Duncan’s Economic Blog

The Inevitable Costs of the Crisis: Who Pays?

Posted in Uncategorized by duncanseconomicblog on January 26, 2011

Last night Mervyn King warned that the UK faces the worst decline in living standards since the 1920s.

He stated that: 

unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal.

Because: 

one way or another, the squeeze in living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.

The “inevitable price” of the financial crisis, we are told, is falling living standards.

Certainly the financial crisis had extremely high costs – lost output, higher unemployment and hole blown in the Government’s finances. That may be inevitable, but the question of who pays that bill is a political choice.

I’ve argued before that this is the situation Ireland now faces:

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 bill following the financial meltdown is collusal, the political question is – who pays it?

We have Osborne’s and King’s answers: the crisis may have started in the financial sector but the adjustment costs will be met by the general public. And they’ll pay twice, once through the decline in living standards noted above and again in terms of higher taxes and lower quality public services from the Government’s deficit reduction programme.

There is however another answer, one that looks to an increasing wage share of GDP, public investment and growth.

I know which option I prefer.

23 Responses

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  1. Dave Holden said, on January 26, 2011 at 12:45 pm

    The issue I have with the “left” is a simple one – where does the money come from and how do you reduce the risk of more crony capitalism and debt based speculation.

    That said I agree with your point that the wrong people are going to pay for this.

    Presently those mainly to blame for the current crisis – the bankers, politicians and economists, and the revolving door thereof – are not only being bailed out by the rest of us but rewarded for their incompetence.

    What should happen is banks are forced to mark to market their bad loans, after which it will instantly become obvious they’re insolvent. Bond holder should then be forced to take the hit for the banks bad decisions. The banks temporarily nationalised, properly audited and criminal prosecutions instigated where appropriate. Then they should be split up and privatised either with increased reserve requirements or the investment side split from the deposit side.

    At the same time there needs to be a concerted international effort to reduce global health and safety, environmental and wage arbitrage. How can you average British worker or company compete with those in a country that have next to no environmental or health and safety regulations and that effectively live off of slave labour.

    All of this will be painful but there is no pain-free way of dealing with the current situation and at least those responsible will bear a their fair share of the burden.

  2. Newmania said, on January 26, 2011 at 2:32 pm

    How about the Public Sector through a wage reductions. Their wages have outstripped private sector by 15% over ten years and for the last two real economy wages have been falling while they are sitting pretty. A real world re-negotiation of their pensions which are not sacrosanct contracts like ordinary ones as they are paid by future tax payers. Why should they have them what actually is their worth … bugger all , no -one is competing for their services .
    Why can`t they take their fair share of the strain?
    Banks are an essential part of international capitalism and if you want to do without that then good luck with the scurvy and ricketts. It is not the “Banks`s fault” because they are not a ‘thing ‘ far less a thing that has a will or makes descisions . Their plight is just a market malfunction such as ( you are always keen to say) is inevitable . yes – re-set the market but fault is a silly word .
    t was up to the government to plan for this .They do make descisions and they made the wrong ones .
    We should cancell the £15 billion of international aid and use it for tax cuts which are really what we need . That would help about £750 per hosuehold per year

  3. Dave Holden said, on January 26, 2011 at 3:33 pm

    I agree with you on public sector pensions but that will happen – what can’t be afforded won’t be afforded.

    With regard to blaming the bankers, yes I do blame them but I group them in with politicians and economists and note the revolving door between those three. The bankers essentially failed to properly assess risk yet they’ve not been made to pay for that mistake. Instead they’ve been rewarded, the man on the street however is being made to pay for that mistake. No one (at least I’m not) is talking about doing “without” bankers but they cannot be allowed to externalise risk.

    I also disagree on international aid – yes we have some very tough times ahead but they pale against the situation faced by many in the world.

    • Newmania said, on January 27, 2011 at 2:01 pm

      Then feel free to give to this charity or indeed any other of your choice . I have my own children to worry about ta

  4. gastro george said, on January 26, 2011 at 5:01 pm

    @Dave Holden

    It’s notable that both Blair and Mandelson now work for investment banks …

  5. Dave Holden said, on January 26, 2011 at 5:12 pm

    @gastro george

    Yes both are nauseating examples (I didn’t know Mandelson had also followed that path)

    The US government is just as bad, if not worse. When you see the revolving door between Goldman Sachs and the US government it’s hard not to be suspicious about the real goal of “quantitative easing”

    See Golem’s excellent post on who benefits from the resulting inflated share prices.

    http://golemxiv-credo.blogspot.com/2011/01/zenos-recovery-looking-forward-with.html

    to quote

    “I doubt you own any. Because 90.3% of ALL the stocks, shares and Mutual fund ownership (Which are large, pooled investment funds) are owned by just 10% of Americans. 50.9% of the stocks and shares are owned by a single, golden ONE PERCENT. That ONE PERCENT of the families of America runs, owns or works at Wall Street’s Banks, America’s largest corporations, including its largest, Congress inc.”

  6. gastro george said, on January 26, 2011 at 5:30 pm

    Well it’s also notable that while we have had 6 years of stagnant incomes, executives and bankers have been doing rather better. So if we’re “all in this together”, I know which people have more disposable income than the rest, relative to 2005.

    But, I forgot, the rich need more money as an incentive to work harder, but the poor need less.

    Eventually the man-in-the-street is going to wake up to who is benefiting form the way the economy is run – even those who think we are all middle class now.

  7. Liam Murray said, on January 27, 2011 at 10:43 am

    I’m never comfortable with the characterisation of the crash as ‘the fault’ of bankers as though it were some grand experiment from which only they benefitted but which we pick up the cleaning bill for.

    Surely the revenue from corporation tax & income tax from FTSE100 Directors etc. went to the public good? It probably paid for the majority of the welcome (& long overdue) investment Labour made in public services from which the vast majority of us benefit. It’s always dangerous to talk of groups (bankers, the public etc.) as though they were single, sentient beings but surely we collectively bought into that bubble & the revenue that ‘bankers’ created because of the investment it allowed us to make? I don’t recall Gordon Brown or any significant figures from the political left doubting the wisdom of spending on schools or hospitals because at source it came from these dubious financial practices.

    It’s also true that many bankers made tremendous personal gains but if we were comfortable with that because of the greater good we can’t credibly make an issue of it now.

    It may well be the case that in terms of picking up the bill the bankers & the wealthy aren’t taking a fair share – I just don’t know enough to make a judgement on that. But I do know that the public did tremendously well during that bubble as well and we should show a little more readiness to accept as much.

  8. gastro george said, on January 27, 2011 at 12:02 pm

    Personally, I think the “we should be grateful of all the tax that the rich pay” is entirely spurious – it amounts to “we should be grateful for the crumbs that fall from the table”.

    Regarding the “greater good” and “public doing tremendously well” – well, there is a pretty high percentage of the public that have not been doing tremendously well for a number of decades (look at the decile statistics for incomes), especially if you take into account the deterioration in working conditions and loss of future pension income. This is even worse in the US where incomes for the majority of people have been falling.

    And if that “golden era” leads to a bust (or several busts over the decades) that the poor (and middle incomes) pay for, then overall that’s a good deal more people not doing “tremendously well”.

    It just sounds tremendously complacent.

    • Liam Murray said, on January 27, 2011 at 2:29 pm

      You’re missing my point George.

      If tax revenues from the rich are only ‘crumbs from the table’ then fine, let’s say so at the time, demand more of a share and forego those crumbs until we get a fairer share. My point is you can’t happily consume those ‘crumbs’ & make tremendous political capital from it (i.e. Labour campaigning on ‘investment in public services’) and then point out later that the loaf they fell from was irresponsible and the whole thing was the baker’s fault!

  9. Dave Holden said, on January 27, 2011 at 3:04 pm

    @Liam

    You’ll note I don’t just blame “bankers” I blame bankers, clueless economists and self-serving politicians. Chief amongst that latter category are Gordon Brown and Ed Balls. Both for whom the words hubris and self-regard just don’t cover it.

    Let’s put a little poetic narrative to the last few years. Clearly there was little in the way of a god like guiding hand, no, it was simply the self-interest of those in power.

    So to start; the last ten years and in fact longer than that there has been a gradual moving of production (jobs) by corporations to places in the world where health and safety and environmental regulations are non-existent and where workers are easily exploited.

    For a brief period (about ten years) this all seemed great, we got cheaper stuff, developing countries began to grow, and it kept western inflation in check. In fact this is what Mervyn King referred to as the great moderation.

    So for a while we in the west were happy. So what if China polluted its river and choked its cities. Yes it may be slave labour that’s producing those 3 pound shirts but at least they’ve now got jobs.

    Then someone realised, “if we are exporting all these jobs and arbitraging down the wages of those left how are folks going to pay for all this cheap stuff from China?”

    “Easy!” said the vested interests (yeh, that’s the bankers, economists and politicians) “we make money cheap, that way we can have people borrowing to spend and we can all keep the wheels turning. Even better, China will lend us the money to do it, brilliant! ”

    But wait a minute what if some of that borrowed money ends up being used to speculate on say house prices rather than productive investment? “Meh!”, said the bankers and politicians and economists, “Everyone know houses prices always rise and any way we don’t include house prices in the inflation figures so we can just ignore that when setting interest rates.”

    It was at this point that some people – the wise, prudent and millions not able to partake in the debt driven binge – turned around and look at each other and thought “has the world gone mad”.

    Still these people were not pulling the levers of power, no it was the partier’s that were doing that.

    * Cut to Ocean finance advert for extra pathos *

    At this point the bankers left the politicians behind in their self-serving zeal. They were parceling up debt, slicing, dicing and passing it on to pension funds and the like faster than Gordon Brown could say boom and bust. Not only were they doing this they weren’t even keeping track of what debt belonged to which house (c.f. http://rortybomb.wordpress.com/2010/10/08/foreclosure-fraud-for-dummies-1-the-chains-and-the-stakes/)

    Now somewhere along the line some of these “smartest” men in the room had a “Wiley Cayote” moment – they looked down.

    *Boom* or should I say Bust!

    Frantic scramble ensued, banks stopped lending to each other, why? Because they all knew how much crap they had on their books as the house price bubble began to deflate. They rightly presumed every other banks was in a similar amount of do do.

    Politicians looked at each other, then at the clueless economists and said “how did that happen”

    The wise and prudent ones looked at each other and said “yeh go figure!”

    Those wise and prudent folks also said “so I presume we’re going to let the banks go bust and clear out all that bad debt – after all debt that can’t be paid back won’t be paid back”.

    The vested interests look at each other and said “sod that for a game of soldiers. No, we’re going to take all those bad debt and debt risks on to the public books.”

    The bankers jumped for joy! Yippee!

    The politicians said “but wait you’ve got to start lending again or else”.

    The bankers said “or else what!” The politicians looked at each other – stumped.

    “Yeh your right” they said, “no we’ll just make all those poor wise and prudent plebs pay it back in service cuts and tax increases, oh and by the way we’re also going to print a load of money, stick it into your reserves and allow you to continue speculating – you know carry trade, stock and commodities – that way you can still keep paying your bonuses.”

    *bankers look smug*

    Wise and prudent plebs look at each other and say “but won’t all that speculation lead to a commodities prices bubble causing input inflation. And because we’re in a deleveraging recession and those input costs can’t be passed on the consumer won’t that cause profit compression and therefore more job losses”

    The politicians look at each other and say – “yeh ok but at least the bankers will be paying tax on all those bonuses they *still* getting. ”

    The end.

    • duncanseconomicblog said, on January 27, 2011 at 3:08 pm

      A rather superb comment.

    • Liam Murray said, on January 27, 2011 at 3:20 pm

      I’d say ‘amusing’ more than superb. The flaw lies here:

      “It was at this point that some people – the wise, prudent and millions not able to partake in the debt driven binge – turned around and look at each other and thought “has the world gone mad”.”

      Show me where & when that happened, when people started arguing for more expensive money and disinvestment in developing countries, when people were happily offering to forego public investment because it was rooted in such a ‘mad’ system – then I’ll buy this version of events.

      • Dave Holden said, on January 27, 2011 at 3:25 pm

        @Liam they we’re there but they weren’t being listened to. In fact even the great Mervyn king himself started to feel uneasy toward the end of the bubble about the mismatch between his inflation target not including what was clearly a bubble in asset prices. The likes of Bernanke of course remained clueless to the end.

      • donpaskini said, on January 27, 2011 at 4:25 pm

        I remember dimly Larry Elliott and Dan Atkinson arguing roughly this in Fantasy Island (published early 2007).

        • Liam Murray said, on January 28, 2011 at 10:52 am

          Sorry, that doesn’t sound credible.

          For the level of anger being directed at bankers & politicians now to have any justification you’d need to be able to cite swathes of experts & people who warned about this outcome. Saying ‘they were there somewhere’ or ‘I think I read someone arguing that at some point in a 2007 book’ is laughable and only reiterates my original point – this wasn’t some grand experiment in which we were innocent bystanders, we were willing & active participants.

          • duncanseconomicblog said, on January 28, 2011 at 11:02 am

            Liam, I don’t agree with all of this post – but I think it might interest you:

            http://nihoncassandra.blogspot.com/2009/03/what-is-your-real-name.html

            • Liam Murray said, on January 28, 2011 at 11:53 am

              Cheers. Likewise I don’t agree with every word but when I read:

              “Understanding everyone has a piece of political or economic shit on their shoe, one may begin to let go of the anger and accept that socialization of The Tab is not wholly unjust”

              ….I got a bit irritated, only because they’d said well in one sentence what I’d failed to say in several paragraphs!

              • gastro george said, on January 28, 2011 at 1:42 pm

                Google is your friend.

                Stiglitz in 2005, directed at Greenspan, but indicting the whole edifice.

                Lower interest rates worked, but not so much because they boosted investment, but because they led households to refinance their mortgages, and fueled a bubble in housing prices.

                In short, as Greenspan departs, he leaves behind an American economy burdened with high household and government debt and fragile balance sheets – a legacy that is already contributing to global financial instability.

                • Liam Murray said, on January 28, 2011 at 2:34 pm

                  Again I think your missing my point – I’m not suggesting nobody foresaw this, of course some people did.

                  I’m making the point that the majority of us either didn’t foresee it or, if it was pointed out to us didn’t give credence to those warnings because we liked the upside we were experiencing at the time.

                  Or, to put it in terms of party politics, you can’t laud Labour for ‘investing in public services’ and then blame the bankers for the crash – that investment came from the very activities which the left are now expressing faux outrage about.

                  • gastro george said, on January 28, 2011 at 9:38 pm

                    Well I think that you’re making a false linkage between the two.

                    Just because Labour tried to take a free ride on the neo-liberal “boom” shouldn’t mean that the money raised is tainted in some way. I’d be the first to decry Labour for pursuing the consensus neo-liberal policies. But what if they had chosen a different path, and that had been similarly profitable? We’ll never know, of course. But the money would still have been spent. One is one lot of money tainted but the other not? If the money is well-spent, then that stands alone (certainly better than more tax cuts, anyway).

                    Actually that logic might not work in the case of the Mafia …

                    Of course, if one was a believer in MMT, then there even less linkage between tax and expenditure – but that’s another story.

        • Luis Enrique said, on January 31, 2011 at 11:55 am

          I think you mis-remember Don,

          in that book they actually complain interest rates are higher in the UK than in Japan (“the City does not work for us”) – plus they focus on consumer debt and as far as I recall completely miss leverage within the banks.

          and predicting a housing bubble does not equate to predicting the financial crisis – any idiot could tell you house prices were too high – I started saying that around 2005 and I am certainly any idiot – but falling house prices ought not destroy the global financial system. that’s the bit nobody saw coming.

  10. gastro george said, on January 27, 2011 at 4:01 pm

    Yes, brilliant summary, Dave.

    Another point worth making is that, while the “masters of the universe” are not as intelligent as they think they are, they’re certainly more knowledgeable than most politicians when it comes to the world of finance.

    And politicians have other agendas to watch as well. Like the media and getting elected. So when somebody sells them a source of almost free (and pain-free) money – an easy way out – then they’ll bite your hand off. If they can get away with it, then politicians will try to have their cake and eat it several times over. But that is the nature of the job unfortunately.

    Not that I let the politicians off the hook. The nature of the job should also be to resist temptation and Do The Right Thing.


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