UK: the best laid plans of mice and George Osborne

Today, the UK’s Chancellor of the Exchequer (finance minister to the rest of us), George Osborne, outlined his plans for government spending and revenue for the next few years.  Back in May 2010, the newly elected right-wing Conservative party formed a coalition with the middle of the road, Liberal Democrats.  The coalition was immediately committed to the austerity camp of mainstream economic policy.  The Austerians argue that there can be no proper recovery in capitalist economies unless ‘excessive’ debt levels in the public sector are brought down and governments stop borrowing more to fund the difference between tax revenues and government spending.  So the government pledged to reduce borrowing and get the public debt ratio to GDP stable and falling over the life of the new parliament (to 2015) by significant cuts in government spending and higher taxes.  This was the Plan A in economic recovery.

18 months later, is Plan A working?  Well, 100 ‘leading economists’ recently sent a letter to the papers arguing:  “It is now clear that plan A isn’t working. Wave after wave of economic figures from HM Treasury, national and international economic institutions such as the OECD, the IFS and the IMF have all concluded that the British economy is faltering. The UK jobless total is now at its highest for more than 17 years, while growth has all but stalled.  We urge the government to adopt emergency and commonsense measures for a Plan B that can quickly save jobs and create new ones. A recovery plan could include reversing cuts to protect jobs in the public sector, directing quantitative easing to a green new deal to create thousands of new jobs, increasing benefits to put money into the pockets of those on lower and middle incomes and thus increase aggregate demand. This could in part be paid for by the introduction of a financial transactions tax. The government could do far more to create the space for new and innovative industries and companies to flourish. One idea is a British investment bank, to leverage and back investment in low-carbon sectors such as housing, transport and renewable energy.  Doing nothing is not an option. We therefore call on the government to put the national interest first and hold an emergency budget that would instigate a Plan B for jobs, fairness and sustainability to rapidly get the economy moving again.”

These economists were attacked by the Conservatives as not being leading economists as they came from ‘lesser universities’ or were opposition Labour party supporters in disguise.  Leaving aside the insults, who is right?  The Austerian coalition government or the 100 leading economists?  Well, it is clear that Plan A is not working.  The best laid plans of mice and George Osborne are in shreds.

The UK economy now has a record trade deficit and falling employment.  Official data showed Britain’s goods trade deficit widened to £9.8 billion in September, its highest since the series began in 1998, after a record jump in imports countered a tepid rise in exports.  The economy has barely grown in the last year and yet annual inflation is stuck at around 5%.  And now the UK economy is set to contract over the next two quarters.  In its latest economic forecast, the OECD reckoned that the UK economy would shrink by a tiny 0.03% in this current quarter and by a further 0.15% in Q1’2012.  The UK will struggle to have any growth at all in 2012.

Like other capitalist economies coming out of the Great Recession, the British economy has struggled to recover.  Annual real output is still some 4% below its previous peak in Q1’2008.  At the current rate of recovery it will not surpass that peak until 2015, or seven years later.  As I said in a previous post (The weakest recovery since 1918, 18 October 2011): “the recovery in the British economy since it bottomed in mid-2009 has been the weakest since 1918 after the end of the First World War.  The recovery is even weaker than in the first period of the Great Depression during 1930-34.  It is now 44 months since the peak of the UK GDP in 2008.  After the same period in the Great Depression, the UK’s real GDP had nearly returned to its peak in 1930.

Unemployment is now rising significantly, with 2.6m out of work.  Youth unemployment is now over one  million, 21% of the age group, an all-time high and nearly double where it was in 2004.  The OECD expects the unemployment rate to hit 9.1% by 2013.   The government was claiming that as it cut 400,000 public sector jobs over the next two years, private sector employment would rise to more than compensate.  At present, 23m people work in the private sector, while the public sector employs 6m.  So it would not take much growth in private sector employment (leave aside at what wages and conditions) to overcome losses in the public sector.  But it has not happened.  Private sector employment is still nearly 2% lower since the peak in mid-2008, while it’s down 5% in the public sector.

Private sector employment peaked at 23.542m during the first quarter of 2008.  Private jobs reached a trough in the final quarter of 2009, when private sector employment fell to 22.515m, down 1.027m from the boom-time peak.  From there, British companies started to add to their staffing levels, with a net 617,000 jobs added, taking the total back to 23.132m.  But that growth in private sector employment has stopped, while public sector employment is falling.  Public sector employment reached its peak as a share of total jobs in late 2009, hitting 21.9% on the official measure; state payrolls reached 6.327m at the end of 2009.  They then started to fall and dropped to 6.037m in the second quarter, 20.7% of the total.  So far, total state sector jobs are down by 290,000, through a combination of non-replacement and redundancies.

That is how much the capitalist slump has wasted of the resources and labour of the nation.  British businesses have seen a recovery in profits, although not yet back to previous peaks (unlike in the US).  Profits (gross operating surplus) fell 13% during the slump to reach a trough in mid-2010.   Then there was a brief recovery before a flattening out.

Government bailouts helped financial sector profitability during 2009, but that has now faded and the banks and financial sector profitability is dropping back.  The profitability of the rest of the UK corporations is still well below the peak of 2007.

Small businesses that employ the bulk of the British workforce are struggling, faced with heavy debts and low sales – so there’s no call to invest now.  Also, the large corporations are reluctant to invest in the UK.  Over 40% of the top 100 UK companies are in energy, commodity resources and FIRE (finance, insurance and real estate).  Also many make their money by investing abroad, not ploughing back cash domestically.  Big profits have been made through soaring commodity and energy prices.  But investment in these sectors goes mostly abroad.  Domestic industry remains a weaker partner.  Just as British capitalism took a bigger hit than other major capitalist economies in the financial crisis, because it is so much a rentier economy, its recovery is also weaker and oriented outside the UK.

While profitability for the capitalist sector remains low and the government sector (particularly investment) is cut back by the coalition, there is little prospect of any ‘normal’ recovery in the UK economy.  British capitalism is into a decade of ‘deleveraging’ .  Since the Great Recession began, corporations have gone bust and banks have been bailed out.  As a result, corporate debt to GDP has fallen from 122% in early 2009 to 108% now.  Similarly mortgage defaults and repayments of debt have meant that household debt to GDP has fallen from 111% to 103% now.  Both of these levels are high by international standards.  In order to bail out the banks and provide support to the unemployed and mainly because of the drastic fall in tax revenues as corporate and personal incomes plummeted, government borrowing rocketed, reaching 90% of GDP.  As a result, the overall national debt (private and public) has hardly moved since the property and credit bubble burst in 2007-8 (from 294% of GDP to 291% now).  So if the level of debt is the problem as Osborne and the Austerians argue, then Plan A has miserably failed in that task too.  Indeed, Osborne now admits that the public sector debt ratio will not be stabilised until 2017 on his own estimates.

But at least the government can borrow at low rates unlike Greece or Italy, or so Osborne argued.  But that is because the government bond market has been rigged.  As fast as banks and other private sector bondholders sell, the Bank of England buys them up.  The BoE has been turned into the government’s lender of last resort. It is purchasing another £75bn in gilts as part of the so-called quantitative easing programme.  Thus the rate of interest on government borrowing is kept artificially low.  This is Keynesianism from the BoE while the government proclaims the virtues of an Austerian policy for government spending.

In his statement to the UK parliament, Osborne argued that Britain’s sorry state was not due to his policies but to the economic collapse in Europe, the UK’s biggest trade and investment counterparty.  But as Michael Burke has pointed out in a number of recent posts (http://socialisteconomicbulletin.blogspot.com/), it is domestic demand not exports or trade which has provided the biggest drag on annual output.  Domestic demand started to fall when the Osborne government came into office in May 2010, well before the Eurozone went into a downward spiral.   And the main reason was the massive cutback in private sector investment, the key to growth in a capitalist economy.  Indeed, according to Burke, 80% of all the total lost output since the recession began was due to a fall in private investment.  But thanks to the policies of the coalition, public sector investment was not increased to compensate (as it was in China or Brazil) but instead has been slashed, down £12bn or 0.9% of GDP directly, and another 0.4% of GDP lost indirectly from income to that part of the private sector that depends on government procurements.

So what now?  Osborne says that the programne of fiscal austerity will stay in place and is the only way to recovery.  And he is backed in this view by the IMF, the OECD, and most of mainstream economics, as well as the governments of Europe, which are trying to do something similar.  From Ireland to Greece to Italy to France, austerity is the order of the day.   The other side of mainstream economics, the Keynesian wing, begs to differ, on the whole.  The ‘100 leading economists’  have been supported by several studies that argue there is a Plan B to the government’s Plan A.  The Compass group presents on such Plan B: a good economy for a good society (http://www.compassonline.org.uk/).   Compass wants the creation of a ‘social investment state’ where the public sector takes more of a lead.  They propose raising the minimum wage level, while reducing ‘excessive pay at the top’ by getting shareholders to block executive remuneration deals.   By spending more, domestic demand can be kickstarted and the extra revenue in taxes will still reduce the deficit.  But Compass stop well short of a radical change to the economy.  They want to ‘severely limit’ the the government cuts, but not reverse them.  They want the Bank of England to print even more money to stimulate the economy and pay off some government debt.  They want a financial transactions tax to raise revenue from the financial sector; end tax advantages for private pensions; and increase corporation tax, while closing the so-called ‘tax gap’ of around £70bn, made up of illegal tax evasion and clever accountancy tax avoidance that the rich and the big companies engage in.    They want to use the partially nationalised banks in Britain to drive up lending to small businesses and invest in housing, transport and environmental projects.  However, the main thrust of the Compass Plan B is to encourage or stimulate the business sector (and yet tax them more and remove their tax loopholes!) to invest and less to replace it with state-led infrastructure and manufacturing investment.

Similar ideas have been expressed in another study by Michael Burke, George Irvin and John Weeks, A brighter economic vision for Britain (brighter).  They favour a British Investment Bank based on the existing publicly owned banks to boost investment and thus create jobs and incomes.  Of course, Osborne is doing the opposite.  The government has just sold the nationalised mortgage bank, Northern Rock, to Virgin Group at a price some £400m less than the taxpayer paid the bank’s former shareholders for it.  And having sacked thousands of staff from Northern Rock, the government continues to keep all the bad debts of the bank on the taxpayers books!

The Austerians say that economic recovery will not be successful unless the capitalist economy reduces its burden of debt and that is mostly in the public sector.  If the government borrows more to try and boost the economy, it will only make the debt burden even more onerous to service, thus restricting profits and growth.  The Keynesians say that cutting government spending to reduce debt when the private sector is also contracting will just drive the economy into a deeper recession.  The debt burden is not too high and anyway is not costly to service.  More government spending and stimulating ‘animal spirits’ in the private sector with more money will get economic growth and actually produce more tax revenues, so the deficit and debt ratios will not worsen.

Who is right?  Well the Austerians are right that very high debt levels (whether in the private or public sector) eat into profitability and low profitability means low investment and low growth in a capitalist economy.  They are wrong to think that cutting government spending, particularly investment, will achieve economic recovery quicker and cannot not lead to a lengthened period of recession – the evidence of the UK economy now refutes that.  The Keynesians are right that a boost to government spending, especially investment, will help avoid a deep depression, but they are wrong to think that debt levels don’t matter under capitalism.  They do.  High debt means that profits will disappear from productive sectors like manufacturing into paying interest to bankers.  And printing money to finance investment will not necessarily achieve higher growth.  If the extra money goes to the private sector,  they will only invest if it is profitable to do so.  Otherwise, they will hold the cash or speculate in ‘fictitious capital’.  And that is where all the ‘quantitative easing’ money has gone so far.  If the extra money goes into public investment, then that will mean a huge expansion of the public sector and that will threaten the property rights and profitability of the capitalist sector.  The real alternative to Plan A is not one that tries to ‘stimulate’ the banks and big businesses, but one that replaces them.

ADDENDUM

The independent Office of Budget Responsibility (OBR) published its November analysis of the UK economy and its public finances at the same time as George Osborne’s statement to parliament.  It makes pretty awful reading for working people and those not working.  Here are some bullet points from the OBR report.

  • Real household disposable income in the UK fell 2.3% in 2011, a post-war record.  Real average  incomes will fall further in 2012 and there will not be any real recovery in household income until 2014.
  • Employment in the public sector will fall 710,000 up to 2017; public sector workers have their wages frozen through 2012 and then capped to a 1% rise for two further years.  By 2015, public sector workers still in a job will have suffered a 15% real fall in income.
  • The unemployment rate is expected to rise to 8.7% by the end of next year and will not fall below the level of 2010 until 2017.
  • The UK economy is expected to grow only 0.7% next year in real terms, eventually rising to a 3% rate by 2015.  But this acceleration to moderate growth depends on business investment (excluding government investment) growing from -0.8% in 2012 to 12.6% a year by 2015, a truly staggering acceleration.  Whereas business investment contributed nothing to UK real GDP growth in 2011, it must contribute more than 40% of growth by 2015.
  •   Net government investment will be cut by 54% through to 2017  and will drag growth down by 25%.
  • The whole point of this fiscal austerity apparently is to get the public sector debt ratio stabilised and falling and the budget deficit eliminated.  This will be achieved by reducing government spending by 7.6% of GDP up to 2017 but increasing revenues by only 0.5% of GDP.  The burden of austerity is through government spending while increased taxation (both VAT, corporate and household) is avoided.
  • The OBR shows that the UK’s public sector debt to GDP ratio will not be stabilised until 2016, even on its own relatively optimistic assumptions of 3% real growth by then.   By which time, the gross government debt ratio will be 93% of GDP.  That level will still be higher than most governments in Europe.

ANOTHER ADDENDUM

Truly staggeringly awful forecasts for living standards in Britain over the next few years in a report by the Institute of Fiscal Studies.   The IFS finds that there will be a 7.4% fall in real average household income between 2010 and 2013, the largest fall since records began.  This will meant average household living standards will be lower in 2016 than in 2003, a period of 13 years!   The heaviest fall in living standards will among the poorest, with the bottom 20% of income earners suffering a real fall in net income of 1.7% from now to 2013, while the richest 10% will suffer a fall of only 0.4%.  And the hit will be more for families with children, down 1.6%, while those without children will have a 0.3% fall in household income.  As a result, child poverty will increase over the next two years and “it is inconceivable” that the government will get close to its 2020 target reduction in child poverty.

IFS living standards

 

5 Responses to “UK: the best laid plans of mice and George Osborne”

  1. Jurriaan Bendien Says:

    The point is that the public debt is dwarfed by the private debt and that in a debt-ridden economy, aggregate demand does not behave in a Keynesian way.

  2. Luis A. Osorio Moure Says:

    Ok, Michael. I agree completely.Quantitative easing doesn’t work.
    The keynesian way is no the solution.The problem is the capitalist system.We have to come back to The transitional Programme. Whithout to take control of the banks, and big companies there are no solution to the actual situation.

  3. paulc Says:

    Perhaps then a debt jubilee as suggested by Stephen Keen. Those who can’t pay,won’t!
    On a similar tack. If debt doesn’t behave in a keynsian fashion as Jurrian suggests. Let’s just inflate and borrow on a state level.
    All debt is not created equal. Private debt concentrated in debt constrained hands. Public debt faces no such constraints [forget about the ‘markets’ for the moment]. If the Public sector creates/borrows tens of billions additional every year until unemployment is substantially reduced there are two results.
    First, inlfation or some degree thereof reduces the burden of debt to those debt constrained consumers and business’. Secondly, more people are employed in the Governments efforts to revitalise th economy via direct and indirect infrastucture spending, that simultaneously increases our capacity for further production increases. Better than a vicious circle at any rate?

  4. P Spence Says:

    Where is the mass party of the Left which is going to challenge the orthodoxy? The Labour Party will not move beyond pale Keynesian responses and when ordered by international capital to tow the line undoubtedly will. We cannot have any optimism that socialism will be the alternative
    people turn to in the present climate. We have a long to go in the system’s degeneration before the majority are open to radical reform: having said that, events may move quickly in that direction given the atmosphere of pending meltdown.

  5. Matt Says:

    As a Marxist, I don’t carry a brief for Keynesianism. However, I don’t think it is accurate to say that left Keynesians like Paul Krugman, Brad De Long or Dean Baker “think that debt levels don’t matter under capitalism.” What I think they think is that crises such as the present one are generated by *private debt over-leveraging*, that private debt deleveraging should occur according to the market, with the state intervening to keep the process “orderly”, and that therefore public debt should for the meantime expand, not only to compensate for private deleveraging but also to prevent a fall in aggregate demand and maintain GDP expansion at levels of full employment.

    What the Keynesians miss in this analysis are 1) the weakness of the market as a means of deleveraging, especially a market “ordered” by the State and 2) simply expanding public debt is in itself no guarantee of countercycle success even in the medium term. On the first point, there is really no “propensity” for capitalists to deleverage substantially precisely in an “orderly” market, and no incentive at all for rentier capitalists in the FIRE sector (and beyond, including the educational, military, telecommunications and medical “complexes”, a.k.a. State sponsored oligopolies exercising monopoly pricing power over the “market”, these favored by FIRE for investment as the resulting surplus profits can potentially be converted into rent).

    On the contrary, the FIRE and allied sectors thrive on *expanded* private debt, and that is why it is precisely in Britain we see both the disproportionately highest private-to-public debt ratio of all the OECD countries, and the most fanatical Austerianism. The Austerians implicitly understand with their silence on private debt and single-minded focus on public debt that the whole point is to re-expand private debt asap. In a crisis where private debt cannot be deepened where it exists, it must be expanded laterally (or horizontally) into “greenfield” debt. That is why in this crisis we are seeing, not a reversal of neoliberal privatizations as we would logically expect, but just the opposite, an *intensification* of the privatization drive, as these will act as new fields for the expansion of private debt.

    This relates well to point 2) above. Keynesians will of course talk about the need to direct increased public expenditure towards meaningful investments, such as “infrastructure” and the like. But deep down one gets the sense that Keynesians don’t really care where the money is spent, so long as it has the potential to maintain aggregate demand. This tends to be expressed in automatic approval for every CB QE measure in the present situation, irregardless of where those credit emissions might flow to. What Keynesians are shrinking from is the inevitable public economic planning required to actually make this countercyclical policy work. This would publicly demonstrate to the masses that they don’t need to wait on the capitalists to restart the economy, and eventually to conclude they don’t need capitalists at all.

    That of course is the demon that drives the Austerians so as to ensure that nothing can happen without the capitalists. Putting points 1) and 2) together makes for a pretty coherent program from their perspective. They are acting on it with vigor throughout the OECD, and that guarantees not just more of the same of what’s been experienced over the last 30 years, but a qualitative *intensification* of “more of the same”. The Keynesians, meanwhile, will be left clueless, wondering why things are moving in the wrong direction, and why only the Austerians are being listened to.

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