The first estimate of real GDP growth for Q3 2102 in the UK came out today. The UK headline figure was up 1% for Q3’12, higher than expected. But it was misleading, as the data were affected by the Olympics and an extra working day in the month. Compared to this time last year, UK real GDP was completely flat. Manufacturing output was down on the year, as was the whole productive sector, especially construction, so the recovery was mainly due a rise in business and financial services.
Although they showed a slight improvement over the last quarter, the data confirm that both these economies are experiencing the weakest economic recovery from a slump since the 1930s. These ‘Anglo-Saxon’ economies are more dominated by unproductive financial sectors than any other major advanced economy and it shows. Manufacturing has increasingly given way to banking, insurance and commercial services in the UK and US economies.
But, unlike the Eurozone governments in the depth of a depression, both Anglo-Saxon governments control their own monetary and fiscal policies and have their own national currencies that they can manipulate. Many argue that this gives them an advantage in solving the crisis. Yet it seems that the US is doing only marginally better than core Europe. As for the UK, the FT summed up the picture: “its economic performance looks remarkably similar to that of its neighbours. Despite the freedom of having its own currency and the ability to set monetary policy, Britain is growing at about the same rate as a middling performer in the eurozone. “
I have outlined the main causes of this weak recovery in several previous posts. For me, it is due to low corporate profitability and the excessive build-up of debt (fictitious capital in Marxist terms) and ‘dead’ physical capital in the boom that now needs to be deleveraged (devalued), before profitability can be restored and sustained growth can resume. In the UK, profits remain below the peak reached before the crisis. There has been little improvement in UK overall corporate profitability in the last decade while the rate of return on manufacturing (the main productive sector) has plummeted.
So UK corporations have cut investment. UK corporations’ financial surplus is what they have left over after investing, paying out dividends, interest and taxes. As we can see in the graph for the UK corporate financial surplus below, all profits generated are normally fully spent on investment or dividends; and at the height of any boom, corporates will even start borrowing funds to expand faster; and the financial surplus turns to deficit. But when slumps come, firms retrench, stop investing, reduce dividend payouts and hoard any profit and the financial surplus rises. Well, right now, in addition to profits not having recovered, UK corporations are hoarding what they do have and have gone on an investment strike. The financial surplus is near a record high.
Business investment has risen slightly in the last two years, a miserly 2.4%, but it is still 13% below its peak at the beginning of 2008. And to top it all, the UK government’s main austerity measure has been to slash government investment by 35% in real terms since it came into office (ironically, spending on public services is actually slightly up – it’s tax increases that have enabled the government to get the budget deficit down a bit). So total (capitalist and government) investment in UK economy is back at the levels of eight years ago in nominal terms.
The UK’s right-wing coalition government tries to defend itself by claiming unemployment is dropping and employment looks much better than in Europe or even the US. The UK unemployment rate doubled during the recession of 1980-2 to over 11%, but in the slump of 2008-9 it rose only (!) to 8%. And there have been more than 1m net new private sector jobs created since the start of 2010.
How has that happened? Well first, wages have been held down so that cheaper labour has helped minimise redundancies. Second, much of this new employment is part-time, self-employed or temporary. Full-time employment remains well below the peak. Total hours worked remain 1.3% below the peak and income security is lower. And employment is rising mainly for skilled people above 50 years old. The under-25s have remained with very poor job prospects. Bank of England figures show that growth in private sector jobs is almost exclusively in high-skill occupations. Moreover, once you are out of a job in this depression, it is not easy to get one: long-term unemployment has stayed stubbornly high. And the ratio of unemployed to vacancies is at record levels.
Even if employment has not deteriorated as much as in previous slumps, this recession has seen the biggest ever fall in real incomes. During the Great Recession, UK GDP fell 6.3% from peak to trough by mid-2009. It then rose to reduce the contraction from the peak to 4.1% by Q2 2012. But GDP per head is still down 7% from its peak and there has been no improvement for three years. Net national income per head, which is a better measure of living standards, is down over 13% since its peak in early 2008 and is still falling – a truly horrendous reduction.
The UK’s Office for Budget Responsibility said this fall in real income was due “stubborn inflation hitting consumption and export markets hitting net trade”, plus maybe, the “possibility that fiscal consolidation hit growth harder than thought” (http://budgetresponsibility.independent.gov.uk/forecast-evaluation-report-october-2012/). So inflation wiped out the small rise in incomes, exports did not jump and government austerity may have made things worse.
This is where that second lesson from the Anglo-Saxon recovery comes in. One of the big advantages that the UK economy was supposed to have over the Eurozone was that it could run its own monetary policy unlike the likes of Greece or Spain and it could devalue its currency in order to sell more exports. This would boost the capitalist sector while austerity was applied to the public sector.
Well, has this combination of Keynesian policies for the capitalist sector and Austerian fiscal austerity worked for the UK? The answer is clearly no. During the Great Recession, the value of sterling fell over 25% against other trading currencies (as measured by the ‘effective exchange rate’). Since then, the nominal value of sterling (blue line in graph below) has appreciated slowly, but is still way cheaper than at the start of the crisis. But this competitive advantage has not delivered on exports. According to the OBR, UK exports have risen 8% (half what was expected two years ago), but UK export markets have expanded even faster, by 13%. So the UK has lost market share and exports have made virtually no contribution to real GDP growth, such as it is.
Indeed, the devaluation of the pound in 2009 just kept inflation at a much higher level than expected or targeted by the Bank of England. Of the past 60 monthly inflation publications, the annual rate has exceeded the Bank of England’s 2% target 54 times and has averaged 3.2%. Last week, the central bank admitted its most recent inflation forecast was again too optimistic and inflation would stick at a higher level than hoped for the rest of the year. Next year does not look much better, with higher oil prices, new student tuition fees and higher gas and electricity prices likely to keep inflation stubbornly above target and hovering close to 3% for the whole of 2013. As a result, the real effective exchange rate (red line) which takes into account relative inflation levels in different countries with UK inflation, is now higher than in 2005, making UK exports uncompetitive. Devaluation has proved to be only a temporary and ineffective booster to an economy in a slump.
And Keynesian-type monetary policies of driving down the basic interest rate to zero and ‘printing money’ to buy government bonds under quantitative easing (QE) have been equally unsuccessful in reviving the economy. According to Mervyn King, the governor of the Bank of England, QE has reached “the limits of its effectiveness” as “printing money is not …. simply manna from heaven. There are no short cuts to the necessary adjustment in our economy.” To date, the Bank has printed £375bn to fund government debt purchases and reduced interest rates to almost zero. “When the factors leading to a downturn are long-lasting, only continual injections of stimulus will suffice to sustain the level of real activity,” But King said. “Obviously, this cannot continue indefinitely”. King hinted at the real reason for the lack of economic recovery: namely, the financial crisis “has rendered unprofitable some of the investments made before the crisis”. He added “I am not sure that advanced economies in general will find it easy to get out of their current predicament without creditors acknowledging further likely losses, a significant writing down of asset values and recapitalisation of their financial systems.”
The US GDP figure comes out tomorrow and will confirm two things. First, the US capitalist economy is doing slightly better than elsewhere. Second, that this economic recovery is still the weakest since 1945. Again I have argued in previous posts that the reason for the better relative performance by the US is because profits have been restored and profitability has also recovered somewhat, unlike the UK or most of Europe. It is not because of different or better (no austerity) policies.
Yet the reason that the US has done slightly better has led to an argument among mainstream economists. Right-wing economists like John Taylor and Michael Bordo, who are also advisers to Mitt Romney, have disputed the conclusions of Carmel Reinhart and Kenneth Rogoff that severe “systemic financial crises” lead to much weaker and slower recoveries (Bordo, M and J Haubrich (2012), “Deep Recessions, Fast Recoveries, and Financial Crises: Evidence from the American Record,” NBER Working Paper 18194). Taylor et al argue that there is no evidence that recoveries are slower after financial crises and the US recovery is only weaker this time because of Obama’s refusal to cut taxes and get debt down and because of Fed Chairman Bernanke has gone a wild policy of quantitative easing. In other words, it is Keynesian policies that are making the US economic recovery weaker this time, not the problem of deleveraging excessive debt and certainly it’s nothing to do with business investment.
Reinhart and Rogoff responded strongly to defend their evidence and conclusion that systemic financial crises produce a weaker and slower recoveries (http://www.voxeu.org/article/time-different-again-us-five-years-after-onset-subprime-0). And Keynesians like Martin Wolf (http://www.ft.com/cms/s/0/791fc13a-1c57-11e2-a63b-00144feabdc0.html#axzz2AIN4bxnV) and Paul Krugman (http://krugman.blogs.nytimes.com/2012/10/17/financial-crisis-denialism/) have latched onto R&R’s evidence to argue the US recession was relatively mild and the recovery better than elsewhere because of Bernanke and Obama’s policies. Indeed, the weak recovery is due to insufficient fiscal stimulus, not too much.
Yes, it’s the same old battle between the Keynesians and the Austerians – see my last post, The dilemma of the mainstream, 17 October 2012. In an excellent article for the Socialist Economic Bulletin (http://socialisteconomicbulletin.blogspot.co.uk/), Michael Burke sums up the split: “The deep split within mainstream economics and the controversy over the IMF research are associated with the same trends. Countries which have adopted the ‘orthodox view’ have generally experienced sharp slowdowns and renewed deterioration in government finances. Other countries, such as the US and Germany, which have ‘supported demand’ have experienced mild but slowing recoveries. In the US this has required the maintenance of large budget deficits. While the latter policy has clearly been more effective in restoring growth it is not sustainable over the medium-term. There is little official enthusiasm in either Germany or the US for further measures to support demand. In effect both ‘austerity’ and ‘demand support’ are running out of road.”
That’s because both sides of the mainstream debate are ignoring one of the key features of this crisis. According to Professor Alan Taylor (see his paper, The Great Leveraging, NBER working paper 18290, August 2012), overhangs of credit that build up before a financial crisis imposed “abnormally severe downward pressures on growth, prices and capital formation for sustained periods”. In other words, when the capitalist sector is overladen with debt and a crash comes, it takes a long time to clear that debt, whatever government measurs are adopted.
I infer from this that it is the profitability of the capitalist sector that matters and that depends partly on the weight of debt accumulated. Taylor found that the size of leverage in the banking sectors in the advanced capitalist economies had never been higher. It was worse in the Anglo Saxon economies. Indeed, as Steve Keen and William White have argued (see my paper on The causes of the Great Recession), when private credit rises much faster than GDP to high levels, it is good predictor of upcoming crises. Interestingly, according to Taylor, rising public debt is not. He estimates that when an economy has high private sector debt growth before a crisis, the subsequent economic recovery will be weaker – indeed by up to 4% pts of real GDP growth on average. You see what matters is the health of the capitalist sector in a capitalist economy.
Taylor has updated his paper is to compare the UK and US experience on credit, crashes and any subsequent recovery. Taylor reckons that the expansion of credit to GDP (bank loans and ‘shadow banking’ credit) before the crisis in 2007 was very similar in both ‘financialised’ economies, at about 5% a year. And the subsequent crash in GDP was similar. But the UK recovery since 2010 has been much weaker, even dropping below the low end of Taylor’s forecast band in the fifth year since 2008! It seems that low profitability, poor exports and UK government austerity is making things relatively worse.
I repeat the points of previous posts. US corporate profits have surpassed their previous peak, but corporate profitability remains in the doldrums. US capitalism is still weighed down by past dead capital and debt, so it is reluctant to invest, as the graph of investment to GDP below shows.
That also means weak employment growth that keeps a sizeable section of the working population out of full-time work.
Indeed, the crisis merely adds to the long decline in the productive sectors of these two Anglo- Saxon economies, so dominated by their financial sectors. Manufacturing jobs in the UK and the US as a percentage of the population have contracted more in the UK and the US anywhere else over the last 15 years.
It’s Anglo-Saxon angst.