In a first for this blog, I put some questions to economist Ann Pettifor on economic recovery, private debt, and the way politicians talk about their economic plans. Ann is a Director of Policy Research in Macroeconomics (PRIME) and a fellow of the New Economics Foundation. She is well known for her leadership of an organisation Jubilee 2000, that placed the debts of the poorest countries on the global political agenda, and brought about both substantial debt cancellation, and radical policy changes, at national and international levels. In 2006 Palgrave published her book: “The coming first world debt crisis”. It came. I really appreciate her taking time out of her schedule to answer my questions so comprehensively. Hope you like it.
Austerity can do a great deal of harm to the economy, but try as they may, politicians and neoclassical economists cannot kill it off. And sure enough the patient shows signs of life. All the same, the policies applied by Chancellor Osborne and his deputy Danny Alexander, in particular the slashing of public investment after 2010, extended, quite unnecessarily, the longest post-crisis slump since records began. Sixty-six months after the crisis the economy remains 2-3% smaller than it was in 2008. Sixty-six months after the 1929 crash, the economy was bigger by 5-8%.
This failure should not surprise us. Both Treasury politicians take a hands-off approach to the finance sector, and both are determined to shrink the public sector. The pro-cyclical application of austerity was an ideologically driven no-brainer for both men. Neither would have been willing to restrain the ‘irrational exuberance’ of the finance sector with a touch of austerity during the boom years; but both endorsed austerity during the slump.
As a result Chancellor Osborne and his deputy will go down in history as the Jehova’s Witnesses of economics. Unlike the Obama administration they have preferred ideology and prayer to the well-tried and tested economic medicine of fiscal stimulus in a slump: a point well made by Tim Harford in the Financial Times, Dr. Osborne’s bitter medicine.
As a result, unemployment remains unacceptably high – a reckless waste of Britain’s investment in the nurturing, health and education of 2.49 million people – 7.7% of the economically active. The immeasurable pain and anguish caused by unemployment, the family breakdowns, the mental health effects; the personal and social dislocation suffered – all these will remain as deep scars on our society and will blight their futures. A shocking 1.09 million of Britain’s young people are not in education, employment or training, according to the ONS. 584,240 young people were classified as unemployed between April and June, 2013. While political leaders may enjoy prospects, for the young prospects are bleak.
Nevertheless employment has remained surprisingly buoyant. The pre-crisis decline in wages and the post-crisis slump has proved that wages after all are not so ‘sticky’. As Shaun Richards notes, UK real wages are now falling at an annual rate of 2% if based on CPI and 2.5% if based on RPI – “as the real wage crisis builds.”
GDP is just 2.2% higher today than in Q2 of 2010 (when the Coalition Government came to office). Given that UK population is increasing at about 0.8% per year, this means that GDP per head of population is completely flat, following the big drop in 2008/9.
Not much to write home about there.
And while the flickers of increased economic activity now evident are heartening, questions must be asked about how this very weak recovery will be sustained? By household and company borrowing?
I don’t think so.
British individuals, households, firms and banks are still heavily indebted, and the Chancellor has done little to help debtors pay down, clear or re-structure that debt – a hangover from the pre-crisis credit bubble.
So far from borrowing from banks, individuals and firms are saving, and effectively lending to banks, according to data from the Bank of England. There are two exceptions. Borrowing for mortgages has risen. Borrowing from non-standard financial institutions – e.g. payday lenders – is also up from £4bn in February to just over £5bn in August, according to the Bank of England. This latter increase is not significant in itself, but because such borrowing is at higher (and sometimes obscenely high) rates of interest, and because wages are falling, signs that consumers are turning to pay day lenders in larger numbers, are worrying.
Nor has the government worked to re-structure the broken banking system – and so SMEs continue to be starved of credit and overdrafts. This means that SMEs wanting to employ new staff, or to improve and update their businesses, fund investment out of cash flow, erratically.
By contrast, business is better-than-usual for bankers. Not only are they too-big-to-fail, and too-big-to-jail, but the British government now actively subsidises their lending on existing housing – and in the process inflates house prices. And the Chancellor is the banker’s strongest ally in Brussels where attempts are made to limit bonuses and tighten regulation.
Will recovery by powered by business investment? I don’t think so. The ONS recorded the lowest ever capital spending by the private sector, in the first half of 2013.
And what of public investment? Will that sustain this ‘recovery’? Hardly. Under Labour between 2007 and 2010 public net investment increased by £7bn. In 2011 under the coalition government public investment fell by £9.7bn and was slashed once more in 2012 by another £9.6bn. Predictably, the deficit remains far higher than the Chancellor and his deputy intended.
Will exports drive the recovery? Total exports since Q2 in 2010 (when the coalition came to power) have risen by about £9bn in real terms (ONS) whereas imports have gone up by nearly £8bn. In the second quarter of 2013 there was an uptick in exports, matched by an uptick in imports, with a deficit of £5bn. However, the uptick in exports is not a trend, and it will take several quarters of export rises to convince economists that this sector will drive recovery.
So not much to sing about there.
Total industrial production makes up 15% of the economy (and includes manufacturing, oil and gas; electric, gas, steam and air; water supply and sewage). At the end of June 2013 industrial production was 4.2% below what it was in 2010.
Manufacturing is down 0.5% since 2010. North Sea Oil and Gas is down by a massive 25%. Construction is down 5.8% since 2010.
Not much joy there then.
Total services (which make up 78% of the economy) have risen by 4.4% since 2010. Health and social work are up by 7.4%; real estate is up 5% and wholesale and retail up by 5.7%. The finance and insurance sector has shrunk by 2.9% since 2010.
However the big rise in services is driven by professional, scientific and admin services, up 14.1% since 2010.
So we have scientists, the creative industries and administrators to thank for the growth in services, driving the recovery.
Is the rise in services sufficient to fuel and sustain recovery? I would be encouraged if it were not for the overhang of private debt that will once again threaten Britain’s large numbers of private, individual, household and corporate debtors when interest rates begin to rise. There were signs of interest rates tightening in the bond markets over the summer. Any further signs of recovery are bound to trigger rises in rates and these will, as before, lead to rises in mortgage rates and choke back any sign of recovery. In September the Federal Reserve seemed prepared to ‘taper’ its $85bn monthly (QE) purchases of assets from the financial sector, but was deflected from its strategy of unwinding QE by rises in long-term bond yields – which similarly pose a threat to recovery in the US.
2. We’re repeatedly told that government debt is our biggest problem. But private sector debt is still almost 450% of GDP. Despite this, a lot of the Coalition’s economic policies seem to be about encouraging more private sector debt. Is there any reason to believe that government debt of around 90% of GDP is more dangerous than the much larger private sector debt?
By simultaneously presiding over cuts in incomes, the Chancellor has made it harder for debtors to pay down their debts. Indeed falling incomes have led to a growth in household debt and a boom in payday and other risky lending. Private household debts have not been de-leveraged on any meaningful scale. Instead they are held in suspense – at about 140% of UK GDP. Low interest rates are used to lull private debtors into complacency.
The overhang of household, corporate and bank debt is a buffer that is likely once again to choke back any recovery – as it did in 2009 and 2011.
The ONS reports that household incomes fell for the first time in 20 years by an average of £615 in 2011. Under the Cameron government there has been no period when pay has not fallen in real terms. The last time pay rose higher than inflation (CPI) was in the period January to April 2010, according to ONS.
From this year benefits will only rise by 1% – less than current inflation levels, slashing the living standards of the most vulnerable. This too will drive more people into the arms of payday lenders and loan sharks – worsening debt at the lowest levels of income…
Unlike Mrs Merkel, who compared the fiscal budget with the private household of a Swabian housewife, I say that there is a huge difference between public debt and private debt. The key point to understand is that private and public debts are redeemed differently. Private debt is largely repaid from incomes, currently falling in the UK. However, budget deficits can be solved by various means. One crude measure is to impose austerity, cut government spending, and increase public sector saving in line with increased private saving. With both the private and public sectors saving, spending into the economy is cut sharply, which is bad news both for private firms trying to sell their wares, but also for Her Majesty’s tax collection officers. No wonder Britain’s firms and corporations are hoarding cash! Customers are not coming through the door, and the customer-of-last-resort – the government – is refusing to step into the breach.
Another more sustainable measure is for government to invest in employment. If government would undertake infrastructure investment to increase economic activity, including employment, and to raise incomes – hey presto, the budget deficit would fall, and the public finances would be restored to sustainability.
3. Now we have seen a moderate rise in growth, the government say they feel vindicated and that this proves that austerity has ‘worked’. Do they have a point?
This “recovery” is hardly based on austerity. Academics tried in recent years to prove that a high level of government debt causes economic slumps. Some renowned orthodox economists, like Professors Reinhart and Rogoff, were so keen to make what is effectively an ideological point, that they misused excel tables. However, the empirical evidence we have suggests the opposite: Austerity harms the recovery, whereas fiscal stimulus increases economic activity in a slump. This has been shown by – among others – Taylor and Jordan in their recent publication.
The problem of continuing high deficits despite austerity only reinforces my argument. Public spending cuts cannot help recovery nor can they fix the deficit. Instead, they cut economic activity and reduce tax revenues.
4. Whenever one of the main parties (usually Labour) proposes a new policy, the other parties immediately demand to know how it would be paid for. Tax rise or spending cut elsewhere. What do you think of this debate? For example, I’ve heard you talk of Labour’s announcements on childcare and the youth jobs guarantee as being ‘salami slicing’. Could you explain what you mean by that?
The Labour Party will only discuss its plans in microeconomic terms. By this I mean that it offers its plans for the future – e.g. banning the bedroom tax, and simultaneously explains what tax revenues would be used to compensate for the abolition of the tax.
This causes Labour to fall into the microeconomic trap set by the Chancellor: namely that public spending can only be financed by existing tax revenues – not by increased economic activity, rising employment and the revenues associated with increased economic activity.
This approach boxes in policy-makers – which is what it is intended to do.
Labour would be much better off by arguing that its central objective would be to increase employment – and to do this by using public sector investment to increase private sector as well as public sector employment. For example, investment in retrofitting Britain’s housing stock would be stimulated by public sector funding for this purpose. But the retro-fitting would be undertaken by the private construction sector, and would be labour intensive, while at the same time increasing energy efficiency and saving on household bills – which would increase household income.
The public sector investment could be financed in just the same way as the bailout of the banks was financed: by resources issued through the government’s nationalised banks: the Bank of England, the RBS and Lloyds Bank. The BoE can work with the UK Treasury and the Debt Management Office who would issue bonds for financing for example, the retrofitting of Britain’s housing stock. These bonds can be purchased by the Bank of England at a very low and even negative rate of interest. And the tax revenues that accrue from the retrofitting process would then be used to repay the low-cost debt incurred by government.
RBS and Lloyds Bank can be encouraged to lend to firms and SMEs at very low rates of interest. If they fail or refuse to do so, government can withdraw taxpayer-backed guarantees, and access to Bank of England low rates.
This method of financing is much to be preferred to the current approach of financing every opposition policy from the existing and declining tax base!
It’s not complicated!