Whatever Osborne says, not all ‘debt’ is the same

Quote

Corbynomics: winning with policy clarity by Michael Burke first posted 15th october 2015

Economic policy is central to the survival and eventual victory of the new Labour leadership, even though it is clearly not the only issue.  Contrary to the usual Tory media reports, Jeremy Corbyn and his Shadow Chancellor John McDonnell registered an advance with the debate and vote on Osborne’s risible Fiscal Responsibility Charter.  That advance came because the correct position of voting against was adopted.  As this question will not go away, further advances will require even greater clarity.

The measure of the advance can be summed up in its political aspect with an analysis of the vote.  Just 20 Labour MPs rebelled against Labour’s line by abstaining on the Charter.  It may be recalled that of the 35 nominations, Jeremy Corbyn received from MPs in the leadership contest, only about half of them actually supported him.  During that campaign, the vast majority of MPs followed the line of abstaining on the Tories massive cuts in the Welfare Bill.  Now the overwhelming bulk of the Parliamentary Labour Party has voted against the key Tory legislation of permanently enshrining austerity and ruling out borrowing for investment.  This is despite the fact that, as recently as May, the party’s economic line was ‘fiscal rectitude’, ‘zero-based spending reviews’ and sticking to outlandish Tory spending cuts in the first two years of the Parliament (something the Tories could not do in their own June 2015 Budget).

Politically, the 20 abstainers have isolated themselves within the party (although they will no doubt find regular berths in the BBC studios and lots of column inches in the Murdoch press).  Jeremy Corbyn and John McDonnell have led the PLP to a much better economic position by opposing Tory economic policies.  As the Tories are committed to austerity and this will be central to the economic debate over the next five years, that leadership will need to keep moving forward.

Exposing Osborne’s fallacies

Labour lost the last election because its economic policies were not credible.  There is a concerted effort to distort this factual finding to suggest that Labour was too anti-austerity.  Therefore, the debate on economic policy is central both to the future direction of Labour policy and its election prospects.

Osborne’s great fallacies, like most distortions of the truth, have some connection to popular understanding otherwise it would be impossible to explain their political power.  A central fallacy is to treat all debt as essentially the same, with equally negative consequences.  Instead, as Socialist Economic Bulletin (SEB) has repeatedly shown John McDonnell and Jeremy Corbyn have made the correct distinction between borrowing for consumption and borrowing for investment.

In the homely analogies beloved by this Chancellor and by Margaret Thatcher, ordinary households understand very well the difference between different types of borrowing.  Borrowing to buy a home, or borrowing to pay for night classes, or a new work-related computer all provide an asset or additional income and so are an investment.  But borrowing to pay the electricity or grocery bills is not sustainable.  It may ‘circulate more money in the economy’ but can only be done in extremis and not in the long-term.

Likewise, businesses understand cashflow.  Business makes an appraisal of investment opportunity on the basis of cost-benefit analysis.  If a reasonable expected rate of return exceeds the cost of borrowing then the investment will be made.  But if the business is borrowing to meet day to day expenses it will soon face insolvency and possibly bankruptcy.

Government relies on these economic agents for its income.  But in truth it is not unique as all three agents, government, business and households rely on each other for their income both directly and indirectly.  In that sense, government is no different.  Government borrowing for investment delivers an economic return, either direct or indirect, will expand the economy and, just like business a key criteria will be whether the rate of return on the investment exceeds the borrowing cost.  Contrary to views Keynes did not hold, but which are misleadingly entitled ‘Keynesianism’, borrowing for day to day consumption will not necessarily expand the economy – this depends on whether extra production increases profit, and in a number of situations expansions of demand may not increase profit and may actually reduce it.  Consumption should usually be met by current revenues from taxation.  If there is a shortfall between desired government current spending and revenue, wasteful spending can be cut (e.g. Trident) and/or taxes can be increased.

SEB has repeatedly demonstrated that investment is the decisive input for growth and consumption cannot lead growth, and from this it follows that government borrowing should be used for investment over the business cycle (running deficits/borrowing for consumption as well as investment may of course be valuable in economic downturns)

Alliances

The clear opposition to the Fiscal Responsibility Charter from the ‘Corbyn/McDonnell’ team on the Labour front bench was supported by strong economic arguments from a number of quarters, not all of them long-standing allies.

In the Commons debate, Caroline Lucas said, “The Chancellor is incredibly irresponsible to imply that borrowing is always bad. If we borrow to invest, we increase jobs, stabilise the economy and increase tax revenues. That is good for the economy, not bad for it…… If we are investing in jobs, that gets taxes going back into the Revenue, which is good for the economy.”  And:

“The Chancellor is deliberately misleading the public by continuing to claim that all borrowing is irresponsible. It is not. What is irresponsible is failing to borrow to invest, providing we are able to sustainably meet the cost of borrowing.”

Jonathan Reynolds, describing the Charter as intellectually moronic said, “It essentially commits this House to never borrowing to invest, even when the cost-benefit analysis of that investment is such that the country would benefit greatly.  That is why it has not one serious economist backing it.”

Helen Goodman said:

“One of the most pernicious things about the rule that the Chancellor has chosen is that it treats capital and current spending the same.  He is ignoring the fact that investing in housing, science, broadband, transport and the university system is a way of strengthening economic productivity and increasing growth in the British economy.  Nobody thinks that it is right to max out the credit card to pay the weekly grocery bill—of course not—but families up and down this country take out mortgages to buy their homes.  There is a precise parallel here.”

Regarding what John McDonnell himself said, as much of the press will not report it accurately, here are some of his key points:

“The worst false economy is the failure to invest.  This will be a direct result of Government policy embedded in this charter, with its limits on all public sector borrowing.  This Chancellor’s strategy has given us investment as a share of GDP lower than all the other G7 countries, falling even further behind the G7 average in recent years.  It is incomprehensible for the Chancellor to rule out the Government playing a role in building our future.  For him to constrain himself from doing so in the future, no matter what the business case for a project, has no basis in economic theory or experience.”

“We will not tackle the deficit on the backs of middle and low earners, and especially not on the backs of the poorest in our society.  We will tackle the deficit, but we will do it fairly and to a timescale that does not jeopardise sustainable growth in our economy.  We will balance day-to-day spending and invest for future growth, so that the debt to GDP ratio falls, paying down our debts”.

“That is why we will establish a National Investment Bank to invest in innovation across the entire supply chain, from the infrastructure we need to the applied research and early stage financing of companies.  To tackle the growing skills shortages, we will prioritise education in schools and universities along with a clear strategy for construction, manufacturing, and engineering skills to build and maintain sustainable economic growth.  The proceeds of that growth will reach all sections of our society.”

Outside the Chamber, Chi Onwurah had previously written a strong piece deriding Osbornomics’ refusal to invest “The Osbornomic farmer wouldn’t borrow to buy a tractor unless crop prices were falling.  The Osbornomic househunter would not take out a mortgage unless her salary was being cut.  The Osbornomic CEO would only invest in a new product line when revenues were falling.”

Long-standing Corbyn/McDonnell ally, Diane Abbott made a series of similar points on Twitter:

“Osborne’s Fiscal Responsibility Charter effectively outlaws the equivalent of taking out a mortgage…..Osborne’s Fiscal Responsibility Charter is a con-trick from a charlatan. Outlawing borrowing for investment means long-term stagnation….Every household and firm knows that borrowing for investment boosts incomes. Only Osborne and the austerity fanatics are unaware of this.”

These analogies are extremely useful for popularising the alternative to austerity, which is investment.  The new leadership team has shown it can command an overwhelming majority in PLP with clear opposition to Tory austerity.  Developing a broader understanding of the distinction between borrowing for investment and borrowing for consumption, and why Labour should support the former will be key in pushing back the Tories in the period ahead.

The economy is not growing strongly

Quote

Crisis hasn’t gone away.  Corbynomics will be increasingly necessary.

By Michael Burke   First posted 17.09.15 at http://socialisteconomicbulletin.blogspot.co.uk

 

One of the most widely repeated falsehoods about the British economy is the assertion that it is growing strongly and that the crisis is over.  This is not borne out by even a perfunctory economic analysis but it serves a political purpose.  In the first instance, the assertion was important in order to blunt any criticism of renewed Tory austerity policies, which will begin again earnest with the Comprehensive Spending Review in December.  Now that Jeremy Corbyn has won the leadership of the Labour Party the same falsehood is pressed into slightly different service- with the idea that his policies represent a threat to the current recovery, or are at least unnecessary.

In reality, the extremely limited upturn in output is already giving way to renewed weakness.  UK industrial production and manufacturing fell in July.  Monthly data can be erratic but this is the second consecutive fall for industrial production and manufacturing peaked in March, shown in Fig. 1 below.

Fig.1 Industrial production and manufacturing index from April 2013 to July 2015

Source: ONS

This is not the boom that is repeatedly claimed.  The recovery to date is primarily based on consumption not investment.  Since the beginning of the recession to the 2nd quarter of 2015 consumption has risen by £70bn, a modest rise of 5%.  But investment has risen by just £4bn, a cumulative rise of just 1.3% over 7 years, less than 0.2% annually.

In terms of output and investment, the notion of a boom amid austerity is entirely misplaced.  There is only stagnation.  In fact, the levels of industrial production and manufacturing are effectively unchanged since the Coalition took office in May 2010, despite inheriting a mild recovery.  In May 2010, the index levels of industrial production and manufacturing were 100.2 and 97.6 respectively.  In the most recent data they were 99.2 and 100.6.  The trends in output are shown in Fig.2 below.  They clearly show that under austerity, production has stagnated.

Fig.2 Output trends from January 2008 to July 2015

Far from a boom, the current economic situation is best characterised as stagnation.  In one form or another this also characterises the Western economies as a whole.  Since the recession began in the OECD as a whole, the average annual level of GDP growth has been under 1%.  Consumption has risen by US$2.5 trillion over that time.  But Gross Fixed Capital Formation has declined by $200bn over the same period.

For the British economy, this continued reliance on consumption holds a particular threat. The relative weakness of investment, and hence the relative weakness of productivity, is a chronic one in Britain. The current crisis has deepened these severe long-term problems.  Output has fallen back to levels last seen in the 1980s, as shown in Fig.3 below.  This represents a combination of both the long-term weakness of manufacturing and the decline in the output of North sea oil, a financial windfall that has been almost entirely wasted.

Fig. 3 Industrial production over the long-term

As it is not possible to consume that which is not already in existence, consumption must follow output.  It cannot lead it.  As the output of the British economy is experiencing both a structural and a cyclical decline, its increased consumption has been funded by its surplus on ‘financial services’, the money British banks extort from the rest of the world, and on increasing indebtedness.

As the revenue from financial services has now also gone into decline, so the resources for consuming without producing are increasingly through borrowing.  The broadest measure of Britain’s overseas borrowing requirement is the balance on the current account.  The current account includes both the trade balance and the balance on all current payments , primarily company dividends and interest payments by borrowers.  Any deficit on the total current account must be met by increased borrowing from overseas (or asset sales to overseas).  The latest 3 quarters have seen the worst current account deficits as a proportion of GDP since records began, as shown in Fig.4 below.

Fig.4 Current account blance as a proportion lof GDP

The financing of this deficit depends on the willingness of overseas investors to buy UK assets.  It is impossible to predict the precise point or catalyst for them to stop doing so.  But what is known is that the British economy has faced a number ‘balance of payments’ crises before when the relative level of overseas borrowing was far lower.  One possible way of reducing the current account deficit is to impose higher savings rates on the household sector, raising the taxes and reducing the welfare transfers to them from government, which is one effect of renewed austerity.  But even austerity Mark II will be unable to close the current account gap of this magnitude entirely.Therefore the British economy is facing a series of interrelated crises, of production, slow growth and unsustainable borrowing.  In reality they are key products of a single crisis – the crisis of weak investment.  Contrary to the Tory propagandists, the supporters of austerity and their apologists, the crisis of the British economy has not at all gone away.  As a result Corbynonics, a state-led increase in investment, is vital to end it.

Yvette Cooper hasn’t got the economics right

Quote

In the last of the Labour leadership debates, Yvette Cooper repeated her attack on Jeremy Corbyn’s economic strategy.  As a New Keynesian, she believes that since the economy is finally growing, the time for government investment or a fiscal stimulus has passed.  She should tell that to the 2.3m unemployed and the millions more who are underemployed.

In the re-posted article below, Richard Murphy explains why her belief that Peoples’ Quantitative Easing would be inflationary, is simply not true.

Re-posted from Tax Research UK

 Why no inflation?

POSTED ON 

The question of inflation is coming up time and again in the Labour leadership election. Yvette Cooper is certain that People’s Quantitative Easing will lead to a mass outbreak of hyperinflation in the UK. It’s time to address the issue.

First, some general background. PQE is simply a way of injecting money into the economy. Such injections have happened before: £375 billion happened from 2009 to 2012. The US has only just stopped its QE programme. Japan is still doing one. The EU is near the start of a €1-trillion programme. Money printing is normal. There has been or will be about ¢5 trillion of it over a relatively short period.

And around the world there is almost no inflation. After QE the UK has got to zero inflation.

Japan would love inflation but can’t manage it.

The whole point of the EU programme is to create inflation, and many doubt it will.

In the US the inflation rate is 0.2%.

What is more, as the FT reports this morning, a Boston Fed official with some influence is today reporting that the Chinese slowdown is already making him doubt that the US can reach its 2% target inflation rate anytime in the foreseeable future. I have some considerable sympathy with that view. In fact, let me summarise what almost all the world’s central bankers are looking for right now: it is a magic bullet that might create the inflation that they want.

So the question has to be asked as to why they can’t get it? The Wall Street Journal raised this question last week. As they noted:

Central bankers aren’t sure they understand how inflation works anymore. Inflation didn’t fall as much as many expected during the financial crisis, when the economy faltered and unemployment soared. It hasn’t bounced back as they predicted when the economy recovered and unemployment fell.

As they then note, this is a massive issue. If you can’t predict inflation then what is the point of central bank independence which is all about controlling inflation as if it is the only task of significance in an economy? What if, in other words, all the priorities are wrong and for reasons central bankers and some well-trained economists (like Yvette Cooper) don’t understand inflation simply is not the threat it was? And in that case what new policies are needed?

Let me explain why I think the inflation conundrum exists i.e. why we can’t deliver the inflation we want.

First, it’s because inflation measures are measuring the wrong things. We have had massive inflation in asset prices, for example, many of which have real impact on well-being, but asset price inflation is not included in our inflation measure.

Second, some inflation measures fail to measure the right things. So, for example, in the UK there is a current belief that we will have inflation soon because we supposedly have wage inflation right now. But firstly, that is wage inflation after eight years of decline and with GDP per head only at pre-crash levels. And second, this measure might be hopelessly inaccurate. That’s because it excludes the earnings of the at least 5 million UK self-employed, who we know have had seriously declining income. That decline may be enough, given their number and the relatively small increases in wage growth to neutralise that wage increase impact entirely: the reality is that this measure of apparent inflation might be completely wrong.

Third, what the decline in self-employed earnings shows is that inflation risk is being outsourced: it is now passed on to some elements within a profoundly deregulated labour force, many of whom are suffering unrecorded real earnings decline of such extent that they are in poverty, but so destabilise the rest of the labour market by accepting any offered pay rate (which rates are beyond the control of minimum wage regulation) that  any amount of upward pressure on prices can simply be externalised into this unmeasured pool of labour meaning that anticipated inflation outcomes simply do not happen.

I stress, I am speculating. But let’s suppose across 25 million workers there is a 2% pay rise and across 5 million self-employed people a 10% wage drop (which is not impossible) then there is no net wage inflation at all: the wage rate data is just wrong as a result because it is missing an important variable that did not matter at one time but is now deeply significant.

In that case the amount of inflationary pressure in the UK economy might well come back to being effectively nothing at all, whilst we have at the same time unemployment, under-employment and a stark need for real investment which is the only way to boost earnings growth for those most in need of it, which is the only true economic goal a Treasury and a central bank should have. But because of poor inflation measures, poor theory and poor appraisal of why we do not have inflation at present, when if theory was right we should, we are denied that possibility of investment for the common good. I find it deeply frustrating that adherence to economic thinking that is obviously past its sell-by date should be used to oppose necessary ideas for reform that could massively benefit the people of this country.

Yvette Cooper is an able person. She seems to have read Keynes. She would be wise to recall his maxim that:

Practical people who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

I fear that may be the case.

It is time to move on. There is no inflation risk right now. PQE probably will not change that: if it did then without major labour market reforms the impact would be modest, at best. But many wish for even that modest inflation impact, and most of them are central bankers. Yvette Copper should take note.

 

Creative Commons License
Tax Research UK Blog by Richard Murphy is licensed under a Creative Commons Attribution-NonCommercial 3.0 Unported License. – See more at: http://www.taxresearch.org.uk/Blog/2015/09/02/why-no-inflation/#sthash.Mp9XSmlK.dpuf

The Massive Cash Hoard of Western Companies

Quote

The cash hoard of Western companies

By Michael Burke
Published previously  by
 
Supporters of ‘austerity’ would have a very strong argument if there really were no money left. In that case, opponents of current policy would be left arguing only for a fairer implementation of those policies, or that perhaps they could be implemented more slowly. This is not the case. Firms in the leading capitalist economies have been investing a declining proportion of their profits. This is the cause of the prolonged period of slow growth prior to the crisis and a number of its features such as stagnant real wages, so-called ‘financialisation’ and the growth in household debt.

This negative trend of declining proportion of profits directed towards investment reached crisis proportions in 2008 and is the cause of the slump. As a consequence of the sharp fall in this investment ratio there has been a sharp rise in the both the capital distributed to shareholders and in the growth of a cash hoard held by Non-Financial Corporations (NFCs). This cash hoard is a barrier to recovery, releasing it could be the mechanism for resolving the crisis.

The chart below shows the level of surplus generated by US firms (Gross Operating Surplus) and the level of investment (Gross Fixed Capital Formation) for the whole economy. Since the former are only presented in nominal terms, both variables are presented here in the comparable way.

Fig.1

The nominal increase in profits has not been matched by an increase in nominal investment. In 1971 the investment ratio (GFCF/GoS) was 62%. It peaked in 1979 at 69% but even by 2000 it was still over 61%.

It declined steadily to 56% in 2008. But in 2012 it had declined to just 46%.
In a truly dynamic market economy there is nothing to prevent the investment ratio from exceeding 100% as firms utilise resources greater than their own (borrowing) in order to invest and achieve greater returns.

Therefore even an investment ratio of 69% is sign of a less than vigorous market economy.
However the subsequent decline in the investment ratio to 46% is a sign of enfeeblement. If US firms investment ratio were simply to return to its level of 1979 the nominal increase in investment compared to 2012 levels would be over US$1.5 trillion, approaching 10% of GDP. This would be enough to resolve the current crisis, although it would not prevent the re-emergence of later crises.

Distribution of profits

The uninvested portion of firms’ surplus essentially has only two destinations, either as a a return to the holders of capital (both bondholders and shareholders), or is hoarded in the form of financial assets. In the case of the US and other leading capitalist economies both phenomena have been observed. The nominal returns to capital have risen (even while the investment ratio has fallen) and financial assets including cash balances have also risen. One estimate of the former shows the dividend payout to shareholders doubling in the 8 years to 2012, an increase of US$320bn per annum.

The growth of cash balances is shown in the following data from the Federal Reserve. They are the changes in key balance sheet aggregates for US non-financial corporations from 2008 to Q2 2013.
Change in Balance Sheet Components, US NFCs, 2008 to Q2 2013, US$bn.

2008 Q2 2012 Change
Total assets 29,881 33,662 3,781
Total net assets (deducting liabilities) 16,656 19,470 2,814
Non-financial assets 16,945 17,686 741
Financial assets 12,937 15,975 3,038
-checkable deposits 14 386 372
-time deposits 382 597 215
-non-financial item:
Business equipment
3,896 4,191 295

Source: Federal Reserve

Total assets of US NFCs have risen by nearly US$4trillion over the period which is equivalent to approximately 25% of US GDP. The increase in net assets of US$2.8bn (after accounting for the rise in liabilities over the same period) is more than accounted for by a rise in financial assets of over US$3 trillion.

By comparison the rise in the current cost value of business equipment has been less than one-tenth that (and is accounted for by inflation).

Within the rise of financial assets, cash or near-cash instruments have contributed a rise of nearly $600bn (the biggest single contributor in the accounts is ‘miscellaneous financial assets’).

Generalised phenomena

The same is true in other capitalist economies. In 1995 the investment ratio in the Euro Area was 51.7% and by 2008 it was 53.2%. It fell to 47.1% in 2012. In Britain the investment ratio peaked at 76% in 1975 but by 2008 had fallen to 53%. In 2012 it was just 42.9% (OECD data).

The cash hoards are no less striking. The total deposits of NFCs in the Euro Area rose to €1,763bn in July 2013 of which €1,148bn is overnight deposits. This is a rise of €336bn since January 2008, nearly all of which is in overnight deposits, €306bn. In Britain the rise in NFCs bank deposits has been from £76bn at end 2008 to £419bn by July 2013.

In reality, this extraordinary accumulation of cash by NFCs began well before the immediate depression in 2008, along with the slump in investment. Both of these merit further elaboration elsewhere.

Conclusion

The profitability (profit rate) of US firms and firms in other Western economies has fallen, and even the absolute mass of profits fell for a period in the recession. While the former has not recovered, the latter has. But this has not led to a corresponding rise in investment and the investment ratio has fallen sharply.
The destination of of these uninvested profits is twofold. Owners of capital are in receipt of record payouts. And the financial assets of NFCs have risen dramatically, often primarily cash as firms are unwilling to risk any type of investment.

This hoarded store of capital is both the main impediment to recovery and the potential source of resolving the current phase of the crisis.