Countering the Attack on Corbynomics


The counter-attack on Corbynomics

From Michael Burke

Published on Socialist Economic Bulletin

The economic policies of Jeremy Corbyn have come under widespread criticism.  This exceeds the level of scrutiny of his policies; many of his critics do not seem to have troubled themselves to read his key policy document.  It also by far exceeds the level of scrutiny devoted to any of his leadership rivals.

This is not surprising.  All major sections of big business in Britain and in the western economies as a whole are committed to austerity policies.  The economic consensus in favour of austerity arises not from economics textbooks or any appraisal of economic history – even recent history such as the stagnation from 2010 to 2012, and the rise in the deficit that resulted.  Austerity is the consensus because it represents the interests of those dominant sections of the economy and therefore society.

This explains the assault on Corbynomics, which we should expect to intensify if he wins the leadership of the Labour Party.

Therefore, it is important to address these arguments.  The BBC’s economics editor Robert Peston, led the way and was closely followed by the Financial Times’ economics editor Chris Giles.  Academics have weighed in, with one characteristic contribution from John Van Reenen at the LSE.  There are important nuances between these and other critics of Corbynomics but they have common central arguments. All summaries are reductive and readers are encouraged to review these pieces themselves.  But the central argument is this:

· the British economy is dependent on foreign capital inflows
· instructions from government to the Bank of England undermine the Bank’s independence
· the flow of international capital on which Britain depends will halt as investors take fright
· as a result, the currency will fall and interest rates will rise
· this will cause inflation and reduce investment, the very opposite of Corbynomics’ aim
· And, the existing £375bn in Quantitative Easing cannot be used as an example as this may be temporary and almost solely focused on the purchase of government bonds (gilts)

It is noteworthy that the critique begins with capital flows and rests on the absolute power of financial markets to set exchange rates and interest rates.  These are real and powerful forces and cannot be ignored.  But the dominance of finance capital in British society is so great, it influences opinion so that the argument ‘There Is No Alternative’ appears to have great weight.  The weight of this argument would be lesser in countries such as Germany, or Sweden, or even the US.

There is no denying the British economy is increasingly dependent on inflows of overseas capital, setting new lows last year. This is not simply or even primarily the chronic UK trade deficit, which has persistently oscillated around 2% of GDP in recent years.  As Fig.1 below shows it is the sharp deterioration in the primary income account which has caused a sharp and unsustainable rise in the current account deficit. It has swung from small surplus in mid-2013 to a deficit of 3% or more of GDP in recent quarters.

Fig. 1 Current account balance, % GDP & components
Source: ONS

The primary income account and its components is shown in Fig.2 below.  There are two key points to be highlighted.  The first is the very large and persistent deficit on portfolio investment, ranging between 5% and 10% of GDP.  This is a net outflow of capital representing the far greater propensity of British capital to invest overseas because of higher returns.

But this persistence means that portfolio investment outflows are not responsible for the recent sharp deterioration in the primary investment account, and therefore in the current account as a whole.  The balance of Direct Investment has swung from a surplus to a deficit and accounts for the deterioration in the external accounts.  This has taken place while corporate taxes have been cut and while the last government was claiming that ‘Britain was open for business’.

Fig.2 Primary income account and components
Source: ONS

It is a remarkable fact that the government’s repeated assertions that its policies are promoting growth and investment are rarely challenged although they are so clearly false.  George Osborne has repeatedly asserted that his policies are successfully promoting investment.  Specifically, he and his supporters have argued that the cut in Corporate Tax rates from 28% to 18% is and will promote Foreign Direct Investment.  Fig.3 below shows that FDI inflows have been declining over the medium-term, even while corporate taxes have been cut and ‘business-friendly’ policies have been adopted.

Fig.3 Net FDI Inflows and components
Source: ONS

It is no accident that the sharp deterioration in the external accounts occurred in mid-2013.  As SEB has shown elsewhere the Coalition government halted new austerity measures and even slightly increased government spending in order to get re-elected.  Borrowing, particularly for housing and other consumption was encouraged.  Unless government borrowing was to increase, or were to companies face higher taxes, then the increase in borrowing had to be sourced from overseas.

In order to get re-elected the government encouraged an unsustainable borrowing binge.  It now proposes to deal with this crisis with renewed austerity, which will cause an economic crisis.  Overseas investors have a diminishing appetite for investment in Britain because it is a slow-growth, low-investment economy.  Low British investment levels become self-reinforcing.

The entire criticism of Corbynomics can be shown to be a case of what Freudian psychoanalysts term projection.  It is the current policy which has dramatically increased the dependence of the British economy on overseas capital inflows.  And the only remedy offered is renewed austerity.  This is simply ‘TINA’ (there is no alternative) purportedly from the perspective of the all-powerful dealing room floors of the City.

One of the weakest points of the critique is that it rests on the outlandish proposition that the Bank of England retains credibility.  The independent Bank has presided over the biggest ever financial crash in Britain and the longest recession.  Throughout most of 2008, the MPC was discussing the need to raise interest rates, even as the economy had already begun its biggest slump since the 1930s.  The Bank’s record on growth since independence has been markedly worse than the rest of the post-WWII period.  It has also persistently missed its own inflation target.  It has a spectacularly bad forecasting record for growth and inflation even in the short-term.  It is even questionable how independent the Bank is on decisive matters as the bank bailout of 2008 was clearly a government plan, with Bank officials still delivering speeches about ‘moral hazard’ (pdf).

The superiority of Corbynomics 

The weakness of his opponents arguments do not by themselves mean that Corbynomics can succeed.  But this has been dealt with in a previous post.

Instead, it is important to state why Corbynomics is superior to the alternative, based on economic fundamentals.  The critics argue that government intervention may have been a necessary evil at the time of the banking crisis (and unsurprisingly acceptable to bankers) but that government intervention in the real economy is unacceptable.

This turns economic reality on its head.  The returns to productive investment in the economy are far higher than government bond yields. The rate of return for UK companies is currently around 12%, and never fell below 8% even in the depth of the recession as shown in Fig.4 below.

Fig.4 Net rate of return to Private Non-Financial Corporations, %
Source; ONS

By contrast the British government can borrow at extraordinarily low rates to fund investment, as shown in Fig.5 below.  At the time of writing the yield on 10 year UK gilts is 1.8% which is a fraction of the rate of return on private investment.

Fig. 5 UK 10 year gilt yields
Source: Bank of England

The objection raised at this point (see Peston in particular) is that there are no projects or sectors where such returns are additionally available, otherwise the private sector would be investing in them.  But this criticism is misplaced and only serves to highlight the innate superiority of state-led investment over that of the private sector.

On exactly the same investment, the returns available to the public sector are higher.

To demonstrate this, take the obvious case of housebuilding.  Private builders estimate an average construction cost per home of £100,000 in Britain, and a sale price of £175,000 to cover their fees, borrowing costs and of course profits (National Association of Home Builders estimates).

Yet government can build exactly the same home at exactly the same price.  It will naturally have far lower borrowing costs than any private sector company.  But it is the returns to government which are massively higher.  This is because government obtains tax revenues which of course are unrecoverable by any private sector developer.  This will be both income taxes on all labour employed, plus tax revenues on all consumption financed by that income, and all other consequential taxes.  There is also a benefit to government finances from the increase in economic activity arising from lower social security payments.

The UK Treasury estimates that for every £1 increase in economic activity there will be a 75p boost to government finances, 50p in tax revenues and 25p in lower social security payments*.  As a result the net cost of home construction is just £25,000 (after all returns are included) while it now has an asset with market price of £175,000.  Employment and a home have been created and a genuinely affordable rent is easily possible.

The superiority of the public sector is even greater in a strategic sense.  Government can direct investment to the most-needed or most productive sectors of the economy, energy, transport, infrastructure and education, in addition to housing in a coordinated fashion.  The vastly greater returns to the government means that it is not even the main direct beneficiary of the investment.  It is private firms who benefit most, at least in a direct sense, from investment in transport, education, infrastructure and so on.  But the key condition is that they not be allowed to act as a brake on investment, as they are currently.

The trading response of financial operators is entirely predictable.  Irrespective of their political views, their purpose is to make money.  The dire warnings against the 2009 Labour stimulus Budget, that interest rates would soar was actually followed by a sharp fall in interest rates.  Investors were more likely to get their money back from a government whose economy was growing rather than contracting.  (The political response may be another matter, but that is a separate discussion on the levers a radical government would have to use).

Government investment in the productive sectors of the economy yields very high returns, much higher than the interest payable on government debt.  Corbynomics has offered a range of options to achieve that increase in investment.  All of them are preferable to current policies because they can work.

*Treasury Working Paper No.5, Public Finances and the Cycle The author is grateful to the office of Caroline Lucas MP who managed to locate this paper. It seemed to have been buried away under the Coalition government.


The Deficit Narrative – Understanding and Reframing : Richard J Murphy


The deficit narrative: understanding is the key to successfully reframing it

I have argued for longer than I probably care to remember that the last thing we need in our economy right now is a balanced budget. When and if we have full employment, higher productivity and a confident business sector that is investing heavily and exporting at considerably higher levels than at present I will change my mind: right now we are so far from that situation that a government surplus makes no sense, in theory or in practice.

To complicate consideration of the issue I have also argued that, as a matter of fact, having a balanced budget is something no government can expect or promise to deliver. There is good reason for this. As I have argued in more depth here (and many other places):

The reason is that there are, in macroeconomic terms four sectors in the economy and they must balance. The first is consumer spending. If consumers borrow more to increase spending then someone must lend it to them, or borrow less, as a matter of fact. That person who must borrow less might be business, who might invest less as they borrow less to compensate for more consumer borrowing, or it might be net overseas trade, or it can be the government. But the point is that the net lending and borrowing of these four sectors, consumers, business, overseas and government, will always balance, as a matter of fact.

So, frustrating as this might be to a politician who wants to appear to be in control of the destiny of their government and the state, the fact is that they have remarkably little control over how much they will borrow. If consumers insist on saving, as does business, and trade is running a deficit, (which in effect means foreigners are saving in Britain) then as a matter of fact the government will run a deficit whether it likes it or not. And there is nothing, bar stimulating business investment, exports, or consumer borrowing that they can do to change this.

Let me put this in context. These are the sectoral balances and forecasts for them as per the March 2015 budget data:

All of these balances add to zero. And, as is clear some factors make it very hard indeed to achieve a balanced budget, let alone a budget surplus. The only time it happened in this period, from 2000 to 2002, it was only really possible because of the enormous corporate borrowing during the era. That Labour kept the deficit under reasonable control from then on was, as is widely known, because consumers borrowed during this period to compensate for the fact that after the dot-com crisis business simply stopped net borrowing – which is why they have ended up with what Gillian Tett of the FT has called ‘zombie piles of cash’.

And throughout this period note the enormous impact of the ‘rest of the world’. Because of trade and investment flows flows the ‘rest of the world’ has persistently saved in the UK throughout this period. The result has been that even if business and consumers decided to just lend and borrow from each other and always themselves equalled their flows out to zero (which is very unlikely to happen, but is technically plausible) the UK government would have, for this one reason of the overseas flows, have had absolutely no choice but, as creator of the UK currency, to have run a deficit throughout this period to meet the demand for lending that overseas savers had in the UK and which in that circumstance could only be met by government borrowing. And I stress, there is nothing the government can do about this because, unlike business and households (and the rest of the world when it is stated vis-a-vis the UK) only the government is the creator of currency that can make this equation work. It supplies this currency by running deficits. As a previous post argued, this means it must either create gilts to satisfy the demand for savings products that the actions of others in the economy demands that the government must meet or let reserves at the Bank of England accumulate, but one or other must happen.

In that case the real issue to be discussed when it comes to deficits, as John McDonnell MP, a close colleague of Jeremy Corbyn did in the Guardian recently, is ask just what aspect of the deficit is really being discussed. There are a number of obvious splits within the data to be made to make such discussion meaingful. The first is between current and capital deficits. It baffles me why this distinction is not normally offered when discussing deficits. For the record, this is the data I am using from the June 2015 PSA1 Summary of public finances from the ONS:

Screen Shot 2015-08-16 at 17.41.21

The current deficit is anything not for investment, of course. Net investment is government investment in this case, not that for the economy as a whole. Figures are in millions barring the last column which is in billions. This is that data plotted:

Screen Shot 2015-08-16 at 17.39.32

But suppose that borrowing to pay for net investment (i.e. cost net of sale proceeds) is charged to a capital account. £444 billion over this period then falls out of current account borrowing. From 1997/98 to 2011/12, when QE ended, the borrowing for capital spending was £350 billion. £375 billion of QE did, of course, pay for all that. In fact, you could argue it looked suspiciously like PQE did actually take place, retrospectively, for the entire cost of state spending for that period. If PFI had been added in it would have been less, but the point is QE cancelled all that investment spend: it has now gone from the state balance sheet as debt and is now paid for with much cheaper reserves. So, we have already, in effect done PQE and still met the demand for savings.

What about the rest of the deficit? Go back to the sectoral balances and look at this data, based on the OBR for March 2015 using historic data for the overseas element of the sectoral balances combined with ONS GDP data to indicate a cash value:

Screen Shot 2015-08-16 at 20.44.49

Since 2000 more than £640 billion of deficits have occurred in the UK simply because people from the rest of the world insist on saving in the UK, in sterling and the government had no choice but create the currency they need to let them do so. That effectively meant it had to run deficits for almost all that period for this reason alone. I stress: they had no real choice.

Now compare this data with the data on borrowing and if you exclude borrowing for investment, which it can be argued should be on a separate loan account, and you deduct from the remaining deficit that which had to be created to fuel foreign demand for sterling savings you end up with this data with the reported deficit shown just for comparson:

Screen Shot 2015-08-16 at 21.15.46

Which looks like this when plotted:

Screen Shot 2015-08-16 at 21.15.57

This implies the UK only ran a deficit to meet current domestic need from 2009/10 to 2012/13. Overall it ran a surplus for this purpose over the period.

Is this a fair way of viewing the deficit? I suggest it is. I also suggest, immediately that this is not the only alternative way of looking at deficit data: I can and maybe will juggle this data in numerous other ways as yet to see what might be useful. But my points are threefold.

The first is that, as I repeat, some parts of the deficit are out of the governments control. This is most especially true of the net amount of foreign saving in the UK in a time of floating exchange rates. This demand for sterling has to be met and the government has to meet it: only it can create the currency to do so, usually in the form of gilts. Not recognising this would be absurd. To also try to eliminate this would be to look a gift horse in the mouth: do we really want to stop people from outside the UK effectively subsidising us, which is exactly what they are doing, at incredibly low interest rates over very long debt repayment periods, with a fair chance that a good part of the debt will be written off by the impact of inflation in the meantime and without foreign currency risk as they are saving in our currency? I suggest not.

Second, it is also absurd to lump together the borrowing for government investment with that to meet current domestic need not funded, in effect, by overseas lenders. This borrowing for investment to be accounted for quite separately. This is borrowing to fund improvements in our national infrastructure. We need this. We should be proud that we make such an investment and want to continue to do so. We should be really worried if it declines – as in real terms it is at present. That puts our well being at risk. We need a way to separately and clearly identify this spend to make sure it is properly recognised and managed. No one is going to be surprised that I think this is  a role for PQE.

And, thirdly, what’s left? Well, as the last graph shows, all too often it is a government surplus, much (but not all of it) happening because of increasing household debt. I am not too sure that is something we should be celebrating, and so there is an issue to consider here and how it is business surpluses that need to be addressed here.

I stress: this is a quick analysis. What I am suggesting though is that the deficit narrative is far too constrained and and that if discussion of the deficit and whether or not part of government activity is to be run in surplus is to take place then we need to be aware of what the surplus is made up of, what elements might be controllable, what parts might be fundamentally useful and essentially suited to a controlled borrowing programme, and how the remaining balances need to be managed to ensure overall wellbeing of people in the country is maximised. And in the process I am saying that the deficit narrative we have suffered to date has utterly missed the point in economic terms and been deeply misleading in terms of its consequences for political economy.

If we’re going to have a debt and deficit narrative let us, for heaven’s sake, make it one that is useful and based on what really happens. That’s the least the left should be doing now because if and when we do so the policy implications would be deeply significant.

by Richard Murphy (under a Creative Commons Attribution-NonCommercial 3.0 Unported License.)

From Think Left: