This article traces the history of ‘crowding out’, and its use as a justification for austerity and state deflation from its origins in the 1920s to its latest post-2010 incarnation. It examines why governments have kept turning to austerity and continue to justify it on the grounds that public sector activity crowds out more productive private activity, despite the accumulated evidence that this traditional pro-market formulation has failed to deliver its stated goals. It examines three other embedded forms of crowding out that have been highly damaging—leading to weakened social resilience and more fragile economies—but which have been ignored by both governments and mainstream political economists.

THE IDEA OF ‘crowding out’ has long been one of the central canons of pro-market economic theory. The concept was first promoted at an international conference of officials in Brussels in 1920 to discuss ‘sound economic policy’ in the postwar years. Given limited capital, asked the British delegation, will ‘Governments or private industry’ use it more productively? ‘The answer is … private industry’.¹ This argument was then placed at the heart of a strategy of state-imposed austerity through cuts in public spending and wages applied in Britain and other nations in the early 1920s.

Following the short-lived boom at the end of the 1914–18 war, Britain, along with much of Europe, faced growing economic turbulence and surging dole queues, along with high levels of public debt from funding the war. With heightened public expectations of social reform, the coalition government Prime Minister, David Lloyd George, initially promised social reconstruction through higher state spending, especially on homes and schooling. Simultaneously, the Prime Minister faced demands from the owners of capital for a return to the pre-war status quo.

During the war, large chunks of the economy had been taken under state control, with the subordination of private profit to steer resources to the war effort. While the public was calling for a better society in return for the sacrifices of war, business leaders were demanding the dismantling of the heightened state intervention of the war years, lower rather than higher public spending, and the reversal of the strengthened bargaining power labour had enjoyed during the war years. Political and industrial clashes were the inevitable outcome.

Deepening recession and the fear of mounting unrest, fuelled by the shadow of Bolshevism, induced panic among the ruling political and corporate classes. In response, the government dropped its commitment to social renewal in favour of a programme of austerity, or state induced deflation. This involved severe cuts in public spending, including reductions in pay for police, teachers and other public servants—cuts dubbed the ‘Geddes axe’ on the advice of a committee chaired by Sir Eric Geddes, the Minister of Transport.

Economic revival, it was argued, depended on lower spending by the state, lower wages and a return to a balanced budget, with state spending matched by tax revenue. If the state had borrowed more to meet its high-profile postwar pledges on housing and education, it was argued, more efficient and more pro-value private activity would have been ‘crowded out’. The measures, based on the idea of an automatic trade-off between state and private activity, were, it was asserted, simply sound economics based on fundamental laws—and not to be tinkered with—of how the economy worked. These ‘laws’ drew on the doctrines of the early classical economists that free markets and minimal state intervention would bring equilibrium, stability, and optimal growth.

Austerity Britain

Since the 1920s, governments have repeated this strategy of austerity—based on the doctrine of crowding out—on several occasions. These include the early 1930s, the 1970s, the 1980s and the post-2010 decade. Despite the time gaps, these episodes have been marked by almost identical justifications and remarkably similar impacts.

One of the constant themes has been a replay of the balanced budget theory of the 1920s and 1930s. Another has been that public spending cuts and lower wages would release scarce resources for the private sector. In 1975, two Oxford economists, Roger Bacon and Walter Eltis, argued in Britain’s Economic Problem: Too Few Producers that Britain’s economic plight stemmed from too many social workers, teachers and civil servants and not enough workers in industry and commerce. Buying into this argument, the new Chancellor of the Exchequer, Geoffrey Howe, told the House of Commons in 1979, ‘[we need to] roll back the boundaries of the public sector’ in order ‘to leave room for commerce and industry to prosper’.2 In June 2010, launching another rolling programme of spending cuts in his first budget, the Chancellor, George Osborne, repeated this claim that public spending ‘crowds out’ private endeavour.

Again, the presumption was that a more robust economy requires more private and less state activity, along with the counter-intuitive idea that austerity was the route to growth and enterprise. The somewhat crude ‘private sector good, public sector bad’ mantra was widely echoed. ‘The next government is going to have many challenges’, wrote the Times in 2010, ‘but tackling a public sector that has become obese … is going to have to be a priority’.³ Channel 4 went a step further with a programme describing state spending as a ‘Trillion pound horror story’, while The Spectator magazine called it ‘the most important programme to appear on British television this year’.⁴

So, does the austerity/crowding out theory stand up? And if not, why has it been so widely applied? The accumulated evidence shows that it is at best a significant oversimplification of the way economies work. Crowding out of private by too much public sector activity might apply when an economy is operating at full capacity and employment, but the doctrine has only been applied in situations of economic crisis, high unemployment and inadequate demand. Even at full capacity, there is still a choice to be made about the appropriate balance between public and private activity.

Heterodox economists, such as John Hobson in the early twentieth century, had offered an alternative route to growth and out of crisis. His work, which had an important influence on J. M. Keynes, showed that recessions were the product of a shortfall of demand stemming from ‘under-consumption’ and ‘over-production’ triggered in large part by a lack of purchasing power among low- and middle-income households arising from extreme levels of wealth and income inequality.⁵

In the 1920s and early 1930s, slamming on the public spending brakes proved counter-productive. It cut demand and slowed recovery, with private as well as public activity ‘crowded out’. The strategy had minimal effect on improving the state of the public finances, but led to a retreat on social programmes, while unemployment never fell below one million in the inter-war years.

A hundred years on, the Osborne cuts have had a very similar, and predictable impact. They also came with a new label: ‘expansionary austerity’, but an identical message—that a smaller state would generate greater stability via lower interest rates, greater confidence and faster growth. In the event, the strategy turned out to be an additional assault on an already weakened economy, with the cuts in public spending having little or no impact on expanding private activity, while damaging the quality of Britain’s social infrastructure and weakening its system of social support.⁶ One critic, David Blanchflower, a former member of the Bank of England’s Monetary Policy Committee, concluded that, by destroying productive capacity and making households worse off, the austerity programme simply ‘crushed the fragile recovery’.⁷ In one estimate, rolling cuts in public spending were said to have shrunk the economy by £100 billion by the end of the decade.⁸ Another study showed that if real-terms growth in public spending at the 3 per cent level inherited in 2010 from the previous Labour government had been maintained and paid for by matching tax rises, Britain’s government debt burden would still have been lowered by 2019.⁹

None of this means that crowding out never occurs. It just takes very different forms from the process advanced in neoliberal thinking. There are three alternative and distinct types of crowding out at work that have consistently had a malign effect on both the economy and wider society, yet have not been systematically addressed in the mainstream economic literature or by relevant government departments.¹⁰ First, the idea that markets know best in nearly all circumstances has shifted the balance between private and public activity too far in favour of the former, thus crowding out the latter. Second, an increasing share of private activity has been geared less to its primary function—to building economic strength and creating new wealth—than to boosting personal corporate rewards in a way which fuels inequality, weakens economies and crowds out economic and social progress. Third, there is the way the return of the ‘luxury capitalism’ of the nineteenth century (triggered by the application of pro-inequality neoliberal policies) has come at the expense of the meeting of essential material and social needs.

The balance between private and public activity

The simple notion—private good, public bad—has long been overplayed by neoliberal theorists. Both have a role to play and the real issue is getting the right balance between the two. State spending plays a crucial role not just in meeting wider social goals, but in supporting economic dynamism and stability. Private corporations do not operate in a vacuum. The profits they make, the dividends they pay and the rewards received by executives stem from a too-often unacknowledged interdependence with wider society, including the state. Business provides jobs and livelihoods, while responding to consumer demand. Society provides the workforce, education, transport, multiple forms of inherited infrastructure and often substantial state subsidies.

History shows that while bad decisions are too common, carefully constructed and evidence-based state intervention can have a highly positive impact. Government responsibility lies in helping to shape markets, prevent market abuse, support innovation, share the burden of risk-taking in the development of new technologies, promote public and private wealth creation and protect citizens. It is now time to ask if these functions—from market regulation to citizen protection—have been underplayed.

Britain is a heavily privatised and weakly regulated economy. Among affluent nations, it has a comparatively low level of public spending, including social spending and public investment in infrastructure, relative to the size of the economy.¹¹ A relatively low portion of the economy is publicly owned.¹² With the cut-price sell-off of state assets, from land to state-owned enterprises, the share of the national wealth pool held in common has fallen sharply from a third in the 1970s to less than a tenth today. This ongoing privatisation process has also greatly weakened the public finances. Britain is one of only a handful of rich nations with a deficit on their public finance balance sheet, with net public wealth—public assets minus debt—now at minus 20 per cent of the economy. The balance stood at plus 40 per cent in 1970. This shift has greatly weakened the state’s capacity to handle issues like inequality, social reconstruction and the climate crisis.¹³

The emphasis on private capital as the primary engine of the economy has failed to deliver the gains promised by its advocates. Since the counter-revolution against postwar social democracy from the early 1980s, and especially since 2010, levels of private investment, research and development, and productivity—key determinants of economic strength—have been low both historically and compared with other rich countries. Several factors account for Britain’s relative private ‘investment deficit’. They include Britain’s low wage history, with abundant cheap labour dulling the incentive to invest, and the perverse system of financial incentives that makes it more attractive for executives to line their pockets than build for the future. There is also the preference given to capital owners—an increasingly narrow group—in the distribution of the gains from corporate activity. In the four years from 2014, FTSE 100 companies generated net profits of £551 billion and returned £442 billion of this to shareholders in share buy-backs and dividends, leaving only a small portion of these gains to be used for private investment and improved wages that support economic strength.¹⁴ With UK corporations increasingly owned by overseas institutional investors, such as US asset management firms, little of this profit flow has ended up in UK pension and insurance funds and back into the domestic economy.

Some forms of financial and business activity have played a destructive role. In a remarkable parallel with the 1929 stock market crash and the Great Depression, the 2008 financial crash and the financial crisis that followed were classic examples of the impact of uncontrolled market failure. They were the product of tepid regulation of the financial system that turned a blind eye to a lethal cocktail of excessive profiteering and reckless gambling by global finance. It was only public intervention on a mass scale to bail out the banks—and many of the architects of the crash—that prevented an even greater crisis.

Claims about the overriding benefits of the outsourcing of public services to private companies have been exposed by a succession of scandals involving large British companies like G4S and Serco and by damning reports of the consequences of outsourcing in the NHS, the probation service and army recruitment.¹⁵ Such claims were also undermined by the collapse of two giant multi-billion-pound behemoths—the UK construction company Carillion and the public service supplier Interserve (which employed 45,000 people in areas from hospital cleaning to school meals). In the ten years to 2016, Carillion, sunk by self-serving executive behaviour and mismanagement, liked to boast about another malign form of crowding out—of how it raised dividend payments to shareholders every year, with such payments absorbing most of the annual cash generation, rather than building resilience.

Extraction

A second form of crowding out stems from the return of a range of extractive business mechanisms aimed at capturing a disproportionate share of the gains from economic activity. While some of today’s towering personal fortunes are a reward for value-creating activity that brings wider benefits for society as a whole, many are the product of a carefully manipulated, and largely covert, transfer of existing (and some new) wealth upwards. Early economists, such as the influential Italian economist Vilfredo Pareto, warned—in 1896—of the distinction between ‘the production or transformation of economic goods’ and ‘the appropriation of goods produced by others.’¹⁶ Such ‘appropriation’ or ‘extraction’ benefits capital owners and managers—those who ‘have’ rather than ‘do’—and crowds out activity that could yield more productive and social value. It delivers excessive rewards to owners and executives at the expense of others, from ordinary workers and local communities to small businesses and taxpayers.¹⁷

Extraction has been a key driver of Britain’s low wage, low productivity and growth sapping economy. Many large companies have been turned into cash cows for executives and shareholders. A key source of this process has been the return of anti-competitive devices described as ‘market sabotage’ by the American heterodox economist Thorstein Veblen over a century ago’.¹⁸ In contrast to the claims of pro-market thinkers, corporate attempts to undermine competitive forces have been an enduring feature in capitalism’s history, contributing to erratic business performance and economic turbulence.

Far from the competitive market models of economic textbooks, the British—and global—economy is dominated by giant, supranational companies. Key markets—from supermarkets, energy supply and housebuilding, to banking, accountancy and pharmaceuticals—are controlled by a handful of ‘too big to fail’ firms. The oligopolistic economies created in recent decades are, despite the claims of neoliberal theorists, a certain route, as predicted by many distinguished economists, from the Polish economist Michal Kalecki, to the Cambridge theorist, Joan Robinson, to weakened competition, extraction and abnormally high profit. This new monopoly power, according to one study of the US economy, has been a key determinant of ‘the declining labor share; rising profit share; rising income and wealth inequalities; and rising household sector leverage, and associated financial instability.’¹⁹

Although they helped pioneer popular and important innovations, the founders of today’s monolithic technology companies have turned themselves from original ‘makers’ into ‘takers’ and ‘predators’. Companies like Google and Amazon have entrenched their market power by destroying rivals and hoovering up smaller competitors, a form of private-on-private crowding out of small by more powerful firms. Multi-billionaires in large part because of immense global monopoly power, the Google, Amazon and Facebook founders can be seen as the modern day equivalents of the American monopolies created by the ‘robber barons’ such as J. D. Rockefeller, Andrew Carnegie and Jay Gould through the crushing of competitors at the end of the nineteenth century.

The House of Have and the House of Want

The third type of crowding out follows from the way the growth of extreme opulence for the few has too often been bought, in effect, at the expense of wider wellbeing and access to basic essentials for the many. Today’s tearaway fortunes are less the product of an historic leap in entrepreneurialism and new wealth creation than of the accretion of economic power and elite control over scarce resources. It is a paradox of contemporary capitalism that as societies get more prosperous, many fail to ensure the most basic of needs are fully met.

In Britain, elements of the social progress of the past are, for a growing proportion of society, being reversed. Compared with the 1970s, a decade when inequality and poverty levels were at an historic low, poverty rates have more or less doubled, while both income and wealth have become increasingly concentrated at the top. Housing opportunities for many have shrunk and life expectancy rates have been falling for those in the most deprived areas. Mass, but hit and miss, charitable help has stepped in to help fill a small part of the growing gaps in the state’s social responsibilities. While Britain’s poorest families have faced static or sinking living standards, the limits to the lifestyle choices of the rich are constantly being raised. The private jet, the luxury yacht, the staff, even the private island, are today the norm for the modern tycoon.

In heavily marketised economies with high levels of income and wealth concentration, the demands of the wealthy will outbid the needs of those on lower incomes. More than one hundred years ago, the Italian-born radical journalist and future British MP, Leo Chiozza Money, had warned, in his influential book, Riches and Poverty, that ‘ill-distribution’ encourages ‘non-productive occupations and trades of luxury, with a marked effect upon national productive powers.’²⁰ The ‘great widening’ of the last four decades has, as in the nineteenth century, turned Britain (and other high inequality nations such as the US) into a nation of ‘luxury capitalism’. The pattern of economic activity has been skewed by a super-rich class with resources deflected to meeting their heightened demands.

While Britain’s poorest families lack the income necessary to pay for the most basic of living standards, demand for superyachts continues to rise. The UK is one of the highest users of private jets, contributing a fifth of related emissions across Europe. The French luxury goods conglomerate, LVMH—Louis Vuitton Moët Hennessy—is the first European mega-company to be worth more than $500 billion. Resources are also increasingly directed into often highly lucrative economic activity that protects and secures the assets of the mega-rich. Examples include the hiring of ‘reputation professionals’ paid to protect the errant rich and famous, the use of over-restrictive copyright laws, new ways of overseeing and micromanaging workers, as well as a massive corporate lobbying machine.

The distributional consequences of an over-emphasis on market transactions is starkly illustrated in the case of the market for housing. Here, a toxic mix of extreme wealth and an overwhelmingly private market has brought outsized profits for developers and housebuilders at the cost of a decline in the level of home ownership, a lack of social housing and unaffordable private rents. The pattern of housebuilding is now determined by the power of the industry and the preferences of the most affluent and rich. Following the steady withdrawal of state intervention in housing from the 1980s—with local councils instructed by ministers to stop building homes—housebuilders and developers have sat on landbanks and consistently failed to meet the social housing targets laid down in planning permission. Instead of boosting the supply of affordable social housing, scarce land and building resources have been steered to multi-million-pound super-luxury flats, town houses and mansions. In London, Manchester and Birmingham, giant cranes deliver top end sky-high residential blocks, mostly bought by speculative overseas buyers and left empty. The richest crowd out the poorest, or as Leonard Cohen put it, ‘The poor stay poor, the rich get rich. That’s how it goes, everybody knows.’

There has been no lack of warnings of the negative economic and social impact of economies heavily geared to luxury consumption, most of them ignored. Examples include the risk of the coexistence of stark poverty and extreme wealth: of what the radical Liberal MP, Charles Masterman, called, in 1913 ‘public penury and private ostentation’, and what the American radical political economist Henry George had earlier called ‘The House of Have and the House of Want’.²¹ Then there was the influential 1950s’ warning from the American economist, J. K. Galbraith, of ‘private affluence and public squalor’.²² ‘So long as material privation is widespread’, wrote the economist, Fred Hirsch, in the 1970s, ‘the conquest of material scarcity is the dominant concern.’²³

For much of the last century, policy makers have seen wealth and poverty as separate, independent conditions. But that view has always been a convenient political mistruth. If poverty has nothing to do with what is happening at the top, the issue of inequality can be quietly ignored. Yet, the scale of the social divide and the life chances of large sections of society are ultimately the outcome of the conflict over the spoils of economic activity and of the interplay between governments, societal pressure and how rich elites—from land, property and private equity tycoons to city financiers, oil barons and monopolists—exercise their power. In recent decades, the outcome of these forces has favoured the already wealthy, with the shrinking of the economic pie secured by the poorest. As the eminent historian and Christian Socialist, R. H. Tawney, declared in 1913, ‘What thoughtful people call the problem of poverty, thoughtful poor people call with equal justice, a problem of riches.²⁴

Conclusion

These three alternative forms of crowding out have imposed sustained harm on social and economic resilience. Despite this, governments have continued to apply a long-discredited austerity-based theory of crowding out, while ignoring other, arguably more damaging forms of the phenomena. The latest application of the original theory since 2010 has inflicted ‘vast damage on public services and the public sector workforce’, without delivering the declared goal of ‘crowding in’ through faster recovery and growth, or improved public finances.²⁵

Britain is currently being subjected to yet another wave of austerity, with the 2022 Autumn Statement announcing a new package of projected public spending plans, higher taxes and lower public sector real wages, again in the name of fixing the public finances and boosting growth.²⁶ It’s the same short-term, narrowly focussed strategy that, by digging the economy into a deeper hole and cutting public investment, has failed time and again over the last 100 years.

Meanwhile, other damaging forms of the crowding out of key public services, value-adding economic activity and the meeting of vital needs, driven by over-reliance on markets, excess inequality and dubious private-on-private activity, are simply ignored or dismissed.

Notes

¹ C. E. Mattei, The Capital Order, Chicago IL, University of Chicago Press, 2022, p. 156. ² House of Commons, Hansard, 12 June 1979, col 246. ³ J. Tomlinson, ‘Crowding out’, History and Policy, 5 December, 2010; https://www.historyandpolicy.org/opinion-articles/articles/crowding-out⁴ J. Delingploe, ‘Britain’s trillion pound horror story’, The Spectator, 13 November, 2010. ⁵ J. A. Hobson, The Industrial System, London, Longmans, Green & Co., 1909. ⁶ C. Breuer, ‘Expansionary austerity and reverse causality: a critique of the conventional approach’, New York, Institute for New Economic Thinking, Working Paper no. 98, July 2019. ⁷ D. Blanchflower, Not Working, Princeton NJ, Princeton University Press, 2019, p. 172. ⁸ A. Stirling, ‘Austerity is subduing UK economy by more than £3,600 per household this year’, New Economics Foundation, 2019; https://neweconomics.org/2019/02/austerity-is-subduing-uk-economy-by-more-than-3-600-per-household-this-year⁹ R. C. Jump, J. Michell, J. Meadway and N. Nascimento, The Macroeconomics of Austerity, Progressive Economy Forum, March 2023; https://progressiveeconomyforum.com/wp-content/uploads/2023/03/pef_23_macroeconomics_of_austerity.pdf¹⁰ See S. Lansley, The Richer, The Poorer, How Britain Enriched the Few and Failed the Poor, Bristol, Policy Press, 2022. ¹¹ K. Buchholtz, Where Social Spending is Highest and Lowest, Statistica, 28 January, 2021; https://www.statista.com/chart/24050/social-spending-by-country/¹² OECD, The Covid-19 Crisis and State Ownership in the Economy, Paris, OECD, 2021; https://www.oecd.org/coronavirus/policy-responses/the-covid-19-crisis-and-state-ownership-in-the-economy-issues-and-policy-considerations-ce417c46/¹³ L. Chancel, World Inequality Report, World Inequality Database, 2021. ¹⁴ High Pay Centre/TUC, How the Shareholder-first Model Contributes to Poverty, Inequality and Climate Change, TUC, 2019. ¹⁵ National Audit Office, ‘Transforming Rehabilitation: Progress Review’, National Audit Office, 1 March 2019; https://www.nao.org.uk/reports/transforming-rehabilitation-progress-review/¹⁶ V. Pareto, Manual of Political Economy, New York, Augustus M. Kelley, 1896. ¹⁷ Lansley, The Richer, The Poorer. ¹⁸ T. Veblen, The Theory of the Leisured Classes, New York, The Modern Library, 1899; T. Veblen, The Engineers and the Price System, New York, B. W. Huebsch, 1921. ¹⁹ I. Cairo and J. Sim, Market Power, Inequality and Financial Instability, Washington DC, Federal Reserve, 2020. ²⁰ L. Chiozza Money, Riches and Poverty, London, Methuen, 1905, pp. 41–3. ²¹ C. Masterman, The Condition of England, Madrid, Hardpress Publishing, 2013; H. George, Progress and Poverty, New York, Cosimo Inc., 2006, p. 12. ²² J. K. Galbraith, The Affluent Society, Boston, Houghton Mifflin, 1958, ch. 23. ²³ F. Hirsch, The Social Limits to Growth, Abingdon, Routledge & Kegan Paul, 1977, p. 190. ²⁴ R. H. Tawney, ‘Poverty as an industrial problem’, inaugural lecture at the LSE, reproduced in Memoranda on the Problems of Poverty, London, William Morris Press, 1913. ²⁵ V. Chick, A. Pettifor and G. Tily, The Economic Consequences of Mr Osborne: Fiscal Consolidation: Lessons from a Century of UK Macroeconomic Statistics, London, Prime, 2016; G. Tily, ‘From the doom loop to an economy for work not wealth’, TUC, February, 2023; https://www.tuc.org.uk/research-analysis/reports/doom-loop-economy-work-not-wealth²⁶ Chancellor of the Exchequer, Autumn Statement, 2022, Gov.uk, 17 November, 2022; https://www.gov.uk/government/topical-events/autumn-statement-2022

This article was first published in The Political Quarterly 

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Biography

• Stewart Lansley is the author of The Richer, The Poorer: How Britain Enriched the Few and Failed the Poor, a 200-year History, 2021. He is a visiting fellow at the University of Bristol and an Elected Fellow of the Academy of Social Sciences.

picture credit flickr

The post Rethinking ‘Crowding Out’ and the Return of ‘Private Affluence and Public Squalor’ appeared first on The Progressive Economy Forum.

By Josh Ryan-Collins

After a decade of austerity and the trauma of a two-year long pandemic, the UK’s public sector workers deserved some respite come 2022. Instead, they are now enduring the largest real wage cuts in recent history.

Average settlements on offer to public sector workers are currently around 3% with inflation at 10%. This 7% cut in real wages amounts to almost a month’s salary not being paid. Furthermore, the private sector is enjoying wage deals more than twice as high at around 7% as shown in Figure 1.

Under such conditions, the withdrawing of labour is an entirely rational response. It is even more understandable when you consider the wider macroeconomic policy regime that appears rigged against the public sector.

The argument being repeatedly made by both the government and the independent Bank of England is that paying public sector workers close to or above the current rate of inflation would be self-defeating because it would lead to higher prices. This is due to the so called ‘wage-price spiral’ where higher prices lead to calls for higher wages which then feed through to higher prices and so on.

There are four reasons this argument is flawed.

Firstly, in capitalist market economies the public sector does not set prices, firms do. So the wage-price spiral can only apply to the private sector in as far as it is a direct relationship between wages and consumer prices.

The only way the government could finance additional wages for the public sector would be raise taxes or borrow more. Taxing directly removes money from the economy so it is difficult to see how this could be inflationary.

Borrowing involves investors spending money buying government debt instead of other assets. Bank of England governor Andrew Bailey has stated this would affect “overall demand in the economy” and force the Bank to raise interest rates, further adding to the cost-of-living crisis facing low paid workers.

There is evidence that bond financed fiscal deficits are associated with higher inflation. But this relationship is almost exclusively found in developing countries with weaker institutions and tax raising powers, not in high income economies like Britain.

Second, current inflation in the UK is mainly driven by supply-side factors, in particular rising energy prices caused by the Ukraine war feeding through to other sectors. There is evidence that rising energy costs have led firms to raise their prices and evidence that other firms have exploited the situation of rising prices to use their market power to raise prices above inflation, generating excess profits. If anything, there is more evidence of a ‘profit-price spiral’. None of this has anything to do with what public sector workers are paid.

Thirdly, public sector workers make up only around 17% of the workforce. Thus inflation-linked wages to help public sector workers catch up with years of real wage cuts would have much less impact on total demand in the economy than they would in the private sector.

Finally, the public sector is suffering from a serious shortage of labour caused by the COVID pandemic and difficulty recruiting workers from the EU post-Brexit. In particular the healthcare sector is in crisis, making up 13% of all jobs advertised in the UK last month.

Keeping wages well below those available in the private sector — which they have been over most of the past eight years (Figure 1) — will make the situation worse as employees are more tempted to leave. In turn, this will require even larger pay increases down the line to bring workers back.

Given flatlining growth, fears about excess demand and entrenched inflation have to be tempered with the risk of rising unemployment and even more individuals leaving the workforce, worsening an already extremely weak macroeconomic environment.

Striking public sector workers have the support of the majority of the public. They seem to recognise, better than the politicians and policy makers in charge of our economy, that a strong public sector is the building block for sustainable economic growth. Let us hope that those taking industrial action succeed in pushing through higher wages for all our sakes.

This blog was first published on 14th February 2023 on the official blog of the UCL Institute for Innovation and Public Purpose | Rethinking how public value is created, nurtured and evaluated | Director @MazzucatoM | https://www.ucl.ac.uk/bartlett/public-purpose/

The post Industrial action is the only rational response to the UK’s rigged macroeconomic policy regime appeared first on The Progressive Economy Forum.

The Governor of the Bank of England, speaking at an IMF conference yesterday evening:

Bank of England, as reported before breakfast this morning:

In between time, the pound had done this:

Modern central banking is mostly about the communications of modern central banking. Take former European Central Bank president Mario Draghi’s declaration that he would do “whatever it takes” to save the euro, in 2012. Did Draghi actually have to do “whatever it takes”? No, just declaring clearly and credibly that he would was enough to end the speculation around the terms of the euro’s disintegration and immediately improve financial condition in the eurozone and beyond.

What Bailey and the Bank of England have just done is the exact opposite.

Confusion

So why the confusion? Why the mixed messaging? The Bank’s fundamental problem, beneath whatever it wants to tell the world, is that its two major objectives now contradict. The Bank of England, like any central bank, has a primary task of ensuring financial stability. This is why central banks exist at all, in their modern form: central banks emerged as a “lender of last resort” for a currency’s banking system, meaning it was known by all other banks, financial institutions, and their customers, that the central bank was ready to step in and preserve the system’s stability if needed – by issuing emergency loans to failing institutions, for example.

Their second function, inflation targeting, emerged only very much later – really in the last few decades or so. Although much better-known today, inflation targeting by central banks is only possible because of their fundamental role in trying to preserve financial stability. By acting as the fundamental support for the whole monetary system, central banks develop great powers over the system. The interest rate central banks pay on the bank accounts the commercial banks hold with them grows to exercise a control over interest rates in the system more generally. When the Bank of England or some other central bank is reported to be adjusting “the” interest rate, this “Bank rate” is the rate it is adjusting. The idea is that by the central bank changing the interest rate paid out on its own reserves, every other bank and financial institution will adjust its own interest rates. (The Bank of England has a clear explainer here.)

Under normal circumstances, these two functions work together. The Bank of England’s Monetary Policy Committee (MPC) meets monthly to set the Bank’s main interest rate, aiming to keep inflation at the government’s target level of 2%. The Financial Policy Committee, meanwhile, keeps an eye out for future financial crises and potential instability. After the 2008 crash, the MPC has also overseen the massive programme of government bond-buying called “Quantitative Easing” (QE), taking decisions on the value of government bonds the Bank should buy with freshly-issued Bank money. Novel in early 2009 when it was introduced, for good or ill QE is now an accepted part of most central banks’ policy toolkits. Again, this has all been accepted as normal, innocent central bank behaviour – even when QE was expanded by some £400bn to cover the costs of covid in 2020. At the start of September, the MPC announced it would be reversing QE with “Quantitative Tightening” (QT) – selling government bonds back to the financial markets – as part of its effort to control inflation, alongside increasing the Bank rate.

Normal

Alas, the times are not normal, and haven’t been for a while. Kwasi Kwarteng’s mini-Budget on September 23rd, containing £45bn of additional borrowing (on top of the Energy Price Guarantee) and including an unexpected new tax cut for the wealthiest, sparked an almighty panic amongst those in financial markets. The pound fell rapidly in value against other currencies and the price demanded by traders for lending to the British government – the “gilt rate” – shot up. This sudden change in the gilt rate in turn seems to have destabilised British pension funds, who had, over the previous decade or more, developed sophisticated ways to try and match up the payments they make to pensioners with the earnings they receive from their assets. These techniques, collectively known as “Liability Driven Investment” were sophisticated but, it turned out, fragile if market conditions changed rapidly. By Monday 26th, there was a risk that some pension funds faced insolvency and therefore of much wider market disorder.

The Bank of England, as the situation worsened, moved on Wednesday 29th to operate its primary function: preserving financial stability, promising up to £5bn-worth of additional bond-buying a day for the next 13 working days, and ending Quantitative Tightening.

But notice that this is a screeching reverse of the earlier decision to start QT to combat inflation. The Bank’s aim of preserving financial stability runs directly counter, right now, to its aim of keeping inflation low. The same tools and instruments are being used to try and do two, contradictory things. This contradiction by itself would be a decent reason for the Bank to try and impose a time limit on the extra support it has offered, and was (presumably) the reason for setting that limit. But without the pension funds magically managing to reorganise themselves at very short notice – and the picture here is unclear – the time limit just delayed the inevitable, currently set to arrive on Friday morning.

This contradiction is the reason for the confusion at the top of the Bank. But the confusion should alarm all of us. The Bank of England has been the most important economic institution in the country for the last decade. Time and again its interventions have enabled an otherwise weak economy to steer through a series of crises, from Brexit to covid, with relatively little damage. If the Bank is now itself starting to look as dysfunctional as every other major institution, we are collectively in a very bad place. And it is absolutely not a good look for the governor of a central bank to say one big, important thing and then have himself immediately contradicted by his own bank a few short hours later.

Chicken

What to do? There might be ways for the Bank to try and manage this mess more effectively. Steven Major, HSBC’s head of global research has suggested they should make clear the financial stability intervention is only buying long-term bonds (which it is), whilst the monetary policy intervention (“Quantitative Tightening”) is only selling short term bonds (which it is). These are two different parts of the market and two different financial products, so – in theory – two different interventions could be applied. Major goes on to suggest that the Bank rate could still be used to signal the Bank’s intentions about inflation, with Bank rate rises (expected to be steep over the next few months) continuing.

Perhaps more fundamentally, as former Permanent Secretary to the Treasury Nick Macpherson has said, it isn’t actually the Bank’s job to bail out pension funds. That falls to the government – the Bank was only bounced into intervening as it became apparent, barely two weeks ago, that a general failure of pension funds had bigger market implications. That would mean the Treasury pulling together a rescue package for the funds, which, one way or another, means adding still further to the government’s rapidly rising pile of debt and more pressure on interest rates. One, possibly generous, reading of Bailey’s behaviour is that he has thrown down the gauntlet not so much to pension funds as to the government: that either the Treasury will have this mess resolved by Friday, or the Bank will not be responsible for the consequences. (You may think it’s a bad sign that a central bank is playing chicken with its own government, and you’d be absolutely right.)

So a quick, relatively low-cost resolution to the current mess would be for the government to U-turn on whatever remains of the Budget, although plausibly this would end Kwasi Kwarteng’s political career; the slower, higher-cost resolution would involve a government backstop for failed pension funds, although this might allow Chancellor Kwarteng to remain in Number Eleven. It’s a dilemma: who amongst us can truly say which of these options is best? Most likely, of course, is some fudge, whereby the Bank declares and end to the current round of exceptional support, but then cunningly reintroduces something quite similar looking for Monday morning whilst the government continues to chisel away at its own mini-Budget.

Either way, the resolution would only be temporary. The cost of government borrowing has been forced upwards, to heights unheard of even a few years ago, and is unlikely to come back down much in the future. The pound continues its long-term decline. The economy is shrinking as we slide into a probable recession. If we get right down to the fundamentals, Britain is a weak, unproductive, low investment, low wage, high debt economy with a massive dependence on imports for essentials like natural gas and food. It has run off fumes for much of the last decade, leaning more and more heavily on the historic reputation of its core institutions – like the Bank of England – to maintain a semblance of progress. But there are limits to how much the Bank can do with monetary policy, and the Truss government has cack-handedly exposed those limits in the last few weeks. Things are only likely to get worse, and potentially much worse, from this point onwards.

The post What is the Bank of England playing at? appeared first on The Progressive Economy Forum.

Overshadowed by the appalling news from Ukraine, Chancellor Rishi Sunak presented the annual Mais Lecture in London a couple of weeks ago. Traditionally used by Chancellors (and, sometimes, Shadow Chancellors) as a space to fill out the detail of their economic plans, and (they hope) give the impression of some depth of thought behind them, this was, as other commentators have pointed, out a comparatively rare insight into Sunak’s mind a few weeks of what will be, for him, another Spring Statement severely rattled by external events.

Battered by the pandemic, and subject to the whims of a once all-powerful Prime Minister, Sunak has spent two years in office cranking up government spending whilst offering variations of St Augustine’s prayer: “Lord, make me fiscally conservative, but not yet!” Mais Lecture was no different in this respect, once again promising the faithful that he would soon, very soon, start cutting taxes.

And of course you have to read the whole thing through a potential Conservative Party leadership battle. It helps to read British politics in general through the prism of a never-ending Tory leadership contest: like other semi-democracies, squabbles amongst factions in the ruling party matter far more than debates between the ruling party and the tolerated opposition – whatever the likelihood of any actual changes at the top.

But with Liz Truss letting her Tory MMT tendencies be known early on, judiciously making sure news of her indifference to deficits was leaked to the Times just ahead of Tory Party Conference last year, Sunak had to establish some clear blue water on the question of spending. Truss wants to cut taxes, regardless of the impact on government borrowing. Sunak “firmly believes” in low taxes but is “disheartened… by the flippant claim” that taxes pay for themselves. Tut tut. Once again, low taxes, but not yet.

What’s more striking is, as per usual, what Sunak doesn’t talk about. For a decade Tories noisily insisted that the government debt and the government’s deficit were the most important problem in the world, and that all other government spending could be sacrificed to shrinking both. Former Chancellor George Osborne used his own Mais Lecture to spell out the argument for immediate action on government spending, back in 2010. Osborne offered a cogent and closely-argued case for finding the poorest and most vulnerable in society and fiscally waterboarding them for a decade.

Never mind that the gurus he cited, Kenneth Rogoff and Carmen Reinhart, turned out to have made a spreadsheet error in their calculations on the impact of government debt on growth which rendered their most eye-catching claims useless. And never mind, too, that by the time he left office, Osborne had overseen the longest decline in living standards since the dawn of industrial capitalism, even as the government debt burden continued to rise. What matters here is the intellectual framing of the discussion around the role of government in the economy as entirely negative: that government, with its shocking debts and yawning deficits, was little more than a deadweight on a long-suffering private sector, yearning to be free.  Aided and abetted by a compliant media, who didn’t know better, and the Institute of Fiscal Studies, who should’ve known better, the economic illiteracy of the story mattered less than its political purpose in justifying the reshaping of the British economy back around the interests of its financial system in the years after the 2008 crisis.

So tightly were austerity’s mind-forged manacles that it took the triple shock of Brexit, Jeremy Corbyn and covid to break them. Brexit gave us a Tory Prime Minister who wanted to talk about the “burning injustices” of the economy. Corbyn, in turbulent years after the 2017 election, gave us a different Tory Prime Minister who consistently increased spending. And covid has given us a Tory Chancellor who scarcely references the government debt.

The contrast between Osborne and Sunak, then, is stark. The current Chancellor reflects a new consensus, apparent across the business press in recent months, that government spending in the future is going to be higher: on (his words) “health, pensions and social care” for an ageing population; on the “legacy of covid” in annual vaccination programmes, antivirals, and testing; on education; on government infrastructure investment, praised by Sunak; and of course on the military, where demands have been raised for a 25% increase in the current budget.

This isn’t the austerity economics of the 2010s. It is a higher-spending, bigger-state Toryism that means, come 2024, the difference between the two main parties’ spending plans – widening in elections 2015 onwards – is likely to be substantially reduced. Reduced, too, will be their rhetoric on the fundamentals of the economy: both accept a significantly increased role for government investment, including on renewable energy; both accept the need for  intervention in the economy to address inequality, beyond using the tax system alone (aka “Levelling Up”); both accept the idea that intervention can address the productivity problem. And both have decided to foreground economic growth as the key to a successful economy.

Market morality

It’s here that Sunak gets interesting, once we get past the boil-in-a-bag Treasury policy prescriptions for growth. Sunak wants to cut taxes on investment by businesses, invest more in “adult skills”, and spend more on R&D – so far, so familiar, although Sunak at least throws in the possibility of scooping up “entrepreneurs and highly skilled people” from all over the world, post-Brexit.

Instead it is when Sunak tells us about his desire to create a “new culture of enterprise” that we should be paying more attention. Sunak’s carefully-curated public image has been of a man somewhat wary of big ideas and book-reading (“all my favourite books are fiction”), but it is to Adam Smith he turns to make the link between culture and economic growth: not via the Wealth of Nations, but its forerunner, the Theory of Moral Sentiments: that a free market not only ensures outcomes that are economically efficient, but that markets themselves are grounded in morality, Sunak here referencing the late Jonathan Sacks’ own Mais Lecture. The process of market interaction itself (says Sunak) shapes morals and therefore culture. “Moral responsibility,” he claims “can only come from being exposed to the consequences – whether good or bad – of our own actions.”

This isn’t a conventional, libertarian-inclined defence of the free market, often associated with the Wealth of Nations, in which freely-transacting individuals are magically guided by the “invisible hand” to produce the best possible outcome for society. This “invisible hand”makes no claims about the morality of your choices, simply that everyone’s preferences will be met best if we allow it do work its mysterious magic. Sunak says this is reading Smith wrong: “Smiths account of the market economy, is not as some have suggested a values free construct which rationalised social choice.”

But this argument for market morality is also not quite that of Sacks’ original Mais lecture, which was a slightly more conventional take on how free markets, desirable as they for producing economic growth and productive cooperation, also require stable social institutions: family, religious organisations, community groups, and so on. We get on with our social interactions, the market sorts out that section of them we call the economy, and the greatest happiness of the greatest number is ensured. We learn our morals and “habits of cooperation” in “the domain of families, congregations, communities, neighbourhood groups and voluntary organisations”.

The invisible hand of Sunak, on the other hand, has a decidedly morally interventionist streak. We will have better moral characters if we allow a market-type process of rewards and punishments to shape them, facing the “consequences… of our own actions”. Happily, the shaping of our characters in turn shapes a culture which then creates the conditions for economic growth through the “universal and laudable desire to better the condition of ourselves and those we love”. A free market fosters an “enterprise culture” which will, in turn, make Britain more receptive to economic growth delivered by a succession of terrific new technologies, lead by Artificial Intelligence (as always).

Note the firm limits to “laudable” bettering here, and what it should be aiming for; and whilst Sunak identifies the need for government to provide some minimum level of support where needed, the boundaries for government action are constrained. Whereas Sacks suggests that economic growth, engendered by the free market, is just one part of a what makes a good society, and that this culture provides the necessary foundations of the market, Sunak’s rather darker argument is that the desirable culture is one that produces growth, and that market outcomes themselves are crucial to shaping that culture.

Sunak may talk up economic growth. He suggests he is an optimist on its future. But if the growth pessimists he cites are right, we left with only the moral claims. What he establishes here looks more like the moral and intellectual framework for a low-growth and significantly more authoritarian version of capitalism.

The post Rishi Sunak’s market moralism appeared first on The Progressive Economy Forum.

The policy is uniquely flawed, with multiple faults. Of course, if government throws over £60 billion of subsidies to a minority of firms and workers, that will be popular with the recipients. But a scheme should be judged by what it does for the many, not the few, and for its opportunity cost.

The government’s furlough scheme was possibly the most regressive social policy in modern history. Recall that it paid 80% of the wage of those earning up to £3,000 a month. So, it meant that somebody earning £3,000 received £2,400 only if they did no labour, whereas somebody earning £800 a month received £640. So, a high-wage earner received nearly four times as much as a low-income one. And for a low-income earner losing £160 would make it less likely they could service debts or pay the rent, risking homelessness and abject impoverishment. Under the scheme, those laid off or without employment contracts obtained nothing, as did those on Universal Credit or legacy benefits. My grandmother would have described this as ‘nutty as a fruitcake’.

If the Left believes in policies that reduce inequality and that increase economic security for everybody, the CRCS should be regarded with contempt. Perhaps, 11 million people gained income from it or the equally regressive scheme for the self-employed. That means only a minority of the labour force benefited, or a much smaller minority of the population. One could understand the IMF backing such a policy, because it props up capitalism. But why should the Labour Party, the TUC and progressive commentators do so? Surely, they cannot be indifferent to inequality

The inequities are also extensive. Suppose you worked in a firm struggling to survive and had your earnings cut by 30%. You were penalised relative to those furloughed, who only lost 20%. In which economics textbook or ideology would that be regarded as fair? The scheme was also unfair to those who lost jobs, who obtained much less in benefits, simply due to bad luck.

There is also something Labour and others should take up. With benefits for the unemployed and others in poverty, the government imposes strict conditions on those wanting help, or sanctions them by denying them benefits. In the case of help to firms, they do not apply any behavioural conditions. That is double standards.

So, for example, under the furlough scheme Donald Trump received over £3 million for furloughed staff on his luxury golf resorts, but his managers laid off hundreds of staff anyway. Trump is a multi-billionaire and surely could have afforded to cover the wages. No whiff of means-testing for corporations. Major multinationals making billions of pounds in profits gained from the furlough scheme, while the near destitute had to prove destitution before obtaining a pittance.   

Furlough schemes generate huge moral hazards. They pay people not to do what they might wish to do, creating a new ‘poverty trap’. If you did some labour, you would probably lose more than you would gain. And they pay high earners on condition they do not work, while welfare claimants receive a pittance only if they do everything possible to find work. How does that make sense?  

Immoral hazards are worse. When the CJRS was introduced, I predicted in the Financial Times that it would be subject to massive fraud. Even the head of HM Revenue and Customs said so. Sure enough, an early survey found that one in three on the scheme was actually working. Another survey suggested the figure was much higher. Later, the HMRC estimated that over £6 billion had been paid to organised criminals or fraudsters. In one case, a man was caught having invented a huge number of employees and fake national insurance cards, having received millions of pounds under the scheme. He was surely not alone. And, as is well known, high earners were more able to ‘work from home’ while receiving furlough support than low earners, further contributing to the scheme’s regressive character.

Belatedly, the HMRC set up a taskforce of 1,265 staff to try to combat fraud; there have been over 26,500 investigations so far, representing a waste of resources that could have gone to the impoverished queuing at food banks. Most who cheated will go undetected, because adequate evidence will be hard to obtain or not merit the cost of investigation. Confronted by the evidence, the government had the temerity to say the priority had been ‘to get money to those who need it as fast as possible’. That was not what the policy was intended to do. It gave nothing to those most in need. But what was meant was that the likelihood of fraud was tolerated in the interest of speed. It is surely amoral to support a policy that is prone to massive fraud. Any furlough scheme would have that feature. Yet progressive commentators seem indifferent to fraud.

Then there are the economic effects. If you pay people not to work at all, it encourages inactivity rather than merely reduced production and short-time working. Furlough schemes depress production more than it would otherwise be. And they prop up ‘zombie firms’. In the past two years, the bankruptcy rate has declined during what was a major recession. A German bank estimated that 2.5 million jobs covered by the UK’s furlough scheme were ‘zombie jobs’, i.e., were unviable anyhow. Sunak implicitly recognised that by introducing a ‘job retention bonus’ of £1,000 if firms kept employees once the subsidy ended.

Furlough schemes also discourage firms from restructuring in the face of the pandemic. They also deter labour mobility. If somebody is offered 80% to do nothing, why move to a firm in which they might earn 70% of what they were receiving? And there is bound to be ‘deadweight’ – paying for employees who would have been covered by their firm. The CEO of Bet365, who received £300 million in 2019, could easily have paid laid-off employees.  

In sum, a minority do well, but furlough schemes worsen inequality, are inequitable and contribute to economic inefficiency. Above all, by diverting funds from providing universal basic security they erode the societal resilience so vital in an era of pandemics. No progressive should support them. A new furlough scheme would ‘certainly make no sense’.

Guy Standing is author of The Corruption of Capitalism: Why Rentiers thrive and Work does not pay (2021). He is Professorial Research Associate, SOAS University of London, and a council member of the Progressive Economy Forum.      

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This week the UK Chancellor Rishi Sunak delivered the 2021 Autumn Budget in the House of Commons. The Budget confirms that this government has accepted a permanently larger role for the state in the economy. Spending will grow in real terms by 3.8% across government, amounting to a £111bn annual increase by 2024–25. Analysis by the Office of Budget Responsibility (OBR) shows total public spending levelling out around 42% of GDP once the huge rises associated with the pandemic wear off. This is not high by European standards. However given the figure averaged around 37% in the 30 years preceding the Great Financial Crisis it marks a step change, in particular for the Conservative party.

But Rishi Sunak and the Treasury remain fiscal conservatives. The Chancellor has created a new ‘fiscal rule’ (the fifteenth since 1997) which requires balancing day-to-day spending, excluding investment, within three years and keeping public sector investment from averaging more than 3% of GDP. Instead of achieving this through spending cuts, the Chancellor is embarking on major tax rises. Post-budget analysis by the Resolution Foundation finds that by 2026–27, tax revenue as a share of the economy will be at its highest level since 1950 (36.2%), amounting to an increase per household since Boris Johnson became Prime Minister of around £3,000.

The fiscal rule itself is arbitrary and appears to be more driven by politics than economics. With interest rates on long-dated government debt remaining at record lows, there is no obvious reason to balance the budget over the short-term when the economy faces longer-term ‘scarring’ effects from the pandemic, which the OBR estimates will be around 2% of GDP.

More generally, the Budget lacks any real vision for how to achieve the ‘high skill, high productivity, high wage’ economy that Boris Johnson spoke about in his party conference speech.

On the spending front, the biggest increases will go towards the NHS, social care and pensioners. With an ageing population and technological advances in healthcare, such increases are inevitable. They should arguably be higher, in particular for social care, which ultimately could help reduce costs on the NHS in the long run.

Disappointment

The biggest disappointment, ahead of the UK’s hosting of the COP26 summit next week in Glasgow, is the lack of any new plans to support a green transition. Keeping public sector investment to below 3% suggests the Chancellor is not yet taking seriously the massive transformation of our energy, housing and transport infrastructure required to meet the UK’s net Zero 2050 targets. The Treasury appears unable to see the potential of policies such as a national home insulation program to reduce carbon emissions, create good quality jobs and reduce the cost of living for those many poorer households in leaky homes. The announcement of a tax break on short haul flights — which are already significantly cheaper for equivalent journeys than trains in this country — confirms the Treasury’s myopic views on the net zero transition.

Sunak made much of the announcement of reduction of the rate at which universal credit is taxed for those who are in work. How the remaining four million or so households on universal credit who haven’t found work are supposed to survive the £1,050 per year reduction in their incomes from the reversal of the £20 uplift remains to be seen.

But the broader point here is that if the Treasury was genuinely interested in ‘making work pay’ as Sunak emphasised in his speech, they would be taxing wealth and not wages. A recent analysis found that the Treasury could raise £16bn a year if shares and property were taxed at the same rate as salaries. Currently, the richest 1% of the population take 13% of their income in the form of capital gains.

Given that the bulk of new spending announced in the budget will mainly support older, wealthier people, the case for a gradual shift towards taxing some of the assets they have built up over their lifetimes rather than the income of the wider population seems strong. This should also encourage more private investment into productive activities rather than property. But, just as with climate change, this kind of broader strategic vision seems missing from the Chancellor and the Treasury’s thinking.

Originally published on the UCL Institute for Innovation and Public Policy blog.

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The Bank of England’s new chief economist, Huw Pill, gave his first interview in the job to the Financial Times a few days ago. It will do little to confirm the fears of those of us think, at the worst possible moment, the Bank is about to lurch into a round of interest rate rises on the back of inflation fears.

The focus has been on his comments about the short-term outlook, noting that forecasts suggest it will reach 5% over the next year or so. This, claims Pill, is “very uncomfortable” for a central bank with a target for inflation of 2%. True – but an indicator of the weakness of the Bank’s inflation mandate, drafted 24 years ago in a very different world. As the previous Bank governor, Mark Carney, demonstrated, in practice a central bank has significant discretion over its interpretation. The principle of discretion is built in to the Bank’s operations, with the governor merely having to explain, in a formal letter to the Treasury, why the Bank was missing its inflation target should it do so. (This relative autonomy is, after all, the point of saying the Bank is “independent”.) Under current circumstances, with inflation very obviously driven by supply-side shocks, there is no reason for the Bank to be expected to hit its target.

More concerning, however, were Pill’s comments about his “mentor”, first chief economist at the European Central Bank, Otmar Issing. Issing was (and is) a notorious inflation hawk, acting as one of the leading academic advocates for the high interest, tight money policies of the 1970s and 1980s that were crucial to securing the neoliberal turn against post-war Keynesianism. As central banks like Germany’s Bundesbank, the Bank of England and, especially, the Federal Reserve drove up interest rates, supposedly with the aim of targeting inflation, businesses failed and millions were pushed into unemployment.

Issing himself joined the board of the Bundesbank in 1990, as the reunification of Germany following the fall of the Berlin Wall gathered pace. The same high-interest, tight money approach by the Bundesbank, pushed by Issing, helped bring devastation to the former East Germany, as factories closed under the lash of an overvalued deutschmark and skyrocketing borrowing costs. Ratcheting up the interest rate, supposedly to cope with inflationary pressures and rising budget deficits, saw East German unemployment peak in 1992 at around 15% – up from scarcely 1% a few years earlier.

Issing later brought the same approach to the ECB where he pushed for a similarly “sound money” approach to designing the euro – this time, attempting to hitch the entirety of the Eurozone on to a monetary policy designed around the preferences of the richest parts of its largest economy. When the Great Financial Crisis erupted over 2007-8, the ECB’s brutal enforcement of its tight money policies under its President, Jean-Claude Trichet, helped push southern Europe into a devastating recession.

Pill himself makes clear that he believes the primary focus of the Bank of England should also be “price stability”. After a number of years in which central bankers, including those at the Bank of England, have recognised that a central banks’ footprint is necessarily larger than just controlling inflation – including, for example, recognising that environmental instability also hurts financial stability, and so central banks must take account of the environment – this looks like a real step backwards.

Facing a spike in prices as a result, primarily, of environmental instability – including the impact of covid-19 – there could surely be no worse time to back away from the Bank’s welcome and growing focus on environmental issues, whilst at the same time threatening to drive up interest rates. Increasing the Bank’s base rate won’t deliver more gas, or grow more food, or end the semiconductor shortage; but it will make it harder for companies to finance themselves, and risk rising unemployment here in Britain.

The Bank of England has an unhappy history of lurching back to monetary orthodoxy at the worst possible time: the disastrous 1925 return to the Gold Standard is the outstanding example, resulting in an immediate fall in exports and rise in unemployment as the pound was overvalued. If that return to orthodoxy happens now – if the Bank starts pushing up rates in the belief this will restrain inflation – future students of economic history may well have cause to view it in the same light.

The post New Bank of England chief economist interviewed, and it’s not good appeared first on The Progressive Economy Forum.

In less than six months since his inauguration as US President, Joe Biden’s administration has staked out a new agenda for US policymaking, breaking with the previous four decades of Republican and Democratic domestic economic policy to focus deliberate government action on job creation, addressing racial equality, environmental goals, and rebuilding American manufacturing industry. A dramatic expansion in trade union rights, pushing back on four decades of draconian restrictions on workplace organising has been pledged, and over $6tr of public spending is lined up, to be funded mainly by taxes on the richest Americans and the biggest corporations.

The UK equivalent for the whole programme (using share of 2020 GDP as the baseline) would be £560bn: £170bn for immediate coronavirus relief; £240bn for investment and business support; £150bn for welfare and education.

Surprising many with the scale and scope of its ambitions, the Biden Administration’s domestic economic programme has raised the bar for progressive governments across the world. This briefing breaks down the emerging details of the programme for a UK audience and lays out the main political conclusions.

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Jan Toporowski

TO PURCHASE THIS BOOK click here and use AGENDA25 to obtain a 25% discount

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And what extraordinary fruit it has produced. Lockdowns both collapsed economic activity, leading to a sharp fall in the tax take, and, through the demands of furlough expenditure, other benefits increases, and increased health spending, saw government spending increase hugely. Over the last year, the British government spent an additional £280bn last year because of the coronavirus. The deficit (the gap between government spending and taxes) has risen to a peacetime record, and the government debt (the total amount it has borrowed throughout history) has shot up to almost 100% of GDP. Yet the sky has not fallen in: despite a brief wobble in March last year, interest rates on government borrowing have remained very close to the lowest they have been in human history.

There are three reasons the government has been able to fund all of its expenditure. The first is that as a simple technical fact, if a government with its own currency (like Britain with the pound sterling, or the US with the dollar) wants to spend more money, it can do so by issuing currency  – the complications emerge after the spending has taken place, not before. As economist Jo Michell has explained, the challenge is that whilst a government with its own currency can ultimately always produce more of the currency as it wishes, and therefore in theory spend whatever amount it wants to, the ability of government to offer (in the UK case) unlimited pounds sterling in payment doesn’t necessarily guarantee the goods and services are available to be paid for. This could result in price rises, as supplier push up prices to meet demand. Or those receiving the new money may decide to use it to buy assets, inflating their prices, or sell the pounds to buy different currencies, pushing the value of the pound down relative to other currencies. In most circumstances, then, governments will find they need to not only decide what spending they wish to make, but also show how the economy’s real resources will be directed towards meeting them.

Borrowing is very cheap

For most governments in the developed world over the decades since the Second World War, making good the gap between what the government spends and what resources it can call on has involved raising taxes, and raising borrowing through government bonds – effectively today a certificate sold to those in financial markets to raise funds, with a promise to repay (usually with interest) later on. A government that can sell these bonds quickly will be in a better position than one which struggles to do so, since a struggling government may well have to offer higher interest rates to lure potential bond-buyers in to the market. Governments that are seen as “safe” by bond traders (that is to say, committed to the interests of bond traders) are likely to face lower interest rates. But since 2008, with some crisis-ridden exceptions like Greece, interest rates demanded by bond traders across the developed world have been exceptionally low. The great fear of the 1990s, of “bond vigilantes” poised to swoop and attack governments not obeying their wishes, does not hold.

This is the second reason funding has not been a problem: if the British government chooses to borrow, it can do so very cheaply. The graph below is from the House of Commons Library, and shows how much the government has been paying in debt interest, relative to GDP, since 1970. Low interest rates mean that even with exceptional levels of borrowing, the government is paying much less (relative to the size of the economy) in interest than it used to.

The third reason is that this government has continued to rely on the ability of its central bank, the Bank of England, to issue new money as it wishes. This is what “Quantitative Easing” amounts to: for Britain, it is a slightly peculiar process whereby the Bank of England creates new money to buy British government bonds from their current owners – typically major financial institutions like pension funds and banks. But by buying the bonds, and using new money to do so, the Bank is making it far easier for the government to issue bonds now and in the future. The process is a bit more roundabout, since the Bank is buying bonds that are already in circulation, but the effect of the process is to finance government borrowing with new Bank of England money. Over the last year, this has been exceptionally important in keeping government going: government borrowing is £340bn higher than expected in March last year, but the Bank of England had issued £350bn of new money through QE. In other words, the entire cost of government borrowing has been (in effect) financed by QE. The Bank is, as some City investors also believe, very close to “monetising” the government’s debt.

This isn’t a cost-free process: the effects of all that new QE money sloshing around has been to increase asset prices, which in the US has primarily meant rising stock market prices, and in the UK has meant largely rising property prices. This happens because those holding the QE money look for other assets to invest it in, driving up their prices: but the overall impact on inequality is bad, and the effect on the whole economy is to steer more resources into asset ownership, rather than useful spending in the real economy.

But we are simply nowhere near the point at which we should be worrying about the debt, despite its increase. If we were, we might find (for example) that the government was finding selling its bonds difficult. But that isn’t happening. There is a consensus in the economics profession on this point, marking a distinction with the period after 2008 when some prominent economists favoured austerity, but too often we find some politicians and, worse, some senior political journalists repeating nonsense about the government running out of money, or about how concerned we must now be about the debt.

The truth is that we had an exceptional public health emergency to deal with and, like other national emergencies, such as the Second World War, we simply had to spend the money to deal with it. Just as we didn’t panic about repaying the debt as fast as possible after WW2, instead building the NHS and the welfare state, so today we shouldn’t be panicking about it, either. And, looking ahead, it seems likely that much higher public spending will be needed to cope with coronavirus – and meet the demands for improved public services that we are crying out for after a decade of austerity. A sensible balance between some increased taxes on the wealthy – many of whom have done incredibly well financially out of the crisis- and higher government borrowing would take care of this. What we cannot risk, and should give no credence to those calling for it, is another lost decade of spending cuts and austerity.

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