Other things I’ve written recently

An article in Red Pepper on the corporate surplus, the deficit and investment.

An article from Soundings (written in May) on the Greece and the Euro Crisis, now available online thanks to the New Left Project.

Two articles on False Economy – one on multipliers and another on Ireland.

Plus, for those you haven’t – I’d recommend September’s ebook from the New Political Economy Network (pdf), which I was one of the co-authors of.

I’ll try and get one more post up this year – a sort of economic outlook for 2011.

Merry xmas all,

Duncan

Get Ready for Emergency Budget II

We’ve known for a while that as much as George Osborne has a “Plan B” it is for more quantitative easing from the Bank of England, the so-called QE II option.

I think, in light of today’s public borrowing figures, it might be time to start worrying about Emergency Budget II.

I’ve argued that a policy based on cutting the deficit through cutting spending won’t work – to quote John Maynard Keynes – “you can’t balance the budget through measures which reduce the national income”. Cuts, at the pace Osborne is planning, suck demand out of the economy leading to lower growth, higher unemployment and hence lower tax revenues and higher welfare spending.

The Chancellor is aiming to slash £15bn from the welfare budget. How likely is that if unemployment remains high or rises?

Today the Treasury greeted the worst November public figures on record by saying that “this shows why the UK had to take decisive action”.

The thing is though, that is also what they said in September and August when borrowing increased year on year.  It’s time to step back and take a longer-term look.

In the five months (November back to July) since the emergency budget, public borrowing has totalled £65.3bn. In the period July to November 2009 (when we where “on the verge of bankruptcy”) public sector borrowing totalled £63.6bn. Public sector borrowing is up 2.6% in that timeframe. (Details in pdf table PSF2).

With Danny Alexander reaffirming the Coalition’s commitment to cuts in this morning’s FT, and with last week’s declaration that there is no plan B, one has to start to worry about next March’s budget. They’ve lashed themselves to the mast of deficit reduction through spending cuts, and even if it patently fails they’ll find it hard to back down. If the medicine isn’t working they’ll simply double the dose

We only have to look across the Irish Sea to see how this ends.

In December 2009 Irish Finance Minister Brian Lenihan said that Budget 2010 was ‘the last big push’ of this economic crisis, adding that ‘the worst is over’. It didn’t work, the deficit continued to rise as fiscal policy depressed the economy. One year later an even more savage budget followed.

Will next year’s budget be even more savage than the Emergency Budget/CSR? I’m starting to worry that it might be.

Increase Wages to End the Crisis (Says the IMF!)

Last week I again argued for “re-balanced domestic demand” as a solution to Britain’s economic woes and questioned the Coalition’s emphasis on “export-led growth”. Simply put, policy should aim to increase the share of GDP going to workers by increasing wages.

A policy based on rising wages and employment would allow for sustainable domestic consumption without recourse to consumer borrowing. This would be coupled with policies aimed to unlock the corporate surplus and increase investment (whether though public capital spending or subsidies to private business investment). I consider such a policy to be not only more likely to succeed than a policy of gambling on export recovery but also far more in keeping with Social Democratic aims.

So, I’m pleased to see some new analysis from the IMF (pdf), an institution notoriously staffed entirely by Bolsheviks and widely known for it’s pro-labour sympathies and heterodox solutions. (Or maybe not!)

As a Fistful of Euros reports:

The other was to shift the labour share of income upwards. They found that this achieved a faster, bigger, and more lasting reduction in leverage and a reduced probability of crises. In their own words:

“The main difference to Figure 14 however is observed following period 30, where under a loan restructuring leverage and default probability resume an upward trajectory for several additional decades, while under the bargaining power solution both immediately go onto a declining path. By year 50 leverage is around 20 percentage points lower under the bargaining power solution than under the loan restructuring solution. For long-run sustainability a permanent flow adjustment, giving workers the means to repay their obligations over time, is therefore much more successful than a stock adjustment, unless the latter is extremely large….But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy.”

They also argue that the inequality-finance-lending transmission mechanism might also explain the global imbalances, with the emergence of a globalised rich elite driving the demand for AAA-rated assets, the growth of the financial sector, and the emergence of persistent large capital account surpluses and trade deficits. (My emphasis).

There we have it, the IMF thinks that policies designed to raise the share of GDP going to wages would produce a “faster, bigger and more lasting reduction in leverage” and reduce the probability of further crises occurring.

This should be Labour’s agenda.

(Hat top for the link to the ever-insightful Luis in the comments).

The Coalition: Favouring Capital over Labour

Regular readers will know that I’ve been arguing for some time that the surest way to a sustainable economic recovery is through rebalanced domestic demand rather than relying on exports.

“Rebalanced domestic demand”, in practice, means two thing – a greater emphasis on investment and policies designed to lead to sustainable consumption – i.e. consumption based on decent wages not borrowing.

As the ebook put it:

In the 1920s much of Labour’s economic thinking was rooted in theories of under-consumption. The argument was that as one becomes wealthier, one tends to save a greater proportion of one’s income; so that vast disparities in wealth lead to too much saving in the economy as a whole, and not enough demand. Social liberal and liberal socialist thinkers such as J.A Hobson, E.F Wise and J. Strachey, associated with the Independent Labour Party, made the case for a more equal distribution of income not only on moral grounds, but also on economic grounds. A redistribution of the economy’s wealth towards the working class would lead to higher consumption and hence higher employment.

This insight still holds true. As we argued at the beginning of this e-book, the impact of rising inequality has been masked for the past three decades by increased borrowing by those further down the income scale. But increased personal indebtedness has proved unsustainable, and, given this difficulty, if living standards are to be maintained a solution will have to be found in greater wealth equality. Government intervention will be required – whether through increasing the minimum wage or using the power of public sector procurement to enforce a living wage – as will changes in the tax system to reduce taxes on low earners.

(Readers should feel free to substitute the “old school” reference to the “working class” with a more “next generation” category such as “squeezed middle” if they prefer.)

Browsing through the supplementary data to the OBR’s November Forecast, I came across their forecast of the “labour share” of GDP over the next few years.

Here it is – the share of GDP taken by wages over the next 5 years on a quarterly basis expressed as a percentage.  Wages as a share of GDP will drop from around 68% when the Coalition took office to about 64% by the time they hopefully leave.

So, there we have it – the Conservative-Liberal government’s policies will favour capital over labour. Who’d have thought it?

The Coalition’s Plan B?

One serious charge against the coalition’s economic policy is that it lacks a “plan B” if things go pearshaped in 2011. (See for example my own article on this with Chuka Umanna).

In as much as Osborne has  a plan B it is for more QE from the Bank of England. Today’s inflation numbers provide a further reason for caution – higher than expected inflation strengthens the hand of the hawks on the MPC, making such a monetary stimulus less likely.

So today’s claim from Philip Stephens in the FT that Cabinet Secretary Gus O’Donnell has written a paper emphasing the uncertainity in the OBR’s forecasts and calling for “if not a plan B” than at least a series of “possible stimulus measures” is important.

Politics Home reports that government sources (I’m guessing Treasury) are briefing that “Treasury ministers” have not asked for a “plan B”. But that is not a denial of the FT story, which is that a paper arguing for a quasi-plan B is circulating in Number Ten and, presumably, the Cabinet Office.

Are we seeing a divide emerge between Number Ten and the Treasury? Is Number Ten getting nervous about growth whilst the Treasury refuses to contemplate any alternative?

The UK Credit Cycle Across Ten Different Monetary Regimes

As calculated by the Bank of England and offered without comment.  (Hat tip Paul).

 

Fiscal Multipliers

The table below is from the neutral Congressional Budget Office.

Now, as I’ve said before, multipliers are probabaly a bit lower in the UK than in the US (we have a more open economy and so spending is more likely to “leak” abroad), but this is still important.

The concept of the multiplier is simple – it measures the effects of changes in fiscal policy on the economy as a whole. A multiplier of 1.0 means that a one pound change in policy effects GDP by one pound. A mutliplier of 1.5 means a one pound increase in policy increases GDP by £1.50p.  0.5 means a £1 change in policy moves GDP by 50p.

Notice that tax cuts on low and middle earners will be more stimulating to the economy than tax cuts on high earners. Notice too that generally spending is a more effective means of getting growth than cutting taxes and remember that these multipliers work in reverse to – so cutting spending is likely to hit growth harder than raising taxes.

Questioning Export-led Growth

I am quite looking forward to reading Gordon Brown’s new book and his FT article this morning makes for interesting reading.

He make’s a compelling case for a multilateral solution to the world’s economic ills, a solution I’d be more than willing to sign up to. But as I asked earlier this week, what is the Centre Left’s approach to global economic problems in the absence of international co-operation?

And are we right to hope for export led growth?

Brown is right to note that rising Asian consumption presents the West with an opportunity and the world will a chance to rebalance global growth. As he notes Asian consumption (excluding Japan) will rise from 12% of world consumption before the crisis to 32% by 2020.

But note the time scale – a decade away and there is no guarantee that UK exporters will be able to fill the gap.

George Osborne, as we know, is very keen on “export-led growth” and indeed the OBR forecast are premised on strong export growth coupled with historically low import growth (they see import growth 2011-2015 running at level below its post-1948 or post-1979 average, despite also forecasting a strong increase in business investment, which in the UK typically increases imports as we buy capital goods from overseas).

As the Wall Street Journal has reported, the OBR’s predicted export numbers may well be on the high side:

Yet if one realm of uncertainty stands out it is the strong export growth the OBR is predicting will drive the recovery in coming years.

With many of the U.K.’s major trade partners still suffering economic problems and financial system tremors, it is here that the OBR’s crystal-ball gazing looks most vulnerable to disappointment.

“Their forecast for [GDP growth] next year has been revised down from 2.3% to 2.1%,” said Simon Kirby, economist at the National Institute of Economic and Social Research. “We think their projection for GDP growth next year is still too strong given the weak prospects for Europe.”

In its report Monday, the OBR sees net trade–export growth minus imports–contributing 0.7 percentage point to 2.1% growth in 2011, 0.9 point to a 2.6% expansion in 2012 and 0.7 point to the 2.8% growth in 2013. In its June forecast the OBR gave net trade a slightly bigger role in the U.K.’s expected growth.

Export growth was revised up from the OBR’s last forecast for 2010, 2011 and 2012 at 5.4%, 6.9% and 7.1%, respectively. Offsetting that somewhat–import growth was also seen rising more quickly in 2010, 2011 and 2012 than the OBR had previously estimated.

Stepping back, it is worth asking – what is required to achieve this “export-led growth”? And is an export-led growth model compatible with the type of economy we want?

I find it difficult to understand how exactly “export-led growth” will be achieved. Sterling’s large fall in 2008-09 (as I argued at the time) was certainly helpful, but it is difficult to see this feat being repeated in an age of more aggressively managed currencies.

Or is the Government really planning on adopting the Irish model of reducing costs by driving down UK wages in order to make us more competitive? I don’t see that as politically possible or in anyway desirable. A lesser from of this strategy, embracing a “flexible labour market” is still favoured by some Labour MPs.

Roger Liddle’s summary of a recent Policy Network seminar on “a new political economy for social democracy” is worth reading in this regard.

I’m particularly drawn to Anke Hassel’s reported comments:

Anke Hassel of the Hertie School in Berlin argued for a new “social investment” political economy to build on the partially discredited “social market” paradigm. The key to this is that public spending be seen not just as compensation to correct the inequities of the market, but as economic investment to help shape its outcomes.

 I’ve argued myself that the Social Democrat solution to global imbalances is increased domestic investment, with a developmental role for government.

A state backed investment bank to fund business investment, a state backed infrastructure bank to fund large scale projects, a state backed green investment bank to fund the technologies of the future could all be combined with state backed venture capital firms to incubate new firms.  All of these measures would have one real purpose – to take the private sector surplus and turn it into real assets that increase employment, create high skilled jobs and ultimately help reduce the deficit.

I also argued, with others, in “Britain’s Broken Economy and How to Mend it” that a sustainable model for the British economy would be based around higher investment (initially state driven by ultimately aimed at unlocking the corporate surplus) coupled with higher wages.

The surest route to a sustainable recovery is a short-term increase in government investment, until such a time as the private sector is prepared to invest itself, coupled with an expansion of the purchasing power of lower- and middle-income families, and a long-term focus on the financial sector supporting the real economy. A macroeconomic policy focused on green and sustainable growth in the real economy, in recognition that the government has an important role to play here, will create greater equality and a more stable economy. It will have direct effects on the lives of low- and middle-income households, who will have less need to borrow. It will provide the foundation for reforms to the jobs market, and to housing, pensions and the banks.

The point here is that such a solution is not necessarily “export-led”, it’s about re-balancing domestic demand and, in the final analysis, being less import-reliant. I do wonder if this might not be more achievable than banking on a export renaissance.

The Centre Left and Globalisation

The IPPR is doing some excellent work at the moment – their New Era Economics programme looks very promising and I heartily recommend the first major pamphlet on innovation policy.

Today they announced “a major new project on the future of globalisation” chaired by Peter Mandelson.

In the press release they state that:

The benefits of global growth have not been shared equitably (either between or within countries) and global institutions have been unable to resolve the major fault lines which have emerged in the global economy (including trade and currency imbalances).

Nothing to disagree with there. Where I become a tad more concerned is with:

The project will start from the position that free trade, global integration and open markets are vital for economic prosperity… In this context, there is a risk that centre-left policymakers will retreat into a more protectionist mode. 

I am simply not convinced that a belief in “free trade, global integration and open markets” is the best starting point when considering globalisation. And I’m far from convinced that centre-left policy makers retreating into a more protectionist mode is a major risk. The bigger risk, as I see it, is centre-left policy makers (who like the authors of the IPPR press release remain convinced of the benefits of free trade) reacting to the world as they wish it to be rather than as it is.

Now let me caveat this – my ideal solution to the question of global imbalances would be some form of International Clearing Union (as proposed by Keynes as Bretton Woods), in the spirit of this I thought the Geithner Plan presented at the recent G20 summit was a worthy aim. I agree with Gordon Brown that a Global New Deal focussed on correcting imbalances and creating jobs and, in a first best world, some form of progressive multilateralism is the centre-left’s base response to globalisation.

But we don’t live in a first best world. We live in a world of rising currency and trade tensions. We live in world in which Germany seems unprepared to engage in multilateral action within the Eurozone itself, let alone globally.

Leaving aside the current currency and trade tensions, we live in a world in which the future of globalisation will be shaped more by China than by liberal democracies.

I’d rather the IPPR started with a blank page and considered the centre-left response to globalisation from first principles than began by believing that such actions are “vital” to prosperity.

As Paul Krugman noted yesterday (a man who won his nobel prize for his work on trade theory) “trade does not equal jobs”:

If you want a trade policy that helps employment, it has to be a policy that induces other countries to run bigger deficits or smaller surpluses. A countervailing duty on Chinese exports would be job-creating; a deal with South Korea, not. If you want the Korea deal, fine; but don’t claim virtues for it that it doesn’t possess.

We should look again at Alan Blinder’s (another noted Liberal, in the US sense, economist) work from 2006.

So repeat after me: Globalization is good for the world. Which is where economists usually stop.

And where my alleged apostasy starts.

For these same forces don’t look so benign from the viewpoint of an American computer programmer or accountant. They’ve done what they were told to do: They went to college and prepared for well-paid careers with bountiful employment opportunities. But now their bosses are eyeing legions of well-qualified, English-speaking programmers and accountants in India, for example, who will happily work for a fraction of what Americans earn. Such prospective competition puts a damper on wage increases. And if the jobs do move offshore, displaced American workers may lose not only their jobs but also their pensions and health insurance. These people can be forgiven if they have doubts about the virtues of globalization.

Or note what Michael Pettis say about protectionism:

[Trade barriers] force domestic consumers and foreign producers to bear the cost of the adjustment.  Remember however that local households comprise both domestic consumers and domestic workers, so the real impact on household income may be positive if trade barriers are expansionary for employment (which they usually are in diversified deficit economies).  The question is which households.  The unemployed working class may benefit while the struggling middle class may get hurt.

A few weeks ago I challenged free marketeers as to what was here response to rising protectionism.

I understand that their ideal scenario would be unfettered free trade, free floating currencies and minimal government action – but in a real world in which country after country is adopting (or threatening to adopt) measures such as deliberate devaluation, tariffs or export subsidies, what exactly do they propose the UK should do?

I am increasingly realising that that very same question (with a slight amendment or two) could be addressed to much of the centre-left.

Ireland: The Bill Arrives

One week on from the Irish “bailout” and with days to go before the budget (for the latest shenanigans and arm twisting of independent TDs see this excellent Bloomberg story), some excellent analysis is appearing. Much of the best commentary is appearing at the superb Social Europe website and I’d especially recommend the articles by John Weeks, George Irvin and Andrew Watts.

Barry Eichgreen’s article (from a long term supporter of the Euro) is an important contribution.

I’m currently fleshing out my own thoughts on how to move from a short term fix (see here) to a longer term resolution (hopefully finished in the next day or so).

But in the meantime it is worth pausing for a moment and taking stock of what is happening. Because really it’s very simple: Europe has been presented with a bill and is bickering over whom will pay it.

I’m sure we’ve all been there – a long and rather good meal with a large group of people, some of them close friends and some of them vague acquaintances. The bill arrives and suddenly people are disputing exactly how much wine they drank, asking who had a starter and who ordered coffee.  

The situation in Ireland is simply this writ large. During a decade long boom, induced by negative real interest rates, too light regulation and a too-close-for-comfort relationship between Irish politicians, bankers and property developers Ireland has run up a huge amount of debt (government, household and banking sector). The debate now is about how that is settled.

As Michael Pettis has clearly set out, the different strategies open to Ireland and Europe will land different countries and social classes with the adjustment costs:

1. Abandoning the euro and devaluing imposes much of the burden on creditors whose assets are redenominated, especially those with newly mismatched books (i.e. their redenominated assets were funded with non-redenominated euro liabilities).  These may include the wealthy, but because they know this, we will probably see significant flight capital as they liquidate assets and take them out of the country.  Foreign banks who have lent to the redenominating country will also take big losses.  This may sound invidious, but although an approach in which foreigners bear a disproportionate share of the pain may not be fair, it certainly is convenient.
2. Forcing down labor costs through unemployment puts the bulk of the burden on workers and the lower middle classes, especially non-unionized workers.  Other forms of deflation hurt borrowers, including small businesses and mortgage borrowers.
3. Trade barriers may be impractical within Europe (at least before abandoning the euro), but to the extent that they are imposed they force domestic consumers and foreign producers to bear the cost of the adjustment.  Remember however that local households comprise both domestic consumers and domestic workers, so the real impact on household income may be positive if trade barriers are expansionary for employment (which they usually are in diversified deficit economies).  The question is which households.  The unemployed working class may benefit while the struggling middle class may get hurt.
4. Inflation hurts everyone on a fixed income.  Middle class people with savings, pensioners, and non-unionized workers are usually the ones hurt the most.
5. Default and debt forgiveness places the adjustment cost on lenders, in this context especially on lenders to the sovereign borrower.  Again, it is worth remembering that if a disproportionate share of lending comes from foreigners, they absorb a disproportionate share of the cost.
6. Raising consumption and value-added taxes hurts consumers, mainly the middle and working classes since the poorer you are the higher consumption is as a share of your income, while raising income taxes on businesses puts the pain of adjustment on businesses, especially small businesses who often aren’t able to protect themselves.  Finally cutting fiscal expenditures mainly affects the middle classes (medical and education) and the working classes and poor.

As Michael argues, this is essentially a political question – there isn’t a simple, technocratic economic solution. A point worth remembering when economists offer their own solutions. The question is ideological not technical and what matters is no just “what works” but what is right.