Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 5 of 9 – The Two Great Traditions in Western Economic Thinking

In studying what actually happened to the Japanese economy and then testing various explanations

for consistency with the observed data, Professor Richard Werner of

Southampton University has placed himself firmly in the first of the two great traditions in

Western economic thought. That first tradition, dating from the time of

Adam Smith, derives economic conclusions from detailed observation and

inductive reasoning based upon the observed facts and data analysis. The

second tradition, most highly developed in the 20th century with the

development of mathematical economic models and more lately computers,

develops a body of deductive reasoning based upon stated theoretical

propositions.

The “bottom up” tradition of observing what is happening, building

economic understanding on the foundation of the observed circumstances

or measured data, and arguing from the observations or the data to the

economic theory is exemplified by Adam Smith’s, The Wealth of Nations.

An example of his technique is his reference to the productive power of

specialisation, which he illustrates by referring to the workers in a pin

factory, and demonstrating how, by breaking down the elements of

production into their constituent parts, a few specialised workers can

create thousands of pins a day when one man could hardly produce one pin

per day on his own. Smith’s book is a major illustration of the major

scientific principle – revived in the Renaissance – of learning by observation,

extracting the particular principle from the general, and basing theory upon

precise, real-world, observation.

The one common factor in the work of Adam Smith, and of John Maynard

Keynes, Osamu Shimomura, Kenneth Kurihara and Richard Werner is that

they all belong to the first tradition in economics, the derivation of valid

theory from detailed observation. Smith in the pin factory; Keynes in his

observation that labour markets, left to market forces, do not produce full

employment; Shimomura deriving the economic model for Japan from his

observation of the productive force of credit creation in the USA from

1938-44; the Japanese-American Kurihara – examining and discussing the

Japanese economic miracle in close-up while acting as the Fulbright

Professor to Tokyo University in 1965; the German-born and Japanese-fluent

Werner in Tokyo, working from the Bank of Japan financial data about

credit creation in Japan, and analysing it into its three key functions of

investment credit, financial credit and the presence (or lack of)

consumption credit, and then proving the predictive linkages using Granger

causative analysis – the work of all these economists is located in the great

inductive tradition of economics.

The second and more recent tradition in Western economics is the “topdown”

approach. This starts from explicitly stated but theoretical

assumptions and then proceeds logically from these to policy

recommendations, using deductive reasoning and highly developed

mathematics. A number of assumptions are made – that consumers and

investors act within perfect markets, with access to perfect information, in

a world in which perfect information has levelled out local differences. On

this basis, deductive logic arrives at economic models which appear to have

great logical validity but which – as Keynes asserted – may bear little

relation to reality. In view of the imperfect outcomes of this second

approach, as evidenced by the declining fortunes of many western

economies, there is much to be said for a return to the methods used by

Adam Smith and his great successors.

Three Practical Illustrations of the Use of Credit Creation

As we have seen, if credit creation is left to the tender mercies of self-interested

commercial banks, credit will be largely devoted to gambling on

property creating a housing and other asset bubbles so as to maximize

profits for private shareholders while the real economy languishes for want

of adequate liquidity and investment capital, and the economy as a whole is

handicapped by a shortfall in effective demand.

An incoming Labour government, however, fully understanding the use of

credit creation in the public interest, could resolve many outstanding

problems. We provide three examples of the way in which this would work

to achieve quite different kinds of objectives.

The Acceleration of British Economic Growth Through Higher Investment

This aspect of central bank credit creation is by far the most potent policy

within a government’s control. It would allow the government to create

earmarked investment credits, cost-free, for use by SMEs and other private

companies to ensure the fulfilment of the Government’s economic, social

and environmental policies.

The provision of these funds would be directed by the Bank of England,

reflecting advice from the Treasury – a technique described as “Window

Guidance” when used by the Bank of Japan in using similar mechanisms in

the 1960s and 1970s. There would need to be a bank which was, or ideally a

number of banks which were, prepared to use its local branches as taps for

local investment (as the Sparkassen in Germany are) and not just – as

currently occurs – as drains to collect local saving, taking it away for

whatever fashionable policy use the London HQ decides.

The initial creation of credit could be at the level of about 10% of GDP, that

is about £150 bn a year; multiplier effects might create an eventual new

level of commercial and industrial funding of about £300 billion. We would

expect these funds to be initially used to provide an improvement of about

£100 billion in business liquidity, about £100 billion in early new plant and

equipment investment and about £100 billion in funding higher levels of raw

materials, working capital and work in progress. If the usual level of tax

take of 42% applies to the new investment and to work in progress,

government revenue receipts could increase by about £84 billion – an

excellent return to government in addition to the overall benefit to the

economy as a whole. Furthermore, that new investment would produce a

permanent increase in output of about an extra £100 billion a year, equal to

a permanent increase in GDP of about 6.7%, and a permanent rise in

government revenue of about £42 billion a year. We think these changes

would occur within about two years.

Some economists have traditionally argued that, because an extra job in

manufacturing industry has historically created another job in the service

industries, the final effect could be twice the initial stimulus. It is indeed

likely that placing the economy on a higher growth path will enable the

under-performing assets and spare capacity in our industries to respond to

the higher levels of demand created by this stimulus.

The experience of other countries shows that investment credit economics

works by creating wealth in the productive sector of the economy. The

loans made are almost completely repaid (the failure rate is typically about

2.5%) out of the growth of the economy resulting from the additional

investment. The failure rate of these loans matters little in any case

because the loans cost nothing to create; their consequences matter,

however, because they produce their targeted effect in reducing poverty,

stabilising the banking system, and creating widespread prosperity through

many flourishing private industries in all the areas of the country.

The increase in output would obviously negate the risk that a substantial

increase in the money supply could be inflationary, as Keynes recognized

and as the Japanese experience in particular demonstrates. The

consequence of the increased money supply could well be a fall in the

international value of the pound, which could only be helpful in

ameliorating the competitiveness problem of British industry and in

ensuring readily available markets for increased British production.

Unemployment will fall to a low level. Social security payments will

automatically reduce as fuller employment becomes the norm and

Government income will cease to be disappointing, ending the need for

austerity in government expenditure and bringing to an end all of its ill

effects for our people.

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 4 of 9 – Shimomuran Economics

The body of developed policy that underpins Asian industrial and economic

success is not understood in the West, yet it was clearly foreshadowed in

the work of the greatest western economist of the twentieth century, John

Maynard Keynes. It is a sad reflection on western economists that the

Keynesian insights were most fully developed by the great Japanese

economist, Dr Osama Shimomura 1910-89, whose work has only recently

come to the attention of western economists by virtue of the sustained

efforts over four decades by the second author of this paper.

An indication of the extent to which Shimomura has been overlooked in the

West is the fact that his works have never been translated Into English

except by the Indian Statistical Institute1, (and even in that work the

Development Bank of Japan has edited out Shimomura’s key formulae).

Shimomura enjoys, however, a towering reputation in his own country. The

Development Bank of Japan offers a “Shimomura Fellowship” to

commemorate his life on the basis that “during his long career as an

economic scholar and critic, Dr Shimomura rose to become Japan’s most

influential post-war economist, founding a school of thought based on the

“Shimomura Theory,” which attracted numerous followers.”2

He was acknowledged, within Japan and during his lifetime, as the “brains

behind the Japanese economic miracle” – the most successful national

economic growth plan of the 20th century. Five of his published works

became available in the British Library last year but there seems to be little

interest in how Japan, in the course of a few decades, progressed from the

war-damaged, impoverished country of 1945 to become one of the most

highly developed and powerful industrial economies in the world.

Shimomura’s major contribution to macro-economics is his economic growth

model, the basis of which was that the total level of Japanese investment is

equal to the natural investment level (that is, investment financed by

savings) plus the additional investment financed by credit creation

originating at the Bank of Japan. The model illustrated the range of that

additional credit-created investment as no less than 10% to 15% of national

income a year.

It is generally agreed by most economists, following Keynes, that

investment is the major key to economic development and growth.

Shimomura’s economic model applied an extension of the Keynesian

analysis and showed that an economy could selectively increase its

investment level through an increase in investment credit at the central

bank, if that credit was earmarked for commercial and industrial

investment. The rapidity of Japanese industrial development in the 1960s

and 1970s, in apparent response to the stimulus provided by investment

credit-creation by the Bank of Japan under instructions from the

government, is widely seen in Asian economies as a vindication of

Shimomuran policies.

Professor Kenneth K Kurihara (1910-1972) – the Distinguished Professor of

Economic Theory at the State University of New York in Binghampton,

teacher of macro-economics at Princeton and Rutgers, the State University

of New Jersey, guest lecturer at the universities of Oxford and Cambridge,

and author of “The Growth Potential of the Japanese Economy” – was one

of the most influential interpreters of Shimomuran economics; he also had

the great advantage of being able to write in English. He concluded that

“if, therefore, greater investment can be financed partly by credits, there

is no need for that ‘abstinence’ which the classical economists considered

necessary for economic progress, any more than there is for that ‘austerity’

which some present day underdeveloped countries impose on already

under-consuming populations at the constant peril of social unrest. Nor is it

difficult, in such credit-creating circumstances, to agree with Keynes’

observation that investment and consumption should be regarded as

complementary rather than competitive.”3

After more than two decades of persistent stagnation, during which

Shimomuran policies were lost sight of, and supplanted by policies urged on

the Japanese by the IMF and western economists, Shimomura is now back in

favour in Japan. The Prime Minister of Japan, Shinzo Abe, announced on 19

April 2013 in a speech to the Japan National Press Club that Japan is once

again implementing Shimomuran economics – he explicitly made two

references to Dr Shimomura – in order to end the Japanese depression and

restore high growth to create once again what he described as “a Japan of

abundant capital.”4

Western economists, however, seem to be unaware of this revival of

Shimomuran economics. On the rare occasions that they have been invited

to consider the issue, they have maintained that correlation is not

causation, and that there is no evidence that the new credit created by the

Bank of Japan “caused” the observed growth in the 1960s and 1970s, or

that the cessation of that growth was the consequence of abandoning credit

creation. And there the argument might have rested except for two recent

developments.

First, the British economist Sir Clive Granger produced, in a 1969 paper in

Econometrica, a new statistical technique called Granger Predictive

Causation Analysis – an achievement that led in 2003 to his award, along

with his colleague Robert Engle, of a Nobel Prize for contributions to

economics. The Granger Causality Analysis tests the validity of predictive

causative links between two economic factors; using Granger predictive

analysis, it can be shown whether there is a predictive link between two

items of economic time series.

Second, and more recently, detailed and expert work on the course of the

Japanese economy – both its period of sustained and almost unprecedented

growth, and its subsequent period of stubborn stagnation – was undertaken

by Professor Richard Werner, professor of economics at the University of

Southampton. Professor Werner originated the term “quantitative easing”

and in 1991 predicted the imminent ‘collapse’ of the Japanese banking

system and the threat of the “greatest recession since the Great

Depression”. He is a specialist in the Japanese economy and became the

first Shimomura Fellow at the Research Institute for Capital Formation at

the Development Bank of Japan where he spent ten years in the 1990s.

Professor Werner has applied Granger Predictive Causation Analysis to the

Japanese data over a long period and has shown in his book “New Paradigm

in Macroeconomics” – that there is a clear Granger causation predictive link

between investment credit creation at the Bank of Japan and subsequent

rates of Japanese economic growth, both positive and negative. He also

found that the causative link that is so clear in the case of investment

credit creation does not hold good in respect of any other of the

candidates, such as interest rates, structural changes, and so on, that are

often advanced as potential explanations for the vagaries of the Japanese

economy over five decades. Significantly, Werner also found that excessive

credit creation where that credit is not earmarked for use in new

investment in productive capacity will finds its outlet in speculation and the

creation of asset bubbles, as occurred in Japan from 1986-91.

Werner’s use of the Granger technique and the conclusions he is able to

draw allow us to say with certainty that the use of investment credit

creation has been the essential element in determining the rate of growth

for the Japanese economy. Empirical observation and the analysis of the

observed data allow for no other explanation. It is on that basis that we can

extrapolate from the Japanese experience, as identified by Werner, to

western economies, and say that – since advanced economies function very

similarly, whether in Japan or elsewhere – the solution to the poor

performance and lagging development of western economies is the adoption

of investment credit economics, which is fully capable of reversing the ill effects,

including the damage to personal incomes and the social fabric, of

austerity.

1 A reference to that inadequate translation of what is perhaps Shimomura’s most significant

books, Seicho Seisaku No Kihon Mondai (Basic Problems in Growth Policy, 1961) can be found

http://books.google.co.uk/books/about/Basic_Problems_of_Economic_Growth_Policy.html?

id=DyNjHQAACAAJ&redir_esc=y

2 See http://www.dbj.jp/ricf/en/fellowship/

3 See “The Growth Potential of the Japanese Economy” (John Hopkins Press Maryland 1971), pp.

137-138

4 http://www.kantei.go.jp/foreign/96_abe/statement/201304/19speech_e.html

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 3 of 9 – The Different Uses of Credit Creation

Credit creation when properly deployed can serve five main purposes, each

having major and differential effects on the real economy. We cannot

expect, and nor can an incoming Labour government, to produce better

economic outcomes unless we understand the differences between them.

First, credit creation may be undertaken (and usually is) for purely

speculative purposes. Its principal purpose and effect is to fund housing

purchase and speculative financial transactions; it is often the main factor

in the development of housing, land and asset bubbles. It is this aspect of

credit creation that attracts most attention in today’s economy and which is

the main focus of the banks’ activities, since it is the easiest business to

attract, the most secure (since mortgages guarantee the value of the credit

in most cases) and the most profitable.

It is also the principal factor in stimulating inflation; housing values, in

particular, rise sharply as large volumes of credit-created money flow into

the housing market, and the consequent asset inflation is inevitably

followed by consumer led inflation as home-owners use the increased value

of their equity to increase consumption. This is, of course, of great

significance, given that the control of inflation is the prime and virtually

only focus of macro-economic policy; it suggests that the use of interest

rates to tighten monetary conditions, impacting as it does on the whole

economy, fails to address effectively and accurately the real cause of

inflationary pressures and is an unnecessarily broad and badly focused

instrument that does great damage to the wider economy at the same time.

The overwhelming dominance of credit creation for speculative purposes –

for both housing and other financial transactions – has other adverse

features. It distorts the desired operation of the economy by diverting

investment capital away from productive purposes, and by creating asset

bubbles in both residential housing and financial assets, not least in western

stock exchanges; and the resultant constant inflationary impetus then has

to be restrained by measures such as higher interest rates, so that the

chances of greater innovation and productivity are further prejudiced.

Despite all of these downsides, credit creation for speculative purposes as a

major economic factor impacting on the real economy is virtually ignored

by our policy-makers, except to the extent that it is seen as perfectly

normal and relatively benign.

The second kind of credit creation operates as an important element in

demand management. It is used to raise purchasing power by putting more

money in people’s pockets, and thereby can help to resolve the problem of

deficient demand that Keynes identified as the key element in the Great

Depression and that continues to characterise recessionary conditions today.

It would normally be undertaken by the banks, under direction from the

central bank or the Treasury, though it could also be undertaken directly by

the central bank or the government. It is little used in today’s Britain, not

surprisingly, when the Coalition government does not recognise a deficiency

of demand as the feature of a recessionary situation that needs correction.

It has, however, returned to favour as a counter-recessionary instrument in

the thinking of some of our leading monetary economists. Keynes had

suggested in the 1930s – half-jokingly but so as to make a serious point –

that a valuable counter-recessionary outcome could be obtained by burying

money in the ground and then paying firms to employ people to dig it up.

Their increased income would represent a significant increase in purchasing

power and therefore demand.

Such a policy today is often pejoratively characterised as “helicopter

money” – the notion that demand could be raised if pound notes were

scattered from the air – but has been seriously analysed by economists such

as Adair Turner and Michael Woodford who have reached the point of

debating whether it would best be delivered by fiscal measures (such as tax

cuts) or by monetary policy (essentially printing money).1

Credit creation undertaken to raise demand does not mean that it cannot

serve other purposes at the same time; or, to put it in another way, credit

creation undertake for other purposes, such as funding the purchase of

assets or providing capital for investment, may well also have the additional

effect of lifting the level of demand. As we shall see, the crucial question

is then as to whether the increased demand is merely inflationary or is

matched by increased output.

Thirdly, credit creation can also be undertaken for the purpose of stabilising

the financial system; this technique, which has been called Quantitative

Easing over recent times, has been implemented by governments in both

the UK and the US, and was meant to remedy – in the wake of the Global

Financial Crisis – the precarious situation of an otherwise bankrupt financial

system. In the case of the UK, the policy took the form of the Bank of

England’s £375bn of financial credit to stabilise the UK Clearing Banks but it

did nothing to benefit the wider economy. The greater proportion of that

sum was used by the banks to strengthen their balance sheets (and to

resume paying large bonuses); very little found its way into lending to the

Small and Medium-Sized Enterprises that desperately needed help in

maintaining adequate liquidity (and for plant and equipment investment).

Credit creation for the purpose of funding major innovative programmes –

sometimes called Government Credit Creation (GCC) – is the fourth kind of

credit creation and is designed to enable major innovative structural

economic change, such as the invention of the atomic bomb, the mass production

of synthetic rubber in the US in 1940-44, and President Obama’s

Energy Initiative; it is often resorted to in wartime. The intention is to

stimulate innovation in the public sector or infrastructure area of the

economy and to undertake large-scale projects that are vitally important to

the economy but are too large or not commercially rewarding enough to

attract private capital.

This kind of credit creation for public purpose is being supplanted

increasingly in Britain today by Public/Private Partnerships, on the specious

ground that they offer better value to the taxpayer; the reality is that they

are much more expensive than publicly funded projects, but they have the

great merit in the eyes of right-wing governments of offering fat profits to

their friends in private industry.

The fifth and, for our purposes, most interesting and important form of

credit creation is usually called Investment Credit Creation (ICC). This form

of credit is targeted at increasing investment in the plant and equipment

level in private industry, with the goal of encouraging productivity

improvement, accelerating the rate of economic growth and providing full

employment. Investment Credit Creation is usually delivered through the

local banks (if you have any) at the behest of the central bank and the

government. It is this aspect of credit creation that has been virtually

ignored in western economies over recent decades but which offers by far

the best prospect of breaking out of our seemingly irreversible economic

decline.

There is today virtually no understanding in Britain and other western

countries of how Investment Credit Creation functions and of the benefits it

can bring to economic development. The provision of credit – that is, bank

lending – is seen almost exclusively in terms of its capacity to stimulate

inflation and is seen therefore as a potential threat rather than as an

essential element in producing a better economic performance.

This is notwithstanding Keynes’ perceptive assertion that there is no reason

why the provision of credit for the purpose of productive investment should

not precede the increase in output that it is intended to produce, provided

that the increase occurs over an appropriate time frame. Other economies

have understood and benefited from this insight and have used Investment

Credit Creation to stimulate growth, without being inhibited by the

conviction that any increase in the money supply must necessarily be

inflationary.

There are, in fact, many persuasive instances from both recent history and

from other countries of the successful deployment of Investment Credit

Creation. One of the most striking examples of the use of credit creation,

not to inflate the property market for private profit as is done in the West

at present, but to stimulate rapid industrial growth, was provided by the

United States at the outbreak of the Second World War, when Roosevelt

used the two years before Pearl Harbour to provide virtually unlimited

capital to American industry – simply by printing money – so that the

country could rapidly increase its military capability.

Roosevelt encountered the usual objections from conventional economists

but the exigencies of war and his own political strength and will prevailed.

The results were spectacular and hugely significant. American industrial

output grew on average by an unprecedented 12.2% per annum from 1938

to 1944 – an outcome that went a long way towards enabling the US, and

the Allies more generally, to win the Second World War.

An equally impressive instance is provided by Japan in the 1960s and 1970s,

when Japanese industry was enabled by similar means to grow at a rapid

rate so as to dominate the world market for mass-produced manufactured

goods. Western economists have typically shown no interest in how this was

done and are almost totally ignorant of the work of leading growth expert

economists such as the Japanese Osamu Shimomura and the American-

Japanese Kenneth Kurihara. We shall look in more detail 2 later at exactly

how Investment Credit Creation was specifically implemented by the Bank

of Japan, at the behest of the government and following the advice of

Shimomura and his colleagues, and accordingly brought about the Japanese

economic miracle.

More recently, China has used similar techniques to finance the rapid

expansion of Chinese manufacturing. The Chinese central bank, and their

provincial counterparts, under instructions from the government, makes

credit available to Chinese enterprises that can demonstrate their ability to

comply with the government’s economic priorities. Enterprises that wish to

build or buy new capacity in compliance with the overall industrial strategy

are provided with the required investment capital, obtained through cost-free

credit creation; Chinese manufacturing capacity in particular has

largely been funded by such government-authorised new credit, as has the

huge purchasing programme of strategic assets from around the world that

is currently being undertaken by Chinese enterprises. This is admittedly, in

principle at least, easier to bring about in a totalitarian regime than in the

UK, but in practice there is nothing to stop a British government from

requiring the central bank, as the Chinese have done, to create cost-free

credit for specific (and productive) purposes.

Other Asian countries, such as Korea and Taiwan, have applied similar

policies in order to produce rapid industrial growth. Typically, however,

Western economists have arrogantly assumed that these successful

economies have nothing to teach us, and are easily dismissed as

undeveloped economies relying for competitive advantage on cheap labour;

the reality is, of course, that these economies are, as a consequence of the

rapid economic growth and industrial development made possible by

Investment Credit Creation, delivering incomes and living standards to their

populations that are approaching and in some cases surpassing those in the

West.

1 See www.voxeu.org/article/helicopter-money-policy-option

2   http://londonprogressivejournal.com/article/view/1565/the-key-relevance-of-the-writings-of-professor-kenneth-kenkichi-kurihara

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 2 of 9: Stimulating Wealth Creation

If we are to find that better way, we must clearly understand the failures

and deficiencies of what has gone before. A major milestone in that quest

for understanding was reached earlier this year when the Bank of England,

in an article published in its first quarterly bulletin for the year1 became

the first significant central bank to acknowledge that the vast proportion of

money in our economy (calculated by the authors at 97% of the total money

supply) is created by the banks. This admission, which has been hotly

contested and denied by bankers and economists for decades, if not

centuries, casts a whole new light on the meaning of money and its

significance for economic policy, and is the key to a new approach – not

only as a response to recession – but as the foundation of a successful

economic policy.

We need not explore here the mechanisms by which the banks create

credit; suffice to say that they are well set out in the Bank of England

paper, and in the end amount to the simple fact that the banks are not

simply intermediaries, bringing savers and lenders together. They do not

lend money deposited with them but instead lend money that they

themselves create by making book entries unsupported by anything other

than their willingness to lend. But while the mechanisms may be simple,

the implications for policy are huge.

The facts that the quantity of money is almost entirely a function of bank

policy and that its continuing but regulated growth is the normal and

required condition for a well-functioning economy suggest strongly that the

conventional treatment of money as a neutral factor in economic policy is

completely mistaken. Current monetarist orthodoxy treats the money

supply as reflecting more or less automatically the needs of the real

economy, and impacting on it only in the sense that, if it is allowed to grow

too fast, it will generate inflation. The reality is, however, that the rate of

growth in the money supply is not just a function of the level of real

economic activity but is, as we shall see and according to the purposes to

which it is put, an important determinant of that level.

It is worth registering at this point that the banks’ remarkable monopoly

power to create (or “print”) money is exercised entirely in the interests of

profits for their own shareholders rather than of the economy as a whole.

It might be thought that this private exploitation of such an important

power would warrant the most careful public scrutiny, yet it attracts

virtually no attention from policymakers, other than in terms of countering

inflation; the Coalition government prefers to focus on reducing

government spending, as the supposedly essential feature of macroeconomic

policy.

They thereby totally overlook the fact that it is extraordinarily important

for the purposes of economic policy-making as a whole to understand the

impact of private money-creation on this scale and, in particular, to analyse

the purposes for which that credit is created.

A Labour government should no longer, in other words, accept that credit

creation by the banks is benign, and automatically serves – because it is

allegedly self-regulating – the public interest; a more effective economic

policy depends crucially on an acknowledgment that credit creation (and

therefore the whole of monetary policy) is hugely important and impacts

directly and substantially on the development of the real economy, and can

be made to serve a variety of wider economic interests rather than simply

those of private profit-seeking bank shareholders. A Labour government

that took this position would surely be encouraged to find that, on this

issue, public opinion had got there first.

Keynes was well aware of the fact, and of the almost unlimited potential,

of credit creation by the banks and recognised it as an important element in

macroeconomic policy. His pre-war contention that “there are no intrinsic

reasons for the scarcity of capital” is supported by compelling evidence, not

least now by the Bank of England’s recognition that money is created by the

banks from nothing. What should now be fully recognised, however, is that

the purposes of credit creation could and should extend well beyond the

funding of house purchase, which is currently its major feature.

Credit creation at the central bank, if properly directed and managed, can

be used to selectively increase the private investment level of the country,

as has previously occurred in all very high-growth economies, and as could

happen in Britain.

1Bank of England Quarterly Bulletin, 2014, Q1 “Money Creation in the Modern Economy” by

Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate.

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 1 of 9: The Coalition Government’s Failed Austerity Programme

The outcome of the next general election cannot be confidently predicted but one thing is clear; the odds on both a Labour election victory and a successful term in office would be greatly increased if the Labour leadership had the confidence and courage to develop and deliver a convincing alternative economic policy.

At present, Ed Miliband and Ed Balls seem inhibited from attacking the

failed policies of austerity (to which George Osborne claims there is no

alternative) and are content to focus on policy in other areas as a means of avoiding any real debate on economic policy. Yet there is, as both

experience and reason demand, a growing consensus that austerity has

failed and, as a consequence, an urgent need for Labour to describe clearly what an alternative and better policy should be and how it would operate.

The purpose of these articles is to identify one of the basic and central

issues on which that successful alternative policy should be developed. A full understanding and adoption of the proposals advanced here would allow the Labour leadership, in the run-up to the election, to attack the

Coalition’s economic record with greater conviction and confidence, and

would provide the launching-pad in government for a long-delayed and

hence urgently needed restoration of Britain’s economic fortunes.

Not A Moment Too Soon

The new direction that an incoming Labour government must adopt will

come not a moment too soon. The damage done by the Coalition

government is cumulative and fundamental, and extends beyond purely

economic failure to social dislocation and political disintegration.

In economic terms George Osborne’s record is appalling. The so-called

recovery has been delayed unnecessarily for more than half a decade and means that a return to pre-2008 living standards is still many years away.

Median GDP is still 3% below 2007 levels, and since the population has

increased by3%, that means an average fall in individual incomes of 6%.

The decline of the productive sector and particularly of manufacturing has meant that only 10% of our GDP is now accounted for by manufacturing -the lowest proportion of any major developed economy – and our share of world trade has fallen to just 2.7%.

Coalition polices have resulted in the sharpest fall in living standards in

more than 60 years. According to data from the Institute of Fiscal Studies, average wages have fallen by over £1,600 since 2010, at an average rate of over £530 a year. The pre-Coalition reduction in median income (not the same as average wages, but an acceptable proxy), can be calculated at about £5,400 over thirty years (1980 to 2010) – about £180 a year – so that the Coalition has produced a reduction in worker incomes of almost three times the previous trend.

But these figures relate only to the working population, and take no

account of the reduction in unemployment and disability benefits, the

denial of benefits to mothers seeking work because they have not been

employed during the previous two years, and the exclusion from the data

for both the employed and unemployed of the growing practice of zero hours contracts, all of which mean that the real extent of income cuts is

much larger than official figures indicate.

The burden imposed on working people has not of course been shared by the wealthiest people in our society. According to an Oxfam report1, the richest 5 families in Britain have more wealth than the poorest 20% of the population. That level of inequality is unprecedented since records began in the UK.

In an even more recent report2, Oxfam also reports that the Coalition’s

welfare cuts have pushed 1.75 million of the UK’s poorest households

deeper into poverty, suffering an absolute cut in their income in the past

three years and leaving them struggling to cover food and energy bills.

The national scandal that millions of children in the UK are going to bed hungry is not some accidental by-product of Coalition policy. It is the inevitable and deliberate consequence of policies pursued by a government that is “of the privileged, by the privileged, for the privileged”.

The disadvantaged poor – the disabled, the sick and the unemployed – have suffered, through cuts in their benefits, the greatest burdens in dealing with the recession. SCOPE, the charity supporting disabled people, have shown, for example, that 600,000 people in the UK lost a total of £2.62 billion pounds a year from Monday 8 April 2013 as a result of the Coalition Government abolishing the Disability Living Allowance (DLA) and introducing the new Personal Independence Payment (PIP), with tighter eligibility criteria and a controversial new assessment. The purpose of that change is not to improve service or to make things more fair but simply to save money. The lack of concern for the most disadvantaged in our society was compounded by the amazingly (and deliberately) inaccurate statements about incapacity benefit made by Ian Duncan Smith.

Coalition policies have disproportionately affected women, who are

more often found in lower-paid occupations and in the caring

professions. An analysis of Treasury data by House of Commons Library

researchers in 2012 showed that £11.1bn of the £14.9bn raised from the

five spending reviews since 2010 comes from women even though they earn less than men on average. Planned changes to tax credits, child benefits and public sector pensions were largely to blame. They came shortly after the government announced plans to cut the 50p top rate of tax for all those earning over £150,000.

A Failed Banking System

The failures of the Coalition government have extended into other areas of policy. One of the principal reasons for both the excesses that led to the Global Financial Crisis and the difficulty we have had in recovering from recession has been the absence of a responsible and supportive financial-industrial banking system in the United Kingdom. The Coalition Government acknowledged as much in “The Coalition: our programme for government”3 where they promised that, “We will reform the banking system to avoid a repeat of the financial crisis, to promote a competitive economy, to protect and sustain jobs”.

None of this has been done. There has been no reform of the banking

system with the result that, as Mervyn King has regularly warned, a repeat of the financial crisis is still a major risk.

They further promised that “We will introduce a banking levy and seek a

detailed agreement on implementation.” The banking levy was introduced in 2010 and was intended to raise £2.5 bn, but has raised nothing like that sum. In the 2014 Budget, George Osborne restructured the levy to provide maximum limits for individual banks and five bands, which meant a cut that is disproportionally beneficial to the very largest banks.

They also undertook to “bring forward detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector; in

developing these proposals, we will ensure they are effective in reducing

risk.” Less than six months after the Coalition came into Government, the proposal to deal with bonuses was abandoned. Bonuses are back with a vengeance.

A fourth promise to “bring forward detailed proposals to foster diversity in

financial services, promote mutuals and create a more competitive banking industry” produced no action whatsoever, while a fifth to “develop effective proposals to ensure the flow of credit to viable SMEs … which will include consideration of both a major loan guarantee scheme and the use of net lending targets for the nationalised banks” produced an extra £80 bn of re-discounting of loans by banks, part of which may have proved useful to some banks who wished to reduce the bank levy, but which nevertheless produced a fall in loans to SMEs of about £56bn.

The failure to take effective action on any of these issues has been, as we shall see later, hugely detrimental to any attempt to correct one of the main deficiencies in the management of the British economy. The failures were compounded by the fate of the Parliamentary Commission on Banking Standards which was established in July 2012, following the LIBOR-rigging crisis. The Commission’s report was set aside by politicians who showed themselves anxious to find reasons to shy away from the necessary reforms. It was claimed that such reforms had been rendered unnecessary by reforms already being implemented, that they would damage the competitiveness of the City and cost jobs, and that they would harm the banks’ ability to support the rest of the economy.

The UK’s competitiveness will be threatened in the long-term by this

indifference to the dangers associated with poor banking standards and

culture. If the arguments against complacency and inaction have not been heeded now, when the crisis in banking standards has been laid bare, they are yet more certain to be ignored in the future when memories have faded.

It should be understood, however, that the real problem with British

banking is not about dubious ethics but that it does not, unlike foreign

banks, see the funding of investment in productive capacity as its main

function. The right ethics with the wrong agenda is no recipe for British

economic recovery.

The list of failures demonstrates one central theme; because the Coalition Government does not understand the process of wealth creation at all, their focus is on the side-issue of making economies in the budgeted cost of government. Their obsession with the objective of achieving a balanced budget blinds them to the fact that there is a much better way to govern Britain – a way that increases the wealth and welfare of all, as we will illustrate in the following articles in this series.

1 www.theguardian.com/business/2014/mar/17/oxfam-report-scale-britain-growing-financial-inequality?

CMP=EMCNEWEML6619I2

2 www.theguardian.com/politics/2014/apr/22/welfare-cuts-drive-uk-poorest-poverty-oxfam

3 www.gov.uk/government/uploads/system/uploads/attachment_data/file/78977/ _programme_for_government.pdf

© Bryan Gould and George Tait Edwards 2015