George Osborne’s Deep Hole
Whatever George Osborne may say on Wednesday in his budget speech, he cannot extricate himself from the wreckage that now surrounds him. He may be just about the last person in Britain to believe that austerity offers a credible path to recovery from recession – and it may be doubted that even he remains a true believer. The repeated fall back into recession, a government deficit that goes on rising, and the loss of the country’s top credit rating are surely enough to shake the confidence of even the most arrogant and obtuse practitioner of the dismal science.
The Chancellor’s continued commitment to austerity has made a significant personal contribution to the digging of an economic hole from which there now seems no discernible path to recovery. Perhaps his only saving grace is that he should not be left to bear the burden of that responsibility alone.
As a long-time critic of British economic policy under successive governments, I hear the flapping wings of chickens coming home to roost; for the truth is that the current difficulties – and the imminent prospect of long-term economic decline – are the inevitable consequences of decades of mistaken policy choices and the worship of false gods.
It is hard to grasp, even now, just how thoroughly and comprehensively the favoured nostrums of the last four decades – those nostrums that have guided our fortunes over the whole of that period – have now been disproved and discredited. Let us look at some of them in turn.
Take the propositions that the market (and especially financial markets) can be accurately predicted on the basis of mathematical models, that they are self-correcting and do not therefore need regulation, and that any intervention in unregulated markets will automatically produce results that will be worse than if they had been left alone. As Keynes warned, and experience in the form of the global financial crisis has confirmed, markets – and financial markets in particular – are all too likely, if unregulated, to lead to excess and collapse.
Or, what about the belief – maintained for more than three decades – that macro-economic policy is not a matter for government but is a simple matter of restraining inflation – an essentially technical task through setting interest rates that can safely be entrusted to unaccountable bankers? Do we still believe that monetary policy is all that is needed for a healthy economy? Or that it is any more effective than pushing on a piece of string as a means of escaping from recession? Or – when we look to more successful economies overseas – that there is no role for government?
And what about the related confidence displayed in the expertise and objectivity of bankers in running our economy? Do we still believe that bankers have the common interest at heart and do not make decisions to suit themselves? Are we happy that they continue to enjoy the astonishing privilege, as private monopolies, of creating money out of nothing, thereby exercising hugely more power over our fortunes than do elected governments?
What do we think of the faith placed by successive governments, not least by New Labour, in the financial services industry as the means of paying our way in the world? Do we still accept that the huge fortunes made by a few in a largely unregulated City represented real and sustainable wealth-creation in which the rest of us would share?
Even more importantly, what do we think of the careless assumption that focusing on financial services made it unnecessary to concern ourselves with our manufacturing base? Do we now understand that the loss of manufacturing means – now that the chips are down – that we are denied the most reliable way of maintaining our standard of living, the most important source of innovation, the most substantial creator of new jobs, the most effective stimulus to improved productivity and the provider of the quickest return on investment?
Do we understand that globalisation has meant, with the removal of exchange controls, that major global investors can now move huge volumes of money – totalling as much in a single day as the total annual production of most economies – from one country to another, and have thereby disabled democratic governments from doing anything to protect us?
And do we understand that the combined effect of all these policies has been to create a huge mechanism for shifting wealth and resource from the poor to the rich, and that it is that which is responsible, rather than any great ability or virtue on the part of the rich, for the widening inequality that weakens and disfigures our society?
Underpinning all of this is a fundamental failure – an obstinate refusal to recognise that the world has changed and that, with the rise of newly efficient economies around the globe, we have no innate right to have a privileged standard of living delivered to us on a plate. The fact is that the UK has been a fundamentally uncompetitive economy ever since the 1970s, but we have preferred to avert our gaze from this uncomfortable truth.
The issue of competitiveness is not recognised, let alone discussed in Britain; yet much more successful economies use measures of competitiveness as their guide to what is required from macro-economic policy. We, on the other hand, have preferred to take refuge in a range of nostrums that we can now see have little merit.
George Osborne’s budget will be scrutinised for signals that tiny changes in direction might be forthcoming and that salvation might lie therein. But the budget will be a minor factor in an economic dilemma which George Osborne – and his predecessors – have spent painstaking decades in creating.
Bryan Gould
17 March 2013.
Bryan Gould’s new book Myths, Politicians, and Money will be published by Palgrave Macmillan later this year.
This article was published in the online Guardian on 18 March.
A Litany of Errors
George Osborne may be just about the last person in Britain to believe that austerity offers a real path to recovery from recession and the resumption of growth – and it may be doubted that even he remains a true believer. The repeated fall back into recession, a government deficit that goes on rising, and the loss of the country’s top credit rating are surely enough to shake the confidence of even the most arrogant and obtuse practitioner of the dismal science.
We now know for sure what Keynes and commonsense always told us – that responding to recession by cutting spending is akin to the medieval practice of blood-letting as a treatment for disorders. The Chancellor’s continued display of commitment to failed policies may, of course, be for public consumption only and it may be that his real purpose is not economic but political and social. His undeclared goal may well be to drive home – at whatever economic cost – changes in the balance between private and public sectors, and rich and poor, that will take a generation to undo.
What is undeniable, though, is that in economic terms he has dug himself – and the rest of us – into such a deep hole that there is now no discernible way out. But while his may be the most egregious of all the errors made by successive Chancellors, it would be wrong to overlook the fact that others have also contributed their efforts to digging a hole that has grown ever deeper over four decades or more.
My own interest and involvement in these issues goes back to the mid-1970s, when – as a young Labour MP – it seemed clear to me that Britain’s real but unacknowledged economic problem was one of declining competitiveness. We refused to recognise then, and have done ever since, that the world has changed and that the rise of newly competitive economies has meant that we cannot rely on some kind of natural law that guarantees us a higher standard of living than others should enjoy.
The competitiveness issue thrust itself centre-stage in 1976 in the form of a fully-fledged sterling crisis; but, true to form, and rather than concede that sterling was then overvalued, the UK exhausted its reserves and virtually bankrupted itself in trying to defend sterling’s parity.
The resultant need for an IMF bailout did not arise, as popular (and an oxymoronic right-wing) wisdom often has it, because the Labour government profligately allowed public spending to rise out of control, but because it was determined to defend sterling at all costs. That same determination then dictated our (literally) counter-productive response to the course that the IMF suggested we should follow in order to overcome the crisis.
The IMF recommended that monetary policy (which was already assuming greater importance as monetarism became fashionable) should be conducted in terms of Domestic Credit Expansion (DCE); we were free, in other words, to grow the economy as fast as we wished, provided that a credit-fuelled domestic inflation was restrained. This recipe for export-led growth was an explicit recognition that our problem was one of competitiveness and an implicit recommendation that the exchange rate should be lower.
This advice was, however, under the influence of advisers like Terry Burns and Alan Budd, rejected by the Treasury who persuaded Denis Healey to go on protecting sterling and to frame monetary policy in terms of sterling M3 rather than DCE. In line with this decision, and as Denis Healey was forced by the crisis to turn back from the airport, Jim Callaghan told the 1976 Labour conference, “you can’t spend your way of recession.”
The statement was of course a nonsense. There is no remedy for recession that does not involve spending more. Callaghan’s statement would have been more accurate if he had said, “we can’t do what is required to escape from stagflation because our fundamental lack of competitiveness means that spending more would make our inflation and balance of payment problems even worse.” The problem he was trying to describe was really one, in other words, of competitiveness rather than anything else.
By the time Margaret Thatcher came to power, supposed monetarist certainties[i] were the order of the day and – with sterling floating and exchange controls removed – the much-heralded benefits of North Sea oil were confidently expected to resolve any balance of trade problems and to usher in a new era of prosperity.
But North Sea oil, combined with monetarism and a floating exchange rate, proved a toxic combination. The monetarist prescription made it inevitable that, as North Sea oil output became available, some other area of production should decline – and manufacturing duly obliged. The theory predicted that the discovery of a new source of wealth would inevitably drive up the exchange rate so that other sectors of production were priced out of markets both at home and abroad. It was never explained why this should be inevitable in Britain but not apparent in the case of Norway, a smaller economy where the advent of North Sea oil was proportionately even more important, but where steps were taken to protect the rest of the economy. The Norwegians in fact found ways of insulating the domestic economy against the boost produced to overseas earnings by oil exports and import saving.
Many monetarist economists at this time went so far as to work out the level of demand for money of a given economy (incidentally ignoring the significance of the velocity of circulation, which can vary substantially over time). This approach necessarily fixes a given economy in a given condition. The British economy was assumed to have a lower demand for money than the German economy and if this was exceeded, increased inflation was inevitable. This assertion, which was unexplained or unsupported by argument, was necessary to explain the fact that growth in the German money supply ran at a significantly higher level than the British money supply while at the same time permitting the Germans to maintain a stronger growth rate and a lower inflation rate. No attempt was made to explain why this supposedly immutable condition of the British economy should apply.
In the same way, each economy was assumed to have a naturally occurring rate of unemployment which could not be changed by policy. A NAIRU, or non-accelerating inflation rate of unemployment, was ascribed to each economy. In the case of the United Kingdom, it was assumed to be relatively high and, more significantly, impervious to attempts to bring it down. In fulfilment of this prophecy, unemployment rose sharply through the 1980s, despite the repeated attempts to massage the statistics downwards. The number of claimants of unemployment benefit jumped from just over 1 million in 1979 to over 3 million in 1986.
The UK balance of payments remained in substantial deficit throughout the period, reaching record levels at times in relation to GDP. The deficit reflected, of course, the decline of manufacturing and the deterioration in the balance of trade in wide areas of the productive sector. That in turn reflected the loss of competitiveness, which was shown – but ignored – by the various indices used to measure competitiveness.
John Major’s government, supported by Labour, sought to address the continuing economic problems by taking refuge in the Exchange Rate Mechanism, thereby handing responsibility, in effect, for restraining inflation over to a foreign central bank and avoiding – it was hoped – any opprobrium for the price to be paid for such “discipline”. But, true to form, an inappropriate parity and the mistaken analysis that identified inflation rather than a lack of competitiveness as our fundamental problem wreaked such damage that we were eventually forced out of the ERM.
By this time, our policymakers were running out of options. There was some respite as the UK, freed from the shackles of the ERM, performed a little better than most of our European partners. But we had long since surrendered ourselves to the belief that we could no longer – in the face of newly competitive developing economies – compete as a manufacturing economy.
Instead of addressing that problem, and exploring appropriate remedies for it, however, we determined to find an alternative way of paying our way. I was the Opposition spokesperson on financial matters in 1986 at the time of the so-called Big Bang – the removal of effective regulation from City institutions – and had led for the Opposition in the Committee stage of the Financial Services Bill.
I had argued in vain that self-regulation would be ineffectual in restraining excesses and maintaining prudential supervision. But an essentially unregulated financial services industry was – with heroic optimism – advanced as the ideal substitute for our declining manufacturing; it had the advantages of requiring a great deal of capital (which could not be replicated because it was not at that time available to most developing economies) but little by way of real skill, and it also offered the political bonus to Thatcherite politicians of disabling the large industrial trade unions.
These dazzling prospects seemed for a time to be delivered. As recently as 2007, and as evidence of how thoroughly New Labour welcomed these developments, Gordon Brown, in his annual Mansion House speech – his swansong after a decade at the Treasury – heaped praise on the financial services industry developed by the City of London, and predicted that “it will be said of this age, the first decades of the 21st century, that out of the greatest restructuring of the global economy, perhaps even greater than the industrial revolution, a new world order was created”.
We now know, courtesy of the global financial crisis, that financial services did not provide the secure base for economic development that had been hoped for, and that such benefits as were delivered went in large volumes to a very small proportion of the population. Even more seriously, our neglect of manufacturing as a wealth-creator has meant that we are denied the great advantages that manufacturing alone can deliver – as the most important source of innovation, the most substantial creator of new jobs, the most effective stimulus to improved productivity and the provider of the quickest return on investment.
George Osborne, and his dwindling band of supporters, seem bereft of any understanding of this sad history. Their insistence on austerity as the cure for recession is just the latest instalment in a total refusal by a long succession of Chancellors to face the reality of our long-standing difficulties – so that we are now facing the probability of permanent economic decline.
We now seem to have run out of options. We have tried qualitative easing and low interest rates, apparently unaware that using monetary policy to promote recovery is like pushing on a piece of string. We reject an expansionary fiscal policy in favour of cutting spending, refusing to acknowledge that this has meant, inter alia, a larger rather than a smaller deficit. Even if we now wished to take the commonsense path, and focus on rebuilding our long-neglected productive industries, we would find that we have lost much of the technological lead, the workplace skills, and the available markets that were once ours. Without the political will to change tack completely and to plan and make provision in the long term to rebuild our industrial strength – learning to think, in other words, as a developing economy and eschewing short-term fixes – the future looks grim.
George Osborne, in other words, is heir to a long and dishonourable tradition. He is not the only person who must carry the can. But the immediate challenge is not just to escape from recession but to recognise and deal with the long-term problems. The Chancellor has shown that he is not the man to do it.
Bryan Gould
10 March 2013
[i] See Monetarism or Prosperity by Bryan Gould, John Mills and Shaun Stewart, Macmillan, 1981
The Deal-maker
Our Prime Minister revels in his reputation as a deal-maker – and with good reason. His success in making a personal fortune as a foreign exchange dealer is, it seems, a major factor in establishing his claim to be an expert in how to run our economy.
It may not be immediately obvious that the short time horizon of the foreign exchange dealer – perhaps at times only a few hours or even minutes – is necessarily the best qualification for making good long-term strategic decisions about our economic future. But few would doubt John Key’s ability to close a deal.
It is only when we look closer at the deals that the Prime Minister concludes that doubts might arise. It seems that his negotiating stance in approaching a potential deal usually begins with, “The answer’s yes, now what’s the question?”
Those doubts might seem to be well-founded when we look at some of the deals he has concluded in recent times. The “negotiation” with Warner Brothers over The Hobbit seems to have been a process in which the Hollywood moguls dictated their requirements – $67 million in tax relief and a change to employment law that reduced the rights at work of actors and film crews – and John Key’s government “negotiated” by meekly complying, with the passage of overnight legislation.
We see a similar pattern in the “negotiation” with Sky City over a convention centre in Auckland. The Sky City offer was made conditional by the gambling bosses on the award of a significant number of new pokie machines – something strongly opposed on social and health grounds by those rightly concerned at the damage done by gambling to families who can ill afford it, but immediately conceded by John Key.
On this form, we can be confident that we will see the same pattern in future “negotiations” with, for example, overseas firms wishing to drill for oil, or mining companies wanting to operate in conservation areas, or foreign buyers proposing to purchase national assets. In all such cases, we can expect our “deal” maker to take whatever is offered and run.
“Show me the money” was John Key’s election campaign challenge to Phil Goff; in his mind, it seems, “showing the money” is the essential and only condition needed to settle any deal on offer.
Peter Dunne’s blog last week, in which he warned that there were real dangers in the Prime Minister’s propensity to “cut through” obstacles to a deal, was making a similar point. John Key, it seems, is quite ready to set aside legal safeguards, as well as commonsense considerations, if that is what is needed to close out a “deal”.
The defining characteristic of the Prime Minister’s big-ticket deals is that they typically involve large firms, preferably from overseas. He seems so impressed at being involved with such entities that any concern about whether or not a “deal” offers good value for New Zealand goes out the window.
The worry is that, in negotiations like those with the US and others over a Trans Pacific Partnership, the Prime Minister will take a similarly cavalier attitude to the protection of our national interests. We are already being softened up for what seems now to be an inevitable outcome – that, on a range of important matters, such as a continued and unchanged role for Pharmac, the “negotiations” will end up with an abject capitulation by our government. For John Key, the outcome that matters is putting the signature to the “deal” – not the practical (and possibly adverse) consequences thereafter for our economic wellbeing.
A similarly short time horizon is in evidence when it comes to asset sales. It is almost as though the Prime Minister is so dazzled by the potential price tag of billions of dollars that he is blind to any longer-term disadvantage. Yet, selling assets that generate a minimum return of 7% per annum at a time when the government can borrow at roughly half that rate is simply to put a short-term gain ahead of a much larger longer-term loss for future generations.
As on so many other issues, John Key seems not to understand that the sale of our income-producing assets into foreign hands is to deny future generations important (but dwindling) national income streams. Their loss makes us poorer, increases our need to borrow from overseas and weakens still further our power to decide our own future.
We have travelled a long way from the time when New Zealand was prepared to take a stand and stick to it, even in the face of condemnation from powerful overseas interests. Ask yourself a simple question. If John Key had come to power before our non-nuclear policy had been decided, would he have taken the initiative and introduced it on his own account, and then maintained it against all the odds? Or would keeping in with the Americans have been his first priority?
Bryan Gould
8 March 2013
Eastleigh Leaves Labour with Lessons to Learn
The Eastleigh by-election will attract attention for many reasons – a significant Lib Dem win in a contest triggered by the criminal conviction of the sitting Lib Dem MP, the undeniable emergence of UKIP as a mainstream player, and a body-blow to David Cameron and the coalition that may determine the result of the next election.
Little attention will be paid to the fact that Labour – admittedly in unfavourable territory – came in a poor fourth. It was, of course, only a by-election, with all the attendant and specific peculiarities of such a contest, but it is at least troubling that – given the unpopularity of the coalition partners and the single-issue profile of UKIP – more voters did not turn to Labour as their preferred means of expressing their discontent.
Not to worry, many will say. The national opinion polls tell a different story. Labour is tracking well and Ed Miliband is playing a canny game. We need not concern ourselves too much about a single by-election.
Yet real concerns remain. Ed Miliband has certainly done well to move Labour into a position where it can credibly attack the coalition without being reminded that his immediate predecessors were equally open to the same criticisms. And there are limits – strenuously emphasised by old New Labour veterans – to which he can, assuming he wants to, entirely disown his inheritance.
But the Eastleigh by-election points up just how far Labour still is from capturing that middle ground that is increasingly disenchanted with Osborne’s manifest failures and Cameron’s vacillations but which retains fresh memories of the failures and betrayals they have had to endure at the hands of New Labour as well as the Tories.
Even Labour’s new leadership has not, I believe, fully understood the mood swing that is now under way before our very eyes. The perennially unsolved problems, the specious remedies, the constantly misplaced optimism, the cosy clubbiness of our political leaders as they pretend and posture have now been around for a very long time. They date back at least to the late 1970s when the post-war consensus finally collapsed and a brave new world of “free” markets, monetarism, globalisation, finding our salvation in financial services, and riding shotgun to the Americans as the world’s policeman was ushered in.
Faith in that toxic mix has taken a long time to dissolve, helped no doubt by the new lease of life it gained from New Labour. The death knell, though was sounded by the global financial crisis. While many of us expected that voters would immediately realise that the game was up and that their old certainties had crumbled, it has actually taken the slow unfolding of real consequences to drive home the lessons.
Let us review what we – and a growing sector of the public – now know and understand as the true seriousness of our plight becomes undeniable. We now know that markets are not infallible, that they misbehave and are exploited by the powerful to the disadvantage of the rest of us unless they are properly regulated.
We know that governments have an unavoidable responsibility to help us recover from recession and to stimulate economic activity and that austerity is the worst recipe for doing so, condemning us as it does to continued economic decline. We know that the monetarist obsession with inflation misses the point by ignoring our real problem which is an endemic and deep-seated loss of competitiveness in international markets.
We are beginning to understand that our carelessness with our manufacturing base and our misplaced faith in financial services has cost us dearly, since there is no substitute for manufacturing as the most important source of innovation, the most substantial creator of new jobs, the most effective stimulus to improved productivity, and the provider of the quickest return on investment.
We realise that our engagement with the global (and European) economy can pay off only if we get our domestic economy in good shape; otherwise, it is a recipe – as it has proved – for running massive trade deficits, having to borrow excessively, and – as a consequence – losing control over our own destiny.
These are massive changes in the perceptions of an election-deciding sector of the electorate, and represent a point-by-point rejection of virtually every element in the agenda accepted for most of the past thirty years; yet we (and the political class more generally) persist in behaving as though the voters are so enchanted by their experience that they have some settled allegiance to an established orthodoxy from which it would be suicide to depart. Those perceptions of the mistakes that have been made and of the changes that are needed will only strengthen; Labour’s task is to help them to crystallise and to become embedded, and to offer themselves as the means by which we can start afresh.
The electorate is crying out for release from the shackles of the orthodoxy of the past thirty years. They will turn, if they have to, to the single-issue and limited negativity of UKIP, but they would respond more positively to Labour if they could show that they understand that the last thirty years have been years of failure and that we can do better – by restoring democracy, by facing our problems realistically and by re-establishing government as the essential agency by which that is to be done. The political rewards of adopting that new agenda could be immense.
Eastleigh may have been just a by-election; but it should have been a chance taken to set out that new agenda and to make common cause with the impatience and ambitions of a confused and disappointed people. Ed Miliband has made a good and sensible start; now is the time for courage.
Bryan Gould
2 March 2013
Bryan Gould’s new book Myths, Politicians and Money will be published by Palgrave Macmillan later this year.
Why Ignoring the Exchange Rate Widens Inequality
Last week’s report of an unexpected deterioration in our terms of trade adds a further and unwelcome twist to an already distressing story – the damage being done to our productive sector by an overvalued dollar.
The recent admission by the new Governor of the Reserve Bank, Graeme Wheeler, that the dollar is overvalued is welcome evidence that the issue is at last attracting the attention of our policymakers – and so, too, is the suggestion that the Reserve Bank might restrain bank lending for the purposes of house purchase.
But we have lived with an overvalued currency for so long that we no longer have a proper base mark by which to measure it. What we can do, however, to establish whether the dollar is overvalued is to ask what we might expect to see in an economy that has been fundamentally uncompetitive over a long period.
The answer is that such an economy would exhibit slow rates of growth, high unemployment, low rates of investment and productivity growth, persistent trade deficits, a perennial need to borrow overseas, a propensity to sell off assets – including national assets – into foreign ownership, high levels of import penetration, a weak export sector, and low rates of return on investment and therefore of profitability.
Sound familiar? If we do not immediately recognise these characteristics as the hallmarks of New Zealand’s economic performance, it is only because of the resolute refusal of our policymakers to think about our loss of competitiveness, let alone do something about it.
We are not alone in this refusal. Many western countries are reluctant to recognise that the world has changed and that many developing countries are becoming, or have already become, more competitive than we are.
Yet to ignore our competitiveness problem is to invalidate the whole of our economic policy. It leads us to pay excessive attention to inflation, so that we slam the brakes on at the slightest hint of inflation re-appearing, because our unacknowledged lack of competitiveness makes us rightly fearful of any increase in our costs.
It means that we dare not – even in a long drawn-out recession – stimulate the economy so as to bring down unemployment, restore public services, reduce the government deficit through buoyant tax revenues and resume a sustainable rate of growth because we know that any growth will simply suck in more imports, worsen our balance of trade and increase our need to borrow. If we were competitive, we could afford to stimulate the economy because the growth would come in the form of exports and investment, not consumption and imports.
It means that – as all the signs confirm – any recovery from recession will lead us straight back to an overheated Auckland housing market and an import orgy.
It encourages the delusion that we can somehow improve productivity in a vacuum and that a few more ministerial speeches about it will do the trick. We do not grasp that productivity improvements are a function of competitiveness, not the other way round.
Most worryingly, our determination not to recognise our competitiveness problem means that we (or at least our government) are – apparently without a care in the world – destroying our future by selling off our productive capacity to foreign owners. The loss of those income streams makes our lack of competitiveness even worse and handicaps our ability to do anything about it.
And there is another – hitherto unrecognised – aspect of that blind spot on competitiveness that reflects not just ignorance or carelessness but, perhaps, a deliberate bias in favour of the “haves” as opposed to the “have nots” – an aspect that could be an important factor in New Zealand’s widening inequality gap.
The most obvious remedy for an economy-wide lack of competitiveness is to reduce our costs across the board through bringing down the value of the dollar. That would require everyone to make a fair and shared short-term contribution to the solution of our problems while providing a solid basis for future growth.
But our policymakers are reluctant to ask the better-off to make that contribution. They seem to be quite relaxed about workers losing their jobs and beneficiaries being targeted. They are quite prepared to force wages down by reducing workers’ rights at work and lowering, in real terms, the floor placed under wages by the minimum wage.
But they draw the line at a devaluation of the currency that, as part of the effort to reduce our costs, would have the immediate effect of reducing the value, in international terms, of financial assets, and would therefore impose a cost on the holders of those assets, and on financial institutions and banks.
They are asking, in other words, wage-earners to bear the whole burden of improving our competitiveness, while protecting the value of the assets held by the wealthy. Sadly, such a policy is doomed to fail in terms of improving our competitiveness; but it will certainly be effective in widening the already damaging gap between rich and poor.
Bryan Gould
1 March 2013
This article was published in the NZ Herald on 7 March