12 Aug 2013

Krugman Sees the Light

Paul Krugman, Noble Prize winner and influential US economist, has called time on Neoclassical Economics, which might be the turning point in the insane experiment with laissez-faire markets. This seems to me to be a very significant moment in history. The call comes in his New York Times Blog under the title "Synthesis Lost".
"So the neoclassical synthesis — the idea that we can use monetary and fiscal policy to make the world safe for laissez-faire everywhere else — has failed the test." 
"At the very least it means that we need “macroprudential” policies — regulations and taxes designed to limit the risk of crisis — even during good years, because we now know that we can’t count on an effective cleanup when crisis strikes. " [emphasis added]
This is a huge admission of failure on the part of Neoclassical Economics since the Reagan/Thatcher era. The deregulation of finance created a dangerous situation that lead to economic crisis and made it much more difficult to deal with it when it happened.

Having helped to recreat the conditions for the Great Depression one of the mainstream has admitted that it simply lead to disaster all over again, and that the impulse to put controls in place in the post-war years was the right one.

Lest we forget the post-war years were years of steadily growing prosperity and a lack of economic instability, and the contrast with the present could hardly be more stark. The UK started off with massive debts and a lot of damage to repair. And it responded by building: houses, roads, the NHS. And it paid off those debts. There were no recessions from 1945 to 1973. Yes, there were problems, by the end of that period, but they were not because of the controls, but in spite of them.

This opens the door to wider public debate of the alternatives and opens up the possibility of real change in the way we run our economy. This is the first genuinely optimistic news I have read about the economy since I started taking an interest in it a couple of years ago.

Other Responses

Duncan Weldon. Political Economy Trumps Macroeconomics.
"Yesterday Paul Krugman wrote [one] of the most significant blog posts on economics I’ve ever read."
"Essentially Krugman’s (and indeed Kalecki’s) point is this – we have the macroeconomic tools to restart a robust recovery and get unemployment down but these tools are not being used for political reasons." 

Dan Kervick. Escaping from the Friedman Paradigm.
"Aspects of Friedman’s macroeconomics might be in trouble; but Friedman’s broader paradigm for political economy is still, regrettably, too much with us. In fact, Krugman himself doesn’t seem to have moved much outside that paradigm, as I will try to show."
"What Krugman might have pursued further here [but didn't] is that not only have Friedman’s views about central bank policy been proven wrong, but his broader views on the decisive role of monetary aggregates and monetary policy on economic activity are flawed as well." 
"On the whole, [Krugman's] view seems to be that central bank management of macroeconomic affairs is effective except in the unique circumstances of a liquidity trap."
"Krugman...is working within a framework that is based on a natural real equilibrium rate of interest." [Which is to say that he still accepts the idea that aspects of the economy will tend towards an equilibrium value. This central assumption of Neoclassical economics is demonstrably wrong. Complex systems, like national economies or weather, do not tend to equilibrium at all.]
"So, in substantial measure, Krugman embraces the Friedman paradigm prescribing central bank direction of macroeconomic policy, but has sought to repair the flaws in that paradigm with the addition of a few epicycles." 
Matias Vernengo. Krugman on Friedman, Austrians, and Paradise Lost.
The Neoclassical Synthesis, was based on Hicks ISLM and Modigliani's fixed wages. The fundamental idea is that with wage flexibility the system would lead to full employment, a proposition that Keynes denied in the General Theory.

John Quiggin. Krugman, Keynes, Kalecki, Konczal. Crooked Timber.
"Still, this marks a striking shift in macroeconomics, where only five years ago, the leading figures were congratulating themselves on the convergence between saltwater and freshwater schools, under the banner of dynamic stochastic general equilibrium. As I argued in Zombie Economics, it’s precisely the centre ground of convergence that has been rendered most thoroughly untenable by the crisis. Yet that is still where the majority of academic work being published in journals is grounded."

11 Aug 2013


For the last three years Osborne and Cameron have had a mantra that they repeat. They invoke the recklessness of the last government which left the "finances in a mess" and saddled the government with massive debts. Their response to this has been to minimise debt at any cost. Then they tell us that the answer is for banks to lend to business and for business to invest; and for banks to lend to home owners.

In short the govt wants the private sector to borrow its way out of the depression, while the govt refuses to borrow. They want the private sector to invest, while the govt refuses to invest. This is economic Neoliberalism: free markets and small government which plays little or no active role in the economy. Unfortunately every where and every time these kinds of policies have been enacted the result has been growing inequality and instability - with frequent descent into chaos.

The government stands alongside business and households as a major sector in the economy.

At present government debt is about 75% of GDP and still rising.

As previously note the last government started borrowing more after the crisis of 2009 in order to meet the costs to the nation of the worst recession on record. On the other hand, according to the Governments own figures, private debt is more like 440% of GDP.

2013 Budget Report, Chp 1, p.12.
But more to the point the non-finance sector debt is about 110% of GDP and household debt is about 100% of GDP. So just to put these together:
  • Government debt = 75% of GDP.
  • Non-finance business = 110% of GDP.
  • household debt = 100% of GDP. 
Now if economic growth is the answer to our problems, and that is in itself a vexed question, then investment of capital is required. It is true that there is a lot of capital tied up in savings at present. Though we noted recently that household savings are declining. The depressing likelihood is that the depression has gone on so long that people are either desperate enough to spend their savings on basics. Note that due to high unemployment there is an over-supply of labour at present. But during a long period of stagnant demand does it make sense to invest precious capital in more supply? It does not. The only obvious area of excess demand in the UK is housing where we have both a significant shortfall in supply and over-pricing and there are complex reasons why the market is unwilling to supply more housing. But if there is overall reluctance to invest capital to create growth then what do we do? Many economists argue that it is the role of government to invest when the private sector cannot or will not, and to save when the private sector is investing.

The alternative which seems to be favoured by the Neoliberals is to just wait until the market corrects itself. Low demand ought to lead to lower prices. Certainly we are seeing real wages fall (pay rises are less than inflation) in a market over-supplied with labour. But food and energy, for example, are going up in price due to external forces. With housing, food and energy costs all going up at a time when wages are going down it suggests that domestic demand for all commodities will stay stagnant at best. And given that our major trading partners are all going through a similar process, having also embraced Neoliberalism, then foreign demand is also low. Where a few months ago people were pointing to China and Brazil as untapped sources of demand, we are seeing their economies slowing down as well.

In terms of business you have to be a mug to start investing in increased supply at present unless you build houses. For banks the risks of lending in an economy already super-saturated with debt, and with chronic low demand, are too high to be worth it. Bank of Dave notwithstanding. Of course the economy continues to turnover £1.5 trillion. There is a huge amount of economic activity happening. Loans are being made and even paid off in good time throughout the land. Houses are being built. It's just that its not enough to make a difference to the big picture. And while the big picture is depression then investing is going to be on a small scale. if we want to turn around the high unemployment and falling wages then we need the economy to grow at an appreciable rate (4-5% per annum) for about 5 years. That would be a recovery. What we have at present is stagnation - those who look at the surface seem optimistic and throw the word recovery around, while those who look beneath seem pessimistic and are reluctant to use the word recovery.

Of the three main sectors: government, business and households, only the government is free to act at present. Since the government can act, it seems to me that there is a moral imperative to act.

The government needs to do one of two things.
  1. They could borrow money to build many new houses - perhaps a million of them to bring the cost of housing down, provide employment, and stimulate spending which would in turn make investment seem sensible.
  2. They could use QE (money printing) to have a modern debt jubilee - aka helicopter money. They could give money to the people, especially the poorest people who spend all their income. This would stimulate demand in the short-term at least. Steve Keen's answer to the problem that this indirectly punishes those who were prudent enough to save money (and a lot of people were prudent), is to require recipients of jubilee money to pay off debts before spending. This will cramp the cashflow of lenders. Wonga might go out of business, but that is no great loss. 
They won't chose the first option because this would be an electoral disaster. For most people their home is also their main investment. If you bought a house in the last 20 years it's now massively over-valued. If housing sank to something like it's true value, vast numbers of the middle classes would have more debt than the worth of your asset (negative equity).

In terms of making tough decisions this is one that our tough-talking government will almost certainly not do. It's one thing to oppress and undercut the poor and the sick, but making the middle classes uncomfortable is not something a populist government would do. Also most of the government have their own money invested in property and have a vested interest in high property values. Instead they are complicit in keeping house building at a minimal level and the cost of housing obscenely high. This is how free markets work when one party is both free not to participate and extremely greedy and the other party is compelled to participate (or be homeless in this case).

They won't chose the second option because they are deeply imbued with the ideology that inheriting money is good - though it is wealth obtained with no effort or application of effort - while giving money to the poor and ill is encouraging dependence and laziness. Trust-fund good. Dole bad. Though both are something for nothing. Again I don't think we can expect the government to change the focus of their money printing from banks to households.

What the government are in fact doing is minimising government debt at a time when government debt has never been cheaper, madly encouraging the private sector to borrow more (and trying to cajole banks to lend them more), and crossing their fingers that historical patterns of recovery from recessions will eventually reassert themselves. Like back pain, 80% of recessions cure themselves. But in this case a vertebrae is fractured and they haven't realised it yet.

In the meantime private sector debt is still 440% of GDP and non-finance and household debt are both a or a little over 100% of GDP.

10 Aug 2013

Manufacturing and Production

We heard last week from the ONS that manufacturing and production figures went up in Q1 2013. While this is certainly good news, it's still too early to be talking about a recovery.

Following Frances Coppola I note that the rise is pretty small and we're still well below the levels of 2007/2008. Again it's far to soon to call this a recovery. We've already seen a much larger increase in both manufacturing and production fritter away in recent years. Indeed the trend in both lines on this graph is headed downwards still.

It's all too easy to latch onto good news as being yet another round of "we're past the worst" but that narrative has been an almost constant refrain since 2008. Just as one quarter of negative growth does not make a recession, one quarter of positive growth does not make a recovery (and we have yet to see one quarter of above trend growth since 2007).

Everyone is a bit desperate for good news and that is understandable. But the government have failed to address the fundamental problems with the UK economy and we probably won't see sustained growth for some years to come.

9 Aug 2013

Barclays vs UK GDP

When I commented on Shaun Richards's blog about Barclays Bank he responded:
"The next number two numbers may also provide some food for thought on the amount of credit around. Barclays balance sheet size £1.56 trillion. UK GDP (seasonally adjusted) for the latest 4 quarters £1.51 trillion...."
The basic formula for a balance sheet is

Assets = Liabilities + Shareholders' Equity

And for a bank it's assets are made up of reserves, buildings, and its investments and loans. And the total, just for Barclays Bank, is more than the GDP of the UK.

This is how they can report half year profits of £3.6bn. And while this seems a huge number, it is only about 0.25% of their assets. But it's also what makes them "too big to fail". A disruption on a par with the GDP of the UK would be a disaster.

HSBC has total assets of £1.7 trillion.
RBS has total assets of  £1.4 trillion.

This is also suggests why bankers salaries and bonuses are so high - each bank manages assets on the scale of a moderately sized country. By comparison US based Goldman Sachs has assets of ca. £6.18 trillion and the net worth of the UK (effectively the county's balance sheet) was £6.8 trillion.

7 Aug 2013

Good news?

If you were listening to Radio 4 last night at about 10:30pm you would have heard France Coppola being interviewed about the recent goods news on the economy. She pointed out that growth in economic activity is correlated to a rise in consumer credit and a decrease in savings. This is "heading down the same track" as before the crash. 

We need to be clear that if we base growth on spending savings and borrowed money that it will end in tears.

UK GDP is about £1.4 trillion. According to Humber Debt Solutions in July 2013:
Outstanding personal debt stood at £1.424 trillion at the end of May 2013.
This is up from £1.410 trillion at the end of May 2012. 
Average household debt in the UK (including mortgages) was £54,024 in May.
This is up from a revised £54,002 in April. 
The Office for Budget Responsibility (OBR) predicted in March 2013 that total household debt will reach £1.931 trillion in Q1 2018. This would mean that average household debt would reach £73,284 (assuming that the number of households in the UK remained the same between now and Q1 2018).
The levels of debt that we are sustaining at present is a significant drag on the economy. We cannot add more debt and expect positive results in the long term. Any growth we get is likely to be short-term.