Duncan’s Economic Blog

The Real Big Issue: Government Spending or the Wage Squeeze?

Posted in Uncategorized by duncanseconomicblog on June 8, 2011

I’ve been inspired to break my ‘no blogging when on holiday’ rule by a few reports this week.

We got the IMF’s latest update on the economy, the downgrade in growth forecasts was no surprise – the IMF was simply out of line with the OECD and other forecasters. The UK is now in a downgrade cycle, one can reasonably expect the OBR to downgrade it’s own forecast when it’s next updated (which I assume is in November at the next economic and fiscal outlook) and I doubt we have seen the last downgrade from the Bank of England.

These downgrades make for grim reading for the Treasury and will make the task of reducing the deficit that much harder.

But they don’t necessarily spell good news for Labour.

The IMF, the ratings agencies and (despite recent wobbles) the OECD remain backers of George Osborne’s approach. We can disagree with them, we can point of the potential pitfalls of there approach and we can worry that the strategy may prove self-defeating but we can’t close our eye to this.

Those (like myself) that argue against the speed and depth of Osborne’s austerity agenda (too far, too fast)  can marshal Nobel Prize winners, current and former members of the Member Policy Committee and  various other prominent economists on our side. But so can George Osborne.

One sometimes gets the impression reading left wing blogs that George Osborne is a complete economic illiterate and out of touch with all sensible opinion. This isn’t exactly true.

As I’ve tried to point out the real debate here, as in so much of macroeconomic policy, is around a balance of risks – in this case the risk of a bond market panic driving up the cost of borrowing (which I perceive as less likely than HMT) versus the risk of tough austerity damaging the economy (which I perceive as more likely).

What I occasionally worry about is that elements of the left perceive government spending as the only answer.

I’ll be very clear – cutting government spending at a rapid pace whilst demand is weak risks serious damage to the recovery. But it is unclear to me (despite good work by, for example, Anne Pettifor) that more government spending is necessarily the answer.

Labour oversaw a relatively large expansion in state spending in the second half of it’s time in office (although without increasing tax revenues by a corresponding amount). Whilst many of the outcomes of this were beneficial (vastly improved health and education services, a marked fall in child poverty), outcomes that we should be proud of and strive to repeat,  the overall macroeconomic impact is debateable.

The question that people in Labour should be asking themselves is this – do we just want to go back to 2006? Before Northern Rock, before Lehman’s and when Labour had a reputation for economic competence. Back in 2006 it was business-as-usual for Brown at the Treasury, a steady increase in state spending increasingly financed not by taxes on ‘voters’ but by bubble-related revenues from frothy asset markets and a credit boom.

As important work by CRESC has shown
, the UK’s ‘undisclosed business model’ was reliant on a combination of finance in the South East (including London) and then para-state in the regions. The actual productive and real private sector was anaemic.

This model may have succeed in generating a decent rate of GDP growth but is failed many ordinary people.

As recent and highly relevant work from the TUC and the Resolution Foundation has shown. The TUC note that:

The wages of middle income Britain have grown by an average of just 56% since 1978, despite GDP increasing by 108% over the same period. For workers in some skilled trades incomes actually fell in real terms between 1978 and 2008.

The Resolution Foundation’s recent work has demonstrated that between 2003 and 2008 median wages flat-lined and disposable income actually fell in every English region outside London despite headline economic growth of 11%.

I remain convinced that ‘wage-led growth’ is the not only the best route out of the current crisis but also offers a more sustainable future and a model of growth that will benefit ordinary people. Osborne’s policies in this area are totally wrong, he is adding to rather than alleviating the squeeze in living standards. His economic projections are underpinned by a rising level of household indebtedness. He seems to agree with Mervyn King that this is all somehow inevitable.

I’d rather we on the left spent more time focussed on this and less arguing about the right level of government spending.


6 Responses

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  1. Dave Holden said, on June 8, 2011 at 2:01 pm

    I’m fascinated by your need on economics to align with “the left” whatever that is. But that said, I find myself largely in agreement with all of this.

    If we differ it’s that I currently don’t believe there is a path forward that doesn’t involve the required but postponed deleveraging and therefore I can’t see any policy options that will not lead to another recession. Your right however in that if there is a way forward its balancing the risks of increased interest rates against the effects of public spending cuts. This need for balance is why I find the IPPR deficit reduction averaging approach attractive.

    I don’t follow “the left” (or right for that matter) as such but are they generally talking about an increase in spending or just cutting less quickly?

  2. SubstantiveChanges said, on June 8, 2011 at 3:25 pm

    Completely right, and this governments insistance on hammering middle and low incomes will lead to economic meltdown. It is only a matter of time that those forwrd thinking employee empowering companies decide to invest in other countries, and despite what the government says it wont be because wages here are too high it will be because the chances of returns on investment are not possible in a stagnant economy. Countries where there is growth led by wage strength will be the countries that organisations will want to invest in. A strong economy with opportunity and motivation will succeed not those with a ‘can’t do – it is all inevitable’ attitude. this course of action is a recipe for those at the top took keep what little is left but it will not drive the country forward. The last Conservative government had it’s bad points but one of it’s only redeeming features was that it beleived in wealth creation and ambition – this conservative government seems set on reducing the economy at a cost to everyone but hopes those at the top can keep as much as possible. It wont be long before a lot of ambitious companies interested in mutual wealth creation will leave this country to those without ambition whose only option is to keep returns up by wringing savings out of their workforce. with inflation rising and set to rise significantly again downward wage pressure can only lead in one direction and whilst the government may wish to blame unions it will be their policies that sink the ship not honest working people who have accepted a lot in the wake of this recession but there comes a tipping point at which greed at the top in hammering those at the middle/bottom fatally damages an economy and the aspiration and ambition of it’s value adding workforce.

  3. George Irvin said, on June 9, 2011 at 1:29 pm

    Fully agree about the importance of high wages in a recovery. But there are two points, surely. First, higher wages might simply mean increased short-term consumption. Secondly—and crucially—low net investment (net GFCF) is at the heart of the ‘depression’ (I use the NIESR definition of ‘depression’). As long as private sector animal spirits remain low, the state must drive investment—and there is no lack of worthy candidates. State investment—which under current circumstances could be initially funded by monetisation—would ‘crowd in’ private investment, and a sensible way of achieving this would be through a national investment bank which (much like its German equivalent) would raise part of the capital by moping up the excess liquidity of the private sector.


  4. CharlieMcMenamin said, on June 9, 2011 at 9:19 pm

    The issue isn’t the right balance between state and non state investment/expenditure. The current ‘national business model’ really is fucked, I totally agree. The question is, surely, about how to negotiate our way to a future which allows more of our children to enjoy secure, well resourced lives. This may, in the short term, mean a focus on demand increases via increased wages but in the medium term it surely means investment in the industries and services of the future and an acceptance that the finance driven ‘national business model’ we currently have is a function of our post imperial status and can’t *but* decline inthe medium term.

    So who is is going to drive forward this investment, this re-invention of the nation? I don’t think it can be the private sector, at least not the domestic private sector, because they’re so totally in hock to the City. So who else is there to break the logjam but the state?

  5. Barry Thompson said, on June 10, 2011 at 8:15 am

    This is true across the whole Western world, not just for the UK. Rising private debt:GDP levels have occurred everywhere since WWII. This has co-incided with rising inequality.

    If by ‘wage-led growth’ you mean GDP growth with a falling private debt:GDP ratio, then you are absolutely correct – because the private debt:GDP ratio cannot realistically rise much further. Debt must be serviced with income. Western society may have gained an appetite for high leverage, low interest rates, interest-only loans and asset price speculation, but this is not a model for continued growth.

    So, what’s the answer?

    I would argue that new borrowing (public and private) needs to be funnelled into real investments that generate jobs and income. Bank credit creation for speculation in asset prices should be strongly discouraged by government. ‘Investing’ with borrowed money in stocks, commodities or real estate should not be the national obsession. Real investment in new businesses, infrastructure, education, science & technology, and construction should be celebrated and encouraged.

    Currently, the private sector is not borrowing enough to keep GDP growing. So the government should step in with more borrowing and investment to maintain GDP growth. The fear of the bond market is pure paranoia.

  6. Paul Newman said, on June 10, 2011 at 4:01 pm

    ’ll be very clear – cutting government spending at a rapid pace whilst demand is weak risks serious damage to the recovery. But it is unclear to me (despite good work by, for example, Anne Pettifor) that more government spending is necessarily the answer.

    I do not recall you agreeing with me on the many occasions you have said that Government spending was the answer and I have pointed out how unlikely that was . Duncan you are saying in this intelligent and interesting post..( ahem) exactly what I have been saying to you every time I pop in only to be jeered at ,not to say scoffed at .You seem to be getting to a point I made simply ages ago that the sort if New Labour model was not just gone but it could never come back
    Still at least you are repenting your spendaholic ways probably only because you see that at it stands New Labour are dead in the water mid term with nowt but bad news around . God know what it would be like when you actually have to vote and the only support left is Union members
    Politically you have a long long way to go before there is even any traction with private sector wage working people in the South on whom you plan to feast . Establishing credibility requires a lot more than dipping your toe into the waters of sanity , it requires a fully emersed re birth and conversion

    Step into the waters brother Duncan and recieve the wisdom into your soul

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