Ideology driving the attacks on the incomes of the poorest and universal child benefit

By Anne Kane

Reprising the theme of the June Budget, George Osborne claimed his Conservative Party conference announcement of a simultaneous cut in Child Benefit for higher rate tax payers and an absolute cap on benefit income was ‘fair’. The cuts are not even-handed, let alone ‘fair’: cutting the income of one section of people paying higher rate tax but not others; attacking the living standards of children in families on the lowest incomes. But they do give a flavour of how the fabric of the post-war welfare state stands to be shredded by the scale of cuts this government aims to make.

The Comprehensive Spending Review on 20 October will provide the full taste. The Financial Times urged: “universality is a wasteful principle. Now that Mr Osborne has broken the taboo, he should go further. Free bus passes, winter fuel payments and free TV licenses for the elderly regardless of need look insupportable. Given the brutality of the cuts being demanded of departmental budgets, the coalition could usefully look at other areas of expenditure that have been protected, such as health and overseas aid.” Attacking the poorest while ending not only benefits but services that, while often low in substance, rationed in delivery and of modest quality, have been ‘universally’ available and the hallmark of the post-war welfare state, this is the Conservative-led government’s ‘fairness’.

The “brutality” of these cuts is indeed such that they are invoking a quite Dickensian rhetoric, with David Cameron’s talk of the ‘deserving’ poor and Jeremy Hunt’s moralising about poor people having children they can’t afford. We can expect more of this language encouraging fear, hatred and the delusion that the cuts won’t hit ‘us’. In reality, as the scale of the cuts will hit virtually everyone – except the tiny minority who can afford private health care, school and university education, housing, social care, unemployment protection, income cuts and much more – this fiction will prove impossible to sustain.

Yet, at the same time, those on the lowest incomes will be affected most from a combined attack on public services, jobs and welfare benefits. This will intensify inequality, because social groups are not evenly distributed across the income spectrum: for example, median earnings for full-time male employees in 2009 were £531 per week compared to £426 for women¹ (with a much higher gender pay gap in the private sector, at 21%, compared to the public sector, 12% in the public sector); in a study of 17 OECD countries single parent households were concentrated in the bottom of the income distribution²; child poverty is higher than the national average among BME groups³; disabled people in employment are more likely to be low paid.⁴

Child benefit signals wholesale attack on universality

The decision to means test Child Benefit is made in this context. The proposal to set a cut-off point at the threshold for higher rate income tax, was said by Osborne to mean from 2013 that households with at least one parent earning more than about £43,875 a year would not be eligible. An estimated 1.2 million families in the higher rate tax bracket will be affected (about 15 per cent of taxpayers, covering a range from the threshold of just under £44.000 to the extremely wealthy). The cut will mean a loss of £1,055 a year for a family with one child or £2,500 with families of three. It comes on top of the freezing of Child Benefit for three years, keeping it at £20.33 a week for the first child and £13.40 for subsequent children regardless of cost of living changes.

The website Mumsnet reported seven out of ten respondents opposed the move in an instant poll. Many criticised the logic of the cut: two earner households with both people below the threshold (up to almost £88,000) will be eligible while single earner households (two or single parent) with one person above the threshold will not.

The Conservatives’ apparent attempt to appease criticism by reviving a proposal to introduce a tax break for married couples underlines that the cut is driven by ideology: married couples without children could get a tax break while unmarried couples with them, and with just one earner in the higher tax bracket, would get no tax break and no child benefit. Allowing for a moment that the priority to deficit reduction was reasonable, taxing high earners would be a fairer and simpler way of raising revenue. The government is choosing not to do this, but to use the excuse of deficit reduction to attack universality.

While means-testing has become standard across a range of benefits, a number of universal benefits continue to reflect an understanding of inequality and approach to ameliorating it. If that principle is to be ditched for child benefit, other universal benefits are not safe (as the egging on from the FT, above, indicates), regardless of pledges in the Conservative manifesto (“we will preserve child benefit, winter fuel payments and free TV licenses. They are valued by millions”).

In the case of child benefit, it is paid to women, and universally available, because it is recognised that women take the lion’s share of domestic and child-rearing responsibilities, lose out financially for doing so and, within heterosexual couples where the man is earning, often cannot be assumed to have access to a shared income. These facts have an impact on children and child poverty. The realities of household financial dynamics often become brutally clear upon divorce.

Does the change in women’s economic position over the last few decades make child benefit to higher earners unnecessary? While more women overall are in employment, the positive meaning of this is offset by the reality of unequal pay, mothers having to take part time and lower paid jobs to juggle two ‘jobs’, or having to leave the labour market altogether when employers and the logistics of work don’t adapt to the demands of children. In any case, the cut is taking place regardless of the economic position of the woman in a household.

The case for keeping child benefit universal is strengthened by other government plans: such as the threat to Sure Start and affordable childcare.

In practical terms, a household with an income of just under £44,000 and dependent children while not poor, is not rich, and certainly not in London. Among respondents to the Mumsnet survey 38% said they used it for necessities and 28% said they would have to rethink their lives. One, in a household in the income bracket to be affected, but who does not go out to work herself said: ‘we use the money for things like nappies and milk. We have budgeted the money – it is built into our grocery bill and pays for one and a half weeks shopping each month.’

The Child Poverty Action Group have condemned the cut is a ‘child penalty’ which is irreconcilable with reducing child poverty: ‘It's difficult to see how the Government is going to meet its target of ending child poverty by 2020 through undermining the most popular, widely understood and targeted benefit helping families.’⁵

Despite such protests, the CSR may introduce an even deeper attack on Child Benefit than that announced at the Conservative conference.⁶ This may link to Ian Duncan-Smith’s ‘universal credit’.

Duncan-Smith has said: ‘We have identified that there is a problem here ... come the spending review, this will be brought into context...We're bringing in a thing called the universal credit, which will actually be a device which brings together all this stuff and we'll be able ... to rectify and ameliorate some of these points because of the way it tapers and all that.’⁷ The ‘universal credit’ has been spun as a concession to Duncan-Smith, with the intended implication that it is something progressive. There is no reason to believe this is that case and every reason to believe it is aimed at reducing cost, assisted by losing the focus on specific need that lies behind individual benefit and tax credit calculations.

Benefits cap signals attack on the poorest

Disdain for child poverty was underlined by Osborne’s other announcement – to cap income from benefits at £26,000 from April 2013. This attracted far less media comment – unsurprising as it hits the poorest people, with the least voice, and who are already fairly heavily demonised. It will particularly hit children.

The cap will be on the basis of median earnings after tax and is given an indicative Treasury figure of £500 a week. It will take into account income from unemployment, income support and Incapacity Benefit (ESA), plus other benefits such as Housing Benefit, Council Tax Benefit, Child Benefit and Child Tax Credit, Carer’s Allowance and Industrial Injuries Disablement Benefit. So, regardless of need, the number of children a family has and the costs derived from their household size, or other basic costs, there will be a flat cap on income.

The Treasury roughly estimates 50,000 families will be affected. Many of these will be in London where high housing and other living costs drive up benefit levels, entirely out of the control of recipients. High benefit levels don’t mean high incomes, they just mean high rents. As the FT puts it: ‘They will be larger families, probably with three or more children, living in higher-cost urban areas, and are more likely to be receiving housing benefit for privately rented rather than social housing’.⁸

The Treasury is uncertain about the spending that will be saved, estimating it at ‘hundreds of millions’ a year. The BBC’s Stephanie Flanders quotes £300 million. As she says, ‘not big bucks: for reference, Mr Osborne is expecting to save £3.9 billion...in 2012-14 simply from uprating benefits to CPI rather than RPI’ .

One reason, as Flanders puts it, is that ‘most of the families who now earn a lot of benefits will see their payments cut long before 2013 as a result of the housing and other benefit cuts already in train’. By 2013 these will amount in a spending cut of £8 billion a year. However, the second reason is that many of those who will be affected by the broad sweep of government benefit and tax credit cuts will anyway be on incomes under £500 a week.

Making a feature of this cut in his party conference speech was a purely political act by Osborne, part of setting an atmosphere receptive to the severity of the cuts to follow in the CSR and to encourage the belief that cuts will simply shake up a shiftless underclass of benefit scroungers. Hence David Cameron’s follow up: ‘Fairness means giving people what they deserve – and what people deserve depends on how they behave.’ Those who will get what they deserve include low paid workers in London upon whom the cap on Housing Benefit will provoke what one Conservative minister called a ‘Highland clearances’ in London. ⁹ One to be ‘cleared’, a single mother in central London, explained that the benefit cap will leave her with a rent shortfall of £180 a month, forcing her to move out of the area where her family live and who provide childcare and domestic support.¹⁰

Disabled people not exempt

George Osborne said that ‘Unless they have disabilities to cope with, no family should get more from living on benefits than the average family gets from going out to work’. This suggestion that disabled people will be exempt from the income cap is false.

Disability Living Allowance claimants will be exempt. So also will be War Widows and working families claiming the working tax credit. But income from Employment Support Allowance (ESA) (Incapacity Benefit) will be included. That means that disabled people unable to work will have their benefit levels capped, potentially losing income, their homes and adding to the poverty that disabled people are already disproportionately likely to experience. The process of transferring all Incapacity Benefit recipients to ESA is also intended to cut the number of recipients.

Industrial Injuries Disablement Benefit will also be included in the benefit cap. Other specific benefits available to disabled people, such as Mortgage Aid, have already been cut.

Additionally, income from Carer’s Allowance will be included: this is a weekly benefit, worth a measly £35, that people may be able to get if they care for a disabled person at least 35 hours a week. Poverty among carers is intense: research shows that 72% are worse off since they assumed significant care responsibilities, with 30% cutting back on food or heating and 10% unable to pay their rent or mortgage.¹¹

As far as Disability Living Allowance (DLA), there would have been a huge political storm if this universal benefit had been included in the cap. DLA makes a (small) contribution to the costs of disability and supports disabled people to be independent and exercise a greater degree of personal choice. However, it is not safe: the emergency Budget announced a push to cut the number of people receiving DLA by a fifth. Related benefits, such as the Independent Living Fund, which supports disabled people with high support needs, has already run out of money and is accepting no new applications until at least the new financial year.

There is no doubt that these cuts will intensify poverty among disabled people. They will come in alongside cuts in social care and local authority budgets which threaten to evacuate programmes for ‘personalisation’ of care of progressive content.

Crossing the Ts

Alongside all this, the government is in the process of weakening the safeguards that people may otherwise have found under equality legislation. The government is considering not bringing into force parts of the Equality Act 2010, such as in positive action, equal pay reporting and disability accessibility in schools. Their proposed equality duties for the public sector, currently out for consultation, will allow public authorities to take much less action on equality. If successful, the proposals reverse the impetus created by the MacPherson Inquiry and the disability rights campaigning of the 1990s.

Notes:

1 ASHE 2009, Office for National Statistics

2 The Contribution of Women’s Employment and Earnings to Household Income Inequality: A Cross-Country Analysis, Harkness, June 2010, Centre for Analysis of Social Policy, University of Bath

3 Child Poverty in Black and Ethnic Minority Groups , Willis, CPAG, http://www.cpag.org.uk/campaigns/articles/CPAG_article_child_poverty_in_BME_groups.pdf

4 How Fair is Britain, EHRC October 2010

5 http://www.cpag.org.uk/press/2010/041010.htm

6 ‘Lord Freud also suggested that the government may be planning to undertake a wider reform than simply removing child benefit from higher rate taxpayers as announced by the chancellor’, Guardian 12 October 2010

7 Fairness means giving people what they deserve, Cameron to tell Tory conference, Guardian, 6 October 2010

8 Financial Times 5 October 2010

9 http://www.telegraph.co.uk/comment/columnists/benedict-brogan/8047179/Conservative-party-conference-2010-Let-battle-commence.html

10 Benefit cuts: 'I cried when I heard about the changes. What will I do?' Guardian 6 October 2010

Local Impact of the Coalition’s Policies

By Michael Burke

Opposition to the Tory dominated coalition government’s economic policy is already growing, with just 22% supporting their programme of cuts. This is well before the majority of this year’s cuts of £9bn are implemented, which are themselves overshadowed by the £41bn in spending cuts due next year. The Comprehensive Spending Review on 20^th October will spell out in greater detail where spending will be axed. The unpopularity of current policy seems set to grow.

One of the key areas targeted by the coalition is spending in the devolved authorities, regions and local authorities. Local government spending was cut almost immediately after the election, £2.8bn slashed from the devolved administrations, local government and Transport for London in the first £6.2bn package . Other cuts, such as to transport projects and flood defences will have a specific impact on local spending and services.

Reactionary “Localism”

This is a political choice. The coalition’s aim is twofold: to deflect criticism away from central government and to co-opt others, especially those outside the coalition parties into supporting or defending the programme of drastic cuts. Floundering for a contemporary or historically important example of where spending cuts had actually reduced the deficit, the coalition has met with the BBC”s approval in alighting on the Canadian cuts of the 1990s. Ignoring the five-year domestic recession and rising debt level the Canadian federal government policy caused, even while benefitting from the “Clinton boom” to its South, the main mechanism Ottawa chose was simply to choke off the very large transfers to Canada”s provinces, which were responsible for huge budget items such as healthcare and welfare provision.

Now a host of reactionary commentators, such as the Centre for Policy Studies are urging a new “localism” on the coalition, a call which is echoed by Guardian columnists including Simon Jenkins, who cynically argues that Cameron can “spread the blame on cuts” by devolving welfare budgets to local authorities, and cutting them. This has nothing to do with increased local democracy, but is merely a self-serving attempt to avoid the political consequences of a reactionary and deeply unpopular policy.

Local Effects of the Cuts

That cynicism is widespread, with many local political leaders attempting to blame coalition cuts for their own policies which had pre-empted them. This is true of Boris Johnson in London and the Tory-LibDem coalition in Birmingham, both of which cut spending before their government funding was reduced. Yet the power of local opposition to cuts is demonstrated by the postponement of the measures for one year in Scotland- even if the cynical motivation is the same, with Tories, LibDems and the incumbent SNP all hoping to soften the expected backlash at the May 2011 Assembly elections.

The actions of the mini-coalition leadership of the council in Birmingham are perhaps the most brutal. Almost 26,000 local authority staff (all the council’s non-teaching employees) have been threatened with redundancy and issued with legal notices informing them that their pay and conditions have been cut.

The impact of either redundancies or pay cuts will be severe, not only for the workers and their families and all those who rely on the services provided. But it will also have a direct negative impact on the local economy.

These can be measured in terms of employment and incomes. There are both direct and indirect effects of reducing employment in the public sector. The indirect effect falls mainly on the private sector. This is shown in the table below, from analysis of the Input-Output tables, and is published by the Scottish government . Type I effects in this table are the direct impacts of a change in the employment levels or incomes of the sector. Type II effects include the indirect effect from those changes on other sectors (arising from changes in demand for supplies to the sector, and in demand arising from changes wage totals, etc).

Table 1

Therefore, if 1,000 jobs are cut in public administration the direct effect will be to create 1,410 total job losses mainly as private sector activity is also hit. As jobs are also hit in those sectors the total job losses arising from the initial job losses of 1,000 rises to 1,760.

Likewise, if incomes (pay) are cut by £1mn in public administration, the direct effect will be to reduce incomes by £1.35mn as the loss to spending power multiplies through the economy. But, as incomes in other sectors are also adversely affected, this total loss of income rises to £1.6mn. These losses mainly take place in the locality where the initial cuts are made, since middle and lower income workers spend the overwhelming bulk of the pay locally.

Outsourcing, Privatisation

In the case of Birmingham, any redundancies will cause private sector job losses, and any reduction in pay will have the same effect. The actions of Suffolk county council also directly impact 26,000 workers, although here the mechanism is to cut 30% of the budget and outsource the entirety of its current service provision- in all areas. Community groups, volunteer and charities are supposed to fill the gap. But in reality, the bulk of all outsourced services will go to the private sector, where the compulsion to secure profits will mean either a worse service and fewer jobs, or higher costs than via council provision.

In both the Birmingham and Suffolk cases a policy of reducing public services and jobs in order to boost the profits of the private sector is being dressed up with the rhetoric of “fairness” and “democracy”. There will be more dishonest rhetoric, and greater damage done to the wider economy as the programme of cuts deepens.

As I have already shown in Tribune, the alternative approach, investing to boost the economy, already had a limited but definite beneficial effect in the UK, due to measures taken by the Labour government, and has already shrunk the budget deficit. The fall is a modest one, but that is a function of the very small boost to the economy from the 2009 Budget. The general proposition is that cuts lead to a disastrous slump and deficit-widening, while government spending focused on investment increases wider activity, which reduces the deficit. This is very clear from the different trajectories of Irish and Spanish economic activity and their public deficits – an issue I have looked at in detail on the Guardian’s Comment is Free.

Lessons for Britain’s economy from the stimulus packages in Europe

By Michael Burke

The pattern emerging from the European economies on growth and public finances holds important lessons for Britain as the coalition begins its policy of cuts to public spending. Most European economies adopted some combination of tax and spending stimulus measures in 2009 in an attempt to restore economic activity. By contrast, the Dublin government took the diametrically opposite approach, and in a series of Budget and ‘emergency’ measures embarked on a ferocious reduction in public spending. The verdict on the impact of those differing policies is now in, and holds clear implications for Britain over the next period.

The Impact of Measures To Support Growth

The economic response to any stimulus measures is apparent after a time lag of some months. There is a further time lag as this change in economic activity is reflected in government finances. This is because many taxes (self-assessed income taxes and taxes on profits in particular) are paid some time after the income or profits were made, sometimes long afterwards.

The size and composition of the measures to boost growth varied across Europe. The European Central Bank (ECB) has an analysis of those measures, which were mostly adopted in 2009. (France and Germany also took further measures at the beginning of 2010, which are not part of the ECB’s analysis). Following the ECB, the table below sets out the level of fiscal stimulus measures in some European economies as a proportion of GDP. Alongside we show the impact both on taxation receipts and the overall level of the public sector deficit in the latest data for those countries.

Table 1

The most striking feature is that in all cases, without exception, taxation revenues are increasing and the deficit is falling in those countries which adopted measures to boost growth. By contrast, in the one country which did nothing to boost activity, Berlusconi’s Italy, taxes continue to wilt and the deficit is higher in the first half of this year than in the same period in 2009.

It should also be noted that the size of the stimulus measures has some relationship with the pay-off in terms of the subsequent growth of taxes. But there is not a direct correlation. This is because the composition of the measures is also significant. In Keynesian terms, it is because differing types of stimuli have different multipliers attached; they have a widely differing ‘bang-for-buck’, with investment the highest multiplier of all. In Marxist terms, an increase in productivity relies on the investment of capital - combined with the energy and intelligence of labour. But investment formed only a fraction of the overall stimulus measures in the EU as a whole. The chart below, reproduced from the ECB shows that just 28% of the entire stimulus measures were public investment. The remaining two-thirds were measures to support household consumption and businesses.

Chart 1

But the different impact of these can be noted from the from the fact that the latest forecasts from Eurostat are that EU household consumption will rise by 2.3% this year, while investment (gross fixed capital formation) will fall again, by 2.6%

That is to say, the measures to boost private consumption have had a modest positive effect, whereas the measures to support business activity have not produced any positive result.

Lessons From Madrid

If we take the case of Spanish state, which had the largest package of measures, there has been a vigorous economic response. This seems to have completely by-passed the English-speaking commentators and analysts, who have focused on the meagre recovery in aggregate GDP, up just 0.3% in the first half of his year .

But there has been little analysis of the data, which shows a surge in import demand that masks the much stronger rise in the domestic economy and arithmetically subtracts from it. The final consumption expenditures of households, government and the non-profit sector rose by 1.9% in the first half of this year. Only investment continues to decline, down 2.4% in the first half of the year, hampered by the continuing meltdown in construction. But even here, investment in equipment has risen sharply. In the year since the stimulus measures were announced, investment in equipment has risen by 8.7%. As a result of this rising activity, the public sector deficit has halved in the first 7 months of this year. Rising taxes are overwhelmingly responsible, €18.5bn higher of a total €21.3bn improvement .

Of course the combination of EU, IMF, ratings’ agencies and financial markets have all conspired to strong-arm the Spanish government into adopting massive spending cuts, which were implemented after these data and will impact fully only with their own time lag. A rear-guard action in the form of clinging to cherished investment projects and a modest rise in the minimum wage will not be enough to prevent this capitulation from wrecking both the recovery and the improvement in government finances.

Crucially, over 50% of Spain’s measures took the form of direct investment by the government via public works’ programmes. Of the remainder, the bulk was in tax cuts aimed at the poor, along with the 1.5% increase in the minimum wage. It is this composition of the ‘stimulus’ measures, relying mainly on government investment and boosting the incomes of the poor, that accounted for the Spain’s relative success story. By contrast, initially, the entirety of Germany’s measures were tax cuts, with much more modest results.

Lessons From Dublin

The policy of the Dublin government was precisely the opposite to that of Madrid. Beginning at the end of 2008, a series of Budgets and emergency measures provided a fiscal contraction equivalent to 6.6% of GDP. More spending cuts were made this year more again are threatened for 2011.

The effects have been the reverse of those advertised. Recent editorials in both the Financial Times and the Guardian have highlighted the growing disillusion with the Dublin government’s severe reductions in public spending, arguing that they have not led to any narrowing of the Budget deficit. Only The Economist could find (modest) reasons for optimism, by the simple expedient of accepting the Dublin government’s own forecasts for the deficit rather than analysing the current situation .

The latest economic data show the Irish economy contracting once more in the 2^nd quarter of this year. In contrast to Spain, the domestic sector has contracted at a faster rate than GDP, as import demand has plummeted. Crucially, this domestic downturn has led to a continuing contraction in taxation revenues despite a series of tax increases. Overall, investment is 54% below its peak level and is equivalent to the entirety of the slump in GDP.

Equally bad, there is outright deflation in the economy, with prices falling since the end of 2008. These price falls include wages as well as goods, and therefore lower the taxation revenues on all activity. This has the disastrous effect of reducing the government’s income stream to finance the existing level of debt. In real terms, deflation increases the debt burden.

Normally, ‘Depressions’ are spoken of when output falls by 20% or more. In nominal terms Irish GNP, excluding the external sector, has now fallen for 9 consecutive even though the Euro Area recession ended a year ago. And it has fallen by 24% from its peak. This is an Irish Depression.

Of course, Irish tax revenues have plummeted as a result, and now the public sector deficit is projected by the EU to be 14.7% of GDP next year. This is more than double the initial size of the deficit in response to the slowdown and is now the highest in the Euro Area. This is a policy-induced crisis of the economy and of government finances.

The cuts promised by the collation government in Britain are of the same order as their fellow Thatcherites in the Dublin government.

Structural weakness of UK GDP

By Mick Burke

The British economy grew 1.2% in the 2^nd quarter of this year, following a rise of 0.3% in the previous quarter. It was the strongest quarterly growth rate recorded since the beginning of 2001, prompting the Daily Express to talk of a ‘mini-boom’ continuing into next year.

A more sober consensus is that this may be the strongest growth rate for some time and many commentators, some of whom are very far from the political left, continue to point to the danger that the government’s fiscal policy is increasing the risks to the recovery. Thus for example, according to David Kern, economist at the British Chamber of Commerce: ‘The huge scale of the retrenchment that the government wants to implement, and the decision to cut the fiscal deficit at an accelerated pace, will inevitably increase dangers of double-dip recession. In spite of the relatively strong recent UK performance in the second quarter, the recovery is still fragile and risks of a relapse are high.’

State of the Economy

The cyclical upturn in the economy follows the sharpest British recession in the post-World War II period, a contraction of 6.4% taking place over 18 months (six quarters). The economy has been expanding now for nine months and yet GDP remains 4.5% below its peak.

There is nothing ‘V-shaped’ about the recovery. In monetary terms the real decline in the economy, measured in constant 2006 prices, was £88bn, while the subsequent expansion has been just £20bn - £16bn of that in the latest quarter.

Even this rebound is not a token of renewed underlying strength, but above all a restocking of inventories. The quarterly change in business inventories accounts for 1.0% of the 1.2% growth in the quarter. Even if the restocking has further to run, which seems probable, it is not a sustainable basis for economic recovery without a rebound in consumption and investment.

The slump in fixed investment was a key contributor to the recession and remains its main area of weakness. The charts below highlight this Figure 1 shows the changes in the components of GDP over the six quarters from the beginning of the recession to its deepest point.

Figure 1

GDP contracted by £88bn. This was driven almost equally by a fall in personal consumption and in fixed investment (gross fixed capital formation) which were down £42.9bn and £40bn respectively. Declining inventories also subtracted from growth. Statistically, net exports rose but this was only because the decline in imports exceeded the fall in exports. The only substantive positive contribution to growth came from rising government consumption spending which was up £9.5bn. It should be noted that the latter important government prop to growth has led to a reduction in the budget deficit, not an increase. As SEB has previously shown, government income have risen in response to increased government spending.

Chart 2 below shows the same components of GDP from the beginning of the recession in 2008 to the second quarter of 2010. The main feature is that the decline in investment has continued, falling again in the 2^nd quarter of this year even while other components such as personal consumption have recovered and dragged aggregate GDP higher.

Figure 2

As a result, the decline investment now accounts for nearly two-thirds of the entire decline in GDP to date, £40bn within a total decline of £62.7bn. In consequence, net exports make a reduced contribution to growth, as exports have barely recovered and remain 9.4% below their peak while imports have risen faster. Among the many fantastical forecasts made by the Office of Budget Responsibility was that a 6.1% rise in world trade this year would lead to a growth in British exports of 4.3%. Yet the rebound in world trade already exceeds that forecast, up 7% according to the IMF. Yet British exports are up just 2.7% in the 1^st half of this year, despite a fillip from Sterling’s depreciation.

Since investment is the key determinant of long-term growth the persistence of this private sector investment strike will transform a cyclical weakness into deepening structural one.

Private firms cannot be certain of achieving a profit when demand is subdued. Their response is to cut investment programmes and to attempt to reduce costs. They also look to government to reduce their external costs via lower tax rates and other means (reduced pension contributions, lower entitlements to sickness and maternity pay, abandoning equality provisions, etc.) and above all, lower wages.

The chart below shows the main income categories of GDP; compensation of employees, the gross operating surplus of firms (GOS - akin to profits) and taxes (all in nominal terms). As the chart shows, the GOS fell in the recession, down by 8.3%. It has since recovered but remains well below its peak, whereas taxes have risen and the compensation of employees, initially flat, has recently risen. (This rise is not a significant increase in wage levels but reflects the increases in pay and bonuses in the financial sector).

Figure 3

Political Response

From the perspective of many individual capitalists, all this is a disaster. Profits have declined, but taxes and compensation have risen. Aside from reducing investment and hoarding cash, the response demanded is that the government reduce taxes and take measures to reduce wages. The hue and cry about the deficit masks this central thrust of economic policy. Corporate taxes are being lowered towards 24% (even as VAT rises, hitting the poor) and all types of welfare benefits are reduced in an effort to drive incomes lower.

This is the thrust of government policy. It has the effect not just of increasing short-term risks to the economy but ensuring long-term damage via the continuation of the investment strike. It enshrines a lower level of wages and benefits to the poor in return only for the prospect of increased profits.

But recently, David Milliband argued, echoed by Tony Blair in the BBC interview with Andrew Marr on his biography, that this government economic policy should be accepted!

David Milliband even claimed:"The closest parallel [to Labour’s current situation] I can think of is the Tories’ rethink under R.A. Butler after they lost the 1945 General Election". "Rab" Butler was the prime mover behind the post-War Conservative acceptance of the 1945 Labour government’s reforms, the introduction of the welfare state, the NHS and nationalisation of major bankrupt industries. In this speech, David Milliband signals he is willing to accept the ferocious assault now being organised against workers and the poor. It would condemn the whole economy to prolonged slow growth, with the poorest suffering the most.

US economy - the combination of structural slowdown and cyclical recession

By John Ross

Summary

This article focuses on evidence confirming long-term slowdown, as well as cyclical recession, of the US economy as indicated in the latest release of the 2^nd quarter 2010 US GDP figures.

Introduction

As widely reported, the second estimate of 2^nd quarter 2010 US GDP revised annualised US growth down from 2.4% to 1.6% - i.e. US GDP grew by 0.4% during the 2^nd quarter. The main changes compared to the first GDP estimate, in constant and annualised 2005 price terms, were a downward revision of net exports by -$19bn, due primarily to an upward re-estimation of imports by $14bn, and a revision of inventories downwards by -$13bn. Fixed investment remained essentially unchanged compared to the earlier first GDP estimate, with a revision downwards of -$1bn, and personal consumption was recalculated as $8bn higher than in the first GDP estimate (Bureau of Economic Analysis, 2010b) (Bureau of Economic Analysis, 2010a). An earlier article made a detailed examination of 2^nd quarter US GDP data and therefore only the implications for long-term trends are dealt with here. (Ross, 2010)

Slow recovery

The downward revision of 2^nd quarter GDP naturally highlights how much slower present US recovery is than in previous post-World War II business cycles. Ten quarters into the downturn US GDP still remains 1.3% below its peak in the 4^th quarter of 2007 – see Figure 1. In the previous worst post-World War II business cycle, that following 1973, recovery to the previous peak level of GDP was complete after eight quarters. Unless there is a significant acceleration of growth, US GDP will not regain its peak level until 2011 – meaning at least three years of net zero percent growth.

Figure 1

This slow recovery is, however, in line with a gradual but clear deceleration of long-term growth in the US economy – see Figure 2. The moving 20 year average of US GDP growth has now fallen gradually to 2.5% - significantly below its 3.5% historical average. Reasons the US is unlikely to reverse this trend in the foreseeable future are analysed below.

Figure 2

Fixed Investment fall

The new GDP figures also cast clear light on the issues of whether the recession in the US is primarily created by trends in consumption or investment. A number of analyses suggested that the core of the US economic crisis would be deleveraging by US consumers– see for example (Roach, 2009). If so the decline in US GDP would be centred in US consumption. The present author has consistently argued that this analysis is in error and that the core of the recession in the US is the decline in fixed investment. (Ross, 2010a) This is again strongly confirmed by the new revision of US GDP data.

Due to the significant downward revision of the US GDP figures, and the small upward revision of the consumer expenditure figures, consumption as a percentage of US GDP clearly remains well above its pre-financial crisis level – see Figure 3. Between the peak of US GDP, in the 4^th quarter of 2007, and the 2^nd quarter of 2010, US personal consumption has risen from 69.9% of GDP to 70.5% and total US consumption has risen from 85.8% of GDP to 87.6%.

Figure 3

The 1.8% of GDP increase in consumption as a percentage of US GDP is accounted for by a 0.8% of GDP increase in the share of military expenditure, a 0.6% of GDP increase in the share of personal consumption, and a 0.4% of GDP increase in the share of Federal non-military consumption.

In contrast the share of fixed investment in US GDP has fallen sharply by 3.6% of GDP. The share of non-residential fixed investment has fallen by 2.1% of GDP and the share of residential fixed investment by 1.5% of GDP.

The changes in components of US GDP, in terms of fixed price annualised 2005 dollars, are shown in Figure 4. US GDP remains $172bn below its previous peak level. However net exports, inventories, and government consumption are already above their 4^th quarter 2007 level – by $116bn, $51bn and $112bn respectively. Personal consumption is below its 4^th quarter 2007 level but only by $72bn. The US recession is entirely dominated by the $410bn decline in fixed investment.

Figure 4

The US economy, therefore, has not responded to the financial crisis primarily by reducing consumption, through personal debt deleveraging or other means, but by sharply reducing fixed investment.

Implications for long term US growth rates

A severe decline in US fixed investment, however, does not have only short term effects. As confirmed in the latest data of Jorgenson and Vu, capital investment continues to account for more than fifty percent of US GDP growth – the percentage for the latest period they analyse, in 2004-2008, is 61%. (Jorgenson & Vu, 2010) Under such conditions a severe decline in US fixed investment, of the type seen during the current recession, in practice excludes a rapid resumption of US GDP growth.

The slowdown that has been witnessed in long term US economic growth is therefore likely to continue. The present recession confirms a pattern of not simply cyclical downturn but structural slowing.

In that context the marked acceleration of US GDP growth which took place in 1995-2000 would appear to be a temporary upward fluctuation, financed by large scale import of capital, within an overall context of a long term structural slowdown of the US economy. It would not appear to mark the beginning of a more rapid US growth period.

The above trends therefore indicate that not only short but medium and long term projections for US economic growth should be assumed to be lower than historical averages. The US economy has been gradually slowing in not only a cyclical but a structural fashion.

* * *

This article originally appeared on the blog Key Trends in Globalisation.

Bibliography

Bureau of Economic Analysis. (2010b, August 27). National Income and Product Accounts Gross Domestic Product, 2nd quarter 2010 (second estimate). Retrieved August 27, 2010, from Bureau of Economic Analysis: http://www.bea.gov/newsreleases/national/gdp/2010/gdp2q10_2nd.htm

Bureau of Economic Analysis. (2010a, July 30). National Income and Product Accounts: Gross Domestic Product: Second Quarter 2010 (Advance Estimate). Retrieved July 30, 2010, from Bureau of Economic Analysis National Economic Accounts: http://www.bea.gov/newsreleases/national/gdp/2010/gdp2q10_adv.htm

Roach, S. (2009). The Next Asia. Hoboken, New Jersey: John Wiley and Sons.

Ross, J. (2010a, February 11). The myth of the decline of the US consumer. Retrieved August 28, 2010, from Key Trends in Globalisation: http://ablog.typepad.com/keytrendsinglobalisation/2010/02/the-myth-of-the-decline-of-the-us-consumer.html

Ross, J. (2010, July 31). US 2nd quarter GDP figures - investment remains the key issue for US recovery. Retrieved August 28, 2010, from Key Trends in Globalisation: http://ablog.typepad.com/keytrendsinglobalisation/2010/07/us-2nd-quarter-gdp.html