The high-speed rail track is the latest signal that the route to deficit reduction now runs via ‘saving to spend,’ explains Alan Shipman.

Banks’ recent mishaps with ‘financial innovation’ have demanded some unusual displays of Finance-Minister innovation. And George Osborne has confirmed his role as one of the most innovative modern Chancellors, even before he prepares to deliver the next Budget in March.

In expanding the UK government’s infrastructure-building commitments while pushing for another round of welfare spending cuts, Osborne has gone the opposite way to most of his post-war predecessors. They tended to let the welfare budget expand, as the inevitable consequence of falling income and rising social need during recession. To fund it, they traditionally swung the axe over capital projects – trusting that most existing roads, railways, power stations and public buildings could creak along for another year without major upgrades or replacement.

The northern extension of HS2 (see this Guardian video is just the latest in a long line of contrarian Coalition commitments, which also include a revived school rebuilding programme, support for the Crossrail project whose cost was questioned in opposition, and a new way of letting big institutions finance public investment projects. Although capital spending reductions announced in 2010 have not yet been fully reversed, it is now clear that further cuts to the government’s redistribution and running-costs will be used to finance new capital projects, and not directly repay debt.

The Coalition headstand 
Past Chancellors have usually taken the opposite approach to ‘fiscal rebalancing’ because cuts to benefits and tax credits are more socially (and electorally) painful than cuts to most infrastructure projects. Indeed, big civil engineering plans often bring some distinctly uncivil responses from the ruling parties’ supporters, as confirmed by those living close to the proposed high-speed route (see HS2 route set to trigger fresh protests).

Economically, spending more on benefits has the merit of immediately boosting demand, by putting money into some of the poorest pockets – shortening the post-Christmas roster of retail-chain closures, even if not enough on its own to get the economy growing again. A higher welfare bill is traditionally the ‘automatic stabiliser’ that helps to end the recession which gave rise to it. In contrast, even a ‘shovel-ready’ infrastructure project can take months to get into motion.  Those crossing affluent backyards can take years, even when planning procedures are fast-tracked to HS2 speed.

Osborne has taken the opposite approach because investment is the key to long-term expansion. A consumption boost worked in 2009-10, restoring the economy to growth, because there was plenty of spare capacity. But three years and a double-dip later, it’s uncertain how much idle machinery can still be easily switched back on. With unemployment falling, the amount of easily-redrafted labour is also unclear. Some economists fear another burst of inflation as rising demand hits inflexible supply. So investment, which adds to capacity as it boosts demand, looks like the safest way to engineer an upturn.

Investor of last resort
Another powerful argument for more public investment was delivered to the Treasury Select Committee at the end of January, as it probed the impact of Quantitative Easing (QE) – the wholesale purchase of government debt by the Bank of England. QE has enabled the Bank to keep base rates interest at a historically low 0.5% throughout the recession, when the wider public deficit and above-target inflation would normally have been expected to send them up. Low interest rates were intended to promote economic recovery, by boosting business investment and reviving the housing market.

But pensioners’ and pension-fund managers’ representatives pointed out two serious side-effects. Low interest rates widen the deficit on the remaining final-salary pension schemes, forcing big companies to divert funds away from investment so as to plug the gap. Low rates also flatten the incomes of pensioners, and others now living on their savings – squeezing their own expenditure, and tying the helping hand that previously assisted younger family members with home-deposits and other big expenditures (see this article).

So for low interest rates to be sure of stimulating recovery, those who benefit most from them have got to be willing to spend more. The government is the biggest beneficiary, and will still enjoy the country’s cheapest credit even if agencies downgrade its currently top (AAA) credit rating. As the damage to pension funds is already done, QE’s overall success may now rely on the Treasury’s ability to splash the cash.

Infrastructure spending has one other major benefit from the Chancellor’s perspective. Because the public outlay can lever-in substantial private investment , and because much of it will take place beyond the Treasury’s 5-year budgeting horizon, the succession of big projects announced with increasing boldness since 2010 need not undermine the Coalition’s promise to eliminate the structural budget deficit.

Many economists are anyway convinced that governments should borrow for public investment, and that the UK should follow standard accounting practice by separating its capital budget (on which rising debts are usually justified by rising assets) from its budget for current expenditure, where debts incurred in downturns should be paid down during recovery. The Treasury’s own forecasting model was highlighting the need for more public capital spending, even before the release of disappointing fourth-quarter growth figures. Osborne’s break with tradition, to boost investment, is fast becoming the new orthodoxy. It should help sidestep the awkward question of whether HS2 will eventually get him (First Class) from Plan A to Plan B.

Alan Shipman 6 February 2013

Alan Shipman is a lecturer in Economics at the Open University. He is responsible for the modules You and your money:personal finance in context and Personal investment in an uncertain world,  part of the foundation degree in Financial Services.

Cartoon by Gary Edwards

Europe’s imposition of common, restrictive economic rules is draining the strength that arose from its structural diversity, argues Alan Shipman.

Carlsberg recently found a new tactic for preventing a strike at its Lithuanian brewery. It persuaded a court that beer supply is an essential public service. Employees would therefore be breaking the law if they disrupted the flow of lager-fuelled lifeblood. A British union leader, recalling the Danish brand’s iconic advertising slogan, called the court’s ruling “probably the most ridiculous decision in the world".

Though a blow for labour rights, this elastic legality might be good news for the wider cause of European survival. It would show that national diversity is alive and well within the troubled economic union. 

Lithuania is still waiting to learn if it can adopt the Euro in 2014. But its lacing of lager and lifeblood, like France’s faith in nuclear power and Belgium’s shops that open only at night, are part of a network of national idiosyncrasies whose erosion could destroy the ‘ever-closer union’.

The dangers of monoculture – whole crops wiped out by the same disease, species extinguished by change in an environment to which they’re too-well adapted – have been known to biologists for years. 

But when economists tried to build on the success of Europe’s single market, they overlooked its lesson in the limits of uniformity. Although we need to standardise definitions for lager, jam and other products, progress then depends on generating variety and competition within the categories. The EU’s strength is based on its assemblage of nations that differ in what they’re best at producing, and what they most like to consume.

So when it comes to the single currency, efforts at ‘convergence’ have been a disaster. The formation of the Eurozone was predicated on the idea that its members would grow ever more structurally similar, so that their comparative production costs would move together (making exchange-rate adjustment unnecessary), and they would all experience and react to economic ‘shocks’ (like an oil-price rise or a banking collapse) in the same way. 

This convergence was meant to ensure that the single market could be turned into a single currency area, without the inter-state labour mobility, large central budget and unified bond market enjoyed by the USA, the only other comparably large currency union.

 

'The dangers of monoculture have been known to biologists for years' 

Defenders of Eurozone experiment still claim that problems arose because member states did not converge far or fast enough. They argue that if only Greece, Ireland, Portugal, Spain and Italy had behaved more like Germany – linking pay growth to productivity and making their labour markets more flexible, keeping budget deficits down, not borrowing too much – they would have been able to co-exist alongside Germany, without running up widening trade deficits against it and worsening debts to its banks.

But the Euro is actually suffering from an excess of convergence. The downward movement of new members’ interest rates towards Germany’s, underpriced their risk; while the upward movement of their wages towards the German level overpriced their labour. Investors’ scope to spread their risks was severely reduced because the more integrated stock and bond markets started to rise and fall together; correlation of asset values wrong-footed even the normally resilient hedge funds in the financial turmoil of 2011.

Pulling the wrong levers
The convergence of policy responses is proving even more damaging.  By shackling every member to the same restrictive fiscal policy, the Eurozone is standing economic logic on its head. 

Countries that have already overborrowed are being ordered to make budget-balancing efforts that are bound to fail, as stalled growth results in ongoing deficits that drive them to default. Larger countries that could afford to borrow more are deliberately not doing so: in particular, Germany restricted its fiscal deficit to 1% of its GDP last year. The reward for this Pyrrhic prudence is that its growth rate will drop to less than 1% this year (even on optimistic official forecasts), and it could end up having to support domestic banks that lent too much to its recession-hit trade partners, including Italy and Spain. 

Recession-induced panic over ‘peripheral’ Eurozone sovereign debt has painfully prolonged the credit crunch that began with mortgage debt defaults in 2007-8. A drop in banks’ asset values has forced them to reduce the flow of new lending, which reduces investment demand and causes asset values to fall further. 

Instead of arresting this ‘de-leveraging’, European governments have promoted it. They are raising capital and liquidity requirements so that banks must put a lot more in reserve before they lend again, and insurance companies restrict their investment in private-sector equity or debt. They are acting to stifle deficits that are actually the inevitable counterpart of big companies’ large surpluses (which reflect their lack of investment opportunity in a stagnant single market), and of households’ tightening of belts to pay-down debt 

The European Central Bank has done its best to prevent another downturn, with massive purchases of public and private debt. But this will just leave it with a bundle of bad assets that ties its hands in future, unless its still-solvent member governments follow-up with some investments of their own. The Eurozone will meanwhile try to export its way back to health, in a world economy that cannot absorb more exports (especially if it is China’s turn for an asset-price drop).

Europe is unnecessarily following the example of Japan, which allowed a gradual collapse in banks’ leverage after its property bubble burst in 1990, resulting in two decades of painfully slow growth. But Japan had systems of redistribution – between regions and households – that appropriately spread the pain, and a willingness to prevent outright deflation by running large central government deficits. 

Despite creating the opportunity to establish the euro as a global currency, Europe is deliberately avoiding the example of the US, which arrested the collapse in leverage with a federal stimulus programme comparable in scale to the New Deal public-works initiatives that halted the 1930s depression.

Significantly, the Americans took that action after realizing that they, too, had seen an excess of convergence. Their real-estate market had lost its regional diversity, so that property prices staged an economy-wide fall for the first time in 2007-8. But they were able to respond appropriately because of the large federal budget, which could move into deficit to complement the central bank’s asset-price stabilization efforts. 

The Eurozone lacks the power to take such action centrally, and Germany has shown that it does not possess the political will to do so on behalf of the other 16 members. 

If France’s new president can persuade Berlin to change course, there is hope of breaking the currency-union’s fall. If not, it will take more than the free flow of Lithuanian lager to drown the continent’s sorrows.

Alan Shipman 1 May 2012

Alan Shipman is a lecturer in Economics at the Open University. He is responsible for the modules You and your money:personal finance in context and  Personal Investment in an uncertain world, part of the foundation degree in Financial Services.  

The views expressed in this post, as in all posts on Society Matters, are the views of the author, not The Open University.

Cartoon by Catherine Pain

 

 

 

On the eve of the Budget, UK individuals now owe as much as the entire country produced in 2011, writes Dick Skellington

The average British household now owes £56,000, if you include mortgage debt, and £7,975 if you do not, and in both debt categories the amount of debt is increasing monthly. 

The findings, from the money education charity Credit Action, show that despite UK households succeeding in reducing their unsecured debts (excluding mortgages) by £355 in 2011 – the third year the debt has fallen – UK consumers have made only a very small dent in the total levels of borrowing, and worse, confidence in the future is affecting consumer ability to repay their debts in the future.

Each UK adult now owes, if mortgages are included, £29,634 in January 2012. This is 122 per cent higher than average earnings (at around £26,000). 

At the end of January 2012 the charity Credit Action estimated the outstanding UK personal debt to be £1.456 trillion, slightly higher than the £1.452 trillion in January 2011. Mortgage lending was also up from £1.240 trillion in January 2011 to £1.248 trillion in January 2012. Household debt excluding mortgages rose to £7,975 in January 2012, up from £7,951 in December 2011. 

Based on January 2012 trends, the UK's total interest repayments on personal debt over a 12-month period would have been £63.2 billion.

Of all debt reported to the Consumer Credit Counselling Service last year, 43 per cent was credit card related. People who asked for help with their unsecured credit card debts owed over £11,000 on average. On average Credit Action estimate that  UK households will pay over £2,400 in annual interest repayments in 2011.

The Government’s Office for Budget Responsibility predicts that by the first quarter of 2017 total UK household debt will have reached an astonishing £2,045 trillion This suggests that the Government confidently believes that average household debt will have reached an astonishing £78,669, assuming the number of UK households is similar to what it is today) 

Credit Action estimate that each day in the UK:

  *   The Government's Public Sector Net Debt (including financial interventions) will grow by an average of £212.1 million today, equivalent to £2,454 per second (based on January 2012 data).

  *   The Government pays an estimated £137.75 million of interest each day on the UK's Public Sector Net Debt of £2311.6 billion (including financial interventions).

  *   318 people are declared insolvent or bankrupt (based on Q4 2011 trends – that is, trends in the final quarter of 2011). This is equivalent to 1 person every 62 seconds during each working day.

  *   1,473 Consumer County Court Judgements (CCJs) are issued every day (based on Q4 2011 trends). The average value of a Consumer CCJ in Q4 2011 was £2,949.

  *   Citizens Advice Bureaux in England and Wales dealt with 8,652 new debt problems every working day during the year ending September 2011.

  *   It costs an average of £28.44 per day to raise a child from birth to the age of 21.

  *   93 properties are repossessed every day (based on Q4 2011 trends).

  *   82 new people a day became unemployed for over 12 months during the year ending December 2011.

  *   1,797 people a day reported they had become redundant between October and December 2011.

  *   196 mortgage possession claims are issued and 149 mortgage possession orders are made every day

  *   388 landlord possession claims are issued and 275 landlord possession orders are made every day.

  *   25.9m plastic card purchase transactions were made every day in December 2011 with a total value of £1.222 billion.

  *   8.0m cash withdrawals will be made daily with a total value of £531m (based on Q3 2011 trends).

To rub in the economic problems faced by UK households, a week after the Credit Action report the Centre for Economics and Business Research (CEBR) revealed UK households were more than £2,000 a year worse off than they were in 2007 – a fall of 5.7 per cent – and they now face a third successive year of falling disposable incomes, largely due to a rise in commodity costs, the high price of oil and changes in Government welfare policy.  CEBR report the fall in income adds up to the equivalent of a cut of £2,210 over the full six-year period. It is therefore hardly surprising little progress is being made in reducing household debt. 

It will be fascinating to see if this week's Budget makes it even more difficult for individual households to pay off their debt and whether it will create the conditions for further increased borrowing simply for low income households simply to pay utility and food bills. If the rumours are right, and Chancellor George Osborne does cut national public sector pay in some of Britain's poorest regions as forecast over the weekend then the UK debt mountain is likely to rise while inequality in the UK, widening under the Coalition Government, will widen further, raising the prospect of industrial action on two fronts, pay and pensions.

Dick Skellington 19 March 2012

Cartoon by Gary Edwards