Posts Tagged uk

Time to nationalise the big banks

Posted by George Irvin in EU on July 22, 2012

In the past 30 years a great number of utilities in the developed world have been privatised. That trend seems likely to be reversed. Why? Because the ideology which drove the project—in particular, the notion that the private sector is always more efficient than the public sector—is collapsing. Effective public ownership is being reconsidered not just for the banking sector, but in rail transport, in water and power provision, in communications—in short, in a range of industries where large scale privatisation and deregulation over the past decades has been tried … and found wanting.

Banking provides the most dramatic example. Deregulation and demutualisation, particularly in the USA and Britain, led to a near-meltdown of the financial system in 2008 and, in consequence, a major and on-going recession—-in Britain, one longer than that of the 1930s. Willem Buiter, chief economist at Citi, argued in favour of taking the biggest banks into public ownership in 2009. Although there was a period of recovery after 2009, recession seems to be returning—and with it ominous signs of another financial and economic crisis, a ‘perfect storm’ potentially far more serious than that of four years ago.

After the banks were bailed out in in 2008, there was much talk of regulation. Today, new revelations and scandals (eg, Barclays’ fixing of LIBOR, HSBC’s money laundering) have again raised the issue of regulation and public ownership. While it is true that in the UK, the public owns two of the largest banks (RBS and Lloyds) and that Labour wants to set up a British Investment Bank, in reality almost nothing has been done to take effective control of the largest banks.

The simple truth is that the financial sector is too big and powerful to regulate effectively. In the US the sector’s ‘lobbying power’—the problem of regulatory capture —is now acknowledged on both the political left and right. And even if the biggest banks are broken up, as Professor Gar Alpervitz of the University of Maryland argues, it is likely that they will come back in even more concentrated form.

Britain is less transparent than the US, but few can deny the baleful influence of the City of London in emasculating the 2011 Vickers Report. Instead of calling for the physical separation of commercial and investment banking, Vickers called for ‘ring-fencing’—and then, only by 2019.

Typically, the argument against publicly-run banks is that they are inefficient; ie, that ‘civil servants cannot run banks’. But the key issue is not one of public efficiency—there are many well-run publicly owned or mutualised banks in the world. The issue is of private efficiency.

Can we afford not to take the largest players into public ownership, particularly if there is another financial crisis? The big private banks have cost the taxpayer trillions and brought about economic depression, resulting in a massive loss in output and jobs throughout the OECD. By speculating against sovereign bonds, private banks are a major player in the current Eurozone crisis. One might add, too, that these same banks have been a major driver of growing income inequality: tax havens have thrived and the culture of bankers’ bonuses has worsened since 2008!

Note that it is not being argued here that all banks should be publicly owned. But if banking scandals multiply, if the advanced economies continue to stagnate, if jobs are scarce and unemployment grows—and particularly, if the taxpayer is asked once more to bailout the banks in the wake of another financial crash—then it is a near certainty that within a decade, the largest banks will become public utilities.

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The Greek debacle

Posted by George Irvin in EU on February 13, 2012

Does the Greek Parliament’s latest vote in favour of further cuts—despite the 40 deputies who defied the whips and were forced to resign—mean that the Greek crisis is resolved?  Of course it doesn’t.  For one thing, the troika (ECB, IMF and EU) will not approve the €130bn ‘bailout package’ next Wednesday unless Antonis Samaras, leader of the New Democrats, agrees to sign. Samaras has made it clear he will not do so until after the April elections because he knows that if he signs now, his party is toast.

For another, even with Parliamentary endorsement of nearly €4bn in cuts for 2012, it is hard to see how the government of Mr Papademos—or whoever succeeds him after the elections—can deliver. And of course, there must be a serious question about whether Ms Merkel and her Eurozone (EZ)  allies want Greece to stay in the euro. As the Dutch PM, Marc Rutte, is reported to have said last week, the EZ is now strong enough to weather Greece’s departure—eurospeak for ‘get out’.

Recall what the troika is demanding for 2012 alone:

  • a 22 per cent cut in the monthly minimum wage to €586;
  • layoffs for 15,000 of civil servants;
  • an end to dozens of job guarantee provisions;
  • a 20 per cent cut in its government work force by 2015;
  • spending cuts of more than €3 billion;
  • further cuts to retiree pension benefits.

These demands come as the country faces its fifth consecutive year of recession, and recent OECD figures showing GDP to have fallen by nearly 15% since January 2009 with unemployment standing at 18.7%. As Helena Smith reports in The Guardian, ‘Greece can’t take any more’. Even with the latest cuts and bailout, it is optimistic to forecast that the country’s debt/GDP ratio will be 120% in 2020. According to the FT’s Wolfgang Münchau: “[a] 120% debt-to-GDP ratio by 2020?  That’s 9 years of strikes in Greece,” and that is not sustainable.

Is Greece’s problem high labour costs?  Nouriel Roubini’s influential think-tank RGE estimates that as far as labour costs are concerned, the view that Greek wages rose too much during the good years is pure myth. In fact, over the period 2005/08, Greek wages rose less quickly than the average for the EZ.

Further cuts mean further recession, and it should be perfectly obvious by now that Greece cannot pay down its sovereign debt as long as the economy is shrinking. As I (and many others) have explained elsewhere, the debt/GDP ratio can only fall where the rate of interest on the debt is less than the rate of GDP growth. Just as Osborne’s cuts are jeopardising the future of the UK economy, so Merkel’s cuts are sinking a (far weaker) Greece.

Unlike some of my colleagues on the left, I have always been pro-euro. But the suffering imposed on Greece now makes me ashamed of being European.

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Europe’s new credit crunch

Posted by George Irvin in EU on October 7, 2011

As the Euro Area (EA) dithers about bailing out Greece in the short term and continues to argue about how to expand the European Financial Stability Facility (EFSF), the sovereign debt crisis is turning into a full-blown banking crisis. Shares in Dexia, the Franco-Belgian banking group, are down 72% on their 52-week high—closely followed by other pillars of western finance such as Bank of America (-66%),  RBS (-57%) and Deutsche Bank (-50%). [1]  In effect, financial markets have seen the wiring on the wall and have been pulling out of bank shares—both banks that hold euro sovereign debt assets and those that hold shares in other banks that do. This means that the asset side of banks’ balance sheets are contracting and that insolvency looms.

True, the gloom lightened briefly when both Angela Merkel and EU President J-M Barroso announced they favoured a pan-European recapitalisation programme—causing EU bank shares to rally for a time. Governments are trying to pour cash into the banks—in the UK, Mervin King has announced an extra £75bn of quantitative easing (QE), allegedly to help industry get more and cheaper credit, but in reality to ward off a new credit crunch along the lines of what happened after Lehman’s collapsed in 2008. In his words, we face the ‘worst financial crisis ever’.

However, the recapitalisation of Europe’s banks faces a serious credibility gap. First, Dexia was one of the banks to pass the European Banking Authority’s (EBA) ‘stress tests’ with flying colours. Secondly, one result of these tests was a serious underestimation of the degree of recapitalisation required.  In consequence, a new round of tests will be required adding further to delays. Perhaps more importantly, there is growing pressure from investors to make banks ‘mark to market’; ie, report the current market value of their assets. Adoption of such a rule combined with current market volatility would doubtless lead to a large number of banks failing the stress tests.

And of course, the prospect of a Greek default looms larger by the day. The problem is not so much that a Greek default is unaffordable; doubtless, were the country to default on its own, it would take some banks down—starting with its own banks. The real danger is that of contagion. We know that Spain and Italy are ‘too big to fail’, and the markets have already begun to mark down commercial banks with exposure to them, not just in Spain and Italy but in France and even the UK. Whatever one may think about financial markets, their analysts are not fools; what they are telling us is that a Greek default will trigger widespread contagion.

Meanwhile, EA Parliaments dither about just how the EFSF’s limited capital can be stretched to meet the bill. Since the €440bn available cannot be miraculously turned into the €2tn required for ‘shock and awe’ to be sure of succeeding, the latest twist involves turning the EFSF from a lending institution into a insurance company, in effect selling credit default swaps (CDSs) to those most in need of insurance. These would be structured into equity, mezzanine and senior layers just like their Wall Street cousins, thus enabling €440bn to be hugely leveraged.

But as more than one commentator has pointed out, there are several problems here. First, one is using over-leveraged instruments to deal with the problem of over-leverage. Second, there is no ‘lender of the last resort’—if the scheme goes wrong, governments cannot bailout the losers since it is governments who hold the equity tranches. In principle, the ECB could perform this role—but the Germans are resolute in their opposition to the ECB acting as a Central Bank for governments. [2]  For that matter, tiny Slovakia is threatening to upset the EFSF applecart unless collateral is provided for its pledged assistance.

An obvious way out of this nightmare would be to forgive Greece at least half its debt (which the markets believe is in any case unpayable) while further reducing the interest on its loan, lengthening its debt maturity profile and aiding the country to become more competitive. Cynics might say this has been obvious from the start, and that it is now too late. If a European financial crisis does not happen next week, it will occur as part of a disorderly default in December when the pain finally becomes too much for Greeks to bear. It is then that we shall all feel the pain of a full-blown financial crisis, most probably followed by more years of economic recession.

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[1] See D Blanchflower ‘As bankshares tumble ..’ New Statesman, 10 Oct  2011.

[2] See http://on.ft.com/qi7ZIw

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The big bailout scam

Posted by George Irvin in EU on April 11, 2011

Suppose that my rich neighbour down the road mortgaged his mansion up to the hilt to bet on the horses, ran up millions in debt and asked me, an ordinary punter, to pay off his debts plus interest. Suppose that foolishly I accepted, and while I struggled to pay it off while barely able to feed my family and pay off the mortgage, my super-rich neighbour acquired an even bigger mansion. To make matters worse, he used all sorts of clever dodges in the Caymans to pay negligible taxes, while if I failed to pay mine I knew I’d be sent to prison.

It may sound like total madness, but that’s pretty well what’s happening to a growing number of Europeans (including Brits) today.

How did we get here? In Britain, the 2008 credit crunch produced a massive recession which played havoc with government finances. In Ireland the government took over the entire debt of its banking system, while in Greece, the rich paid minimal taxes and successive governments, unwilling to challenge them, indulged in creative accounting.  That’s somewhat simplified, but it’s the essence of the story.

Everywhere in Europe, voters are being told that decent pensions and universal welfare provision are no longer affordable and that we must all tighten our belts. Governments can no longer borrow because the credit rating agencies might downgrade their bonds. First it was Greece and Ireland, today it is Portugal, and tomorrow perhaps Spain, then Italy, and then … who knows?

But ordinary punters are starting to wake up. Instead of enduring years of economic depression, the Greeks and the Irish will probably have to default, as will the Portuguese if their economy reacts the same way to belt-tightening.[1]   And what if Spain has to be bailed out, still less defaults? That would spell a major hit for banks in Germany, France, the UK (and elsewhere), all of which could easily add up to another major financial crisis.

Are we really so vulnerable? The answer is indeed yes—-because so little has been done to address the underlying causes of the 2008 crisis.

While the recent Basle Three agreement requires banks to carry a slightly higher cash cushion, nothing has been done to re-establish the division between investment banking and commercial high-street banking, a division which disappeared with the repeal in the US of Glass–Steagall in 1999. Except for a temporary ban on naked short sales in Germany, the derivatives trade remains mainly unregulated.[2]  Credit default swaps (a form of insurance on risky financial products) are still sold over-the-counter rather than through an official market, the US President having failed to follow up his 2009 promise to re-regulate these.[3]

Meanwhile, the trillions poured into the big banks since 2008, instead of going to cash-starved small business or being used to build infrastructure and to create jobs, have largely helped fuel a new stock market bubble.[4] The extraordinary rise in the value of companies such as Facebook and Zynga provides a worrying parallel with the dotcom bubble of 2000.

Tax dodging is now a major growth industry—witness the latest GE scandal. As for making the bankers pay by introducing some form of Tobin tax, there’s been much talk but little action.

Perhaps most galling of all is the injustice of using Keynesian economics to justify the need for state intervention in banking bailouts while claiming today that the profligate state caused the problem, as politicians now argue in London, Brussels and Frankfurt.[5] How long will sensible people go on accepting this nonsense before venting their anger on our ruling classes?[6]

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(An earlier version of this piece first appeared at http://www.social-europe.eu/2011/04/the-big-bailout-scam)

1 http://www.bbc.co.uk/news/business-12864413

2 http://online.wsj.com/article/SB10001424052748703957904575252611852571860.html

3 http://www.cnbc.com/id/30731157/Regulating_Wild_West_CDS_Market

4 http://www.marketoracle.co.uk/Article19523.html

5 See Ha-Joon Chang, ‘The revival—and the retreat—of the state?’ Red Pepper, Apr/May 2011.

6 http://www.france24.com/en/20110312-300000-protest-job-insecurity-portugal

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UK Targeting Stagflation

Posted by George Irvin in EU on March 2, 2011

However circumspect Mervyn King may have been about raising interest rates in the Bank of England’s (BoE) quarterly inflation report issued in February, it is clear that the City wants him to do so. Indeed, judging from the fact that 12-month interest rate futures are now 1.4%, it is generally thought that there will be three to four quarter-point hikes over the next twelve months, while over the coming two years the rise may be twice that figure. One must ask, first of all, is such a rise justified by inflation; and secondly, if not, what damage will raising UK interest rates do?

The proximate cause of the problem is that the Retail Price Index (RPI) has jumped to just over 5% in the UK, mainly reflecting rising world food and energy prices, but also the effect of a sterling devaluation of over 20% in 2008 working its way through the economy as well as January’s VAT rise. Even the Consumer Price Index (CPI), which strips out housing costs, is rising at a rate of 4%, twice the BoE’s 2% target.

Of course, stripping out food and energy, core inflation is well below the BoE’s target, but inflation hawks would argue that several other factors must be taken into consideration. First, inflation is rising not just in the UK but in the US and the core Eurozone countries such as Germany and France, in part reflecting strong inflationary pressures in countries such as China and Brazil. Secondly, UK firms may be raising prices to recoup the profits lost during the credit squeeze, or even in anticipation of lower future profits. Finally, the fact that the recession has pulled down UK trend growth means that the weight of the structural deficit is all the greater;  ie, a return to (lower) trend growth would leave a larger proportional gap between public spending and receipts than would have been the case before the recession. On this view, the larger the structural deficit, the higher are domestic inflationary expectations.

The counter-argument goes roughly as follows. First of all, the main domestic culprits—devaluation and the VAT rise—are once-and-for-all events, so their inflationary impact can be expected to decline over time. Secondly, with regard to the key imported components, mainly food and energy, it is not so much a case of gradual price inflation; rather, these prices have exhibited strong fluctuations. Energy prices peaked in 2008, then fell and have now risen again; there is every reason to believe that they will fall again. And even if imported inflation continues to rise, raising domestic interest rates will not seriously arrest this rise. Thirdly, there is no sign of wage inflation in the UK economy—indeed, with unemployment at 2.5 million and rising, real wages are falling. Moreover, with the bulk of government spending cuts still in the pipeline, unemployment will rise (and real wages fall) further. This being the case, ‘inflationary expectations’ are groundless. As one academic colleague put it, ‘there has been no Phillips curve [expectations augmented or otherwise] in the UK for a generation’.[1]

Little wonder then that Mervyn King is being circumspect about raising interest rates when the prospects for UK growth are so poor and their impact on inflation is likely to be negligible. Nevertheless, it is equally clear that George Osborne wants higher rates and that the MPC, which has been dovish on the matter, is now split and edging towards hawkishness.[2] Such hawkishness will come at a cost. In the words of one commentator:

‘charts in the Inflation Report suggest the Bank now believes the UK economy must grow by about 0.25 percentage points less than it thought in November to avoid sparking inflation. That is a loss to economic output which accumulates by roughly an additional £4bn every year, making fiscal consolidation even more difficult.’[3]

Indeed, such a loss would come on top of the cuts. A recent report by the IMF suggests that, even if interest rates remain near zero, public sector cuts equivalent to 1.5% of GDP per annum over the next four years will subtract an equivalent amount from growth, or about £20bn every year.[4]

According to the IFS ‘green budget’, between 2010 and 2015, the UK is forecast to have the third largest reduction (behind Ireland and Iceland) in the share of government borrowing in national income among 29 high-income countries.[5] As Martin Wolf has noted, using the OBR’s latest figures, the implicit (compound) rate of growth of GDP between 2007 and 2015 is just 1.2% per annum.[6] And if interest rates rise in response to a perceived inflationary threat, the growth rate will be even less.

In a word, Britain under the Tory-led government faces years of not merely stagnation, but quite possibly of something worse: stagflation. Perhaps Monsieur Trichet at the ECB should be pondering the lesson for the Eurozone.

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*diagram source: N Cohen, ‘King denies interest rate rise certainty’ FT, 16 Feb. 2011
1 In private correspondence with Martin Hoskins.
2 David Blanchflower is more optimistic and believes the MPC will remain dovish; see http://www.newstatesman.com/blogs/david-blanchflower/2011/02/mervyn-king-growth-inflation
3 See C Giles, ‘Slower growth seen as inflation buster’, FT, 16 Feb 2011; http://www.ft.com/cms/s/0/3279a6ee-3a0c-11e0-a441-00144feabdc0.html#axzz1EDbJnmWK
4 See Duncan Weldon ‘The danger of spending cuts: some advice from the IMF’; http://duncanseconomicblog.wordpress.com/2011/02/15/the-dangers-of-spending-cuts-some-advice-from-the-imf/
5 See http://www.ifs.org.uk/publications/5460.
6 See M Wolf, ‘Britain’s experiment in austerity’ FT, 8 Feb 2011; http://www.ft.com/cms/s/0/5e5a6d1e-33c9-11e0b1ed-00144feabdc0.html#axzz1EDbJnmWK

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VAT and voodoo economics

Posted by George Irvin in EU on January 5, 2011

Whatever else can be said about the British Chancellor, George Osborne, he certainly does not lack chutzpah. His latest canonical pronouncement is that VAT (value added tax) is a progressive tax. For sheer guile, this statement must rank alongside Arthur Laffer’s famously misleading advice to Ronald Reagan that cutting income tax for the rich would actually increase tax revenue, a statement (rightly) dismissed by the then US Vice-President, George H W Bush, as ‘vodoo economics’.

How does Osborne justify his position? The simplest argument–as advanced on 4 January by the BBC’s flagship Newsnight programme–is that VAT is progressive because the poor pay less in absolute terms than the rich; ie, if  (say) you earn only £10 a day, the £2 you pay in VAT is far less than the £20 in VAT paid by somebody on £100 a day. Since £20 is greater than £2, the conclusion is that the rich ‘shoulder the heaviest burden’. Note that this holds true even if the rich man saves half his £100-a-day income, paying total VAT of only £10. The accompanying diagram illustrates admirably how to mislead the public with numbers.

That television presents data in such a manner says a good deal about the near contempt with which our elite view the average member of the viewing public, but never mind. More to the point, the above argument is just plain wrong. A progressive tax is one which takes a larger proportion of one’s income as income rises. This is true by definition. The principle that tax should be linked to the ‘ability to pay’ comes from Adam Smith’s Canons of Taxation in The Wealth of Nations (1776).[1] We accept as fair an income tax system based on rising marginal rates of taxation, just as we reject (say) a flat poll tax. Equally, we make the distinction between a direct tax (such as income tax) which is progressive, and an indirect tax (such as VAT) which is regressive, precisely because it is thought unfair to tax the rich and poor at the same flat rate.

When I was an undergraduate, Alfred Marshall’s Principles was required reading: Marshall, perhaps Britain’s best known neo-classical economist, famously set out the principle of ‘diminishing marginal utility of money income’—in everyday English, that an extra daily £2 is worth much more to a poor man than to a rich one.

Consider the example. If the rich and poor consume all their income, each pays 20% of income in VAT. But if the rich man saves half his income and pays only £10 in VAT, he pays out only 10% of his income. So where the rich save more than the poor, the proportion of income paid out in VAT is actually lower for the rich; ie, the tax is highly regressive.

So far so good, but apologists for Osborne don’t stop there. Rather, they roll out three further (and logically distinct) arguments. The first argument can be dealt with fairly rapidly. Because some basic necessities (food, children’s clothing) are VAT exempt in the UK, it can be argued that VAT is ‘mildly progressive’, a view apparently shared by Vince Cable.[2] But for this to be true, the share of non-VAT rated items as a proportion of the bottom decile’s income would need to be greater than the savings propensity of the top decile.

In the UK, the poorest 10% of the population spend about 15% of their income on food.[3] Look again at the above example. For simplicity’s sake, let us assume I receive £10 per day but that instead of paying £2 per day in VAT, I pay £1.70 (because only £8.50 of my daily income is spent on VAT rated items); the effective rate of VAT I pay is 17% of income. Now look at savings behaviour. Roughly speaking, in normal times the average British household saves about 7% of its total income; moreover, the higher your ‘financial capability’ (the richer you are), the more likely it is that you will save more.[4] So take our rich man who receives £100 per day; he can safely be assumed to set aside twice this proportion (or £15), spending the remaining £85 on which he will pay 17% effective VAT—no progressive element discernible there.

The second argument is that the above calculations depend on looking at the economy in ‘snapshot’ mode rather than considering the lifetime behaviour of economic agents. When people are young—so goes the argument—they earn little and pay little VAT, but as they get older and earn more, their VAT increases (and of course when they retire, consumption falls as does the VAT burden). But the counter-argument is simply that the lifetime consumption profile doesn’t matter. What we want to know is the likely impact of the VAT rise today and in the months to come. For example: a tax/benefit system which comprised a tax system with a personal allowance of (say) £10,000, a 40% flat income tax rate above this, a proportional VAT on all goods and no benefit system at all (including pensions) might be highly progressive in a lifetime incomes context, but it would also leave a lot of low-income people dependent on charities, or dead in the streets.[5]

The third argument is perhaps the most important, since it comes from the much-respected Institute of Fiscal Studies (IFS). IFS argues that instead of looking at the distributional impact of VAT as a proportion of income, we should take income net of direct tax and savings and look at VAT as a proportion of consumption. Of course, if there was zero household savings and direct tax across the income distribution, using such a measure would make no difference. But since the rich consume less than they earn (and the poor use their credit cards to consume more), the consumption pyramid is far flatter than the income pyramid. Combining this with the fact that the poor spend more of their income of zero-rated essentials such as food produces a mildly progressive VAT impact.

However, such an argument is simply disingenuous. As a matter of accepted convention, calling a tax ‘progressive’ depends not on looking at consumption propensities but rather (as Adam Smith argued) on comparing people’s ability to pay. The IFS has simply dragged out yet again an old argument about ‘not taxing savings’ since future investment depends on the ‘supply of loanable funds’, an argument disposed of long ago by Keynes but still echoed by the UK Treasury.

Let me leave the reader to ponder the apparent paradox that according to Tim Montgomerie, a leading right-wing blogger, four of London’s leading conservative think-tanks have now attacked the rise in VAT as a bad idea.[6] We should perhaps recall that although George H W Bush was a fiscal conservative who attacked ascendant neo-liberalism as ‘vodoo economics’, much of that same voodo is still picked over today.

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[1] See Book V, Chap 2, part 2.
[2] See http://www.libdemvoice.org/vince-cable-why-the-vat-rise-had-to-happen-20039.html
[3] See http://www.foodsecurity.ac.uk/issue/uk.html
[4] See http://www.cfebuk.org.uk/pdfs/CRS02_Financial_capability_and_saving_summary.pdf
[5] This argument comes from Howard Reed who is gratefully acknowledged.
[6] See http://conservativehome.blogs.com/thinktankcentral/iea/

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The mistake of the century

Posted by George Irvin in EU on October 26, 2010

In Brendan Barber’s words, Britain has been experiencing a ‘phoney war’—living in anticipation of what the cuts might mean, without experiencing their reality.[1] Although high-profile academic economists, from Robert Skidelsky to Paul Krugman and Joe Stiglitz, have warned about the consequences of Osborne’s reckless gamble, it is only now that the results of the spending review have become official that one can begin to appreciate the irreversible nature of the deed.[2] It was David Blanchflower who put it most succinctly in The Guardian on 18 October: ‘The austerity package is likely to turn out to be the greatest macro-economic mistake in a century.’[3]

George Osborne has pursued his goal of emasculating the welfare state with unswerving determination and ruthlessness. What is more, according to a recent YouGov poll, nearly half the electorate believe that the last Labour government was responsible for Britain’s current economic plights—less than one-fifth blame the Coalition.[4]  Cameron et al have endlessly chanted the mantra of Labour’s irresponsible spending as the cause of the crisis, which flies in the face of everything we know about the origins of the banking fiasco, the OECD-wide recession following the credit crunch and the collapse of Britain’s fiscal balance which until 2008 had been reasonable.

The Coalition’s message may be totally at odds with most economists’ take on the need to react to an economic slump by stimulating aggregate demand, but Osborne has capitalised on the widespread belief that when times are bad, everybody—starting with Government—must tighten their belt. The Tories have put right-wing LibDems like Nick Clegg and Danny Alexander in key positions, marginalised Vince Cable and kept out the rest. It has been an object lesson in the realpolitik of the Thatcherite legacy.

There is a real sense in which Labour share the blame for all this. For a decade Brown boasted of his ‘fiscal prudence’, attempting to offset what New Labour perceived as the damaging legacy of its tax-and-spend image. The Brown-Darling response to the credit crunch was as Friedmanite as it was Keynesian, while the economic downturn which followed produced a puny stimulus package.[5]  Early in 2010, Alistair Darling caved into the IFS-led chorus of deficit cutters and proposed cuts ‘deeper than Thatcher’.[6]

Nor does the change in leadership appear to have radicalised Labour. Ed Milliband, sensitive to the accusation that he was elected by the ‘union bosses’, was visibly absent from the TUC rally against the cuts on 19 October. Alan Johnson, the new shadow chancellor, has little bark and no credible bite, while within the shadow cabinet the row continues over the proportion of spending cuts and tax rises in Labour’s own deficit reduction plan.[7]

In truth, the economic crisis presented both Labour and the Tories with an opportunity for radical change—an opportunity which Labour squandered and which the Tories were quick to capitalise on.

If Labour really had been a party of the left, it would have taken the bailed-out banking sector into genuine public ownership, re-introduced mutualisation, thoroughly reformed the tax system using the proceeds for public-led investment in sustainable growth and jobs, and reversed the creeping privatisation of public services. In Brussels, Britain would have called for an EU-wide stimulus package and backed improved economic governance and better financial regulation.

The single-mindedness with which the Tories have capitalised on the crisis to drive through draconian measures stands in stark contrast to Labour’s inability to seize the moment. In a decade’s time, history may judge Osborne’s cuts with the same disdain as it does the poll tax and similar Thatcherite policies. But by then it will be too late—Slasher Osborne will have killed the welfare state in Britain.

It goes without saying that there’s a wider lesson for the rest of Europe to draw about what’s happening in Britain.

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[1] See http://www.guardian.co.uk/politics/2010/sep/10/tuc-brendan-barber-spending-cuts

[2] See http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/19/no-confidence-fairy-for-austerity-britain; also see http://www.skidelskyr.com/site/article/the-wars-of-austerity/

[3] See http://www.guardian.co.uk/commentisfree/2010/oct/18/george-osborne-spending-review

[4] See http://www.guardian.co.uk/commentisfree/2010/oct/19/osborne-public-wrath-labour-blame-game

[5] See http://www.social-europe.eu/2010/08/running-a-permanent-fiscal-deficit/

[6] See Larry Elliot, ‘Alistair Darling: we will cut deeper than Margaret Thatcher’, Guardian, 2010; http://www.guardian.co.uk/politics/2010/mar/25/alistair-darling-cut-deeper-margaret-thatcher

[7] See http://www.guardian.co.uk/politics/2010/sep/26/darling-balls-labour-deficit-clash

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Cuts won’t work: the UK example

Posted by George Irvin in EU on October 17, 2010

As the Comprehensive Spending Review is unveiled in Britain, some of you will recall the recent Compass pamphlet, The £100bn gamble, of which I was a co-author.[1]  I’ve just read an exceptionally good short piece by Malcolm Sawyer, Professor of Economics at Leeds, which made me realise that the pamphlet did not pay sufficient attention to Osborne’s highly unrealistic assumptions about just how much the private sector is assumed to expand as the public sector shrinks.[2]  As the current plight of Greece and Ireland shows quite clearly, cutting public sector spending in the name of ‘sound finance’ could make things worse, not better.

To show how shaky the current budgetary assumptions are, Sawyer rightly starts with the basic national accounting identity for the ‘savings balance’:

Investment = domestic private savings plus domestic public savings minus the current account.

Why is the current account (CA) netted from the above? Because if a country is running an external current deficit (which is true for Britain just like the USA), it must be financed by a capital inflow from abroad; in economists’ jargon, such a capital inflow is known as ‘foreign savings’. So if you wish, you can replace the phrase ‘minus the current account’ in the above definition with the phrase ‘plus foreign savings’.

Table 1 below—which I’ve taken from Sawyer—shows the evolution of macroeconomic aggregates used by the Treasury to underpin Osborne’s position.[3] In particular, look at the bottom row which shows the percentage changes implied.

Britain’s problem at the moment can be characterised thus. While domestic private savings is (once again) positive, domestic public savings is negative (the budget is in deficit) while foreign savings (the current account deficit) is high. So if both the government and current accounts are to move to zero, export growth must recover strongly and private investment must shoot up by 2015 must match the pool of domestic private savings.

Table 1:  Key Macroeconomic aggregates 2009-2015 (figures in £bn at constant prices)

Year Household

Consumption

 General Govt Consumption Investment Exports Imports GDP

(mkt prices)

 Houshold savings CA= trade balance
2009 825.5 288.8 182.4 323.3 353.4 1264.6 62.1 -30.1
2010 827.5 293.9 196.6 337.2 373.2 1279.3 61.3 -46.0
2011 837.8 290.5 208.9 355.8 380.8 1309.2 61.1 -35.0
2012 852.1 284.8 225.3 378.1 391.1 1346.3 58.3 -13.0
2013 869.9 278.2 244.7 401.3 405.4 1385.7 55.5 -4.0
2014 888.9 269.8 264.1 424.8 421.4 1423.3 52.7 +3.4
2015 908.7 264.1 282.1 448.9 438.9 1462.0 51.9 +10.0
Change 2015/2010 81.2 -29.8 85.5 111.7 65.7 182.7 -9.46 40.1
%change 9.8 -10.1 43.5 33.1 17.6 14.3 -15.4

Source: Table 1.11 and Table 1.6 (and Table 1.3 for household savings rate) of Office for Budget Responsibility (2010), and calculations (for household savings) based on those Tables.

First, consider the current account. By 2015, it is forecast that the overseas trade deficit will have shrunk to near zero (ie, foreign savings will be negligible). For the period from the beginning of 2011 to the end of 2015, exports are assumed to growth 33% and imports by only 18%. The forecast for the current account in 2015 is the most favourable since 1983. This is totally at odds with the current trend. In the past decade, imports have grown faster than exports. Moreover, despite a nominal devaluation of 23% since 2008, export growth in 2010 was still negligible.

Next consider domestic savings. With the budget assumed to be in balance by 2015, government savings is zero. Household savings decline somewhat as a percentage of GDP. Although corporate savings do not appear explicitly, these can be calculated and their GDP share is seen to fall by about 10%. Such a result is important since corporate savings are such a large proportion of total domestic savings. But corporations have been busy ‘deleveraging’; ie, rebuilding savings. In reality, it is difficult to see why corporate savings would fall for the period in question.

Crucially, it will be seen that investment is assumed to rise by 44% between 2011 and 2015. UK gross Investment (including public investment) at present in slightly less that 14% of GDP: the Treasury assumed that it will reach over 19% of GDP by 2015. This is higher than at any time in the past decade, and is to be achieved despite cuts in public sector investment. The resulting annual GDP growth rate forecast for the period 2011-2015 is 2.7%, higher than the underlying trend growth rate in the past decade.

In summary, if private investment does not growth as rapidly as forecast, if export growth does not quickly outpace that of imports and if domestic savings do not fall enough, it will not be possible to balance the budget. This is not a matter of conjecture but of national accounting definitions. Moreover, as Sawyer’s piece rightly argues, since the probability of each of the above outcomes is not high, the probability of their joint occurrence is remote. George Osborne’s gamble looks problematic indeed!

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[1] See http://www.compassonline.org.uk/news/item.asp?n=11115

[2] See M. Sawyer ‘Why the structural budget deficit will not be eliminated by 2015’;  http://129.11.89.221/MKB/MalcolmSawyer/budget2010.pdf

[3] See HM Treasury (2010a), Budget 2010, London: The Stationary Office, HC61; also Office for Budget Responsibility (2010), Budget 2010:The economy & public finances– supplementary material

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