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Only Corbynomics can reverse the economic slowdown

Corbynomics1-2The British economy is slowing down. In the 3rd quarter of 2015 the economy had expanded by just 2.3% from the same period in 2014. This measure removes the volatility of erratic quarter to quarter movements in GDP.

The most rapid pace of growth in this recovery has been the 3.1% recorded in the 2nd quarter of 2014, which mainly reflected government efforts to stoke consumption (particularly in housing) in the run-up to the election. Since that time the growth rate has progressively slowed. This is shown in Fig.1 below. Despite the severity of the recession, at no point has the growth rate matched the higher levels seen before 2008 to 2009.

Fig.1 UK GDP- Growth is slowing

The slowdown does not mean that a recession is imminent, although this business cycle will come to an end at some point and the global economy is also experiencing some difficulties. The more immediate danger is the effect of government policy and the renewed imposition of austerity policies.

As SEB has previously shown, Austerity Mark II announced in the July 2015 Budget is exactly the same as Austerity Mark I announced in June 2010, a fiscal tightening of £37 billion in both cases. The real effect will be somewhat less this time as the economy has expanded moderately in the interim. Even so, the effect of the first round of austerity was to slow the economic growth rate from a little over 2% year-on-year to 1%. A similar outcome should be expected this time around.

Examining the slowdown

This weakening outlook is the increasing subject of commentary. An article in the Guardian by David Graeber has received a lot of attention. He is a committed opponent of austerity, and all disagreements should always be read in that context. In ‘Britain is heading for another crash: here’s why’ he correctly castigates George Osborne’s economic fallacies, but then supplies a few of his own. As these appear to be widely shared by other progressive economists and opponents of austerity, they are worth debunking.

Graeber argues that any government surplus must entail a private sector deficit. As he correctly states, this is simply an accounting identity and must be true; every borrower requires a saver and vice versa. He goes on to say that the determination to run public sector surpluses is necessarily negative, as it forces the private sector to borrow. He further states that this debt is forced on to those least able to pay it and that this causes recessions, which is often the case.

But in this key passage (using the chart he supplies) he adds, “But if you push all the debt on to those least able to pay, something does eventually have to give. There were three times in recent decades when the government ran a surplus:

Note how each surplus is followed, within a certain number of years, by an equal and opposite recession.”

Note the reason why the surpluses of the private sector do not cause recessions is never explained, nor why we might be entering another recession even though there are still large government deficits.

There are in fact four separate episodes of fiscal surpluses in Britain shown in the chart. Examining them debunks the fallacy that government surpluses cause recessions. The chart used shows the largest surplus of all on the overall fiscal balance in 1948. There was no recession at all until 1974! At the end of the 1960s there was modest surplus, followed by 5 years of continuous growth, and the largest-ever growth rate recorded in a single year, 6.5% real GDP in 1973. The small surplus in 2000 was a result of New Labour sticking to extreme Tory spending plans in the first two years after election in 1997, which was subsequently relaxed. Reasonably strong growth (in British terms) followed and the subsequent crash 8 years later had nothing to do with that surplus. The surplus in the late 1980s was a function of the glut of North Sea oil. This should in fact have been larger, had Government saved this windfall for future investment, as Norway did. Instead, along with Government borrowing it was used to stoke a consumption surge, the ‘Lawson Boom’. The subsequent recession occurred when boom turned to bust. The surplus did not cause the recession – borrowing for consumption while also floating in oil revenues caused an unsustainable boom that inevitably failed.

This argument for permanent fiscal deficits makes no distinction at all between borrowing for investment and borrowing for consumption. The long-run history of the British economy and its decline is in part characterised by the rising rate of Government consumption coupled with a falling rate of Government net investment.

Fig.3 below shows that the strongest rate of growth of GDP in the 1960s was associated with the lowest levels of Government current spending, and vice versa. The higher rates of Government consumption are associated with the slowest levels of growth. The long-term trends are also clear; rising Government spending and declining rates of GDP growth.

Fig.3 UK Public Sector Current Spending Rises As GDP Growth Declines

By contrast, high or rising rates of public sector net investment are associated with high or rising rates of GDP growth (again, in British, not global terms). This is shown in Fig.4 below with public sector net investment as a proportion of GDP alongside the rate of growth of GDP.

Fig.4 UK Public Sector Net Investment, % GDP & GDP Growth

Here, although the GDP data is erratic the relationship clearly trends in the opposite direction; as net investment declines so does the GDP growth rate, and vice versa.

In fact there is a significant negative correlation between public sector current spending and GDP growth of -0.41326. By contrast, there is a very small positive correlation between public sector net investment and GDP growth of 0.1281, which rises to 0.21235 if GDP growth is lagged for 3 years (possibly to account for the economic effects of large projects). But in an economy like Britain’s, public sector net investment is usually too small to determine the overall rate of economic growth.

Fig.5 below shows the rate of GDP growth alongside the proportion of total investment (Gross Fixed Capital Formation) in GDP from both the public and private sectors. Even a cursory glance shows the strength of this relationship and the correlation is 0.7721. It is investment which is the primary driver of growth.

Fig. 5 GDP Growth & GFCF as a Proportion of GDP

The proportion of GDP devoted to investment (GFCF) is the main determinant of the growth of GDP. But currently the level of public sector net investment is too small to affect the outcome of GDP. At the same time, the level of private sector investment is too weak to support a more robust economic recovery. What can be done?

‘Crowding out’ and Corbynomics

One of the greatest fallacies in modern economics is the notion of ‘crowding out’. This is the assertion that if a level of public sector investment or borrowing is too high then this will prevent the private sector from investing. It particularly came into vogue during the era of privatisations under Reagan and Thatcher and is inscribed in most Western econometric models.

It is a nonsense because it assumes a fixed or steady state economy. But if either the public or the private sector invests in the productive economy, there will be economic growth and so increased funds available for investment.

Over many decades the Western economies have provided ample evidence that the notion of ‘crowding out’ has little basis in fact. Fig. 6 below shows that over the medium-term UK public sector net investment as a proportion of GDP has been cut. In common with most Western economies, the total level of investment as a proportion of GDP has not risen but has actually fallen, although the British case is one of the more extreme examples of both.

Fig.6 GFCF as a proportion of GDP & Public sector net investment as a proportion of GDP

It is clear from the chart that public sector net investment leads investment overall. There is a lagged effect, so that the strongest effect of rising public investment on total investment is registered 5 years later. On this basis the correlation between the two variables rises to 0.6820. Far from public sector investment ‘crowding out’ private sector investment, high and/or rising public sector investment ‘crowds’ it in.

This in turn is a significant part of the answer to the question posed earlier, what is to be done if investment is the main determinant of economic growth, yet public sector net investment is currently too small to effect the outcome of GDP as a whole?

The austerity policy is in part a failed answer to this question. It assumes that if wages and taxes on business are pushed down, businesses will increase the proportion of their profits assigned to investment. This has not occurred.

By contrast, Corbynomics has a very different answer. As high or rising public sector investment crowds in private sector investment, the policy response should be to raise the level of public sector investment in order to raise the total level of investment in the economy. The purpose is to raise the sustainable growth rate of the economy and so improve living standards.

If there are future crises of private sector investment, it may be necessary to raise the level of public sector investment once more. But the answer to the current crisis is to increase public sector net investment to a level where total investment is sufficient to sustain much higher, more sustainable growth.

Currently, the level of investment as a proportion of GDP is 20.6% in the OECD as a whole. In Britain it is 16.9%. An immediate objective should be to raise British levels of investment towards that average, so that competitiveness is not further eroded and living standards do not fall further behind. That is the first step towards addressing the current crisis. Future steps will be discussed in subsequent pieces.


  1. David Ellis says:

    Whilst Corbynomics is a welcome breaking of the austerity and even the neo-liberal spell it can have no impact on the rotting corpse of capitalism. In fact stimulus in the end will have an identical effect to austerity. Globalised capitalism’s problem is that its markets are glutted and its customers are skint or worse drowning in debt. Austerity simply exagerrates that fact by reducing the spending power of individuals and the state. Stimulus on the other hand can only add to the glut of commodities that cannot be sold at a profit. Austerity is the embalming of the corpse whilst stimulus which induced the fatal heart attack in the decrepid old patient in the first place via the bankers’ thirty year credit bubble turned ponzi scam is like injecting steroids into rotting flesh. No, I’m afraid Corbynomics, by ignoring the fundamental contradictions of capitalism and eschewing a socialist repsonse is headed up a dangerous dead end. But it is not all bad. Marxists and socialists can take this opportunity to push a genuine programme for working class power and the transition to socialis. Whilst operating a united front on specific policies with the Corbynistas where we can and ruthless criticism where we cannot our programme can gain the ear of the vanguard who can bring with them the rest of the class.

  2. Jim says:

    Excellent statistical analysis. Now all we have to do is wait 54 months for an election and hope that the Tories screw up and lose their current 42% approval rating (up from 33% since the election). In other words, there will be no Corbynomics – the real battle is electoral and constitutional reform, get people on side with that and we might just have a chance of implementing some socialistic policies as part of a future coalition of the ‘good’

  3. I wish economists would learn to use terminology correctly. An unsound economic argument is not a “fallacy”; it’s an unsound economic argument, and in the case of “crowding out” it is unsound because it contains a hidden false premise–that economic output remains fixed with investment.

    A fallacy, as anyone using the word should know, is a non-obvious error in logical reasoning. The author might do well to learn this; he’d know not to make extrapolations from macroeconomic data, because of what is known as the *post hoc, ergo propter hoc* fallacy. Macroeconomic data gives you information about an economy (albeit in a flawed manner, as with GDP) and can tell you if an economy is in recession; but it what it can’t tell you is *why*. That requires finding a cause, and establishing a *causal link* between the cause (x) and the effect (y).

    For example: say you observe a correlation between public investment and economic growth–or, more correctly, a positive change in GDP. This is a correlation; explaining *why* it is the case that public investment leads to economic growth requires having an understanding about how the economy works. Namely, it is because public investment–in the form of e.g. roads, bridges, or schools–allow economic activity to be carried out more efficiently, or allow superior goods to be produced: for example, giving workers an engineering degree allows them to design cars with more efficient engines; or building roads makes transporting goods cheaper.

    This is why I’m always very sceptical of statistical analyses like this. They only show trends, not causal links. This is especially problematic when considering how complex macro-economies are, and how many factors can affect them. The UK’s low GDP growth this year, for example, is especially concerning when you consider that the price of oil fell considerably in this time.

  4. Sandra Crawford says:

    “Reasonably strong growth (in British terms) followed and the subsequent crash 8 years later had nothing to do with that surplus”.

    YES IT WAS – Because the surplus reduced the amount of government spending into the economy, and forced people to borrow more from banks. The growing trade deficit increased the trade deficit and light touch regulation caused the growth of a housing bubble. With less government spending, a crisis was caused by unsustainable bank debt.

    A very experienced bank economist, Francis Coppola will tell you that you are WRONG. David Graeber may not have explained everything with absolute clarity, but he is RIGHT. Look at Francis Coppolas work here, on sectorial balances:

    I am sure that Anne Pettifor would agree with Francis and David Graeber more than she would with this article.

    Even the excellent economist Thomas Palley, a post Keynesian, who is a little critical of MMT, concedes that they have got their basic premises correct.

    John Maynard Keynes stated in his Treatise on Money that there are two sources, Government Sovereign issue and bank debt. When Government cuts, especially during a recession, there is a surfeit of bank debt that builds up and causes a recession.

    Irving Fisher called this situation debt deflation because bank debt eats up your income.

    Government deficits and surpluses are automatic stabilisers – governments cannot control them unless they want a depression or runaway inflation.

    For instance, Norway has to have a surplus because it earns so much abroad in oil sales.
    The UK has to have a fiscal deficit because it has a very large trade deficit, and this external bleeding of money would impoverish people or drive them into unsustainable bank debt to buy things.

    Joseph Stiglitz told Yanis Vakoufaris that a surplus would be very unwise in Greece in a interview. Vakoufaris agreed and stated – yes, of course, the private sector would collapse in Greece without a government deficit, and that is because they have no exports, and have a lot of private debt.

    David Graeber is absolutely right – and this article is wrong.

    1. Sandra Crawford says:

      In my second paragraph I meant to say the growing trade deficit increased the fiscal deficit eventually.

    2. David Pavett says:

      Sandra, your case seems to be an argument by authority rather than a response to the specifics of Michael Burke’s case. He says that Graeber is wrong to see government surpluses as necessarily causing recessions because the data shows this is not always the case. Your answer amounts to a claim that Pettifor, Palley, Keynes and Fisher believed that it must be the case. But MB’s point is that the facts suggest otherwise. When theory is a variance with the facts either the facts must be re-interpreted or the theory must be revised/dumped.

      You have appear to have ignored MB’s point that a key to understanding is to disaggregate government spending into its investment and consumption components.

      1. Sandra Crawford says:

        Firstly, it is standard practise to reference academics when pointing out facts along with your evidence. It is only appropriate to patronise a person for doing this if their evidence and references are weak. I find this approach very distressing on “Left Futures,” because the economic evidence given by the Sectorial Balances approach strongly supports the left, and in particular Corbyn’s PQE, which would be a real boon for the economy and the people.

        If you read the letter written by 77 highly eminent economists who wrote to George Osborne in the summer, you will note a reference to sectorial balances as evidence that his desire to frame surpluses into law were very foolish and would lead to financial crisis.
        The article states there that-
        “The academics said Osborne was shifting the burden of debt from the government to ordinary households because “surpluses and debts must arithmetically balance out in monetary terms”.

        The sectorial balances of a particular country are an accounting identity, they are not disputable in themselves. The weakness in David Graebers article was not that he was wrong, but that he did not explain things properly. This is standard MACRO ECONOMICS.
        The accounting identity of any country is
        GDP = C + I + G + (X – M)
        Note that it states on WIKI PEDIA, that these accounting identities are a matter of national accounting and not of opinion.

        Now, in the UK, the trade deficit (X-M), is negative, because the UK runs a current account deficit of -5% of GDP per year, which represents domestic spending leakage of 5%. If the government is not making up that difference with a 5% of GDP budget deficit, what is going to make up that spending difference? The result will either be a recession or private credit boom. Thus, your options are economically limited to either a government deficit (which, if you understood fiat currency, you would understand is basically costless), a recession and reduction of living standards, or a private credit boom, financial instability, and an eventual financial crisis.

  5. Sandra Crawford says:

    GDP growth can occur via bank lending as well as government spending, so the graphs do not mean much in terms of predicting a boom, recession or a crisis.

    Professor Richard Werner has stated that the predictor of recessions and crises can be found by looking at a graph of GDP and the growth of bank debt.
    If bank debt is rising faster than GDP, you can guarantee that an economic bubble is brewing (like the housing bubble, where mortgages are worth more than the stock and people cannot afford to pay).

    This also supports the sectorial balances argument, as when households are taking on too much debt, and government spending shrinks, and businesses are also taking on too much debt with no government subsidy, the system collapses. Government is the sovereign currency issuer, the payer of last resort.
    When people cannot pay the banks, the government has to – in the form of a bailout.
    It they ran suitable deficits to start with and made sure we had full employement and money to pay debts, this would not happen. They also need to regulate the banks too!!!

    1. J.P. Craig-Weston says:

      I never ceases to amaze me how exited you lot can get about this, I hesitate to use the term, “crap,” (because it isn’t, not completely,) but really I’ve read more comprehensible treatises on theoretical physics and anyway chancellors have always tended to act far more according political expediency than theoretical economics, (Blair massively irresponsible profligacy during the boom for example.)

      In the mean time the UK has; during my lifetime been shifted away from having a skilled industrial manufacturing base that serviced our domestic needs and also exported high value goods, (ships, steel, nuclear reactors, munitions, etc,) to a foreign owned, tax payer subsidized, low pay, (increasingly for millions even a subsistence,) service, rent seeking, economy that can no longer, (or so we are now being told,) maintain even basic universal public services, (increasingly being operated simply as rackets,) and where the evils that traditional socialism had largely succeed in eliminating; lack of decent basic education, education, poverty, sickness, homelessness, inequality, political and commercial graft and corruption, (that are at the root of many them,) are back with vengeance.

      And all the labour party seems to have to say abut is, “aren’t these tuition fees dreadful.”

    2. J.P. Craig-Weston says:

      Also of course economic bubbles are, (and particularly with hindsight,) well trodden ground, (and can even be government policy, again Blair’s massively irresponsible attempt to artificially prolong the last one by using ever more desperate, short term and massively expensive, (long term,) tactics like what was essentially, the sale of future public revenues, (as rents,) via and PFI and other deals.)

      But here once again the allegedly cold hard logic of economic theory however acute or erudite, (and which like climate theory; with which it seems to share many intrinsically unpredictable, except in retrospect, variables,) fails to have last word or to tell us whole story.

      There is a an interesting and famous, if far from rigorous book on what might best be described, (perhaps somewhat generously,) as the psychology of economic and other, “bubbles,” by a contemporary of Dickens, Charles Mackay, Extraordinary popular delusions and the madness of crowds, in which the point he makes is that even when people know whats happening; ie that than they’re in an economic bubble, it’s still almost impossible to stop the process or to get off, which is, or so I would argue much what went wrong, (among other things like his infamous lack of scruple or basic human decency and the war on Iraq etc,) with the Blair regime in the end and the legacy of which is the economic mess we’re in to day, (OK, special award for crude and horrible oversimplification, but in my view still a valid and perhaps an important point nonetheless.)

    3. David Pavett says:

      To reject Michael Burke’s argument you would need to consider his specific arguments about (1) the correlation between the investment component of government spending and growth (you simply dismiss this with an assertion that the graphs don’t mean much) and (2) his point that Graeber’s argument is based on a steady state view of sectoral balances rather than a dynamic (growth) one.

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