Debt, deleveraging and depression

September 30, 2014

Last week the Economist magazine reiterated its view that global growth has been slowing (http://www.economist.com/blogs/buttonwood/2014/09/markets-and-economy). This would be no revelation to readers of my blog, as I have been arguing that the world capitalist economy has failed to return to previous trend growth rates since the end of the Great Recession in 2009. And this confirmation that the world is a depression.

What is a depression and how does it differ from a ‘common or garden’ recession? Think of it schematically. A recession and the ensuing recovery can be V-shaped, as typically in 1974-5, or maybe U-shaped, or even W-shaped as in the ‘double-dip’ recession of 1980-2. But a depression is really more like a square-root sign, which starts with a trend growth rate, drops in the initial deep slump, then makes what looks initially like a V-shaped recovery, but that then levels off on a line that is below the previous trend line. In a depression, pre-crisis trend growth is never restored for anything up 10-15 or even 20 years.

Depression

In its piece, the Economist highlighted the significant slowdown in global trade growth. This is a point that I have made before (http://thenextrecession.wordpress.com/2014/07/21/global-trade-doldrums/), that world trade has slowed to the to the point where the growth in trade is slower than world GDP growth – a situation that means economies with weak domestic demand cannot compensate by selling more goods in world markets.

The Economist adds that the World Trade Organisation has now cut its forecast for trade growth this year from 4.6% to 3.1% and for 2015 from 5.3% to 4%. And that is optimistic as actual trade growth in the first half of the year was just 1.8, lower than in 2012 (2.3%) and 2013 (2.2%). Economists at Citibank, the huge American bank, now reckon global real GDP growth will be just 2.8% this year rising to 3.3% in 2015, well below trend, the slowdown being led by the so-called emerging economies.

And a new report warns that this slowdown coupled with a failure to cut back the overhang of debt, both public and private, built up in the major economies, threatens to cause a new slump in the world economy. This is the so-called 16th annual Geneva report, commissioned by the International Centre for Monetary and Banking Studies and written by a panel of senior economists including three former senior central bankers (http://www.voxeu.org/article/geneva-report-global-deleveraging).

As bankers, naturally the authors of the report are worried about the level of debt and the failure to ‘deleverage’ while the global economy struggles to recover. The report warns of a “poisonous combination of high and rising global debt and slowing nominal GDP, driven by both slowing real growth and falling inflation”.

According to the Geneva report, the total burden of world debt, private and public, rose from 160% of national income in 2001 to almost 200% in 2009 at the depth of the Great Recession. But the slump did not deliver any deleveraging and total debt rose further to 215% in 2013. “Contrary to widely held beliefs, the world has not yet begun to delever and the global debt to GDP ratio is still growing, breaking new highs,” the report said.

Global debt-to-GDP ratio, 2001-13

Debt

Debt did not fall in the developed capitalist economies because the banks were bailed out by huge dollops of public sector funding raised through government borrowing. So while financial sector debt was ‘written off’, it was replaced by public sector debt so that the banks did not lose out. But in the ‘recovery’ period since 2009, the debt build up has been more in emerging economies. The advanced capital economies have debt levels (excluding the banking sector) of around 260% of GDP in 2009 while the emerging economies had ratios half that, but now heading higher (mainly in China).

Debt dynamics for a selection of advanced and emerging economies

Debt EM and DM

Note: DM = developed markets, EMU = Eurozone; EM = Emerging Markets.

Excluding the public sector, only the US and the UK have seen a reduction in private sector debt, (mainly household debt and households defaulted on their mortgages or paid them down. But corporate debt has stayed high and with pitiful levels of growth in real GDP, if interest rates were to start rising significantly, then the corporate sector could find itself in trouble.

That is what happened in 1937 during the Great Depression, when the Federal Reserve decided that it could safely hike interest rates again and the government could stop running budget deficits as the US economy had recovered. That proved badly wrong (see my post, http://thenextrecession.wordpress.com/2014/08/01/the-risk-of-another-1937/).

The continual optimism about a ‘return to normal’ has been dashed again and again since 2008. Another figure from the Geneva report shows the slowdown in growth forecasts for both advanced and emerging economies, as captured by the progressive reduction in output projections in the different vintages of the IMF’s World Economic Outlook since 2008. Global growth is now way off trend and well below where it was expected to be in 2008 and every year since.

GDP forecasts

Behind the failure of the world economy to get back on track is the failure to restore the profitability of capital in nearly all economies from the peak of 2006 and certainly from the peak of 1997. In addition, given that the burden of debt on capital remains so high, it is no wonder that smaller companies are unwilling to invest in new technology in any significant way, while larger companies prefer to hold cash, buy up their own shares or issue higher dividends to their shareholders rather than expand productive capacity.

The irony is that if companies do start to expand capacity they will eventually drive profitability down further and so lay the basis for a new slump that would be triggered by any significant rise in the cost of borrowing. That is what the Geneva report’s debt analysis is telling us. And they are worried.

Solving crises – it’s easy!

September 27, 2014

You see the cause of slumps under capitalism is easy to discern and, as a result, what to do to avoid them is also straightforward. John Maynard Keynes sorted this out nearly 70 years ago – and without any reference to Marx or any other theorist of crises.

So says Philip Pilkington in a recent post on his blog (Keynes’ Theory of the Business Cycle as Measured Against the 2008 Recession). Pilkington is a research assistant at Kingston University and member of the Political Economy Research Group (PERG) at Kingston University, a UK centre of radical post-Keynesian economists, with its economics department now headed by the brilliant Steve Keen (see my post, http://thenextrecession.wordpress.com/2012/04/21/paul-krugman-steve-keen-and-the-mysticism-of-keynesian-economics/.) Pilkington blogs at http://fixingtheeconomists.wordpress.com/

Pilkington tells us that Keynes sorted all this out in Chapter 22 of the General Theory when he discussed the nature of the ‘business cycle’ and Pilkington concludes that of Keynes’ explanations: “I think they hold up pretty well today”. Pilkington says that Keynes makes clear what the “key determinate” of slumps in production and investment under capitalism: (Keynes quote): “The Trade Cycle is best regarded, I think, as being occasioned by a cyclical change in the marginal efficiency of capital, though complicated, and often aggravated by associated changes in the other significant short-period variables of the economic system.”

As Pilkington says, Keynes’ category of the marginal efficiency of capital (MEC) is “basically the expected profitability that investors think they will receive on their investments measured against the present cost of these investments.” Keynes’ concept of MEC is his version of Marx’s rate of profit. But it is different in some very important ways. First, Keynes is wedded to the neoclassical concept of marginalism. This is the idea, as things (supply or demand) grow, they rise, at the margin, at a slower rate; so there is a diminishing return on each new unit added. Marginalism is not justified in reality: indeed, there is plenty of evidence that there are economies of scale i.e. returns can increase not fall i.e. MEC can rise with expansion. But Keynes joins the neoclassicals in reckoning that, as capital gets larger, the MEC will fall. Indeed this is the basis of his view that capitalism will eventually move to some ‘stationary state’ of nirvana, leisure and prosperity. But that’s another story.

The other aspect of Keynes MEC is that his definition of capital is full of as many holes as Piketty’s (see my post, http://thenextrecession.wordpress.com/2014/04/15/thomas-piketty-and-the-search-for-r/ and others). Is capital just new investment of the stock of capital; is that investment just in tangible structures, equipment and technology, or does it include financial assets like bonds, stocks etc? It is not clear. Also, like all mainstream economics, capital is a ‘thing’ for Keynes, namely it is either tangible equipment or claims of ownership on companies like stocks.

For Marx, capital is a social relation: it is about the way the ownership of things by capitalists enables them to exploit the labour power of those who own nothing but the ability to work. In practical economic terms, that means Marx’s rate of profit includes the cost for capitalists in employing the workforce, as well as purchasing raw materials or factories. So you cannot work out what is happening to the rate of return on capital without including the value creating role of labour. Keynes and all mainstream economists since Smith and Ricardo carefully ignore the value of labour power in their definition of capital.

In doing so, we expose the real difference between Keynes explanation of crises and that of Marx – and which is closer to reality. What happens to cause a slump (recession or depression) in an economy, according to Keynes/Pilkington, is that there is “a sudden collapse in the marginal efficiency of capital.” Pilkington is keen to show that, as against the more ‘orthodox’ Keynesians, the “predominant explanation of the crisis is, not primarily a rise in the rate of interest”.

Pilkington expounds the thesis in relation to the US property slump in 2006-7 that triggered the Great Recession: “Keynes would argue that the causal chain went as follows: interest rates began to rise => the MEC of investors began to fall => eventually the MEC reached a threshold point at which investors stopped building houses. A recession ensued”. Who these ‘investors’ are that stopped building houses is not clear, but leave that aside. The question that flows from this ‘causal chain’ is: why did the MEC fall at some ‘threshold point’? According to Pilkington/Keynes: “The key component in the MEC is, of course, investor expectations. Keynes is clear on this and distinguishes himself from those who claim that a rise in the rate of interest is the cause of the crisis.”

So there is a ‘sudden collapse’ in the MEC of ‘investors’ because they change their ‘expectations’ on the future return of their investments. The cause of crises is thus reduced to the unpredictable (and possibly irrational) psychology of capitalists (investors). This is a subjective, ‘individual agency’ theory of slumps. In contrast, Marx looks at the aggregate accumulation of value and surplus value by the capitalist economy and develops a law of profitability based on the exploitation of labour that explains objectively why capitalists ‘suddenly’ stop investing and a slump ensues.

Moreover, Marx’s theory of crises can explain their regularity; Keynes/Pilkington’s cannot. In the latter, slumps are unpredictable and cannot be regular because they depend on ‘expectations’. Indeed, as Pilkington points out, Keynes denies that there is any ‘business cycle’ at all. And yet when Keynes wrote the General Theory, the evidence of cycles of boom and slump in capitalist economies had been well documented by the likes Wesley Mitchell, Burns and Schumpeter (see Jose A Tapia Granados entitled Does investment call the tune? Empirical evidence and endogenous theories of the business cycle, to be found in Research in Political Economy, May 2012, http://sitemaker.umich.edu/tapia_granados/files/does_investment_call_the_tune_may_2012__forthcoming_rpe_.pdf).

Anyway, with MEC as the cause of crises, Pilkington argues that the cure for crises follows. If the MEC falls ‘suddenly’, then the authorities must cut interest rates to the bone, below the MEC, to restore investment and growth. The problem is that in a depression even that may not be enough and liquidity preference (the desire to hold cash) turns into a ‘liquidity trap’ that an economy cannot get out of even when interest rates are ‘zero-bound’ as they have been since 2008. So Pilkington/Keynes says the authorities must resort to fiscal expansion to ‘pump-prime’ the economy i.e. increase government spending and/or cut taxes. Again to quote Keynes: “the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough” especially “as it is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world. It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism.”

So you see, crises are down to ‘confidence’ and ‘business psychology’ and we must turn these around for the better. Government spending and tax cuts for capitalist companies can do this. Thus the Keynesian answer is not to replace the failed capitalist sector with a planned economy owned in common (heaven forbid!), but to restore the ‘confidence’ of capitalists.

Now I and others have discussed in detail why fiscal spending, whether to raise consumption or boost investment, in a capitalist economy is no guarantee that it will recover (see my posts and papers, http://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/). The Keynesian multiplier won’t work unless the profitability of capital rises (the Marxist multiplier). Indeed, increased government spending in a depression can lower profitability further and extend a slump. Even more important, Marx’s law of profitability will eventually return and the boom will turn into another slump in due course.

Fiscal austerity will make the crisis worse or prolong it, according to Keynesians. This is the line of Simon Wren-Lewis, the arch Keynesian who blogs at http://mainlymacro.blogspot.co.uk/. In a recent post (The entirely predictable recession), he argues that the ‘second Euro crisis’ of 2010 onwards was caused by Euro governments trying to reduce government spending at a time when private investment had collapsed. Instead there was a need for ‘countercyclical’ fiscal stimulus to the economy. So the second recession was entirely predictable under Keynesian theory, he says.

Actually, just how much fiscal austerity was applied by Eurozone governments is a matter of debate, but what Wren-Lewis does not explain is: why the crisis started in the first place back in 2008 – a global crisis clearly nothing to do with fiscal policy and more to do with a collapse in capitalist sector investment. Why was that not predictable from Keynesian theory?

Anyway, Pilkington continues. Keynes’ explanation of ‘sudden’ slumps provides a model for avoiding slumps, you see. “Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

So we need to maintain very low rates of interest ‘permanently’ so that the MEC (hopefully) is always higher and an economic boom can go on forever. If this sometimes generates ‘credit bubbles’ and dangerous artificial booms in property or stock prices, then that is where we use fiscal policy and tax those bubbles away. As Pilkington concluded “I think that this is overly simplistic but certainly on the right track….In this scheme the central bank controls overactive investment markets but does not really hold responsibility for ensuring that economic growth be maintained continuously. That is the role of fiscal policy.” By this judicious macroeconomic management, we can avoid crises forever!

Pilkington, however, is reluctant to allow the people and politicians to have a say in this brave new world of Keynesian policy. “Personally I think that democracies are seriously flawed and politicians generally stupid and short-sighted. For this reason I would recommend building institutions that automatically open up the fiscal deficit”. So fiscal action will become outside democratic control, just as finance capital has managed to get monetary policy out of democratic control with ‘independent’ central banks. The more you consider the Pilkington/Keynes causal chain of slump and the policy solutions of macroeconomic management divorced from democracy, the less it is convincing and the more it is distasteful. Keynes, the patrician, the Platonian philosopher king, knows best.

But would such macro-management of a capitalist economy work? Well, we have had the experience of such attempts in the post-war period when governments attempted to use fiscal policy ‘countercyclically’ to keep the economy on even keel. For a while, it seemed to work and in the Golden Age, investment and GDP growth was strong. But then it all went ‘pear-shaped’ in the 1970s, with the first simultaneous international slump in 1974-5 since the Great Depression and the emergence of ‘stagflation’ (low growth and high inflation) – the opposite of what Keynesian economics predicted. Why did this change take place?

Marxist theory explained it best. The Golden Age was nothing to do with successful Keynesian macromanagement and the subsequent crisis was nothing to do with it being dropped. It was down to the profitability of capital. This fell from the mid-1960s onwards through the 1970s and no matter how much fiscal management or interest rate juggling governments engaged in, governments could not avoid slumps and slower growth. It was not the ‘psychology’ of investors that changed the economy; it was the objective change in profitability that changed ‘investor expectations’.

It also changed bourgeois economic theory. Keynesian economics gave way to monetarism and neoclassical equilibrium theory. The more radical aspects of Keynesian theory (uncertainty, irrational expectations, the marginal efficiency of capital) were dropped for more orthodox theories of supply and demand for money.

Simon Wren-Lewis, has been lamenting the failure to maintain Keynesian economics as providing the best explanation of capitalist economies and the best prescription for avoiding slumps. In Where macroeconomics went wrong, he comments “Why did we have a revolution which overturned an existing methodology and temporarily banished Keynesian theory,… I would love to know the answer to these questions.”

I think the answer is obvious: the Keynesian approach in its most radical form (“the socialisation of investment”) was unacceptable to the strategists of capital anyway; and even its more moderate approach was a failure in explaining the crises of the 1970s and 1980s. So mainstream economics returned to the theory of ‘free markets’ untouched by expensive government taxation and spending, and to a forthright attack on wages, regulations and employment. This was necessary to restore the profitability of capital. This became the neoclassical, neoliberal mainstream (for more on this, see the draft of an appendix on Keynesianism for my forthcoming book, The Long Depression, APPENDIX TWO). Keynesian economics had no answer to ending crises while preserving capitalism, so it was dropped or merged into the mainstream. It still does not provide an explanation for the current slump and depression or a way out.

Where is the economic recovery?

September 20, 2014

The two major international economic agencies of the global capitalist economy continue to revise down their forecasts for economic growth in this year and next.

In an update to its forecasts made last May, the OECD announced that the “outlook had darkened for 2014 and 2015 for almost all the world’s large economies”.  The OECD revised down its forecasts for 2014 growth for all large economies except India.  It now expects growth of 2.1% in the US, 0.8% in the Eurozone and 0.9% for Japan, downward revisions in each economy between 0.3-0.5% points. The UK will be the leader among the advanced capitalist economies at 3.1%.  For 2015, the OECD continues to hope for a pick-up but even here it has again trimmed most of its forecasts. The US is forecast to grow 3.1%, down from the 3.5% forecast made last May, while the Eurozone and Japan are now expected to manage only 1.1%.

Real GDP

The OECD admitted that world GDP growth of just over 3% a year was well below pre-crisis rates, confirming that there has been no return to ‘normal’.  What is also interesting is that the so-called emerging economies are also slowing down.  According to the OECD, of the major ‘emerging economies’, China will still achieve 7.4% growth, although that is looking increasingly doubtful.  And Brazil will achieve only 0.3% growth this year.

And the IMF in a new report reckons out that average real GDP growth in the emerging economies (including China) declined from 7% during the pre-crisis period (2003-8) to 6% over the post-crisis period (2010-13) and will now slow to 5% over the next five years (2014-18). Growth rates have been lower than the pre-crisis average in more than 70% of emerging markets since 2012.

EM forecasts

Ironically, having called for wage restraint and fiscal austerity for several years since the end of the Great Recession in 2009, the OECD now says that “while [weakness in wages] helped contain job losses during the crisis and was necessary in some euro area countries in order to regain competitiveness, it is now holding back a stronger recovery in consumer spending.”  Productivity growth in the major economies is pathetic at around 1%, but even that is being eaten up by profits as real wages have been virtually flat since the end of the Great Recession.

Wages and productivity

So it’s no wonder financial markets have been booming while global growth has not.  This worries the OECD.  “Exuberant financial markets are “at odds” with growth in the real economy and “this highlights the possibility that risk is being mispriced and the attendant dangers of a sudden correction.”

The IMF, in a document prepared ahead of this weekend’s G2o meeting of finance ministers and central bank governors in Australia, said that growth in the first half of this year was weaker than it had predicted in April and is set to reduce its own forecasts.  The IMF warns that “the global recovery is on precarious footing, as rising geopolitical tensions and the prospect of tighter monetary policy in the US risk dampening the outlook for global growth.”

This contrasts with the optimistic talk coming out of the US and the UK from economists and government officials about economic recovery.  Britain’s faster growth rate still seems to me to be based on an imbalanced economy, led by booming house prices and financial markets, rather than a recovery in manufacturing, exports and productive investment that could raise productivity.

The latest official data on UK home prices show a spirally housing market, with average home prices in London hitting over £500,000 or $850,000!  Up to July, house prices were rising at 11.7% yoy, with London up 19%.

UK home prices

At the same time, while unemployment has been falling, real wages have been falling too.  Wage growth at just 0.7% yoy is still well below an inflation rate of just 1.7% yoy.  And real disposable income is probably contracting even more if taxes and benefits are taken into account.  This is not a recipe for sustained economic growth and a reckoning is likely to come.

UK real wages

The lack of any rise in the real incomes of average households is repeated in the US.  The US has suffered another year of stagnant incomes as the economic ‘recovery’ failed to translate into rising prosperity for average households.  Inflation-adjusted income for the median American household rose by just 0.3% in 2013, according to the Census Bureau and is no higher than a quarter of a century ago.

The well documented rising inequality gap since the mid-1990s was confirmed by the Census Bureau.  Since the 1990s, the top 5% of American households have increased their real incomes by 1.4% a year while middle-income households got only a 0.4% rise each year, or more than three times as fast.

US real incomes

And there has been a huge decline in household incomes for the bottom 20% who have seen a staggering 16% fall in real income which peaked way back in 1999!  Indeed, 60% of American households have seen a fall in real incomes of about 10% since 2000. And the biggest hit to incomes is with households with adults aged between 45-54, who should be getting their peak lifetime earnings and are having big spending for kids going to school etc.  Since 1999, household real incomes for this age bracket are down nearly 16%.

US age income

Even Federal Reserve Chairwoman Janet Yellen was forced to comment on this.  She admitted that the 2007-2009 recession had “left lasting scars on the poorest American families that have yet to heal more than five years” into the official economic recovery.

So if economists are expecting a sustained economic recovery based on increased consumer spending then they will be sadly disillusioned.  No wonder the OECD is worried.

Of course, capitalist production can recover through increase business investment that generates more employment.  But investment in the real economy and particularly in productive sectors remains in the doldrums globally, while corporate profit growth seems to have reached its limits in this cycle even in the US (see my post, http://thenextrecession.wordpress.com/2014/08/24/getting-out-of-a-jackson-hole/).  So that does not augur well for a pick-up in global growth in 2015.

Scotland: one prediction right

September 19, 2014

Back last June, I made some rash predictions about the UK and globally (http://thenextrecession.wordpress.com/2014/06/10/uk-industry-some-predictions-for-2015-onwards-and-a-piketty-review/).

The first was that “the Scots will narrowly vote no to independence, reducing the uncertainty about the break-up of the UK for another decade. This will be a relief for British big business. Alex Salmond and the Scottish Nationalists will use the narrow defeat to get more concessions on tax-raising powers (already promised by the Conservatives) and will look for another vote down the road.”

The vote NO was decisive on a large turnout, but Glasgow, Scotland’s biggest city, voted YES to independence.  That suggests a significant anti-Tory and anti-political elite vote, probably from the younger voters.  The economic case for an independent Scottish capitalist state  that would benefit working people compared to the Union was weak at best (see my post,
http://thenextrecession.wordpress.com/2014/09/04/scotland-yes-or-no/) .
But the mood of opposition and disgust at the UK’s governing circles was strong and expressed in the size of the yes vote.

The major parties have promised extra tax and spending powers to the Scottish parliament and a continuance of the so-called Barnett formula for the distribution of central government expenditure to the regions.  Scotland already gets a higher share of spending per head than elsewhere.  So, in effect, the new powers (to be rushed through the Westminster parliament by Robbie Burns night on 15 January) mean that Scotland will have ‘home rule’ in all but name.  This could lead to moves for similar regional powers for Wales, Northern Ireland and even the English regions.  This is a creeping federalisation of the state in the UK.

Also, the failure of the Euro leaders to revive the Eurozone economy, provide more employment and rising real incomes for the majority is breeding fragmentation of European politics, both in a falling share of the vote for the major capitalist and social democratic parties, and in calls for independence by Catalans, Flemish Belgians and Romanians in Hungary etc.  We shall see where it leads.

My other – very rash – predictions are still pending – Conservatives to win in the May 2015 election; the British people to vote to stay in the EU in a referendum in 2017; a peak in global growth in 2015; a fall in the rate of profit in all major economies from then; a new slump in 2016 or so.

 

 

Rethinking economics in the backwater

September 16, 2014

Almost 1000 people attended the three-day Rethinking Economics meeting in New York, the follow-up to the recent RE meeting in London (see my post http://thenextrecession.wordpress.com/2014/06/30/rethinking-economics/). Rethinking Economics is an organisation set up by mainly postgraduate economics students concerned at the failure of mainstream economics to grasp the reasons behind the global financial collapse and its failure to open up the curriculum in university economics departments to economic thinking beyond mainstream neoclassical or ‘orthodox’ Keynesian ideas.

There seems to a huge interest among young economics students and academic economists to break with the ‘closed shop’ of mainstream thinking. And the New York chapter of Rethinking Economics was able to get some ‘big hitters’ from mainstream and heterodox economics to make presentations or join discussion panels. The whole thing was live streamed across the globe.

Watching online, we were greeted with a panel composed of leading Keynesian guru and Nobel prize winner, Paul Krugman; Willem Buiter, now chief economist at Citibank and former professor at the LSE; and James Galbraith, son of the legendary JK Galbraith and one of the few heterodox professors of economics in a university post.

The eminent three were asked why mainstream economic theory failed to forecast the global crisis and why it had struggled to explain it. Krugman said he held to the view that mainstream economic theory with its models of markets, representative economic agents and equilibrium analysis was still useful, but was inadequate without recognising that economic reality was lot ‘messier’.

Willem Buiter seemed to go further when he reckoned that what was wrong with mainstream economics was that it assumed equilibrium from the start and then added in ‘frictions’, ‘instability’ or ‘imperfection’. It ought to start by assuming ‘chaos’ and then build in content and form to develop useful theory. This seemed so vague as to be useless. But to be fair, this was panel discussion without the chance to develop arguments in detail.

In a recent post on his New York Times blog, Krugman explained his position on models and theory better
(http://krugman.blogs.nytimes.com/2014/09/11/their-own-imaginary-keynes-wonkish/).
The famous Keynesian model of the macro economy is the IS-LM model (investment=savings on one side and liquidity preference and money supply on the other). The IS–LM model attempts to explain the relationship between interest rates and real output. The intersection of the IS and LM curves is the ‘general equilibrium’ where there is simultaneous equilibrium in both money and ‘real’ markets. In this model, the equilibrium is not met (and crises occur) if savings exceed investment causing a lack of effective demand and/or liquidity preference exceeds money supply and causes a rise in the price of money (interest rates) that makes equilibrium growth unviable.

Many heterodox or post-Keynesian economists deny this was Keynes’ view of a monetary economy and that he was much more concerned with instability, irrational expectations and uncertainty as the explanation of financial crises. Krugman argues that Keynes may have been interested in uncertainty as a cause of financial instability but his real contribution was to show that a capitalist economy can establish an equilibrium where underemployment is permanently established and to restore full employment requires intervention to lower interest rates and/or boost investment. That is the value of the IS-LM curve model. All else is too vague.

Krugman’s position at Rethinking Economics has come in for some strong criticism by ‘post-Keynesians’ like Philip Pilkington and Lars Syll (https://fixingtheeconomists.wordpress.com/2014/09/15/krugman-at-the-rethinking-economics-conference-still-wrong-on-monetary-theory/ and http://larspsyll.wordpress.com/2014/09/16/krugman-and-mankiw-on-loanable-funds-so-wrong-so-wrong/).

It has become an interminable debate between orthodox Keynesians and neoclassical economics on whether there has to be some ‘exogenous’ intervention to get going a capitalist economy that has slipped into permanent stagnation or lack of effective demand; or whether the market can right itself through changes in wages and prices of assets.

As James Galbraith put it in his contribution, mainstream economics is divided between ‘freshwater economists’ (those based in Chicago like Lucas, Fama (see my paper The causes of the Great Recession) etc who reckon that a ‘free market’ can solve all) and ‘saltwater economists’ (those based in the East Coast universities like Yale, MIT, Harvard and Columbia who follow Keynes in reckoning the capitalist economy needs the help of fiscal and monetary authorities to put a modern economy in depression back on an ‘even keel’).

Galbraith said he was in neither camp. He was part of ‘backwater economics’, those economists of the heterodox tradition that saw modern capitalism as full of inherent flaws that required institutional change and radical surgery to deal with recurrent crises and rising inequality, for example. It was backwater economics, because it was ignored or excluded by the mainstream camps. There were hardly any heterodox economists in university posts anywhere and yet it was some of these economists who were the only ones to predict the financial crash and ensuing Great Recession. Galbraith referred and pointed to Steve Keen in the audience who had predicted the crisis (see my post http://thenextrecession.wordpress.com/2012/04/21/paul-krugman-steve-keen-and-the-mysticism-of-keynesian-economics/), subsequently lost his job in Western Australia and only just been appointed head of economics at the radical heterodox University of Kingston, London.

Galbraith wanted economics to return to a study of economic history and institutions and not get bogged down in economic models and maths without any political economy. That brings me to Marxian economics. Marx’s economics is ‘political economy’, or to be more exact, Marx made a critique of political economy, or the ‘mainstream economics’ of the early 19th century. Marx was not afraid of, or opposed to, using models or maths to explain the laws of motion of capitalism. But the main task of Capital and Marx’s other economic writings was to expose the flaws in the economic theory of the great ‘classical’ economists like Adam Smith and David Ricardo who had tried to analyse the nature of the capitalist mode of production objectively, if from the point of view of the rising capitalist class. Marx also aimed at exposing the apologetic ‘vulgar’ economists like Malthus and others who just wanted to propagandise the necessary role of the capitalist class and the market economy.

This was part of the theme Professor Richard Wolff (http://www.rdwolff.com/) presented in the only presentation on Marxian economics in three days at Rethinking Economics – as in London, the New York conference was dominated by either orthodox Keynesians or ‘post-Keynesian’ speakers. Marxist economics remains the real backwater.

In an excellent account, Wolff explained that Marx made a critique of the ideas of Smith and Ricardo, developing their labour theory of value into a theory of exploitation that explained why capitalism, in overthrowing feudalism and supposedly establishing ‘liberty, equality and fraternity’ (to use the slogan of the French revolution), did no such thing. One class system of exploitation had been replaced by another, only the mode of production and social exploitation had changed.

For Wolff, this was the decisive insight of Marxian economics that had to be denied by mainstream economics. From the 1870s onwards, an honest objective critique of capitalist flaws was replaced by apologia. And a counterrevolution in economics began, with the labour theory of value and exploitation dismissed and ridiculed (and relegated to the backwater), to be replaced by ‘utility’ theory, marginal productivity and equilibrium markets. Austrian economist Bohm Bawerk did the demolition job on Marxist theory and Jevons, Walras and others developed the ‘neoclassical’ propositions and theory that still define the mainstream (including Keynesianism). For an excellent account of the major differences between Marxian economics and classical and neoclassical economics, see Alan Freeman’s paper (Freeman on Marx’s theory). And also read Wolff and Resnick account in their book on comparative economic theories (http://www.rdwolff.com/content/contending-economic-theories-neoclassical-keynesian-and-marxian.)

As Wolff said, there is no real alternative to economics in universities that does not assume the capitalist mode of production is here to stay. The split in mainstream economics in the 1930s was product of the Great Depression and the rise of a labour movement demanding change. Thus Keynesian economics reared its theoretical head in recognising that capitalism had serious flaws (at a macro level) that must be addressed by intervention (even extreme interference in markets on occasion) in order to save capitalism from itself. Such an approach has never been fully adopted by the majority of mainstream economics and after the 1970s , Keynesian ‘intervention economics’ was dropped in place of a return to free markets, particularly in labour, with globalisation and financial deregulation.

There was a certain naivety in the work of Rethinking Economics that things can change. Marxian economics, let alone heterodox economics, will remain a ‘backwater’ in academic institutions because these things are not decided by the strength of ideas (contrary to Keynes’ view) but the economic and social power of the ruling class.

Paul Krugman has commented that “hardly anyone predicted the 2008 crisis… but more damning was the widespread conviction among economists that such a crisis couldn’t happen. Underlying this complacency was the dominance of an idealized vision of capitalism, in which individuals are always rational and markets always function perfectly.”

But it was not just the failings of mainstream theory; there was a deliberate ideological need to defend capitalism and the status quo: “Clearly, economics as a discipline went badly astray… But the failings of economics were greatly aggravated by the sins of economists, who far too often let partisanship or personal self-aggrandizement trump their professionalism. Last but not least, economic policy makers systematically chose to hear only what they wanted to hear. And it is this multilevel failure — not the inadequacy of economics alone — that accounts for the terrible performance of Western economies since 2008.”

As one tweeter on the meeting commented, “arguing with economists about ‘rethinking economics’ is like arguing for abortion with the Pope in front of the College of Cardinals”.

Crises and their Resolution

September 15, 2014

The Resolution Foundation in the UK does important economic and statistical analysis in highlighting the exploitation of labour, inequalities in wealth and income and failures of the welfare system to defend the poor (http://www.resolutionfoundation.org/). It recently hosted the UK book launch of House of Debt, with both authors (Mian and Sufi) on stage alongside Martin Wolf, the Keynesian FT columnist and Stephanie Flanders, formerly the BBC economics editor, but now taking a pay packet from JP Morgan, the American investment bank. (see
https://www.youtube.com/watch?v=UmSU0jCGt6k&feature=youtu.be)

It was standing room only to hear praise heaped from those present on Mian and Sufi’s book, increasingly regarded in the mainstream as important an explanation of the global financial crisis and the ensuing Great Recession as Thomas Piketty’s book, Capital in the 21st century is seen by the leading mainstream economists as offering the best explanation for the growing inequality of wealth and income in the major economies.

I have critiqued Mian and Sufi’s book in a recent post (http://thenextrecession.wordpress.com/2014/06/28/its-debt-stupid/). For them, it is excessive debt that was the cause of the US housing bust, the banking crash and then the recession. The answer is to introduce measures that control excessive credit and all will be well.

I criticised this view from two angles: the first was that Mian and Sufi provided no real explanation for why debt got excessive except that central banks let it happen through a lack of regulation. As I argued in my post, behind the rise in debt and the subsequent collapse is a crisis in the profitability of capitalist production. Not surprisingly, this explanation is ignored by Mian and Sufi and, of course, by the likes of Wolf and Flanders.

The second point is that Mian and Sufi’s solution to future excessive debt is to get creditors and debtors to share the risk of any default, thus making the bankers more careful about lending to people who cannot pay it back.  This policy would be a major interference in the free market for credit and in the profits of the financial system and has as much chance of being adopted as Piketty’s policy to reduce inequality through a global wealth tax.

Both the House of Debt and Capital in the 21st century deliver the worst of both worlds – they don’t identify the real cause of crises and inequality in modern capitalism, but at the same time offer utopian and unrealistic policies to solve these problems because they want to sustain the capitalist mode of production. So it is no surprise that Keynesians like Wolf, the economists of the Resolution Foundation and subtle supporters of the financial system like Flanders and her mentor Larry Summers, reckon the House of Debt has the answer.

Wolf himself has just published his book, The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis (see an interview with Wolf in http://www.newrepublic.com/article/119403/qa-martin-wolf-his-new-book-financial-crisis). In it, he argues, as do the Keynesian wing of mainstream economics, that the cause of the Great Recession “was a savings glut (or rather investment dearth); global imbalances; rising inequality and correspondingly weak growth of consumption; low real interest rates on safe assets; a search for yield; and fabrication of notionally safe, but relatively high-yielding, financial assets.” There is little explanation for the occurrence of these bad things, or why they keep recurring over the history of capitalism, except to lay the blame on lack of banking regulation.

So, while Wolf backs Mian and Sufi’s policy answer, he also calls for a return to the deep regulation of the US Glass-Steagall Act of the Roosevelt era that broke up huge universal banks so that none were ‘too big to fail’ (i.e. would cause a systemic collapse). Wolf demands that banks hold more capital (equity) on their books from investors, so that they can withstand any future crises. But such ‘heavy’ regulation has already been bypassed or rejected by national governments, the IMF, the BIS and the World Bank. So again Wolf’s explanations of crises and policy prescriptions are both wrong and utopian at the same time.

World economy: getting back to trend?

September 14, 2014

The latest high frequency indicators of economic activity in the major economies suggest that global economic growth picked up a little in the summer. Based on my measures of the so-called purchasing managers indexes (PMIs), business activity in both the advanced capitalist economies and the so-called emerging economies is up from a weaker first quarter.

Business activity indexes

This would suggest a global annualised growth rate of about 3.0-3.5% for 2014. That’s better than the first quarter by some way, but still below the rate achieved in the recovery from the Great Recession in 2010.

Global PMI

And, as has been documented in this blog and in many other places, the economic recovery from the Great Recession has been the weakest of all recoveries from slumps since the second world war. Since the end of the Great Recession, world industrial production growth has averaged only 40% of the rate achieved before the Great Recession and only 60% of the long-term average. The productive sectors of world capitalism are crawling along.

And that conclusion also applies to the US, the economy that has achieved the best recovery of the all major capitalist economies (G7) since 2009. The US GDP is still 5% pts below its ‘full potential’, even though it has been the US economy that has led the way in this ‘recovery’. The last set of US GDP and employment figures, as I outlined in a previous post (https://thenextrecession.wordpress.com/2014/08/29/the-us-recovery-the-long-depression-and-pax-americana/), suggest that the US economy is expanding at little more than about 2% a year, well below the post-war average of 3.3% and even more behind the pre-crisis rate.

However, there is more talk among mainstream economists that the US, at least, is now on a path of sustainable ‘normal’ growth, something I questioned in a recent post
(http://thenextrecession.wordpress.com/2014/08/14/the-myth-of-the-return-to-normal/).

Gavyn Davies, former chief economist at Goldman Sachs and now a columnist for the FT, reckons that the US recovery now looks sustainable. Davies recognises that global financial crashes and slumps combine to limit and delay economic recovery, but: “such recoveries are slower than normal in their early phases, and they therefore take much longer to bump into supply constraints. On average, such shocks are followed by economic recoveries that last for 8-9 years, as compared to 5 years for the present US recovery. At about the current stage of the recovery, they actually tend to speed up a bit.” http://blogs.ft.com/gavyndavies/. And he quotes the work of his old employer, Goldman Sachs, which shows that the US economy could at last be about to head back to the trend growth rate of the past (see graph below).

Wolrd recovery cycle

The evidence of the weekly US economic indicator ECRI would also suggest that the US economy might be reaching a lift-off point.

ECRI

But these activity surveys are the only evidence that I can find for Davies’ assertion. US business investment shows little sign of a significant pick-up and corporate profits have actually stopped rising.

US business investment level

Employment growth remains lacklustre and real wages for average Americans are flat at best. Indeed, the latest Federal Reserve survey of household finances shows that median family incomes in the US have dropped so much in real terms since the Great Recession that they are now no higher than they were 16 years ago!
(http://www.federalreserve.gov/pubs/bulletin/2014/pdf/scf14.pdf).

US median family income

So a Keynesian-style demand boost for the US economy from household spending looks unlikely. If consumption and business investment remain in the doldrums, so will the US economy.

The United Nations Commission for Trade and Development (UNCTAD) just released its annual report on the global economy. UNCTAD remains gloomy about a return to normal (http://unctad.org/en/pages/PublicationWebflyer.aspx?publicationid=981). UNCTAD concludes “six years after the onset of the global economic and financial crisis, the world economy has not yet established a new sustainable growth regime. With an expected growth between 2.5 and 3 per cent in 2014, the recovery of global output remains weak.” It points out that “international trade remains lacklustre. Merchandise trade grew at close to 2 per cent in volume in 2012−2013 and the first few months of 2014, which is below the growth of global output. Trade in services increased somewhat faster, at around 5 per cent in 2013, without significantly changing the overall picture. This lack of dynamism contrasts sharply with the two decades preceding the crisis, when global trade in goods and services expanded more than twice as fast as global output (at annual averages of 6.8 per cent and 3per cent respectively).

UNCTAD, being an institution that is somewhat ‘off message’ compared to the IMF and the World Bank, calls for coordinated global action by governments to reverse ‘market liberalism’, reduce inequality and follow the prescriptions of Pope Francis (see my post, http://thenextrecession.wordpress.com/2013/11/28/ayn-rand-pope-francis-and-the-philosophy-of-greed/)!

Don’t hold your breath.

Scotland: yes or no?

September 4, 2014

With two weeks to go, the latest polls suggest that the upcoming referendum vote on independence for Scotland could be close, although the average of all polls still suggests that Scots will vote no to independence. It’s going to be a big turnout though.

In this post, I want to try to analyse the arguments for and against independence mainly from the point of view of whether an independent capitalist Scotland would be better for the Scottish working class in economic terms, and for that matter the rest of the British working class, than remaining in the Union with the rest of the UK.

Principles

But first let’s start with the principles. A united world in a fair and equal federation or commonwealth of states would be the most beneficial to the majority. It would mean sharing resources, culture and ideas to the benefit of all through a democratic process. So, a federation of the old nation states of the British Isles would be better, in principle, for the majority who live by their labour and not by profit and ownership of capital. But this implies a socialist federation.

Of course, if any nation wants to stay separate, or to become separate, from such a union, then that is up to them. They should be able to decide in a free and fair vote. And a union or federation of nation states that is not equal and is more of an oppressive union of the large and powerful over the small is not good news – and this is the model of all capitalist federations. On the other hand, staying separate as a ‘nation’ for the sake of it is an antiquated and backward idea in human social development, and particularly for working people. It also ensures the continuation of the capitalist mode of production.

The decision for yes to independence or no should not be based on whether Scotland needs to be a nation – it is one, in geography or territory and, to some extent, in culture, although that has been diluted over centuries with the gaelic language almost dead and ‘scots’ seriously reduced. Catalonia in Spain, also possibly considering independence from Spain, is more of a nation in that sense, as it still has its own living language. But then Ireland is clearly a nation, but uses English. And the Scots clearly consider themselves a nation.

Scots

And yet there is little difference in attitudes between the majority of English and Scots. Polls show that Scots have similar views to the rest of the UK when it comes to welfare, immigration, benefits, unemployment and public spending. Summarising the data from social attitudes surveys, Lindsay Paterson of Edinburgh University writes: “These differences, though generally placing Scotland to the left of England, are not so huge as to signal a fundamental gulf of social values.” Most people in the UK did not vote for the Conservatives in 2010. Most people in Scotland did not vote for the SNP at the Holyrood elections in 2011.

For the English working class (if we can talk about such a thing), the issue is clear. It is much better for the English if the Scots stay within the Union as an important part of the electoral and industrial struggle against the pro-capitalist parties. Only the most reactionary of the English working class favour independence for Scotland – i.e. ‘getting rid of the moaners north of the border’. In all polls on the issue, those south of the border favour the Scots staying, including those Scots living south of the border.

The reality

Of course, in the real world, principles do not apply. The Union of Scotland with England and Wales first became a reality under absolute monarchy, with succession of James VI of Scotland to the English throne in 1603, although the parliaments of the English and Scottish aristocratic elite remained separate. Formal Union with the ending of the Scottish parliament was established by decrees from both parliaments in 1707. Article 1 of the Act of Union of 1707 states that: “the two kingdoms of Scotland and England shall on the 1st of May and for ever after be united into one kingdom by the name of Great Britain.”

The Union was forced on the Scottish ruling class by economic circumstance. Its wild speculative schemes to set up a ‘colony’ in Panama (ironically raised as model for an independent Scottish currency now – see below) as a pale shadow of English colonial development, had bankrupted the Scottish economy. The Scottish ruling elite then agreed to a ‘merger’. Actually, the majority of the English ruling class was opposed to the Union as they thought it was too costly to bail out the Scots (similar to the arguments about Scottish bank failures now). But Union was forced through by the strategists of the rising English capitalist class and backed by the budding urban bourgeois of the Scottish lowlands. It was opposed by the rural highlanders and chiefs who wished to preserve their clan system and looked to a reactionary Catholic monarch, then in exile, as a saviour from English/Scottish capitalist takeover.

But let’s return to now. The question for the Scottish working class is whether having an independent capitalist government operating out of Edinburgh is better than having a British government operating from Westminster – for their living standards, control over production and distribution, defence and security, health, housing and education.

It will be a pro-capitalist government, whether Scottish Nationalist or Scottish Labour. The SNP see their vision of an independent Scotland as one where banks and big business continue to accumulate profits and capital; and where land ownership is the most concentrated in the developed world (half of Scotland’s land is owned by just 500 people).  “We are now six years into an SNP government which has done absolutely nothing legislatively about the most concentrated, most inequitable, most unreformed and most undemocratic land ownership system in the entire developed world”, Jim Hunter, Land Reform Review Group.

An independent Scotland will retain the Queen and the British monarchy as the official head of state, the (English) pound will remain the currency, a ‘nuclear deterrent’ is still accepted and the armed ‘defence’ of the country will remain in the hands of others (NATO). Private education and health sectors will remain (and even increase), and housing will continue to be dominated by private landlords and construction companies, with the public housing playing little role. And the SNP wants Scotland to join the EU, a reactionary ‘free market’ based union, but with all the ‘opt-outs’ that were ‘won’ by the Thatcher government for the UK (something that will not be granted). And the EU is now imposing severe public spending targets on its members.

That part of the Scottish business class that favours independence is pleased with this vision. “The SNP is patriotic, well organised and has prominent business support just like the old SUP. My suspicion is that, whatever he says publicly, Alex Salmond is well aware of his potential support from the patriotic right wing in Scotland, which is why he was so keen to back the Scottish regiments and abandon opposition to Nato. Whatever happened to the Scottish Tories? They turned into Scottish Nationalists. You read it here first”, says Jim Walker, a hedge fund adviser., And “It will be fascinating to observe Scotland becoming more Thatcherite while pretending not to do so. “ says another City economist Andrew Smithers, in the FT.

So it’s a moot question whether much will change for the working people of Scotland. But let’s consider the economics of it.

The oil

The mainland (excluding offshore energy) Scottish GDP per head is almost bang on average for the UK as a whole. If it included all the oil, Scotland’s GDP per head is about 18% above average. Unemployment, inequality, growth and the structure of the economy is closer to the UK average than in Northern Ireland, London or northeast England. Over a long-period, real GDP growth has been a touch slower than England’s.

Scotland’s exports to the rest of UK (rUK) account for 70% of its exports. Exports to Scotland account for 11% of rUK exports. So Scottish capitalism is heavily integrated into British capitalism, more so than Canada into the US. In 2012, Scottish exports to rUK amounted to £48bn while rUK exports to Scotland were £59bn. So an independent Scotland would run a trade deficit with its main trading partner, the rUK, thus requiring investment or credit funds from ‘abroad’ to fill the gap.

Scottish exports

Scotland would be a small capitalist state dependent on trade with rUK and little possibility of reducing that dependence. Now it could be argued that Scottish capitalism would have more flexibility and it’s true that some small states sometimes do better economically than large ones. But small states are also more vulnerable to the vicissitudes of global financial and production crises like the Great Recession, as the experience of the Baltic states, Ireland, Portugal, Greece, Iceland and Cyprus has shown in the last six years. They have suffered far more than Scotland did as part of the UK.

Energy-rich Norway has one of the highest living standards in the world, it remains outside the EU and has huge financial reserves. Could an independent Scottish capitalist state become another Norway? Well, if we analyse the projections for future oil and gas production in the North Sea, the answer is no.

Even if Scotland were to gain rights to 90% of UK energy revenues through taxing the multinational oil and gas companies after independence, most forecasts suggest a decline in those revenues over the next decade or more. Forecasting revenues is extremely difficult given that volatility in prices, fluctuations in output and oil industry investment have a direct impact on the tax take. Technological advancement and policy reform could help turn marginal fields into profitable ones. An independent Scotland would depend on oil for 18% of its wealth, yet North Sea production has been falling 6% a year for the past decade.

Professor Rowthorn from Cambridge has pointed out how oil price uncertainty was “one of the strongest arguments against independence”. Over the next 25-30 years, most estimates are that North Sea oil revenues will decline whatever happens to the price of oil. David Phillips, a senior research economist at the Institute for Fiscal Studies think-tank reckons that “even with a geographic share [of revenues], Scotland’s finances get worse by the middle of this decade”.

The Aberdeen-based billionaire Sir Ian Wood, former head of oil services supplier Wood Group, who in the past year has led a government-commissioned review into how best to exploit the North Sea’s remaining resources, has also warned of a sharp tail-off in production from 2030. Sir Ian acknowledged that as many as 24bn barrels of oil equivalent may remain, but he suggested 15-16.5bn as a more likely total – compared with the more than 40bn extracted since the 1970s. Oil & Gas UK puts the range between 12-24bn. The Department of Energy and Climate Change reckons UK oil production will decline from 43m tonnes this year to 23m a year by 2030.

If you assume that the oil price will rise from $102 a barrel in 2015 to $160 by 2040, in other words, stay much the same in real terms, then revenues from the North Sea will not rise in real terms at best and probably will fall. Robert Chote, chairman of the OBR, predicted a sharp fall in UK oil and gas receipts from £6.1bn in 2012-13 to £3.5bn by 2018-19, with far steeper declines after that. The UK culled total revenues of £4.7bn from the North Sea in 2013-14.

oil revenues

Public finances

And this brings us to government finances under an independent Scotland. The latest Scottish official figures show that, if calculated on the same basis as the rest of the UK, a so-called per capita basis – with oil revenues shared equally across the UK – Scotland’s public sector had a budget deficit of 13.3% of GDP in 2012-13, the latest year for which figures are available. That compares with 7.3% for the UK as a whole; the Scottish deficit is nearly twice as large. Even with 90% oil, Scotland’s budget deficit in 2012-13 was 8.3% of GDP, bigger than that for the whole of the UK. Indeed, it has been bigger on that basis for the past 25 years. The Institute for Fiscal Studies reckons that, over time, a Scottish government will run bigger fiscal deficits than the UK over the next 50 years.

fiscal

This is because Scotland will have a population that ages more than the rest of the UK, so pension and health costs will rise more. Also public spending per head in Scotland is 10% higher (maybe for the best reasons). Yet the SNP plans to cut corporate taxes for business to attract more investment, so relying on foreign capital to boost growth and jobs.

So it is not going to be easy for a Scottish government to maintain slightly higher levels of public spending for Scots than south of the border without running larger fiscal deficits that will have to be financed by borrowing (issuing Scottish government bonds) from the City of London and elsewhere. The energy revenue stream has varied between 5-22% of Scottish tax receipts over the last 20 years, averaging around 12%. Managing such violent swings, with such a large fiscal deficit as a starting point, would be no easy task. The government will face rising interest costs on that borrowing compared to the cost of borrowing by the Westminster government, perhaps an interest rate premium of 50 to 100 basis points, potentially more. Scotland would also inherit a significant proportion of UK government debt. This is what the SNP wants to negotiate.

Also, if Scotland joins the EU as a separate member, it will be subject to the severe fiscal austerity targets now being imposed on the likes of Greece, Portugal, Spain and others by the EU under its fiscal pacts. That threatens the ability of the government to sustain better health and education services as well as welfare benefits, especially if corporate taxes are being cut at the same time. Already, it has been revealed that current Holyrood control of the health service has led to significant privatisation of contacting services, just as in England. A major study by the Nuffield Trust in April suggested the performance of the health service in Scotland had improved in relation to England. But the policies that had made the difference were UK-wide – such as waiting list targets – not the result of devolved decision-making.

The currency

The cost of borrowing by a Scottish government raises the issue of Scottish banks and the role of the Bank of England, which has been a major issue of debate between the yes and no camps. Scotland’s banking assets – in practice the potential liabilities of an independent Scottish government in the event of independence – are a staggering 1,100% of GDP. Scotland has a potential banking liability of Icelandic proportions and much bigger than those (700% of GDP) which almost bankrupted the Irish economy. This oversized banking sector will shrink as the likes of Lloyds and others take their Scottish base away (with the loss of jobs and income), but RBS apparently plans to stay. Ironically, this is 86%-owned by the Westminster government and regulated by the Bank of England (BoE).

Under a proper currency union of Scotland and rUK using the pound, the BoE would set interest rates independently of government and parliament. So a Scottish government would still have no say over the basic interest rate, which would be determined by unelected BoE members using just the inflation rate of the UK as a guide. Scotland would remain under the grip of the City of London and the fluctuations of economy and the financial sector of rUK, as before.

A sterling monetary union is the Scottish Government’s preferred option for an independent Scotland (new report). So this would mean accepting the interest rate decisions of the BoE and allowing fiscal control to remain with Westminster or the EU, just as happens now in the UK. These would include submitting budgetary plans to Westminster, accepting some continuing oversight of its public finances by UK authorities and limiting the degree of tax competition between Scotland and the rest of the UK.

But so far, all three major parties south of the border say that the Bank of England should not act as ‘lender of last resort’ to Scottish financial institutions after independence if they get into trouble. Of course, a Scottish government can adopt the pound as its currency without being part of currency union with rUK, or the credit backing of the BoE. This is what Panama does with the US dollar. But then Scottish capitalism is on its own if things go wrong in the night with its banking system or if inflation takes off north of the border. That risk means that the City of London will want to charge more to lend to a Scottish government and corporations because of the extra risk involved.

The only faction of pro-capitalist economists who think that the Panama solution would be best is the extreme ‘free market’ Adam Smith Institute. Research director Sam Bowman, commented “the ‘Panama option’ may be his best bet for an independent Scotland… emulating Panama could give an independent Scotland a remarkably robust financial system because Scotland’s banks could not depend on an unlimited central bank lender of last resort.” No central bank for Scotland would be good news.

It’s true that other ‘currency pegs’ (as they are called) have been successfully sustained over lengthy periods. Hong Kong’s link to the US dollar has been maintained since 1983 and the exchange rate between the Danish krone and the euro has been fixed since the formation of the Eurozone. But these are separate currencies from the dollar and the euro. And the Hong Kong Monetary Authority has accumulated massive dollar reserves. The Scottish situation would be different. Scotland could presumably expect to receive a pro rata share of Britain’s gold and foreign exchange reserves. But the £10bn or so that Scotland might expect would be hopelessly inadequate to defend a fixed exchange rate from speculative attack.

Alternatively, a variable exchange rate between Scots and English pounds would be a mess. The queues at the bureau de change at Edinburgh’s Waverley railway station would be the most visible result. More important, Scottish households and companies would have to decide how to denominate their assets and liabilities and choose the currency in which they wished to trade. This is what Hungarians and Poles found after taking out ‘cheap’ euro mortgages and watching their income in forints and zlotys to service them plunge.

Three models

We could sum up the future of an independent Scottish state from three possible models. The first is that Scotland becomes an energy-rich Norway with huge oil and gas revenues, staying outside of the EU, with the highest living standards in the world and huge reserves for a rainy day. This is not possible for Scotland with declining North Sea output and revenue in real terms and the need for multinational investment in energy technology.

Second, it could become an Ireland based on a low corporation tax and incentives for multinationals to come and invest. Ireland achieved this in its Celtic tiger period, but mainly because it was part of the EU and the Eurozone, as well as having access to the UK market. This will not be possible for Scotland as Ireland has already occupied that space and Scotland would have to be in the EU as well (possibly at a time when the UK withdraws!). To get into the EU, Scotland would probably have to agree to join the Eurozone at a certain point (that’s what every new member must now agree to), thus dropping the pound, for rule by the ECB and the EU fiscal pact.

The third model is Iceland: a small independent state with a high standard of living relying on fishing and bauxite mineral mines, outside the EU and with the ability to devalue its own currency in crises. However, Iceland is only the size of Coventry and it did not escape the global financial crisis either.

Both Ireland and Iceland were brought their knees by an oversized banking sector that took ‘hot money’ and relent it recklessly to destruction. The banks were bailed out in Ireland at huge and continuing cost to Irish households. Iceland was forced to devalue, creating sky-high inflation and it had to negotiate a deal for repaying lost bank deposits with the UK and Holland, again at a huge loss to the living standards of its small community (see my post, http://thenextrecession.wordpress.com/2013/04/28/icelands-electors-how-ungrateful/). Scotland would face the same issue.

At best, the majority of the Scottish people will find little difference under Holyrood than under Westminster and it could be worse if a global crisis erupts again. Scotland as a small economy, dependent on multinationals for investment, still dominated by British banks and the City of London and without control of its own currency or interest rates, could face a much bigger hit than elsewhere in terms of incomes and unemployment.

So independence would not bring dramatic economic improvement to the majority of Scots; indeed, it could mean a worse situation. But then the decision on independence is not just a question of the economy and living standards. That brings us back to the issue of the Scottish and English/Welsh (and Irish) working class sticking together in the struggle against British capital. Will an independent Scottish capitalist state strengthen that in any way?

If the vote is yes, I’ll look at the repercussions for the UK and Europe in a future post.

Ukraine: a grim winter ahead

August 31, 2014

As the war along Ukraine’s borders takes a new turn, with Russian incursions on the south-east coast and NATO preparing a new ‘expeditionary force’, Ukraine’s economy heads fast down a black hole. New President Poroshenko, one of Ukraine’s feuding oligarchs (in his case, the confectionery king), has dissolved parliament and called elections for 26 October. The election will probably lead to the removal of all the old supporters of the ousted pro-Russian former president still in parliament. They have been blocking attempts by the current caretaker prime minister Arseniy Yatsenyuk to carry out the dictates of the IMF under the $17bn ‘reform’ programme agreed last April.

In return for IMF money to meet foreign debts and fund the state (for arms mostly), the Kiev government agreed to huge cuts in public spending, pensions and welfare and, above all, to privatise state agencies and raise energy charges for heating and fuel by over 40%, a total reduction of government spending of 6.75% of GDP. The government agreed to these draconian measures because there was no alternative. As Yatsenyuk said, while the IMF deal would mean hardship for the people and be unpopular, he was prepared to conduct ‘suicide politics’.

Yatsenyuk was so frustrated by parliament’s lethargy in agreeing the IMF measures that he threatened to resign, forcing a collapse of the government. The measures were finally passed, but not before the economy minister Pavlo Sheremeta also threatened to resign in anger at delays in implementing the IMF ‘reforms’. “We need to change this whole paradigm: the system, the people, the processes,” Sheremeta said.

The problem for the pro-IMF government and its foreign investor supporters is that the economy is on its knees and the targets set by the IMF will not be met. In addition, the war is destroying the country’s infrastructure. For example, an $80m food processing plant, opened in 2000 by Cargill, was one of the first big greenfield investments into independent Ukraine. It was abandoned by the US agriculture group’s employees after being stormed by pro-Russian gunmen. Now it has been destroyed by fire.

The latest data indicate that the Ukrainian economy has contracted almost 5% yoy so far this year, the IMF’s forecast for the whole year. The final contraction for 2014 is likely to be 8% in real terms, even if the war should subside.

Ukraine GDP.jpg

The loss of Crimea alone has cut Ukraine’s GDP by 3.7%. The rebel provinces of Donetsk and Lugansk account for about 16% of GDP and 25% of exports.

An energy crisis looms for the winter. Russia’s Gazprom, which provides more than half the country’s gas, stopped supplies in June. The government has been paying fuel subsidies equivalent to 7.5% of GDP. Its energy intensity – the ratio of energy used to economic output – is twice that of Russia and ten times the OECD average. Reducing this huge waste of energy is part of the IMF plan. Carl Bildt, Sweden’s foreign minister, reckons: “If Ukraine improved its energy efficiency to reasonably EU levels, I doubt it would need to import any energy at all.” The resources to do this through better management of heating, insulation and control of private energy companies are not there, of course.

The IMF wants to cut public spending so that government debts do not rise so much that foreign lenders, including the IMF itself, won’t get their money back. You can see how much Ukraine will owe to the IMF by 2018 in the graph below.  Public sector debt-to-GDP will double towards 87% by 2018, as taxation of the rich oligarchs is non-existent. Ukraine owes $3bn to Russia itself and Moscow can demand immediate repayment.

Ukraine FX debr

As I argued in my last post on Ukraine (http://thenextrecession.wordpress.com/2014/08/11/ukraine-a-rock-and-a-hard-place/), the falling value of the hryvnia only makes the debt on foreign currency terms worse. The IMF’s own risk assessment warns that if the hryvnia falls to 12.5/$, then the stresses on bank balance sheets would require a bailout of at least 5% of GDP. The currency is currently weaker than that, at 13/$.

Ukraine currency

The IMF issued a statement before the weekend congratulating the Kiev government on trying to meet its demands: “Overall, economic policies have generally been implemented as agreed in the program, as the Ukrainian authorities have persisted in taking difficult measures despite the volatile political situation.” But despite the imposition of severe austerity measures, the IMF is worried that it will still go pear-shaped: “However, the conflict in the eastern part of the country is taking its toll on the economy and society, and compensatory measures will be critical to achieve key program targets agreed for 2014 and beyond. The program remains highly challenging and continues to hinge crucially on the assumption that the conflict will subside in the coming months.”

As Christine Lagarde, the IMF’s managing director, said: “Downside risks to the program remain very high. The program success hinges on a timely resolution of the conflict in the East, as well as on the authorities’ strong policy performance and adherence to the planned reform.”

What is the IMF answer to the worsening economic situation? More austerity. Lagarde (now under investigation for corruption herself) called on the government to “(i) take steps to accumulate international reserves, (ii) tighten the fiscal stance in 2015–16 relative to the initial program targets, and (iii) step up efforts to put Naftogaz on a sound financial footing by improving bill collections and adjusting energy prices as needed.”

It is almost certain that the IMF will have to cough up more money to tide Ukraine over or Ukraine will default on its debts and obligations to foreign governments and investors. A “reprofiling” policy is being discussed by the IMF board. This would ‘stretch out’ any repayments but leave the overall debt untouched – still a default and restructuring but a ‘soft one’.

There is an alternative to the Kiev government policy of capitulating to the IMF. A socialist government would take over the interests of the oligarchs who stole Ukraine’s wealth in the first place. It would seize those funds to meet the needs of ordinary people on heating, education and public services. It would revoke the debts owed to Russian and Western banks and demand that the IMF write off its loans so that Ukraine could start without the heavy burden of debt. Ukraine remains a key agricultural exporter and also a low-cost steel producer. If the banks and major export sectors were in the government’s hands and not those of oligarchs (and foreign private equity companies in the future), then a national plan could be implemented.

Also, it would offer to discuss with genuine representatives of the Russian-speaking eastern areas a proper federation and autonomy, a guarantee of rights in education and language. The aim would be to reassure the Russian-speaking areas with economic and political support, rather than the alternative of war that Poroshenko and Putin promote. Instead, Ukraine’s people, both in the west and east, face a grim and increasingly deadly winter.

The US recovery, the Long Depression and Pax Americana

August 29, 2014

Revised figures for growth in the US economy in the second quarter of this year were released yesterday. Most analysts were pleased as the rise in real GDP in Q2 2-14, was revised up from a 4.0% annualised rate to 4.2%. The drop in real GDP for the first quarter of this year was confirmed at -2.1%. When compared to the prior quarter, the new measurement is up about 6.3% pts from the -2.1% contraction rate for the 1st quarter of 2014. This is the largest positive quarter to quarter improvement in GDP growth in 14 years.

The reason for the slight rise in the revised figure was that business investment (i.e. investment by companies in new equipment, offices and technology as opposed to residential investment by household buying houses) was revised up from 5.5% to a 8.4% annual rate of growth. At the same time, the first figures for corporate profits in the second quarter were announced. Profits rose $155bn compared with a drop in profits of $202bn in the first quarter of this year.

So it would appear that the US economy is now growing quite strongly and the terrible first quarter was really just due to a ‘bad winter’ as was argued by the mainstream at the time. But looking at quarterly rates of growth (annualised) may be useful to show how an economy is doing from one quarter to the next. But it does not show the trend of activity. For that, it is better to compare year-on-year growth. And here the story is less exciting.

After the revisions, the US economy in real terms has grown 2.4% compared to this time last year. Not bad, and certainly better than anywhere else among the top economies, apart from maybe the UK. But growth in the first quarter was only 1.9% yoy, so in summing up, in the first half of this year, the US economy expanded in real terms by 2.2%.  But as you can see, this growth rate is pretty much in line with the trend since end of the Great Recession.

US real GDP

Indeed, the current rate of 2.2% yoy for H1 2014 compared with the average rate of growth since mid-2009 of 2.0%, hardly higher; and with the average in the credit boom between 2002 and the onset of the Great Recession of 2.6% yoy. And the current rate is still one-third below the long-term average rate in the post-war period for the US economy of 3.3% a year. So, not so great. Indeed, US GDP per-capita is 9.8% below the pre-recession trend (graph below from Doug Short).

US real GDP per cap

Also to get the real GDP figure, the official stats assume an annualized quarterly inflation of 2.15%. Yet during the second quarter, the seasonally adjusted inflation index rose at a 3.53% annualized rate. If that inflation rate were used to deflate nominal GDP growth, the Q2 growth rate would be 2.9% not 4.2% and real growth would be close to 2%, with per-capita GDP growth (after taking into account a growing population) just 1.1%.

And this recovery does not feel like one to most Americans. Real annualized per-capita disposable income is now $37,481, up only 2.19% in total since the second quarter of 2008 — a miserable 0.36% annualized growth rate over the past six years. And that’s the average – for most Americans disposable income has fallen. Of course, the forecasts are for a huge pick-up in the rest of this year to take US growth up to 3% or more and so start to change the whole picture – we shall see.

The US economy is clearly stuck in below-trend growth.  I have called the period since 2008 a Long Depression and it now seems that even some of the mainstream Keynesian economists are prepared to use a similar term.  Brad de Long has now noticed that the US “did not experience a rapid V-shaped recovery carrying it back to the previous growth trend of potential output.(http://equitablegrowth.org/2014/08/28/start-calling-greater-depression-early-friday-focus-august-29-2014/). Indeed, the recession trough in 2009 saw the US real GDP level 11% lower than the 2005-2007 trend. Today it stands 16% below (see De Long’s graph below).   Cumulative output losses relative to the 1995-2007 trends now stand at 78% of a year’s GDP for the United States, and at 60% of a year’s GDP for the Eurozone.

Dropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression htmlDropbox 20140825 Financial Crisis to Great Recession to Lesser Depression to Greater Depression html

De Long goes on: “A year and a half ago, when some of us were expecting a return to whatever the path of potential output was by 2017, our guess was that the Great Recession would wind up costing the North Atlantic in lost production about 80% of one year’s output–call it $13 trillion. Today a five-year return to whatever the new normal might be looks optimistic–and even that scenario carries us to $20 trillion. And a pessimistic scenario of five years that have been like 2012-2014 plus then five years of recovery would get us to a total lost-wealth cost of $35 trillion.”

De Long concludes that “At some point we will have to stop calling this thing “The Great Recession” and start calling it “The Greater Depression”. When?”  How about now?

As for business investment, which has been performing really badly since the Great Recession, optimism was expressed at the upward revision in the second quarter data. But the yoy rise in business investment at 6.4% was only slightly higher than the post-recession average of 6.1% and business investment as a share of GDP is still lower than it was before the Great Recession.

In my opinion, sustained growth that would be close to the trend average would require a significant rise in the rate of business investment. And business investment growth depends in turn on the movement in corporate profits.

The latest corporate profits figures are really not encouraging on that basis. The data show that corporate profits have been falling in the first half of this year compared to the first half of 2013. As the figure below shows, business investment tends to follow the direction of corporate profits (CPBT) with a lag. As I have shown before, and as the graph below confirms, US corporate profits went negative some six to nine months before the credit crunch began in mid-2007 that kicked off the global financial collapse in 2008 and the Great Recession. Indeed, US real GDP did not contract until mid-2008. In reverse, corporate profits began to rise in mid-2009 well ahead of investment (some nine months later) and GDP. Profits lead investment.

US profits and investment

The latest data for corporate profits, if sustained in the next few quarters, would suggest that business investment will eventually drop towards zero. Again ,we shall see.  A further decline in the mass of corporate profits will depend on whether the profitability of capital, and in particular, the rate of return on new investment, falls or not. The best data on this will not be available until November, but I shall try to make some forecasts in a future post. If that happens, then it could herald a new recession by the end of 2015.  But we are getting ahead of ourselves.

Talking of the US rate of profit, I have been looking again at the long-term trajectory of the profitability of US capital. Dumenil and Levy made an estimate of the US rate of profit a la Marx going back to 1870 (http://www.jourdan.ens.fr/levy/uslt4x.txt). Recently, as part of his analysis of the ‘world rate of profit’, Esteban Maito also made an estimate of the US rate of profit over the same period (see http://thenextrecession.files.wordpress.com/2014/04/maito-esteban-the-historical-transience-of-capital-the-downward-tren-in-the-rate-of-profit-since-xix-century.pdf). His data are exactly the same, because he takes his figures directly from Dumenil and Levy.

Dumenil and Levy measured the US rate of profit using current cost estimates for fixed capital and excluded variable capital (the cost of labour). This is not the best way theoretically to do it (see my paper, http://thenextrecession.files.wordpress.com/2011/07/the-profit-cycle-and-economic-recession.pdf). Using historic costs for fixed assets and including variable capital would be the closest to the rate of profit a la Marx. Using current costs can distort the level and direction of the rate of profit for periods of time, as Andrew Kliman has pointed out (http://thenextrecession.wordpress.com/2011/12/08/andrew-kliman-and-the-failure-of-capitalist-production/). But as Deepankar Basu has shown, over a very long period of time, these distortions will tend to disappear as the impact of inflation or deflation on fixed asset values is ironed out (see BASU capmeasure).

If we take D-L’s data as the best we have for the rise of American capitalism from 1870 into an imperialist power in the 20th century, what it shows is that, over the whole period, there is actually a slight trend upward in the US rate of profit, not down. We can see why in the graph below.

US profitability since 1870

In the post-Civil War boom, a rising American capitalist economy had very high rates of profit. The Depression of the 1880s drove that down sharply. Then there was a recovery that peaked at a lower level in the mid-1890s before falling again. World War 1 got the rate up a bit with a rise to a new peak in 1924. The decline after that presaged the Great Depression of the 1930s. World War 2 pushed the US rate of profit into the stratosphere and signalled a new hegemonic role for US imperialism and the age of Pax Americana. World wars are great for profitability, particularly for the US.  The US rate of profit is still higher than in the inter-war period. Indeed, only the post-civil war boom period of 1870s saw higher rates. WW2 transformed the US ROP and its global power status.  So US capital has had a higher ROP in the last 70 years since 1945 than it did in the 60 years before 1945.

The drop in profitability post-1965 coincided with revolutions in Europe: Spain, Greece, Portugal; in Vietnam, Latin America and parts of the Middle East; as well as intensified class struggle in France, the US and the UK. A rising rate of profit in the so-called neoliberal era of the 1980s and 1990s coincided with reaction, the collapse of the Soviet Union, the end of the cold war and a brief New World Order around US dominance.

But since the late 1990s, the US rate of profit has stagnated at best, now engendering a long depression in growth and investment, as discussed above.  Pax Americana has waned too (as the failure of US imperialism’s objectives in Vietnam, Somalia, Iraq, Afghanistan, Syria and Ukraine show).  American hegemony is increasingly difficult to sustain as the profitability of American capital stagnates or falls.

 


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