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

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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

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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.

Antidote to Osborne’s fairytale economics

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Panel of leading economists discuss and debate the true state of the economy and the lies underpinning the Government’s austerity programme.

The panel includes:
Owen Jones, Journalist
James Meadway, Senior Economist, New Economics Foundation
Ann Pettifor, Prime Economics
Micheal Burke, Economist
Chaired by:
Christine Blower, General Secretary, NUT

This economic briefing was recorded just a few days ahead of George Osborne’s Autumn Statement… but none of the panellists came close to anticipating the level of hubris, triumphalism and double-dealing that accompanied the Osborne Autumn Statement.  It was a truly breath-taking performance!

Find out the real effects and intent of austerity that George Osborne and the Government don’t want you to know…

 

The People’s Assembly Against Austerity – Economic Briefing – 27.11.14

It is the Tories who have a 30% strategy

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It is the Tories who have a 30% strategy by Michael Burke

First posted on Socialist Economic Bulletin 20.05.14

Ed Miliband is accused of having a ‘35% strategy’, meaning that he is banking on doing only just enough to win an overall majority at the next general election.  Polling models suggest that 35% would be enough for Labour to achieve an overall majority in Parliamentary seats.  This is because the Tory vote is increasingly concentrated, while Labour’s is far more widely spread geographically.
Since Labour’s electoral strategy has not been divulged to SEB, it is idle to speculate on it, although this has not prevented others from doing so.  Instead, it is possible to demonstrate that the Tory policy is based on an electoral strategy that is focused on an even narrower section of the electorate.  It is the Tories who have a 30% electoral strategy.

The map below (which the present author first saw published by Ian Wright MP) shows the cumulative effect in English constituencies of cuts under the Coalition government during this parliament.  The Tory Party is a fringe grouping in Scotland and is headed in that direction in Wales.  Despite repeated attempts it has also failed to resurrect Conservative Unionism in Ireland.

Chart 1. Cumulative effect on change in spending power 2010/11 to 2015/16

The areas in beige have been barely affected by government cuts (although these are averages, there will be many people living in those areas who are badly affected by austerity).  The areas in green have experienced no net cuts at all.

By contrast, areas coloured in red have seen a fall in living standards of between 15% and 20%.  Those areas coloured deepest red have seen falls of greater than 20% and take in all the large cities, including London.

The economic map almost precisely coincides with the electoral map of Britain.  The Economist and others are keen to argue that this is a North-South divide in British politics.  To that end, they are obliged to perform some logical contortions.  In order to make the main divide in British politics North versus South, The Economist excludes the Midlands from the North and excludes London from the South!

In reality, the Tory Party has been forced out of Ireland, Scotland, the cities, Wales and the North in succession.  It is retreating to its birth place and stronghold in the English shires.

The economic response of the Coalition government led by the Tories is to protect and promote those Tory heartlands, as shown in Chart 1 above.  SEB has previously shown how a minority of society, the owners of capital and the rich, are benefitting from the ‘recovery’ in which most people’s living standards continue to fall.

Perhaps the most flagrant policy in this regard is Osborne’s ‘Help to Buy Scheme’.  The entire policy of increasing demand for housing while doing nothing to increase supply inevitably leads to higher prices.  A number of commentators and economists from the Right have attacked the scheme as an absurd policy, designed solely to boost property prices rather than housing availability.  It is a ‘help to get re-elected’ scheme.  The resulting property price bubble is concentrated in London and the South-East, and even here there is growing resentment at the unaffordability of housing, not a feel-good factor.

Politically and economically, the Tories are pursuing a core vote strategy.  This may not amount to much more than 30% at the next general election, and will certainly be less than the 36.9% they received in 2010.
As a result, support for the LibDems has collapsed as this does not at all coincide with the interests of their electoral base, higher-paid workers, professional classes and small business owners.

Labour’s winning electoral strategy should be equally clear and substantially broader.  In terms of political geography it should embrace the democratic demands for greater national rights within the British state, as well as finally ending the British presence in Ireland.  It needs to have a programme of economic regeneration for the North and the big cities.  It should adopt a very large scale programme of council house building with London at its centre-piece.  Socially, it needs to be a champion of equality and democracy, tackling the huge inequalities faced by women and tackling the endemic racism of British society, which cannot be done while promising to be tough on immigration.

Above all now, it needs to reverse the policy of austerity which is lowering the living standards of the overwhelming majority and will continue to do so.  The Tory policy, of government spending cuts and inducements to the private sector to invest has not worked.  A policy of government-led investment is required, combined with other policies that will directly lift standards.  The Tory party is pursuing a narrow electoral strategy to shore up its support.  Labour can offer something better.

Has Austerity led to a Recovery? (Hint: No)

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Did austerity lead to recovery? No, GDP was increased by government spending

By Michael Burke

First posted on Socialist Economic Bulletin 9th September 2013

The government and its supporters have been quick to claim that the most recent GDP data have vindicated its austerity policy.  George Osborne says the argument in favour of austerity has been won, some more excitable commentators have even talked of a boom.

Usually, SEB would provide analysis of the GDP data after the publication of the national accounts, the third release in the cycle from the Office of National Statistics, which provides a detailed breakdown of the components on economic activity and the final revision to the data.

But the claims made for the British economy following the most recent GDP release (and some subsequent surveys) are so outlandish, and so at odds with the facts, that is worth providing a short analysis now.

The data is still partial and subject to revision.  But there is enough evidence to demonstrate factually that the weak recovery is not a reward for austerity, but is in fact entirely a function of increased government spending.

The economy has expanded by just 1.8% in 3 years of austerity, an annual rate of 0.6% which is less than one-quarter of previous trend growth.  The gap between the current level of GDP and trend growth for the British economy is widening.  In addition, the growth to date is entirely a function of increased government spending.

Factual Analysis

This verdict is so at odds, with both stated government policy and the overwhelming commentary on the latest data.  Therefore it is important to provide the hard evidence supporting this analysis.  This can be found on Table C2 of the latest release, Second Estimate of GDP, Q2 2013 (ONS).

Total government current spending was barely changed from the time the Coalition took office to the end of 2011.  (In the ordinary course of events real government spending should rise in line with population growth and in a recession should rise much faster to offset the effects of recession.  Unchanged government spending represents a harsh ‘austerity’ stance).

However, from the 4th quarter of 2011 to the 2nd quarter of 2013 government current spending has risen decisively by an annualised £15.1bn.  GDP did not begin to expand until two quarter later.  This is the time lag SEB has previously identified in the relationship between changes in government spending and changes in GDP.  Rising government spending has led the recovery.

While the increase in government spending since the 4th quarter of 2011 to the most recent quarter amounts to £15.1bn, the rise in aggregate GDP over the same period is just £14.8bn.  Therefore, the rise in government spending not only led the recovery, but more than accounts for the entire expansion over the same period (as some other components of GDP have contracted).

Rising government current spending tends to support consumption, which is exactly what has happened over the last 18 months.  The rise in household consumption has been the strongest of all components of GDP over that period, rising by £25bn.  The chart below shows the changes in the national accounts since the government began increasing its current spending after the 4th quarter of 2011.

Fig 1

But weak household spending is not the source of the crisis.  This remains the slump in investment.  GDP is still £50bn below its previous peak in the 1st quarter of 2008, but investment (Gross Fixed Capital Formation) is £65bn lower.  Household consumption also remains below £24bn its pre-recession peak.  But it has been rising continuously for 2 year and now accounts for under half of the total decline in GDP.  The fall in GFCF more than accounts for the entire fall in GDP.

It is not possible from the partial release of the data for the 2ndquarter of 2013 to establish the role of government in the continuing investment strike.  But from the 1st quarter national accounts, it is clear that declining government investment has been exacerbating the private sector decline in investment.  Government investment peaked under the last Labour government and has been cut continuously ever since.

But the analysis is confirmed by the separate ONS data on public finances.  The presentation of the public finances data vary significantly from the presentation of government consumption data in the national accounts.  Among the many differences is that the former are presented in nominal terms only.  Even so, these show (Table PSF5) that in nominal terms the level of departmental outlays rose to £305bn in the first half of 2013, from £283bn in the same period of 2012.  This is a rise of 7.8% and way above the rate of inflation.

Conclusion

There is no mystery to the current very weak recovery.  It is led by a moderate increase in government spending, which more than accounts for the entire increase in GDP over the same period.

This runs counter to the government’s stated ‘austerity’ policy.  But it is accompanied by a cut in government investment, which exacerbates the private sector investment strike.  It is this investment strike which remains the source of the crisis, which cannot be resolved by increasing current spending.

Logic would dictate that any government which wanted to support the economy would increase investment, which is the source of the crisis.  Conversely, any government fixated on deficit reduction would probably be inclined to cut both current and capital spending.

This government is committed to neither economic recovery nor deficit-reduction.  Instead, it is committed to boosting profits.  That is why it is willing to increase current spending which supports consumer demand but refuses to increase investment as this would displace private capital from potentially profitable sectors of the economy.

Since this government is not sticking to its own spending plans, it makes even less sense for an incoming Labour government to do so.  Instead, it needs to address the source of the crisis by increasing state investment.

Fig. 2

Britain’s High Spend on Foreign Wars and Adventures Must End

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Britain can increase investment by slashing military spending

By Michael Burke (From Socialist Economic Bulletin)
The momentous decision by Parliament on August 29 not to participate in a military attack on Syria raises important points both for the trends in British politics and for economic policy.

SEB has repeatedly argued that there is no prospect of a Tory election victory in 2015. After the failure of Cameron’s military agenda the certainty of a Tory loss has become the possibility of an electoral rout. In politics, whoever sets the agenda wins and the Tory agenda has spectacularly unravelled.There is too a direct economic impact from the vote and the potential for an indirect impact. Britain spends far more than comparable countries on warfare. Now that there is clearly a diminished appetite for foreign wars and adventures this should be addressed. 

There is a great deal of publicity about cuts to the Ministry of Defence Budget under this government. However, the cuts are focused on planned current spending. The capital budget is rising. In addition, this government has introduced an entirely new Budget category something called the ‘Special Reserve’, which has only been used to fund military operations.

Published Defence Spending, £bn

FY 2012/13 FY 2013/14 2014/15
Current 27.1 26.5 21.5
Capital 7.4 9.8 9.0
Special Reserve 0 0.5 1.1
Total 34.5 36.8 31.6

Source: UK Treasury

It should be noted that this is only the official estimates of military spending. In their book The Three Trillion Dollar War Joseph Stiglitz and Linda Blimes examine the full costs of the Iraq and how the US Administration has disguised them. The medical costs of treating war veterans, as well as social consequences and their costs, all of which apply to Britain and are not identified in government accounts. 

Britain has the 4th largest military spending in the world. The economy is only the 7th largest in the world. Successive British Prime Ministers have been committed to Britain ‘punching above its weight’, that is, spending a disproportionate amount on the military and using it. The current Prime Minister has been blocked in his attempt to repeat that. A cut in defence spending to Britain’s close economic peers, countries like Italy and Brazil, would yield a saving of at least £14bn per annum at current levels. 

The potential indirect impact arises in relation to the renewal of Trident. Britain does not have an independent nuclear deterrent as it is wholly operationally dependent on US satellite systems. It is precisely the type of expenditure which is designed to project imperial power, and allow Britain to ‘punch above its weight’.

After the vote against military action against Syria it seems glaringly obvious that the pursuit of Trident renewal is a pointless and absurdly expensive exercise. The replacement cost and running costs are estimated by CND to rise to £100bn over the lifetime of the programme.

These are extraordinary sums for a system that could never be used, or could only be used if the US wished to pursue nuclear war against another country.

The Coalition has cut government investment across the board, in the vain hope that private firms will increase their investment. Transport, housing, education, health and infrastructure are all deteriorating as a result.

Redirecting resources away from the military budget is one simple method of financing the state-led investment that the economy needs.

Austerity – Why do we have it, and what is the Alternative?

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Why do we have Austerity, and What is the Alternative?

previously published by Socialist Economic Bulletin
By Michael Burke

The national launch of the People’s Assembly Against Austerity is a very welcome development. It brings together a number of the largest unions, anti-cuts group and political forces both inside and outside the Labour Party in opposition to austerity policies. Many will have been drawn into active opposition to government policies because a single aspect of them, perhaps the cuts in public sector pay and pensions, or social protection for people with disabilities, or the imposition of the bedroom tax or the very high level of unemployment among young black people, or the string of cuts which have driven women out of public sector jobs, facing reduced childcare provision and increasingly bearing the burden of reduced social care. All of these policies are linked and generally go under the title of ‘austerity’. The term is a little misleading, as it implies that conditions have generally become worse for all. But that is not the case. Transfer of incomes One of the first acts of the Coalition government was a simultaneous increase in VAT and a cut in the level of corporation tax. According to the Treasury these amounted to approximately the same (£12bn to £13bn) in terms of revenue. But the VAT hike was disproportionately paid for by the poor and middle income earners, who spend more of their incomes on VAT-able goods. The corporation tax cut was an increase in the net income for firms. Taken together they amount to a transfer of incomes from workers and the poor to capital and the rich, the owners of firms. This transfer of incomes from labour and the poor to capital and the rich is the essence of austerity policies. It is workers and the poor who are being made to pay for the crisis. The purpose of austerity In an economic downturn, profits fall at a greater rate than the fall in output. This is because profits are the surplus of firms after they have paid costs, including fixed costs, and the costs of labour and materials. As the revenue from sales falls but costs are static or do not fall so far then profits are hit. Therefore a key mechanism for restoring profits is to reduce costs, most especially the costs of labour. This is what happened in the current slump, as shown in Fig.1 below. In nominal terms, before taking account of inflation, between 2008 and 2009 GDP contracted by £39bn and the operating surplus of firms fell by £33bn. Of course, in real terms the fall was more severe in both cases. But the natural outcome is that profits will bear the brunt of the fall in output.

Figure 1

13 06 20 Chart 1 The aim of austerity is to interrupt, divert and reverse this process by cutting wages so that profits can be restored. Cuts to public sector pay have a ‘demonstration effect’, designed to lower the ceiling for pay in the private sector. Cuts to social protection entitlements are meant to force all workers to accept lower pay. These policies are supplemented by privatisations which reintroduce the accumulation of profits into areas of the economy formerly run by the state (NHS, rail, Royal Mail, and so on) and corporate taxes are cut to boost net profits. This has had an effect. The austerity policy introduced in 2010 has led to a £40bn increase in firms’ operating surplus from their low-point in 2009. But this is not yet a thorough-going reversal. Nominal wages have risen by £43bn over the same period. It should be stressed that these data do not take account of inflation, so that there has been a real fall in living standards but equally only a very limited rise in profits. Austerity policies have reversed the decline in profits and reduced the wage share of national income. But they have not yet allowed profits to rise so far that firms are once more investing and expecting profits. The alternative to austerity The cause of the economic slump remains the slump in investment. In Britain the fall in investment (gross fixed capital formation) more than accounts for the entire fall in GDP. In real terms between the 1stquarter of 2008 and the 1st quarter of 2013 GDP fell by £38.7bn while the fall in GFCF is now £50bn (as other components of growth have risen such as government spending and net exports). This is shown in Fig. 2 below.

Figure 2
13 06 20 Chart 2

This is now a combination of the private sector’s refusal to invest alongside government cutting its own investment. It is not possible to have a sustained improvement in economic activity without an increase in investment. The long-term relative decline of the British economy is driven by the declining rate of investment. In 1970 the ratio of investment to profits was 70%, that is the total level of investment in the economy was equivalent to 70% of firms’ operating surplus. In 2012 this investment ratio had fallen to 42%. As a result, investment has fallen from 19.4% of GDP to just 14.1%. The declining rate of investment has been a long process. But even as late as 2007 the investment rate was 51% and the rate of investment as a proportion of GDP was 17.7%. As a result of the crisis quantitative change has become a qualitative one.

Figure 3

13 06 20 Chart 3 As the private sector’s refusal to invest is because they cannot be certain of making a profit it falls to the state to invest on its own account. It can make successful large-scale investments which are not profitable to the private sector because uniquely it derives its return from taxation. Any general increase in economic activity will see tax revenues rise and social protection payments automatically fall. The vast level of uninvested profits is now sitting idle in state-owned banks which failed because they made unprofitable investments. It is simply a matter of political will to tap these vast resources for investment in housing, energy, transport, infrastructure and education. This would lead to economic revival. The reason it is so fiercely resisted is because it runs counter to the whole thrust of austerity, which is to restore profits. But increasing state-led investment is the only feasible road out of the crisis which does not lead to the further immiseration of the overwhelming majority of the population.