Can The UK Escape Five Years Of Depression?

George Irvin

The National Institute of Social and Economic Research (NIESR) uses the term ‘depression’ to mean any period in which output remains below its previous peak. ^[1] The UK depression has already lasted three years and is likely to last five years or more; ie, longer than that of 1930s.^[2]  Not only must Osborne’s Plan A be reversed, but any Plan B must be about escaping from the on-going depression.

The real danger is of stagnating for years to come—a fate dangerously similar to that of Japan after 1990.  After the Great Depression in 1930 and again during the 1979-83 recession, it took Britain 48 months to return to its previous peak output level. NIESR is forecasting 61 months in the present case, and even this is based on forecasts of 0.5% growth in each of the two final quarters of this year. Unless these optimistic predictions are realised for the rest of 2011, we could be in for an NIESR-defined depression lasting even longer than five years.

The notion that stagnation is the necessary consequence of deficits and debt in the UK inherited from a profligate Labour government is nonsense—nonsense of the same order as Tea Part-led hysteria sweeping the USA. At the end of 2007 just before the global crisis, gross debt of the UK public sector was slightly less than fifty percent of GDP, which was well below the Maastricht criterion of 60 percent.  Public debt for Germany and the United States was slightly over sixty percent, far above the UK relatively and absolutely, and the French percentage was close to two-thirds.  UK public debt rose from just below 50 percent at the end of 2007 to 82 percent of GDP at the end of 2010, with the USA experiencing a similar percentage point increase.

It is crucial to note that these ratios refer to gross public debt, ignoring public sector assets.  If one uses the OECD measure of public assets (e.g., foreign exchange reserves, gold in the central bank and public enterprise net value), the UK net public debt increased from 29 percent of GDP in 2007 to only 56 percent in 2010.  The failure to distinguish between the two—or even to provide an economic rationale for using gross debt—reflects the uninformed character of the debate over pubic debt in the UK and elsewhere.

John Weeks

Just as the Tory-dominated debate fails to distinguish between gross and net debt, almost all of the Coalition references to the ‘deficit’ refer to total expenditures minus total revenues, or the ‘general deficit’.  But the most important measure of the deficit is the primary deficit, defined as public expenditure excluding interest payments on the public debt, minus total revenue.  This measure indicates the addition to the stock of debt.  Any intelligent discussion of deficit reduction must refer to the primary deficit, because interest payments on the debt are contractual and cannot be directly reduced by policy measures.  In 2010, although the general budget deficit of the UK was 10.3 percent of GDP, the primary deficit was 7.7 percent.

Moreover, part of public expenditure, namely capital expenditure, creates assets; eg, new transport, education and health facilities.  When a business borrows money to build a factory its net assets are unaltered, its increased debt (borrowing) is matched by an increased asset (factory). The same applies to public investment in a railway, a school or a hospital.  In 2010 government investment of all types was about £70 billion or five percent of GDP.^[3]  Therefore, the net debt creating deficit on government current account was only 2.7 percent of GDP. So much for conservative deficit hysteria.

Like the US, Britain has slipped into what Keynes called a ‘liquidity trap’; ie, a situation where entrepreneur’s expectations and interest rates are already so low that they cannot be cut further to stimulate the demand for new investment. The collapse of private sector investment now accounts for 80% of the total output lost since the recession began in 2008. GDP in Q1 of 2011 was £56.3bn below its peak level in Q1 of 2008 and the fall in private sector investment (gross fixed capital formation) is £44.9bn. No sustained recovery can take place without breaking that pattern.

What the UK requires is a purposeful economic programme of recovery that will not merely reflate the economy but lead to sustained, high-quality growth. The key areas for that investment are housing, transport, infrastructure and education. 2010 saw the lowest level of homebuilding in 83 years—even though there are 1.8mn households on council waiting lists and 300,000 unemployed construction workers. In addition, a qualitative reduction in carbon emissions is required which can only be achieved via investment. There is a chronic investment deficit in these areas.

The current share of  investment in UK GDP is les than 15%, lower than the historical average which even in boom times was too low and too skewed towards residential investment. What is worse, although the earnings of the UK business sector have recently risen, a falling share of retained earnings is going to investment. The share of capital spending out of retained earnings in Q4 of 2010 was only about half its historical average—or the lowest since records began in 1987—and did not improve in H1 of 2011.^[4]

The reluctance of firms to invest is bad news for the Conservative-led coalition on several counts. Not only does investment drive growth but it drives wages: it embodies new technology which stimulates productivity growth, particularly in manufacturing, an area in which Britain has fallen behind. There can be no idea of a sustained recovery without an increase in investment.

Since the private sector is unwilling to invest some mechanisms must be found where the public sector can temporarily take over that investment function. The government already has majority shareholder control over both Lloyds-TSB bank and RBS (as well as Northern Rock).  Part of RBS, for example, could be turned into a British Investment Bank (BIB).The idea is hardly new: not only is there a European Investment Bank but public investment banks exist in Germany and in the Nordic countries.^[5]

The longer the UK economy stagnates, the greater will be the pressure to formulate a Plan B, and we must ensure that it is a progressive Plan B, not an even more regressive one. As Ed Miliband said during the 2010 leadership race:

‘I think we can’t just go back to business as usual when it comes to the banking system. If we think we’re just going to end up back in a situation of the private sector banks with just a bit more regulation, then I don’t think that that’s the right way forward. We’ve got to look at all of these options, not just mutual ownership by the way, public ownership, because that’s what they do in other countries like Germany where they’ve succeeded in building a bigger industrial base.’^[6]

In our view, Ed Miliband is absolutely right. A publicly-owned Investment Bank is a central component of any strategy designed to help Britain escape from recession and regain prosperity.

________________

 ^[1] See ONS: http://www.statistics.gov.uk/pdfdir/gdp0711.pdf

^[2] See Philip Inman: http://www.guardian.co.uk/business/2011/jul/07/uk-flat-growth-viewpoint

^[3] See http://www.hm-treasury.gov.uk/pespub_economic_functional_analysis.htm

^[4] See Chris Dillow, ‘Investment dearth worsens’(28 June 2011): http://bit.ly/opXfcq

^[5] http://www.social-europe.eu/2011/06/britain-needs-a-genuine-public-investment-bank/

^[6] Reported in Richard Stevens: http://www.progressonline.org.uk/columns/column.asp?c=528; for the interim report see http://s3-eu-west-1.amazonaws.com/htcdn/Interim-Report-110411.pdf

No related posts.