George Osborne is destined to be remembered as the most inept Chancellor in British history

DAVID BLANCHFLOWER

Sunday 27 January 2013

Endless grim news confirms our worst fears about the man running the Treasury. And until workers see a growth in their real earnings, our economy is go rise?

It wasn’t a great week for the Coalition. First the Prime Minister made hismuch-awaited EU speech, which increased the levels of uncertainty for UK businesses just when they needed it least. Firms are sitting on loads of cash but are not willing to invest it as consumers aren’t spending; they are even less likely to do so now after David Cameron’s intervention.

This may have satisfied his Eurosceptic MPs, but was disastrous in economic terms. Any foreign firm considering setting up business in Britain as a gateway to Europe will inevitably be having second thoughts. The speech was clearly bad for growth and jobs.

Then the IMF lowered its growth forecast for the UK, and its chief economist, Olivier Blanchard, called for a fiscal U-turn. A few weeks earlier Mr Blanchard had argued in an important paper that fiscal multipliers – estimates of the impact of tax hikes and spending cuts on overall GDP – were much larger than the Office for Budget Responsibility had factored in, with the implication that any decline in growth was likely to have been caused by 11 Downing Street.

Debacles, cont'd

Next, the PM was caught out on a party political broadcast where he claimed the Coalition had been reducing the country’s debts even though they have been increasing it. Data on the public finances released last week also confirmed that, far from having cut the deficit by a quarter, it has in fact risen over the last 12 months. Then there was the Pizza¬gate PR disaster, when Dave and Slasher noisily celebrated their apparent success over a deep dish in Davos. Commentators took it to mean that GDP numbers – that the two would have already seen – were going to be positive. Debacle on debacle.

As I had feared, the growth numbers were bad again. The recession deniers had forecast positive growth, of course, but this was just wishful thinking: even the hopeless MPC had predicted a fall in output. A 0.3 per cent contraction means that the economy hasn’t grown for the last year at all. The economy is running on empty. In terms of the speed at which lost output has (not) been restored the economic pygmies in the Coalition are now responsible for a much worse slump than the Great Depression.

The economy was growing nicely when the Coalition took over in the spring of 2010. Indeed over the period Q32009-Q32010 the Labour government under Alastair Darling generated five successive quarters of growth; the economy grew by 2.7 per cent. During the succeeding nine quarters, Q42010-Q42012, under George Osborne the economy has grown by 0.4 per cent, zero over the last year. Four of the last five quarters have been negative.

For comparison purposes over the last five quarters, in contrast to Mr Darling’s growth the economy has shrunk by 0.3 per cent. The economy has still not restored half of the drop in output experienced from 2008Q2-2009Q2 of 6.5 per cent, and there is no chance under current policies that output will be restored before the 2015 election. Our part-time Chancellor will go down in history as the most inept ever; his austerity strategy has failed; borrowing is up, and the economy has been flatlining for two years. Ed Balls can now say he warned us this was going to happen. Told you so. Triple-dip here we come.

Boris Johnson stirred things up at Davos when he said it was “time to junk the language of austerity” and that the language of cuts was “not terribly useful in this sort of climate”. Good for him. He went on to argue for infrastructure spend on housing and transport for starters, and that “the hair-shirt Stafford Cripps agenda is not the way to get Britain moving again”. I couldn’t agree more – at long last someone who is prepared to lift animal spirits. At last someone in the Tory ranks is stirring things up.

One big puzzle

There is one big puzzle; poor growth jars with the recent news on the labour market, which showed some improvement. Of course some of this has to do with workers being hours constrained. The main explanation, though, appears to be that instead of big increases in unemployment, there have been big falls in prices, that is in wages and earnings. The graph above illustrates the movement in real earnings over the last decade; it simply takes annual weekly earnings (AWE) growth and deducts from it from inflation.

So if weekly wages grew by 5 per cent and the consumer prices index rose by 2 per cent real earnings increased by 3 per cent. It is clear that real earnings growth has been negative since the start of the recession – with one brief exception in early 2010 as the economy started growing before the Coalition took office and stopped that. Between March 2008 and November 2012 weekly earnings have risen from £440 a week to £472, or by 7.3 per cent; over the same time period prices have risen by 17.2 per cent, so real earnings are down by a tenth.

Wages have taken the strain. Falling real wages means that people’s living standard are falling, and they aren’t spending. How¬ever, this fall has been mitigated somewhat for people with mortgages by the decline in their mortgage payments due to low interest rates on their trackers. This means that any increase in interest rates would decimate living standards of working people even further, so sorry savers. Falling real wages have prevented unemployment from rising.

Recent work by Paul Gregg and Steve Machin suggests that wages recently have become a lot more responsive to an unemployment shock, that is the wage unemployment elasticity of pay (the “wage curve”) has risen. My own research suggests that hasn’t happened in the United States, which may help to explain why it has had a much bigger rise in unemployment for around half the drop in output the UK had. Until workers start to see a growth in their real earnings, this economy is going nowhere. Maybe those folks in Davos should think about sharing some of their profits with their workers. Hey boss, can I have a pay rise? 

Marx takes on Keynes, Friedman and Schumacher

The ultimate Davos debate: 

If you could construct the best panel at a World Economic Forum debate, this would be it. But what would they say about present problems? Read on …

What if Karl Marx and Keynes, Friedman and Schumacher were at the 43rd World Economic Forum in Davos, Switzerland? Photograph: Laurent Gillieron/AP

Imagine that you could construct the ultimate Davos panel. From the annals of history you can choose any quartet that could put the world to rights in an hour-long talk, the format beloved of the World Economic Forum.

Klaus Schwab, the man who has been organising the forum since 1971, ensured there were plenty of stellar names strutting their stuff in the high Alps last week. Davos attendees could watch Nouriel "Dr Doom" Roubini cross swords with Adam Posen, recently a member of the Bank of England's monetary policy committee about the merits of quantitative easing. They could listen to Mark Carney, soon to take over from Sir Mervyn King at Threadneedle Street, warn that the global economy is far from out of the woods. George Soros held forth on drugs; Facebook's Sheryl Sandberg spoke passionately about sexual stereotyping; David Cameron called for the G8 to act against tax avoidance and corruption.

But how about this for a panel? Karl Marx, John Maynard Keynes, Milton Friedman and Fritz Schumacher, all no longer with us, kept in line by the IMF's Christine Lagarde, thankfully still alive and kicking, and one of the standout performers last week.

Lagarde kicks off our fantasy discussion with a few words of introduction. She says business leaders have left Davos in a slightly better frame of mind not because of the millions of words spouted in Davos, but because of three little words spoken by the president of the European Central Bank, Mario Draghi, in London in July. Those words were "whatever it takes", a commitment by the ECB to buy up the bonds of troubled eurozone countries in unlimited quantities. That has removed one of the big tail risks to the global economy – a chaotic break-up of the eurozone. But, she adds, any recovery in 2013 will be fragile and timid, and there is a risk of a relapse. "Turning first to you Karl, how do you see things".

Marx: "The capitalist class gathered in Davos has spent the last few days wringing their hands about unemployment and the lack of demand for their goods. What they seem incapable of recognising is that these are inevitable in a globalised economy. There is a tendency towards over-investment, over-production and a falling rate of profit, which, as ever, employers have sought to counter by cutting wages and creating a reserve army of labour. That's why there are more than 200 million people unemployed around the world and there has been a trend towards greater inequality. It is possible that 2013 will be better than 2012 but it will be a brief respite."

Lagarde: "That's a gloomy analysis, Karl. Wages are growing quite fast in some parts of the world, such as China, but I'd agree that inequality is a threat. The IMF's own research shows that inequality is correlated to economic instability."

Marx: "It is true that the emerging market economies are growing rapidly now but in time they too will be affected by the same forces."

Lagarde: "Maynard, do you think things are as bleak as Karl says?

Keynes: "No I don't Christine. I think the problem is serious but soluble. When we last faced a crisis of this magnitude we responded by aggressive loosening of monetary policy – driving down both short-term and long-term interest rates – and by the use of public works to boost aggregate demand. In the US, my friend Franklin Roosevelt supported legislation that allowed workers to organise. After the second world war, the international community created the IMF in order to smooth out balance of payments imbalances, prevent beggar-my-neighbour currency wars and control movements of capital. All these lessons have been forgotten. The balance between fiscal and monetary policy is wrong; currency wars are brewing; the financial sector remains largely unreformed, and aggregate demand is weak because workers are not getting a fair share of their productivity gains. Economics is stuck in the past; it is as if physics had not moved on since Kepler."

Lagarde: "I gather from what you are saying, Maynard, that you do not approve of the way George Osborne is running the UK economy."

Keynes: "The man has taken leave of his senses. Britain has a growth problem, not a deficit problem."

Lagarde: "I daresay Milton that you disagree with everything Maynard has said? You would make the case, presumably, for nature's cure?"

Milton Friedman: "Some of my friends in the Austrian school of economics would certainly favour doing nothing in the hope of a cleansing of the system, but I wouldn't. Unlike Maynard, I wouldn't support measures that would increase the bargaining power of trade unions and I've never been keen on public works as a response to a slump.

"But I would certainly support what Ben Bernanke has been doing with monetary policy in the US and would support even more drastic action if it proved necessary."

Lagarde: "Such as?"

Friedman: "Well, I think monetary policy should be set in order to hit a target for nominal output – the increase in the size of the economy unadjusted for inflation. If that growth is too high, central banks should tighten policy. If it is too low, the trend since the crisis broke, they should loosen it. In extreme circumstances, I'd favour policies that blur the distinction between monetary and fiscal policy. That's what I mean when I talk about helicopter drops of money into the economy."

Lagarde: "Fritz, you have been sitting there patiently listening to Karl, Maynard and Milton. How do you assess the state of the world?

Fritz Schumacher: "I am greatly disturbed by the way the debate is being framed. There is an obsession with growth at all costs regardless of the environmental costs. Climate change was rarely mentioned in Davos: this after a year of extreme weather events. It is frightening that so little attention has been paid to global warming, and almost criminally neglectful of governments not to use ultra-low interest rates to invest in green technologies.

"As has been the case in the past, recessions have pushed green issues down the political agenda. In good times policymakers say they are in favour of sustainable development, but the pledges are forgotten as soon as unemployment starts to rise. Then it is back to business as usual: more roads, expanding airports, tax cuts to encourage consumption. When scientists are warning that global temperatures are on course to rise several degrees above pre-industrial levels on unchanged policies, this is the economics of the madhouse."

Lagarde: "Maynard, what's your response to that?"

Keynes: "I agree with him. If I were advising Roosevelt today I would be calling for a Green New Deal. I find it hard to envisage a world without growth, something that is politically unacceptable in the developing world in any case. But Fritz is right, we need smarter, cleaner growth. As you yourself said last week, Christine, if we carry on as we are the next generation will be 'roasted, toasted, fried and grilled'."

Schumacher: "I couldn't have put it better myself."