Rethinking Rethinking economics

Can economics ever become ‘pluralist’?  Namely, will the universities and research institutes in the major capitalist economies expand their teaching and ideas to cover not just mainstream neoclassical and Keynesian theories but also more radical heterodox themes (post-Keynesian, Austrian and Marxian)?  If you look at the list of study courses that are considered heterodox by Heterodox News, there are not many in the UK and the US and are concentrated in a just few colleges – with the big names having no such courses at all.

Rethinking Economics, a pressure group of academics and students was launched over four years ago to turn this round. Now in July, Rethinking Economics said Britain’s universities were failing to equip economics students with the skills that businesses and the government say they need. Following extensive interviews with employers, including organisations such as the Bank of England, it found that universities were producing “a cohort of economic practitioners who struggle to provide innovative ideas to overcome economic challenges or use economic tools on real-world problems”.  Moreover, the group said, “when political decisions are backed by economics reasoning, as they so often are, economists are unable to communicate ideas to the public, resulting in a large democratic deficit.” 

There are efforts among some academics to broaden the outlook of economics graduates. The Core project was adopted by 13 UK universities last September and has won £3.7m from the Economic and Social Research Council.  As the Guardian put it: “the developers of the programme also claim it has freed itself from neoliberal thinking, which judges markets to be self-adjusting and consumers and businesses to be operating with the same information. The world is full of asymmetric power and information relationships, and Core reflects this.”

The Core project has produced an antagonistic reaction from right-wing commentators.  The prolific right-wing British political blogger, “Guido Fawkes”, tweeted: “The left in the universities are trying to rehabilitate Marxist economics to poison the future. Very concerning that they got £3.7 million of taxpayers’ money to do it”.  One strong promoter of Core and Rethinking Economics, the leftist economist, Jonathan Portes, responded to Fawkes that he was sure that none of the contributors to the Core programme were Marxist and “I’m obviously not a “Marxist”.  And that is true.  

The reality is that Rethinking Economics and Core is dominated by Keynesian ideas with hardly any look-in for Marxist ones.  It’s true that Sam Bowles is one of the main coordinators of the Core textbook project and he considered himself a (neo?) Marxist in the past – but his recent comments on Marx’s theories at the 200th anniversary suggest otherwise now (see here).

I am reminded of that first London conference of Rethinking Economics.  At that meeting, leading radical economists Victoria Chick and Sheila Dow told us that reform of society would be impossible until we can change the ‘closed mind-set’ of mainstream economics. As if the issue was a psychological one. Mainstream economics is closed to alternatives because there a material interest involved. But Chick and Dow seemed to think that it’s just a question changing the mind-set of other economists that support the market – for their own good because austerity and neoliberal policies are actually bad for capitalism itself.

More recently, leading leftist economists in the UK held a seminar on the state of mainstream economics, as taught in the universities.  They kicked this off by nailing a poster with 33 theses critiquing mainstream economics to the door of the London School of Economics.  This publicity gesture attempted to remind us that it was the 500th anniversary of when Martin Luther nailed his  95 theses to the Castle Church, Wittenberg and provoked the beginning of the Protestant reformation against the ‘one true religion’ of Catholicism.

The economists were purporting to tell us that mainstream economics was like Catholicism and must be protested against, just as Luther did back in 1517.  But as I commented then, is a revolution against the mainstream really to be painted as similar to Luther’s protestant revolt?  The history of the reformation tells us the protestant version of Christianity did not lead to a new pluralistic order and freedom to worship.  On the contrary, Luther was a bigot who worked with the authorities to crush more radical movements based on the peasants, led by Thomas Munzer.

Don’t get me wrong: attempts to expand economic ideas beyond the mainstream can only be good news and the content of the Core project is really stimulating and educational.  But it seems that, for Rethinking Economics and Core, the mainstream economic ‘religion’ is just neoclassical theory and that it is neoliberal economics that must be overthrown. They have nothing to say against Keynesian economics – indeed variants of Keynes are actually the way forward for them.

Take the new course at University College London for undergraduates. It’s called Rethinking Capitalism – a new elective module for UCL undergraduates.  Run by Mariana Mazzucato, the director of the Institute of Innovation and Public Purpose (IIPP) and author of The value of everything, it’s a great initiative, with guest lecturers including Branco Milanovic. . The module aims to “help students develop their critical thinking and make the connections between economic theory and real world policy issues. It will provide an introduction to a range of different economics perspectives, including Neoclassical, post-Keynesian, ecological, evolutionary, Marxist and institutional economics theories and how their different assumptions link to different public policies.”  But looking at the BASC0037 Rethinking Capitalism. I am sceptical that students will hear much about Marxist economic theory within its ‘heterodox’ approach.

Keynesian theory dominates in Rethinking Economics and so do the policy conclusions arising from Keynesian ideas in wider left circles.  Take the recent seminar organised by the IIPP in the UK’s House of Lords to discuss the financing of innovation (badly needed given the poor performance of the British capitalist sector in productivity growth).  But who did the IIPP line up to discuss with Mazzacuto the very limited proposal for a UK national investment bank to replace the European Investment Bank when the UK leaves the EU next year?  It was Tory Lord David Willetts, and as keynote speaker, Liberal leader Sir Vince Cable!  Cable was quoted approvingly to say that “The current enthusiasm for ‘selling the family silver’ (ie privatisation)) has its roots in bizarre Treasury accounting conventions.”  This was very rich hypocrisy coming from Cable, who when in coalition with the Conservatives, presided over the privatisation of Royal Mail, Britain’s state-owned postal service, selling it off for a price at least £1bn below market value – yes, selling the ‘family silver’.  I’m not sure that the IIPP will get far with its laudable aim of increasing the state role in innovation and investment by relying on these people for support.

And Keynesian ideas are central to the opinions of key advisers for the leftist Labour leaders in Britain.  In a recent article, Ann Pettifor, director of Prime Economics, blamed the economic crisis in Turkey and other ‘emerging economies’ on ‘orthodox economics’, in particular the move by central banks to hike interest rates and ‘normalise’ monetary policy. I’ll be debating with Ann Pettifor on what to do about finance at this year’s Momentum conference taking place during the Labour Party conference in Liverpool in late September.  I too have pointed out the risk that this policy entails for the world economy when profitability is still low and debt is high.

Pettifor’s conclusion was that “it was time to ditch economic orthodoxy” and….”revive the radical and revolutionary monetary theory and policies of John Maynard Keynes” as the way to avoid another global crisis.  But regular readers of this blog will know that I have shown Keynes’s ideas were far from radical, let alone revolutionary.  And they certainly would not avoid another global crisis.  And thinking they would do so would be a step back for the labour movement and its leaders.

One key point is that capitalism is not just a monetary economy as Keynesians think; it is a money-making economy.  You can print money indefinitely, but you cannot turn it into value under capitalism without the exploitation of human labour.  When you sift through the body of ideas in Core, one thing stands out: the failure to analyse modern economies with a law of value and a theory of exploitation for profit.  Profit and exploitation do not appear in the body of Core work (except for fleeting references to Marx).  And yet this is at the heart of capitalism and is the soul of Marxist theory.

Are there textbooks that do offer a Marxist alternative to neoclassical and Keynesian schools?  My favourite is Competing Schools of Economic Thought by Lefteris Tsoulfidis.  Then there is Contending Economic Theories by Richard Wolff And Stephen Resnick.  There is the new two-book textbook on Microeconomics and Macroeconomics by Ben Fine and Ourania Dimakou.  And of course, there is Anwar Shaikh’s monumental Capitalism (which the dedicated can dip into if they have their brains working!).  These should be on the curriculum of Core and Rethinking Economics courses. Maybe they will be.  But it may require a rethink.

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Turkey: total meltdown

The Turkish lira is in total meltdown.  It has lost 40% of its value against the dollar in the last six months and fell nearly 20% in the last week.  The turkeys have come home to roost on the country’s economy and the erratic economic policy of its autocratic (recently re-elected) leader, Recep Tayyip Erdogan.

What triggered the crisis was when the US imposed asset freezes on Abdulhamit Gul, Turkey’s justice minister, and Suleyman Soylu, interior minister, for their alleged roles in the detention of Andrew Brunson, an American pastor. Mr Brunson, who ran a small church in Turkey for two decades before he was arrested in October 2016, is accused of participating in a conspiracy to topple Mr Erdogan. The pastor has described the charges as “slander”. His detention is just one of a number of disagreements between Turkey and the US that range over divergent stances on Syria to the delivery of US arms.

Then on Friday, Wilbur Ross, US commerce secretary, said the US would double the tariff on imports of Turkish steel to 50 per cent, because the previous level of 25 per cent had not been enough to sufficiently reduce Turkish exports to the US. “Doubling the tariff on imports of steel from Turkey will further reduce these imports that the [commerce] department found threaten to impair national security,” said Ross.

That was the trigger but it was not the revolver that now is pointed at the head of Turkey’s economy.  That was the fast deteriorating economic situation.  After the botched attempted military coup against him in 2016, Erdogan launched a credit boom to boost the economy while locking up thousands and sacking even more from their jobs in academic and government positions.  He insisted on keeping interest rates low and blocked any action to curb fast-rising inflation by Turkey’s central bank, describing interest rates as “the mother and father of all evil”.

Turkey’s capitalist economy could not handle this, just at a time that the US dollar strengthened after the US Federal Reserve began to raise US interest rates.  The problem for Turkey, a country without energy resources and only its human expertise and cheap labour to sell is that the vast majority of the funding for industrial development, construction and real estate comes from abroad:  American and European investors.  Turkey’s citizens and companies borrow significantly in dollars and euros.

The apparently fast economic growth of the last two years was built on turkey legs (credit and foreign borrowing) while imports flooded into the economy not matched by exports and the profitability of Turkish capital fell sharply.  The rise of the dollar and interest rates globally brought an end to the party and has exposed Erdogan to the realities of global capitalism.

Turkey banks and corporations are now in dire trouble. Turkey’s non-financial companies’ foreign currency liabilities now outstrip their foreign exchange assets by more than $200bn.

The country’s banks and corporations have billions of dollars of hard-currency debt coming due.  Turkey’s banks are scheduled to repay $51bn over the next year, while the remaining $18.5bn sits on non-financial corporate balance sheets. These bills are coming due at a time when corporate indebtedness sits at 62 per cent of GDP, half of which is denominated in foreign currencies (dollars and euros, mostly).

Foreign investors are now worried that Turkey will not be able to finance this.  Relative to its short-term external debt, Turkey’s FX reserves have declined to new lows.

So capital has fled the country and the lira has tumbled.

Now the extra worry for global capital is that if Turkey’s banks and corporations start defaulting on their debt servicing, then European banks could suffer significant losses on their own balance sheets – what markets call ‘contagion’, the spreading of losses and default internationally.  Some of Turkey’s banks are foreign-owned and the biggest lenders to Turkey are Spain’s BBVA, Italy’s UniCredit and France’s BNP Paribas.

Turkey’s banks appear to have plenty of reserves and loans to Turkey are just a small part of total loans made by these foreign banks.  But even ‘marginal’ losses can sometimes be a tipping point when profits are tight.  And bad debts in the banks have already been rising (% of debt that is ‘bad’ graph below)

How can Erdogan get out of this currency crash?  The capitalist solution is to hike interest rates to an astronomical height so that further borrowing is stopped.  Then the government should dramatically cut government spending and raise taxes (ie fiscal austerity) and use the ‘savings’ to bolster the banks and meet foreign debt repayments.  Turkey should also turn to the IMF for a loan – Greek style.  Under IMF rules, it could borrow up to $28bn to fund future debt repayments but then be subject to the dictats of IMF austerity measures.  This capitalist solution means an outright slump in the Turkish economy, hitting its citizens hard and seriously damaging Erdogan’s support in the country.

The government could introduce capital controls and block any money leaving the country.  But this would mean that foreign lenders would just stop lending, driving the economy into a slump anyway.  Or Erdogan could try to get funding from Russia, China or Saudi Arabia (as Pakistan has just done).  Unfortunately, he is on bad terms with all these countries.  Erdogan is resisting all these options so far, telling his supporters to ‘trust in God’ and him.

The bigger issue is the growing emerging market debt crisis. This is what I said in May after Turkey’s general election. “Rising global interest rates and the growing trade war initiated by US President Trump are going to hit the so-called emerging capitalist economies like Turkey.  The cost of borrowing in foreign currency will rise sharply and foreign investment is likely to reverse…..Turkey is now near the top of the pile for a debt crisis, along with Argentina (already there), Ukraine and South Africa.”

So there’s more to come.

Greece: on parole

Today Greece officially came out of the strait jacket of the so-called Troika bailout programme.  The Troika of the Euro Group, the European Central Bank and the IMF are now longer openly calling the shots on how the Greek government should spend its tax revenues or how much it can borrow.

However, Greece is not really free for two reasons.  First, the Greek government has signed up to a new deal with the Euro Group which will involve an unending process of implementing strict fiscal spending measures including more ‘reforms’ in pensions and public services.  In return, the Greeks get some so-called debt ‘relief’ on its public sector debt currently equivalent to 180% of Greek GDP.

Under the agreed debt-relief plan, maturities on E97bn ($112 billion) of loans Greece has received from its second bailout would be pushed out by ten more years. The extension will be accompanied by a ten-year grace period in interest and amortization payments on the same loans. Creditors also agreed to disburse E15bn aimed at helping Greece repay arrears, finance maturing debt and build up a cash buffer of E24bn.

So Greece won’t have to start paying back what it ‘owes’ the Eurogroup until 2032.  That sounds good.  But the debt remains – and as one study explained in a past post on Greece:  “To achieve debt sustainability without face-value debt relief, ….would imply a large increase in the total exposure to Greece of the European official sector from currently expected end-2018 levels, that is, by 50% or more. It would also mean that Greece could still be paying off debts to European official creditors well into the 22nd century.”!

The other shocking thing that has now been admitted is the IMF officials responsible for loans to Greece as part of the Troika programmes broke all the IMF rules and procedures and hid the facts from the IMF board.  This has been revealed in a damning report by the IMF’s Independent Evaluation Office (IEO) which reports to the executive directors (government reps) over the heads of Christine Lagarde, the IMF MD and her officials.  In the bailouts of Greece, Portugal and Ireland, they were ‘allowed’ to borrow over 2000% of their allocated IMF quota in direct violation of the official limit of 435%.

This was not done because the IMF officials were trying to help these countries.  No, the aim was to save the banks of Europe from going under because likely defaults on payment of government bonds that these banks held.  French, German and British banks had bought government bonds from these distressed governments because they ‘earned’ a very high rate of interest and so they could make huge profits.  Any defaults could have brought the whole European banking system down.  Saving capitalism (finance capital) was more vital for the IMF, so the living standards and lives of Europeans had to suffer instead. As the Evaluation Report baldly says: “If preventing international contagion was an essential concern, the cost of its prevention should have been borne – at least in part – by the international community as the prime beneficiary,”.

When the Euro debt crisis broke, the IMF, the ECB and the EU ensured that the banks got nearly all their money back and also kept their profits – so no risk!  In the meantime, Irish, Portuguese and Greek citizens faced years of severe austerity to meet Troika demands – what the then Greek finance minister Yanis Varoufakis has called “fiscal waterboarding”.

The Greeks still remain with a monstrous debt even if the burden of servicing that debt has been reduced. And there is still little ‘fiscal space’ to end austerity, let alone reverse it.  As I said last May, “The reality is that with the Greek economy unlikely to grow at more than 2% a year after inflation for the foreseeable future and the burden of financing the debt standing at 15% of GDP each year and rising, there is no way that Greek capitalism can escape of the spectre of the debtors prison.”

Greece has lived through eight lost years. Since 2010, its economy has shrunk by one-quarter, the disposable income of its citizens by-one third. More than 300,000 of those people have emigrated; among those left, unemployment is at 20 per cent.  Pavlos Ravanis, president of the Athens chamber of small business and a veteran entrepreneur, said: “Of the companies that were doing well before the crisis, about 20 per cent have innovated successfully and are flourishing, and another 40 per cent are getting by, servicing debt but not making money.” That leaves 40 per cent described as “zombies” by Mr Ravanis. “They are not paying tax or meeting their obligations to the banks,” he added. “Less than half [of these companies] are rescuable, even if an investor showed up willing to put in large amounts of cash.”

And if Greek economic growth slips below 2% or global capitalism enters a new recession, then the debt financing burden will rise out of control again.

China’s ‘Keynesian’ policies

China’s reaction to Donald Trump’s trade war has been to retaliate with its own tariffs on US exports to China, particularly agricultural/food exports like soybeans.  Also the government has allowed the Chinese currency, the yuan, to depreciate towards the bottom of its controlled range against the dollar.  This makes Chinese exports cheaper in dollar terms and so defeats the purpose of Trump’s tariff increases on Chinese goods coming into the US.

But there is a third move: a considered expansion in government investment in and funding of construction projects to boost domestic output to compensate for any decline in exports.  The policy of government investment was hugely successful in helping the Chinese economy avoid the consequences of the Great Recession back in 2008-9.  While all the major capitalist economies suffered a contraction in national output and investment, China continued to grow.  In 2009, when GDP in the advanced countries fell by 3.4%, Chinese growth was 9.1%. Only one capitalist economy also grew – Australia – an economy increasingly dependent on exports of its raw material resources to its fast-growing Asian giant neighbour.

Simon Wren-Lewis, leading British Keynesian economist and blogger, claims that China’s success in the Great Recession demonstrated two things: 1) that it was austerity that caused the Great Recession and the weak economic recovery afterwards in the major capitalist economies and 2) it was Keynesian policies (ie more government spending and running budget deficits) that enabled China to avoid the slump.

Well, it is no doubt true that after a massive slump in investment and production in the capitalist sector of the major economies in 2008-9, cutting back further on government spending would make the situation worse.  In that sense, ‘austerity’ was a wrong-headed policy for governments to adopt.  But as I have argued in many previous posts, austerity was not some insanity in economic terms for capitalism, as the Keynesians think.  It has a rational base: namely that with profitability in the capitalist sector very low, costs must be reduced and that includes reducing taxation of the capitalist sector.  Also the financial sector had to be bailed out.  It was much better to pay for that by reducing government spending and investment rather than raising taxes.  And the huge increase in public debt that resulted anyway would require controlling down the road.

But what about getting economies out of the slump with more government spending?  Wren-Lewis comments “China is a good example of that idea in action. What about all the naysayers who predicted financial disaster if this was done? Well there was a mini-crisis in China half a dozen years later, but it is hard to connect it back to stimulus spending and it had little impact on Chinese growth. What about the huge burden on future generations that such stimulus spending would create? Thanks to that programme, China now has a high speed rail network and is a global leader in railway construction.”

So you see, Keynesian policies work, as China shows, says Wren-Lewis.  But were China’s policies really Keynesian?  Strictly speaking, Keynesian macro management policies are increased government spending of any type (digging holes and filling them up again) in order ‘stimulate’ the capitalist sector to start investing and households to spend, not save, all through the effect of the ‘multiplier’.

Sure, Keynes talked about going further, with the ‘socialisation of investment’ as the last resort.  But no government of Keynesian persuasion has ever adopted that policy (if it meant taking over capitalist investment with state investment).  Indeed, the Wren-Lewis’s of this world never advocate or even mention the idea of the nationalisation or socialisation of capitalist sectors.  For them, Keynesian policy is government spending to ‘stimulate demand’.

China’s policy in the Great Recession was not just ‘fiscal stimulus’ in the Keynesian sense, but outright government or state investment in the economy.  It actually was ‘socialised investment’.  Investment is the key here –as I have argued in many posts – not consumption or any form of spending by government.  The Great Recession in the US economy was led and driven by a fall in capitalist investment, not in personal consumption or caused by ‘austerity’.  In Europe,100% of the decline in GDP was due to a fall in fixed investment.

As John Ross said on his blog at the time, “China is evidently the mirror image of the US …If the Great Recession in the US was caused by a precipitate fall in fixed investment, China’s avoidance of recession, and its rapid economic growth, was driven by the rise in fixed investment. Given this contrast, the reason for the difference in performance between the US and Chinese economies during the financial crisis is evident.”  

Wren-Lewis thinks that Keynesian measures would have done the trick and it was “a failure of imagination” by the governments of major economies not to act, but instead impose ‘austerity’.

It’s true that the governments of the major capitalist economies did not follow China’s example partly because they were ideologically opposed to state investment – indeed, their first measure of ‘austerity’ was to cut government investment projects – the quickest way to cut spending.

But the main issue was not ideology or a “lack of imagination”.  It is that Keynesian stimulus policies do not work in a predominantly capitalist economy where the profitability of capitalist investment is very low and so investment is falling.  With government investment in advanced capitalist economies only around 3% of GDP compared to capitalist sector investment of 15%-plus, it would take a massive switch to the public sector to have an effect.  ‘Stimulating’ capitalist investment with low interest rates and welfare spending would not be enough.  Capitalist investment would have to be replaced by state ‘socialised’ investment.  That only has happened (temporarily) in war economies (as 1940-45).  In the last ten years, in the US, Europe and Japan, it has been capitalists who made the decisions on investment and employment and they did so on the basis of profit not economic recovery.  Quantitative easing and fiscal stimulus – the two Keynesian policy planks – were ineffective as a result. In contrast, China’s fixed investment increased rapidly because it was driven by a programme of both direct state investment and use of state owned banks to rapidly expand company financing.

This difference between Keynesian measures in capitalist economies and China’s state-directed investment is about to be tested again.  Most mainstream economists are predicting that China will take a hit from any trade war with Trump’s America and economic growth is set to slow – indeed, there is a growing risk of a huge debt-induced slump.  But the Chinese authorities are already reacting.  Ordinary budget deficits (fiscal ‘stimulus’) are being supplemented with outright state funding of investment projects (dark blue in graph).

Most of this government investment funding is coming from sales of land by local authorities.  Through local government funding vehicles (LGFV), they build roads, homes, cities by selling land to developers.  But funds also come directly from the national government (80%).

We can expect such funding to rise and investment projects to expand if China’s exports drop back from a trade war with the US.  State investment will keep China’s economy motoring, while the major capitalist economies flounder.

A new global credit crunch to come?

At the time of the general election in Turkey, I pointed out that Turkey was near the top of the pile for a debt and currency crisis. It was running a massive current account (trade and payments) deficit with other countries and its external debt (what it owes to other countries in credits) was over 50% of its annual output (GDP), the highest among major ‘emerging economies’, while it foreign exchange reserves to cover repayments and support the value of the currency, the Turkish lira, were just 12% of GDP.  The country was now being run a self-aggrandising autocrat in (what we now call) “Trump-style”, and who was refusing to allow the main monetary authority, the Central Bank of Turkey, to impose higher interest rates in order to ‘curb’ inflation and attract ‘hot money’ from foreigners; or to implement any fiscal austerity, orthodox capitalist style.

The only escape valve was a collapse in the lira.  And in the last few weeks, the currency has depreciated exponentially.  And fear that Turkish banks and corporations will not be able to pay their debts and the economy will suffer a meltdown has driven up the cost of its bonds and insuring against default (CDS).

Turkey’s CDS spread and bond spreads have risen nearly 350 basis points—the highest level seen since the peak of the Euro area debt crisis. Higher refinancing costs will put further strain on government budgets and corporate borrowers.

But Turkey is just the most extreme example of the growing debt crisis beginning to hit economies that depend on foreign capital flows and investment in order to grow (and that’s most).  I have raised this prospect of an emerging economy debt crisis in previous posts, most recently with the fall of the Argentine peso.  A strong dollar (the main currency of loans), rising interest rates (with the Fed and now the Bank of England hiking policy rates) and higher oil prices for those that must import energy (eg Argentina, Turkey, Ukraine, South Africa etc): are the factors triggering this impending crisis – not seen since the Asian/EM crisis of 1998.

According to the IIF, the international research body of major multi-national banks, global debt (including financial sector debt) has reached $247trn, nearly 250% of world GDP.  That would mean world debt grew something like 13% in the three years ended 2017.

And as I have argued before, the locus of this impending debt crisis is not to be found in household debt (as it was in the global credit crunch in 2007 that led to the Great Recession) or in public sector debt (where governments have been applying stringent ‘austerity’ measures), but in corporate debt (the heart of capitalist accumulation).

The global financial crash of 2008-9, ten years ago, did not lead to a total collapse of capitalism, even though it triggered the worst slump in investment and production since the 1930s.  The financial sector was bailed out by huge injections of credit and cash and the capitalist sector was supported by zero or even negative interest rate policy by the central banks and unprecedented levels of money ‘printing’, called quantitative easing.  The result was not much of an expansion in investment or production.  In the major capitalist economies, economic growth (real GDP growth) has averaged no more than 2% a year (slightly more in the US and less elsewhere).  In the so-called emerging economies, average growth rates also fell back.  But above all, debt in all sectors rose.  The result was inflated financial asset prices without the kind of “recovery” seen in previous ‘business cycles’.

Just a decade after the Great Recession, the average US non-financial business went from 3.4x leverage (debt to earnings) to 4.1x. They are now roughly 20% more leveraged than they were the last time all hell broke loose. While Trump boasts of 4% growth and the US corporate sector never having it so good, the level of corporate debt in the US, alongside rising interest rates, is setting the scene for a new debt crisis.

How will such a crisis emerge? In the next year, US companies must refinance about $4trn of bonds, almost all of it at higher interest rates. This will hit debt-burdened companies that are already struggling and make it almost impossible for some to keep operating. Lenders, i.e. high-yield bond holders, will try to exit their positions all at once only to find a severe shortage of willing buyers. Something, possibly high-yield bonds, will set off a liquidity scramble.

Almost half of US investment-grade companies are rated BBB (just above ‘junk’) and could easily slip into junk status in a downturn. Rising defaults will force banks to reduce lending, depriving previously stable businesses of working capital. This will reduce earnings and economic growth. The lower growth will turn into negative growth and we will enter recession.  That is the likely scenario ahead.

Returning to ‘emerging’ economies, already banks and financial institutions globally are cutting back on their loans to the likes of Turkey etc.

But also capital flows from the non-financial sector to invest globally have declined.  Global foreign direct investment (FDI) flows fell by 23% to $1.43 trn in 2017, according to the latest report by UNCTAD.  Investment in new projects fell 14%.  Interestingly, most of this fall was between the advanced capitalist economies.  FDI flows to developing economies remained stable at $671 billion, after a 10 per cent drop in 2016.  But inward FDI flows to developed economies fell sharply, by 37 per cent, to $712 billion.

Global capital movements, driven mainly by debt-related flows, increased rapidly in the run-up to the financial crisis but then collapsed from 22% of global GDP in 2007 to just 3.2% in 2008. The subsequent recovery was modest and short-lived. In 2015, flows were still only 4.7% of global GDP.  Cross-border capital flows remain well below pre-crisis levels.  Overall net capital flows to ‘emerging’ economies were actually negative in 2015 and 2016, before turning slightly positive in 2017.

According to UNCTAD, “projections for global FDI in 2018 show fragile growth”. Global flows are forecast to increase marginally, by up to 10%, but remain well below the average over the past ten years. Multi-national companies are cutting back on international investment, partly because of the risk of a future trade war after Trump’s protectionist measures; and partly because possible debt crises in the most vulnerable ‘emerging’ economies.  But a key reason is a fall in profitability from overseas investment.  UNCTAD found that the global average return on foreign investment is now at 6.7%, down from 8.1% in 2012. Return on investment is in decline across all regions, with the sharpest drops in Africa, Latin America and the Caribbean.

As a result, the rate of expansion of international production is slowing down.  Assets and employees are increasing at a slower rate. Growth in the global value chain (GVC) has stagnated. Foreign investor profit in global trade peaked in 2010–2012 after two decades of continuous increases. UNCTAD’s GVC data show foreign value added down 1 percentage point to 30% of trade in 2017.  It’s not just as profitable to trade or invest globally compared to before the Great Recession.

The story of the last ten years since the Great Recession is that the world capitalist economy has staggered on at low levels of growth and investment and with virtually no improvement in real incomes for the 90%.  And it has only staggered on because of a huge build-up in debt, particularly in the capitalist sector.  Now, monetary authorities are trying to reverse the credit binge and restore ‘normality’.  As a result, the cost of servicing that debt is on the rise and availability of more credit to finance is shrinking.

When we read the financial press, we see the huge profits being made by the top companies (mainly in the US – in Europe, profits are down even for the large), but the vast majority of companies are still not achieving the profitability they need to finance their debts if the cost of servicing rises sufficiently.  And globally, banks and corporate investors are reducing their loans and investments because of low profitability and concerns about declining trade growth and a global trade war.  And that pending trade war still has some way to go.

World trade and imperialism

There is a new dataset on world trade that looks at changes in exports and imports globally going back to 1800 and the beginnings of modern industrial capitalism.  Two authors, Giovanni Federico, Antonio Tena-Junguito have presented a number of papers on the trends found in the data.

Their main conclusions are that trade grew very fast in the ‘long 19th century’ from Waterloo to WWI, recovered from the wartime shock in the 1920s, and collapsed by about a third during the Great Depression. It grew at breakneck speed in the Golden Age of the 1950s and 1960s and again, after a slowdown because of the oil crisis, from the 1970s to the outbreak of the Great Recession in 2007. The effect of the latter on trade growth is sizeable but almost negligible if compared with the joint effect of the two world wars and the Great Depression. “However, the effects might become more and more comparable if the current trade stagnation continues”.

The data show that there were two major periods of ‘globalisation’, if you like.  The first was from 1830-70 when the export to GDP ratio, a measure of openness in trade, rose.  The second was from the mid-1970s to 2007 – the great globalisation period of the 20th century.  According to the data, the current level of openness to trade is unprecedented in history. The export/GDP ratio at its 2007 peak was substantially higher than in 1913.

There were two periods of stagnation or decline in global trade expansion: during the depression of the late 19th century up to the start of WW1 and then in the 1930s Great Depression.  Indeed, “openness collapsed during the Great Depression, back to the mid-19th century level.”

Now we appear to be in another downturn in globalisation and trade.  “Since 2007, the apparently unstoppable growth of world trade has come to a halt, and the openness of the world economy has been stagnating, or even declining. The recent prospect of a trade war is fostering pessimism for the future. Some people are hinting at a repetition of the Great Depression”, conclude the authors.

As you would have expected, the rise of industrial capitalism globally meant that the share of agricultural and mineral products in total exports declined for both advanced capitalist (imperialist) countries and (interestingly) for the peripheral (colonial) economies.  The share of primary products fell from about 65% in the 1820s to slightly above 55% on the eve of WWI, with an acceleration of the trend around 1860 (as industrialisation spread).

The big change was the move of America from an agriculture exporter to industrial giant in the 20th century.  The continued rise in industrial and services trade in the late 20th century globalisation has been in turn been led by China’s transformation from a poor agricultural peasant economy into the manufacturing (and increasingly hi-tech) workshop of the world.

Share of primary products on exports, baseline series, 1820–1938

The data in general confirm that my own study of globalisation and imperialism that I recently presented.

In my thesis, I argue that globalisation and increased trade are responses by capitalism to falling profitability and then depression in a previous period.  Globalisation of trade and capital took off whenever profitability of capital fell in the imperialist centres.

Between 1832-48, profitability of capital in the major economies fell; after which there was an expansion of globalization to drive up profitability (1850-70).  However, a new fall in profitability led to the first depression of the late 19th century (1870-90), during which protectionism rose and capital flows shrunk.  With economic recovery after 1890, imperialist rivalry intensified, leading up to the Great War of 1914-18.

Again after the defeats of various labour struggles post 1945 in Europe, Japan and in the colonial territories, capitalism entered a new ‘golden age’ of relatively fast growth and rising profitability.  Globalisation of trade (reduction in tariffs and protectionism) and capital (dollar-led economies and international institutions) revived, until profitability again began to fall in the 1970s.  The 1970s saw a weakening of trade liberalization and capital flows.  From the 1980s however, capitalism saw a new expansion of globalization in trade and capital to restore profitability.

The beginning of the 21^st century brought to an end this wave of globalisation.  Profitability in the major imperialist economies peaked by the early 2000s and after the short credit-fuelled burst of up to 2007, they entered the Great Recession, which was followed by a new long depression.  Like that of the late 19th century, this brought to an end globalisation.  World trade growth is now no faster than world output growth, or even slower.

So the counteracting factor to low profitability offered by exports, trade and credit has died away. This threatens the hegemony of US imperialism, already in relative decline to new ambitious powers like China, India and Russia. With US President Trump now launching his attempt to put the US back in the driving seat for international trade, renewed rivalry threatens to unleash major conflicts in the next decade or so.

Pakistan: it’s not cricket

Pakistan has 200 million people and 105m of them were registered to vote in today’s general election.  This makes it the fifth largest democracy and second largest Muslim democracy after Indonesia in the world.

Who won?  Well, it seems that voter turnout was unchanged from the last election in 2013, at just 53%.  So the ‘no vote’ party was the biggest winner.  But a relatively new party has won the most seats in the National Assembly.  This is Pakistan Tehreek-e-Insaf (PTI) or Pakistan Justice Party, led by Imran Khan, a former international cricketer (the sport inherited from British colonial rule and godlike in the Indian sub-continent, muslim and hindu alike).

Khan’s party has defeated Nawaz Sharif’s Muslim League.  Sharif was the former prime minister of Pakistan before he was convicted of corruption.  Sharif’s family came under judicial scrutiny over the Panama Papers. After disqualifying Sharif from holding public office the Pakistan courts was sentenced him to jail and he absented himself to the UK.  Just before the election he came back to Pakistan to start a 10-year jail sentence.  This martyrdom, as he sees it, was designed to increase the chances of an election victory for his party now led by his brother.  But this risky move appears to have failed.

Pakistan is one of the most unequal countries in the world.  Just 22 families control 66% of Pakistan’s industrial assets and the richest 20% consume seven times more than the poorest 20%.  Both the names Khan and Sharif mean ‘ruler’ or ‘noble’. According to a 2013 study, 45% of all holders of office across Pakistan came from family ‘dynasties’, moving from one party to another with bewildering rapidity, with their political direction decided by whom the military establishment selects.

Khan has won because he had campaigned for several years on ‘fighting corruption’, for which the previous two main parties of government, the Muslim League and the People’s Party (led by the Bhutto dynasty), were notorious.  The anti-corruption message has won over sufficient voters, mainly middle class.  Khan appealed to this layer as a more ‘secular’ candidate (not surprising considering his personal affairs).

Although, the PTI’s support comes from the urban middle classes, in the election he aligned his party with smaller extreme religious parties in order to try to gain a majority, stepping back on equality and ‘social’ issues.  Moreover, he is regarded as the new favourite of the military, which wishes to continue its policy of backing the Taliban in Afghanistan and allying Pakistan with China against India.  China is now Pakistan’s largest foreign investor.

Khan claims he wants to ‘depoliticise’ the police and establish ‘law and order’ in a violent crime-ridden society; to ‘improve health and education’ through bringing health insurance to 70% of the population. Yet in no way is Khan sympathetic to the interests of Pakistan’s working class or rural farmers.  He is set to follow the dictates of the IMF as the ‘solution’ for Pakistan’s continuing economic failure.  And that means his policy ‘aspirations’ will never be met.

The reality is that Pakistan’s stuttering economy is entering yet another period of slump and crisis after a short boom.  The IMF’s last report reckoned that Pakistan was growing at 5-6% a year. But this was only being achieved by cheap money policy from the central bank, fiscal spending and a rising current account deficit.

Foreign exchange reserves have fallen to just 2.3 months of imports as the authorities tried to support the currency despite the deteriorating economy.  The trade deficit and upcoming FX debt repayments will double external financing needs, taking a further toll on foreign exchange reserves.  Pakistan will soon require an IMF funding package to pay its way, and with it, will follow yet another period of ‘austerity’.

Although there has been some improvement in human development indicators in Pakistan since 2010, youth enrolment in higher education and skills training remains very low. In health, stunting is chronically high among children under five years of age, with 44% in this age group being either severely or moderately stunted.  A large proportion of the population still does not have access to piped water at home or toilets linked to a sewage system.

There is little in public funds available to deal with these problems because the rich pay little or no tax.  Less than 1% of the country’s working population file income returns. Of the 72,000 or so firms registered in 2016, less than half filed returns. And of those that filed returns, half paid no tax at all. Pakistan aims to increase tax collection to 15% of GDP by 2020.  But growth in direct taxes is actually slowing because of a sustained reduction in corporate taxes. Most taxes are indirect i.e. through consumption purchases, which hit the poor the most.

Investment by the capitalist sector is just 11% of GDP (and falling), with another 4% from the public sector.  This compares with China at 45% or even most less developed countries at over 20%.  Most income held by the rich goes into real estate and financial assets (much of it spirited abroad).

Exports make up just 7.6% of the country’s GDP. That’s nearly 17 percentage points less than than the average for middle-income countries overall. What the country does export tends to be low-value-added products, like cotton and rice. Pakistan is the 115th most competitive nation in the world out of 137 countries ranked in the 2017-2018 edition of the Global Competitiveness Report.  As a result, Pakistan relies on an ever-decelerating flow of remittances and outside funding, which makes it highly susceptible to external shocks.

As Khan takes over (with the military behind the scenes) Pakistan is facing another balance of payments crisis.  The Pakistan rupee is diving as a result as FX reserves run out.

Without Chinese investment and funding, the crisis would already be upon the Pakistan economy.  The China-Pakistan Economic Corridor (CPEC) is a collection of infrastructure and trade projects, valued at up to $63bn.  It has become the centrepiece of China’s $1 trillion-plus Belt and Road Initiative (BRI). From shoddy ports and expressways to inefficient power plants, the Chinese-funded CPEC aims to resolve many of the shortcomings that have stifled Pakistani manufacturers. The flow of loans to Pakistan has surged since 2015.

All this means that the Pakistan ruling elite must choose between the IMF for future funding or rely on the ‘goodwill’ of China.

Over to you, Imran Khan.

Big data, fake news and global growth

This week, it was reported that the number of Americans filing for unemployment benefits last week was the lowest since 1969!

The official unemployment rate is also near an all-time low.  In Japan and the UK too, the unemployment rates are near lows and in Europe, the official rate is heading back to pre-global crash levels.

As I have reported in previous posts, measures of economic activity from various sources suggest that the world capitalist economy has been picking up pace in growth since the near slump of 2015-16.  This is particularly the case for the most important capitalist economy, the US.

Below is the world composite PMI (purchasing managers index).  This is a survey globally of the state of economic activity in both manufacturing and service industries as the corporate executives see it.  If the measure is above 50, world economic activity is rising.  Currently, the PMI shows a return to trend expansion after the near contraction of 2015.

Next week we shall get the first estimate of US real GDP growth for the second quarter of 2018.  It is likely to be strong.  The Atlanta Federal Reserve has a ‘high frequency’ forecast measure for each quarter’s growth and it currently expects the Q2 figure to come in at a 4.5% annual rate.  That means real growth in Q2 would be about 1% point above Q1.  If that turns out to be right, it means that the US economy would have motored along at about 3% for the first half of 2018.

No doubt President Trump will make much of this apparent fast expansion and claim it for his policies of tax cuts for the corporate sector and the top 10%.  However, as a recent study has shown, this will be ‘fake news’.  The study by some European economists found that there was no difference between the post-election performance of the US economy under Trump and a synthetic ‘doppelganger’ US economy without Trump, suggesting that there has been no ‘Trump effect’. “The employment performance of the US economy since the election was no different from its doppelganger. There is nothing in the data that indicates an acceleration of employment creation because of President Trump.”

But the most usable surveys of economic activity in the US do show that the economy is expanding at a reasonably fast rate (if no faster than the average of 3.3% since 1945).  Here is a graph that combines various surveys of economic activity in the US.  Anything above 0 (LHS) or 50 (RHS) implies that the economy is growing.  The current RHS rate is close to 60 which implies fast expansion – certainly compared to 2016 when the measure was below 50, implying contraction and, of course, much higher compared to the Great Recession when output collapsed.

The other major capitalist economies do not seem to be doing as well as the US, despite previously optimistic reports.  The EU is growing at about 1.6% annually, the UK at under 1%, and Japan is actually contracting.  Nevertheless, global growth is expected to show an acceleration in 2018 over 2017, when all the emerging economies of China, India etc are included.

But can we get more frequent and comprehensive measures that could actually forecast accurately what will happen in future quarters and years?

The huge eruption of what is called ‘big data’ from the internet, social media and other sources in the last ten years has led to a new industry of forecasting that aims to deliver more frequent and accurate estimates of future developments, in the same way that weather forecasting has improved.

The Federal Reserve Bank of New York has refined this big data in its own survey of US economic activity.  And as long ago as 2013, the Bank of England’s economists looked at the use and efficacy of big data.  They looked at indicators for global growth in industrial production and trade.  They found that sharp changes in various indicators were a good guide to future production and growth.  However, the problem with these indicators of future expansion is that they are not that timely, with data only on a monthly (if you are lucky) but more usually on a quarterly basis.

The statistical economists have recently looked for more timely data and a Bank of England economist recently published a paper on the best predictors of global growth. The paper found that the daily movement in metals prices was a reasonably accurate measure of global economic activity.  “Metals prices are highly correlated with world activity… and perform well at predicting world GDP in the near-term.”

In other words, the pace of change in metals prices in this month of July will give a reasonable estimate of world real GDP growth for July (and eventually Q3), well ahead of any official data (Q3 world growth is not going to be available until January 2019).

The Bank of England economists used the S&P metals prices index as their metals prices indicator.

As you can see (circles), the metals index fell sharply during the Great Recession in real GDP and predicted the subsequent recovery exactly in mid-2009.  Similarly it predicted the recovery from the relative slump in 2015.  Remember the actual real GDP figures for most countries do not become available until up to two quarters later or even more.  So the metals index becomes a ‘high frequency’ indicator for growth.

Copper is the largest constituent of the index and it is a metal used in just about every important industrial and consumer appliance or service.  So the copper prices index is also likely to be a good indicator, in my view.  When I ran the copper price against world GDP growth, the correlation was very good.

So looking ahead, what do the metals price and copper price indexes tell us about the current Q3 period and onwards?  I did the trend measure of the copper price, and it shows that expansion from the trough of 2015-16 seems to have peaked.  That suggests the global expansion from 2017 which was above the trend rate has now subsided back to the trend and may fall below.

The metals price index also suggests that the peak in the current acceleration of global (and US?) growth ended in June 2018 and the direction is now downwards in Q3 (the period beginning in July).

So don’t be overwhelmed by the good news stories about US real GDP figures for Q2 2018 next week.

Free trade or protectionism? – the Keynesian dilemma

The trade war that has broken out has confused mainstream macroeconomics.  The majority still see tariff increases as ‘protectionism’ and ‘free trade’ as the only way to operate. Trump’s measures are generally condemned.  But among the Keynesians, there is confusion and split.

Martin Wolf, the Keynesian economic journalist, who writes for the FT, reckoned that the trade war would be costly for global capital: “Global co-operation would surely be shattered”  Nevertheless, he argued for UK retaliation against Trump’s measures “more because the alternative looks weak than in the belief that it would work. Another thing the rest of the world should do is to strengthen their co-operation.”  On the other hand, he thought Trump’s wild proposal to create tariff-free area (for rich countries only) could be taken up. “Who knows? It might even work.”  He did not explain how cutting tariffs on goods from the 3-4% (that they average now for most advanced countries) to zero would make any difference.

While Wolf looks for ways to ‘save globalisation and free trade’ through retaliation, another Keynesian Dani Rodrik actually advocates protectionism as a good idea for economies with weak domestic growth: “US protectionism surely will generate some beneficiaries as well in other countries.” 

In a contrary view to Wolf, who calls for retaliation to stand up to Trump. Rodrik says Europe and China should “should refuse to be drawn into a trade war, and say to Trump: you are free to damage your own economy; we will stick by policies that work best for us.”  Indeed, he says, domestic industries may benefit from tariffs on their exports to the US – they could sell at home instead. He cites how Boeing could sell more planes in the US and Airbus could do the same in Europe. “Some European airlines favor Boeing over Airbus, while some US airlines prefer Airbus over Boeing. Trade restrictions may result in a total collapse in this large volume of two-way trade in aircraft between the US and Europe. But the overall loss in economic welfare would be small, so long as airlines view the two companies’ products as close substitutes.”  According to Rodrik, “US protectionism surely will generate some beneficiaries as well in other countries.”

The protectionist line has also been peddled by leftist economist Dean Baker.  He points out that not everyone gains from ‘free trade’. He claims that it was free trade that lost manufacturing jobs in the US, echoing the Trumpist argument.  However, there is much evidence that this was not the case.  As I said in a past post on Trump, trade and technology, “the loss of US manufacturing jobs, as it has been in other advanced capitalist economies, is not due to nasty foreigners fixing trade deals.  It is due to the inexorable attempt of American capital to reduce its labour costs through mechanisation or through finding new cheap labour areas overseas to produce.  The rising inequality in incomes is a product of ‘capital-bias’ in capitalist accumulation and ‘globalisation’ aimed at counteracting falling profitability in the advanced capitalist economies. But it is also the result of ”neo-liberal’policies designed to hold down wages and boost profit share.”

Baker claims that trade deficits lose jobs because it reduces “demand” and so reducing the US trade deficit would save jobs.  He makes this argument when the official unemployment rate in the US, the UK and Japan is at an all-time low (yes, I know many are crap jobs)!  Apparently, if everybody ran a trade surplus (impossible by the way) all would be better off.  What he really means is Trump is right to turn the US trade deficit into a surplus and get manufacturing jobs back from the developing world and Europe. It is certainly a weird and confused argument for nationalism.

The Keynesians are confused about whether they favour ‘free trade’ or protectionist/nationalist measures.  That echoes that confusion that Keynes had during the last Great Depression of the 1930s.  He changed his mind from a strong free trader in the late 1920s to a protectionist and advocate of tariffs by the mid-1930s.  This changing view was really an expression of the changing view of British capitalism.  Free trade is fine for those winning in markets; protectionism is better when a national capital loses share.  And that was Britain’s position.

In 1923, Keynes endorsed free trade in no uncertain terms: “We must hold to Free Trade, in its widest interpretation, as an inflexible dogma, to which no exception is admitted, wherever the decision rests with us. We must hold to this even where we receive no reciprocity of treatment and even in those rare cases where by infringing it we could in fact obtain a direct economic advantage. We should hold to Free Trade as a principle of international morals, and not merely as a doctrine of economic advantage.”

But his ‘moral’ position soon dissipated as British capitalism fell into a long depression in the mid-1920s and then in the 1930s.  In his seminal work, The General Theory, published in 1936, he concluded that “the one big (and smart) idea of absolute monarchy was to push exports over imports…..“A favorable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression.”

He advocated tariffs on imports into the UK as an alternative way of cutting real wages (by increased import prices) and to boost domestic production.  For Keynes, it was a way for British capital to gain a cost advantage over its rivals by reducing wage costs in real terms.  “I am frightfully afraid of protection as a long-term policy,” he testified to a UK parliamentary commission, “but we cannot afford always to take long views . . . the question, in my opinion, is how far I am prepared to risk long-period disadvantages in order to get some help to the immediate position.” Of course, once capitalism globally had recovered and, with it British capital, then ‘free trade’ could be renewed.

The current confusion in macroeconomics and particularly among modern Keynesians mirrors the changing views of Keynes as the current Long Depression lingers and ‘globalisation’ fails for all.  So now we have Keynesians like Rodrik and Baker supporting tariffs on US imports and pushing for trade surpluses, while calling on Europe and China not to retaliate!  And Wolf calls for retaliation by Europe and Asia.

What is the Marxist view?  Should we support tariffs and other protectionist measures introduced by weaker capitalist nations to ‘stand up’ to Trump’s measures (Wolf)?  Alternatively should we support Trump’s measures as a way of saving US manufacturing jobs (Baker) and perhaps helping other countries to boost their domestic industries (Rodrik)?

Free trade or protection?  I outlined my answer in a previous post.  Free trade has been no great capitalist success.  Capitalism does not tend to equilibrium in the process of accumulation.  As Adam Smith put it, in contrast to Ricardo, “When a rich man and a poor man deal with one another, both of them will increase their riches, if they deal prudently, but the rich man’s stock will increase in a greater proportion than the poor man’s. In like manner, when a rich and a poor nation engage in trade the rich nation will have the greatest advantage, and therefore the prohibition of this commerce is most hurtful to it of the two”. Capitalism does not grow globally in a smooth and balanced way, but in what Marxists have called ‘uneven and combined development’.  Those firms and countries with better technological advances will gain at the expense of those who are behind the curve and there will be no equalisation.

Free trade works for national capitalist states when the profitability of capital is rising (as it was from the 1980s to 2000) and everybody can gain from a larger cake (if in differing proportions).  Then globalisation appears very attractive.  The strongest capitalist economy (technologically and thus competitively in price per unit terms) will be the strongest advocate of ‘free trade’, as Britain was from 1850-1870; and the US was from 1945-2000.  Then globalisation was the mantra of the US and its international agencies, the World Bank, the OECD and the IMF. But if profitability starts to fall consistently, then ‘free trade’ loses its glamour, especially for the weaker capitalist economies as the profit cake stops getting large.

Marx and Engels recognised that ‘free trade’ could drive capital accumulation globally and so expand economies, as has happened in the last 170 years.  But they also saw (as is the dual nature of capitalist accumulation) the other side: rising inequality, a permanently floating ‘reserve army’ of unemployed and increased exploitation of labour in the weaker economies.  And so they recognised that rising industrial capitalist nations could probably only succeed through protecting their industries with tariffs and controls and even state support (China is an extreme example of that).

Engels re-considered the case for free trade in 1888 when writing a new preface on a pamphlet on free trade that Marx had wrote in 1847.  Engels concluded that “the question of Free Trade or Protection moves entirely within the bounds of the present system of capitalist production, and has, therefore, no direct interest for us socialists who want to do away with that system. Whether you try the Protectionist or the Free Trade will make no difference in the end.”

But it is informative to see the Keynesians split over favouring free trade for global capital (Krugman) or protection for national capitals (Rodrik and Baker for the US and Wolf for the UK and Europe).  Sign of the times.

Trade war and depression

Today is a threshold date for the global economy.  Trump’s US administration starts imposing trade tariffs on $34bn of imports from China.  And Beijing is set to target an equal amount in retaliation.  Add that to the pile of tariffs and counter-tariffs growing across the Atlantic and North America, and the value of trade covered by the economic wars that Trump has launched will race through the $100bn mark by today.

And that’s just the beginning.  This escalating trade war could easily surge through the trillion-dollar mark, taking 1.5% of global GDP. It would be equivalent to a quarter or more of the US’s $3.9tn total trade with the world last year and at least 6% of global merchandise trade (worth $17.5tn in 2017, according to the World Trade Organization).

The $34bn in Chinese imports being targeted by the Trump administration today are roughly equivalent in value to a month of imports from China.  In this tranche, a 25% import tax will be applied on 818 products ranging from water boilers and lathes to industrial robots and electric cars. In return, Beijing charge a similar tariff on a list that includes soya beans, seafood and crude oil. Both countries have also issued further product lists that would take the total trade covered to $50bn on each side.

Angered by China’s retaliation, Trump has ordered a further $200bn worth of imports to be targeted for a 10% tariff and threatened to go for another $200bn beyond that.  To which Beijing has vowed its own response.  US imports from China were worth $505bn last year while US exports to China reached a record $130bn.   So a £450bn rise in tariffs will sweep across much of China’s imports.

The Trump auto wars could be worth even more than $600bn. In a televised interview on Sunday the US president called his plan to impose tariffs on imported cars and parts in the name of US national security “the big one”. And that is certainly how the EU and others see it.  According to official data, the US imported $192bn in cars and light trucks in 2017 and a further $143bn in parts for a total of $335bn.

Then there’s NAFTA.  The US trades more with Canada and Mexico ($1.1tn) than it does with China, Japan, Germany and the UK combined.  Trump is seeking to renegotiate it just as a leftist and nationalist President AMLO has been elected in Mexico.  Trump seems to believe the auto tariffs will give him leverage over the EU and Japan in trade negotiations as well as over Canada and Mexico in the continuing talks over an updated North American Free Trade Agreement.  Mr Trump is dialling up the pressure to force capitulation. For that reason, the US could impose 20% tariffs on some or all of those imports.

Then there is FART.   Trump is planning a bill through Congress, called the Fair and Reciprocal Tariff Act, or FART for short. FART would allow Trump to abandon the World Trade Organization’s tariff rules, granting him new authority to unilaterally change tariff agreements with certain countries; to abandon central WTO trade rules, namely the “most favoured nation” principle that keeps countries from setting different tariff rates for different countries outside of free trade agreements and “bound tariff rates,” the tariff ceilings that each WTO member country has previously agreed to. In short, it would give Trump the authority to start a trade war without Congressional oversight, all while flouting the WTO’s rules.  It would mean the end of the WTO, in essence. Already, at least one prominent Trump backer, Trump’s short-lived communications director Anthony Scaramucci, tweeted that FART “stinks.”  But the smell is getting worse.

Any US tariffs are likely to be met with retaliation.  EU officials have been working on a plan to target upwards of €10bn in US goods for retaliation if it goes ahead with tariffs on the $61bn in cars and parts it imported from the EU in 2017.  But in the extreme scenario — of like-for-like, tit-for-tat tariffs — more than $650bn in global trade would be covered, with consequences for companies globally.

What is the likely impact on global growth from this trade war?  Well, Paul Krugman, Keynesian economist, won the Nobel prize in economics for his work on international trade and recently he did a ‘back of the envelope’ calculation. Krugman reckons that “there’s a pretty good case that an all-out trade war could mean tariffs in the 30-60% range; that this would lead to a very large reduction in trade, maybe 70%”! And the overall cost to the world economy would be about a 2-3% reduction in world GDP per year – in effect wiping out more than half of current global growth of about 3-4% a year (and the latter assumes that there is no new global recession).

Krugman reminds us that in the Great Depression of the 1930s, the trade war launched by the US with the Smoot-Hawley tariff, pushed tariffs up to 45%. “So both history and quantitative models suggest that a trade war would lead to quite high tariffs, with rates of more than 40% quite likely.”  Remember current global trade tariff rates are about 3-4% only.

Already, world trade has been staggering from the impact of the Great Recession and the subsequent Long Depression.  And world trade share (share of trade in global GDP) has stagnated at about 55% (see figure below).  Indeed, the great era of globalisation is over.  Now the trade war – another consequence of the Great Recession and the Long Depression since 2008 – could roll back the world trade share to 1950s levels, according to Krugman. ”If Trump is really taking us into a trade war, the global economy is going to get a lot less global.”

Given this, Krugman looked at the hit to US economic growth.  He reckoned it could take 2% of GDP off real growth each year.  As average growth is expected to be about 2% a year over the next five years (assuming no world slump), that would mean the US economy would stagnate.  That is not as bad as the Great Recession, which knocked 6% of US real GDP growth, but it’s bad enough to sustain a further leg of the current Long Depression.

And other countries will be hit even harder. Several major economies rely on trade much more than the US and Europe for growth.  In the league of global value chain for trade, Taiwan is top with nearly 70% of value-added coming from exports; and many Eastern European countries also have high export ratios.  The US is only at 40% and indeed China is under 50%.

According to Pictet asset management, if a 10% tariff on US trade were fully passed onto the consumer, global inflation would rise by about 0.7%. This, in turn, could reduce corporate earnings by 2.5% and cut global stocks’ price-to-earnings ratios by up to 15%.   All of which means global equities could fall by some 15-20%. In effect, this would put world stock market price back by three years – indeed a crash.

Meanwhile, Asian governments, led by China, are continuing their drive to relax trading restrictions among themselves, while retaliating to Trump’s trade war.  Last week, the 16-nation Regional Comprehensive Economic Partnership, which includes China, Japan and India but not the US, met in Tokyo to try and complete a new trade pact that would include the 10 members of the Association of Southeast Asian Nations as well as South Korea, Australia and New Zealand, and cover one third of the world’s economy and almost half its population.

And of course, as I have argued previously, China is driving forward its belt and road global investment scheme across central Asia.  So, although many Asian and Eastern European economies may suffer more than the US initially from a global trade war, longer term, trade pathways may alter to make them more Euro-Asia centric, to the detriment of the US and Latin America.

Global growth has been picking up in the last 12 months after a near-recession in 2015-16.  Indeed, Gavyn Davies, FT economics blogger and former Goldman Sachs chief economist, reckoned that world growth was growing at 4.4%, about 0.6% above trend, and a full percentage point higher than a couple of months ago.

But the trade war will particularly hit the manufacturing and productive sectors of the major economies.  And while global growth as a whole may have picked up recently, world manufacturing growth is looking frail.  The global manufacturing PMI measures activity in manufacturing and anything over 50 means growth.  So not looking so rosy.

Indeed, the US stock market has not bounced very much because, counteracting the one-off rise in corporate profits, has been the possibility of rising interest rates driving up the cost of borrowing and servicing existing debt and the potential hit from the coming trade war.

Hopes for a sharp rise in productive investment from the tax cuts appear dashed.  Instead of more investment, there has been a three-fold increase ($150bn) is share buybacks. In Q1 alone, US corporations collectively repatriated $217bn of their international stashes, around 10% of the $2.1trn of greenbacks estimated to be currently offshore.  But JPMorgan calculates only $2bn of the $81bn repatriated in Q1 by the top 15 companies was spent on productive investment.

World economic growth (and US growth may have peaked in Q2 2018 and now there is the prospect of an all-out trade war.