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

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“… weapons producers want governments to underwrite the profitability of their investments. This is precisely the alliance between industry and the state that formed the basis of the military Keynesianism that Michal Kalecki criticized during the 1950s. He showed how, at the height of the Cold War, Western governments subsidized private capital with arms contracts paid for by taxpayers.”

photo flickr

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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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We are living in an age of chronic uncertainty, in which crises pile into one another, plunging millions of people deeper into insecurity, impoverishment, stress and ill-health. There was the financial crash of 2008, a decade of austerity, a series of six pandemics culminating in Covid, with more to follow, and now the ‘cost-of-living’ crisis as inflation mounts, possibly reaching an incredible 20% by the winter.

Nassim Taleb coined the term ‘black swans’ to designate shocks that were rare, unpredictable and had devastating consequences. Now, they are not rare. But they are uncertain in terms of when, where and why they occur and who will be adversely affected. As such, you and I cannot be confident that we will not be among the victims.

There is something else too. It looks as if a large proportion of the population will be affected. It is predicted, for example, that 45 million people in Britain will be suffering from fuel-related hardship this coming winter, bringing more deaths and ill-health. Natural disasters could hit numerous communities, and being in a job is far from a guarantee of escaping poverty or economic insecurity.

Three deductions should flow from this bleak scenario. First, feasible economic growth will not overcome the threats. Second, old policies are not valid for tackling the new crises. Third, we need to build societal resilience, a new income distribution system and a new social protection system. ‘Targeting’ on a minority would be futile and inequitable.

The post-war welfare state was built on a presumption of Full Employment of men in full-time jobs earning family wages, in which there was a need for compensation for ‘contingency risks’ or ‘temporary interruptions of earnings power’. It was always sexist. But the essence was ex post compensation. This is inappropriate today where the core challenge is chronic uncertainty, for which one cannot devise a social insurance system. What is needed is an ex ante protection system, one which gives everybody guaranteed basic security.

But our politicians are failing to appreciate the nature of the challenge and are resorting to yesterday’s answers to yesterday’s problems. First, the Conservative leadership contenders and the Labour leadership are making overriding commitments to maximising economic growth. Keir Starmer says that the Labour motif for the next General Election will be ‘Growth, Growth and Growth’, and that he will only consider policy proposals from the Shadow Cabinet if they promote growth. Meanwhile, an adviser to several Tory Chancellors says the next Conservative Prime Minister will commit to an ‘absolute priority of maximising growth’.

A phrase that comes to mind is the one used by Michael Gove to characterise Liz Truss: they are taking a holiday from reality. Both the Conservatives and Labour are misdiagnosing the nature of the recurrent crises. Both are chasing the mirage of high GDP growth, wishing away the awful ecological implications. Starmer says the free market has failed. But we do not have a free market. It is rentier capitalism, in which most income flows to the owners of property – financial, physical and ‘intellectual’. Economic growth has to be unrealistically high for the precariat and other low-income groups to gain anything. This is why real wages have stagnated over the past three decades, and why earnings have lagged GDP growth, the difference made up by rising debt.

The income distribution system has broken down. Across all OECD countries, financialisation has accelerated, and is fuelling inflation for its benefit. In the UK, financial assets of financial institutions have risen to over 1,000% of GDP, with most finance used for speculative activity rather than for productive investment.

A rising share of income is going to capital, and more is going in rent, in excess profits. Within the shrinking share going to labour, more has gone to the top, again in forms of rent. The value of wealth has risen sharply relative to income, while wealth inequality is much greater than income inequality.

All the time, the precariat grows. What should exercise progressive politicians is that for a growing proportion of the population income instability and insecurity have grown by more than is revealed by trends in average real wages. A result is that millions of people are living on the edge of unsustainable debt. People lack income resilience. Desirable as that is, raising the minimum wage will not solve that, and nor will trying to be King Canute in banning flexible labour relations.

So what are our politicians proposing in this context of chronic uncertainty, a broken income distribution system and a daunting ecological crisis? What marks all of what they are offering is ad hoc window dressing that seems deliberately intended to avoid the reality that we have a transformation crisis on our hands. Tax cuts would benefit the relatively secure, price freezes would cost the public finances and distort markets, raising the minimum wage would bypass the precariat and those outside the labour market, and targeting more benefits to those receiving Universal Credit would merely bolster an unspeakably punitive and inequitable scheme.

It brings to mind what William Beveridge wrote in supporting his 1942 Report that led to the post-1945 welfare state. ‘It’s a time for revolutions, not for patching.’ So far, our mainstream politicians seem to lack the backbone. The strategy should be one of dismantling rentier capitalism and recycling rental incomes to everybody. Above all, in the foreseeable future of chronic economic, social and ecological uncertainty, the base of social protection should be the provision of ex ante security. People – all of us – must know that, whatever the shock, we will have the wherewithal on which to survive and recover.

This is when politicians should be looking at ways of introducing a basic income for every usual resident. It would not replace all existing benefits, and would have to involve supplements for those with special needs. It would have to start at a modest level, but would be paid to each man and woman, equally and individually, without means-testing or behavioural conditionality. Legal migrants would have to wait for a period, which does not mean they should not be assisted by other means. And to overcome the objection that it should not be paid to the rich, tax rates could be adjusted to make them more progressive.

Before coming to how to pay for it, I want to emphasise the reasons for wanting a basic income for all. The fundamental justification is moral or ethical.

First, it is a matter of common justice. Our income owes far more to the contributions of all our ancestors than to anything we do ourselves. Even Warren Buffet admits that. But as we cannot know whose ancestors created more or less, we should all have an equal ‘dividend’ on the public wealth. After all, if we allow the private inheritance of private wealth, there should be a public equivalent. The Pope has come round to that rationale for his support for basic income. It is also a matter of ecological justice, since the rich cause most of the pollution while the poor pay most of the costs, primarily in diminished health. A basic income would be a form of compensation.

Second, it would enhance personal freedom, including community freedom. Although paid individually, that would not make it individualistic. Experiments have shown that when everybody has basic income, that induces stronger feelings of social solidarity, altruism and tolerance.

Third, it would enhance basic security, in a way that means-tested, conditional benefits cannot possibly do. Politicians seem reluctant to offer ordinary people basic security, which they would always want for themselves and their families. Insecurity corrodes intelligence and induces stress and loss of the capacity to make rational decisions. We are experiencing a pandemic of stress and rising morbidity. None of the existing policy proposals would reduce that.

Finally, there are instrumental reasons. Experiments with basic income around the world have shown it results in improved mental health, less stress, better physical health, more work, not less, and enhanced social and economic status of women and people with disabilities.   

Basic income is not a panacea, but it should be part of a transformational strategy, complemented by putting public utilities, most notably water, back in public hands and by rent and energy price controls. There must also be fiscal reform that would help in the fight against the ecological decay while helping to overcome chronic uncertainty. Progressives should accept that taxes on income and consumption should be raised, because they are relatively low in this country and because more revenue is needed to pay for our public services, and in particular reverse the privatisation of our precious health service.

The call for Universal Basic Services is state paternalism and would not help with the nature of the crisis. People need financial resources to overcome the economic uncertainty and lack of resilience. No government can know the particular needs of particular people, and so subsidising some services would be both arbitrary and distortionary.

However, in addition to higher taxes on income to pay for services, we should think of ‘the commons’, that is, all that inherently belongs to every citizen of the UK, beginning with the land, air, water and sea, and the minerals and energy underneath. Over the centuries, they have been taken from us illegitimately, without us or our ancestors being compensated. This includes all the land that has been ‘enclosed’, the forest and public spaces that are being ‘privatised’, the seabed that is being auctioned off, and the oil and gas sold for windfall gains given away in tax cuts for the wealthy.

This line of reasoning leads to the proposal that levies should be put on elements of the commons that we have lost, with the revenue put into a Commons Capital Fund, which would be charged with making ecologically sustainable investments, from which ‘common dividends’ would be paid out equally to every resident citizen.

The initial base for paying for a basic income would be conversion of the personal income tax allowance, which benefits higher-income earners and contradicts the view that in a good society everybody should be a taxpayer. If the revenue from that were put into the Fund, it would provide enough for £48 a week for every adult. Then add a 1% wealth tax, justifiable because wealth has risen from three times GDP to seven times, wealth inequality is much greater than income inequality and over 60% of wealth is inherited, unearned. A 1% wealth tax would be sufficient to pay a modest basic income. And more revenue could be raised by rolling back on many of the 1,190 subsidies and tax breaks given mostly to wealthy people. A modest Land Value Tax, based on size and value of land, is also justifiable on common justice grounds, especially as the value of land has grown from an already high 39% of non-financial assets in 1995 to 56% in 2020.

Then add a Carbon Tax, vital if we are to reduce greenhouse gas emissions and global warming, but which will only be politically popular and feasible if all the revenue from it is recycled as part of Common Dividends. Other levies into the Fund could include a Frequent Flyer Levy and a Dirty Fuel Levy on all those cruise liners and container ships that keep their engines going all the time they are in port, poisoning the atmosphere and causing widespread throat cancer.   

Here we have the basis of an income distribution system suited to the era, with supplements for all those with extra needs. It is an approach that would open up a vista of multiple forms of work, unpaid as well as paid, putting care at its centre. It would be an era in which basic security was regarded as a fundamental right, and it would be one in personal freedom would be enhanced while precarity would be reduced, the precarity that comes from dependency on a discretionary state and undignified charity. At this moment of omni-crisis, we need to march in that direction.            

Postscript:

In their response to the cost-of-living crisis, the New Economics Foundation proposes ‘free basic energy’ for all households. Besides penalising those outside households, this presumes that all households’ poverty and insecurity is due to high energy prices. For many that will be so, but for some other factors may be more important.

It would also raise moral hazards. Some people may not need the full free allocation, but would be inclined to waste what they did not need, because it was free. The amount given free would have to be based on some ‘average’ household. But many are in non-average households, or are outside them more, for whom the free allocation would be too little or exceed our basic need.

Some people might prefer to cut energy use a little if given the choice of spending on food, debt reduction or extra clothing. Better to enable them to make the choice that suits their particular needs.

The NEF also propose to top-up Universal Credit and legacy benefits. But we know these do not reach many of the poor, due to sanctions, the humiliating application process and long delays. What about the millions in need who would be excluded? Much better than relying on paternalistic measures and behaviour-conditioned targeted benefits would be a basic income, with supplements for those with special needs, coupled with a modest wealth tax and land value tax. 

Guy Standing is a Professorial Research Associate, SOAS University of London and a council member of the Progressive Economy Forum. His new book is The Blue Commons: Rescuing the Economy of the Sea, published by Pelican. He is a technical adviser to the basic income pilot being conducted by the Government of Wales.  

photo credit flickr

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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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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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LONDON – Amid all the talk of when and how to end or reverse quantitative easing (QE), one question is almost never discussed: Why have central banks’ massive doses of bond purchases in Europe and the United States since 2009 had so little effect on the general price level?0

Between 2009 and 2019, the Bank of England injected £425 billion ($588 billion) – about 22.5% of the United Kingdom’s 2012 GDP – into the UK economy. This was aimed at pushing up inflation to the BOE’s mandated medium-term target of 2%, from a low of just 1.1% in 2009. But after ten years of QE, inflation was below its 2009 level, despite the fact that house and stock-market prices were booming, and GDP growth had not recovered to its pre-crisis trend rate.

Since the start of the COVID-19 pandemic in March 2020, the BOE has bought an additional £450 billion worth of UK government bonds, bringing the total to £875 billion, or 40% of current GDP. The effects on inflation and output of this second round of QE are yet to be felt, but asset prices have again increased markedly.

A plausible generalization is that increasing the quantity of money through QE gives a big temporary boost to the prices of housing and financial securities, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth trickles through to the real economy, but most of it simply circulates within the financial system.

The standard Keynesian argument, derived from John Maynard Keynes’s General Theory, is that any economic collapse, whatever its cause, leads to a large increase in cash hoarding. Money flows into reserves, and saving goes up, while spending goes down. This is why Keynes argued that economic stimulus following a collapse should be carried out by fiscal rather than monetary policy. Government has to be the “spender of last resort” to ensure that new money is used on production instead of being hoarded.

But in his Treatise on Money, Keynes provided a more realistic account based on the “speculative demand for money.” During a sharp economic downturn, he argued, money is not necessarily hoarded, but flows from “industrial” to “financial” circulation. Money in industrial circulation supports the normal processes of producing output, but in financial circulation it is used for “the business of holding and exchanging existing titles to wealth, including stock exchange and money market transactions.” A depression is marked by a transfer of money from industrial to financial circulation – from investment to speculation.

So, the reason why QE has had hardly any effect on the general price level may be that a large part of the new money has fueled asset speculation, thus creating financial bubbles, while prices and output as a whole remained stable.

One implication of this is that QE generates its own boom-and-bust cycles. Unlike orthodox Keynesians, who believed that crises were brought on by some external shock, the economist Hyman Minsky thought that the economic system could generate shocks through its own internal dynamics. Bank lending, Minsky argued, goes through three degenerative stages, which he dubbed hedge, speculation, and Ponzi. At first, the borrower’s income needs to be sufficient to repay both the principal and interest on a loan. Then, it needs to be high enough to meet only the interest payments. And in the final stage, finance simply becomes a gamble that asset prices will rise enough to cover the lending. When the inevitable reversal of asset prices produces a crash, the increase in paper wealth vanishes, dragging down the real economy in its wake.

Minsky would thus view QE as an example of state-created financial instability. Today, there are already clear signs of mortgage-market excesses. UK house prices increased by 10.2% in the year to March 2021, the highest rate of growth since August 2007, while indices of overvaluation in the US housing market are “flashing bright red.” And an econometric study (so far unpublished) by Sandhya Krishnan of the Desai Academy of Economics in Mumbai shows no relationship between asset prices and goods prices in the UK and the US between 2000 and 2016.

So, it is hardly surprising that, in its February 2021 forecast, the BOE’s Monetary Policy Committee estimated that there was a one-third chance of UK inflation falling below 0% or rising above 4% in the next few years. This relatively wide range partly reflects uncertainty about the future course of the pandemic, but also a more basic uncertainty about the effects of QE itself.

In Margaret Atwood’s futuristic 2003 novel Oryx and Crake, HelthWyzer, a drug development center that manufactures premium-brand vitamin pills, inserts a virus randomly into its pills, hoping to profit from the sale of both the pills and the antidote it has developed for the virus. The best type of diseases “from a business point of view,” explains Crake, a mad scientist, “would be those that cause lingering illness […] the patient would either get well or die just before all of his or her money runs out. It’s a fine calculation.”

With QE, we have invented a wonder drug that cures the macroeconomic diseases it causes. That is why questions about the timing of its withdrawal are such “fine calculations.”

But the antidote is staring us in the face. First, governments must abandon the fiction that central banks create money independently from government. Second, they must themselves spend the money created at their behest. For example, governments should not hoard the furlough funds that are set to be withdrawn as economic activity picks up, but instead use them to create public-sector jobs.

Doing this will bring about a recovery without creating financial instability. It is the only way to wean ourselves off our decade-long addiction to QE.

Robert Skidelsky

The post Where Has All the Money Gone? appeared first on The Progressive Economy Forum.

PEF Council members recently discussed, via email, the government’s plans for social care and its financing. We were unanimous in agreeing on the bad design of the scheme, on the absence of real funding and reform for social care. And we also agreed on the need for a significant shift in the balance of taxation towards wealth. The points of contention are around how the latter should take place and a macroeconomics that might help explain why.

Stewart Lansley

The case for financing social care through wealth is overwhelming. There are two broad options: first, the 2010 Burnham Plan, which means all those needing care would keep their home and a charge made at death. Alternatively, an annual property charge of say 1% pa up to say a maximum of 5%. Both of these could be paid into a social care fund, as argued in Remodelling Capitalism.

The last two decades have seen a great surge in asset values and unearned wealth (what John Stuart Mill called “getting rich in your sleep”), notably in property. The total value of personal wealth in the UK in 2018 was £14.6 tr of which property is £5tr and financial wealth £2.2tr – so a hypothetical one per cent tax on all property and financial wealth would yield £70bn a year, and just on property would be £50bn per year. Any such tax should be charged on assets above a certain level, which would then yield less than the estimates given here.

Yet the tax take from wealth is tiny, with the UK tax system disproportionately dependent on taxing income. In 2015/6, the combined revenue from existing capital taxes – stamp duty on property transactions and shares, capital gains and inheritance tax but excluding council tax – raised about £27bn a year, some 3.9% of all tax revenue.  This accounts for less than one per cent of total private asset holdings.

The case for higher taxation on personal and corporate wealth is being widely recognized. Before the 2017 November budget, the National Institute of Economic and Social Research proposed an annual tax on net wealth (assets minus liabilities) above £700,000 (including residential property) to replace three existing capital taxes on inheritance tax, capital gains and dividends. A tax set at 2 per cent would raise £72 billion (gross).

The scheme would may have been unpopular in 2010, but might be much more popular now given that the public accept that we need to find a way of paying for social care and are unconvinced by Johnson’s plan. This is surely an area where KS should be out with all guns blazing!

Danny Dorling

I was one of the people earlier suggesting taxing wealth would be difficult. I don’t think I explained myself well. It is not the taxing of wealth that is difficult, that is easy. Ireland showed how it could be done on property with a progressive property tax where the percentage taken rose according to the value of property. They did it in an extremely short amount of time when forced to by the Troika in the Eurozone crisis at the start of the last decade. When that process began, they had no “gazetteer” – no universal register of properties – let alone any decent sets of valuations.

The best systems of wealth taxation make paying the tax annually part of the way you claim and maintain a record of your ownership of property. You can chose not to pay the wealth tax if you wish to gift that wealth to the state. You can also argue that your property is worth less than the valuation of the state. However, when you then come to sell that property, you may find that buyers don’t wish to pay more than you have said it is worth. Wealth taxes should also decrease the value of property which would not be a bad thing. So my concern is not with the idea of wealth taxes.

My concern is with suggesting it – and suggesting introducing a wealth tax to pay for the NHS/Social Care, without suggesting all the other mitigations you would do at the very same time that would make it appear plausible to many people.

But so many mitigations are needed that you end up needing a whole manifesto to explain them. I’ll give just one example. A large group of people in their 40s and 50s who have managed to get a mortgage now talk of their home as their pension. Their various precarious jobs have meant they have no decent pension, and although they may now be being auto enrolled into a pension. It is not one where they can envisage a future of being able to “keep the thermostat on 17 in their old age” as it was recently put to me by one home owner (still paying off their mortgage, and with the annual average income of the UK). What they plan to do is sell their home when they retire, downsize and use part of the savings to (among other things) pay the gas bill in winter.

If we suggest a wealth tax, taxing away a slice of what they see as their savings every year without also suggesting how pensions will be improved, then in the mind of someone in that position your policy will condemn them to an old age of being cold. Gas and electric bills have just risen very quickly so these bills are on peoples’ minds at the moment. In effect, for them a wealth tax is an annual tax on their future pension. And quite a low pension at that.

I think this is one of the dangers of talking about raising a new tax to pay for one thing, when all the others things are not considered.

My preference is to keep taxing and spending separate, not hypothecated. So talk about rebalancing the tax system to make it fairer – with the emphasis always on fairness. And I would bring the overall level up to what is normal in Germany (almost identical to what Labour promised in their 2019 manifesto). Talk about bringing in taxes on wealth solely for the purpose of increasing fairness, not to pay for a particular policy, but also partly to allow other less fair taxes to be reduced, and partly to allow overall public spending to be at normal European levels.

On spending, we shouldn’t talk too much about the amounts of money in each sector, but much more about what it is you actually want to see. Something that is very good need not be very expensive. The Finns spend less as a share of GDP on their school than we do on ours, but their schools are much better. In contrast, we spend an enormous amount on our now almost entirely privatised universities, but we don’t see that as a tax. In the USA, they have the highest spending on health care in the world – and in general poor health.

I’ll stop there, but hope it helps explain my worry about suggestions of introducing a wealth tax to pay for health and social care.

Josh Ryan-Collins

I agree governments should not hypothecate (and I’m amazed HMT broke its own golden rule on that in this case) both because it can lead to less politically popular services getting neglected but also because it embeds the idea that we can’t pay for stuff unless we raise the money first which is simply not the case in sovereign currency issuing nations.

Having said this, the Tories have hypothecated and they have just implemented the biggest tax rise in living memory indicating (perhaps) a seismic shift towards the centre on economic policy. This threatens Labour in quite a serious way if they can’t differentiate themselves effectively.  The way to differentiate is to focus less on the amount of tax needed and for what (as you say Danny and Sue) but on how that tax should be raised and from whom in a way that is both socially just and economically sensible.

It is not sensible to be withdrawing purchasing power from workers and businesses when the economy remains fragile. But the even bigger issue is that tax needs to be seen as a key tool via which issues like inequality and falling productivity can be addressed via pushing against economic rents and favouring investment and wages.  This NIC tax hike broadly does the opposite. If you make your money from rental income, interest fees or capital gains, don’t pay a penny more, in contrast to workers and firms. The chart below from Resolution Foundation shows how crazy the situation is:

Will Hutton

I am all for taxing capital and am in violent agreement that too much capital taxation has been allowed to atrophy: no revaluation of residential property since 1991 so that council tax yields a fraction of the old rates, de facto semi-voluntary inheritance tax, too low capital gains tax, etc. During the 1945-50 Labour government tax on estates ran at 10 per cent of all tax revenues. There is huge scope to increase capital taxes, and as Josh has argued, property is immovable.

Stephany Griffith-Jones

I agree with Will on practically all points – including the extraordinary absence of  a revaluation of residential property since 1991, which includes periods when Labour was in power! An effective and fairly high inheritance tax is very desirable, as one of the structural problems is perpetuation of wealth concentration via inheritance.

Stewart Lansley

Just on Danny’s points:

1. ONS wealth figures are net wealth and any wealth tax on residential property would be net of mortgage debt, so Danny’s examples would not be affected. 

2. Yes, we must do more to make the existing taxation of income fairer, for example by reform of National Insurance system, but this would not be enough on its own to create a more equal society. 

3. As I argued in Return of the State, we are close to the limits of income taxation, So if we want to raise funds for improving social provision we need to turn to  asset-redistribution, though this would require taking public with us. Wealth is much more unequally distributed than income –  Top fifth hold 64 % of personal net wealth and 80% of financial wealth – and unless we tackle that we will not be able to reduce inequality and poverty on a sustainable basis.  It’s perfectly possible to design a wealth tax system that is concentrated on top wealth holders. 

Geoff Tily 

The TUC have argued that reforming Capital Gains Tax is a much fairer way to fund social care than hiking workers’ and businesses’ national insurance contributions.  But like President Biden’s notion of “work not wealth”, I want to make a broader macro argument that the interests of wealth and of labour are fundamentally opposed.  

My Keynes Betrayed was concerned with restoring Keynes’s conclusion that the long-term rate of interest must be set permanently low. Since I have been at the TUC, it occurs to me that this rate should interpreted more broadly as the return to capital/wealth and should be compared with the return to labour. Keynes’s conclusion that “we must avoid [dear money] … as we would hell-fire” (Collected Works XXI, p. 389) then means that we orient the system to the interests of wealth at our peril.    

The below chart shows a measure of the real (inflation-adjusted) long-term interest on US corporate debt, going beyond the normal comparisons of rates on government bonds. Even this doesn’t capture well the experience since the global financial crisis, but plainly we know full well what has happened to the broader return to wealth versus the return to labour over the past decade. (I suspect US investment grade corporate debt has simply become increasingly regarded as retreating from risk – and this goes right back to dot.com bubble.) “Dear money” can be seen coming in rapidly from 1979 (in parallel to the ‘Volcker shock’), and interest rates were sustained some way above the post-war levels (and back to the 1920s).  

US real interest rate

Josh’s chart from the Resolution Foundation is a nice one, not least because the timing of the key dislocation matches well the restoration of dear money on the above. Above all, this rise in returns to assets is a consequence, not a cause, of dear money.

Previously I had argued (following the General Theory chapter 22) that macroeconomic disarray comes in through overinvestment, but now I like a broader over-production/under-consumption (or rather, under-compensation) approach (it’s trade union friendly, has recently been revived by Matthew Klein and Michael Pettis [though Stuart Lansley had done so nearly a decade sooner], and is likely to be more correct!). Rather than spending to compensate for the underspending of labour, the wealthy speculate and so exacerbate over-production. This leads to unsustainable private debt, and ultimately meltdown; the fear here is Quantitative Easing has simply kicked the can down the road, with the risk of meltdown appearing later.    

Tax on the wealthy can be part of the solution (as in the opening of the final chapter of General Theory), but to restore the balance to labour requires wholesale macroeconomic change that operates on a global basis. Hence my recent argument that ‘internationalism begins at home’.  

We were convened in the first instance as a group inspired by Keynes, so I hope colleagues engage with this argument. On my view, it’s how Attlee, Dalton, Gaitskell, Bevin, Blum and FDR understood the world, helped them successfully to win office, and to begin to make real change.    

Jan Toporowski

The real con trick in the government’s proposals is the claim that this is a solution to the social care crisis, when the funding for that is being explicitly postponed until the difficulties in the NHS have been overcome. So the social care funding is conditional on that same funding being enough to overcome NHS difficulties, a most unlikely prospect. The electoral con is the message that the residual of working people on proper contracts will get in their payslips that their money is going to be spent by the government not once but twice to solve both health crises.

Guy Standing

One cannot sensibly discuss how to pay for social care without a systematic view of what care entails, which encompasses its messy definition, who should receive it, who should receive money being spent on it, how they should receive it, and so on. Once one opens the Pandora’s box one should realise that any hypothecated approach, as implied in what the Tories are doing, makes no sense whatsoever. Hypothecated taxation opens the door to the worst features of utilitarianism, 

The Government’s tax and NI rise is doubly regressive, since it lowers the earning of most paid carers at a time when their income and morale are abysmally low. If a government does not alter the structure of the so-called ‘social care industry’, the primary beneficiaries of pouring more money into it will be the private equity interests (mostly foreign capital) which are plundering money being spent on social care. Removing private equity should be a top priority. And any funding scheme that relies on means-testing will accentuate what is a highly regressive scheme, not reduce it.

More generally, there must be a huge shift in taxation from earned incomes to wealth of all kinds and to incursions into the commons, which means much increased eco-taxation. Ironically, incomes are nowadays the least taxable, with the UK being a rank outlier in the very high extent of tax evasion by high-income earners. But changing the incidence of taxation should be the secondary concern to the need to restructure the care sector. The social care crisis is a structural one, not primarily a fiscal one. Perhaps a Royal Commission should be set up to devise a proper plan for an integrated, universally-based system.

Sue Himmelweit

I agree strongly with Danny about not muddling up comments on taxing and with those on spending. But I don’t think that means that Labour should comment soley on alternative forms of taxation.

The first thing that has to be said about the so-called plan for social care is that it isn’t one, that it won’t be doing anything to improve provision nor even get back to the already failing system that we had in 2010. As the party that stands for protecting the vulnerable by collective provision this must be Labour’s first call. If they are commenting on a policy on social care, their first comment should be on social care and the need for it to be adequately funded (in the sense of enough spent on it), not on different forms of taxation. This should be true of PEF too!

Labour should also make clear that we could benefit from an overhaul of the tax system, so that it taxes, at the very least, gains in wealth. Reforming CGT so that is charged at the same rates as income tax with no specific tax allowance (except to exempt gains too small to count) would be a first step. And I would also like to see inheritance tax replaced by a receipts tax covering all ways of receiving wealth, also taxed at income tax rates (with some allowance for spreading a windfall over a few years). This way all ways of gaining wealth would be taxed at a reasonably high rate. This to me seems easier and more logical than taxing wealth itself at a low rate.

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I’ve written elsewhere on what a poor way the National Insurance Contribution (NICs) rise would be to fund the contribution cap, amounting to a perverse redistribution from mainly younger and poorer workers to at least some better off elderly. Almost any tax alternative currently on the table – from increasing income taxes, with its broader base, to Capital Gains Tax increases, to introducing a proper, progressive wealth tax – would be fairer and preferable.

That the NICs rise currently polls ahead of other options is a tribute to the framing of NICs (and the polling question asked!) more than anything else: it isn’t called a tax, and there’s still a firmly held belief that NICs payments go into a grand national pot that people can draw from later. This was the original intention of the system, dating back to the 1944 Beveridge Report and beyond, in which “national insurance” would act as a genuine, contributory insurance system, providing for those who had paid in during times of need. It has never really functioned like that: the Treasury, as its wont, has always treated NICs payments as just another flow of tax payments (with some slight complications).

But the seeming popularity of NICs rises is likely to prove fragile if the case against them is made, and – crucially – if the case for an alternative is clearly presented. Labour have now indicated that they will oppose the hike, but to clinch the argument they will need to present an alternative. Otherwise, it really will look like the party is just moaning about the world: you can’t look like an alternative government if you don’t have alternative policies. And if they can bite the bullet on wealth taxes for social care – in whatever form here – it can force open the argument about wealth and taxation more generally: a must if the party is to go into the next election with something approaching a serious, long-term programme to solve Britain’s chronic economic problems. And wealth taxes, as the polling evidence keeps showing us, are popular. (Unsurprisingly: by definition, almost none of us are in the top 1%…)

Party Conference

Labour Party Conference, returning to Brighton at the end of the month after a two-year covid-induced pause, will be the biggest opportunity the party and its new leadership has had to date to present its case. You don’t often get a free hit at the following day’s front page headlines as the Opposition, but that’s what Conference can offer, Keir Starmer has offered some rather broad hints about his own speech, and of course it’s the leader’s closing address that gets the bulk of the media attention. But Shadow Chancellor Rachel Reeves’ own speech is going to be worth keeping an eye on. She has already marked out a few key commitments, including a strikingly anti-neoliberal Mariana Mazzucato-style policy to support domestic supply chains and jobs. This was particularly noteworthy: the first time that I can recall Labour offering a genuinely post-Brexit policy under Starmer’s leadership. Now that we have left the EU, there is a seam there to be mined – with a bit of policy imagination.

But the challenge for Reeves and her team in three weeks’ time will be to not only throw in some headline-grabbing policy announcements – essential for the front pages – but to start to create a convincing story about what sort of economy the next Labour government wants to shape. Credibility doesn’t come from parroting the economically illiterate nonsense that clutters Westminster political reporting; it’ll come from having a clear, simple story that potentially millions of people can grasp and understand. The Tories’ NICs hike has given Labour a free gift, the chance to show they are the party that will look after your pay packet. Tax the wealthy, not the workers has a certain ring to it.

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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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