Improved growth shows investment works – the 2nd quarter UK GDP figures

By Michael Burke

The British economy expanded at its fastest rate since the recession ended, up 1.1% in Q2 according to preliminary data. These data are often subject to substantial revisions, but the hope must be that, having been held over and scrutinised for 2 weeks, they are an accurate reflection of the pick-up in activity.

The latest growth rate represents a significant acceleration over the prior two quarters when the cumulative expansion was just 0.7%. But the pace of the recovery is almost exactly in line with the recoveries from both the 1980 and 1992 recessions, which were much milder and shorter than the recent slump. In both the 1980s and 1990s recessions the previous peak in activity was recovered after 3 years. At this similar pace it will take close to 5 years to recover the previous peak in activity.

There are two key factors which supported the modest rebound in activity- the depreciation of the pound and the 2009 Budget.

The fall in the pound has been precipitate. As the chart below shows, prior to the recession Sterling was valued at over 2 US Dollars, and fell by over 26% in 2008 and to a low of US/£$1.37 early in 2009. This depreciation and the recovery in global trade prompted a very modest pick-up in exports. In the Q1 GDP data (the preliminary Q2 do not provide a breakdown of the national accounts) exports are 2.9% above their recession low in Q2 2008.

Chart 1

At the same time government spending has been the main support for the recovery. Current government spending and government’s share of investment (gross fixed capital formation) have risen by a combined 12.6% since the recession began. In the course of the recession, government spending rose by £18bn compared to an aggregate contraction of £88bn. In the two quarters of recovery to Q1, the further direct effect of these two factors, export growth (£7.3bn) and increased government spending (£13.6bn) has more than accounted for the entire growth of the economy (£9.7bn). If, as reported, other sectors of the economy made a greater contribution to growth in Q2 – with construction said to add 0.4% to GDP in the quarter, it will be because of the direct and indirect support received from government spending.

Economic Outlook

These positive effects of increased government spending and a weaker currency are already beginning to wear off and the impulse being reversed. As the chart above shows, the currency has already appreciated by over 10% from its January 2009 low against the US Dollar, and Sterling has also been appreciating against the Euro, the currency of Britain’s main export markets.

It is also widely known that this expansionary fiscal policy is shifting into reverse, with significant cuts enacted and vastly more in the pipeline.

The forward-looking indicators of the economy are already warning of a slowdown, before those cuts bite. Recent surveys of both manufacturing and construction growth have both shown a levelling off in activity. But surveys of the service sector, which accounts for three-quarters of the economy, have seen a marked deceleration with the June reading the lowest for 10 months . As the Bloomberg news service puts it, ‘U.K. services growth slowed more than economists forecast in June after the government’s austerity measures to cut the budget deficit sapped confidence’. Both house prices and consumer confidence recently recorded their first falls in over a year.

Previous optimism that a pronounced slump would lead to a sharp recovery has given way to a more sober assessment. These are strong grounds for the view that the growth rate is already peaking and a slowdown likely later in the year. With the extraordinarily deep cuts planned by the ConDem coalition, a double-dip recession or a severe slowdown in recovery is a real threat.

The Deficit & Growth

It is evidently the case that a further increase in government spending would benefit the economy. It might even lead to a renewed decline in the currency, as the combination of relatively loose monetary policy and fiscal policy is held to be a prescription for currency depreciation.

But the argument of the government and its supporters is that there is simply no room to increase government spending. Drawing comfort from Liam Byrne’s crassly ignorant phrase, they argue that ‘there’s no money left’.

On that logic, of course, however desirable increased government investment might be to support the economy, it is not sustainable. Government finances would go to hell, with huge deficits, loss of credit rating, IMF missions, and so on.

All of which seems very compelling - except that it is factually incorrect. As SEB has previously noted, the 2009 Budget was moderately stimulative and that worked. Growth was higher than anticipated and the deficit narrowed as a result.

The latest trends in public finances confirm that point and amplify it, as well as providing a warning about the impact of cuts. In the December Pre-Budget Report Alistair Darling forecast a public sector borrowing requirement (PSBR) of £178bn in the current financial year. In his March Budget this year, that projection had fallen to £167bn. The Office for Budget Responsibility lowered it to £156bn and Osborne’s June Budget shaved it to £155bn. Yet they are all still playing catch-up to the trend improvement in government finances.

In the chart below we show the 12-month rolling total for the PSBR, which has consistently undershot official forecasts and has been falling outright since February this year, when it peaked at £144.4bn. In June it had declined to £143.1bn.

Chart 2

The reason for the undershoot in the deficit is that tax receipts are much higher than anticipated, up £8.3bn in the latest 3 months alone. In the latest 12 months, that is in the period after the 2009 Budget, total government spending is £36.8bn higher than in the prior 12 months. Of that, £3.4bn is increased interest payments, and therefore £32.4bn is the actual increase in government outlays on goods, services and investment. This boosted economic activity, and the taxes that derive from it. Taxes on production are £18bn higher in the latest 12 months than in the prior period. In addition, the rise in unemployment has only been a proportion of what was expected. This feeds into lower-than-anticipated welfare payments.

Yet according to official wisdom, this cannot be. Increased government spending ought to be leading to an increase in the deficit, not its narrowing. The reason that the forecasts on the deficit are so faulty is that they overlook or completely ignore the stimulative effects of government spending and its positive effects on government finances, both revenues and outlays.

That ignorance stretches into the labour movement. Ex-Chancellor Alistair Darling quite rightly ascribes the improvement in the economy to Labour government’s actions. But these were from the investment and increased spending of the 2009 Budget not his 2010 cuts Budget where he threatened to be ‘worse than Thatcher’. Further, the connection between this rebound in GDP and the improvement in government finances seems to have escaped him entirely.

By contrast, Brendan Barber says, ‘The impressive GDP figures are the result of fiscal stimulus and active policymaking. But continued growth cannot be taken for granted, and there is now a huge risk that cuts in spending will bring the recovery to a shuddering halt. Deficit fetishism still risks a return to a flat line economy’.

The TUC general secretary is quite right. Not only is the policy of cuts to public spending sure to weaken growth, but it threatens, as a result, to lead to renewed widening of the deficit.

Green Campaign Builds for RBS’s Capital To Be Used Productively

By Michael Burke

Campaigners have called for the Royal Bank of Scotland to be transformed into a Green Investment Bank to kick start a wave of investment in green technologies The supporting document suggests that it would create 50,000 new green jobs a year, boost the UK economy, reduce the UK's carbon emissions and improve international competitiveness - whilst not increasing the budget deficit. The report was commissioned by pressure group PLATFORM and the anti-poverty campaigners, World Development Movement, who reject the premise that investment in a green economy should be scrapped due to public sector cuts.

By contrast, it has recently been reported that the coalition government may scrap plans to invest public money in a Green Investment Bank. Instead the government may rely on private capital to fund green projects such as wind farms, high-speed rail and electric cars.

Deborah Doane, director of the World Development Movement, said, ‘It would be completely irresponsible and short-sighted to scrap public investment in a low carbon economy. RBS is sitting on billions of pounds from the taxpayer which is going to finance dirty projects often linked to human rights abuses, instead of more productive ends. The money we've invested in RBS should be directed towards green investment. It's a no-brainer: not only wouldn't it cost the taxpayer directly, it would boost the economy and create new jobs in the UK at a much-needed time.’

The idea has received backing within parliament; one hundred and seven MPs signed an Early Day Motion which calls on the Government to use its majority share in RBS to prioritise climate change as a principal concern in RBS's lending decisions.

Room To Invest

SEB has previously argued that RBS, 84% owned by taxpayers, has scope to increase its lending very substantially without endangering its solvency. Indeed, attempts to bolster RBS’s capital beyond those of its High St. rivals simply increase that spare lending capacity

The recent European-wide stress-testing of banks’ balance sheets was widely criticized as insufficiently robust. British banks had previously been put to a more severe test by the Financial Services Authority (FSA), which also published the results.

The key features of those are set out in the table below - it is calculated from the FSA data.

Table 1. FSA ‘Stress Test’ Results for British Banks

The FSA focuses on ‘Tier 1’ capital, mainly shareholders’ funds, as the main buffer against further crises. It projects what the ratio will be in 2011 assuming economic recovery, rising profits and weak lending growth. It also provided a stress test which included double-dip recession, a rise to 12.5% unemployment, a 60% fall in house prices and default by one or more European government. The FSA’s estimate of the impact of all those events combined for each bank is shown in the final column.

Here it is important to note that the banks actually have a huge and growing excess of capital over any prudent requirements, with RBS one of the most awash with the capital that is being hoarded. Previously, the FSA had required Tier 1 capital to amount to 4% of total assets. During the financial crisis in 2008 it altered the requirement so that total capital, Tiers 1 and2, must be 8% of assets . There has been some discussion that new international rules (‘Basle III’) will change the requirement so that Tier 1 capital must be 6% of assets.

Yet all the banks have spare capital way in excess of the expected 6% total. RBS currently has 14.4%. And even in a disastrous set of circumstances it would have nearly double the required international level. Paradoxically, it is the banks’ refusal to lend which is one of the key factors, along with government economic policy, increasing the risk of a double-dip recession and all its negative consequences. Furthermore, the ratios are based on ‘risk-weighted’ assets where values are already deflated by that adjustment for risk. RBS’s actual assets amounted £1,523bn at the end of 2009 .

Given the vast sums in the banks’ balance sheets, even fractional changes in the capital ratios through increased lending would release very large funds for investment. Currently, £100bn in new investment would only entail RBS’s Tier 1 capital ratio dropping to 13.5% from 14.4%. This could provide an enormous economic boost, kick-starting a Green transformation of the economy, creating new jobs, meeting the needs for housing, transport and infrastructure - and not a penny of new government borrowing.

The Budget’s attack on women, disabled and black people

By Anne Kane

As Socialist Economic Bulletin has pointed out previously, the June Budget, far from being ‘fair’, will attack the poorest in society. But even this it will not do evenly. The Budget will deepen further discrimination and inequality, and will do so increasingly across the lifetime of this government.

Daily, new reports appear of the devastation that will be wreaked by the Budget as rights and equality organisations begin to tabulate its impact. Just one example is the impact on housing as a result of the cap on housing benefit, the pegging of benefit to the lowest third of rents in an area and other changes. The National Housing Federation estimates up to 750,000 in the South East of England will lose their homes.. Many others will be forced to relocate to cheaper areas, uprooting lives, losing jobs and effecting a form of social engineering.

In each of these policy areas affected by the Budget, social inequality – between women and men, of disabled people, of black people and others – will deepen because these are the groups that already predominate among the poorest. Forty per cent of lone parent families (mostly headed by women) are in the bottom fifth by income; disabled people (if they overcome the barrier of employment discrimination) are much more likely to be lower paid than their non-disabled peers and they are much more likely to depend on social housing; among all employees median hourly pay for women is still 21 per cent less than for men; being black continues to mean being more likely to be unable to find a job and much more so for some groups.

Women and disabled people will be hit hard by specific changes and that is what this article examines. Using a House of Commons library analysis Yvette Cooper has highlighted, that more than 70 per cent of the revenue raised from direct tax and benefit changes is to come from female taxpayers. Disabled people will be hit by the attack on Disability Living Allowance (DLA). But this is the tip of the iceberg. The social groups over-represented at the bottom end of the income and wealth spectrum – including black communities, older people and the young – will all be particularly hit

The Budget’s emphasis on public sector and welfare benefits cuts and on regressive taxation makes this inevitable. The reality of inequality is itself reflected in the detailed statistics on who works in the public sector and what particular jobs they work in, who most relies on the services that are to be cut and whose lives depend on the benefits that are to be cut. By placing emphasis on cutting public sector spending, the Budget will inevitably deepen inequality and disadvantage.

But this Budget also went out of its way to attack those already facing entrenched discrimination and inequality.

With regard to public sector jobs, initial estimates suggested up to 600,000 jobs will be directly cut in the public sector, and a similar number in the private sector as a result of public spending cuts. This will disproportionately impact on women: 65 per cent of those employed in the public sector are women while a total of 40 per cent of women in employment work in the public sector compared to 15 per cent of men. Women work more in the public sector in large part because of the gender segregated nature of employment: health, education, social work and other jobs that mirror the gender division of labour and caring in the traditional family, along with a wide range of (lower paid) clerical and administrative posts, account for large numbers of the jobs occupied by women.

As the TUC has pointed out, public sector job cuts will not only just disproportionately impact on women directly as workers. Relatively more generous pension provision in the public sector combined with the large number of women who work there mitigates the levels of poverty among older women, for example - poverty in retirement would be much greater otherwise, and is therefore set to intensify as a result of job losses and the kinds of reduction in the public sector envisioned by the Budget. The wider social impact is likely to be compounded by other factors: the five regions with the highest male unemployment rate are also regions with particularly high women’s public sector employment.

The other impact of public sector cuts will be via service cuts. The scale of these – and linked to the NHS and education restructuring intended – will affect the whole fabric of society. But those at the bottom end of the income scale will feel the need greatest: if you have a lower income you are more likely to experience ill-health, be female, be older or be black; if you are lower income and a health, social care or other service is cut, you are much less likely to be able to replace the loss by private provision. As women, black people and disabled people are disproportionately more likely to live in poverty, or to be at the lower end of the income scale, cuts in public services will entrench inequality.

The realities of women’s social gender role and the unequal gender division of labour in households means that public service cuts will disproportionately hit women as unpaid providers of care. Increased labour market participation has done little to prompt men to take more equal share of household labour: while women spend an average three hours a day on housework (not including shopping and childcare) compared to 40 minutes by men. With nowhere else to go, the childcare, social care, health and other services cut in the ‘Big Society’ will generally be picked up by women or not at all.
Wherever women work, they work, on average, for less pay than men: 40 years after the Equal Pay Act the average gender pay gap is 20 per cent per hour, with the gap wider in the private sector (25.6 per cent) than in the public (18.8 per cent). Pay restraint plus job cuts will combine with benefit and tax credit cuts in the budget to lower women’s incomes further.

With regard to benefits and tax credits, the change to an uprating formula linked to the Consumer Price Index for benefits and tax credits alone will see the value of benefits fall year on year, with an estimated saving to the state of nearly £6 billion by 2014-15.

The Budget included a long litany of benefit and tax cuts that will particularly hit women and families with children: a freeze on Child Benefit, lowering the income cut-off for family tax credits for families (from £50,000 total parental income to £30,000), increasing the rate at which tax credits are withdrawn when incomes rise, abolishing the baby element of child tax credit, abolishing the Health in Pregnancy Grant, restricting the Sure Start Maternity Grant and cutting Child Trust Funds. The TUC has calculated that half a million families a year are likely to lose £1,000.

The Budget report claims that the freezing of Child Benefit will be offset by Child Tax credit increases targeted on low-income families, but of course this represents a shift from a universal benefit, claimed by women, to a means-tested benefit that goes to a household. Given Tory hostility to Child Benefit it could effectively also be the trailer for a not too distant proposal to abolish it.

Women are also attacked by another change. Lone parents, who make up a quarter of all families and are 90 per cent headed by women, will be made ineligible for Income Support when their youngest child reaches 5 years old (instead of 10 as at present). The Budget document estimates this will affect 75,000 a year. If they don’t find a job, single parents will only be eligible for the lower rate Jobseekers Allowance (JSA). At the same time JSA is to be cut by 10 per cent after 12 months receiving it, making lone parents suffer the double whammy of two cuts in income.

The Budget’s proposals aimed specifically at disabled people were staggering. Disabled people will, of course, be brutally and specifically hit by the impact of spending cuts on jobs and on services, as well as by the marginalising impact of the Academies Bill and plans for the NHS. However, the specific cut planned for DLA is eye-watering and will have a major impact in lowering the income and living standards of disabled people and reducing independence. The indirect social impacts are hard to quantify but will be huge.

The number of recipients of DLA is to be cut by 20 per cent and overall spending by the same proportion. This is to be achieved by restricting eligibility and introducing a new medical assessment. A staggering £1 billion is to be cut from this single benefit.

Ministers have fostered confusion about what DLA is, presumably to encourage a public atmosphere conducive to attacking the income of people at the poorest end of the income scale and facing entrenched discrimination. The Budget report deals with DLA under a section saying that ‘the government is committed to creating a fair and responsible tax and benefit system that rewards work and promotes economic competitiveness’ and the benefit system ‘supports those most in need, without creating dependency for those who would be better off in work’ (Budget 2010, HM Treasury).

But DLA is not a work related benefit. It was introduced in recognition of the costs associated with being a disabled person. People get it whether they are in work or out of work and use it for a myriad of things. The Budget policy applies to working age DLA recipients only for now, in line with the faux-rationale about encouraging work.

The government’s own research said that DLA has ‘a key role in reducing potential demand for formal services’, and helping people avoid residential care and maintaining good health.

If the state does not support disabled people with these costs, they don’t go away. They are borne by individuals, resulting in the greater levels of poverty among disabled people along with indignity and marginalisation.

However, cutting DLA it will undoubtedly make it more difficult for many disabled people to maintain work. If people lose DLA they will also lose other benefits that are contingent on it, which also support people being able to take up work, like the Independent Living Fund. People who receive Attendance Allowance – carers, the majority of whom are women – will lose this if those they support lose DLA, as they are inter-related.

The government has said the new medical assessment will mirror that introduced to for the work-related Employment Support Allowance (which has replaced Incapacity Benefit for new claimants and which the government is also extending to all IB claimants). At the moment around 50 per cent of people who apply for DLA are rejected, with a further 49 per cent rejected on appeal – a far cry from the open door claimed by ministers. By contrast, 68 per cent of new ESA applicants are rejected – the kind of scale change envisaged for DLA.

Alongside this, the government is going to cut the numbers of people receiving Incapacity Benefit – which is a work related benefit – and at the same time get rid of specialised employment support programmes for disabled people.

The kind of prejudice that will inevitably encourage was shown by the Treasury’s ‘Spending Challenge’ website. Set up to encourage buy-in to deficit reduction and spending cuts, the website invited people to post ideas of what to cut. Inevitable bile followed. The site was suspended after ‘a lot’ of complaints to the Equality and Human Rights Commission that the Treasury was breaching its responsibilities under the equality duties.

Equality legislation may pose less of a restraint in future however. The Equality Act, which synthesises existing anti-discrimination legislation, is due to start coming into force in the autumn. The Conservatives are on record as saying they would not implement some new parts of it – aspects of equal pay reporting and positive action specifically. Their deregulation drive could see important areas removed from the protection of public sector equality duties. Legislative regression could also follow from the yet to be specified regulations to the Act. These Specific Duties set out the things that organisations actually have to do to monitor who they employ and deliver services to, assess whether their impact supports equality, make changes if it does not, involve people in their planning and measure the impact. Labour wanted to make these duties less robust, but left regulations uncompleted. Their final shape therefore is in the hands of this government – whose lack of commitment to equality is reflected not only in this Budget but by making anonymity for rape defendants one of its first priorities.

Should RBS be used for the interests of the British economy or for private profit

By Michael Burke

RBS has announced it is selling off its insurance arm and getting rid of 2,600 jobs. This is not simply a personal disaster for those workers and the communities in which they live, but it also concerns all taxpayers. That state owns 84% of the bank.

The RBS share price was 44.5p at the end of last week, having been as high as 590p in March 2007. The low was 10.5p in January 2009.While no-one can predict where the share price will go it is clear that all financial assets remain close to fire-sale prices.

But the government is allowing an asset sale when assets can be bought extremely cheaply. There is no doubt too that RBS and other banks are viewed as risky propositions, but the sell-offs, which include branches in Britain and in the high-growth Indian market as well as the insurance businesses are the least risky part of the entire group.

These are effectively public assets which are being sold off cheaply to the private sector in order to boost its profitability. They will also have the simultaneous effect of increasing the public sector’s underlying deficit by reducing its cashflows. SEB has previously pointed out that the management of publicly-owned RBS was also attempting to replace low-interest debt government with higher interest private sector debt, in order to curry favour with financial markets. This is because they intend to be back in the private sector as soon as they can, again at a knock-down price against the interest of taxpayers. So far, they have been frustrated in their fund-raising aims but they are persisting. But the urgency is growing because RBS has moved back into profit. Operating profits were £713mn in Q1, compared to losses of £1.353bn in Q4, partly as bad debts declined .

The stated aim of the RBS bond issuance is to bolster its capital strength. But RBS’s capital strength, measured by its ratio of ‘core assets’ to total loans is currently 10.6%, much higher than both Lloyds and Barclays, which are below 9%. It is difficult to believe that RBS’s loan book is much worse than its rivals and it will face higher levels of default, given the disastrous merger of Lloyds with HBoS.

But so be it. Let RBS borrow more, even at higher interest rates than available from the government. But taxpayers should insist that its capital ratio does not need to be astronomically high, just a circumspect 9%, a little above Lloyds and Barclays. With current capital levels, that would mean RBS could fund a huge increase in productive investment.

RBS’s balance sheet is shrinking because it is refusing to lend and because of losses incurred in speculative investments. But it remains a colossal £1,583bn. Bringing down the capital ratio to 9.0% from 10.6% would release £280bn for productive investment. And with a 9.0% capital ratio, every further £10bn to bolster core capital would release another £100bn for investment. These sums would more than compensate for the entire fall in output during the recession.

RBS can be used for asset-stripping by the private sector and robbing taxpayers, who have poured £122bn into the banks to keep them afloat. Alternatively the public sector, which owns RBS, can use it to benefit the whole of society. The government could end the private investment strike in the British economy simply by instructing RBS to lend to infrastructure projects, transport, Green technologies and housing.

Deception and Distortion at the Treasury

by Michael Burke

The Guardian has done a great service in exposing secret Treasury data on the Budget’s impact on employment. The unpublished estimates show that between 500,000 and 600,000 jobs will go in the public sector as a result of the cuts and that there will be 600,000 to 700,000 job losses in the private sector from the cuts to public spending.

In a previous post, SEB examined the negative impact of cutting output in the public sector on the output of the private sector through the multiplier effect. The Treasury estimates highlighted by the Guardian confirm that analysis and extend it into the area of employment.

In response to the furore caused by the leak of the Treasury presentation, the ‘independent’ Office for Budget Responsibility (OBR) rushed out its own forecasts of unfeasibly strong jobs growth in elsewhere in the private sector so that total growth in employment rises from 28.8 million jobs his year to 30.1 million in 2015. The OBR forecasts were helpfully in time for David Cameron to use at Prime Minister’s Questions in Parliament. As ‘Danny’ Blanchflower remarked ‘So much for independence’.

Professor Blanchflower, who is a former member of the Bank of England’s Monetary Policy Committee whose research centres on employment, has also done a great service in exposing those claims as false. It would require the private sector creating up to an additional 2.6 million jobs over 5 years beginning in a period in which, according to the Bank of England’s latest regional survey , businesses have a great deal of spare capacity and could meet any upturn in demand without employing new capital or new labour. The Financial Times reports its own survey of large companies’ hiring intentions, under the title ‘Private sector unlikely to fill the void’ created by the Budget job losses. In the 8 years of boom which ended in early 2008, the private sector created just 1.6 million jobs, and this was at a time when the public sector was aiding that growth by increasing its own spending and employment. The OBR’s forecasts imply much stronger jobs growth against a much worse domestic backdrop, as their own forecasts also show domestic demand averaging less than 2% growth over the entire period to 2015.

Similarly, exports are forecast to rise by 39% over the next 5 years, having risen by 41% in the 8 year boom to 2008. But the most outlandish forecasts are for the growth in business investment, which is expected to surge by 58% over the next 5 years, having risen by just 26.7% during 8 years of the boom. This at a time when the Budget has cut tax allowances for business investment.

These forecasts seem designed to provide favourable outcomes for the government and take little account of actual trends in the economy, which are actually deteriorating once more. In the first chart below, reproduced from the Bank of England’s recent Credit Conditions Survey the availability of credit to households is shown, along with banks’ expectations of their lending for the next 3 months, which is the starred red line.

Figure 1

Likewise, the availability of credit to companies is also deteriorating, as shown in the chart below. This is despite the fact that the government directly owns some major financial institutions and all the High St. banks exist only because the government has provided state guarantees.

Figure 2

Far from the rosy economic picture painted by the OBR for the benefit of the government, there is a growing likelihood of a second, European credit-crunch induced by a combination of taxpayer-funded bank bailouts and the huge cuts to public spending.

But, if the economy and the government finances do deteriorate once more, don’t expect logic to prevail. The response of his fellow Thatcherites in the Dublin government was repeat the dose, prompting this verdict from the influential Lex column in the Financial Times , ‘But the process of fiscal adjustment across the eurozone is so arbitrary, so uncoordinated, and – in countries like Ireland and Greece – so savage that the cure is as likely as is the disease to kill the poor patient’