the fall in profits, down £43bn and wages rose by £5bn. The entirety of policy since has been to reverse those trends. GVA rose in 2010 by €40bn. (It should again be stressed that these are nominal data, in real terms output is still over 4% below its peak and real wages have fallen).

Figure 3

11 11 13 Figure 3

As a result of initial ‘austerity’ measures, £18bn of the increase in output has been claimed for profits. But it is widely understood that the real offensive in Britain only began in the new Financial Year, which began in April this year. What is being attempted is a decisive reversal of the wages’ share of national income.


Countries like Greece are experiencing a qualitatively sharper crisis than the European average. There is a high correlation between the likelihood of economies falling into this type of extreme crisis and their exceptionally high level of pre-crisis profits. Because the income of the corporate sector is a much greater factor in the economy, their investment strike hass a proportionately greater impact on total output and/or government finances.

Profits remain exceptionally high, so much so that they could finance the deficit while simultaneously increasing the level of investment.

Under normal working of a market economy the tendency is for profits to fall faster than output. The entire ‘austerity’ policy is to prevent this tendency from operating, and to reverse it by reducing wages even faster than the decline in output. In the Euro Area, to date this has only been achieved in Ireland and Greece.

In Britain, it’s too early to say whether a similar ‘austerity’ drive will achieve the same disastrous results. But it is clearly the aim of government policy to drive up profits even while the economy is stagnating. This can only be achieved by driving down wages.
T Walker