Michael Roberts Blog

The UK’s finance minister (we Brits call him, in medieval terms, the Chancellor of Exchequer), George Osborne presented his 2013 budget for public finances today.  Last year, Osborne made a complete hash of it and had to reverse and back down on many measures for taxes and public spending measures that he announced.  More worryingly, he had to admit that his main targets, of eliminating the annual budget deficit and reducing the government debt ratio by 2015, could not be met.  He revised the date to 2017.  Today he has put it back yet another year.  The Chancellor’s ‘austerity’ plan is failing.

Indeed, that is what one of the credit agencies, Moody’s, concluded at the beginning of this year when it downgraded the UK’s government triple-A bond rating.  Moody’s reckoned the government could not meet its targets because the UK capitalist economy was still failing to recover from the Great Recession:  “the country’s current economic recovery has already proven to be significantly slower — and believes that it will likely remain so — compared with the recovery observed after previous recessions, such as those of the 1970s, early 1980s and early 1990s.” 

Instead of a declining government debt to GDP ratio, it would continue to rise until 2018.   But what did Osborne say back at the end of 2011?: “The UK is the only western country that has seen an improvement in its credit rating in the past 18 months. When this Government came to office, the country’s triple A credit rating was on negative watch, which is where it was put by the Labour party. I am delighted that it came off negative watch, but we must stay vigilant. The credit rating agencies have said that an abandonment of our deficit plan would definitely lead to a downgrade of the credit rating.”  Well, the deficit plan was not abandoned, but it still happened.

The right-wing London financial daily, City AM, described the UK economy in harsh capitalist terms: “The stark reality is that the UK is a busted flush: the deficit is increasing again, despite accounting shenanigans, and is being financed through quantitative easing in a dangerous game of financial pass the parcel; an army of zombie firms remain addicted to near-zero interest rates, forcing down productivity and preventing a Schumpeterian process of creative destruction and reallocation of capital and labour; the banking system remains squeezed; and the economy remains tied down by regulations, outdated planning laws and high tax.”   Such is the analysis of the UK capitalist economy from a source that wants to revive capitalism. The stark reality of the British economy is revealed in the figure for national income: stagnation.

As with other capitalist economies, recovery has been weaker in the UK after the Great Recession than in any other recovery from previous slumps.

So Osborne has had to admit that annual government borrowing will rise this year, not fall, as the government reduces its forecast for economic growth.  The Office for Budget Responsibility (OBR) now forecasts real GDP growth of just 0.6 per cent for 2013, down from the 1.2 per cent forecast in December.  It also revised down 2014 growth from 2 per cent to 1.8 per cent.  There were big upward revisions to the borrowing forecasts. This year, the government will borrow £114bn, falling to £108bn next year.  The OBR said Mr Osborne’s promise to have debt falling as a proportion of national income would not now happen until 2017/18, two years later than planned.  Indeed, in 2015, the UK government will have the worst budget deficit as % of GDP in the OECD!

What is the answer of the Chancellor?  Not to reduce the cuts in public spending, not to lower the overall burden of taxes and charges on average householders, but on the contrary to increase austerity measures.  Sure, there have been reductions in tax rates for corporations (Osborne boasted in his speech to parliament that the UK had cut corporation tax on profits more than any other major country); and sure, income tax thresholds will be raised in 2014 to take poorer households out of income tax. But the gains from these tax cuts go disproportionately to the richest income earners, as the graph below shows.

And although employer contributions to social security have been reduced by a special allowance, social security charges for employees will rise sharply, pension contributions will rocket and benefits will be decimated.  Indeed, the last VAT increase will cost the lowest-paid workers four times more than any gain from the £10,000 personal allowance, according to the TUC.  And by the time of the next election, low-paid workers with an average weekly income of £196 will be losing up to four times more per year from the government’s increase in VAT in January 2011 than they will gain from the raising of the personal tax allowance to £10,000. The gain from the tax allowance would be £1.09 a week, but the loss from the VAT increase is £4.26 a week.

At the same time, changes to the state pension will bring the exchequer a stealth windfall of almost £6bn a year from 2016-17, mostly paid by public sector employers and employees in the form of increased national insurance contributions.    Getting rid of the contracted-out rebate on state pension contributions will cost public sector employers £3.5bn a year.   And government departments will end pay progression in the next spending round.  So the government cuts corporate tax, but cuts wages in the public sector by removing contractual progression and replaces it with pay scales aligned with “performance”.   As Mark Serwotka, general secretary of the PCS public sector union, said: “Not content with cutting pay, pensions and working conditions, Osborne’s Treasury now wants to rip up civil service contracts to keep wages low for many years to come.”

Osborne made a gesture to those who are demanding more government spending on infrastructure projects to boost growth and employment (and this includes his own Business Minister, the Liberal Democrat Vince Cable).  The TUC estimated that the planned extra £3bn a year for infrastructure (and not starting until 2015) would “boost growth by a measly 0.06%”.  “Worse still, funding it through departmental spending cuts will mean further reductions in public services,” said general secretary Frances O’Grady.

And nothing has changed in the inexorable reduction of basic welfare support for the poorest and most vulnerable in Britain.  The callous so-called bedroom tax on ‘social housing’ tenants who have an ‘extra bedroom’ is just one example.

The reason that UK companies are not investing at home is that corporate profitability is still well below its peak in 2007 and, even more significant, the ROP in the productive sector of the economy, manufacturing, continues its steady decline from 1997, and now hitting lows not seen since the the recession of the early 1990s.

If we compare the UK’s official data for the rate of profit with the Eurostat’s AMECO data, we get a similar story. The UK rate of profit is down 15-20% from a peak in 2007.

Part of the reason for this is that not sufficient capital has been devalued to raise the ROP despite the Great Recession.  But also, even the mass of profit generated is marking time.

Not surprisingly, UK companies are on an investment strike and business investment as a share of total  profit is near its all-time low.

Instead of investing in the British economy, British companies are investing abroad or paying higher dividends to shareholders or buying back their shares to boost share prices.   This is the reason why the easy monetary policy of the Bank of England, whether it is near zero interest rates or massive buying of government and corporate debt from the banks (QE),  is not working to boost growth.  QE has already been larger, relative to GDP, in the UK (22 per cent) than in either the US (13 per cent) or the Eurozone (4 per cent). It has helped mop up 46 per cent of the massive issuance of UK sovereign bonds over the past five years.  But QE has crippled savers, who are losing an estimated £65bn a year in interest forgone, while sterling has lost 17.2 per cent of its purchasing power thanks to inflation.

I’ve just got back from Slovenia, where I gave a lecture on the Euro crisis to the Institute of Labour Studies (http://dpu.mirovni-institut.si/roberts2013.php).  The Institute was set up by a group of  economics  students who support a Marxist analysis.  They are doing a great job in trying to develop Marxist economic theory by inviting leading Marxist scholars and writers to do lectures or participate in conferences.  The Institute is really a spin-off from Slovenia’s unique Workers and Punks University (http://www.dpu.si/), a sort of alternative university formed by radical young people to present an alternative to conventional educational institutions and dominant ideas that there is no alternative to the current society.  The Institute is funded by the Peace Institute in Slovenia, leftist parties and think tanks in Europe.  Anyway, they asked me to present a lecture on the Euro crisis, to coincide with their enterprising launch of a new Slovenian translation of Marx’s Capital Volume 1.

The subject of the lecture could not have been more apt, because tiny Slovenia, a nation of 2 million people wedged along the Alps, between Italy to the west and Austria to the north, is the only Balkan (ex-Yugoslav) country to be in the Eurozone.  Slovenia has been relatively more prosperous than the other Balkan states and avoided the internecine wars that took place between Croatia, Serbia, Bosnia and Kosovo after the collapse of the ‘communist ‘ Yugoslav federation.  It entered the EU and the Eurozone with great hopes of going forward.  Then the global economic crisis erupted from 2007 onwards. Slovenia seemed to avoid the worst for a while.  But now it has been hit with tremendous damage.  The economy is in a deep recession that began in 2011.  The response of all the political parties has been austerity – under the direction of the EU institutions.  That has been a disaster and eventually Slovenians had had enough.  Last November there were huge demonstrations demanding an end to austerity and a plague on all the political leaders.  This heightened when it was found that both the leaders of the centre-right and centre-left appeared have been involved in corruption scandals.

The Slovenian economic crisis is very similar to that of Ireland.  Slovenia’s state-owned banks had been engaged in massive loans to Slovenian companies, mainly in construction and real estate, stimulating a huge commercial property boom that came crashing down when the global economic slump began.  And just as in Ireland, it has been found that the politicians were in collusion with builders and developers to promote a crazy credit boom, taking a slice of the action for their troubles.

For a while this was covered up, but with unpaid loans now reaching 20% of all lending, the banks are close to bust.  A bailout of the banks is now on the agenda and Slovenia needs at least €5bn by the summer to do it to avoid collapse. Of course, the EU and IMF came up with the usual ‘Irish solution’, which was to hive off all the bad debts into a ‘bad bank’  which the taxpayer must ‘own’, while the cleansed banks are given funds to recapitalise, with the aim of selling them off to foreigners or others as soon as possible.  The Slovenian government will then be left with a public sector debt that will have risen from 23%of GDP in 2008 to 70% by 2017, a massive burden on taxpaying Slovenians.

And the level of debt built up in the credit boom has destroyed the ability of the banks to provide more credit and companies funds for new investment.  Non-residential capital investment has fallen by nearly 6% of GDP since 2007, as the Slovenian capitalist sector went on strike or bust.  That drop is second only to Ireland in the Eurozone.  The depression is mega-sized for such a small country.

Since  the protests began, various coalition governments have come and gone.  As I delivered my lecture, a new left-leaning coalition was being endorsed with a female premier, Alenka Bratusek, who is supposedly an ‘expert on finance’.  The new coalition is now faced with finding the money to bail out the banks or going into an EU-IMF ‘Troika ‘ programme as now Cyprus will shortly.  Bratusek says she can deliver economic growth and fiscal austerity at the same time – if so, that will be a first in this euro crisis.  Of course her aim is not really to relieve the burden of Slovenians, but as she says, but to “reassure financial markets” with a program of “three key things: overhaul of the banks; consolidation of public finances in a way that not hurt growth (!); and better management of state assets (does this mean privatisation?)”.

And the Euro crisis continues elsewhere.  As I write, the EU leaders have just decided on a Troika bailout programme for Cyprus, where the banks have been driven to the wall through acting as a conduit for Russian oligarchs’  ‘hot money’ flows.  Cyprus’ economic boom prior to the crisis was based entirely on providing a safe haven for illicit Russian funds, laundering them so they could then be sent back into Russia ‘clean’.  Cyprus attracted $119.7bn of Russian “investment” in 2011 while itself transferring $129.9bn to Russia the same year, equivalent to more than five times the island’s annual output, according to Global Financial Integrity, a US-based money laundering watchdog. Raymond Baker, GFI’s director, said the amounts reflected “round-tripping” of illicit funds exported from Russia to companies based in Cyprus. The funds then flowed back as legitimate investment.

“I don’t think Cyprus has cleaned up its act. It’s still a centre for disguised entities and for money of suspect origin,” Mr Baker said. “I think the amount of legitimate Russian money coming into Cyprus would be minuscule.”    Cypriot banks used these deposits to invest all over the place: in Greek assets (!) and in property all over Europe.  Now these assets are worthless and they are bust and yet they must meet their obligations to the Russian depositors.  The EU leaders were divided about what to do: they did not want to bail out Russian mafia, but they did not want to set a precedent by reneging on bank debts in case this was used by anti-austerity movements, as in Slovenia, to do the same.  Under pressure from the IMF, the EU leaders have decided that the Russian depositors must take a 10% ‘haircut’ on their deposits, so that of the €17bn needed, only €10bn will now come from the Troika.  Even so, that is a huge burden for Cypriots, equivalent to 40% of annual GDP.  This will be agreed to by Cyprus which has just elected a centre-right president pledged to do so, after throwing out a ‘Communist’ president who was also imposing austerity.

And so it goes on.  Italy is politically paralysed and cannot yet form a government because nobody wants to grasp the nettle of imposing more austerity on an electorate that voted by a large majority against it.  And in Greece, the right-wing coalition government twists and turns with the Troika about how to meet the fiscal targets without imposing even more severe measures that could break up the coalition and engender new elections that could return an anti-Troika leftist party to power.  The government is being asked to sack 150,000 public servants over the next three years, putting all of them on 40% pay right now, along with lots of other measures designed to squeeze yet further the population which has already lost 30% of real incomes.  A deal will be reached with the hope of the government that Greeks will just continue to bear the burden until the Greek economy starts to recover.

But with the Eurozone still in recession this year, even France is getting into trouble.  The French official GDP target for this year was 0.8% but this has now been lowered to +0.2-0.3%. This compares to +0.1% EC forecast. In 2012 growth was zero.   The French budget deficit is seen officially at -3.7% of GDP this year from -4.6% in 2012 (both French government and the EC).   This failure will increase the stresses between Germany and France over meeting EU long-term fiscal targets to get deficits and debt down.  All the bailout countries are getting ‘more time’ to meet their targets.  But without growth, it cannot be done.

And that is what my lecture dealt with: why this is so difficult for the EU leaders to achieve.  The title of the lecture was The euro crisis is a crisis of capitalism. I could have added “and not a crisis of the euro”. In other words, even if  the euro was to collapse and EMU states returned to running their own monetary and currency policies, the crisis would not go away and may even be worse.  That’s because the euro crisis is the product of the failure of the capitalist mode of production globally.  It has had the worst impact on the weaker capitalist economists like Greece, Portugal or Slovenia, but it has hit all.

In my view, that is the point that must be remembered.  The crisis is only partly a result of the policies of austerity being pursued, not only by the EU institutions, but also by states outside the Eurozone like the UK.  If that is right, then alternative Keynesian policies of fiscal stimulus and/or devaluation where possible,will do little to end the slump and will still make households suffer income losses.

Austerity means a loss of jobs and services and thus income.  Keynesian policies will mean a loss of real income through higher prices, a falling currency and eventually rising interest rates.  Take Iceland, a country outside the EU, let alone the Eurozone.  Devaluation, or Keynesian-style ‘beggar-thy-neighbour policies have still meant a 40% decline in average real incomes in dollar terms and nearly 20% in krona terms since 2007.

The Euro crisis is product of the slump in global capitalism and the subsequent failure to recover is the same.  Profitability in most capitalist economies is still well below the peak of 2007 (the US is the only exception) and for economies like Italy and Slovenia it is still heading downwards.

In the lecture, I correlated profitability with growth since the trough of the Great Recession (graph below).  The trend line is positively sloped.  Estonia and Ireland have seen the biggest recovery in profitability (through austerity and cutting wages and living standards for the population, along with massive emigration of the unemployed).  As a result, they have had the best GDP recoveries – such as they are.  Where the recovery in profitability has been weak or non-existent, real GDP has contracted the most since 2009.

The correlation between profitability and growth is much better than between government spending and growth.  Countries where government spending to GDP has increased since 2009 (i.e. Keynesian-style stimulus) like Japan and Slovenia (until now) have not grown at all (see graph below), while there are many countries that applied austerity and reduced government spending to GDP after 2009 and they have achieved some growth.  There is no real correlation between growth and austerity (the trend line is almost flat), whatever Keynesian multipliers might indicate (see my post, The smugness multiplier, http://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/).

And the build-up of debt, not just for banks, but also for the non-financial capitalist sector is exerting downward pressure on the ability of capitalist economies to recover quickly, even after cutting jobs, closing down businesses and ending investment to reduce the cost of capital.  The more the growth in private sector debt before the crisis, the smaller the recovery has been.  The IMF graph below shows how the level of private debt has held down the recovery.  Balance sheet stress is heavier on the weaker EMU states and the financial centres of the UK and the US.

Of course, there are special features involved in the euro crisis.  Capitalism is a combined but uneven process of development.  It is combined in the sense of extending the division of labour and economies of scale and involving the law of value in all sectors, as in ‘globalisation’.  But that expansion is uneven and unequal by its very mode as the stronger seek to gain market share over the weaker.  Yet the Euro project aimed at integrating all European capitalist economies into one unit to compete with the US and Asia in world capitalism.  But one policy on inflation, one short-term interest rates and one currency for all is not enough to overcome the centrifugal forces of capitalist uneven development, especially when growth for all stops and there is a slump.

The aim from 1999 with the Eurozone was that the weaker economies would converge with the stronger in GDP per capita, fiscal and external imbalances.  But instead, as the IMF explained in a recent paper (http://blog-imfdirect.imf.org/2013/02/15/europe-toward-a-more-perfect-union/): “During the years that followed the euro’s introduction, financial integration proceeded rapidly and markets and governments hailed it as a sign of success. The widespread belief was that it would benefit both south and north—capital was finally able to flow to where it would best be used and foster real convergence. But in fact, a lasting convergence in productivity did not materialize across the European Union. Instead, a competitiveness divide emerged. As the financial crisis gripped the euro area in 2010, these and other problems came to the fore…. In fact, there has been little absolute real convergence in the euro area. Those euro area countries that had low per capita incomes in 1999 did not have the highest per capita growth rate”.  The graph below rises up from left to right, instead of being flat.

As I show in the lecture, the global slump has dramatically increased the divergent forces within the euro, threatening to break it apart.  The fragmentation of capital flows between the strong and weak Eurozone states has exploded.  The capitalist sector of the richer economies like Germany have stopped lending directly to the weaker capitalist sectors in Greece and Slovenia etc.  As a result, in order to maintain a single currency for all, the official monetary authority, the ECB and the national central banks have had to provide the loans instead.  The Eurosystem’s ‘Target 2′ settlement figures between the national central banks reveals the huge divergence within the Eurozone, although in recent months there has been some reversal back towards convergence.

Those who wish the preserve the Euro project like the EU Commission, the majority of EU politicians and most capitalist corporations, recognise that the only way to do so is extend the process towards more integration.  That means a ‘banking union’ so that all the banks in the Eurozone are subject to control by the Euro institutions like the ECB and not national government regulators.  And, above all, by the establishment of a full ‘fiscal union’, so that taxes and spending are controlled by Eurozone institutions and deficits in one EMU state are automatically met by transfers from surplus states.  That is the nature of a federated state like Canada,  the US or Australia. These transfers reach 28% of US GDP compared to the controlled and conditional transfers under EU budgets and bailouts of less than 10% of one state’s GDP.

The Eurozone does not have such a fiscal union.  Instead, after much kicking and screaming, the Germans and the EU agreed to set up some fiscal transfer funds, the EFSF and now the ESM.  But these are not automatic fiscal union transfers; they are contingent on meeting fiscal targets in a Troika program and national governments can still set their own budgets.  So there is growing opposition in Germany to shelling out cash for what they see as wayward countries who cannot get their public finances in order.

The IMF summed up the challenge for European capitalism in 2013: “2012 was a year of balancing on the edges of cliffs and precipices for Europe. 2013 needs to be a year of climbing mountains—doing the long and hard work of restoring competitiveness across economies to restore growth and making steady progress on completing the architecture of the monetary union.”

But can it be done?  Is there time and will?  Yes, austerity could eventually deliver the required reductions in budget deficits and debt.  But already there have been years of austerity and very little progress has been achieved in meeting these targets and, more important, in reducing the imbalances within the Eurozone on labour costs or external trade to make the weaker more ‘competitive’.  That could take many more years.  Can the people of Greece, Portugal, Spain, Italy, Cyprus, Slovenia and Ireland endure more years of austerity, creating a whole ‘lost generation’ of unemployed young people, as has already happened in Greece and will happen in Spain, Italy, Portugal and Slovenia?

The electorate is losing patience and is angry as the election turnout and vote in Italy shows and the events in Slovenia.  The EU leaders and strategists of capital need economic growth to  return quickly or further political explosions are likely.  And yet, given the current level of profitability, that may take too long before, perhaps, the world economy drops into another slump.  Then all bets are off on the survival of the euro.

My lecture is on You tube at http://www.youtube.com/watch?v=IaWHNaSRzmY&feature=youtu.be

A lot of people fell asleep.

Boy, are the Keynesian economists boiling mad!  Jeffrey Sachs is regarded as a ‘liberal’ or progressive economist in favour of government action to boost the economy and employment.  He came out last week with an article attacking the basic tenets of Keynesian economics and their policy prescriptions for the US economy
(http://www.huffingtonpost.com/jeffrey-sachs/professor-krugman-and-cru_b_2845773.html).  Sachs denied that there were any beneficial effects for the US economy from the short-term fiscal stimulus packages that Obama introduced.  Indeed Sachs was worried that they would only boost public debt to levels that would stop the economy getting back into long-term sustained growth.

Sachs called the doyen of Keynesianism, Paul Krugman, a ‘crude Keynesian’, for advocating just short-term fiscal stimulus rather than longer-term remedies for the current depression.   Sachs says “I have argued against short-term stimulus packages. Krugman has supported them, and indeed argued that they should have been even larger. I have been against temporary tax cuts and temporary spending programs, believing that instead we need a consistent, planned, decade-long boost in public investments in people, technology, and infrastructure.”   Thus Krugman is a crude Keynesian because, says Sachs, “he takes a simplistic and inadequate version of the Keynesian economic approach as his guide for budget policy. Keynes himself was far subtler. In 1937, with British unemployment still around 10 percent, Keynes wrote: “But I believe that we are approaching, or have reached, the point where there is not much advantage in applying a further general stimulus at the centre.” He believed, for example, that more structural policies were needed to address the continued unemployment.*”

Sachs says that crude Keynesianism has failed because “recovery is impeded by structural factors. These structural components are not susceptible to a Keynesian diagnosis or to a Keynesian remedy…and Krugman seriously and repeatedly downplays these structural changes occurring in the U.S. economy. He repeatedly emphasizes that we suffer a demand shortfall, pure and simple, one easily remedied by more stimulus. Yet it’s increasingly hard to reconcile many features of the U.S. economy with this view.”   Sachs cites the long term problems of the US economy as “large-scale offshoring of jobs, large-scale automation of jobs, decline in demand for low-skilled workers, skill mismatches, broken infrastructure, and rising global energy and food prices. These require various kinds of targeted public investment spending, not simply aggregate demand.”

For Sachs, the problem is that fiscal spending that is not aimed at getting ‘structural’ improvements and just at boosting ‘demand’ will not work and the resulting debt from extra public borrowing will damage the economy ‘down the road’ when interest rates start rising.  Sachs emphasises that “The U.S. needs productive public investments, not wasteful spending. We need to modernize our infrastructure, retool our energy system, make our cities more resilient, and help to train a new productive labor force. “

With this approach, Sachs is really expressing the concerns of America’s capitalist sector that Keynesian-type fiscal stimulus will merely drive up debt servicing costs without restoring growth.  If there is to be government spending, let it be on industrial investment and not on welfare payments or public services.   So there is a vested interest behind Sachs’ criticism of Krugman.

It has produced a barrage of responses from leading Keynesian economists.  First, Krugman himself,  taking a line of the innocent victim, answered: “I don’t know what’s happened to Jeff Sachs. He’s been critical of “crude Keynesianism” throughout this crisis, without ever explaining what’s crude about viewing a huge slump in aggregate demand through a Keynesian lens. So his position has been a mystery.” (http://krugman.blogs.nytimes.com/2013/03/08/i-guess-its-a-form-of-flattery/).

Mark Thoma, a strong Krugman publicist, got really upset (http://economistsview.typepad.com/economistsview/2013/03/crude-sachsism.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View%29).
Replying to Sachs, point by point, he retorted: “Take your time, no need to hurry (other than the millions of people who are unemployed and struggling to make ends meet). Krugman and others (like me) say that yes, of course, shovel-ready infrastructure is the first choice, and of course we need to make progress on our long-run issues. But while we are getting that done, why the hell wouldn’t we want to do whatever it takes to alleviate the suffering in the shorter-run?…. because of problems that might happen “later this decade” we should let people suffer now.”  And again on Sachs’ position:  “We all agree on the need to address the long-run issues, and I have called for infrastructure spending again, and again, and again as a way to help the economy is both the short and longer runs. But that doesn’t mean we should ignore other policies — money spent on things other than infrastructure — that might help people in the short-run. Short-run multipliers are sufficiently large, there is substantial cyclical unemployment, and our debt problems are not immediate.”

Arch-Keynesian professor at Cambridge University, Simon Wren-Lewis (http://mainlymacro.blogspot.co.uk/2013/03/the-unlikely-friends-of-austerity.html) also weighed in: “perpetuating and mis-diagnosing the crisis is precisely what those who want to use debt scare stories to reduce the size of the state are trying to do.”  Sachs was really taking the old line of neoclassical economics: “More fundamentally, it is the line promoted – consciously or unconsciously – in almost every textbook that economic downturns are ultimately self correcting… what I see at the moment is very simple. We have demand deficiency, and the normal means of correcting it is broken. We luckily have a backup system, but the levers of that system are being pushed in the wrong direction.”   In other words, we need more fiscal stimulus of any sort not less, as Sachs seems to be advocating.

Kevin Drum was equally upset at Sachs, but he was also unsure what to do (http://www.motherjones.com/kevin-drum/2013/03/any-way-you-cut-it-weve-got-big-economic-problems): “our biggest problem going forward is indeed structural. Unfortunately, I have my doubts that we have any solutions for the structural problems that bedevil us. Sachs offers up a fairly conventional liberal prescription—lots of investment in infrastructure and education, paid for by carbon taxes and various taxes on the rich—and I don’t have any problem with that. I don’t think Krugman does either.  I’m all for rebuilding our infrastructure, and a strong focus on renewable energy would certainly help reduce our vulnerability to oil shocks. But it will happen only slowly, and only if the entire rest of the world does the same thing. At the same time, improvements in technology will be good for productivity, but are going to put increasing numbers of people out of work for good. Better infrastructure won’t really help that. I’m not sure what the answers are.”  Oh dear.

Dean Baker, another tireless opponent of austerity, inequality and neoliberal policies, also launched into Sachs ( http://www.cepr.net/index.php/blogs/beat-the-press/the-strange-attack-of-jeffrey-sachs-on-paul-krugman?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+beat_the_press+%28Beat+the+Press%29).

Baker dismissed the argument that fiscal stimulus will lead to a debt problem: “it is just difficult to see the case for the horror story of the debt that Sachs wants to portray. The markets clearly do not see the problem or they would not be lending the government huge amounts of debt at very low interest rates. Furthermore, we know many examples of other countries, or the U.S. at other times, that have been able to have much larger debt to GDP ratios without any notable problem borrowing money.”   And Baker made a telling point on the structural problems that Sachs promoted, claiming that Sachs missed the main one: “The main reason for the projected slowdown in potential GDP is the slowing of labor force growth. This is partly the result of the retirement of the baby boom cohort and in part the end of the period in which women were entering the labor force in large numbers.” 

But Baker then assumed that this demographic deficit poses no problem. “Neither development poses a crisis in any obvious way or suggests a structural flaw in the economy.”    Yet as Marxist economics would tell you, that should be cause for concern for the capitalist mode of production.  Only labour power can create value, so, other things being equal, a declining labour force will mean less surplus value generation.  As the employed population shrinks so does the total amount of value (unless hour of works are extended or new technology drives up the rate of exploitation).  And in the US, the ratio of employed to those not working in the total population has been falling fast.

This dispute among mainstream Keynesians might seem rather arcane and irrelevant.  But I think it raises some useful pointers on the weaknesses in the Keynesian understanding of the crisis and its policy prescriptions to end the Long Depression in the major capitalist economies.  Can the slump be ended just by more government spending through more borrowing or will that merely boost debt levels and distract from dealing with ‘long term structural problems’ in capitalist economies like the US?

First, as for the efficacy of short-term fiscal stimulus, I refer to my previous post (The smugness multiplier) on the effect of Keynesian-type fiscal multipliers
(http://thenextrecession.wordpress.com/2012/10/14/the-smugness-multiplier/).

The evidence shows that the short-run approach is limited, at best.  For example, as I noted in another post, one study found that the relatively tougher fiscal adjustment in the UK compared to the US has contributed slightly less than half the 5% pt difference in real GDP growth between the two countries over the last three years (see G Davies, J Antolin-Diaz, Why is the US economic recovery stronger?, Fulcrum Research, November 2012).  So US fiscal stimulus only did so much.

Second, the Great Recession was not caused by a slump in ‘effective demand’, especially consumption demand.  It was caused by a slump in investment.   As one capitalist chief, Fred Smith, the CEO of FedEx, recently observed “The only thing that’s correlated 100% with job creation – and particularly good job creation – is business investment. It’s our reduced level of capital investment that has produced our low GDP growth rates and our high unemployment.”  And if that is the case, then monetary injections through QE or more welfare spending will do little to help drive investment up.  

Investment analyst John Hussman makes a similar point (http://www.hussmanfunds.com/wmc/wmc130304.htm): “I’ve often noted that recessions aren’t simply a time when total demand falls short. They are usually a time where the mix of goods and services that is demanded becomes out of line with the mix of goods and services supplied by the economy. In order to get that mix back in line, it’s not enough to simply “stimulate demand” – it’s important to encourage innovation and investment in areas where needs aren’t being met, and to allow the transition and reallocation of resources away from areas that are no longer in demand.”  

As Hussman points out, the correlation between 8-quarter growth in US gross domestic investment and 8-quarter growth in non-farm payroll employment is 80%, with payroll growth lagging investment growth by about 6 months. Notably, that correlation is not driven by linear trends, but instead by a close match between cyclical movements of both, with employment lagging investment activity.  But growth in gross domestic investment has turned lowerand so is moving in the wrong direction if job creation is an objective of economic policy. “All of the QE in the world will not help this situation, but will instead continue to distort investment decisions away from productive allocation of capital and toward brute speculation in financial assets”.

Hussman singles out a key flaw in the Keynesian approach: ” Because savings and investment must be equal, and Keynes has already assumed that investment is fixed, the attempt by individuals to save a greater portion of their income cannot actually result in a greater amount of total savings. Instead, other things being equal, GDP must fall. There may be a million individual private decisions that produce this result, but in the end, savings must equal investment.  The Keynesian solution to this is to offset the desired increase in private savings with a decrease in government savings. Keynesians typically want savings rates to be as low as possible, on the assumption that spending automatically generates production. Keynesian theory really doesn’t embody the notion of scarcity and economic tradeoffs very well, and both government spending and investment enter the model like any other class of spending, with little attention to the productivity of that spending over time.  

So Keynesian “attempts to “stimulate” the economy by suppressing savings and increase consumption, or by pursuing “beggar thy neighbor” exchange rate policies are weak options compared to policies that encourage productive investment, research, and development. A nation’s “standard of living” is reflected by the amount of goods and services that its people can consume as a result of their efforts. A nation’s “productivity” is reflected by the amount of goods and services that its people can produce as a result of their efforts. Ultimately, one cannot increase for long without the other. Robust domestic investment provides the foundation for both.  The only sustainable course to a higher standard of living is to encourage productive investment. “

In an excellent series of articles (http://socialisteconomicbulletin.blogspot.co.uk/),
Michael Burke has shown exactly how a slump in investment has been the main reason for the failure of the UK economy to recover.  The UK government’s policies of austerity have played their role precisely because they have been mainly aimed at reducing government investment.  Unless long-term productive investment is restored, modern capitalist economies will not recover however much extra money is injected or extra government spending takes place.  This is the point behind Sachs’ criticism, however badly put.  He was more perceptive in a recent article in the FT (Today’s challenges go beyond Keynes, 17 December 2012), when he said: “Unlike the Keynesian model that assumes a stable growth path hit by temporary shocks, our real challenge is that the growth path itself needs to be very different from even the recent past.”

But what do Hussman or Sachs mean by ‘productive investment’.  Under capitalism, productive investment is not aimed at delivering extra output for an economy to use; instead productive investment must deliver more profit, with extra output as a secondary outcome.  The Marxist theory of crisis reckons that slumps or recessions are caused by a collapse of investment, an investment strike.  The investment strike happens because it has been no longer profitable for capitalist to invest and so they stop, lay off labour and reduce production and that ‘multiplies’ through the economy as workers lose their jobs and incomes.  Until sufficient profitability returns, capitalist will hoard their cash or increase dividends to their shareholders or buy back shares rather than invest in new equipment or employ more staff.

That is the missing ingredient from both the analysis of Sachs and his Keynesian opponents: profitability.  The evidence that profits drive investment is now well documented.  See the excellent analysis of Tapia Granados, often mentioned in this blog (see http://thenextrecession.wordpress.com/2012/06/26/profits-call-the-tune/).  Recognise the close connection between past profitability and future expectations of profit on investment, as analysed for the US economy in Andrew Kliman’s book, The failure of capitalist production.  See the recent paper by Andrew Kliman and Shannon Williams on US profitability and investment (http://akliman.squarespace.com/writings/).  And in my book, The Great Recession, even I managed to present evidence for profits driving investment.  This is ignored by neoclassical and Keynesian economics alike.