Moody’s downgrades UK – Osborne ploughs on regardless

Here’s Osborne in April 2012, following S&P’s decision to affirm the UK’s AAA credit rating:

“This is a reminder that Britain is weathering the international debt storms because of the policies we have adopted and stuck to in tough times…The budget showed we are ready to go on making the difficult decisions that are keeping our country safe. Once again we are reminded that those who want to spend and borrow even more would lead our country into an economic catastrophe.”

So the AAA rating proved austerity was the right thing to do and changing course would risk losing it which would lead to “economic catastrophe”. But hang on a minute. Today, horror of horrors, another ratings agency – Moody’s, does downgrade the UK. Economic catastrophe? What does Osborne think now?

“Tonight we have a stark reminder of the debt problems facing our country – and the clearest possible warning to anyone who thinks we can run away from dealing with those problems…Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it…

…[Moody’s] make it absolutely clear that they could downgrade the UK’s credit rating further in the event of ‘reduced political commitment to fiscal consolidation’…We are not going to run away from our problems, we are going to overcome them.”

It’s a little confusing because it seems that a AAA rating means austerity is the right thing to do, because losing that AAA would be a disaster, but in the event of actually losing the AAA rating, that also means austerity is the correct path, because the alternative would be much worse. If I didn’t know better, I’d say George Osborne doesn’t know what he’s doing.

* While now is the time to mock George Osborne, it should also be said that while the economic impact of the downgrade is uncertain, in reality it’s unlikely to amount to anything significant. Moody’s are actually making themselves look a little foolish by downgrading another country with its own sovereign currency, who’s risk of default is near enough zero.

Do 50% of work experience participants find work as a direct result of that experience?

Yesterday Iain Duncan Smith was interviewed on LBC radio by my new hero James O’Brien. The interview is quite novel in that O’Brien actually interrogates IDS like a proper journalist should, (you will never see this on the Andrew Marr show for example) and calls him out on some of his claims. One claim that wasn’t questioned though is one I’ve seen IDS make repeatedly – namely that 50% of those who have participated in one particular work experience scheme (the one that is notionally voluntary), found work as a direct result of that experience.

IDS doesn’t do nuance very well. His grasp of facts and figures is questionable to say the least. So what does the data actually tell us about the success of this work experience?

The 50% IDS mentions, I think refers to the findings of this DWP “ad hoc analysis” (I discussed my issues with these “analyses” here). Published in November 2011, and based on 1,300 early participants (there have been 100,000 participants to date), it found that 51% of participants had come off benefits after 13 weeks. Is this the same as saying 50% found work as a direct result of the work experience?

For starters, as the excellent Fullfact points out, from this figure alone we don’t know how many would have found work anyway, or even how many actually found work at all – many may have just stopped claiming benefits. DWP’s analysis was followed by a more formal analysis carried out by NIESR on behalf of DWP. It found that 21 weeks after starting work experience, 46% of participants had come off benefits. At the same time though, 40% of claimants who did not do work experience also came off benefits. So NIESR found a small, but positive impact of work experience on the numbers of people coming of benefits.

This is a world away from IDS’ claim that 50% of people found work as a direct result of the programme. In reality, because not everyone coming off benefits will have found work, the true figure is likely to be less than 5%. Hilariously, the DWP press release accompanying the NIESR study was titled “New research reveals the true benefits of work experience”. It looks like IDS doesn’t read his own department’s press releases!

Now, you might well say, regardless of IDS’ nonsense, the research shows that the work experience programme does return positive results. You’d be right, but only versus the counter-factual of doing nothing. That is a false choice though. Against an actual job creation scheme, the results of work experience would no doubt look a lot less favourable.

What Most Discussions of the Deficit are Missing

This post will attempt to explain a concept in economics known as “sectoral balances”. This might get a bit wonkish, but hopefully not too much.

We hear a lot about the Government’s debt and deficit, how it is too high and must be reduced even at the expense of jobs and living standards. What we rarely, if ever hear about though is the other side of the ledger – the private sector. Here’s an example of what I mean:


Here’s a chart of UK Government debt. It’s risen from around 40% of GDP 25 years ago, to a little under 70% in 2012. A pretty big rise huh? But what about private sector debt?*

private debt

25 years ago, total private sector debt was just under 150% of GDP, but by the time the 2008/9 crisis hit, this had more than trebled to over 450%. While the debt households and non-financial companies increased significantly over the period (doubling and trebling respectively), the main culprit was the financial sector, who’s debt peaked at 258% of GDP in Q1 2010. Looking at the two charts above, which problem looks more urgent? But yet the focus on the government’s finances is relentless.

Look again at the second chart, and you’ll see that following the crash, all three parts of the private sector started to reduce their debts, although this year that trend seems to have paused. This is what is known as deleveraging – paying down debt. Economists like Richard Koo have labelled this period of deleveraging a “balance sheet recession“. Basically, when asset prices collapse following the bursting of a bubble, millions of private sector entities find themselves in dire straits, so they all simultaneously attempt to increase savings or pay down debt at the same time, causing a collapse in economic activity.

Now back in 2011, David Cameron drew the ire of some economists when a speech he was about to make reportedly contained the lines:

“the only way out of a debt crisis is to deal with your debts. That means households – all of us – paying off the credit card and store card bills”.

Now Cameron’s problem wasn’t the advice per se, (it’s probably a good idea for households in too much debt to cut back) his problem was that he’d forgotten the economics he’d learned while studying PPE at Oxford, namely Keynes’ Paradox of Thrift. While for an individual, saving or paying down debt may be a sensible thing to do, because my spending is your income and vice versa, if everyone tries to do it at the same time, total savings will actually fall. This allows me finally to get to the point of this post.

While the government’s deficit is always discussed, what is never discussed it that the government’s deficit is equal to the surplus of the private sector. The approach of examining changes in the economy by looking at different sectors in the economy is known as the sectoral balances approach, which was popularised by British economist, the late Wynne Godley. It highlights the accounting tautology that shows:

Private Balance = Government Balance + Trade Balance

The private balance is private savings minus private investment spending, the government balance is government spending minus tax receipts and the trade balance is exports minus imports. This equation is always true whether there is a government deficit, surplus or balanced budget. Here you can see a graphical representation* by way of illustration using real data for the UK.

sectoral balances

In this chart, the red bars represent the capital account which is equal but inverse to the trade balance (or current account to be more precise). This just helps to show more clearly how the governments budget position mirrors the position of the non-government sector. So, in the latest quarter, a 5% private sector surplus and a 3% capital account surplus is offset by an 8% deficit.

The point of showing this is to say that the government cannot really have a budget deficit target and hit it because it depends upon what happens in the other two sectors. When Cameron says he thinks households should pay down debts, he doesn’t realise that its impossible for both the government and the private sector to do that at the same time, unless the country has a very sizable trade surplus (which we certainly don’t have). The government can either accommodate the private sector’s desire to pay down debt/save by increasing spending/cutting taxes, or it can try to cut its own spending and at the same time hope households and businesses will be willing to take on more debt.

In a sane world, the government would realise that the first option is preferable, but instead it has plumped for option 2. If you look at the figures produced by the OBR**, you can actually see that deficit reduction is predicated on households going into deficit again. This cannot be a sensible strategy. The problem the government has is that while it can control some portion of its budget, it can’t control other parts like the welfare bill, and it can’t control how much tax it takes in. These things are determined by saving and investment decisions made by the private sector and the performance of exports over imports. Once this is understood, it’s clear to see how commentators like Fraser Nelson are misguided when they say there are no cuts because spending is going up. The government are making cuts, its just that those cuts are causing other parts of the budget (parts they have no control over) to go up.

The sectoral balances approach then allows us to consider how changes in government policy may impact upon the different sectors. Armed with this knowledge you would know that for the government deficit to go down, the private surplus and/or the trade deficit would need to shrink or disappear entirely. At a time of global recession, the prospects for a massively shrinking trade deficit don’t seem good, and the prospects for an already debt-saturated private sector to take on yet more debt also seem less than positive. Both of these things imply that any attempt to reduce the government’s deficit by cutting spending or raising taxes will ultimately be futile, and that’s exactly what we are seeing at the moment.

Here then are the key take away point from this post:

  • Outstanding private debt dwarfs government debt, both as a % of GDP and in the extent to which it is a problem that needs dealing with.
  • Considering the government deficit in isolation leads to wrong-headed policy making. Policy-making should take account of all sectors of the economy when considering the implications of different policy options.
  • The three sectors must balance. In a trade deficit nation like the UK, if the private sector is saving/paying down debt, a government deficit is inevitable regardless of the government’s spending plans. Any attempt by the government to cut it’s deficit will fail unless the private sector is willing to cut its surplus/run a deficit.
  • Those who argue austerity is not happening do not understand the points above and don’t get the ‘tyranny of the accounting’.

* The second and third charts in this post have been taken from this excellent blog. The blog’s author Neil Wilson updates these charts on a quarterly basis as new data is published. Here is the post the charts are taken from.

** The OBR publishes forecasts for what they think will happen to the sectoral balances (they call them financial balances) here (Its the supplementary fiscal tables, tab 1.8).

“There is no secret to solving unemployment”

One of my favorite blogs is “Billy Blog” produced by Professor Bill Mitchell. He somehow manages to knock out several thousand words a day of readable economic analysis – no mean feat. This is great for nerds like me, but it does mean you need to invest a lot of time reading it to absorb it all. So for those without the time to devote to reading long economics blogs, here’s a short extract from Monday’s Billy Blog on unemployment and the demonisation of the unemployed:

“…there is no secret to solving unemployment – produce jobs. There is no financial shortage to fund the necessary jobs – a sovereign government can do that whenever they choose. There is no shortage of productive things to do. There are millions of jobs that I could define which are not currently being done and which would improve the quality of our societies or communities.

The only thing missing is the political will or political leadership necessary for the government to announce that it was serious about eliminating unemployment.

The reason is that the dominant elites, which are increasingly being dominated, in turn, by large financial interests, which themselves are inherently unproductive, have developed a narrative to convince us that it is better to have millions of people doing nothing than advancing societies commonwealth.

If a person is not advancing private profit-seeking behaviour then the work is unproductive. We have bought that narrative from the elites. We have also bought the narrative that the unemployed are in some way letting themselves down – they are lazy, unskilled, lacking in something or other.

The idea that the lack of jobs is a systemic constraint imposed on individuals who are largely powerless to respond has been lost. Now we are somehow meant to believe that the individual – the micro scale – is all dominant and can overcome a macro scale shortage of jobs.

Why, you just create your own job, that’s entrepreneurship! But what would you “sell”? Anything that has a market? But if all the spending by buyers (irrespective of the particular products they buy) doesn’t add up to the total output being produced then isn’t there going to be some sellers who cannot sell anything? That’s competition. And so the denial goes on.

But the point is that the most disadvantaged citizens among them the unemployed are rendered as almost inanimate objects with all-defining characteristics – all lazy, all without entrepreneurial zeal – all just living on welfare.

We don’t publish stories about the huge welfare spending on corporates, which dwarfs the social security payouts to the poorest citizens. That would be too challenging for the narrative.”

On welfare cuts and automatic stabilisers

Cuts to welfare spending seem to be in the headlines daily nowadays. Every time a bad bit of economic news is announced (which is often), the prospect of yet more welfare cuts seems to raise its ugly head. Just this week, following the terrible Q4 growth figures, there was a story in the Independent about certain ministers who are pushing for further cuts to welfare.

There are a number of issues around welfare which are regularly discussed. These include ‘fairness’ and ‘making work pay’. A lot has been written on both sides of the arguments on this, so I’m going to focus on the likely economic impact of welfare cuts.

Now a key argument on welfare cuts is that the deficit needs to come down and everyone needs to contribute (we’re all in this together remember). Putting aside the fact that I don’t think we should try to reduce the deficit at the expense of jobs or living standards, I want to look at whether the claim that welfare cuts help reduce the deficit stand up to scrutiny.

A lot of people would say that the purpose of working-age welfare benefits is to provide a subsistence level of income for those who are either unable to find work, or unable to work altogether due to ill health or disability. While that’s true, welfare payments also serve a very important macroeconomic function. They act as an ‘automatic stabiliser’.

What are automatic stabilisers? From Wikipedia:

“In macroeconomics, automatic stabilizers describes how modern government budget policies, particularly income taxes and welfare spending, act to dampen fluctuations in real GDP.”

In other words, in a boom, the government collects more taxes and pays out less in benefits which helps put the brakes on to prevent the economy from overheating. Conversely, in a slump (like the one we’re in now), less tax is collected and welfare payments soar as people lose their jobs and businesses make less sales. This acts to prevent the economy going into free-fall. The stronger the automatic stabilisers, the shallower are the slumps and the quicker are the recoveries.

In response to criticism of his economic policies, George Osborne has claimed his plan is flexible because he has “been prepared to let the automatic stabilisers operate..”. I’m not sure what he means by that. What would not letting them operate look like? I suppose you could stop paying benefits to new claimants, or make people pay the same rate of tax even when their incomes fall, but no sane person would advocate that. So in Osborne’s world, ‘flexibility’ seems to mean not taking complete leave of your senses.

In any case, the Government are not letting the automatic stabilisers operate, they are trying to weaken them all the time. Bedroom taxes, Atos reassessments, cuts to council tax benefits, these all weaken the automatic stabilisers. What does this mean? It means that income will be taken out of the pockets of the poorest (who by the way spend most of their income), who then spend less in local businesses. These businesses then make less sales, leading to the government collecting less in tax, while the businesses might decide they don’t longer need as many staff, or even go bust.

Spending is a circuit. It goes round and round the system, not stopping after its first use. The government thinks by cutting the amount it pays benefit claimants by x pounds, it will save x pounds. It’s easy to see the flaw in this logic though. If you give someone £100 less in benefits, that’s £100 less going into the economy. Someone else has lost £100 in income (unless that person’s taxes are cut by the same amount, but the Government are not proposing to cut taxes). The actual saving for the Government will not be £100, but a figure much much smaller. It could even be negative if the cuts further depress employment. The welfare bill could actually go up.

This, in a nutshell then is why cutting spending by x pounds is only cutting the deficit by (-)y pounds. This confuses all sorts of people who are starting to claim austerity is not happening because the deficit is rising.

What the cuts to welfare also mean is that the next time there is a crisis, it will be much deeper, because our new, weakened automatic stabilisers are not strong enough to stop the slide and spark the recovery.

There’s actually a strong case for strengthening the automatic stabilisers. You could do this on the tax side by perhaps linking national insurance rates to the unemployment rate, or on the welfare side by guaranteeing jobs for those who are made redundant following an economic slump.

Cutting welfare in a slump is a very dumb thing to try to do. It won’t work and will make things worse. They will be disastrous on an individual level for many families bearing the brunt of these cuts. With jobs not being created in sufficient number (no matter what the Government tries to say), there’s no possible way the cuts can act as an ‘incentive to work’, and as we’ve just seen, in macroeconomic terms, weakening automatic stabilisers in a slump is an awful idea. Dumb, dumb, dumb.