Latest UK GDP data even worse than it looks

By Michael Burke

The latest release for British GDP in the 3^rd quarter was unrevised – but the composition of that growth was awful. GDP rose by 0.5% in the quarter and is just 0.5% higher than a year ago. But analysis of the components of growth suggests the outlook is deteriorating.

Household consumption did not grow at all in the quarter and contracted by 1.5% over the course of the year. Investment (gross fixed capital formation) fell by 0.2% in the quarter and by 1.8% from a year ago. In terms of domestic expenditure only government spending rose in the quarter, up 0.9% on the quarter and 2.9% over the year. This is testimony to the multiplication of ‘austerity’ measures: If unemployment and poverty are increasing at a faster rate even than you cut welfare benefits your total welfare bill will rise.

Taken together UK domestic expenditure rose by £3bn in real terms in the quarter. But inventories rose by £2.9bn at the same time and therefore account for almost the entirety of domestic growth in the quarter. Since GDP rose by just £1.8bn in the 3^rd quarter, the rise in inventories indeed exceeds the growth in GDP as well as accounting for almost the entirety of growth in domestic spending.

Inventory Build-Up

Inventories are a cyclical and erratic component of growth. But a persistent rise in inventories over a number of quarters only occurs if businesses are receiving new orders and are restocking as they become increasingly confident about a sustained upturn. This is sometimes called a voluntary rise in inventories. But this is not at all the situation presently. Domestic demand is stagnant and exports have also fallen in the last two quarters. It seems unlikely that order-books are filling up and businesses becoming more confident about future prospects. In fact the respected Market Purchasing Managers’ Index shows that new orders have been slowing dramatically, as shown in the chart below.

Figure 1 – PMI New Orders, National & London

Therefore the current build-up in stocks is likely to be an involuntary. Inventories are most likely rising because sales have not met expectations. If so, businesses will tend to meet new orders by depleting those existing inventories rather than increasing output. At the very least this rise in inventories is unlikely to be repeated over several quarters. The addition to growth in the 3^rd quarter arising from rising inventories is unlikely to be repeated over several quarters.

As we have seen domestic demand would have been close to zero and GDP would have contracted without rising inventories. To avoid that fate in subsequent quarters some other component(s) of growth will have to begin to grow once more. Otherwise the British economy will begin to contract once more.

Profits and Austerity In the Industrialised Economies

By Michael Burke

A previous SEB article examined the profit rate in the Irish economy which is rising even though the economy continues to contract. Yet at the same time Ireland’s level of investment is falling. Corporate incomes – profits - are rising even though total economic activity is falling. Arithmetically, this can only occur by reducing the income of labour - wages are falling both in absolute terms and as a proportion of total economic activity. It happens that the Irish Department of Finance set this out with some clarity. This is indeed is the thrust of the entire ‘austerity’ policy – a transfer of incomes from labour to capital across the industrialised economies of Europe, as well as in the US and Japan.

Who Is Paying for the Crisis?

The table below shows the Gross Value Added (GVA) of selected economies, and how this is divided between the compensation of employees and the gross operating surplus of the corporate sector. GVA is a measure of all the value created in an economy. It is the same as GDP except that it excludes the impact of taxes and subsidies. With some important qualifications the Compensation of Employees (CoE) is akin to labour’s share of that value added, while the Gross Operating Surplus (GOS) is akin to the level of profits in each economy. This provides an approximate measure of economic activity and its distribution as income: Value-Wages-Profits. In the table blow the profit rate is calculated as the share of GOS in Gross Value Added.

Table 1. GVA, Compensation of Employees, Gross Operating Surplus and the Profit Rate, €bn in 2010 (unless otherwise stated)

The general tendency has been that the crisis-hit countries have the highest profit rates. This was an important factor in the build-up to the crisis. In nearly all countries the crisis was characterised by reduced investment by the corporate sector, which remains the driving force behind the economic crisis. In these higher profit countries the fall in investment had a greater impact on aggregate demand as the corporate sector takes a bigger share of GVA. In turn, the fall in investment had a bigger negative impact on household incomes, especially through rising unemployment.

Profits and deficits

The profit rates should also be seen in relation to the public sector deficits that have caused so much turmoil. In all cases the public sector deficits are a fraction of the level of profits. In Greece the 2010 deficit was €25bn, in Italy it was €70bn, in Ireland it was €19bn (excluding an extraordinary bank bailout), and so on. The deficits could easily be covered in their entirety simply by extracting a fraction of the profit level from the corporate sector in each country. The same is true of Britain, where the profit level in 2010 was £475bn compared to a deficit of £137bn. (The British profit level is depressed and consequently the profit rate is lower because of the slump in the financial sector – a factor which also applies to a lesser degree in the US and even to France).

Who can pay for the crisis?

There are effectively three destinations for profits. These are investment, which raises future prosperity, or dividends for shareholders which are not invested or huge executive compensation and bonuses, both of which do not. The table below shows the level of profits, the level of public sector borrowing and the level of gross fixed capital formation (investment). In the last column the difference is shown between the level of profits and the level of public borrowing and investment combined.

Table 2. Gross Operating Surplus, Public Sector Borrowing and Investment, €bn in 2010 (unless otherwise stated)

Table 2 shows that in all cases the current level of both the public sector borrowing and the current level of investment can be funded by the level of profits in each country and in the Euro Area. In most cases there is scope to fund both the deficit and significantly increase the level of investment. But the opposite has been happening.

The struggle over distribution of national income

In most recessions capital’s share of income falls. This is not because wages rise, but because profits fall at a faster rate than the fall in output. What then usually occurs is a struggle by capital to regain its lost share of income. It does this by cutting wages and benefits, by increasing unemployment and by reducing its tax burden - financed by reducing social welfare benefits. This is the content of ‘austerity’ measures.

Figure 1 below shows how this has operated in the Euro Area as a whole. Between 2008 and 2009 GVA in the Euro Area fell by €254. Confirming the idea that profits fall at a faster rate than output, Euro Area profits (GOS) fell by €227bn. Profits fell by over 6%, twice as fast as the fall in output. Wages (CoE) fell by €17bn.

Figure 1

However, this natural tendency for profits to fall at a greater pace than the fall in output is interrupted and diverted by a series of interventions, including rising unemployment, wages and benefit cuts as itemised above. In the period 2009 to 2010 Euro Area GVA rose by €188bn. Of this increase in output €139bn went to profits and just €53bn accrued to wages.

Because of inflation the real level of both wages and profits has fallen sharply – all these data are in nominal terms and do not take account of inflation. The ‘austerity’ offensive to increase the profit share has partly been successful, but the wage share of national income has not undergone any strategic reversal.

This is contrasted with Greece. Greek nominal GVA did not fall in 2009 at all as the Greek recession was shallower than most. GVA fell in 2010 by €6bn. This is shown in chart 2. The massive offensive against Greek workers and the poor means that the natural tendency for profits to fall faster than output has not operated. The level of wages fell by €4.4bn and profits fell by just €1.8bn. The wage share of national income has suffered a reversal.

Figure 2

Readers will be interested to know where Britain stands in relation to these examples, one of them the extreme case of Greece (and previously, Ireland). In 2009 British GVA fell by £38bn, shown in Chart 3 below. This was exceeded by the fall in profits, down £43bn and wages rose by £5bn. The entirety of policy since has been to reverse those trends. GVA rose in 2010 by €40bn. (It should again be stressed that these are nominal data, in real terms output is still over 4% below its peak and real wages have fallen).

Figure 3

As a result of initial ‘austerity’ measures, £18bn of the increase in output has been claimed for profits. But it is widely understood that the real offensive in Britain only began in the new Financial Year, which began in April this year. What is being attempted is a decisive reversal of the wages’ share of national income.

Conclusion

Countries like Greece are experiencing a qualitatively sharper crisis than the European average. There is a high correlation between the likelihood of economies falling into this type of extreme crisis and their exceptionally high level of pre-crisis profits. Because the income of the corporate sector is a much greater factor in the economy, their investment strike hass a proportionately greater impact on total output and/or government finances.

Profits remain exceptionally high, so much so that they could finance the deficit while simultaneously increasing the level of investment.

Under normal working of a market economy the tendency is for profits to fall faster than output. The entire ‘austerity’ policy is to prevent this tendency from operating, and to reverse it by reducing wages even faster than the decline in output. In the Euro Area, to date this has only been achieved in Ireland and Greece.

In Britain, it’s too early to say whether a similar ‘austerity’ drive will achieve the same disastrous results. But it is clearly the aim of government policy to drive up profits even while the economy is stagnating. This can only be achieved by driving down wages.

The relation of profits and 'austerity'

By Michael Burke

In what may be an important development the Financial Times reports that, in return for accepting much larger ‘haircuts’ (imposed losses on the value of the bonds they own) bondholders are demanding that there must be a growth strategy for Greece.

In a piece headlined ‘Bondholders Demand Greek Growth Plan’ the paper quotes the Managing Director and chief negotiator for the Institute of International Finance, which represents the largest bondholders mainly the banks. The call for a growth plan is not given much substance in the article.

But there is a logic to the demand. Bondholders are most concerned about cash flow from interest payments and the final repayment of debt principal. In all the Euro Area economies where severe ‘austerity’ measures have been applied bond yields have risen - Greece, Ireland, Portugal, Spain and now Italy. This implies that the bondholders’ risk of not receiving those cash flows and principal has risen, and that a higher interest rate is demanded to compensate. ‘Austerity’, a generalised attack on the living standards of the overwhelming majority, has failed to provide reassurance to bondholders that they will get all the bond repayments. Instead, the reduction in incomes and economic crisis that has followed has increased the risks that the governments will default. If it proves to be the case now that the bondholders are demanding not more austerity, but growth, this would reflect the accurate judgment on their part that the risk of default has increased because of massive cuts in government spending. It is a demand that the European governments provide funds to Greece to help the economy recover, not impose more cuts.

Can ‘Austerity’ Work?

Of course the bondholders, mainly the banks but also increasingly other parasites such as hedge funds and ‘vulture funds’, had no qualms about massive assaults on pay, jobs, pensions, services and welfare benefits while they thought it improved their own prospects of being repaid by EU governments. But even at an earlier stage it was clear to some that cuts in government spending would not work. This is shown in the actions of the credit ratings’ agencies – who effectively represent the interests of the bondholders – and have repeatedly campaigned for large cuts in government spending, only then to downgrade countries such as Greece, Ireland, Portugal and Spain because of the negative economic impact of those same cuts.

By now it is increasingly clear in the case of Greece that any further cuts will be equally counter-productive in restoring the growth required to service debt. But the IMF, ECB and EU Commission are holding up another example of how their impositions can be made to work - Ireland. The ‘Troika’ argue that successive Irish governments (the current coalition of the rightist Fine Gael and Irish Labour Party having replaced the populist right of Fianna Fail) have stuck to the measures agreed, that growth has resumed and that therefore the deficit is falling.

In fact, the previous government imposed cuts in 2008 and before any international agency demanded them. The current government is set to announce its own first Budget, which will also impose greater cuts than demanded by the Troika. It is also widely understood, if not by the Troika, that Irish GDP is artificially inflated by the activities of (mainly) US multinationals booking activity and profits in Ireland to avail of its ultra-low corporate taxes. This has seen GDP rise in the latest two quarters. But domestic demand fell again by 1.1% in the 2^nd quarter of this year, a 3 ½ year-long slump collapse and is now 24.8% below its level at the end of 2008. According to the IMF the Dublin government’s deficit will be 10.3% of GDP this year, having been 7.3% before the cuts began to bite in 2008.

Even so, the Troika are increasingly determined that the deficit will decline and prove their case. They point to the fact that, excluding enormous bank bailouts equivalent to over 20% of GDP last year, borrowing fell from €23.5bn in 2009 to €19.3bn in 2010, an improvement of €4.2bn. Yet this is simply because the value of bonds redeemed in 2010 was €4bn lower. Otherwise there is no underlying improvement in the level of borrowing at all.

But there is an important difference with Greece. Following big tax increase Athens’ taxation revenues have fallen by 4.2%in the first 9 months of this year whereas Dublin’s tax revenues are 8.4% higher reflecting the imposition of new income taxes. The key difference is that Ireland was a much more prosperous country than Greece prior to the crisis. Per capita incomes were 50% higher, even adjusted for Purchasing Power Parities. Therefore, while the cuts have certainly had a negative impact on Irish growth, and the domestic economy continues to contract, the level of impoverishment of the entire economy is not in the same category as Greece, where even bondholders may now accept that further cuts are counter-productive. Instead, the impact of the cuts in Ireland might be said to be Greece in slow-motion.

Who Benefits?

The new caution in imposing further cuts in Greece is the worry of the loan-shark that the borrower may go bankrupt. But while there is still blood that can be squeezed in countries like Ireland cuts remain the sole policy agenda. The effect of this policy is clear from the recent publication of the sectoral accounts for the Irish economy.

This is shown in the chart below, which shows that as Gross Value Added continues to decline, profits have started to recover and therefore the profits’ share of national income has increased.

Figure 1

According to the Central Statistical Office (CSO), ‘The operating surplus or profits of non-financial corporations (NFCs) increased from €35.2bn in 2009 to €37.8bn in 2010. The other main component of value added is compensation of employees or wages and salaries which declined from €37.3bn in2009 to €34.9bn in 2010. Therefore the improved profit share relates more to a decline in payroll costs for these corporations rather than to an increase in overall value added.’
Yet this increase in the incomes of the corporate sector, wholly achieved by reducing wages, has not led to an increase in investment. It has led to the opposite, as the chart below shows.

Figure 2

In the words of the CSO, ‘Expressing gross fixed capital formation as a percentage of gross value added gives the investment rate. Gross value added is largely unchanged between 2009 and 2010 while investment fell from €7.5bn to €5.8bn in the same period resulting in a fall in the investment rate between 2009 and 2010.’

But there is also another way of expressing the investment rate - investment as a proportion of corporate incomes, or profits. On this measure, the investment rate has fallen by €1.9bn even as profits have increased by €2.9bn, by reducing wages by €4.9bn. The total investment rate has fallen on this measure from 21.3% to 15.3%.

From the point of the view of the economy as a whole, this transfer of incomes has been disastrous. The corporate sector has €32bn in unspent (uninvested) income from profits. But the household sector – which spends more than 90% of its income – has had its income reduced.

The thrust of policy is not to produce an economic recovery. It is to produce a recovery in profitability. In this, it has been a qualified success. The absolute level of profits has recovered from its low and the profit share of output has also increased to more than 50%, even if profits have not recovered their previous peak. The intention is clearly to achieve that goal at the expense of wages.

In Ireland it has become commonplace to suggest that, while all sorts of investment projects and welfare provision are desirable, ‘there is no money left’. On the contrary, the €32bn level of uninvested profits in 2010 alone is almost exactly equal to the entire reduction in GDP in the recession which began in 2008, €34bn.

This is the thrust of the entire ‘austerity’ policy across Europe, the transfer of incomes from labour to capital in order to increase profitability. In a subsequent blog SEB will examine the effective of this policy in the leading European economies, including Britain.

GDP Data Show UK Stagnation Is Home Grown & Due to Government Policy

By Michael Burke

Publication of the latest estimate of GDP data shows that the recession was much sharper than previously thought. The revision shows that GDP contracted by 7.1% rather than the 6.4% previously estimated. The recovery which began in the 3^rd quarter of 2009 was also slightly stronger than previously estimated, the economy expanding by 2.8% until the 3^rd quarter of 2010. From that time onwards the economy has stagnated completely, with zero growth in the three  quarters since. The result is that the British economy is 4.4% below its peak level before the recession, which is now estimated to have begun in the 2^nd quarter of 2008.

George Osborne and other Tories as well as their supporters in the media are now promoting the idea that the stagnation of the British economy is a function of the turmoil in the Eurozone economy and financial markets. The main channel for economic weakness in the Eurozone to be expressed in British economic activity is via exports. But the British economy has not grown over the last 9 months - while the first dip in exports has occurred only in the latest quarter. This is highlighted in the chart below, which shows the level of total domestic expenditure versus exports. Domestic demand began to contract as soon as the current government took office. Evidently, the stalling of British economy has not been caused by the turmoil in the Eurozone.

Chart 1

In fact the opposite is the case. The British economy comprises 14.5% of the entire EU economy, in OECD terms approximately $2trn of a total $13.8trn (in Purchasing Power Parities). Yet even before the latest downward revisions to GDP by the Office of National Statistics are included, the OECD data show that the entire loss in EU GDP was $355bn, of which British economic weakness is 21.4% of the total, equivalent to $76bn. As the chart below shows, the British economy has been a brake on the Eurozone economy, not vice versa.

Chart 2

Stagnation

Returning to the ONS release, the total loss of output since the UK recession began is £65.2bn. The total loss of investment (Gross Fixed Capital Formation) over the same period was £43.3bn, that is almost precisely two-thirds of the entire recession. But the latest data also represent a turning point. The total loss in household consumption during the recession was larger at £51bn, over three-quarters of the total contraction in the economy. The fall in household consumption began to outstrip decline in investment in the 1^st quarter of this year.

This loss in consumption has therefore not been the catalyst of recession. The decline in investment preceded the recession by 6 months. Declining investment was the driving force of the recession. But it does indicate that there is a new and significant and pressure on household spending in the British recession. Other components of the national accounts have risen over the same period, notably government current consumption and net exports.

It is also no longer the case that the private sector fall in investment exceeds the total decline in investment. Previously, this had been the case as government investment had risen. As a result the fall in private sector investment had amounted to 80% of the total lost output through the course of the recession. Now the decline in private sector investment amounts to £36.5bn - 56% of the total decline in output.
But government investment is now falling. In total, government investment has fallen since the recession began, down £6.8bn. But this is entirely a function of the current government’s policy. Since the Tory-led government took office, government investment has fallen by £12.2bn, more than reversing the very modest rise in investment of the previous Labour government. The direct effect of the government decision to reduce investment is to cut GDP by 0.9%.

Recovery Derailed

These are only the direct effects of declining government investment. It is now commonplace to speak of a continuous recession from the 1st quarter of 2008. Cameron and Osborne routinely speak of their dire inheritance from the Labour government. The actual inheritance of the Tory dominated government was actually an economic recovery underway, which after the latest revisions is now stronger and longer than previously estimated. The economic recovery lasted 5 quarters and GDP expanded by 2.8%, whereas previously it was estimated at 4 quarters long and a recovery of 2.5%.

The Labour government did not begin to increase investment until the 4^th quarter of 2008. From that time until the new government took office government investment rose by £27.2bn. But this had an indirect effect primarily by encouraging private sector investment so that the economy expanded by £38.7bn in total.
On the same ratio the current government’s decision to reduce its own investment will have led to a total decline in output of £17.4bn, or 1.3% of GDP.

Conclusion

The UK economic stagnation is a home-grown one due to the policies of the present government. It began before there were any negative effects from the Eurozone’s turmoil. It is primarily a function of the government decision to reduce its own investment. The British economy is stagnating because of policy made in Downing Street and nowhere else.

Economic downturn in the UK now twice as bad as in the Eurozone due to government deficit cutting

By John Ross

One of the more factually inaccurate pictures being spread by supporters of the policies of the present UK government - with its priority to budget deficit reduction - is that UK economic performance during the financial crisis is superior to that of the evidently crisis hit Eurozone. A typical version of this appears in an article on 3 October in the Daily Telegraph by its international business editor Ambrose Evans-Pritchard.

Evans-Pritchard states: ‘My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse [the Eurozone] by foolish elites.’ Presumably Evans-Pritchard's sympathy goes to the inhabitants of the Eurozone, rather than his own country the UK, because he believes the UK has been doing better than the Eurozone.

The factual situation is the exact opposite of the impression presented by Evans-Pritchard. Judged by economic performance, the average citizen of the UK far more needs Evans-Pritchard’s sympathy than the average citizen of the Eurozone - i.e. the UK’s economic performance during the financial crisis is much worse than that of the Eurozone. This may be seen in Figure 1 – which shows UK GDP compared to that of the Eurozone since the peak of pre-financial crisis output. Comparison is straightforward as in both the Eurozone and the UK the peak of the previous business cycle was in the 1st quarter of 2008.

By the 2nd quarter of 2011, that is 14 quarters after the peak of the previous cycle, Eurozone GDP was 2.0 per cent below its previous peak level whereas UK GDP was 3.9 per cent below its previous peak - i.e. UK economic performance was almost twice as bad as that of the Eurozone.

Figure 1

Equally striking is the clear way in which present government’s policies made UK economic performance worse than in the Eurozone. It may be seen from Figure 1 that while the initial decline in UK GDP was greater than in the Eurozone - the greatest decline in UK GDP being 6.4 per cent registered in the 3rd quarter of 2009, compared to a maximum Eurozone drop of 5.5 per cent in the 2nd quarter of 2009 - recovery in the UK was also initially more rapid. This may be clearly seen in Figure 2, which shows year on year GDP changes.

The UK and the Eurozone reached their 1st quarter 2008 peaks with almost exactly the same economic momentum behind them – 1.9 per cent growth in the previous year in the UK and 2.0 per cent in the Eurozone. However by the 3rd quarter of 2010, the one immediately following the departure of the  previous government, UK GDP was rising at 2.5 per cent compared to 2.0 per cent in the Eurozone. Eurozone recovery subsequently slowed somewhat to 1.6 per cent by the 2nd quarter of 2011.

However UK GDP growth under the new government, which gave priority to budget deficit reduction, dropped astonishingly, by more than two thirds, from 2.5 per cent to 0.7%. Under the new government the year on year growth of UK GDP therefore fell from being higher than that of the Eurozone to being less than half that of the Eurozone!

Figure 2

The present author is not a supporter of the present constitution of the Euro. On the contrary I predicted the current events unfolding in Greece and other countries in advance due to fundamental weakness in the design of the Euro. Writing in 1996, i.e. fifteen years ago:’ [the Treaty of] Maastricht’s proposals are … disastrous. It proposes to create the most fundamental features of a common state — a single currency and a central bank. But it does not create any state budget which can deal with the huge regional and sectoral implications of this. The process that would unfold with the creation of a single currency by this method may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join.There will be sharply deepening regional imbalances and inequalities.’There is evidently no reason to revise that analysis.
It is therefore all the more striking that UK economic performance is actually worse than in the Eurozone. And a substantial reason it is worse is clearly due to the policies of the present government with their priority to budget deficit reduction.

In any discussion of the relative economic performance of the Eurozone and the UK two fundamental facts must be held in mind against unsubstantiated myths:

• UK economic performance during the financial crisis is substantially worse, almost twice as bad, as that of the Eurozone.
• And the reason it is that bad is because the present government, through its priority to cutting the budget deficit, reduced the UK’s rate of economic recovery from substantially above that of the Eurozone to less than half that of the Eurozone.

This factual situation evidently has a more general economic significance than merely for the UK and the Eurozone. For reasons dealt with frequently on this blog a policy of simply running budget deficits is inadequate to deal with the consequences of the present financial crisis as it does not tackle its driving force - the decline in investment. But under conditions of private sector weakness any rapid reduction in the budget deficit will lead to rapid economic slowdown or contraction. This is sharply illustrated by the fact that the UK government, by such policies, has reduced the UK's rate of economic recovery to less than half that of the openly crisis struck Eurozone.

Other countries thinking of embarking on immediate deficit reduction policies, such as those advocated by the Republicans in the US, should look at the UK and draw the appropriate negative conclusions. Do not be totally distracted by financial fireworks: the policies of the present UK government are so bad they have produced an economic recovery which is only half that of the Eurozone!

*   *   *
This article originally appeared on Key Trends in Globalisation.