Sean's Economics

As Alex Little states here  in a sane world Osborne’s announcement that there is to be a legal underpin to government surpluses in “normal times” would have been greeted by laughter followed by his immediate resignation for economic illiteracy.  Instead we have the letter to The Guardian signed by 77 economists, and which I have linked to in the heading to this post.   

The letter puts a sectoral balances analysis of the macroeconomy as the basis for opposing Osborne’s position on this and to austerity itself.  Sectoral balances sum to zero. This means that one sector’s surplus will be another sector’s deficit.   So, in a two sector economy a government running surpluses means that the private sector needs to accommodate deficits each year.  This may be some combination of households, businesses or the foreign sector.  As it happens we know that the UK economy is in deficit to the foreign sector and this is not easy to correct because every government aims for its country to have inflows from abroad that are greater than the outflows.  

The economists suggest that in the presence of government surpluses any economic growth is going to to be underpinned by private sector borrowing.  So the private sector expands its balance sheet and increases its financial commitments into the future (to service higher levels of private debt) whilst the government continues to take money out of the economy to pay off its own liabilities.  Eventually this will be unsustainable and cause a recession when income growth is not sufficient to meet the debt-servicing costs.

Importantly the letter points out that each sector cannot control its net position vis-a-vis the rest of the economy.  A government can cut expenditure, raise tax rates and impose new taxes, but the overall effect of these depends upon the level of economic activity. 

The writers of this article are research psychologists at the Centre for Medical Humanities at Durham University, and it relates to the changes to social security changes that have taken place in Great Britain in the last 10 years.  The article gives interesting technical detail of the psychological programmes run by companies such as A4e.  

Clearly the harsh regime isn't just the result of arbitrary power.  Instead the course of action taken by these programmes is to see the route cause of the problem to be the attitude of people who are long term jobless.

The focus on individuals is particularly on their possessing psychological barriers to gaining employment:  

motivation, confidence, ‘job-seeking behaviour’, ‘a positive change in attitude to work.’ 

And non-compliant behaviour can lead to a referral to the the service provider's psychologist.  Refusing online psychometric testing is potentially sanctionable.  

So, the reason for suffering long term unemployment is each individual's own state of mind, attitudes and motivation, rather than wider economic factors.  Any wider economic factors are not systematic, but down to bad luck, which everyone suffers from.  As the authors point out the denial of pain is also a denial of the problem of neoliberal economics that asserts the jobs are out their in sufficient numbers and so their methods are not just merely shuffling the stack of the unemployed.

This article from the Scottish Daily Record highlights the case of Richard Benyon, Conservative MP for Newbury and descendant of the old British Prime Minister Lord Salisbury.  

Benyon is an outspoken critic of social security but does not demure at taking a total of £625,000 of housing benefits with regard to some of his tenants, or more accurately tenants of his family's company.  To be fair Mr Benyon is stating that the figure is a clear overestimate, without elaboration, and I don't know how good a landlord the company is or whether it charges market rents or social rents or some combination of the two.  However when someone is so vociferous about social security spending then isn't taking 1 pence of housing benefit money too much?

I think the article is also illustrative of the direction of travel in Great Britain today. 

Firstly,  the term "welfare" has become a pejorative term that slews the discourse.  I always use the term "social security".  I do believe that the case needs always to be made for there being a genuine safety net for people, including free medical care, free education and a basic income that can be relied upon irrespective of health or employment status. 

Secondly, we clearly live in a country where someone with immense inherited wealth and a portfolio of properties can stand up and talk about a "something for nothing culture".  I would like to think that his company's property portfolio consists of new built homes and properties brought back into use from a derelict state, but I am ever the optimist.  More likely is that Mr Benyon's company own existing properties and has only marginally added to the local housing stock.  So the rents, subsidised by social security payments, are an award to ownership and not to effort or hard work.  

We live in a country where the "hard working families" agenda (ground over which the major parties squabble) is applied to people who sell their time to employers in return for an income stream.  It is not to be applied to those who do not have to work to receive an income.  It is therefore properly seen as an instrument of oppression.

In an economically just society we would expect all who could work to actually work, and we would also accept a responsibility for ensuring that work was available for all those that wanted it.  That would also involve an examination of the economic rewards going towards profits and rents.  I am firmly of the view that the rewards for mere ownership are too high, that the resulting wealth accumulation ensures that money does not circulate in the economy, providing jobs and wages, but instead accumulates in existing unproductive assets (financial assets and real estate).  

An economic just society would also be a more robust society when economic and environmental shocks and crises struck.  If we are genuinely all in this together then we should not allow politicians and other figures in the media to demonise a portion of the population for being cut off from participating in society because of the lack of financial resources. 

Thirdly,  I continue to notice the widespread incorrect framing of government expenditure as being funded from tax receipts.  We have the great fortune to live in an advanced economy which has its own currency.  There is no sense that the government needs tax receipts prior to meeting an expenditure in its national currency.  In fact there is even an argument that it needs to spend to receive tax receipts, most particularly where economic conditions are depressed and where so much privately held wealth is accumulated in existing assets rather than being put to productive use.

Erik Solheim is chair of the OECD's Development Assistance Committee in this article he raises concerns about how easily illicit money from developing countries finds its way into the global financial system.  The size of the problem is quite huge: an estimated USD 1 trillion annually is almost equivalent to one third of Africa's GDP. 

As well as corruption and inadequate institutions in developing countries rich countries should also a share of the blame for failing to devise and enforce adequate laws to prevent illegal money transfers.  27 of the 34 OECD countries do not have sufficient corporate ownership information and none is fully compliant with the Financial Action Task Force's recommendations on preventing money laundering.  

FATF's recommendations on preventing money laundering are the internationally endorsed global standard against both money laundering and terrorist financing, so the level of non-compliance is very concerning.

The Office of Fair Trading here in the UK has (according to the BBC news website here: OFT orders crackdown on "poor value" pensions) ordered a crackdown on pension schemes that offer poor value to millions of savers.  That will be pretty much all of them then won't it?

The reality is that any pension based on a defined contribution or money purchase, i.e. where the pension holder takes the investment risk, is poor value.  Personal pensions and the like are really only of any good purpose as a tax-planning tool for higher rate tax payers as they are heavily incentivised to make pension savings of cash that would be saved anyway because of the extent of their excess income above expenditures.  As a vehicle for replacing earned income in retirement they are useless for the vast majority of the population because the level of pension contribution that is actually required in the face of low growth and low annuity rates.

The change from Defined Benefit to Defined Contribution schemes has been accompanied by a sharp reduction in employer contributions.  Of course the viability of Defined Benefit schemes came under severe strain as a result of the financial market convulsions in the late 90s and early on in this century, a period that exposed the folly of the contribution holidays that employers awarded themselves when returns were high (don't get me on to the actuarial profession). 

The uselessness of defined contribution schemes is now officially recognised because people are being compelled to put their money into these confections of the financial services industry through the auto-enrolment process.

The issue of charges is secondary, and in itself could only be solved by pension savers accessing the institutional rates that their combined purchasing power could access.  That, rather than further pandering to the "choice" agenda by encouraging people to "shop around" would be a real step forward as it would require an institutional innovation in the UK to receive those contributions and a process to decide how the money collected should be managed, and then a monitoring of the money managers so entrusted.  That oversight of money managers' performance and conduct is something that people in personal arrangements are also missing out on.

I said that these plans are only of any real use to higher rate tax-payers.  Of course they are also of use to the money managers in the city as it co-opts  the savings a broader class of people. There is a circuit here that people need to ponder.  Through quarterly reporting companies' share prices can be put under pressure by the actions of money managers.  This can lead to restructing and a loss of jobs of the people who are funding the money managers.

The other thing to be clear about is that pension savings build up paper claims on the production of future goods and services.  There is nothing to say that the pension savings once deployed will be able to demand those services (to bring them into existence or to encourage production in higher numbers at an affordable price to all pensioners).  Instead prices and services will be skewed towards those with the purchasing power.

I recently read this piece by Stephanie Kelton (Reading between the lines: A memo from from Fed chariman Marriner Eccles) and was struck by the following comment by Eccles,

A flow of money savings into investment channels in excess of the requirements of the capital markets is a comparatively new phenomenon in the United States. Throughout our earlier history, indeed until approximately the World War period, the requirements of business enterprises for funds with which to develop new capital were characteristically in excess of the supply emanating from the savings of the people. The deficiency was made good by borrowing abroad and by the expansion of commercial banking credit. In the last twenty years, however, the situation has been profoundly altered. As a result of a higher average level of income, and particularly because of the concentration of income, the volume of money savings flowing to investment channels has so greatly increased that the balance has been shifted. Instead of having a deficiency of investment money, we have a surplus.

I quite like this as it is clear to me that money being saved in to pension arrangements (and ISAs and the like) do not count as investment when they are actually being placed into secondary financial markets.  It may be suggested that financial markets facilitate investment by providing liquidity in the share and bond markets, but an awful lot of money has to provide that liquidity in comparison to the amount being committed to new issues to fund (one would hope) new investment (which I understand to mean new capital formation to produce services and goods that were not previously in existence).

Nor can there be any real doubt that there is a need for new capital formation in our economy.  Earlier this week the Office for National Statistics revealed the crisis of productivity in the UK economy (International Comparisons of Productivity).  Rather than the present institutional arrangements into which pension savings are locked, surely there is scope for people being able to invest productively, building income streams of profit, wages and interest, in a way that also shields them from the volatility of financial markets.  Perhaps people would also like to see the result in their own city or county of their pension savings.

Thanks to Neil Wilson for continuing to update us using publicly available official statistics on the sectoral balances for the UK economy.  The first thing to say is that using the ONS (Office of National Statistics) website to extract the information you are looking for is not an easy task and Neil has sourced his data so that the reader can go on the ONS website and look at the data itself.  

I also want to comment on the importance, as I see it, of a sectoral balances approach in economics.  The essential point of departure is that income has to equal expenditure for the economy as a whole and so the differences between income and expenditure across the sectors sum to zero.  So, if we look at the first diagram in Neil's post we are seeing that the government deficit (excess of expenditure over income) translates into surpluses for the domestic private sector and for the rest of the world.

This is quite a non-technical way of representing an economy graphically, but it is also the basis for much more complex modelling and use of data, as Wynn Godley's work has shown.  It is interesting, and I think potentially quite fruitful, to have one approach that can provide understanding for non-specialists but also provide a basis for in depth study by specialists.

Before looking at what the data presented by Neil may be interpreted as showing, I just want to say that the approach does emphasise that the burgeoning deficits from quarter 4 2007 were not simply attributable to government decision-making: the collapse of economic activity in the private sector reduced the flow of tax revenues into the government sector and increased the outflows of benefits payments.  There are, of course, all sorts of causalities at play in each of the sectors, and these are important subjects of study, but so is how these fit together, and that is what this approach is good at showing, quite intuitively.

In the first graph I find the most interesting trend is the reducing domestic surplus going hand in hand with the reducing government deficit.  At the same time the rest of the world's surplus vis-a-vis the UK economy is resilient and increasing.  Where an economy is operating an external deficit then the domestic private and government sectors cannot both be in surplus.  This suggests to me that the economy will face headwinds in its recovery and that GBP will depreciate.

The second graph gives a greater breakdown for the domestic private sector.  For the financial sector, it shows that the unprecedented surpluses that it ran in the lead up to and in the immediate aftermath of the financial crisis have been wiped out.  The sector is now running a deficit vis-a-vis the rest of the domestic private sector and the rest of the world in a way that has previously been associated with stockmarket losses following the Tech Boom and during the build-up to the Iraq invasion and, further back in the run-up to and during the short sharp recession of the early 1990s.

The most noteworthy thing about the second graph is the weak surplus in the household sector.  I would expect that households would respond to the depression in much the same way that the graph shows it did following the early 1990s recession: by strongly going into surplus.  This hasn't happened.  The lack of significant retrenchment suggests that the household sector is weak and reflects what we know: real wages are continuing to fall.  

LONDON (Reuters) - BT Chief Executive Ian Livingston said on Wednesday he was stepping down to take up a government job promoting British business, knocking shares in a telecom company he has helped reposition

The movements between big business and government is something that happens very often.  There is almost a revolving door; on both sides of the Atlantic.  I don't think it is altogether desirable if we are to think in terms of a rebalancing of the economy.  Livingston's new role is to help promote British business.  Look at Livingston' CV - Arthur Anderson, Bank of America, 3i, Dixons, Freeserve, PC World and finally BT.  He's an accountant.

So his background is in big business and in finance.

It is important that we do focus on economic activity that produces more goods and services that people find useful - real wealth.  As well as satisfying needs through consumption their production also tends to a sharing of income streams between profits and wages.  Smaller enterprises tend to be more successful at generating jobs.

The point I would make is that most economic rewards are not for effort or innovation but for ownership: money begets money.  Whether it is buying a patent and sitting on it without actually using it to produce things, but just to extract an economic rent from people who want to take the risk of applying technical know how to produce new things, or buying up properties or financial assets - assets already in existence -  to collect an income.

BT was in the news last week.  Twice.  In the first piece of news the company announced profits of £2.5 billion, an increase of 2% even though revenues have fallen.  In the second piece of news BT announced the launch of its sports TV channel with high profile recruitment and a specially built complex on the Olympic site in East London.  Surprisingly the company is not charging for this service.

Clearly, and in the parlance of our times, the company is "extremely cash-generative" and can use the sports channel and fibre optic network to gain greater scale - it is already 48% of the broadband market - hardly a market then.  Anyone would thing that a national telecommunications network was was a natural monopoly.

Both of these stories were announced immediately after CWU recommended acceptance of BT's final pay offer of 2.8% together with a £200 one off payment. So that is only an inflation-matching  (CPI measurement) with a good proportion of the £200 probably being swallowed by people's heating bills for the first quarter of this year. 

Further on with this book and the model building is becoming gradually more complex:

.... The smaller the propensities to consume, the larger the steady-state levels of income and disposable income.  In other words, if households are more thrifty - if they decide to save a larger proportion of their income and of their wealth - the steady-state income will be higher.

It contradicts the well-known paradox of thrift, that had been advanced by Keynes (1936) and emphasised over the last sixty years or so by Keynesians alike.

I am currently reading this book.  Having read the first three chapters I think  it is worthy of some months if not years of study and contemplation.  The following is a splicing together of two short but illustrative extracts from the book.

"Given the level of activity, the quantity of private wealth and the rate at which it accumulates are determined entirely by the propensities of the private sector, which the government cannot change.  But this is to imply (again given the level of activity) that government deficits and debts (being identically equal to respectively, private saving and wealth) are endogenous variables which cannot be controlled by governments.

This conclusion totally contradicts many influential, or even statutory, proposals regarding the regulation of fiscal policy which are made in abstraction of how economies actually work – for instance the European Maastricht rules, Gordon Brown’s Golden Rule in the United Kingdom and, most important, the view widely held by ignorant politicians and members of the public that government budgets should be balanced.

Don't forget that someone's expenditure is another person's income. 

At an aggregate level and a simple closed economy consisting of only firms and households expenditure is consumption (C) and investment (I), and income is profits (pi) and wages (w).

Therefore:

C + I = w + pi

and so:

C + I - w = pi

That is, the higher consumption and corporate investment are relative to wages, the higher or corporate profits.

So, during the 2000s bubble period when consumption (fueled by increasing debt) was higher than wages and companies (fueled by increasing debt) were investing heavily corporate profits boomed. However when the global financial crisis hit consumption and investment and so profits collapsed prompting the economic depression that we are now in.

It would not be correct to say the the causation runs the other way because people can decide to consume more and firms to invest more but the latter cannot decide to earn more. 

Including government deficits (G):

C + G + I - w = pi

So the higher government deficits are relative to wages then higher are corporate profits.

And this explains why since then profits have fared better than wages. In fact this has been recognised in the USA on 13/10/2010 by a briefing note produced by Morgan Stanley: the US fiscal stimulus was a transfer from the public sector to profits.

So profits became a larger part of national income but this did not prompt a recovery of investment and firms, particularly large firms, are sitting on ever larger piles of cash. Hence we're still below the level of national income in 2007. 

Where the Government deficit reduces or even, if we think dynamically, the rate of its growth reduces, in the absence of counterveiling changes in consumption or investment then the rate of growth of national income will also reduce.

The problem is that the economic recovery is to be led by an increase in investment, but expectations of future returns of investments now are too low for that investment to take place because the expectations are coloured by recent experience, by the debt overhang from the boom and by expectations that consumption will stay flat and government deficits will reduce.

What you should also realise is that G is a hybrid item. It is a function of government expenditure plans (expenditure areas where it has discretion), and the level of economic activity in the economy (i.e. the expenditure plans in the private sector of firms and households). The lower economic activity, the lower are tax receipts and the higher is expenditure on welfare benefits, for example.

Reducing government deficits are supposed to reduce interest rates because there is less competition for a finite pool of savings. Interest rates reduce the cost of borrowing and so stimulate investment. The problem with this thinking is BUDGET DEFICITS DO NOT INCREASE INTEREST RATES. 

i) Budget deficits aid private accumulation of financial assets because net positive bank deposits are created in the private sector by government expenditure over government revenue. 

ii) Interest rates are set by central banks, currently, with an inflation rate target in mind. 

iii) lending by banks is not restricted by the level of prior savings but by the supply of creditworthy borrowers: your bank mortgage adviser does not go out back to check that there is enough money to lend to you so that you can buy your house. Instead he checks your ability to repay before the advance of newly created cash to you in return for the promise to repay.

Repeat a lie often enough ....

This story covered in the Guardian (and elsewhere) hints at the extent of household deleveraging in the UK.  Previously repayments were consistently outstripped by borrowing.  This turnaround represents a reduction in spending power in the economy, where aggregate demand is GDP plus the change in the level of debt.    

This subject has very recently got much more exposure. The link is to Robert Peston's blog post of 21st November 2011.  The vital importance of the level of indebtedness in the UK economy and in particular of the level of private debt is slowly dawning on commentators.  However, many of the comments by readers shows that the seriousness of the situation is largely not yet understood, in particular people equate "debt" to "public debt" not realising that the major part of indebtedness in this country is in the private sector.