By Michael Burke
The Financial Times’ veteran economics commentator Samuel Brittan has recently argued for the state’s holdings in the banks to be used as the basis for creating a new state bank focused on productive investment.
Echoing calls from Adam Posen, he argues that the disastrous fall in both the money supply and bank lending needs to be corrected by decisive state action. Posen is perhaps the sole member of the current Bank of England Monetary Policy Committee who understands the gravity of the current situation and is not constrained by official orthodoxy in seeking remedies l.
These are similar ideas as those outlined in the recent pamphlet, ‘A Brighter Economic Vision for Britain. Brittan says his own proposal, ‘...is to use the state-owned banks as the nucleus of Mr Posen’s proposed state lending bank for small and medium enterprises. Who knows what obstacles well-paid lawyers could think up? But in principle this could start next week. The main thing needed would be a Treasury directive to these banks to replace profit maximisation with a requirement to promote economic recovery.’
One reason for the renewed slump in the share price of leading British banks is their exposure to the sovereign debt crisis. Yet Lloyds-TSB Bank, for example has seen the price of its shares fall from 74p at the time of the government’s share-buying programme to 34p as at the close of trading on September 23. This compare to the collapse of RBS’ share price to 22p compared to the government purchase price of 52p – despite the fact that (aside from the US and Britain) Lloyds has no significant exposures to sovereign debt markets at all.
This highlights the fact that the main driver of the slump in banks’ shares is not primarily the debt crisis, severe though that it is. The share prices have collapsed because of economic weakness and the deterioration in the banks’ existing loan book, personal, business, mortgage and other loans.
Therefore it is possible to differ with Brittan’s analysis in two respects. First, the banks’ refusal to lend is driving both the fall in profits and the share price on which it rests. They are not ‘maximising profits’ but hoarding capital in order to preserve it. A government instruction to lend is the only way to break the lending and investment strike. Secondly, it is a widespread misconception that small and medium-sized enterprises (SMEs) are the key to growth. In reality, outside the personal services sector they mainly provide inputs to much larger firms. Bundling up loans to SMEs will not create the investment demand for smaller firms’ output. The largest firms show no intention of increasing their own investment – which is what is required.
Instead, only government can break the log-jam by initiating investment in housing, in infrastructure, in transport and in education. The private sector would benefit. These contracts would mainly be awarded to large firms but they tend to sub-contract or purchase inputs from SMEs and individuals. It is this process which creates employment at the SMEs.
But this is a disagreement only about the nature and direction of the required policy. The basic thrust of the Brittan analysis is correct. Bank lending and money supply are collapsing along with the banks’ share prices. The banks contain the resources to correct the slump, yet refuse to do so. They are in public ownership. All that is required is a government instruction to fund the large-scale investment that is required to produce a recovery.
Eurozone rescue packages will continue to fail until they deal with the central issue in Europe's recession
By John Ross
The international financial system is passing through the agony of a new round of the Eurozone debt crisis for the simple reason that European governments, like that in the US, refuse to deal with the core of the economic recession in Europe for reasons of economic dogma.
Anyone who looks at the economic data for the Eurozone without wearing ideological blinkers can see the situation at once – it is charted in Figure 1. The Eurozone recession is due to a collapse in fixed investment. Taking OECD data, at inflation adjusted prices and fixed parity purchasing powers (PPPs), then between the last quarter before the recession, the 1st quarter of 2008, and the 2nd quarter of 2011 Eurozone GDP fell by $204bn. But private consumption declined by only $29bn while the net trade balance increased by $32bn and government consumption rose by $91bn.
However fixed investment fell by $290bn – i.e. the recession in the Eurozone was wholly due to the fixed investment decline
Equally evidently, due to its scale, until this fall in investment is reversed it will take a prolonged period for the recession to be overcome. Therefore to restore growth, which by now is generally realised is the core to turning round the budget deficit problem, the fixed investment decline must be overcome.
Nor is there anything mysterious about how to do this – the state has entirely adequate means. To take the most decisive international case China made the core of its stimulus package direct state investment particularly aimed at infrastructure and housing – the result being that China’s economy has grown by over thirty per cent in three years.
Europe and the US clearly do not have the scale of state sector, nor the political willingness, to act on the scale China did. But US history shows that even without proceeding to a socialist scale of measures direct state intervention on investment is entirely possible.
Roosevelt expanded US state investment from 3.4% of GDP to 5.0% between 1933 and 1936 (data from US Bureau of Economic Analysis Table 1.5.5). Jason Scott Smith, in his study of New Deal public spending, summarises such investment as including 480 airports, 78,000 bridges, 572,000 miles of highway - which, in addition to its immediate effect in stimulating demand, reinforced the productive position of the US economy. Roosevelt, it is superfluous to point out, was neither a socialist nor a communist (despite claims to the contrary by the US right!).
Quarterly, up to date, data is regrettably not available on what is occurring across the Eurozone for state investment, but it is available for the US and there is no reason to suppose, with current policies, that the situation in Europe is any better. Between the peak of the previous US business cycle, in the 4th quarter of 2007, and the 2nd quarter of 2011 US private fixed investment fell from 15.8% of GDP to 12.2% - i.e. a decline of 3.6% of GDP. Yet in the same period US state investment did not compensate but also fell marginally – from 3.3% of GDP to 3.2% of GDP. Therefore while Roosevelt expanded the weight of US state investment current US administrations have been letting it fall.
Instead of directly addressing the core issue of the investment fall European administrations are either attempting to stimulate it indirectly – which, as it is ineffective, has led to fiscal/sovereign debt crises, or are acting via expansion of the money supply – which, in a situation whereby companies and households are paying down debt, is merely the famous ‘pushing on a piece of string’.
The most favourable outcome of such a situation is that eventually the debt will be paid down, but only after several years of stagnation. The less favourable variant, of course, is that the banking system breaks under the strain and renewed recession is further propelled by fiscal cutbacks. All these problems simply arise from the fact that, under the rubric of the dogma ‘private equals good, state equals bad’, European governments refuse to use the state tools available to deal with the investment fall which is at the core of the Eurozone recession.
Some European politicians are now beginning to call for state measures to increase investment, UK Business Secretary Vince Cable being one. But the action they envisage so far is inadequate to deal with the scale of the investment fall.
China's economy, which does not have such ideological inhibitions, will continue to expand while the Eurozone remains relatively stagnant for a significant period - and as long as economic stagnation continues there will be no resolving of the Eurozone debt crisis.
‘A Brighter Economic Future for Britain’ is the title of a new pamphlet co-written by the present author and Professors George Irvin and John Weeks. In the Guardian we set out the rationale for the publication:‘The UK depression has already lasted three years, and NIESR argues that is likely to last five years or more – longer than that of 1930s.
Yet economic debate is dominated by counterproductive attempts to reduce the deficit through cuts in public spending, which are now the single most important cause of the depression.’The full article can be read here.
In an argument that will be familiar to regular readers of SEB, the pamphlet argues that public spending cuts are counter-productive both in terms of reviving growth and in reducing the public sector deficit. This is because the deficit itself is primarily a product of the depression.Further the underlying cause of the depression is a private sector investment decline, which by the end of the 1st quarter of 2011 accounted for 80% of the total lost output since the economy began to contract 3 years earlier – that, is £44.9bn of a total of £56.3bn.
Therefore breaking that investment strike is a pre-requisite to any sustained recovery. By investing in areas such as housing, transport, infrastructure and education, the government can lead an economic recovery that meets acute economic needs and reverses the rise in joblessness.The pamphlet puts forward two related solutions to the crisis- the creation of a state-owned Investment Bank and using the excess capital at the state-owned banks to fund the needed investment.
Importantly, this analysis is beginning to win political support. In welcoming the attempt to turn the debate towards an investment-led recovery Jon Trickett MP argues in a foreword to the pamphlet,‘Collapsing investment hits current growth and long-term productivity.....Working on the premise that we must tackle investment and long-term competitiveness the authors argue that one way forward which would increase demand in the economy, and raise both employment and productivity, would be to take action now to address this issue.....The pamphlet sets out one idea from the authors to tackle this collapse investment; a National Investment Bank, using the government’s majority stake in Lloyds-TSB and RBS.....There are those who would argue that this would indeed be poetic justice.’
The continued economic stagnation in Britain and some other leading economies will force a reconsideration of policy even among the architects of the current crisis and their supporters. In Britain , though, a Tory economic ‘Plan B’ is likely to include privatisation, deregulation as well as attacks on social protections such as maternity/paternity leave, pensions and an abuse of youth ‘training’ programmes to provide unpaid labour. But none of this will alter the basic problem that private firms are sitting on hoards of cash that they refuse to invest, while also leading to further impoverishment for the overwhelming majority of the population.Likewise, since at least the ‘worse than Thatcher’ New Labour Budget of 2010 there are many now on the opposition benches who fundamentally agree with the ‘austerity’ policy. They merely advocate slower, shallower, more anguished cuts. But as the economy has already stalled under the impact of less severe cuts than they would now be implementing, the Labour supporters of cuts are also obliged to look for a ‘Plan B’. Whether they move towards Osborne, or in the direction of state investment to generate recovery remains to be seen.
In any event, as the pamphlet argues there can be no suggestion of a sustained recovery without replacing the policy of cuts with a government-led investment recovery.