Socialist Economic Bulletin

How To Wreck A Recovery- Tory policy and Q1 GDP Data

By Michael Burke

The latest publication of the British GDP data for the 1^st quarter of 2011 (Q1 2011) is unrevised – the economy expanded by 0.5% having contracted by 0.5% in Q4 2010.

However the much fuller data provided in this third estimate of growth, as well as revisions to prior quarters, gives a clear picture of the dynamic of the economy. The economy has effectively stagnated since the Tory-led government introduced the Comprehensive Spending Review in October (in fact it has marginally contracted). In the previous four quarters to Q3 2010 the British economy had expanded by 2.5%. By examining the data in detail it is possible to determine the causes of that stagnation.

Cause of Recession

The peak of the last business cycle was in Q1 2008 and the trough of the recession was in Q3 2009. From the beginning of 2008 to that latter date the economy contracted by £88.6bn in real terms, on an annualised basis. Household consumption fell by £41.5bn, one of the biggest percentage declines of the major economies, a drop of 4.9%. In the OECD as a whole the fall in household consumption was a more modest 1.5%.

By contrast government current spending rose by £7.4bn. Net exports also rose entirely as a function of collapsing demand for imports, which fell faster than exports. Combined net exports made a positive contribution to growth of £16.4bn during the recession. But investment (gross fixed capital formation, GFCF) fell by £43bn. Of this decline in investment, the private sector is responsible for £51.1bn, as government investment expanded during the recession by £8.1bn. Therefore of a total decline in GDP £88.6bn the decline in private sector investment accounts for £51.1bn, or 57.7% of the total.

These main aggregates of the national accounts in the recession are shown in figure 1 below.

Despite a recovery that began in Q4 2009 the level of GDP remains well below its peak. At the end of Q1 2011 GDP is still £56.3bn below its previous peak level three years ago in Q1 2008, a shortfall of 4.1%. Household consumption has recovered to some extent so that it is now £36bn below its peak level. Government current expenditure and net exports have both risen, by £13bn and £17.3bn respectively. Investment has resumed its decline in the last two quarters. It is now £36.1bn below its peak, fractionally more than the decline in household consumption. Of this decline in investment, the private sector is responsible for £44.9bn as government investment has risen by £8.8bn. This private sector investment strike accounts for £44.9bn of a total loss of output of ££56.3bn – this is 79.8% of the total.

The main aggregates of the national accounts in from the end of the prior boom to date are shown in Figure 2 below.

Figure 2

Cause of Recovery

As previously stated, recovery began in Q4 2009 and lasted four quarters – the economy expanding by £32.8bn. Consumption rose by £11.7bn, up 1.4%. Net exports did not add to growth, but subtracted from it by £12.6bn. Government current spending rose by £3.8bn. Investment rose by £12.5bn. The private sector contribution to this was £15bn, as government investment has been contracting under the impact of the new government’s policies.

This may have lulled the government and the Office for Budget Responsibility (OBR) into the false idea that that recovery would be driven by investment even as government spending was cut. (The other officially projected component of growth is net exports, but the rise in net exports currently remains entirely a function of the slump in import demand. British exports in Q1 2011 remain below their pre-recession peak despite the sharp rebound in world trade).

The OBR forecast¹ in March this year that private investment would rise by 6.7% this year. Currently it is moving in the opposite direction. In Q1 private sector investment fell 3.8% from the final quarter of last year.

To see why the government and the OBR have been proved wrong in projecting higher private sector investment the dynamic underlying the recovery and subsequent stagnation must be examined.

In Figure 3 the trends in GDP and investment are shown in relation to the end of the expansion in Q1 2008.

Figure 3

As already noted the decline in investment is the driving force behind the recession and the subsequent failure to recover to the previous peak level of output. Private sector investment accounts for 79.8% of that total shortfall. As the chart shows public investment moved in the opposite direction, increasing through 2008 and rising sharply in 2009 and peaking in Q1 2010 – the last quarter of the Labour government.

By the time GDP began to recovery modestly in Q4 2009, public sector investment had risen by an annualised £10.5bn. This was far greater than the initial rise in GDP, which was just £6.1bn higher. Therefore the rise in public sector investment was entirely responsible for the recovery.

Private sector investment did not rise as soon as the economy began to expand. It began to rise only after recovery had begun. Since all private investment is determined by anticipated profits, this inability of the private sector to lead the recovery is no surprise.

However, over the course of 2010 private sector investment was the biggest single contributor to growth rising by £22.3bn. Private sector investment increased as a result of growth fostered by the sharp increase in the level of public sector investment.

But instead of understanding that public sector investment was leading to economic recovery, including stimulating private sector investment, both the Tory-led government and the OBR subscribe to the idea that government spending ‘crowds out’ the private sector and if public spending is cut, private investment will increase. The opposite is the case. Government investment ‘crowds in’ private investment.

The false Tory/OBR idea is also demonstrated by the negative reaction to the subsequent cut in public sector investment. Public sector investment peaked in Q1 2010 where it was 38.4% higher than at the end of the prior business expansion. It began to fall as soon as the Tory-led Coalition took office in Q2 2010. Shortly afterwards, in Q4 2010 GDP began to stagnate. Immediately afterwards, private sector investment began to contract once more.

Technical Issues

For those readers interested in these topics, this next section deals very briefly with some interesting technical issues highlighted by the recent zig-zagging of the British economy- from recession to recovery to stagnation. Other readers can skip straight to the Conclusion.

Leading and lagging indicators: Public investment has clearly behaved as a lead indicator for the economy as a whole. Private investment is a lagging indicator. While public investment rose continuously throughout the recession, the significant increase did not take place until after the March 2009 Budget, when the rate of increase doubled. GDP responded two quarters later, in Q4 2010. Private sector investment responded 3 quarters later by recording its first rise in Q1 2010.

Similarly, public investment began to fall in Q2 2010. GDP contracted two quarters later, in Q4 2010. Private investment fell once more 3 quarters later in Q1 2011.

Multipliers: The OBR concedes a point that is almost unanimous in the literature – that the multiplier effect of government investment is greater than all other types of government spending. However, hamstrung by the notion of ‘crowding out’ and determined to promote it, the OBR’s multiplier for government investment is just 1, meaning that there is no more economic effect than simply the government spending itself². Its multiplier for cuts in welfare is 0.6 and for a VAT hike is 0.35, meaning that both of these have far less than the effect of government cuts or increased spending. Bizarrely, the logic is that private agents, both households and businesses, become more confident because of the cuts, and so offset their effects by increased spending and investment.

The economy’s recent gyrations provide evidence to the contrary. It is impossible to determine the precise effect of increased government investment in stabilising the economy prior to actual recovery. But it has already been shown that a cumulative rise in public investment of £10.5bn led to a rise in private sector investment of £22.3bn. This alone is a multiplier of 2.12. The rise in investment will also have boosted household incomes a well as government income (both via increased tax revenues and lower welfare outlays than otherwise). But, as a minimum, it can be stated that the multiplier from government investment is higher than 2, and is likely to be considerably higher.

Conclusions

The recession was driven by the collapse in private sector investment. The fall in household consumption was also important, much more so than in the OECD as a whole.

The resumed private sector investment strike now accounts for close to 80% of the entire output loss since the recession, and the economy remains more than 4% below its prior peak level.

The government and the OBR promote the notion that cuts to government spending will lead to spending in the private sector from households and businesses. The opposite has been the case. The entire recovery was engendered by the rise in public sector spending and private investment followed later.

The Tory-led government has reversed the rise in public investment through its cuts policy. This has led first to stagnation and now contraction of private investment in Q1 2011. The fall in private and public investment combined more than accounts for the entire slowdown in the British economy in the last two quarters. Tory policies have wrecked the recovery. Only a rise in public investment can revive it.

Notes

1. OBR, March 2011, Economic and Fiscal Outlook

2. Treasury, June 2010 Budget, Table C8.

Greece and other failures of EU bailout packages

By John Ross

The great majority of serious economic commentators know that the ‘bailout’ package just agreed between the EU and Greece is going to fail. That in the end Greece will be forced into partial default worsening the terms for its creditors. This will, of course, be politely termed ‘rescheduling’, ‘reprofiling’ or some similar phrase in order to attempt to camouflage reality. The camouflage may, however, be so transparent that the ratings agencies will still declare a default. The main discussion is whether it is better for Greece to default immediately or whether the bailout package is a good idea, not because it will work in the end, but because it will postpone the default.

It is therefore useful to understand that all three bailout packages agreed between the EU and its member countries struck by debt crisis are failing in their declared purpose of promoting economic recovery – that is not only in Greece but also in Ireland and Portugal. This is clear from Figure 1, which shows the trend in GDP for these three countries since its peak in the last business cycle.

As may be seen in none of these countries is serious recovery occurring. Attempts to claim it is, for example by making optimistic publicity about the latest quarter’s GDP figures from Ireland, consists of taking data out of context – Ireland’s GDP figures were better only in comparison to the precipitate collapse which had occurred in the previous quarter.

Taking the three countries which have made agreements with the EU the latest available data, for the 1st quarter of 2011, shows:

• Greece’s GDP is 9.9% below its peak with an insignificant recovery from the low of 10.0% below.
• Portugal had been recovering, but its GDP has turned down in the last two quarters and is now 2.7% below its peak.
• Ireland’s GDP is 11.5% below its peak and is the same level as in the 3rd quarter of 2009 – i.e. no net growth has taken place for the last year and a half of austerity packages.

In short no serious recovery has been created by any EU ‘bailout’.

Figure 1

* * *

This article originally appeared on the blog Key Trends in Globalisation.

The Greek Crisis

By Michael Burke

The Greek economic and social crisis continues to unfold. Around it a series of myths have arisen and been perpetuated. It is necessary first to dispose of some of those myths before moving onto a concrete analysis of the situation.

The present author has a piece in the Guardian‘s Comment Is Free web blog which addresses some of these issues. The present article will deal with rebutting those myths in slightly greater detail before setting out an alternative policy that could both resolve the Greek crisis and reconstitute the European Union and Euro Area on a more stable basis.

Greek Mythology

When the European and international authorities announced over a year ago that there would be a €110bn rescue package for Greece it was claimed that this would be sufficient for the Greek government until at least 2013, at which time the newly-restored health of the Greek economy would allow it to return to international financial markets – especially since it would by then have a far lower borrowing requirement. This rebound in activity would arise from the policies implemented by the Greek government under instruction from the EU/IMF/ECB. On all these fronts, the claims have been shown to be false and the policy a failure.

The EU/IMF/ECB is frequently described as the ‘troika’. The troika have produced a conditional emergency lending programme of €12bn because the €110bn is being rapidly consumed. Greece’s economy has gone into a tail-spin. GDP in the first quarter of 2011 is 5.5% lower than in the same period in 2010, and the rise in output from the fourth quarter of 2010 is entirely accounted for by a collapse in import demand. As a result the public sector deficit has been on a widening and not a narrowing trend. Because of the troika’s policies, the budget deficit has widened to €10.3bn in the first five months of this year, compared to €9.1bn in 2010 before those policies took effect.

It is widely reported that the further emergency funds are required because Greece has missed targets set by the troika. The targets have been missed, but only by a cumulative €1.2bn over five months. Neither this shortfall nor the total €10.3bn deficit level can explain the need for additional funds over and above the €110bn already available.

The capital which was injected has been consumed by the holders of Greek government debt, both short and long-term. As these debt obligations have been redeemed on their due date international investors have simply taken the money. They have not bought any newly issued Greek debt with the proceeds. This redemption of bond holdings has combined with continuing interest payments on the outstanding debts for a total payment to bondholders of over €40bn since the bailout was announced in May last year.

The bailout was therefore one for private creditors – primarily European (including British) and US banks. This was both predicted and predictable, with the FT’s chief economics commentator Martin Wolf noting at the time that the impositions on Greece were worse even than those on Argentina, because the private creditors were being paid to exit the market.

Furthermore, it should be noted that, while the budget deficit has not at all driven the need for extra funds, the €1.2bn overshoot is entirely a function of the collapse in tax revenues, not government overspending. In fact spending is €0.7bn lower than the EU/IMF impositions, but tax revenues are also lower by €1.9bn. This too was predicted, including by SEB.

This reality has not prevented widespread media reports that it is the widening public sector deficit which is the cause of the renewed financial crisis , even that this reflects recent overspending, which is factual nonesense.

This latter point is supplemented by the assertion, applauded by sections of the Greek right wing intelligentsia, that the underlying cause of the crisis is a ‘bloated public sector’. In fact Greek public spending before the crisis in 2007 was 46.3% of GDP, compared to 46% for the Euro Area as a whole. Greece has among the lowest proportions of public spending on both health and education in the Euro Area, while more than half of the concealed government spending in 2000-2003 was on the military – 5.5% of GDP in total.

Added to all this is the campaign to end any further payments to Greece, with Cameron declaring ‘not a penny more’ – so joining the charge led by Boris Johnson and George Osborne and including the reactionary nationalist True Finn party, all of whom ignore the small matter that ‘Greece’ is not the beneficiary of the funds to date. Its creditors are and these include British banks.

To avoid addressing the real dynamics of the situation, the mythology in both Britain and Germany also sinks to reinforcing insulting and wholly untrue stereotypes about the lazy Greeks. In fact, Greeks have the second-longest working hours in the whole of the EU.

Debt Sustainability

Now let us turn to assessing the actual dynamics unfolding in the crisis as well as the likely or preferred policy outcomes.

There is a growing consensus that a debt default by Greece is inevitable. Economists have developed a series of metrics in an attempt to determine where a specific level of debt is sustainable. An influential study from Professors Reinhart and Rogoff is widely quoted that for advanced economies output will slow markedly when the public debt level exceeds 90% of GDP . But this is not substantiated by the post-World War II experience where a host of countries had debt levels for in excess of that. Britain’s debt level exceeded 250% yet the growth in GDP in the last 10 years has been little over half that of the 10 years from 1948 onwards.

A more sophisticated and robust measure of debt sustainability is as follows: the real interest rate minus the real growth rate multiplied by the debt/GDP ratio must be lower than the primary budget balance (primary, meaning before debt interest payments are included).

In a less technical formulation of the same proposition; the economy must be able to grow it way out of the debt. However, if total interest payments rise at a faster rate than GDP growth, the debt burden becomes unsustainable.

In the case of Greece currently interest rates (borrowing from the EU/IMF at approximately 6%) exceed the growth rate (-5.5%) by 11.5%. The debt/GDP ratio is 158%, according to Eurostat. This means the interest burden is 18.17 (11.5 multiplied by 1.58) whereas the primary budget balance is forecast by Eurostat to be a deficit of 2.8% of GDP in 2011. The primary surplus would need to rise by 21% of GDP to be sustainable, effectively that government spending would have to be halved without any detrimental effects on the economy or on taxation revenues.

However, the detrimental effects of far more modest cuts- at least compared to this projected level – have already been so great as to overwhelm any supposed ‘savings’. There is no reason to suppose that cuts of an even greater magnitude will have any other effect. Yet this is the prescription demanded by the EU/IMF/ECB.

Under these policy settings a Greek default seems inevitable. (Using the same metrics and applying the Eurostat data and forecasts in each case, Irish and Portuguese defaults are also unavoidable, without a change of policy).

A Progressive Approach

On current trends for the year to date, the Greek public sector deficit could reach €24bn. However, in common with nearly all advanced economies the recession itself is caused by a private sector investment strike. Of the €11.8bn fall in output in the two years of recession to 2010 the decline in investment (gross fixed capital formation) accounts for €9.9bn, or 84% of the total. This is not to say that households have not been badly hit, and consumption has fallen by nearly as much, €8.9bn (statistically offset by other factors such as falling import demand). But this is in response to falling incomes, rising unemployment and increasing taxes. The driving force is the investment strike- which actually began prior to the recession and now has fallen by 25.9%, compared to a decline of 6.6% in household consumption.

Since the financial accounts of the main sectors of the economy must balance; businesses, households and government if the former two increase their savings/reduce their consumption, then (excluding the external sector) government is obliged to decrease its own saving/increase its borrowing. As elsewhere, the cause of the increase in the public sector deficit and the recession is the same – the private sector investment strike.

But troika policy has not been focused on addressing this investment shortfall but has instead attempted to correct the public sector deficit via sequestration of the incomes of the household sector both directly (lower wage, tax increases) and indirectly (public spending cuts, reduced welfare payments). The effect has been disastrous because it attacks households’ ability to save, a necessary function in any market economy. The more ‘austerity’ that is heaped upon them the sharper the fall in household incomes, and the greater the propensity to save. Instead, a policy should be pursued which addresses the cause of the economic and fiscal crisis. This should be a policy aimed at increasing investment in the economy.

Increasing investment can be pursued in two ways, through international efforts and domestically.

On the international front, clearly the Greek government cannot borrow in the markets and under the impositions of the troika will not be allowed to borrow from them for investment. Yet the EU has traditionally recognised the need to make capital transfers to poorer regions/countries in order to bolster investment, via cohesion, structural and other Funds. These payments are still being made in Eastern Europe, and account for Poland‘s ability to escape recession entirely, for example.

The crisis-hit countries of the Euro Area have just become a lot poorer and on current policy settings will become further impoverished. The previous transfer payments were not altruism, but increased the market for goods and services produced in the ‘core’ economies. At the same time they had the intention of keeping economies together in a single currency area despite their widely different levels of productivity. They prevented repeated rounds of competitive devaluations, which also benefited the core economies.

Therefore, rather than another bailout for private creditors there should be a first bailout for the Greek economy, so that it can be invested productively and growth restored. This should be financed by the core economies, at no greater cost than their intended further bank bailout. Other countries might be willing to participate if there were reasonable investment returns on infrastructure, housing or other investment, perhaps including China.

On the domestic front, there are large resources available in the Greek economy, if only the government chose to access them. In the table below we show the Gross Domestic Product (GDP) for the Greek economy, a measure of output which simply excludes the effects of taxes and subsidies. These are in nominal, not real €.

There are a number of striking features from the data. First the Gross Operating Surplus (GoS) of firms is vastly in excess of the compensation of employees (CoE), that is akin to capital and labour’s relative share of value created. On this measure the GoS is nearly 53% of all value created, compared to just 36.3% for labour, and Greece is by far the most exploitative economy in the Euro Area.

Capital’s excessively high share of income combined with an investment strike starves the economy of its lifeblood, while the excessively low compensation share also weakens its effective final demand.

Secondly, the sums are enormous. It should be recalled than the Greek deficit may amount to €24bn in 2011. Yet taxes on production amount to just €28.4bn, even while the GoS is a staggeringly high €121.8bn. Therefore taxes on production could be significantly increased as a decisive contribution to the necessary combination of deficit-reduction and investment.

A Progressive Default

There have been widespread calls for default and even for unilaterally exiting the Euro Area and reintroducing the Drachma. This last policy is in fact especially dangerous to the Greek economy and most of its population (the exception are those whose wealth can be held overseas or whose incomes derive from overseas, such as the shipping billionaires).

Any New Drachma would immediately devalue versus the Euro and thereby increase the local currency value of the existing debt. Since there is no legal mechanism for such an exit it would no doubt be declared illegal by the authorities working for the bigger powers, not just Germany and France but also Britain and the United States. Since they are already insisting on privatisation as the next chapter in the dismemberment of the Greek economy, the ‘illegal’ exit could be the pretext for the seizure of all manner of Greek assets, including public utilities and state-owned enterprises as ‘compensation’.

In addition, Greek banks have accepted deposits in Euros but their key asset would now be in devalued New Drachma so they would immediately be rendered bankrupt. Only a government prepared to protect all the deposits by taking them into public custody, and itself taking control of key assets to forestall their seizure by the foreign powers, could deal with this. Since Mr Papandreou or any likely successor in the foreseeable future is not Fidel Castro, then that is unlikely to happen. Instead, it is Germany, France, Britain and the US who would be in a position to seize assets. Advocating unilaterally leaving the Euro would unleash just such a dynamic.

As already stated, the question of default seems unavoidable. But efforts should be made to avoid a ‘disorderly default’ which would lead to the same consequences as unilaterally exiting the Euro. It is this type of default being promoted now by Cameron, Osborne, Boris Johnson and others and coincides with the interests of British banks who have exited the Greek government bond market and who feel that they can at least gain a relative advantage from competitors’ distress, or may even have a position to profit from a default.

It is possible if, for example, that the ECB retaliates to a default by withdrawing its liquidity provisions to the Greek banks or by refusing once more to accept Greek government bonds as collateral for liquidity provided to other Euro Area banks. This would bankrupt Geek banks, freeze Greece out of international markets for a prolonged period, and require the immediate closing of the deficit. Unless most of the public sector was fired and welfare payments abandoned, the only way to avoid that would oblige the government to introduce a new currency, or quasi-currency.

Comparisons with the Argentinan and Russian defaults are invalid for that reason. These countries had only debt obligations to countries such as the US. Greece, a far smaller economy than either, has Treaty obligations too which can be used against it.

Instead, a programme of investment-led deficit reduction, financed by core economies and Greece’s own resources would address the objective requirements of the economy. Under those circumstances, it would make no sense to continue further payments to private creditors, so default (or ‘restructuring’) is required. In addition, the accumulated debt burden is unsustainable, so all existing holders of Greek government debt would be obliged to take significant losses. If the Maastricht Treaty insists that 60% is the maximum permissible debt/GDP ratio then it can be asserted that the ‘haircut’ imposed on holders of Greek government debt (which stands at 154% of GDP) must be no less than 61 cents in the Euro, preferably more, for prudence sake.

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Job Fears ReinforcedBy Michael Burke

SEB recently wrote that the improvement in Britain’s employment is unlikely to last. This is because jobs growth is a lagging indicator and reflects the previous upturn in activity. As the recovery has ground to a halt in the last 6 months this will in time lead to renewed weakness in jobs.

These fears are reinforced by the latest monthly jobs survey from the Recruitment and Employment Confederation and accountants KPMG. The May data show a further deceleration in jobs growth. The survey has a good track record, with turning-points in the employment data coinciding with turning-points in the survey. The value of the survey is that it is more timely- while REC/KPMG have produced May data, the next employment release from the Office for National Statistics due on June 15 will be for the period to April.

The survey for both full- and part-time jobs is shown in the chart below. Any reading above 50 indicates an expansion in jobs and anything below 50 indicates a contraction. The May reading extends the trend of decelerating employment growth, heading back towards a stagnant jobs market or even worse.

Figure 1

The Tory-led collation has previously attempted to claim the prior improvement in jobs as supporting its contention that the economy will grow even while it cuts public spending and public sector jobs. It is even implied that private jobs have grown because of government cuts. This was wholly dishonest, as all mainstream economics accepts that changes in employment follow changes in activity. Therefore the previous growth of employment reflects the earlier recovery, not this government’s actions. Government spokespersons have since become more circumspect.

Government policy has led to economic stagnation. Both economic theory and the most recent evidence suggest that jobs losses will follow.

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Public Versus Private OwnershipBy Michael Burke

Recent political and corporate events have thrown the relative merits of the public and private sectors into sharp relief.

The NHS is the most popular institution in Britain. According to recent research (p.386) by Lord Ashcroft for the Tories the NHS has a 79.8% approval rating – ahead of the BBC’s 66% and 61.8% for the Royal Family (and 43.1% for the Daily Mail, the lowest rating of all). Full details of the poll and voluminous and valuable additional information can be found here

This fact, and the recent mobilisations by the TUC, provides a difficult environment for the Tory-led government’s attempts to significantly reduce real health spending while qualitatively increasing the role of the private sector.

It is further complicated by the financial distress and possible collapse of Southern Cross Britain’s biggest care home provider. Southern Cross has nearly 31,000 residents in its care homes, mostly elderly patients. It is widely described as having reached a financial crisis because it sold its care home properties and leased them back prior to its flotation on the stock market.

However, this misses an essential point. Blackstone, the private equity group, owned both Southern Cross and the vehicle which became its landlord, NHL. Both were loaded with debt by Blackstone the proceeds of which it took for itself. The debt was created in order to strip the assets. Blackstone’s initial investment of $500mn became a payout of $1.5bn.

At risk now are all 31,000 vulnerable residents in the care homes. Many have already been living in atrocious conditions for some time as lack of capital and high debts precluded investment. In 2010 Southern Cross reported it had already 19 homes rated “zero stars”. It has been announced that 3,000 jobs will be cut in an effort to return to profitability- and with it a reduction in the level of care offered to residents.

Efficiency

The private firms that the government wants to run most of the NHS functions under its ‘any willing provider’ rule are not small enterprises, but major corporations such as Blackstone. Their purpose is not the provision of healthcare but the maximisation of profit – and they will reduce jobs and services or even declare bankruptcy when profits fall.

But the argument in favour of the public sector is not confined to these extreme cases of asset-stripping induced crisis. In all the ideological campaign against the NHS a central truth is obscured- the NHS is more efficient than private sector healthcare. This is illustrated in the chart below reproduced from the OECD’s European Health At a Glance 2010.

The chart shows the correlation between spending on health in a number of European countries versus healthy life expectancy at birth. As would be expected, the general rule is that the greater the spending on health the longer the healthy life expectancy in each country. (The R2 corrrelation of 0.33 in the top left hand corner means that higher spending accounts for two-thirds of the difference in life expectancy, as a perfect correlation would be 0.50).

Figure 1

Inevitability there is some variability around the central trend. Some of this will be to do with the stage of economic development and location, such as the Mediterranean countries’ better health outcomes.

But if we examine the Northern European developed economies there are three which are significantly above the correlation line, which means that they have an above-average life expectancy relative to the amount of health spending, and there are three significantly below. The three above the line are Britain, Sweden and Denmark. The three countries below the line are Austria, Germany and Finland.

Therefore, strictly speaking the first group of three countries is much more efficient in its health spending- they achieve above-average outcomes relative to expenditure. This includes the NHS. The second group of three countries is relatively inefficient, achieving worse health outcomes relative to health expenditure.

This is explained by who is spending the money, and what it is being spent on. In Britain, Sweden and Denmark the public sector accounts for an average of 81.6% of all spending on health. In Austria, Germany and Finland the public spending sector funds an average of 75.9% of all healthcare provision.

These are significant sums – with annual public spending in the first group amounting to €2,819 per person, while in the second group it amounts to €2,331 per person (adjusted according to OECD Purchasing Power Parities , Tables 4.1.1 and 4.5.1).

It should be stressed that this is not a function of the first group spending more money – they spend less. The average total spending, both public and private sector spending of the higher longevity countries is €2,920 per person per annum. Total spending in the second group is higher at €3,066 per annum.

Public health spending in these EU countries is clearly more efficient than private health spending.

Furthermore, it is clearly more efficient in terms of treatment and care. The average life expectancy at birth (women and men combined) is exactly the same for both groups at 79.5 years (Table 1.1.1). But the average healthy life years expectancy for the first group is 68.0, while for the second group it is just 56.9, with none above 60 healthy life years. These are enormous differences in tens millions of people’s lives.

Source of Inefficiency

It is well-known that the US healthcare system is almost entirely private. As SEB has previously pointed out, the US system is much more inefficient than the NHS – with the same life expectancy and proportionally the same number of health care professionals, while devoting almost twice as much of GDP to healthcare spending .

A recent explanation for part of this discrepancy comes from The Economist magazine, which has great relevance for the current attack on the NHS from the Tory-led government. It argues that the centralisation of drug approval and purchasing by public bodies is vastly more efficient. The alternative US system means private sector drug producers are spend enormous sums marketing their products to a decentralised multitude of purchasers, equivalent to local GP consortia in this country. These costs are of course passed on, and the drug purchased is frequently the one with the largest marketing budget, not the most effective one. This inefficiency is replicated at every level of input for the private US healthcare system

The principles of public sector relative efficiency apply to the delivery of virtually all public goods, not just health, but also education, housing, transport, infrastructure and services such as post and banking. Marketising and privatising the NHS is not only a threat to the quality of healthcare for millions of people, but a hugely inefficient step backwards.

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yesFall in unemployment is likely to be temporaryBy Michael Burke

The latest data show a fall in the UK unemployment rate to 7.7% and an increase of 36,000 in the employment total. This is the fifth consecutive quarterly fall in the unemployment rate, which peaked at the end of 2009.

However, even the Tories constrained their boasting about the data, with employment minister Chris Grayling saying only that it “was a step in the right direction”. Neither Cameron nor Osborne made any pronouncement at all on the employment release.

The caution is well-advised. Economists generally regard unemployment as a lagging indicator of activity. That is, unemployment responds after changes in output with a time lag between the two. So it is often the case that unemployment will continue to rise even after a recovery has begun. This is mainly because there is an inevitable delay between a business reaching a decision to hire more workers or open a new factory or shop and the new workers starting their employment.

This is illustrated in the chart below, which shows the unemployment rate (red line) and the year-on-year growth in GDP (blue line). For example following the recession of the early 1980s the unemployment rate carried on rising for another 21/2 years. Similarly, the jobless rate continued to rise for over a year after the end of the recession in the early 1990s.

Figure 1

A number of analysts have noted that the rise in unemployment in this recession has been more muted than in either the Thatcher or the Major recessions – when the unemployment rate rose by 5.6% and 3.2% respectively. The increase in the unemployment rate in this recession was 2.1%, with the Office for National Statistics providing the official assessment that this is particularly striking as the loss of output in this recession of 6.4% is nearly as large as the other two combined (7.1%) .

A crucial difference is politics. The policies of both the Thatcher and Major governments’ were to engineer a rise in the unemployment rate in order to drive wages down and profits up. If there is any doubt on this question, it should be dispelled by this 1 minute video interview with Sir Alan Budd, Thatcher’s chief economic adviser .

By contrast, no Labour government maintaining any link with the unions could hope to set out on the same path and survive. Labour politicians who did adopt these policies such as Ramsay MacDonald and Philip Snowden had to break with Labour to implement them.

It is not surprising that the official analysis of the subdued rise in unemployment in this recession should neglect this determining political factor. But it also overlooks an important aspect of the most recent trends in unemployment.

Crucially, the rise in unemployment from its cyclical floor of 4.8% began in the second half of 2005, nearly three years before the recession began. This is a much longer period than ahead of either the Thatcher or Major recessions, when unemployment began to rise about a year before recession. From mid-2005 onwards overall employment growth failed to keep pace with the natural growth of the workforce over the period. This applied to nearly all categories of employment, including public sector health, education and administration jobs, which grew a little over 2% between mid-2005 and the beginning of the recession in the 2^nd quarter of 2008. This was approximately one-third of the pace required to prevent a rise in unemployment. The three exceptions to this general picture were real estate jobs (but not finance jobs) which grew by 20% over the period and manufacturing and private sector administration jobs, which both saw outright falls in employment.

In short, parts of the private sector were shedding jobs in order to boost profitability. The rest of the private and the public sector were not growing fast enough to absorb these or the natural growth in the workforce. This rise in unemployment was taking place an exceptionally long period before the recession began. This may help to explain why the decline in jobs was more subdued when the recession actually did begin.

The recent improvement in both employment and unemployment simply reflects the lagged effects of last year’s growth. If previous patterns are repeated this improvement may last another quarter or two. But the economy has already begun to stagnate under the weight of Tory cuts and these will be much deeper this year. Therefore the jobless totals are likely to rise once more as government policy takes effect- especially as driving down wages is an aim of policy.

A rational policy based on optimising growth would be set out to reverse these negative trends on a sustained basis, with a goal of full employment. That is the surest way to maximise the well-being of the population, and, not incidentally the best means also of reducing the public sector deficit.

T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Fall in unemployment is likely to be temporaryBy Michael Burke

The latest data show a fall in the UK unemployment rate to 7.7% and an increase of 36,000 in the employment total. This is the fifth consecutive quarterly fall in the unemployment rate, which peaked at the end of 2009.

However, even the Tories constrained their boasting about the data, with employment minister Chris Grayling saying only that it “was a step in the right direction”. Neither Cameron nor Osborne made any pronouncement at all on the employment release.

The caution is well-advised. Economists generally regard unemployment as a lagging indicator of activity. That is, unemployment responds after changes in output with a time lag between the two. So it is often the case that unemployment will continue to rise even after a recovery has begun. This is mainly because there is an inevitable delay between a business reaching a decision to hire more workers or open a new factory or shop and the new workers starting their employment.

This is illustrated in the chart below, which shows the unemployment rate (red line) and the year-on-year growth in GDP (blue line). For example following the recession of the early 1980s the unemployment rate carried on rising for another 21/2 years. Similarly, the jobless rate continued to rise for over a year after the end of the recession in the early 1990s.

Figure 1

A number of analysts have noted that the rise in unemployment in this recession has been more muted than in either the Thatcher or the Major recessions – when the unemployment rate rose by 5.6% and 3.2% respectively. The increase in the unemployment rate in this recession was 2.1%, with the Office for National Statistics providing the official assessment that this is particularly striking as the loss of output in this recession of 6.4% is nearly as large as the other two combined (7.1%) .

A crucial difference is politics. The policies of both the Thatcher and Major governments’ were to engineer a rise in the unemployment rate in order to drive wages down and profits up. If there is any doubt on this question, it should be dispelled by this 1 minute video interview with Sir Alan Budd, Thatcher’s chief economic adviser .

By contrast, no Labour government maintaining any link with the unions could hope to set out on the same path and survive. Labour politicians who did adopt these policies such as Ramsay MacDonald and Philip Snowden had to break with Labour to implement them.

It is not surprising that the official analysis of the subdued rise in unemployment in this recession should neglect this determining political factor. But it also overlooks an important aspect of the most recent trends in unemployment.

Crucially, the rise in unemployment from its cyclical floor of 4.8% began in the second half of 2005, nearly three years before the recession began. This is a much longer period than ahead of either the Thatcher or Major recessions, when unemployment began to rise about a year before recession. From mid-2005 onwards overall employment growth failed to keep pace with the natural growth of the workforce over the period. This applied to nearly all categories of employment, including public sector health, education and administration jobs, which grew a little over 2% between mid-2005 and the beginning of the recession in the 2^nd quarter of 2008. This was approximately one-third of the pace required to prevent a rise in unemployment. The three exceptions to this general picture were real estate jobs (but not finance jobs) which grew by 20% over the period and manufacturing and private sector administration jobs, which both saw outright falls in employment.

In short, parts of the private sector were shedding jobs in order to boost profitability. The rest of the private and the public sector were not growing fast enough to absorb these or the natural growth in the workforce. This rise in unemployment was taking place an exceptionally long period before the recession began. This may help to explain why the decline in jobs was more subdued when the recession actually did begin.

The recent improvement in both employment and unemployment simply reflects the lagged effects of last year’s growth. If previous patterns are repeated this improvement may last another quarter or two. But the economy has already begun to stagnate under the weight of Tory cuts and these will be much deeper this year. Therefore the jobless totals are likely to rise once more as government policy takes effect- especially as driving down wages is an aim of policy.

A rational policy based on optimising growth would be set out to reverse these negative trends on a sustained basis, with a goal of full employment. That is the surest way to maximise the well-being of the population, and, not incidentally the best means also of reducing the public sector deficit.

T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

Inflation impoverishes the vast majority

By Michael Burke

The latest monthly data show the annual pace of UK inflation accelerating to 4.5% in April, using the Consumer Price Index (CPI). The broader measure of inflation in the Retail Price Index (RPI), which also includes housing costs moderated a little, to 5.2% from 5.3% in March.

The impact of these prices increases is severe. At the end of 2010 the annual level of all wage compensation in the UK economy totalled £800bn. In the February data, average weekly earnings grew by just 0.9%. If sustained the decline in real wages would therefore amount to 4.3%.

For comparison if a decline of 4.3% in real wages were directly translated into total employees’ compensation it would amount to a £34bn annual reduction in incomes. This compares to the government’s already enacted tax increases of £3.8bn and spending cuts of £5.5bn in the previous Financial Year (FY) and £20bn in taxes and £22bn in cuts in this FY.

Unlike the cuts, inflation affects all sectors of society, especially those on low or fixed incomes, in addition to those in the public sector who are seeing their pay fall through a wage freeze and increased pension levy.

Usually the group on fixed incomes would include those receiving the state pension. However for reasons of political calculation, the government has chosen to offer a ‘triple-lock’ on pensions, so that pensioners will receive the highest of earnings growth, the RPI or 2.5%. However it was hardly envisaged at inception that this could mean a pensions increase of perhaps 6% just to keep pace with the RPI. Both the June 2010 and March 2011 Budgets assumed that there would be no additional cost to this policy in the current FY. But if the overshoot in inflation is in line with the Bank of England’s latest quarterly Inflation Report, then the cost to the Treasury will be £2.9bn in this year alone – without leaving pensioners any better off.

If the real aim of policy was to reduce the budget deficit reduction, the government approach would be utterly self-defeating. The rise in pensions and other welfare benefits (although most of these have now been switched to a link with the persistently lower CPI) automatically triggered by higher inflation will cause significant increases in net government outlays, even while entitlements are being cut.

Yet government policy is itself largely responsible for the overshoot in inflation. The chart below is taken from the latest official publication for the Office for National Statistics (ONS). In addition to CPI inflation, which is currently at 4.5%, two other measures of inflation are shown. The CPIY measure shows price increases excluding the direct effect of changes to indirect taxation, such as VAT. This is currently rising at a pace of 3%. The CPI-CT measure is the same as CPI but is adjusted as if all taxes were unchanged during the latest 12-month period (for example, excise duty rose on alcohol and tobacco in the March Budget and these are excluded). This is currently rising at a pace of 2.8%.

Figure 1

The Bank of England’s medium-term target is a 2.0% inflation rate with a tolerance zone 1.0% either side of that central aim. A large part of the current overshoot is a direct effect of government policy, which will also have greater indirect effects too. On both the CPIY and CPI-CT measures which exclude the direct effects of government policies, the inflation rate would be within the target range.

This matters primarily because both the latest data and the Bank’s Report have raised expectations that there will be interest rate increases before the end of the year. At the time of writing the interest rate futures market was pricing in two rate hikes by year-end to take official rates up to 1%.

Government hopes for economic recovery are largely pinned on the ability of very low interest rates to support borrowing by companies and especially households while the cuts are pushed through. If the prop of low interest rates is kicked away the economic outlook will deteriorate sharply. Yet it is in the government’s own hands to lower the inflation rate by reversing the rise in VAT. They could also scrap the rules that allow permanent above-inflation prices rises for the privatised utilities and rail companies, which are set to lead to price rises of up to 14% later this year .

At the turn of the year higher inflation led to calls for significant rate increases and a campaign for a higher pound which Osborne and Cameron were keen to lead. Sterling climbed sharply, as Figure 2 below shows.

Figure 2

But that campaign was punctured by publication of the stagnant GDP data for the latest 6 months. Now there is a gradual realisation of how weak the economy is and sterling finds little support from higher prices or the expectation of higher rates, as the chart shows. Instead the talk has shifted to ‘stagflation’ the combination of economic stagnation and rising prices .

That stagflation is even a possibility after one of the most severe economic contractions on record is itself a damning indictment of policy. Recessions should lead to large excess capacity in the economy allowing a rapid rebound without producing price pressures. Now a combination of government spending cuts, chronically weak investment and excessive monetary creation have created the opposite; flat activity and soaring prices.

The opposite policy is required to produce non-inflationary growth, centred on increased government spending and investment.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com1

Problems deepen at Lloyds Bank – but it could be part of the solutionBy Michael Burke

The initial market reaction to the announcement that Lloyds Bank had made a £3.5bn loss in the first quarter of this year was for the share price to fall by nearly 6%. Every British taxpayer has a material interest in Lloyds as the state effectively controls it through a 41% shareholding.

At the time of writing the share price had fallen to a little over 54p per share, whereas the average purchase price by the state was 68p – see Figure 1. Taxpayers are now nursing direct paper losses amounting to nearly £1bn on the share purchases. However this is a tiny fraction of the total costs incurred by the state in bailing out the banks, which has mainly been in the form of providing funds to the stricken banks rather than share purchases.

Figure 1 – Lloyd’s Bank Share Price

According to the Office for National Statistics (ONS) the total debt incurred in ‘financial market interventions’, that is the bank bailout, was £1,335bn, significantly more than the level of state debt incurred via spending and taxation which currently amounts to £903bn.

For all the lurid headlines about both, the debt and the budget deficit actually fell in the last Financial Year (FY) from £156bn to £141bn under the impact of the recovery fostered by Labour’s increased spending – which has now stalled under the Tory cuts. Similarly, the debt level, excluding the bank bailout,t amounts to 59.9% of GDP which is fractionally below the Maastricht Treaty limit and lower than British public debt in every year between 1916 and 1970.

A chunk of Lloyds’ net loss come from a charge of £3.2bn from the miss-selling of payment protection insurance to individuals, many of whom could never have claimed on the insurance. Many other High Street banks are also guilty of the same swindle. Even so, without this charge there would still have been a loss compared to a profit of £721mn in the previous year.

This renewed loss is a product of the banks own current business practise. Income fell 20% as it reduced its assets and curbed its lending. However, losses on its existing loans are increasing (to £2.6bn in the latest quarter) as borrowers continue to struggle and the economy stagnates. In effect this is a policy of hoarding its capital and hoping that something positive will turn up which will improve the existing loan book. However, this is also the policy of all the other banks too and total bank lending to non-financial businesses and individuals has fallen by £74bn in March from a year ago, which was itself £102bn lower than the previous year.

Worse, government policy now exacerbates this trend as it also cuts spending and investment and makes incredible forecasts that something (net exports?, business investment?) will turn up. As a result of capital hoarding and reduced government spending, nothing is turning up.

But Lloyds, in common with the other High Street banks has considerable capacity to increase its lending. SEB has previously shown that the banks are sitting on large capital assets which could be used to increase loans. The Financial Service Authority (FSA) has performed rigorous ‘stress tests’ on all the major banks. The stress test show what would happen to the banks’ balance sheets from a series of events which include a double-dip recession, a rise to 12.5% unemployment, a further 60% fall in house prices and default by one or more European government. Even if all of these events happened simultaneously the FSA estimates that Lloyds Bank would have Tier 1 capital equal to 9.2% of its assets to act as a cushion against losses, compared to 8.0% set as the international standard. Lloyds is actually the weakest of the banks on this measure.

Even so, this implies that Lloyds could increase its lending by 15% and still meet international safety limits for its capital under an extreme economic scenario. The current policy of hoarding capital and accumulating losses is having the opposite effect, the Tier 1 capital ratio fell by 0.2% in the quarter. The bank is becoming more, not less risky as a result .

The opposite approach would be one which benefitted Lloyds shareholders (including the state) and the whole economy. This would be driven by a sharp increase in productive lending, with a positive investment return. Here the role of government is decisive. It could instruct Lloyds to make a sure-fire investment in state-owned housing. The housing shortage in Britain is both chronic and acute, with the lowest number of homes built in 2010 since 1923. 1.8 million households are on council waiting lists and even those who could afford to buy a home cannot find the mortgage financing, where Lloyds has led the way in reducing its lending.

A state-led investment programme in housing, in conjunction with local authorities and financed by state-controlled banks, could produce affordable homes yielding 6% or 7% a year in rents, double the government’s cost of borrowing and so provide a net return to invest further, or to reduce the deficit. Ed Balls has previously called for £6bn investment in 100,000 new affordable homes. This could be done via the State-controlled banks without any increase in borrowing at all. It would also create 750,000 new jobs in a sector decimated by unemployment. 750,000 new jobs would also have a twofold benefit to public finances, much higher tax revenues from both income and consumption and much lower welfare payments.T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com0

The IMF’s prediction China will overtake the US to become the world’s largest economy in 2016 – chartThis is a link to the chart showing the IMF’s widely discussed prediction that the size of China’s GDP will overtake the US in 2016 in Purchasing Power Parity (PPP) terms.

The chart is interactive. By ticking the boxes on the left-hand side, readers can make their own comparisons. Amongst other comparisons we found interesting; China surpassed the combined economic size of Germany, France, Britain and Italy in 2010; India surpassed all these countries individually in 2006, Brazil in 2011 will have surpassed all those countries individually except Germany.

T Walkerhttps://www.blogger.com/profile/11107827543023820698noreply@blogger.com1