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.

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The main rate of inflation in the UK, the Consumer Price Index, fell from July’s 40-year peak of 10.1% to 9.9% in August. This reflects the impact of sharp declines in the global price of oil over the summer, which fed into the falling price of motor fuel. However, food prices are continuing to rise, and the increasing price of food made the biggest single upwards contribution to the overall figure.

The graph below, from the Office for National Statistics, shows the impact – excluding food and energy price rises from the overall figure would bring the reported rate of inflation down by about 4%.

It’s worth stressing that this general picture is the same across the globe: the surge in oil and gas prices, pre-dating Russia’s invasion of Ukraine (see the graph below), and the very rapid rise in food prices are common everywhere. The graph below shows the same measure of inflation across the G7 economies. The common experience is obvious, although Britain is the worst-affected by the rise:

It’s likely, although not a given, that oil and gas prices will continue to fall over the next few months, easing pressure on inflation significantly. (Goldman Sachs has a particularly optimistic view of this, expecting natural gas prices to “tumble” across Europe in the next few months.) In the UK, the energy price cap, to be introduced by government to limit the October increase in typical domestic energy bills to £600 is forecast, by government, to take 4% off the expected rate of inflation over the end of the year. Some of the predictions of a 20% or even higher inflation rates look less likely to come true – though subject to substantial uncertainty, not least around events in and related to the Russia-Ukraine war.

But this doesn’t mean the great inflationary surge is over. Far from it. There are two points to bear in mind. First, inflation is cumulative. If the rate of inflation today is lower than it was last month, that doesn’t mean prices in general are falling. It means the overall rate of increase is less fast. Those higher price rises are likely to be permanent – prices went up 10.1% in the 12 months to July, and went up 9.2% in the twelve months to August. They’ve not actually fallen. Unless incomes from wages, salaries, benefits and pensions rise rapidly, those high particularly high prices earlier in the year will represent a permanent loss to most people’s living standards. And prices, bear in mind, are still rising.

Second, inflation is unlikely to settle back down to the 2% or so level it has been at for the last two or three decades. The reason for this has less to do with the explanations usually offered, around wages being too high (if only!) or there being too much money in the system. It has to do with the way in which our global, money-based economy responds to continued environmental shocks. Many economic activities are getting harder to undertake, as the environment we live in changes. Extreme weather events are becoming more common. Resources, whether mineral or agricultural, are depleting, pushing up prices. Recent shocks to the food supply include:

• South Africa’s biggest locust plague for 25 years attacked farms in the eastern part of the country in April 2022, following “Biblical” plagues across East Africa in 2020. The worsening outbreaks are thought to be linked to increasingly volatile weather conditions associated with climate change;
• The Environment Agency forecasts that extreme heat in 2022 is will reduce UK production of “carrots, onions, sugar beet, apples and hops” by 10-50%;
• Europe’s “worst drought for 500 years” is forecast to reduce output for maize by 16%, soybeans by 15%, and sunflowers by 12% compared to the average for the last five years.

Some of the impacts of climate change can be quite unexpected, like extreme heat drying out the Rhine and so restricting goods transport across Europe, pushing up the price. But whatever the source, or the specific impact, these environmental shocks keep happening, pushing up the real costs of economic activity. In a global economy dominated by credit money, this translates into rising inflation – increased costs becoming rising prices which then pull more money into circulation.

This has, notably, nothing to do with wages: in fact, faced with shocks like this, the best thing to do in the short term is insist wages must rise to compensate, with profits adjusting to carry the strain of reduced outputs and higher costs, rather wages and household incomes. Wealth, rather than household incomes, can act as a better short-term shock absorber and when British companies have over £950bn stashed in their bank accounts – up  £500bn from 2010– there is no good reason to not put that money to better use. In the long term we need far more resilient energy, food, and transport systems – something likely to start with on-shoring production and the switch into renewables.  

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The IMF reports that inflation globally continues to be driven by rises in the price of food and energy:

Food and energy are the main drivers of this inflation… Indeed, since the start of last year, the average contributions just from food exceed the overall average rate of inflation during 2016-2020. In other words, food inflation alone has eroded global living standards at the same rate as inflation of all consumption did in the five years immediately before the pandemic.

They show the breakdown of the contribution of both to global price rises on their “Chart of the Week”, as below:

Whilst inflation in other sectors (the IMF economists pick out service prices in the US) has picked up a little, it is overwhelmingly the impact of price rises in two essentials that is responsible for the rise in prices felt across the world. And because these two are essentials, with few options for substitution in either for most of us – everyone has to eat! – their combined impact on living standards is being keenly felt across the globe.

That squeeze on living standards, in turn, translates into falling sales of non-essential items. As prices for things we pretty well have to buy increases, those on lower incomes across the world – which is to say, almost everyone – are reducing what they spend on things they can choose to buy. If, as in Britain, your household energy bill has gone up £1,000 in the last few months, there are limits to how much you can plausibly reduce that consumption, especially with winter in the Northern Hemisphere approaching. People have been cutting back on expenditure elsewhere – for instance on going out for meals, or Netflix subscriptions. The price rise is, in other words, inducing a fall in demand and therefore pushing economies into recession. The National Institute of Economic Research reports Britain is already in a recession, and the US and other advanced economies are widely expected to follow suit.

This is not, according to the standard model of the macroeconomy, what is supposed to happen, or how inflation is supposed to operate. The standard models depend, critically, on inflation appearing as a result of changes in demand. If total demand for goods and services is pushed above what the economy can supply – if, for instance, the government borrows and spends a great deal of money – inflation will rise as firms chase that additional spending with price rises, rather than expanding output.

But what we can see now is something like the opposite of this process. Rising prices of specific goods and services, where consumption isn’t an option but a necessity, is causing falling demand for other goods and services as consumer shift their expenditure around. Inflation isn’t occurring from demand factors, but from changes to the supply of critical goods and services.

This has important consequences, the most obvious of which is that the usual mechanisms to regulate demand will no longer work, or at least be very limited in their impacts. Raising interest rates, as many central banks are now doing, is intended to dampen demand in an economy, since borrowing becomes more expensive (and saving more desirable). But if inflation is arriving as a result of supply shocks, changing demand won’t do much beyond perhaps pushing up unemployment. For the Bank of England and other central banks to be pushing up interest rates now risks creating “stagflation”: a recession, combined with high rates of inflation.

Traditional demand management no longer effective

The flip side of this is that, if policies to restrict demand have little impact on inflation so, too, do policies that stoke demand up. In the standard model, for the government to propose (as the British government did last week) to borrow around £150bn more than it planned, and to use this as a subsidy to household consumption (in this case, by keeping domestic energy prices lower than they would have been) would normally stoke up inflation a great deal. This time, the expected effect is likely to be exactly the opposite: any extra cash earned by households will simply compensate them for the loss of disposable income from rising energy prices, rather than adding to their earnings. Overall demand will be returned to where it was (almost) without the price hike. And since the spending is intended to cut domestic energy prices, inflation will automatically be reduced as a result – perhaps by around 4%.

The usual rules of “demand management”, in other words, do not apply in a world with idiosyncratic shocks to supply of the kind we’ve been seeing – and will continue to see in the future as the environmental crisis worsens. The implication is that government interventions against the operation of the market are likely to become more, not less, frequent in future. When price spikes are extreme, as we’ve seen in energy prices, they start to call into question the functioning of the market system itself – if the expected 80% rise in UK domestic energy prices had been allowed to go through entirely, the shock to demand in the rest of the economy would have been disastrous. Price controls, once utterly taboo in polite policymaking circles, are coming back into favour as a result.

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There’s an unpleasant calm before the storm feel to British politics at the minute. Anyone who remembers the period from the end of 2006 through to the debacle of autumn 2008, with the failure of Northern Rock as a half-way point, will be familiar with the sensation: of watching an increasing number of the proverbial warning lights start to flash.

This isn’t, however, a repeat of 2008. (In critical respects, it’s worse – a more fundamental malaise.) Back then, from around 2006 onwards, multiplying defaults in the US housing market were amplified by the complex financial products the same mortgage debts had been packaged into, and then traded between major global financial institutions. Over 2007 and right up to the 15 September 2008 bankruptcy of Lehman Bros, these highly leveraged packages of debt were exploding and bringing down larger and larger financial institutions. By autumn that year, the crisis had spread into the dead-centre of the financial system: the giant, world-spanning investment banks, headquartered in the larger developed economies on both sides of the Atlantic, which now faced bankruptcy. Lehman Bros was allowed by the US government to fail; the shockwaves from the overnight disappearance of one of the world’s largest investment banks were so great as to then mobilise panicked support from the world’s major-economy governments. Various packages were rapidly assembled and, by spring 2009, the Bank of England and the US Federal Reserve had embarked on unprecedented money-printing exercise of Quantitative Easing. (Although sometimes presented as a crisis of “Anglo-Saxon” capitalism, or some similar story about the more risk-taking and unstable US/UK version of capitalism, major European banks like Credit Suisse and Deutsche Bank, had seriously overreached themselves.)

Crucially, the mechanism of crisis here was “endogenous”- meaning it was generated primarily inside the financial system itself. It was a classic debt bubble, as described by Hyman Minsky and others, that was bursting. The years of stability over the 2000s had encouraged the taking of more and more risks by financial institutions in the belief that the bubble would never best. But, as in Minsky’s description of the mechanism for crisis, stability generated later instability: the “Minsky moment” occurred when just a few of those debts could not be repaid – in this case, it was the US “subprime” mortgages that defaulted first – and this wobble was amplified by the huge amounts of debt that the earlier period of stability had built up. That financial crisis was then pushed into the wider economy – a sharp retrenchment of lending leading to less spending which, in turn, pushed economies rapidly into recession.

IMF warnings

This time round, the mechanism is (mostly) running the other way: that succession of disruptions to the real economy might provoke a financial crisis which would act as amplifier for the disruption, but not itself operate as a trigger. In addition, the regulations and additional support for financial systems that have been put in place since 2008 have reduced the presence of “systemic risks”, or at least reduced the systemic risks of the kind that played a crucial role in 2008. The system has been subjected to one, immense shock, when covid first erupted in spring 2020, and, whilst there was a brief wobble in financial markets across the globe, nothing like 2008 recurred.

This doesn’t mean there are no financial risks, with the IMF’s latest Global Financial Stability Report highlighting rising leverage (indebtedness) in corporate and household sectors across the world, the weakly-regulated space of cryptoassets, and the unevenness of the recovery from 2020-21 between the advanced and “emerging market” economies. The latter is already producing strains. Sri Lanka, hard hit by covid, is facing shortages of “food, fuel and medicines” and is heading towards a default on its government debt. The government has approached China and the IMF for additional support, with China already offering a $1bn “swap line” of cheap credit – this arriving on top of the $3.5bn its government already owes to Chinese concerns.

One specific risk highlighted by the IMF across “emerging markets” is a version something that was already seen inside the eurozone in the aftermath of the 2008 crash: the “sovereign-bank nexus” turning rotten. With governments borrowing more, it has been banks in the global south who have loaned the money, leaving them with huge amounts of high-risk government debt on their balance sheet. Should a sovereign default, those banks themselves are at risk of failure. This could lead them to (at the very least) reign in their lending to households and businesses, provoking a recession – and then of course bringing the risk of sovereign default that much closer. Coupled with a slowdown in global trade, and the tightening of monetary policy in the advanced economies, particularly the US, which squeezes export markets for the less-developed world, and makes lending into the less developed less attractive, and the stage is set for an economic slowdown followed, in some cases, by default.

This is a relatively familiar story – one that fits easily into our existing ways of understanding economic crises. Either (as in 2008) a financial crisis causes a shock to demand, provoking recession, or a shock to demand provokes a financial crisis, worsening recession. In both cases the mechanism operates on the demand side. (This, incidentally, is what made austerity such a perverse response to the crash: a crisis driven by a collapse in spending was to be countered by… further cuts in spending.)

Supply-side crisis

Instead, the coming recession is emerging primarily as a result of supply-side factors. The rise in inflation, at least for the large, advanced economies in the OECD, is appearing because of rising import prices of essentials like oil, gas and food. It is not the product of “excess” domestic demand – retail sales are falling in the UK, but the prices paid by consumers are continuing to rise. And then there is the impact of concentration in different industries, enabling mark-ups on goods to stay high, and the hoarding of wealth, particularly of housing wealth: whilst consumers have seen their real incomes squeezed hard by rising prices, many large corporations have enjoyed a bumper few years. House prices, meanwhile, continue their upward march, assisted by the production of vast quantities of new, Quantitative Easing money since early 2020.

In all these cases, the causality runs from supply-side disruptions, led by covid-19, now joined by Russia’s invasion of Ukraine and, increasingly, by extreme weather across the world, that then feed into a grossly unequal distribution of ownership and finally turn into a squeeze on most people’s purchasing power as prices rise faster than their incomes. Throw in, on top of that, rising debt – in part as a result of attempting to maintain purchasing power, but itself turning quickly, via rising repayments, into a squeeze on spending – and the stage is set for a significant downturn in the UK and other advanced economies over the next 12 months.

This may not, as in the textbook demand-side recession, produce huge increases in unemployment, at least in the UK, where the “flexible” labour market has enabled the explosion of bogus self-employment, zero hours contracts, and other more insecure forms of work since 2008. We might well anticipate that if real wages are falling (since prices are rising faster than wages), the incentive for employers will be to maintain existing employment, or at least moderate their attempts to reduce costs by making redundancies. But seeing millions of people maintained in increasingly precarious employment, forced to cut back on their own spending as prices continue to rise, would hardly be a good thing.

The short-run solutions depend on two things, neither of which this government seem willing to achieve: rapid increases in wages and salaries, over and above the rate of inflation, and restrictions on price rises in key goods. Rapid increases in public sector pay, and the National Living Wage, both of which the government can control, would induce pay rises across the rest of the economy. Capping energy price rises in October – which, again, the government can determine – would significantly ease pressure on households. Down the line, a restructuring or simple write-off of unpayable household debt may well prove necessary, freeing up additional consumer spending. A short-run programme of rapid redistribution, from capital to labour and from creditors to debtors, would help get over the immediate hump. In the longer term, a more fundamental shift is needed – away from increasingly expensive non-renewable sources of energy and into cheap, domestically-generated renewables, matched to a programme of efficiency improvements such as providing proper loft insulation.  

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Talk over the last year has been about the disruption to the supply of goods services as lockdowns and restrictions hit production and transport, damaging complex supply chains and creating bottlenecks right the way through the system. As economies opened after the initial shock, rapid increases in demand hit these supply chain disruptions, dragging up prices. This is fairly widely accepted amongst economists as an account of why inflation has risen so precipitously, across the world, from early 2021.

But it’s here that the two or three standard stories start to fall apart. For some Keynesians, these supply chain disruptions were only going to be temporary: a rebalancing of the economy, after covid, as the growth restarted. And in the mainstream Keynesian world, if supply was going to quickly expand, increasing demand – for example, by major government spending increases – was nothing to worry about. Many mainstream economists argued that inflation would only be transitory, as a result. They were wrong.

More pessimistic were the monetarists and the believers in “cost-push” inflation. The former, today a somewhat diminished group, argued that the extraordinary increases in the money supply over 2020, as governments used Quantitative Easing (QE) to help ease their economies through the shock of lockdown (and, implicitly, to help pay for their own expanded spending), would inevitably result in rising prices. “Inflation is always and everywhere a monetary phenomenon,” as Milton Friedman famously argued: he meant that increases in the money supply, more than “real” output increases, would lead to more money chasing the same amount of goods and services, bidding up the prices charged by suppliers. But with QE in operation since 2009 in major developed economies, on a huge scale, inflation over more than a decade in those same developed eocnomies has variously been about as high as today, moderately above zero, and, for a while, actually negative. There is no obvious link between issuing more money and getting more inflation: the causality is not there. Friedman was wrong.

And finally there are those arguing that cost-push inflation would take hold. This depended on the view that rises in a few goods and services would lead to workers demanding more pay to compensate, which would then, in turn, raise costs for businesses and so lead to more price rises. Cost-push could be the mechanism whereby one-off price spikes, caused by the one-off shock of covid, could turn into general and sustained price increases. This isn’t implausible: at the centre of covid’s shock to the economy is its disruption to how work is performed, and one element of that has been the sudden appearance of tight labour markets and at least some workers demanding more pay as a result – or simply walking off their job in the “Great Resignation”.  But labour markets overall, although disrupted in peculiar new ways by covid, are not showing much sign of general wage increases: with inflation rising, the opposite has kicked in, with real wages on average now falling behind price rises. Plausibly, this could change in the future, if pay demands pick up. But we are not there yet and, after a decade of flat or even falling real wages for most people, rising wages today should be the least of anyone’s economic concerns. It’s high time workers took a bigger slice of the pie.

Environmental shocks as a driver for inflation

Instead, as I’ve argued before, I think we are seeing the first years of a new form of inflation, one unknown, I’d suggest, in the years since World War Two when inflation became a general phenomenon in the developed world. (Prior to this point, prices had tended to track the general economic activity – rising in booms and falling in slumps. After WW2, inflation became pretty much continual.) It is price rises driven by successive, seemingly idiosyncratic shocks that have arisen as a result of environmental instability. Covid is the most obvious example of this; if we think of the virus as a disruption to the environment that economic activity takes place in, we can see it has acted as an enormous ecological supply shock – and one whose impacts are unlikely to fade any time soon. But in the same way we can see that (for example) the extreme weather events that have disrupted coffee or wheat production, or semiconductor manufacturing, are also smaller-scale examples of this kind of ecological shock. Each one seems idiosyncratic – some unique event disrupting production at some point in time. They’re nearly always reported like this, as CNN do here for disruption to coffee production – as just another extreme weather event that will fade away and allow normality to return.

But of course we know “normality” isn’t coming back. All the environmental modelling tells us extreme weather – along with desertification and greater constraints on food production – will worsen over time, as the climate rapidly changes. That means we should stop thinking about this or that extreme weather shock as a one-off disruption to production, whose impact will eventually wash out of the system, and as simply one more shock in an environment that produces them at an increasing rate. Prices rise as a result of one shock and then, as that impact fades away, another flood or drought occurs, disrupting prices of some other good or service. Taken in total, the overall impact is to force up prices: inflation remains permanently higher on average, but most likely more volatile, as result.

The existing mainstream models don’t deal with this. Putting up interest rates isn’t going to put out wildfires. (Indeed by making investment more expensive, and so restricting future supply, over the longer term higher interests could actively make inflation of this kind worse.) The best responses involve both building in more resilience to supply – removing just-in-time methods and creating more slack in the system overall. But also, if we have a concern for social justice, attempting to spread the costs of these shocks more evenly, leaning them towards the broadest shoulders. That would mean pay rises for most of those in work and more comprehensive insurance for those not in work – preferably as a form of Universal Basic Income.

And if idiosyncratic shocks are driving general price rises, there is a solid case for specific and selective controls on prices subject to shocks, redistributing the cost of those rises. Interestingly, the UK government appears to be looking at one such mechanism, intended to regulate household gas prices when the wholesale gas price spikes. Their plans are (inevitably) geared towards trying to protect company profits – thus exposing taxpayers to more risk than is needed – but at least in principle the idea of price regulation and social insurance against shocks is a good one to think about.

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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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Both Boris Johnson and Keir Starmer chose to address the Confederation of British Industry conference this week. But far more interesting than the party leaders’ paeans to profit or to Peppa Pig were the comments made the same day by the CBI’s new Director General, Tony Danker. Greeted with pearl-clutching in the Daily Mail, rentagob Tory backbenchers providing the copy, Danker has taken careful aim at forty years’ worth of neoliberal economic policy in Britain, specifically calling out the loss of manufacturing jobs under successive governments. And although reported as an attack on Thatcher, Danker picked his words more carefully: “Since the 1980s, we let old industries die… We have spent the past decades living with these consequences.”

It’s not something Labour like to talk about, but if deindustiralisation under Thatcher is notorious today – informing, still, how much of the North of England is perceived – its second round, under New Labour, was also far-reaching.

Source: ONS

Between 1979, when Thatcher entered office, and 1990, when she left, employment in manufacturing fell by 1.8m. But then between 1997, when Labour’s Tony Blair became Prime Minister and Gordon Brown’s exit from No.10 in May 2010, manufacturing employment fell by 1.7m.

The only periods of sustained increase in manufacturing employment occurred under Conservative Prime Ministers: rather weakly, rising around 200,000 in the nine years from 2010 to 2019; and then more dramatically under John Major, rising 190,000 in just four years from 1993 to 1997.

Deindustrialisation

The big picture here is well-known: deindustrialisation from the late 1960s onwards was common to the developed world, with major industries, from coal mining to car manufacture, shaking out jobs on a huge scale. Thatcher’s destruction of industrial employment was more dramatic than elsewhere, but not completely out of line with the general experience. The second wave of deindustrialisation in the West, apparent from the mid-1990s onwards but accelerating from the 2000s, then helps account for the loss of jobs under New Labour.

An overvalued pound – itself the symptom of government monetary policy – is common to both experiences, with recovery in employment being particularly tied, in the 1990s, to the crash in the value of the pound following Britain’s exit from the Exchange Rate Mechanism.

Of course, under New Labour these lost manufacturing jobs were (in effect) replaced with service sector employment, in both the public and private sectors. Overall employment remained high until the Great Financial Crisis, in striking contrast to the searing rises in unemployment under Thatcher. But the swap of typically better-paid, more secure manufacturing work for typically lower-paid, less secure (private) service sector work was keenly felt and, despite some efforts at geographic redistribution under Labour – whether directly via the old Regional Development Authorities or indirectly via public sector employment – the relative weakening of economies outside of London and the South East became all too apparent once the boom of the 2000s ended.

For the entire period, however, until the last few years, the general direction from government has been consistent: that government itself should, as far as possible, “just get out of the way”. At most, it could compensate for “market failures” in the provision of some essentials – basic infrastructure, say, or education. Labour was more expansive in its spending; the Conservatives, and the Conservative-led Coalition from 2010-15, rather less. When Gordon Brown, as Chancellor the Exchequer, told the CBI conference in 2005 he wanted business regulation to be “not just a light touch but a limited touch”, he was simply repeating the neoliberal commonsense of the time – and no doubt his audience would have nodded along with it.

The contrast with Danker’s argument could not be clearer. Noting the “shot of redemption” new industries give to deindustrialised regions, here he is on making “levelling up” work:

This might be a new line from the head of the CBI, but simply saying the market will fix this is simply not good enough. There are free marketeers in the debate who say government should never play an active role like this. But I don’t know a country in the world – including, and especially, the United States – where governments aren’t active in economic geography.

If we go back far enough we can find heads of the CBI disagreeing with Margaret Thatcher during the early years of neoliberalism. In spring 1981, its then-Director General promised a “bare-knuckle fight” with government over their economic policy. The larger companies the CBI represented were in some “panic” from the 1980 onwards about the impact of mass unemployment and industrial recession on their own profits. Thatcher, for her part, tended to view the CBI at the time as corporatist dinosaurs – bureaucratic managers as responsible for Britain’s presumed decline as the over-mighty trade unions. But for much of the last three decades the CBI has been a reliable defender of the free market doctrine.

It’s a sign of the turn against the neoliberal rules of the game – apparent since the financial crisis, accelerating as the pandemic erupted – that the CBI’s director today will make such a pointed criticism of them, and of how they have failed the last four decades. Would that either main party leader had the same confidence.

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Good news as the Bank of England’s Monetary Policy Committee (MPC) voted to once again hold its base rate steady at 0.1%. This comes a day after the US Federal Reserve Board, the equivalent rate-setter for the US, voted to also leave rates untouched.

After months of warnings that a rates rises was imminent, with inflation now well above the Bank’s 2% target, this was a wise decision by policymakers. As the Bank’s governor, Andrew Bailey, has previously pointed out, with inflation coming in from the shocks to supply over the last 18 months or so, there is little fiddling with interest rates can immediately do:

In considering how to use monetary policy, it is also important to understand the nature of the shocks that are causing higher inflation. The shocks that we are seeing are restricting supply in the economy relative to the recovery of demand. This is important because monetary policy will not increase the supply of semi-conductor chips, it will not increase the amount of wind (no, really), and nor will it produce more HGV drivers. Moreover, tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy.

He’s absolutely right: interest rate rises would do little to dampen the inflation we have today, but would hurt the economy more generally. But this didn’t stop Bailey making hawkish noises over the last few months. Nor did it stop the Bank’s new chief economist, Huw Pill dropping very substantial hints to the FT that he was minded to push for rates rises.

Nonetheless, by a 7-2 vote the MPC’s great and good – which include Bailey and Pill – have decided to hold off on interest rates, no doubt helped along by the Fed’s decision. Not everyone is happy. Some of traders lured into thinking they had a one-way bet on Bank of England rates rises have been whinging to the press, claiming that Bailey’s “credibility” would now be on the line.

Pressure will be on the MPC to shift rates upwards at their December meeting, since it is wholly unlikely that inflation will be coming down any time soon. But it must be resisted: the far bigger risk to the Bank’s “credibility” is, as Charles Goodhart and Majoj Pradhan have argued, if the Bank decides to incrementally raise interest rates but fail to materially influence inflation – as it surely would do.

Bailey has let it be known that rates rises will be heading down the line “in coming months”. But if the logic of holding steady today – that inflation is the result of supply factors, not demand – the same will hold in a few months’ time. For those who take a pessimistic view of likely future supply constraints, the same will hold at any point in the foreseeable future.

Interestingly, the Bank itself also looks increasingly pessimistic. Its forecasts for damage from covid-19 have been revised upwards, to the (in my view, still far too low) level of a 2% permanent loss to GDP from the virus, up from 1% and matching the Office for Budget Responsibility’s assumptions. And the Bank’s view of supply growth in the medium term is low, set at 1.75% as compared to 2.75% it has been estimated as in the decade before the financial crisis.

As this reduction in potential growth suggests, the economic slowdown had happened before covid. What seems likely (although the Bank do not yet accept this) is that covid, alongside the growing frequency of extreme weather, crop failures, and further disease outbreaks as the planet’s climate changes will all turn into hard barriers to supply growth (and therefore long-run growth overall) in the near future. Either way, its short-run forecasts for growth have been revised down for the next four years, hitting just 1.1% growth by 2024 (Table 1.A).

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