Who is the State working for: the banks or the public?

March 26, 2008 By Damien Millet
and Eric Toussaint

Source: Committee for the Abolition of Third World Debt (CADTM)

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In many respects, the ongoing international financial crisis throws into sharp relief the deceit and denials of those who promote financial globalization, whether they sit on the board of the big private banks or move in the higher spheres of the State. Over recent years, the dominant discourse was that all was fine on the debt front: with the introduction of new products, such as the securitization of debts, the risk had been spread among a number of players. No crisis could be expected, profits were astronomical and growth was sustained. 

Today, the edifice is crumbling. How could it be otherwise, when big banks conduct huge operations off the books, erect a house of cards with dubious credit and contribute to the creation of a speculative real estate bubble that eventually bursts? Far from spreading the risk, the system achieved the contrary, with the big banks having accumulated its weaknesses. Each of them then tried to pass the hot potato to its already troubled neighbor.

Instead of acknowledging their mistakes and assuming the consequences, the big banks sought help from the State -- whose actions they are normally quick to disparage. They did not hesitate to seek strong public intervention from the same State they usually consider as too interventionist. In fact, the big banking lobbies have always insisted that the public authorities must respect market forces -- the sole mechanism able to efficiently distribute resources and fix prices at their real values.

Like obedient underlings, the US and European authorities did as they were asked: you do not refuse a favor to the directors of the big banks that support the main presidential candidates and who move in the same close-knit circles... Thus, the rulers quickly came to the rescue of private interests. On the menu: nationalization of the troubled banks, exchange of devalued and distressed debt securities for fresh cash (to the tune of 200 billion dollars in the US), cash injection, rescue plans, decreased interest rates...

In Britain, one of the spearheads of neoliberal globalization, the crisis floored the bank Northern Rock in September 2007, leading to its nationalization in February 2008. Once the ship has been steadied at public expense, it will pass back into private hands. Similarly, in the United States, when Bear Stearns, the country's fifth most important investment bank, found itself short of credit on 13 March, the financial authorities organised a rescue with the help of JP Morgan Chase, which subsequently bought Bear Stearns at a bargain price.

This crisis clearly proves that when management of the world economy is ruled by the logic of maximum profit, society pays an enormous price. The banks have gambled with the savings and cash deposits of hundreds of millions of individuals. Their mistakes have led to huge losses and human tragedy, as was the case with the bankruptcy of the Enron multinational in 2001. Around 25,000 Enron employees found themselves with a paltry pension because the company's pension fund had been diluted by the directors, who had quietly sold their shares for nearly a billion dollars.[1]

In terms of North and South, the similarities are striking. In the South, the debt crisis of the early 1980s was caused by the unilateral increase of interest rates by the United States, leading to a massive hike in the repayments of Third World countries that the banks had encouraged to take out loans at variable interest rates. Simultaneously, the plummeting prices of raw materials and oil prevented them from coping, forcing them ever deeper into a crisis. The International Monetary Fund (IMF), remote-controlled by the United States and the other great powers, then imposed drastic structural adjustment programs on developing countries. The recipe, as in countries of the North, was as follows: a decrease in social spending, complete and immediate economic liberalization, an end to control over the flow of capital, complete opening of the market, massive privatizations. However, contrary to what is taking place in the North, the states of the South have been prevented from reducing interest rates and giving credit to banks, causing serial bankruptcies and severe recessions. Finally, just like today, the State was forced to bail out the troubled banks before privatizing them, usually to the benefit of the major North American and European banking multinationals. In Mexico, the cost of rescuing the banks, in the second half of the 1990s, represented 15% of the Gross Domestic Product (GDP). In Ecuador, a similar manoeuvre in 2000 cost the country 25% of its GDP. Everywhere, the internal public debt rose massively because the cost of the rescue plan for the banks was borne by the State.

The economic deregulation of the last decades has been a fiasco. The only constructive solution would be a complete reversal of priorities: strict constraints on private companies, massive public investments in sectors that can ensure fundamental human rights and protection of the environment, the recovery by public powers of the decision-making levers to favor the general interest.

If the neoliberal train pursues its wild journey, a crash is guaranteed. Those who have set it in motion would like to see it go even faster. The most recent proof: after the last elections in France, the government of Nicolas Sarkozy announced its intention to accelerate the reforms, while the electorate had clearly rejected the current choices. Undoubtedly, a major international economic turnaround is impossible without a massive popular mobilization. Forty years after May 68, such a move is increasingly urgent if capitalism as such is finally to be challenged.
 

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Has market fundamentalism had its day?

Johann Hari

Thursday, 20 March 2008

The sound of scenery collapsing and actors staggering off the stage on Wall Street and in the City of London is echoing all over the world. The reporting of these events is mostly couched here in the anodyne language of economic cycles – there is "market turbulence" and "a down-turn on the way". This makes us think of it all as the economic equivalent of the tsunami – one of those horrible things that erupts every now and then, beyond our control. But this is a lie.

The financial crises of the past year, culminating in the de-clawing of the Bear Stearns bear-pit over the past week, are the direct result of pursuing an ideology to its logical end-point. This financial bubble could only take place because we have been living in an ideological bubble – one of market fundamentalism.

From the trauma of the Great Depression to 1973, there was a broad consensus across the democratic world that markets were absolutely essential to generate wealth, but they will also cause all sorts of problems if they are left unregulated. Economists like JM Keynes and JK Galbraith taught us that if you abolish markets, you get starvation; but if you abolish all the democratic checks and balances on markets, you get a system that eats itself. Unregulated businesses will cause unsustainable levels of pollution and inequality, and ultimately start pursuing unhinged business models that cause the whole system to collapse.

But since the 1970s, we have been lectured that these ideas are stale left-overs. Markets work best when all the fetters on them – a democratic state, and democratic trade unions – shrivel like fruit in the sun. Whatever the problem, the solution is to release businesses from all checks and balances.

So we tried it. We now have a global business system that is virtually unregulated, with trade unions crippled and politicians largely bought by the super-rich to serve their interests. And what is the result? Inequality has returned to 1920s levels, and movement between the classes has collapsed. We have bank runs unseen in a century. And now even senior Wall Street figures mutter – with only a hint of hyperbole – about a looming Depression and "the worst crisis since 1929". All we need now is rising unemployment and Zelda and F Scott Fitzgerald boozily waltzing through Wall Street, and we are back where this story began.

The sub-prime mortgage collapse that started the stock market tremors was entirely and exclusively the child of the deregulation mania. Until the Bush era, banks were forbidden by the state from offering unpayably vast mortgages to the poorest people in America. It was plain that such a system would be unfair to consumers, and introduced a wild instability into the financial system. But – hey! – state regulation is always a problem, and market freedom is always the solution – right? Now that the deregulated market has begun to collapse in on itself, the state has had to step back in with a far heavier hand than before, throwing tens of billions at failed banks.

So as we enter a recession – or worse – caused by market fundamentalism, how will our politics change? The world economy now needs an era of re-regulation akin to Franklin Roosevelt's, which regulated the banks, legalised trade unions and made taxation progressive. This will be harder to do because the economy is now globalised. But with political will, it can be done.

Yet this is not necessarily what will happen. The super-rich speak louder than the rest of us – politicians are dependent on their party donations, for one – and are determined to defend their privileges. As an economy contracts, stress-lines open up in a society – and by looking at British politics today, we can see the conflicting directions these fractures could run in.

When the funds for public services dry up, the right instinctively looks downward for places to save cash. The Tories are pledging a crackdown on dis-ability-benefit recipients, and the abolition of services for the poor like SureStart centres and Educational Maintenance Allowances. Refugees are rarely far behind: remember, David Cameron wrote the last Tory manifesto, which committed to end the 1951 UN Convention on Refugees founded in the wake of the Holocaust.

But there is another place for our anger to be directed. Buried in the many dense footnotes to the Budget last week, there was an extraordinary figure. The Treasury has calculated that the super-rich are using avoidance and evasion techniques to wriggle out of paying £41bn in taxes to the British Exchequer every year. To put this in context: if every single disability benefit claimant and every single refugee was a fraud, they would still be ripping us off for less than the super-rich.

If the super-rich paid their taxes as the rest of us are required to, we could increase every pension by nearly 50 percent, or treble spending on primary schools. (I will post some of my suggestions for how to make them do this on our OpenHouse blog.) We are always hearing about the tiny number of dishonest disability and refugee claimants, but hardly anything about this far larger scandal.

As funds for public services dry up in a recession, our politicians can go after the weak people at the bottom, or they can require the strong people at the top – who caused this crisis with their demands for deregulation – to start paying their fair share. Imagine an election poster bearing the faces of the 10 richest men in Britain, asking: you pay your taxes, why shouldn't they? Some European governments are already making this choice: Germany and Italy are engaged in huge programmes of loop-hole closing and prosecutions.

Of course, the cheerleaders for deregulation who unrepentantly led us into this mess announce that requiring the rich to pay their fair share will only drive away investment and send productivity plummeting. An intelligent writer once answered this point, writing: "The Chancellor has been generous in the deployment of new and lucrative tax shelters for the very rich. The theory is that capital will flourish, that industry and innovation will thereby profit and enterprise will be justly rewarded. The realities are more mundane and more squalid. The rewards are for ingenuity in tax avoidance only. The only beneficiaries are the very rich, who show no sign of becoming more productive – only richer."

The writer was Gordon Brown in 1987. Perhaps somebody could show it to him now – a prime minister who had to be jostled into charging the likes of Mohamed Al Fayed a pittance of £30,000 a year. (Cameron would be even worse: his political career has been bankrolled by a man based in the tax haven of Belize, and his "competitiveness" spokesman, John Redwood, has suggested copying the US deregulation of mortgages here.) In the US, both Clinton and Obama are similarly cautious, looking nervously over their shoulders to their big-money donors.

The 1920s nostalgia of the market fundamentalists has brought us to this crisis, where we could be facing our own 1930s. This should shift global politics dramatically to the left – but not if our politicians' responses are as sub-prime as our mortgages.

How to stop the super-rich scam
By Johann Hari

So what do we do about the fact the super-rich are scamming the British tax system for £41bn a year? In my column today, I point out the super-rich are dishonestly wriggling out of paying tax billions that are enough to treble spending on primary schools, or increase every single pension by nearly 50 per cent. This is being repeated across the Anglo-economies, from the US to Australia.

There is a kind of pessimism about our ability to stop the rich unilaterally exempting themselves from the tax system. They live in our societies - dependent on the same police and army and emergency rooms – but they increasingly refuse to pay the membership fees. Indeed, they demand we show “gratitude” just for them gracing us with their presence.

A superb recent report by the tax specialist Richard Murphy for the British TUC – ‘The Missing Billions’ – details a rich range of options to make it much harder for these people to scam us.

The most simple is to introduce into British law something called a general anti-avoidance principle.
It is simply stated that if any step is added into a commercial arrangement for the sole or main purpose of avoiding tax, then this step will be ignored by HM Revenue and Customs. They will tax it anyway. So if you transfer you earnings into your wife or child’s name just to scam us; if you relocate your business on paper just to scam us; we’ll ignore it.

This is not a magic bullet – but it changes the terms of the debate. Instead of the Inland Revenue chasing retrospectively to close loopholes, accountants have to justify them as being more than mere tax avoidance every time.

The next move is to stop the perverse staff cuts at HM Revenue and Customs. By 2011, three hundred tax offices will have been shuttered, and 25,000 staff laid off. This is a totally false economy: each staff member brings in £2,636,588 a year – more than 96.5 times their wages. But if there’s nobody to track down the tax avoiders, we can’t net the cash.

And we can crack down on tax havens. The German government is now using its equivalent of MI5 to track people dodgily shifting their cash to Liechtenstein. Britain needs to be as proactive. We were constantly being told that it was impossible to restrain tax havens, because the money would simply leech to another haven, then another; there would always be somebody prepared to snub the world and reap the rewards. But after September 11th the US demanded every al Qaeda-related bank account be closed – and it happened overnight. If money stashed away to kill people can be tracked, why not money that could save lives too? An international campaign to end this system is in the interests of the 99.9 percent of humanity who will never use a tax haven.

This isn’t about persecuting the super-rich; it’s about requiring them to pay their fair share for the privilege of living and working in a stable democratic society. I pay my taxes; you pay yours. It is time for the people who can most afford it to do the same.

How dare these soldiers go round getting wounded?

Mark Steel: How dare these soldiers go round getting wounded?

Wednesday, 19 March 2008

Of all the shady reasons for supporting the war in Iraq, the weakest was always how it was our duty to "Support our boys," as they couldn't do their job if people back home were critical. To start with, this doesn't seem logical. Is there any evidence that tank commanders were about to fire off a volley of missiles, but then hesitated saying "Ooh I'm not sure I can go through with it because there was this sniffy letter in The Independent"?

But more important=, what a strange idea that the only true way to support someone is to cheer them into a situation that's likely to get them killed. If these "supporters" ever find themselves looking up at a tower block, with someone 15 floors up threatening to jump off the balcony as friends delicately try to coax him back, they must shout, "Don't undermine him – it's up to all of us to support him – jump, man, jump! Go on – here's Zoe, 22 from Clacton in a G-string and paratrooper's cap. She supports you, so dive!"

Inevitably, once the supported boys started returning from war with bits missing, the governments and newspapers that backed them most enthusiastically decide that they're an embarrassing nuisance. Then their attitude becomes like that of the First World War general who, when he visited a hospital full of soldiers back from the Somme with shell shock, shouted, "Why are you shivering? Only drunkards and masturbators freeze." This must be what causes so many old people to conk out from hypothermia every winter, the filthy minxes.

But that general has been challenged for callousness by defence minister Des Browne, who yesterday went to the High Court to try and prevent a coroner from criticising the Ministry of Defence, during inquests on soldiers killed in Iraq or Afghanistan. The trouble is that a coroner reported, in the inquest into the death of Capt James Phillipson, that the soldier had been given, "a lack of basic equipment". Whereas from now on, presumably, he'll have to say, "The soldier had piles of equipment, so much he didn't know where to put it all. What must have happened is, well, obviously, I've got it – the Taliban magicked it away, with their equipment vanishing cream. So there we are, no one to blame, just one of those things, I'm afraid."

The attempted injunction fits in with the government's attitude to wounded soldiers. For example, families of those who've been disabled have complained about the system for compensation, which only takes into account the three worst injuries received. I'm not an expert on the details of modern warfare, but I'd guess that if you're blown up by a roadside bomb you might be injured in more than three places. This doesn't seem to occur to the Ministry of Defence, who must say to applicants for compensation "All right, Wilkins, so you're trying to tell me that when you were blown across the road by a barrel of explosives you injured not only an arm, a foot and an ear but other bits as well? Do you take us for mugs?"

This procedure has meant that, for example, when Sgt Martin Edwardes came back from Iraq with brain damage, his compensation was £114,000, a fraction of what will be needed to provide him with the 24-hour care he now depends on. Or there's Martyn Compton, who was in a coma for three months, has 70 per cent burns, no ears left, and received £98,000. They'd have got more if they'd been astute enough to suffer three huge injuries instead of dozens of medium-sized ones. Maybe we'll soon see Carol Vorderman asking, "Why not consolidate all your minor amputations into one manageable paralysis?"

Perhaps the next move will be to franchise compensation payments out to the Private Finance Initiative, so disabled soldiers will be instructed to attract investment by converting their wheelchair into a mobile Costa Coffee outlet. Or the system will be made more efficient by placing it into private hands, so the severely wounded will have to attract sponsorship. For example, if they have to use a voice box, it will be programmed to say things like, "Please – take – me – to – the – toilet – Thank – you – this – request – was – brought – to – you – by – Legal – and – General."

Throughout the coverage of the fifth anniversary of the war, there have been discussions around the "mistakes" made in planning the occupation. But the government's attitude towards those whose lives have been wrecked for their vanity project shows the problem wasn't "mistakes", in the execution of the plan, but the whole project. Unless they'll claim, "When we began this operation, whoever could have anticipated that when we invaded the country, some of these chaps would start firing back? I mean – we can't predict everything now, can we?"

Ideas from left field

Ideas from left field

Sport, like life, is pure Darwinism. It is too innovative to be confined by one political theory

* Ed Smith
* The Guardian,
* Saturday March 15 2008


We are all too familiar with debates about sport and political controversies - should we allow an Olympic games in China? Should England play cricket in Zimbabwe? - but we hear little about sport and political ideas. Does the history of sport demonstrate the rightness, or otherwise, of a political world view? If sport had to don political colours, would it wear a red strip or a blue one?

The Marxists, as is often the case, have some of the prose stylists. CLR James, the doyen of all sports writers, was a Marxist class warrior as well as a wonderful cricket writer. Marxism runs through James's Beyond a Boundary rather like Catholicism courses through Graham Greene's fiction: they are all too keen to advocate their respective faiths, rather less good at getting their narratives to embody them.

Far from proving James's Marxist ideals, Beyond a Boundary undermines them. Any static ruling establishment, no matter how well-intentioned, quickly morphs to become very similar to the one it replaced.

The book's convincing strand about the spirit and ingenuity of early black West Indian cricketers proves that, far from cricket needing more Marxism, Marxism needs to learn from West Indian cricket. "Never trust the teller," as DH Lawrence put it, "trust the tale."

To high Tories, of course, the history of sport proves that civilisation is gradually collapsing - it has been all downhill since the demise of the Corinthians. This amateur, and usually victorious, football team rolled penalties back to the opposition goalkeeper (no foul could possibly be intentional) and retired one of their own team should an opposition player leave the field injured.

High Tories cherished the fact that British sports were once governed by institutions that belonged to neither the free market nor the state - the Royal and Ancient, the MCC, the All England Croquet Club. Now business, they say, has vulgarised sport and the government is meddlesome. Who needs either?

For interventionist social democrats, sport proves that something must be done, even if they're not sure what or how. The free market must be curtailed! Fairness must increase! Loyalty can't vanish! Local identity mustn't be lost! We must sort everything out! The centre-left sits very much on the sporting moral high ground - but often in the expensive seats near the halfway line.

In fact, I would argue the history of sport challenges all these political systems of thought. Sport, like life, advances through evolutionary individualism, not top-down institutional diktat. Unfortunately for those who like to control sport from the centre, you simply can't stop people getting better at sport by their own devices.

Sport is about problem solving. A challenge is set: kick the ball into the net; hit the ball over the boundary; jump over the bar. Rules are (eventually) agreed - no kicking of opponents; don't pick up the ball with your hands; stay within this area, and so on. From then on, it is pure Darwinism - players innovate constantly, sometimes deliberately, sometimes by accident.

When the great Australian cricketer Greg Chappell compiled a list of the game's foremost champions, he discovered that an extremely high proportion learned their methods on their own, without first being taught the received wisdom of traditional technique. As a boy, Don Bradman practised at home, hitting a golf ball against the wall with a stick. Garry Sobers played beach cricket. Javed Miandad learned to survive on uneven surfaces on the Karachi streets. Jeff Thomson emerged out of the Sydney surf to learn he could bowl 100mph with a completely unique action.

Gifted human beings, if they address a physiological challenge with their full attention and talents, invariably come up with pretty good solutions. When they are exceptional, they rewrite convention and the game inches forward.

Sportsmen, inevitably always searching for competitive advantage, can't resist asking left-field questions. Why shouldn't I jump over the high-jump bar head first (the Fosbury flop)? Why shouldn't I aim my sweep shot towards off-side where there aren't any fielders (the reverse sweep)? The winning innovations, like dominant genes, survive and are absorbed into the mainstream; the bad ones never get off the ground.

This is taking place all over the sporting world, beyond the control of administrators or writers of textbooks. As such, sport is irreverent, constantly changing and essentially resistant to authority. Sport never stands still long enough to be effectively ensnared by an over-arching political theory. It is much too interesting for that.

PSBR or PSNCR

PSNCR - Explanation

The PSNCR - public sector net cash requirement - used to be called the PSBR - the public sector borrowing requirement. They are the same thing. They measure the amount the government has to borrow to meet all its expenditure commitments. Governments frequently spend more than they are earning in tax revenue, and so have to borrow to plug the gap.
There are two ways to measure the value of the PSNCR. The first is to look at the PSNCR as an amount of money - usually in billions of pounds (£bn). This is useful as a measure, but we may also want to consider how significant this figure is in the overall context of the economy. £5bn sounds a lot of money (and we would all like a share of it !), but in terms of the overall level of GDP it is fairly insignificant. So the other way to measure the PSNCR is as a percentage of GDP.
The PSNCR tends to vary with the trade cycle. This happens because as the level of growth changes the governments expenditure and tax revenue will also change automatically. For example, imagine the economy is going into recession. As people lose their jobs, incomes fall and this means less income tax. They will also spend less which means the government gets less from VAT and other indirect taxes. At the same time they will need to be paid benefits, and this means an increase in government expenditure. The overall effect of the recession therefore has been to increase the PSNCR.

PSNCR and the Trade Cycle - Why does it vary?

The PSNCR tends to change along with the state of the economy. When things are going well and the economy is booming, the PSNCR will tend to be falling (unless the government is going mad spending on other things!). This is because a booming economy means low unemployment and low unemployment means less spending on benefits. Not only that, but when people are employed they will spend more, and this will boost VAT and other indirect tax receipts.
The impact of a recession on the PSNCR will be the opposite. Increasing unemployment means more spending on benefits, increasing the level of government expenditure. Unemployed people don't pay income tax, and others may find their incomes falling. The combination of these two effects means that the government receives less income tax. Spending also will fall as people have less money and are more reluctant to spend what they do have because of uncertainty about the future. As spending falls so does the government's revenue from indirect taxes. As if all this weren't enough of a problem, the performance of firms will also affect the government's finances. In times of recession, firms' profits will fall, in fact they may even make losses. Since corporation tax is paid on profits, the governments tax revenues will be hit even further.
So boom periods should help to lower the PSNCR, while recessions and economic slowdown will tend to push it back up again.

PSNCR Theories - Cyclical or Structural - What determines it?

Theory 1 (PSNCR and the trade cycle) shows that the PSNCR will tend to vary with the economic cycle. If this happens over a number of years and the PSNCR fluctuates around an average value of zero, then the government doesn't need to worry about it too much. A recession may increase it, but the onset of recovery will help it fall again. If this is the case then the PSNCR is termed a cyclical PSNCR.
However, it will often be the case that the value that the PSNCR fluctuates around is far from zero. This means that the government is borrowing all the time. In other words, it is borrowing over the long term. Where this happens, this part of the PSNCR is termed a structural PSNCR. Governments do need to worry more about a structural PSNCR as it is a long-term one, and they need to think about how they can reduce it. They have two main alternatives:

1. Increase taxes
2. Reduce government expenditure

If they don't do either of these, there will be a permanent PSNCR and the national debt will grow over time.

PSNCR and the Money Supply - The effect of borrowing on the money supply

If the PSNCR is high, this means that the government is spending much more than it is receiving in tax revenue. It follows then that it is putting more money into the banking system (from its spending) than it is taking out of it (from taxes). This will increase the money supply in the economy. This may be undesirable as many economists believe that excessive money supply growth will cause inflation. This is a view held particularly by Monetarist economists and Classical economists.
The aim of governments should therefore be to keep the value of the PSNCR down to help keep money supply growth down.

PSNCR and the National Debt - How indebted are we?

The national debt is the total amount of borrowing accumulated by the government that is still outstanding. It is the total amount that the government owes to individuals and institutions.
Think of the national debt as the level of water in a tank. Each year the government borrows more. The amount it borrows is the PSNCR. This is equivalent to a tap filling up the tank - the amount of water (debt) is growing. However, at the same time, the government pays off some of its debts each year. This is like water flowing out of the tank.
If the amount flowing into the tank (the PSNCR) is greater than the amount going out (debt paid off), then the water level (the national debt) will rise. If on the other hand the amount flowing into the tank (the PSNCR) is smaller than the amount going out (debt paid off), then the water level (the national debt) will fall.
The diagram below shows this:

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Laffer and Phillips curve

 The Laffer curve is used to illustrate the concept of "taxable income elasticity", which is the idea that government can maximize tax revenue by setting tax rates at an optimum point and that neither a 0% tax rate nor a 100% tax rate will generate government revenue.

 The curve is most understandable at both extremes of income taxation—zero percent and one-hundred percent—where the government collects no revenue. At one extreme, a 0% tax rate means the government's revenue is, of course, zero. At the other extreme, where there is a 100% tax rate, the government collects zero revenue because (in a "rational" economic model) taxpayers presumably change their behavior in response to the tax rate: either they have no incentive to work or they avoid paying taxes, so the government collects 100% of nothing.

It however does not mean that a 50 % tax rate maximises the tax revenue.

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of change in wages paid to labor in that economy.

Alban William Phillips, a New Zealand-born economist, wrote a paper in 1958 titled The relationship between unemployment and the rate of change of money wages in the United Kingdom 1861-1957, which was published in the quarterly journal Economica. In the paper Phillips describes how he observed an inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and made explicit the link between inflation and unemployment: when inflation was high, unemployment was low, and vice-versa.
In the 1920s an American economist Irving Fisher noted this kind of Phillips curve relationship. However, Phillips' original curve described the behavior of money wages. So some believe that the Phillips curve should be called the "Fisher curve."
In the years following Phillips' 1958 paper, many economists in the advanced industrial countries believed that his results showed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governments could control unemployment and inflation within a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment – there would be a trade-off between inflation and unemployment. For example, monetary policy and/or fiscal policy (i.e., deficit spending) could be used to stimulate the economy, raising gross domestic product and lowering the unemployment rate. Moving along the Phillips curve, this would lead to a higher inflation rate, the cost of enjoying lower unemployment rates.

Stagflation

In the 1970s, many countries experienced high levels of both inflation and unemployment also known as stagflation. Theories based on the Phillips curve suggested that this could not happen, and the curve came under concerted attack from a group of economists headed by Milton Friedman—arguing that the demonstrable failure of the relationship demanded a return to non-interventionist, free market policies. The idea that there was a simple, predictable, and persistent relationship between inflation and unemployment was abandoned by most if not all macroeconomists.

[edit] NAIRU and rational expectations

Short-Run Phillips Curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)

New theories, such as rational expectations and the NAIRU (non-accelerating inflation rate of unemployment) arose to explain how stagflation could occur. The latter theory, also known as the "natural rate of unemployment", distinguished between the "short-term" Phillips curve and the "long-term" one. The short-term Phillips Curve looked like a normal Phillips Curve, but shifted in the long run as expectations changed. In the long run, only a single rate of unemployment (the NAIRU or "natural" rate) was consistent with a stable inflation rate. The long-run Phillips Curve was thus vertical, so there was no trade-off between inflation and unemployment. Edmund Phelps won the Nobel Prize in Economics in 2006 for this.
In the diagram, the long-run Phillips curve is the vertical red line. The NAIRU theory says that when unemployment is at the rate defined by this line, inflation will be stable. However, in the short-run policymakers will face an inflation-unemployment rate tradeoff marked by the "Initial Short-Run Phillips Curve" in the graph. Policymakers can therefore reduce the unemployment rate temporarily, moving from point A to point B through expansionary policy. However, according to the NAIRU, exploiting this short-run tradeoff will raise inflation expectations, shifting the short-run curve rightward to the "New Short-Run Phillips Curve" and moving the point of equilibrium from B to C. Thus the reduction in unemployment below the "Natural Rate" will be temporary, and lead only to higher inflation in the long run.
Since the short-run curve shifts outward due to the attempt to reduce unemployment, the expansionary policy ultimately worsens the exploitable tradeoff between unemployment and inflation. That is, it results in more inflation at each short-run unemployment rate. The name "NAIRU" arises because with actual unemployment below it, inflation accelerates, while with unemployment above it, inflation decelerates. With the actual rate equal to it, inflation is stable, neither accelerating nor decelerating. One practical use of this model was to provide an explanation for Stagflation, which confounded the traditional Phillips curve.
The rational expectations theory said that expectations of inflation were equal to what actually happened, with some minor and temporary errors. This in turn suggested that the short-run period was so short that it was non-existent: any effort to reduce unemployment below the NAIRU, for example, would immediately cause inflationary expectations to rise and thus imply that the policy would fail. Unemployment would never deviate from the NAIRU except due to random and transitory mistakes in developing expectations about future inflation rates. In this perspective, any deviation of the actual unemployment rate from the NAIRU was an illusion.
However, in the 1990s in the U.S., it became increasingly clear that the NAIRU did not have a unique equilibrium and could change in unpredictable ways. In the late 1990s, the actual unemployment rate fell below 4 % of the labor force, much lower than almost all estimates of the NAIRU. But inflation stayed very moderate rather than accelerating. So, just as the Phillips curve had become a subject of debate, so did the NAIRU.
Further, the concept of rational expectations had become subject to much doubt when it became clear that the main assumption of models based on it was that there exists a single (unique) equilibrium in the economy that is set ahead of time, determined independent of demand conditions. The experience of the 1990s suggests that this assumption cannot be sustained.

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Economic Growth

 Economic growth is the increase in value of the goods and services produced by an economy. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment," which is caused by growth in aggregate demand or observed output.

Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run.
The short-run variation of economic growth is termed the business cycle, and almost all economies experience periodical recessions. The cycle can be a misnomer as the fluctuations are not always regular.

The long-run path of economic growth is one of the central questions of economics; in spite of the problems of measurement, an increase in GDP of a country is generally taken as an increase in the standard of living of its inhabitants. Over long periods of time, even small rates of annual growth can have large effects through compounding (see exponential growth). A growth rate of 2.5% per annum will lead to a doubling of GDP within 28 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 9 years. This exponential characteristic can exacerbate differences across nations. For example, the difference in the annual growth from country A to country B will multiply up over the years. A growth rate of 5% seems similar to 3%, but over two decades, the first economy would have grown by 165%, the second only by 80%.

Measuring growth

GDP increase since 1990, in major countries.

World map showing GDP real growth rates for 2007.

The real GDP per capita of an economy is often used as an indicator of the average standard of living of individuals in that country, and economic growth is therefore often seen as indicating an increase in the average standard of living.
However, there are some problems in using growth in GDP per capita to measure general well being.

• GDP per capita growth varies depending on the basket of goods used to deflate the nominal value or on the base year of measure.
• GDP per capita does not provide any information relevant to the distribution of income in a country.
• GDP per capita does not take into account negative externalities from environmental damage consequent to economic growth. Thus, the amount of growth may be overstated once we take environmental damage into account.
• GDP per capita does not take into account positive externalities that may result from services such as education and health.
• GDP per capita excludes the value of all the activities that take place outside of the market place (such as cost-free leisure activities like hiking).
• GDP per capita does not include activities of the informal sector of the economy in precise form. Only as approximate estimates.
• GDP per capita does not account for purchases on goods that were not produced in a given fiscal year, such as used cars or houses.
• GDP per capita does not provide any information about the appreciation or depreciation of goods already produced, which may reflect a change in standard of living. (dilapidation in residential buildings, for example)

Economists are well aware of these deficiencies in GDP, thus, it should always be viewed merely as an indicator and not an absolute scale. Economists have developed mathematical tools to measure inequality, such as the Gini Coefficient. There are also alternate ways of measurement that consider the negative externalities that may result from pollution and resource depletion (see Green Gross Domestic Product.)

Criticism

The real GDP per capita of an economy is often used as an indicator of the average standard of living of individuals in that country, and economic growth is therefore often seen as indicating an increase in the average standard of living.
Four major critical arguments are generally raised against economic growth:^[9]

1. Growth has negative effects on the quality of life: Many things that affect the quality of life, such as the environment, are not traded or measured in the market, and they can lose value when growth occurs.^{[citation needed]}
2. Growth encourages the creation of artificial needs: Industry cause consumers to develop new tastes, and preferences for growth to occur. Consequently, "wants are created, and consumers have become the servants, instead of the masters, of the economy."^{[citation needed]}
3. Resources: similar to the arguments made by Thomas Malthus, economic growth depletes non-renewable resources rapidly.^[10]
4. Distribution of income: growth may reinforce and propagate unequal distribution of income. The gap between the richest in the world and the poorest is growing.^[11]

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