• George Osborne’s Non-Event

    George Osborne’s budget was driven by an obvious political imperative but was, in economic terms, largely a non-event. The major interest, such as it was, lay in the minor adjustments offered to long-suffering consumers in the forlorn hope that they would be cheered up by cheaper beer and marginal concessions on income tax, and might not therefore notice that their jobs, services and living standards are still under constant threat.

    In terms of the wider economy, the Chancellor’s stance was “steady as he goes”; after nearly three years of his stewardship and in the sixth year of recession, nothing much, it seems, needed to change.

    There was no recognition that austerity as a response to recession had not only been invalidated by experience, both in the UK and in Europe, but had also, as a consequence, been rejected – following a review of their earlier recommendations – by the IMF. The Chancellor was apparently unconcerned that output still lagged behind its pre-recession peak, and that the government borrowing, whose reduction he had identified as one of his primary goals, had continued – reflecting the depressed level of economic activity – to grow as a percentage of GDP.

    So little account was taken of the most obvious and pressing problems facing the economy that one must wonder whether the Chancellor’s focus is political and social, rather than economic. It may well be that his unstated agenda is to take advantage of the recession to unleash forces and drive through measures that will change the balance of advantage between rich and poor, private business and the public sector, for a generation.

    The Chancellor may well be, in other words, an (perhaps – if one is being generous) unwitting heir to a long and dishonourable tradition, epitomised by Andrew Mellon, the multimillionaire US Treasury Secretary, who called upon employers in the depths of the Great Depression to “liquidate labour”.

    Austerity, and the withdrawal of government, represent, after all, increased space for private enterprise (though the Chancellor seems not to have noticed that manufacturing is so enfeebled that it is unable to take advantage of any supposed opportunities); and even the resulting failure to get the economy moving has a silver lining, in that it guarantees that unemployment remains an actual and potential restraint on wage growth.

    What was needed from the Chancellor in his Budget speech was so far removed from what was in his mind that there seems scarcely any point in rehearsing it. But the Budget speech would have made a positive difference if it had signalled the abandonment of austerity and its replacement by a strategy to recruit government, banking and industry in a joint effort to raise the level of demand, to provide finance for productive investment, to coordinate an industrial strategy focusing on those areas of manufacturing that represent the best possibilities for growth, and to frame a macro-economic policy with competitiveness rather than inflation control at its heart.

    Bryan Gould

    31 March 2013

    This article was written for Palgrave Macmillan’s newsletter.

  • 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

  • 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

  • Getting the Dollar Down

    That dwindling band who continue to deny that our economy is being hurt by an overvalued currency will usually – in the face of the indisputable evidence – take refuge as a last resort in the assertion that “there is nothing much we can do anyway – we just have to live with it.”

    Nothing is further from the truth. We have an overvalued dollar – which continues to destroy jobs, weaken our industry, worsen our balance of trade, and increase our indebtedness – because that is what our policymakers choose.

    The usual assertion that there is nothing that can be done usually focuses on – and then dismisses – the possibility of intervening in the foreign exchange markets, as though this is the only option. But intervention is the least effective measure that could be taken; it is quite true the Reserve Bank, and its (comparatively) puny resources, would be quite unable to offset the huge flows of hot money that determine the value of our dollar. Intervention is merely a straw man that can be conveniently knocked down so as to distract attention from more effective options.

    That is not to say that the occasional selling of New Zealand dollars (as the Reserve Bank has done recently) would not be helpful in inducing a little doubt in the minds of speculators who are usually confident of a guaranteed interest rate premium and probably a capital gain as well, while the Governor’s unequivocal description of the dollar as “overvalued” was also a useful signal; but there are much more effective measures that can and should be taken.

    The first and most obvious step is to change the policies that inevitably force up the dollar’s value. We persist in paying an interest rate premium to overseas lenders to persuade them to lend us money; and the more we do that, we more we push up the dollar and weaken our economy, and – as a consequence – the more we have to borrow and therefore to offer high interest rates to persuade them to go on lending to us.

    We insist on creating this vicious circle, despite all the obvious downsides, because we assert that controlling inflation – not sustainable growth, not competitiveness, and not full employment – is the only goal of policy, and that raising interest rates is the only way of doing it. If we identified wider goals of policy, and stopped using interest rates and the exchange rate for literally counter-productive purposes (when we should be focusing directly on the actual causes of inflation, such as unrestrained bank lending for non-productive purposes), we could avoid repeatedly shooting ourselves in the foot.

    Other countries are rapidly learning these lessons; even the Governor-in-waiting of the Bank of England has signalled that he is ready to abandon inflation as the sole focus of policy. Sadly, so committed are our leaders to an increasingly discredited orthodoxy that they will not even contemplate any change. And our government has compounded this stubbornness by opposing policies that would help recovery from recession – and bring the exchange rate down at the same time.

    By identifying the reduction in its own deficit as the principal goal of policy, the government has signalled that its priority is the financial rather than the real economy in which most people live and work. This concern for the short-term value of financial assets ensures that foreign lenders will go on buying dollars, secure in the knowledge that nothing will be done to jeopardise “confidence” amongst financial institutions and that the dollar will go on rising.

    Other countries, by contrast, now know better. They know that the only way to escape recession is to get the economy moving again by improving competitiveness. They have increasingly turned to quantitative easing (or printing money) – as in the US and the US – or, even more interestingly and much more effectively, to fiscal stimulus – as in the case of Shinzo Abe’s new Japanese government. The effect of these measures is not only to encourage growth and recovery, and – interestingly – to get government deficits down, but also to devalue the currency; in the case of Japan, that goal is quite overt.

    These measures show that not only that these countries understand the importance of improving competitiveness by bringing down the value of their currencies but at the same time how easy it is to do so – just check out what has happened and is happening to the US dollar, the pound and the yen.

    We remain stubbornly in that dwindling group of countries whose priority is maintaining the value of the currency and who are willing to sacrifice everything, including recovery from recession, to that end. While others reduce the value of their currencies, we say we know better and continue to push up the value of our dollar.

    We have an overvalued dollar, in other words, because we choose to. When bankers, stockbrokers and other holders of financial assets assure us, in other words, that we “just have to live with it”, they are just putting their own sectional interest ahead of the rest of the economy.

    Bryan Gould

    2 February 2013

    This article was published in the NZ Herald on 6 February.