Archive for March, 2012

Olivier Blanchard and TINA

March 28, 2012

Olivier Blanchard is the chief economist of the IMF and he has a blog on the IMF website.  Blanchard’s latest post ( takes up the question of whether there is any alternative to the austerity programme imposed on Greece and other southern European governments to get their economies out of the depression they have entered.  Blanchard argues the position of mainstream economics and the dreaded Troika (the EU Commission, the IMF and the ECB), namely that the governments of Greece, Portugal, Ireland, Spain and Italy have amassed too much government debt to fund lifestyles they don’t earn.  They need to reduce that debt and that can only be done by increasing ‘competitiveness’.

According to Blanchard, there are two ways to become more competitive: become much more productive or reduce wage and non-wage costs.  “The first way is much more appealing. But there is no magic wand.. it is hard to identify where and how progress can be made.”   So Blanchard says that leaves only one way: “a decrease in relative wages, at least until higher productivity can kick in… otherwise competitiveness will not improve, demand will not increase, the current account deficit will continue and unemployment will remain very high.” 

For Blanchard, there is no alternative (TINA), to use the infamous aphorism of that ideological flagholder of ‘neo-liberal’ capitalism, Margaret Thatcher.   Such is the view of the Troika, the European leaders and mainstream economics.  But there is an alternative.  I have tried to outline this in previous posts (An alternative programme for Europe, 11 September 2011, Europe: the path to growth, 14 March 2012).

Blanchard is firmly with TINA. “Were there less painful alternatives? I do not believe there were, or are.  For example, the notion which is sometimes floated that large infrastructure projects might boost growth, increase productivity, and improve the fiscal and current accounts, is fanciful. The problem of Greece is not primarily a problem of physical infrastructure. Projects financed by state funds would do little to impact growth in the short term, would make the fiscal deficit worse and would only delay the inevitable adjustment.”

Yet there is plenty of evidence that you get the best bang for your buck (euro) from investment (see or What these studies show is that government investment can make a significant difference to economic growth, as long public sector debt is not too high.  If it is, then financial markets will drive up the cost of servicing that debt as they fear that budget deficits will get out of hand.  The answer here is to renegotiate a restructuring of that debt with bond holders.  The investment accelerator or multiplier, as it is called, is actually the way economies recover!  Public investment is the most effective way to do that.  Infrastructure projects mean jobs; and they deliver better transport, education and health – all long-term components for higher productivity and better ‘competitiveness’.  Instead, the chief economist of the IMF rejects that and seeks to slash public investment to the bone and privatise public sector assets.

Blanchard then rejects the Keynesian solution of raising wages to boost consumption. “This might indeed increase demand and thus growth in the short run. The increase in disposable income may lead consumers to spend more, although it is likely to be partly offset by a decrease in investment. But the wage increase would exacerbate the problem of competitiveness. Indeed, as imports increased and exports decreased, it would lead to a larger current account deficit. It would just delay and amplify the scope of the inevitable adjustment.”

There is some truth in this criticism.  But my objection to the Keynesian solution would not be that wages should not be increased but that the Keynesian alternative puts the cart before the horse.  What the likes of Greece or Portugal need is investment.  That leads to jobs and then to higher incomes and spending.  Sure, boosting incomes would help demand but it would not provide sustainable growth if the increased income merely eats into profits, curbing private investment.  Increasing wages is not enough or even counter-productive if investment decisions remain under the control of the private sector.

Blanchard rejects the idea of Greece solving its problems by leaving the euro.  “Leaving aside the large costs of no longer belonging to the Eurozone, the dislocations from a disorderly exit—from the collapse of the monetary and financial system, to the legal fights over the proper conversion rates for contracts—would be very, very large.”  I have discussed this alternative in previous posts (Europe: default or devaluation, 16 November 2011).  It is not an alternative on its own. I argue that an alternative policy to the Troika’s should be one of investment financed by public ownership of the banks  and renegotiating the government’s debt burden with Europe’s banks. Leaving the euro and devaluation on its own would not provide sustainable growth.

But is Blanchard right to say that the likes of Greece, Portugal, Spain or Italy can only get out of their mess through being more ‘competitive’?  What does that mean?  Presumably it means being able to sell more goods and services in world markets than others.  If your prices are too high, then you lose market share.  Why would your prices be too high?  Because your costs of production are too high.  What is the biggest component of those costs: labour costs.  That’s why the usual measure of a lack of competitiveness is unit labour costs, or the cost of labour per unit of production sold.

The argument is that the weak capitalist economies of southern Europe have allowed a sharp rise in labour costs or wages, making the goods they produce uncompetitive compared to the super-successful exporter, Germany (see graphic below  showing the change in various countries’  unit labour costs since the start of the euro (1999 =100).

But is this right?  For a start, export growth for Spain, Germany and Greece since the start of the euro in 1999 up to the beginning of the global crisis has been more or less the same, with Spain doing even better than Germany.  And yet Greek unit labour costs rose over 70% in this period, Spain’s were up 13%, while Germany’s fell.  How is that possible?   The answer is revealed if you go back further in time than 1999 and measure unit labour costs from say the early 1980s, it shows that for the 25 years up to 2005-6, the level of unit labour costs in southern Europe was lower than in Germany.  The graphic shows unit labour costs relative to Germany from 1980.

For over a decade, low wages and reasonable productivity growth made exports from the likes of Greece or Spain cheaper than Germany’s.   But during a long period of ‘internal devaluation’ from the 1990s onwards, Germany’s labour costs stopped rising.  So the huge competitive edge that other European countries had over Germany was gradually eroded by the convergence of their unit labour costs with Germany’s.   But the overshoot of peripheral countries’ unit labour costs only occurred in the last few years and is now (painfully) being eliminated.

This not to say that there is not an export problem for the peripherals to be dealt with.  But it is a great deal more finicky to understand.  The southern European economies export much the same range of goods in manufactures, chemicals and autos as Germany.  The differences are in services; tourism looms large in the south and software and business services in the north (Ireland and Germany).  But, after all, there is nothing wrong with offering vacations, if that is where your competitive advantage lies.

It is only when you drill down to another layer of detail that the real export problem appears.  The degree of technical specialty that captures the ability to set price in global markets is very low in the exports of the southern European economies and very high in core Europe and in Ireland (see Jesus Felipe and Utsav Kumar, Unit labour costs in the Eurozone: the competitiveness debate again, Levy Economics Institute, Working paper 651, February 2011).  This matters because of the speed at which emerging market producers like China are moving up the value-added chain.  German capitalism is staying one step ahead; the weak capitalist states of Greece, Spain and Portugal are not.  To do so, they have to become more innovative.  This is a story of the need for better education and more investment in human and machine capital, areas where capitalism in Southern Europe has failed.

But if the Greek or Portuguese people are as lazy as the common perception would have it, no amount of innovation and education will work.  But are they lotus-eaters?  Not if you measure the hours of work they put in – way higher than in Germany (graphic: annual hours worked).

Perhaps the Greeks and Spanish are asking for too much of share of the value they produce with labour grabbing an increasing share of national income at the expense of capital.  Again, that’s not true.  In all these countries, the share of wages in national income fell from 1991-07, with the biggest falls in Ireland, Italy and Portugal.  In 2007, the wage share was lower in Greece, Italy and Ireland than in Germany (see graphic of wage shares to GDP).  So much for the lazy or greedy theory.

What has failed is the capitalist sector to invest and innovate, not workers failing to toil or accept a lower share of value created.  Nevertheless,  mainstream economics sees the solution only in ‘internal devaluation’  to make these economies ‘competitive’.  The problem is that, as the IMF admits in its own review of Greece, “Restoring competitiveness by way of internal devaluation has proved to be a difficult undertaking with very few successes.”   And yet this is the pillar of the Troika’s programme.

The IMF says that governments must reduce the tax burden of corporations to persuade them to invest and exports to generate growth.  And it wants huge ‘deregulation of labour rights and conditions to achieve even cheaper labour costs (via internal devaluation) to help fuel investment and boost profits: “reforms to facilitate investment are being accelerated to allow firms to take advantage of cheaper labour once financing conditions stabilise.”  But will private sector investment and exports tehn deliver?

Blanchard and the Troika want to rely on faster export growth through cheaper labour costs (competitiveness) to get Southern Europe out of its depression.  But if every country had to grow by expanding exports faster than imports, then they would all have to obtain a net export balance with the moon!  Take Portugal for example.  In the last quarter of 2011, real GDP was down 2.8% yoy.  Exports were up 5.8% yoy while imports fell 13.5% yoy, giving an overall boost to real GDP growth from net trade of 8.4% pts.  But you can see that this boost from trade was mostly due to a collapse in imports as Portuguese households stopped buying foreign consumer goods and companies stopped importing as much machinery and raw materials to expand production. Indeed, domestic final sales fell 8.1% yoy, much worse than at the nadir of the financial crisis in 2008 when it fell only 3.2% yoy.  Fixed investment by the Portuguese capitalist sector was down a stunning 16% yoy and has fallen a cumulative 31% from its pre-crisis peak.  A classic capitalist slump.  And yet, Olivier Blanchard and the Troika are relying on private sector investment and exports to turn this round through cutting real wages and stopping all government investment.

Private investment is in free fall in these weak European economies.  There is a clear case for public investment.  This can be financed by public ownership and control of the banks to direct credit to infrastructure projects and to revive small businesses.  Governments can reduce their debt burdens by restructuring (defaulting on) their debts with Europe’s banks that caused the mess in the first place.  This is the alternative to taking Troika money to bail out the banks and complying with fiscal austerity, ‘internal devaluation’ and depression for a decade or more.

Which way for China – part two

March 23, 2012

The sacking of Bo Xilai, the controversial and maverick party secretary of the Chongqing municipality highlights the strategic split that exists at the top of the Chinese government about what direction to take the country over the next generation.  Mr Bo is the son of a revolutionary hero, one of the so-called ‘princelings’, the children of the elite families that rule one and half billion people.   Considered a “prince among princelings”, Bo Xilai is the son of Bo Yibo, one of the Eight Immortals, the group of senior revolutionary veterans who served as the backbone of Deng Xiaoping’s support in the 1980s.

It’s no coincidence that just days after Bo Xilai came under criticism, prominent Chinese academics were attacking him publicly, saying that his career and the entire Chongqing Model were finished   These attacks were from the ‘pro-capitalist roaders’ faction in the Chinese leadership.  This camp disliked Bo because they saw him as a demagogue supporting populist, statist economic policies.  They hinted at corruption, such as Bo’s son driving a red Ferrari – as if most of the princelings and especially the pro-capitalist wing did not do something similar.

What alarmed the top leaders and led to his downfall was partly Bo’s tactic of “mobilising the masses” in ways that explicitly invoked the Cultural Revolution.  That called up deep-seated fears that populist fervour might be used as a weapon against Bo’s rivals.  But Bo’s Chongqing Model also worried the pro-capitalist faction because they are concerned about the current move towards a larger role for the state sector to protect China from the impact of the slump in the capitalist world. The refrain of “guo jin min tui” (the state advances, the private sector retreats) has been the recent sound across China, not just in Chongqing.  Bo jumped on that bandwagon.

The sacking of Bo is a minor moment in the major debate within the leadership on whether China can continue to grow fast through investment in industry, infrastructure and more exports or it needs to switch to a consumer-led economy that imports more and supplies goods to a ‘rising middle-class’ like advanced capitalist economies supposedly do.  Mainstream economics (and their pro-capitalist supporters in China) reckons that this cannot be done without developing a more ‘market-based’ economy i.e. capitalism, because the ‘complexity’ of a consumer society can only work under capitalism and not under the ‘heavy-handed’ central planning of government and state industries.

Leading up to the National Peoples Congress, the pro-capitalist wing was loudly demanding a change of direction by the government.  This was highlighted by a World Bank report on China’s future (China 2030;, published in conjunction with China’s advisory body, the Development Research Center of China’s State Council.  The report argued that there would be an economic crisis in China unless state-run firms were scaled back.  China needed to implement ‘deep reforms’, selling off state-owned enterprises and/or making them operate more like commercial firms. According to the World Bank, China’s growth would decelerate rapidly once people reached a certain income level, a phenomenon that these economists call the “middle-income trap.”   The report said the answer to set up ‘asset-management firms’ to sell off state industries, overhaul local government finances and promote ‘competition and entrepreneurship’.

Two things struck me particularly about this report.  The first of its six strategic measures is the privatisation of the state.  This is put right up front. In contrast, there is no mention of the democratisation of the state, the ending of one-party rule; the ending of the suppression of individual rights and freedoms, allowing trade union rights etc.  What hypocrisy!  The World Bank authors want capitalism, but they don’t care about democracy.  The report is also totally blind.  It wants China to abandon its current economic model and publicly-controlled financial system, which brought it successfully through the world financial crisis, and instead adopt the very model that led the US and Europe into disaster.

But what is also interesting about the report is that it admits that the capitalist mode of production still does not dominate in China – indeed that is the problem according to the World Bank and its domestic supporters.  The report recognises that China’s incredible economic success over the last 30 years was based on an economy where growth was achieved through bureaucratic state planning and government control of investment.  China has raised 620 million people out of internationally defined poverty.  Its rate of economic growth may have been matched by emerging capitalist economies for a while back in the 19th century when they were ‘taking off’.  But no country has ever grown so fast and been so large (with 22% of the world’s population) – only India, with 16% of the world’s people, is close.  As John Ross has pointed out ( in 2010, 87 countries had a higher per capita GDP than China, but 83 were lower.  Back in the early 1980s, three-quarters of the world’s people were better off than the average Chinese.  Now only 31% are.  This is an achievement without precedent.

Even if China slows down as the World Bank predicts, it will still add over $21trn to its GDP before the end of the decade and reach the size of the US economy by then.  Even though China’s consumption as a share of GDP is very low by capitalist standards (anywhere between 35-45% of GDP, depending on how you measure it, compared to 65-75% in mature capitalist economies), it will add another $10trn in annual consumption by 2020, equivalent to the size of America’s annual consumption.  These figures come from the World Bank report itself.

This has been achieved without the capitalist mode of production being dominant.  China’s “socialism with Chinese characteristics” is a weird beast.  Of course, it is not ‘socialism’ by any Marxist definition or by any benchmark of democratic workers control.  And there has been a significant expansion of privately-owned companies, both foreign and domestic over the last 30 years, with the establishment of a stock market and other financial institutions.  But the vast majority of employment and investment is undertaken by publicly-owned companies or by institutions that are under the direction and control of the Communist party. The biggest part of China’s world-beating industry is not foreign-owned multinationals, but Chinese state owned enterprises.

A recent report by the US-China Economic and Security Review Commission (26.10.11) called An analysis of state- owned enterprises and state capitalism in China provides a balanced and objective review ( “The state owned and controlled portion of the Chinese economy is large.  Based on reasonable assumptions, it appears that the visible state sector – SOEs and entities directly controlled by SOEs, accounted for more than 40% of China’s non-agricultural GDP.  If the contributions of indirectly controlled entities, urban collectives and public TVEs are considered, the share of GDP owned and controlled by the state is approximately 50%.”  The major banks are state-owned and their lending and deposit policies are directed by the government (much to the chagrin of China’s central bank and other pro-capitalist elements).  There is no free flow of foreign capital into and out of China.  Capital controls are imposed and enforced and the currency’s value is manipulated to set economic targets (much to the annoyance of the US Congress).

At the same time,the single party state machine infiltrates all levels of industry and activity in China.  According to a report by Joseph Fang and others (, there are party organisations within every corporation that employs more than three communist party members. Each party organisation elects a party secretary. It is the party secretary who is the lynchpin of the alternative management system of each enterprise. This extends party control beyond the SOEs, partly privatised corporations and village or local government-owned enterprises into the private sector or “new economic organisations” as these are called.  In 1999, only 3% of these had party cells.  Now the figure is nearly 13%.  As the paper puts it: “The Chinese Communist Party (CCP), by controlling the career advancement of all senior personnel in all regulatory agencies, all state-owned enterprises (SOEs), and virtually all major financial institutions state-owned enterprises (SOEs) and senior Party positions in all but the smallest non-SOE enterprises, retains sole possession of Lenin’s Commanding Heights.

The reality is that almost all Chinese companies employing more than 100 people have an internal party cell-based control system.   This is no relic of the Maoist era.  It is the current structure set up specifically to maintain party control of the economy.  As the Fang report says: “The CCP Organization Department manag(es) all senior promotions throughout all major banks, regulators, government ministries and agencies, SOEs, and even many officially designated non-SOE enterprises. The Party promotes people through banks,regulatory agencies, enterprises, governments, and Party organs, handling much of the national economy in one huge human resources management chart. An ambitious young cadre might begin in a government ministry, join middle management in an SOE bank, accept a senior Party position in a listed enterprise, accept promotion into a top regulatory position, accept appointment as a mayor or provincial governor, become CEO of a different SOE bank, and perhaps ultimately rise into upper echelons of the central government or CCP — all by the grace of the CCP OD.”

This does not look like the normal relationship of state owned companies or agencies in mature capitalist economies, where the newly nationalised banks in the UK or the now publicly owned General Motors in the US are owned and controlled at ‘arms length’.  In other words, the taxpayer funds them, while they operate purely on the profit motive.  In contrast, Chinese banks have targets for lending and investment set by the government which they must meet, whatever the impact on profits.

The law of value does operate in China, mainly through foreign trade and capital inflows, as well as through domestic markets for goods, services and funds.  In so far as it does, profitability becomes key to investment and growth.  So what has happened to China’s profitability in the last 30 years?  There have been various attempts to estimate the rate of profit in China.  I did so in my book, The Great Recession, chapter 12.  There are other studies that reach slightly different conclusions than I did (Zhang Yu and Zhao Feng, 2006,; and Mylene Gaulard, 2010, ).

I found that there were three cycles of profitability.  Between 1978-90, there was an upswing as capitalist production expanded through the Deng reforms and the opening up of foreign trade.  But from 1990 to the end of that decade, there was a decline, as over-investment gathered pace and other economies, particularly in the emerging world went through a series of crises (Mexico 1994, Asia 1997-8, Latin America 1998-01).  The falling rate of profit then was accompanied by slowing in the rate of GDP growth.  Then from about 1999 onwards, there has been a rise in profitability, which also saw a significant rise in the rate of economic growth (as the world too expanded at a credit-fuelled pace).  A more recent study by the Fung Global Institute (http://www.fungglobal shows that profit margins in industry rose steadily from 1999 as unit labour costs stayed flat, confirming my work (see below).

We may be reaching a peak in profitability again, heralding slower growth over the next decade, as world capitalism struggles big time.

So the Chinese economy is affected by the law of value.  That’s not really surprising.  You can’t ‘build socialism in one country’ (and if a country is under an autocracy, by definition).  Globalisation and the law of value in world markets feed through to the Chinese economy.  But the impact is ‘distorted’, ‘curbed’ and blocked by bureaucratic ‘interference’ from the state and the party structure to the point that it cannot yet dominate and direct the trajectory of the Chinese economy.

Market forces and the law of value remain pernicious, however.   Inequality of wealth and income under China’s ‘socialism with Chinese characteristics’ has never been so bad.  It was one of the issues that Bo Xilai made much of.   He put it thus: “As Chairman Mao said as he was building the nation, the goal of our building a socialist society is to make sure everyone has a job to do and food to eat, that everybody is wealthy together. If only a few people are rich, then we’ll slide into capitalism. We’ve failed. If a new capitalist class is created then we’ll really have turned onto a wrong road.”  China’s Gini coefficient, an index of income ineqaulity, according to Sun Liping, a professor at Beijing’s Tsinghua University, has risen from 0.30 in 1978 when the Communist Party began to open the economy to market force 0.46.  Indeed, China’s Gini coefficient has risen more than any other Asian economy in the last two decades.  The rise in inequality is partly the result of the urbanisation of the economy as rural peasants move to the cities.  Urban wages in the sweatshops and factories are increasingly leaving peasant incomes behind (not that those urban wages are anything to write home about when workers assembling Apple i-pads are paid under $2 an hour).  But it is also partly the result of the elite controlling the levers of power and making themselves fat, while allowing some Chinese billionaires to flourish.

By the end of this decade, China’s GDP will be higher than that of the US, although average living standards, even in the urban and coastal belts, will be only one-third of that of Americans.  But as living standards rise and China gets older (by 2025, the workforce will stop rising and retirees will rise sharply), the Chinese people will want to obtain the material benefits of a modern economy.  That does not mean just cars, hi-tech gadgets and fashion as mainstream economics emphasises.  It also means decent pensions, proper transport and infrastructure, health services and education – the so-called public goods.

Is mainstream economics right to argue that people’s needs and aspirations can only be met by a capitalist economy?  The evidence of the Great Recession and the ensuing long depression suggest otherwise.  If the capitalist road is adopted and the law of value becomes dominant, it will expose the Chinese people to chronic economic instability (booms and slumps), insecurity of employment and income and greater inequalities.  On the other hand, if the surplus created by the Chinese people remains under the control of an elite backed by an army and police and ruling without dissent, then the needs and aspirations of a more affluent and educated population will not be met.

A socialist or capitalist road?  Well, the elite is united in opposing socialist democracy as any Marxist would understand it.  But they are divided on which way to sustain their power.  The people have yet to play a role.  They have been fighting local battles over the environment, their villages and their jobs and wages.  But they have not yet been battling for more democracy or economic power.  The middle classes are still backing the regime.  In a spring 2010 survey by the Pew Research Center’s Global Attitudes Project, 87% of Chinese said they were satisfied with the way things were going in their country.  In another poll taken last November, creating a “democratic political system with Chinese characteristics” was supported by 50% of those interviewed, but only 15% wanted a ‘Western-style democracy’.   Indeed, nearly 70% were against the “total Westernisation” (whatever that might mean) and 69% opted for the ‘social stability‘.

But the key to continued growth and more equality will be democracy.  China needs to move from ‘socialism (i.e. a planned economy) with Chinese characteristics (i.e. autocracy and corruption)’ to a China with socialist foundations (democratic planning and equality).

UK budget: cheap shots

March 21, 2012

The UK government has announced its 2012 budget for annual government spending and taxation.  The budget is full of cheap shots designed to convince financial markets that the government is sticking to austerity and spending cuts while at the same time trying to provide profit-making opportunities for a very reluctant-to-invest corporate sector.  The headline news was the decision to cut the top rate of personal income tax from 50p in the £ to 45% from April 2013, which is paid on any personal income over £150,000 a year.  At the same time, the government is cutting corporation tax by 2% this year to 24% and further to get it to 22% by 2014, the lowest rate among the major economies.

The UK’s Conservative Chancellor, George Osborne, tells us that the 50p rate was a disincentive to entrepreneurs and to investment in the UK.  Of course, this is baloney (see my post, It’s nauseating, 2 March 2012 on this issue).  The government tells the people that they must tighten their belts and accept reduced public services and benefits and the slashing of wages in the public sector, along with higher taxes and social security payments.  And yet the very rich earners, the top 1%, are to get a cut in their tax burden worht £42,00 a year for 114 British millionaires!

Osborne claimed that the 50p tax was raising only £100m a year.  But this is rubbish on any reasonable investigation.  Indeed he admitted that lowering the tax rate will mean a loss of £1bn a year in revenues.  To balance that loss, along with some tax relief for moderate earners, the government plans to cut public spending even more than previously.  Osborne claims that he will block various tax avoidance measures that the rich have been using and raise more money that way.  But where have we heard that before?

The next cheap shot is the decision to take over the pension fund of the publicly-owned Post Office.  The fund has £28bn in the kitty from past contributions by postal workers.  Now these assets will be used to pay down government debt and reduce the annual budget deficit.  But according to the government’s own figures, the contingent liabilities on this fund are £10bn greater than the assets – namely the future payments to pensioners that will have to be met.  And if valued properly, the liabilities would probably be well over £20bn more.  In effect, the government is stealing the Post Office pension fund assets now to make its public finances look better and leaving taxpayers to cover future payouts.  Spend now, pay later – hardly the model of austerity.  The other side of this move is that now the Post Office chiefs are clear of the pension liabilities (it’s now the problem of the taxpayer) making the Post Office look an attractive privatisation.  The unions may think that the state taking over their pension scheme is good news, but if it leads to privatisation, with the new company introducing a poorer pension scheme, they may rue the day.

Privatisation and boosting profitability for the private sector are clearly the motivations behind all these cheap shots.  Britain’s National Health Service is one of the most efficient and universal in the world.  It’s the world fifth largest employer with 1.7 million staff.  This government has seen fit to reorganise it such a way that the control of funds will now drift into the hands of private consultants who are supposedly helping doctors to disburse funds for patients.  This will allow private companies to take over an increasing range of services from NHS direct labour.  Outsourcing to the private sector is the name of the game already in Britain’s courts, the police, job centres, schools and health.   The private companies and equity firms are licking their lips at the profit opportunities.  It means poorer services with less democratic accountability as previous privatisations have proved.

Privatisation in the UK used to be presented as an opportunity for the ordinary person to buy a share in public services.  But now the idea of ‘shareholder democracy’ has been dispensed with.  There is no attempt to hide the idea that privatisation is designed to boost private profit at the expense of public services with the mythical justification that bringing in competition is ‘more efficient’.  Tell that to railway users in Britain.   Or take the water industry, privatised by the Thatcher government in 1989.  This is what David Hall, an expert in the subject had to say in April 2008:,  “In cash terms, the average annual bill for water and sewerage rose from £120 per year in 1989 – the year of privatisation – to £294 in 2006, an increase of 245% in 17 years. In real terms, it represents a rise of 39% over and above the general rate of inflation. A breakdown of the component elements in the water bills shows that operating costs have remained roughly constant in real terms: the increase in customers’ bills is almost entirely due to the various elements associated with the capital – capital charges,  interest, and profits – which have nearly doubled, in real terms, over this period.”  So the huge increase in price was all due to paying shareholders a profit and bond holders interest.  Hall estimates that if the water industry (built by public funds) had stayed in the public sector, UK household bills for water and sewerage would be 12% lower than they are.

And there is the latest cheap shot in the budget: the proposal that new roads in traffic-congested Britain should be owned by the private sector who can then charge the taxpayer for their use.  The Conservatives propose that private companies would build roads in return for 60-year leases on them, for which they charge the taxpayer ‘tolls’ for their use.  Rather than the government issue bonds to raise the money (at currently very low rates of interest) and then build the roads through public investment, the government is keeping the debt off its books but putting the taxpayer at the mercy of private companies to charge them for 60 years.

Behind all these cheap shots is the real issue: economic growth.  All the best laid plans of mice and George Osborne (see my post, The best laid plans of mice and George Osborne, 29 November 2011) will go awry if the UK economy cannot grow enough.  And the reality is that the economy has been struggling.  This is the weakest recovery out of an economic slump since 1918 (see my post, The weakest recovery since 1918, 18 October 2011).

The Economist magazine has constructed a measure of the ‘lost time’ in economic fundamentals that the Great Recession has caused major economies.  Its Proust index measures the decline in GDP, consumption, stock market and house prices, wages and employment.  It found that Greece has been put back 12 years while the UK has been set back eight years, higher than the seven years for the distressed Eurozone economies of Ireland, Spain, Italy and Portugal. By the way, the US was even more damaged, having lost ten years!

This time last year, the government forecast that UK real GDP would rise 2.5% in 2102.  The latest forecast by the Office for Budget Responsibility (OBR) is that the UK will grow just 0.8% this year and only narrowly avoid a technical recession of two consecutive quarters of contraction.  For 2013 , the forecast is just 2%.

This poor growth means that the fiscal targets on the budget and on debt will be difficult to meet despite all the cheap shots.  The credit ratings agency Fitch has already put the UK on a warning that it may downgrade its sovereign debt because its “structural budget deficit is second only in size to the US” and its debt is too high.  Any sign that the UK cannot keep to its draconian fiscal austerity targets and a downgrade will follow, driving up the cost of capital for the government.

Unemployment is still rising – the recent pickup in private sector jobs was mainly in temporary employment.  And living standards for the average household are still contracting. Inflation is still well above the Bank of England’s target rate of 2%.  According to the Centre for Economics and Business research, real disposable income will fall by over 1% this year and again in 2013, so that by the end of 2013 real living standards for the average household will be 5.7% lower than before the Great Recession began in 2007.

Faster economic growth is possible.  It requires a banking system able and willing to lend at reasonable interest rates to allow small businesses to invest and expand.  And it requires major investment in communications, the environment, transport and otehr infrastructure projects to lay the basis for a better economy.  The London Olympics won’t be enough.  Interestingly, research by Experian for the BBC found that, contrary to the mainstream economic myth that Britain’s regions were unable to grow and were too dependent on employment in public services, there were a high proportion of small businesses in computing, finance and creative industries the poorer regions of the country, with the North East in the lead.  But these businesses couldn’t grow because they could not get financing from the banks (although the two biggest are partly publicly-owned) and they could not issue bonds like the big companies.

The British prime minister David Cameron made a big play last week of the need to renew Britain’s infrastructure. to develop the rail network, power stations and broadband.  But Cameron saw only one way to do this: attract the private sector to invest at a profit.  Cameron raised the “Victorian spirit” of the mid-19th century as an example of private sector-led investment in roads, rail and transport.  He forgot that the government then also played vital role in introducing education for all and public funding for sewers and local services.  Cameron wants to build a new generation of ‘garden cities’, a new phase of nuclear power stations, more housing (Britain has a chronically low level of private housing additions), 4G telephony and a super broadband highway.  But apparently, this can only come from private sector investment through schemes like tax-free economic zones.

Cameron may have to wait a long time.  He is looking to corporate pension funds to invest.  But, as we have pointed out before, at the moment, the UK business sector is on an investment strike.  It has been piling up cash to the tune of £700bn, or 6% of GDP.  But business investment in the British domestic economy is now just 8% of GDP, half the rate of the 1990s and 25% below pre-crisis levels.

As a result, the productivity of labour in Britain has been the worst of all the major capitalist economies since the recovery started.

What better case is there for public sector-led investment, financed by publicly-owned banks and bond issuance, alongside higher taxation of the top 1% and the closing of the tax gap (where big business avoids paying what is should)?

Which way for China? – part one

March 19, 2012

China’s National People’s Congress, the supposed decision-making body for China’s leaders, has just finished meeting.  And the main debate (apart from behind the scenes discussions on who would take over as the new leaders from the retiring leadership) was about the state of the Chinese economy.

Mainstream economics is confused about which way the Chinese economy is going.  Some media and economists reckon Chinese growth is slowing fast from its double-digit pace seen in the last few years and indeed is heading towards a crisis or slump brought on by ‘over-investment’, a reversal of a credit-fuelled property bubble and a spiralling of hidden bad debts in the banking system. On the other hand, some economists reckon that economic growth may be slowing, but the Chinese authorities will be able to engineer a ‘soft landing’ through the easing of credit and financing of the writing-off of debt from cash reserves built up over past years.

Behind this debate on the immediate future also lies a debate on whether China can continue to grow fast through investment in industry, infrastructure and more exports or will need to switch to a consumer-led economy that imports more and supplies goods to a ‘rising middle-class’ like advanced capitalist economies supposedly do.  Mainstream economics reckons that this cannot be done without developing a more ‘market-based’ economy i.e. capitalism, because the ‘complexity’ of a consumer society can only work under capitalism and not under ‘heavy-handed’ central planning of government and state industries.

In this first part of a look at the Chinese economy, I’ll consider what will happen over, say, the next two years or so.  China has experienced truly exponential economic growth over the last decade in particular.  And that growth continued apace right through the Great Recession that the major capitalist economies suffered from 2008-9.  But now the question is: can that ‘breakneck’ pace continue or is it really breakneck?

Chinese economic growth is clearly slowing down.  In the first two months of this year, industrial production grew 11.4% yoy compared to 12.8% in December 2011, while China’s power generation increased 7.1%, the slowest growth rate in a year. Fixed asset investment, the main driver of the Chinese economy, was below historical averages. Fixed asset investment growth actually accelerated to 21.5% yoy up from 18,2% in December, although this acceleration was concentated in unproductive investment in property sectors. The comsumer weakened and passenger car sales fell 4.4% yoy to 2.37m vehicles and total auto sales fell 6% yoy to 2.95m units.  Retail sales increased 14.7% yoy in early 2012, down from an 18.1% ypy in December 2011.  Overall real GDP growth has slowed from a peak of 11.9% yoy in Q1 2010 to 8.9% in Q4’2011,  At the People’s Congress, the Chinese leaders targeted real growth at just 7.5% this year, something not seen since the depth of the Great Recession in Q4’2008.

Yet, by global standards, that’s a growth rate to envy: the US can barely manage 2%; Europe and Japan are flat at best, while even fast-growing India will not achieve that rate of growth this year.  But the Chinese economy needs to grow by at least 8% a year in real terms if it is to generate enough jobs to absorb the influx of workers from rural areas into the cities without unemployment rising.  So there would appear to be a problem ahead.  But remember, a target is just a target: China’s GDP has always grown more than projected. Take a look at the chart below. The yellow line shows how China has conservatively set its target GDP growth for the past decade. Every year, actual GDP growth has been higher and much higher in some cases. For example, in 2007, while the government projected GDP to grow 8%, actual GDP growth came in much higher at 14%!

GDP Growth

The main argument presented for expecting that China is heading for a sharp slowdown, or even what is called a ‘hard landing’, is that its fast growth in recent years was based on excessive credit injections by its banks, creating a property bubble that is now bursting.  Much of the property bubble was engendered by local authorities borrowing huge hidden amounts from the banks and financing their spending by selling off land to private developers, often literally over the heads of the local villagers.

That property bubble is now bursting.  Property prices are falling in most Chinese cities and are down 1.5% yoy.  Huge debts have been run up local authorities and developers and hidden in special purpose vehicles off the balance sheets of the banks.  The level of the what is called the total social funding of the economy by the banks has reached 180% of GDP.  This ‘shadow banking’ is similar to the off-balance sheet mess that the US and European banks got into that led to the financial collapse of 2008.  The risk is that China is heading the same way.  But is it?

First, the government has succeeded in reining in inflation, mainly caused by higher food and energy prices globally.  Inflation is now at its lowest level since 2010.

Lower Inflation

So the government is now able ease its monetary policy by cutting the reserve requirements imposed on the banks to hold cash at the central bank, so they can lend more or at lower rates and take some of the pressure off borrowers over the rest of the year.  Monetary growth is already beginning to turn up.  And the new budget announced by the government offers some support to growth, if not as much as the humongous increase in public spending adopted in 2008 to counteract the global economic slump.

Fiscal spending will rise 14% this year with spending on health, education and social security up 19% – hardly austerity.  Taxes on small businesses are being cut as is VAT.  Local government financing through property sales will be curbed, so the issue of local government bankruptcies remains.  But central government has huge reserves to fund such defaults from FX reserves of $3trn and fiscal reserves of CNY500bn in the budget.

Mainstream economics has made much of the news that China ran a deficit on its trade with the rest of the world in the first two months of this year, the first time in a decade or more.  Exports are important to China. During the global crisis, mainstream economics predicted the collapse of Chinese economy because exports accounted for 35% of GDP. With the negative demand shock from the West, export-led growth collapsed, and so would China – that was the conclusion they considered only logical.  But GDP is driven by net trade (exports minus imports), not just by exports. In fall 2008, net exports were 8% of GDP and today are still about 4%.  Private domestic demand has been strong.  And easing  fiscal policy will boost aggregate demand.

The stories of gloom and doom for China have been around ever since the onset of the global crisis in 2008-9. A new round of doomsday prophecies has been accelerating since summer 2011, when the Eurozone crisis escalated and Washington’s debt-ceiling debacle resulted in the downgrade of the U.S. sovereign credit-rating.  Now the argument is that Chinese economy is about to face a “hard landing” because of a bursting property bubble, disproportionate reliance on exports, and excess capacity caused by growth through investment.  But since the housing downturn is induced by policy, it can also be reversed by changes in policy, which is precisely what happened in China during the global financial crisis.  At worst, China is likely to experience slower growth than in previous years.  That’s all.

The big story that came out of the People Congress was the sacking of Bo Xilai as party boss from Chongqing.  Bo was a controversial and flamboyant figure ostensibly attacking inequalities and pro-capitalist policies.  So what does his removal  mean?  I’ll deal with this and the long-term prospects for China in part two.

Europe: the path to growth

March 14, 2012

An unpublished report by EU commissioners on the Greek Troika team reckons that Greece will need to make further cuts of €12bn on top of those already planned in public spending over the next two years to meet Troika targets.  The EU Commission’s Compliance Report said that further drastic reductions equivalent to 5.5% of GDP would be have to be agreed by the end of May to fill “fiscal gaps” in the next two years. The next government’s first task will be to find €7.6bn of savings in 2013 and another €4.1bn in 2014 to stay on track with the fiscal programme agreed with the Troika. The savings are likely to come from fresh cuts to pensions, new reductions in social transfers, the further slashing of pharmaceutical and healthcare spending, another round of cuts to defense spending and a ‘restructuring’ of central and local administration.  Greece has to achieve a primary surplus (ie after debt interest payments) on its annual budget of 1.8% of GDP in 2013 and 4.5% in 2014 to continue to qualify for the loans the Eurogroup approved this week.

That means that any new Greek government elected in early May will not only have to implement the existing Troika measures agreed under the new bailout package.  It would also have to tell the Greek people that it needs even more pain to be inflicted by the government if it is to meet Troika demands.  Given that the current coalition leaders have pledged that there will be no more cuts, we can imagine how this news is going to be received by the people.

The continued drive for fiscal austerity to solve the Euro debt crisis is becoming self-defeating.  Country after country in Europe is announcing that it cannot meet its own fiscal targets and needs more room.  Spain has got the EU leaders to agree to a slightly less demanding target for its government balance in this year although it still has to go from a deficit of 8.5% of GDP in 2011 to 3% by the end of 2013.  A huge task.  Portugal is likely to slip from its targets. Belgium says it now needs to cut more to meet its target and so does the Netherlands and even Finland.  And the story for the UK, the US and Japan is much the same.

The EU leaders are beginning to realise that austerity is not enough.  Debt targets will not be met without economic growth as well.  So more growth is now becoming the mantra of the Euro leaders and mainstream economics.   But how is growth in the weak European capitalist economies to be achieved?  They are contracting by anything between 1-6% of real GDP this year.  The answer from mainstream economics is what we might call the traditional ‘neo-liberal’ solution.  By that I mean that Europe’s economies must become ‘more competitive’.  That means cutting wages to get down unit labour costs, ‘deregulating labour and product markets’ to break the power of trade unions to defend wages and increase the power of employers to hire and fire; and to ‘open up’ professional occupations to the less well-qualified and with poorer expertise at lower incomes. In other words, to try and create conditions for the private sector and especially big business (both domestic and foreign) to want to invest in these economies.

So the neo-liberal solution depends on praying that the private sector gets more profitable and then will invest and create new jobs and thus economic recovery.  It is probably a vain hope.  The reality is that since the trough of the Great Recession in mid-2009, profitability in the major capitalist economies is still generally below that in 2007 (see the graphic below showing rates of profit and my post, The UK rate of profit and others,4 January 2012 ).  So there is no enthusiasm to invest in new capital while ‘dead capital’ remains a burden.

There is an alternative solution for the path to growth. The Greek debt default shows that renegotiating the debt should have been a big part of any proper solution to helping economic growth in Greece.  For a start, the default deal will mean that the Greek public debt ratio will fall from 166% of GDP to about 125% or even lower.  But default was refused and denied for two years by the Euro leaders, the banks and the Greek government.  Eventually reality ruled.  Of course, the Euro leaders and the bankers want Greece to be seen as a ‘one-off’.  But part of the way out of the economic slump for the weaker capitalist states like Portugal, Spain or Italy is to negotiate a debt ‘restructuring’ that reduces the burden on the electorate of paying interest and debt repayments to Euroepe’s financial institutions – who caused the crisis in the first place!  The money saved could then be spent on investment for jobs and growth.  Instead, around 90% of the Greek bailout package funds from the EU-IMF are being spent to recapitalise the banks, paying off private bond holders and repaying the IMF that’s lending part of the money!

The other part of the alternative solution would be based on public sector investment on a big scale in infrastructure, new technology and the environment, as well as funding for small businesses to pick themselves up.  Such a programme is way more job-enhancing than the squeezing wages and sacking people to achieve ‘competitiveness’ that the neo-liberal solution offers.  Indeed, you have to ask the question: to be more competitive than whom?  If Portugal slashes wages like Greece, deregulates and cuts public services to the bone in order to drive down labour costs and become more competitive, where does that leave Greece, Ireland, Italy and the others trying to do the same.  There is no advantage gained (except perhaps to exports outside Europe).  It all smacks of a zero-sum game.  Growth does not have to be export-led growth designed to ‘steal’ growth off other countries unable to cut costs as much.  If that were so, there would never be any growth.  Economic growth can come from increased domestic investment and employment – in other words from a larger cake rather than trying to redivide a smaller cake.

Since the euro started, Germany has not become more competitive in Europe than others because it improved the productivity of its labour force through new investment.  Indeed, productivity growth in Greece has been much more than in Germany since 1999 – up 25% compared to 10% for Germany.  Of course, Germany’s level of productivity is still much higher.  But Germany’s competitiveness improved because German workers’ wage growth was curbed.  Since 1999 German wages have risen only 22% while they rose 66% in Greece.  So although Greek competitiveness (as measured by unit labour costs) improved between 1999 and 2007 by over 5%, Germany did even better  (see my post, Europe: default or devaluation, 16 November 2011).  In other words, Germany stole some growth from Greece by squeezing wages at home.  The neo-liberal solution is to make workers pay for the recovery and boost profits, not to raise productivity through investment and deliver higher incomes for all.

Will a public investment programme work?  Well, it will if the examples of China and Brazil during the Great Recession are any evidence.  According to the IMF, in the last four years, China’s real GDP has risen in real terms 53%!  Brazil’s has risen nearly 16%.  Real GDP in the G7 countries and in the Euro area has not risen at all!  Indeed, in many mature capitalist economies, real GDP is still lower than in 2007.

Why have China and Brazil done so much better?  The Chinese government launched a massive public investment programme in 2008 of $600bn, or 8% of GDP, to combat the impact of the global slump.  Public infrastructure development took up the biggest portion. The projects lined up included railway, road, irrigation and airport construction.  Reconstruction works in the regions were expanded followed by funding for social welfare plans, including the construction of low-cost housing, rehabilitation of slums, and other social safety net projects.  Rural development and technology advancement programs were extended including building public amenities, resettling nomads, supporting agriculture works and providing safe drinking water.  Technology advancement was mainly targeted at upgrading the Chinese industrial sector, gearing towards high-end production to move away from the current export-oriented and labor-intensive mode of growth. This was in line with the government’s aim to revitalize ten selected industries.  To ensure sustainable development, the Chinese government also promoted environmental engineering projects.

To a lesser extent, Brazil did the same through its state-owned development bank BNDES that financed a huge infrastructure programme with cheap credit, much to the chagrin of the neo-liberal voices in the World Bank, the IMF and in Brazil itself.  The BNDES is responsible for 20-25% of all investment in the country.  Over 70% of extra lending to industry during the Great Recession came from the state-owned bank.  That move saved Brazil from the slump.

The reason such an approach will not be adopted by the current Euro leaders and governments is that it threatens the interests of the private sector, particularly big business and their profitability.  The idea that the state should lead economic recovery is anathema.  It is better to have no growth than state-led or controlled growth.  So the major capitalist economies are likely to continue to experience weak growth for years ahead, while the weaker capitalist economies will stay in depression.  Unemployment will fall only slightly and will still be higher than it was before the Great Recession several years down the road.  Indeed, it is my view that before the end of the decade we shall have to face another slump in capitalist production in order to clear ‘excess’ dead capital in the private sector in order to revive profitability.  For now, the private sector is unwilling to invest enough to drive a path for growth in Europe.

Greece: the biggest debt default in history

March 9, 2012

The Greek government has defaulted on its debts to private sector bond holders to the tune of €173bn.  That’s the biggest sovereign debt default in history.  This was achieved by a negotiated ‘voluntary’ deal with Europe’s banks, insurance companies, pension funds and hedge funds.  The Greek banks have taken the biggest hit, along with the Greek state pension funds (Greek state pensions are already being slashed).  Private sector involvement (PSI) in the deal was 95% of all bondholders, after the Greek government invoked so-called collective action clauses (CACs).  CACs meant that those who refused the accept the 50% haircut in the value of their bonds would be forced to because enough bond holders had agreed to the terms ‘voluntarily’.  The remaining bond holders still refusing the deal have until 23 March to change their minds and may still face default anyway.

Of course, the bond holders are not taking a hit to the value of their holdings without some sweeteners.  Under the deal, they receive new Greek government bonds with 30-year lives, paying about 3-4% a year in interest and guaranteed by the Eurozone financing operation, the EFSF.  And they also get some cash upfront for turning in their old bonds.  In addition, those bondholders that took out insurance against default (credit default swaps) may well get compensated for any losses by the sellers of such insurance,often the same banks and insurance companies that hold the Greek bonds in the first place! – such is the madness of finance capital.

With the default deal more or less settled, the Euro leaders will now agree to finance the Greek government’s remaining debt for the next three years at their summit meeting next week.  The Euro leaders in return are expecting the Greek government to impose on its people the most draconian reduction in living standards, public services, jobs and spending seen since the Great Depression for a European country (with the possible exception of tiny Latvia).  The Greek capitalist economy has sunk.  Real GDP fell in the last quarter of 2011 by 18% an annualised basis.  The cumulative fall from peak to trough is likely to be anywhere between 25-30%.  The consequences for the Greek people are difficult to comprehend (see previous posts).

The cruel irony is that the Troika’s demands to cut real wages, destroy trade union rights and labour conditions, while massacring the public sector through privatisations and cuts, will not do the trick and make it possible for Greece to become competitive and grow sufficiently to meet the fiscal targets set by the Euro leaders.  With Greece in such a deep recession, it cannot manage it.

The Troika target is for Greece to get its public debt burden down from 166% of GDP before the debt default to 120% of GDP by the end of the decade.  To achieve that, the Euro leaders and the IMF are providing around €130bn in new money plus €34bn left over from the previous Greek package to fund the interest to be paid on the new Greek government bonds, repayments to the IMF, money to recapitalise the Greek banks and money for the cash on the PSI deal.  But, of the total of €164bn funding, only €23bn is going towards financing the Greek government’s planned sharply reduced budget deficit.  In other words, all this Eurowide/IMF funding is going to pay back the banks, insurance companies and the ECB (another circle of finance!).  Hardly any is going to help the Greek economy and its people get out of the straitjacket imposed on them.

The reality is that just the slightest slip from the budget targets or from the supposed growth projections and the fiscal plan falls apart.  Indeed, the Greek government’s debt ratio could easily be even higher than now by 2020, if growth does not materialise or if privatisation proceeds are not achieved.  From here, about 75% of all the Greek government debt will be held by the Eurozone financial bodies, the IMF and the ECB, ie the Troika.  The remaining private sector debt is also guaranteed by the Troika.

So the question of what will happen when the Greeks fail to meet the targets set by the Troika over the next months will become a political question.  Will the Euro leaders and the IMF be prepared to give the Greek government more money or more time to pay, as they plan to do with Portugal and Ireland, if necessary?  Or will they cut the Greeks loose and let them fend for themselves, as it were, probably outside the Euro area?  The Euro leaders want to keep the Greeks inside because the precedent of a Greek exit could be really damaging to the whole euro project.  But they want the Greeks to take their fiscal hemlock (a la Socrates) or else.  The problem is that they cannot have both.

That question may come to a head even more quickly than the Troika thinks, if the Greeks decide in their upcoming election (it looks like 6 or 13 May) to vote in a government that is opposed to the austerity package.  The latest polls suggest that the those parties opposed will get a higher overall vote than those supporting it – although the anti-austerity parties are all hopelessly divided and may not work together.

Also there are signs that the pressure on left leaders in various parties in Europe is building up from below, forcing them to make statements opposing the Troika’s austerity programme.  The socialist candidate for the French presidency in elections in April-May, Francois Hollande, says he wants to renegotiate the terms of the fiscal compact that the Euro leaders have signed up to.  And Hollande is likely to win in May.  This weekend, Slovakia goes to the polls and looks set to elect an anti-austerity government in a complete reversal of its previous stance.

Sure, this is just talk from the left leaders.  After all Slovakia’s left leader is still committed to the last budget measures, although he now wants ‘progressive taxation’.  Nevertheless, it may not be so easy for the conservative Euro leaders to stick to their fiscal austerity policy, which is designed to appeal to the financial markets and right-wing nationalism in various countries, in the face of growing opposition.

The fightback may come to nothing if the Greeks provide enough votes for the pro-austerity parties to form a government, or if Hollande loses or does nothing afterwards.  If that happens, then the Greek economy will stay deep in depression for a decade and a whole generation of young people in Greece (53% youth unemployed), Spain, Italy and Portugal (among others) will remain without jobs and hope, and pensioners will be reduced to paupers.

A low growth world

March 6, 2012

Back in January I reviewed the latest evidence on the state of the world’s major economies (see my post, World economy: where are we now?, 18 January 2012).  I concluded then that “Capitalism is weak, but the patient is not having a relapse and going back into intensive care.”  That conclusion was based on reviewing the economic forecast from the World Bank and analysing a couple of key high-frequency indicators of economic activity in the US.  The World Bank had forecast just 2.5% real GDP growth for the world economy this year and even lower at 1.3% for the mature capitalist economies of the OECD.  Capitalism appears to be recovering from the slump of 2008-9 but very sluggishly and with even a small setback in 2011 compared with 2010.

Indeed, in a new paper, Barry Eichengreen and Kevin O’Rourke (A tale of two depressions, conclude “that, while industrial production and trade recovered much more quickly than during the Great Depression, both series now appear to be slowing down”. Since the World Bank report, both the IMF and the EU Commission have issued economic forecasts that conclude something similar – namely that capitalism is still recovering but at a snail-like pace.  This gives the Great Recession the character more of a Long Depression, similar to that experienced by capitalism in Europe and America in the 1880s and early 1890s.  Recovery from a significant slump in 1873 was quick but then further slumps ensued and economic growth remained fragile right through the 1880s.

Having said that, again I must emphasise that capitalism is not yet slipping back into economic recession or slump.  I have found that the best high-frequency guide to where US capitalism is going is to look at the monthly Institute of Supply Management (ISM) survey of US businesses, both in the manufacturing and services sectors, for the evidence of orders, employment and costs.  I have combined the ISM indexes in the two sectors to produce a good indicator of the state of the US economy.  Last January, that combined index showed that the US was in ‘low growth’ territory (defined as below trend average of about 3% a year) at the end of 2011, but not in recession.  The latest ISM figures were released this week and they confirm that position.  Indeed, the latest chart suggests that there has been a slight pick-up in US economic activity in its capitalist sectors.

Another high-frequency measure of US economic activity is the ECRI’s leading indicator, which compiles various measures of the economy into one index.   This also shows that the US economy is in a low-growth mode (still well below pre-crisis levels of activity), but not heading back into recession.

What about the rest of the capitalist world?  Well, a quick look at the last two months of purchasing managers data for Europe, Japan and China suggest much the same.  If a PM index is greater than 50, that is supposed to show that an economy is still growing, with anything below 50 suggesting contraction.   JP Morgan have a world index that scored above that 50 in both January and February with the direction up (First bar in red).  Japan is scoring just on 50 (last bar in red).  Only Europe appears to be contracting (slightly) – last bar in blue.  As for China, it depends on which PM measure you want to follow, that of the HSBC survey (first blue) or the official government survey (third red).  HSBC shows China to be contracting (but only just), while the official index shows it still to expanding,if at a slower pace than this time last year,

In sum, the capitalist world economy struggles on at a rate of growth that is not enough to restore the jobs lost in the Great Recession and not enough to encourage big business to kick in with sizeable new investment, or for consumers to want to spend more.  I have argued in this blog before that the reason for this low-growth world is primarily that the recovery in profitability in the major capitalist economies has not been enough; and that these economies are still weighed down by debt (or ‘dead capital’).   This makes it impossible to have a ‘normal’ cyclical recovery for recession as in 1999-2 or 2001.

It’s nauseating

March 2, 2012

As we approach the annual UK budget from the coalition government, the cries for a cut in the top rate of personal income tax have reached a crescendo from the top 1% of income ‘earners’.  Some 507 supposed ‘entrepreneurs’ have written a joint letter to the conservative Daily Telegraph newspaper calling for the abolition of the 50p in the £ top rate of income tax which was introduced by the outgoing Labour government for those earning over £150,000 a year.

This is what the ‘entrepreneurs’ said in their letter: “Given the state of the British economy, we urge George Osborne, the Chancellor, to consider scrapping the top rate of tax in his forthcoming Budget. The tax, which is in effect a 58p tax after national insurance is taken into account, puts wealth creators like us in a very awkward position.  We believe the richest should help the poorest in society. One per cent of taxpayers are already responsible for 24 per cent of income taxes. But penalising high earners through an unfair, politically motivated tax puts populist politics before sound economics. The 50p tax is set to reduce government income, and damages the economy, the public services and charitable giving.  As business people, we want to see our industries, our economy and the Third Sector thrive. Repealing the 50p tax would demonstrate the Chancellor’s wish to celebrate British entrepreneurialism, stimulate industry and contribute to the Government’s growth agenda. The sooner the top rate of tax is repealed, the better.”

The right-wing freesheet City AM paper has added its vigorous support to this call.  “It is good to see that 507 entrepreneurs have put their names to a campaign to abolish the 50p tax rate. It discourages investment, reduces incentives, chases away talent and sends a message to the world that the UK no longer values achievement and success. The rich suffer – but not as much as the poor and the middle classes, for whom job opportunities are reduced. The tax raises hardly anything and will actually reduce revenues over time.”  

The paper quotes one of signatories, Andrew Denny, boss of Fix-a-Form International, who said: “I am simply trying to create wealth for me, my kids and my loyal staff. Why are high earners treated like they have committed a crime and should be punished? The government must listen to entrepreneurs. It is they who are creating the jobs and the growth that the UK economy desperately needs. You can’t tax a country back to prosperity.”

This is just nauseating.  The 50p tax rate for the top earners was not introduced to ‘punish’ capitalists as though they had committed a ‘crime’.   It is an attempt (and a very bad and feeble one) to address the growing inequality of income in Britain (as in many other mature capitalist economies) and to increase the contribution of the richest to government revenues at a time of crisis that the UK government says “we are all in it together”.  Apparently, the likes of Mr Denny don’t want to be in with the rest of us.  The 50p tax is making it impossible for him to “create wealth for him, his kids and loyal staff”.

There is an explicit assumption by Denny that it is he that is ‘creating’ wealth for all in the UK economy rather than just his company (i.e. him) and that it is he in particular that is creating wealth rather than his ‘loyal staff’ who won’t be paying the 50p tax rate. And anyway is the 50p tax rate that onerous? Mr Denny will pay the 50p rate on only anything over £150,000, not on all his income.  And, of course, we assume that all his income comes from profits and dividends in the company and not from capital gains on buying or selling property or stocks and shares, where tax rates are much lower.

If tax does stop ‘wealth creation’  under capitalism, it is not the taxation of any income taken by an owner, but the size of taxes on the profits and employment in companies, large and small.  Most limited companies pay tax at 20% in the UK.  According to Price Waterhouse accountants, between 2006-2009, the average effective tax on UK companies was 23.6% compared to 27.7% in the US, 27.1% in Australia, 27.9% in Germany, 29.1% in Italy and 38.6% in Japan.  On this measure, Britain was near the bottom among mature capitalist economies.  For example, ‘low corporate tax’ Ireland was actually higher at 24.7%.  So the 507 entrepreneurs already have a tax break to help them ‘create wealth’ – a low rate of tax on companies. If they reinvest their profits of their businesses, instead of paying themselves more than £150,000 a year, the 50p rate would not affect them.  And then there is a second tax break for them – gains are taxed at just 10% when they sell their enterprises.  That’s a nice payout for ‘wealth creation’.

City AM’s editor nevertheless hammers on.  Heath says in another editorial, “The next argument is that those on high incomes don’t pay their fair share. The evidence shows this to be untrue, except, of course, if you are a Marxist who believes in entirely eliminating inequality and seizing all of the top earners’ income. The top one per cent of taxpayers (who roughly coincide with 50p tax rate payers on £150k or more) are expected to have earned 12.6 per cent of total income in 2011-12, down from 13.4 per cent at the height of the bubble; they will have paid a massive 27.7 per cent of all income tax, a new record. Without the top one per cent’s tax payments, the welfare state would collapse and the UK would go bankrupt; they pay for a disproportionate chunk of public services.”

It certainly is a relief to know that without the rich we would have no welfare state and we would be bankrupt.  Of course, without the rest of us paying tax, that would be four times more likely than if the rich did not, on City AM’s figures. This argument is bit like that of the 18th century economist Bernard de Mandeville who argued that no poor person would get a job if it wasn’t for the rich spending their income on the luxuries of life to create jobs for the rest.  It’s the ‘trickle-down’ theory of economics, favoured by entrepreneur Denny above who personally creates wealth and jobs for his ‘loyal staff’.

But this figure of the share of the total personal income tax take in the UK that the richest earners contribute is misleading.  If the top earners’ income rises faster than those with median average incomes and there is no reduction in tax rates, then the rich will pay a higher share.  And of course, that is exactly what has happened, both in the UK and the US.  Income inequality among working-age people has risen faster in Britain than in any other rich nation since the mid-1970s, according to a report by the OECD.  The share of the top 1% of income earners increased from 7.1% in 1970 to 14.3% in 2005.  That share fell back during the Great Recession, as City Am says, because property values and the stock markets plummeted.  But it is on the rise again now.

The issue is not how much of the total national personal tax take is paid by the top earners but whether, as a share of their total income, they pay too much or too little.   In the US, back in 1980 the top 1% paid about 34% of their declared income in personal income tax compared to a 15% share for all taxpayers. Interestingly, in the Reagan era, the golden days of ‘free market’ America,  that ratio between the rich and the average did not move.  But now, the top 1% pay only 23% of their declared income in personal tax compared to 12% for the average.  So everybody’s personal income tax burden has fallen (mainly because taxes have been switched into consumption taxes like VAT, customs taxes or other taxes on utilities and air flights etc).

For example, in the UK since 2001, tax receipts have risen £126bn.  Of that rise, only £46bn has come from income tax, a relatively progressive source of revenue (where the rich pay a higher share of their income than the poor, precisely the complaint of the rich!).  But the rest of the extra tax receipts have come from regressive taxes (where the rich pay no more as a proportion than the poor and sometimes even less).  For example, social security contributions, which are at a flat rate, have raised an extra £33bn, VAT another £23bn, and various so-called ‘stealth’ taxes on fuel, air flights, tobacco etc have raised another £16bn.  Income tax has raised just 36% of the increase in the total tax take in the UK since 2001.  So cutting income tax for the rich is not going to make much of a dent on the overall tax burden.

Actually, the total tax burden as a share of GDP is not particularly high in the UK.  In 2011, the OECD estimated that government revenues were 40.4% of GDP compared to 45.3% in the Eurozone area. The Scandinavian countries have a total government revenues at around 50-55% of GDP (and yet the economic growth performance and standard of living is better than in the UK).  Indeed within Europe, only Ireland has a lower overall tax burden.

In the US, the top 1% pay less out of their incomes in income tax now then they did 30 years ago.  They now pay 1.9 times more as a share than the average income earner, compared to 2.25 times back in 1980.  The burden has fallen for all, but it has fallen much more for the very rich earners (see  Using data from the UK’s HMRC, I calculate that, in the UK, the top 1% were paying about 34% of their income in personal tax in 1992 and that is the same ratio now.  That average income earner was paying around 18% then and now too.  So the ratio between the two groups is much the same as in the US and has not changed in the last 22 years – hardly an increased burden.

And all this assumes that those who are in the higher rate tax bracket are actually paying it 50p in the £ for every £ above £150,000 a year.  Tax avoidance and tax evasion are rife and not every penny of tax that is due is paid and collected.  The tax gap in the UK between what corporations and higher earners should pay and what they do pay is estimated at £50-70bn a year.

The other argument trotted out by City AM’ s editor above is that the 50p tax rate is self defeating in that it deters ‘entrepreneurs’ from building their businesses, so they ‘create’ less income tax revenues.  And some even leave the country, reducing further the tax intake.  So raising the top marginal rate of income tax could actually lead to a fall in revenues.  This is the infamous Laffer curve argument named after Arthur Laffer who advised the US Republican administration in the 1970s.  He developed a curve to show what was the optimal top tax rate before the tax take starts falling.  Tory MP John Redwood has been arguing this optimal rate is well below 50p in the £. Yet all the latest evidence (Peter Diamond and Emmanuel Saez) estimates that the optimal rate will be as high as 76%.  So the 50p rate for very top earners will still bring plenty more revenue.

This brings me to the sorry plight of Andrew Schiff, marketing director for Euro Pacific Capital.  According to Bloomberg news, Andrew Schiff earns $350,000 a year, enough to put him in the US’ top 1 percent by income.  But Schiff says that this does not cover his family’s private-school tuition, a Connecticut summer rental and the upgrade they would like from their 1,200-square- foot Brooklyn duplex.  His 10-year- old daughter is a student at $32,000-a-year Poly Prep Country Day School in Brooklyn. His son, 7, will apply in a few years.  People who don’t have money don’t understand the stress.  Could you imagine what it’s like. I got three kids in private school, I have to think about pulling them out? How do you do that? I can’t imagine what I’m going to do.  I’m crammed into 1,200 square feet. I don’t have a dishwasher. We do all our dishes by hand.”  He wants 1,800 square feet — “a room for each kid, three bedrooms, maybe four,” he said. “Imagine four bedrooms. You have the luxury of a guest room, how crazy is that?”   The family rents a three-bedroom summer house in Connecticut and will go there again this year for one month instead of four. Schiff said he brings home less than $200,000 after taxes, health-insurance and 401(k) contributions.  “But I don’t want to whine,” Schiff said.

In such a crisis for the top 1%, reducing their tax burden is the least that society could do.


The latest data on inequality on income and wealth has been compiled by Emmanuel Saez.  I attach his updated research here. As you might expect, the recovery in profits in the US is also restoring the level of inequality seen before the Great Recession.  saez-UStopincomes-2010