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Comment on Martin Wolf’s Wincott Lecture by Robert Skidelsky
13 November 2013
(Download the charts to accompany this comment at:
http://www.wincott.co.uk/lectures/Skidelsky slides.ppt)
I propose to comment on Martin’s excellent lecture under three heads which
all point to the central issue of how sustainable is the welcome recovery now
taking place.
First, Martin poses the important question of whether ‘the losses in output and
productivity are permanent or temporary’ (p.3) and concludes that there is no
convincing reason for them to be permanent, though restoration of the
previous position will take a long time.
Two comments: first, this argument ignores the loss of productive capacity
through hysteresis. In an FT article earlier this year ( FT,18 Feb 2013 ‘Supply
Matters but so Does Demand’) Marcus Miller and I, citing work by Brad de
Long and Larry Summers, argued that prolonged unemployment destroys not
just current but also potential output. If an output gap is allowed to persist, the
effect of hysteresis on skills and infrastructure is to reduce the growth
potential of the economy. We are, so to speak, consuming our human capital:
there is less of it left.
This is the chief long run cost of fiscal austerity. Persisting conditions of semi
–slump cast long shadows, diminishing supply as well as demand. I think
something like this happened in the 1980s. Martin Wolf’s chart no 3 shows no
break in trend of GDP per capita growth from 1950-2007. But if we take a
chart of unemployment, we get a different picture.
CHART 1: UNEMPLOYMENT
The economy never returned to the levels of unemployment it experienced
from 1950 to 1970. In the UK average unemployment went up from 1.6% a
year between 1950 and 1970 to 7.5% between 1980 and 2008. And even
after demand deficiency had been removed, structural unemployment was
twice as high as it had been in the earlier period. In short, the ability of the UK
economy to employ people to produce output seems to have been
permanently impaired.
My second comment is this: I’m not sure there wasn’t after all, something
illusory, or unsustainable, about GDP growth in the pre-recession years. Four
features need to be noticed:
1. Growth (and employment) seems to have been driven disproportionately by
the financial services and the public sector. Financial and insurance services
grew as a proportion of total Gross Value Added (GVA) between the late
1990s and 2009 to a peak of around 10.4%. Between 1999 and 2007, public
sector employment increased by 10.5%, while private sector employment
increased by 7%.
Some of the value added by the financial services was plainly unsustainable,
in that it was a bubble bound to burst. Expansion of the public sector partly
reflected increased demand for the ‘caring’ services: but it also reflected the
difficulty of job placement in the private sector. The public sector became the
employer of last resort. Given the Coalition’s determination permanently to
shrink the public sector, the private sector will have to generate a higher
proportion of jobs than it did in the pre-recession years. Where will they come
from?
2. Relative to other countries, UK productivity growth pre-recession was
unimpressive. The expansion of the UK economy after 1997 was mostly
driven by an increase in inputs rather than outputs (See ‘UK productivity
during the Blair era’, Centre for economic performance). This reflects three
factors: the growth of finance –which disproportionately benefits ‘high
collateral/low-productivity projects’ (cited Wolf p.11), the growth of the public
sector, where productivity gains are hard to achieve, and the transfer from
more productive to less productive jobs, particularly to the lower end of the
retail sector. So where will the productivity growth needed to achieve a
sustained recovery in real earnings come from?
3. Not enough attention has been given to the fact that a sizeable proportion
of British jobs depend on ‘in work’ benefits. These jobs have increased
substantially since the schemes were started in the 1980s. The TUC
estimates that the number receiving ‘in work’ benefits rose from 1.6m in 2003
to 2.1m in 2008; today 21.2% of all employed adults live ‘in a tax credit
recipient family’. It’s true that ‘in work’ benefits are better than out of work
benefits, better for their recipients and more productive for the country. But
one has to ask: if these subsidies were withdrawn, what will happen to the
jobs? Will the earnings of those receiving the benefits fall to the Chinese
level? Or will the erstwhile recipients merely swell the ranks of the
unemployed?
4., One should not ignore the increasing difficulty of the British economy in
creating ‘good jobs’, by which I mean jobs which pay a decent wage; or more
precisely, reverse the growing gap between mean and median incomes.
CHART 2. GAP BETWEEN MEAN AND MEDIAN INCOMES
I would not deny that recession and fiscal austerity have aggravated these
adverse factors. What I am suggesting is that in addition to the losses to
productive capacity caused by prolonged unemployment, there were
distinctively flaky elements in the ‘old’ normal which will make it very hard for
the UK to regain the pre-recession trend of economic growth. The ‘new
normal’ will be the ‘old’ normal stripped of illusions.
Secondly, Martin asks ‘Could [monetary] policy have been more successful?’
Remember QE came in two bites. The first, running from March 2009 to
February 2010, which pumped £200bn into the banking system, was done
to offset the credit crunch which followed the collapse of Lehman Bros. The
second, of £175bn, which has run from October 2011, was intended to offset
the effects of contractionary fiscal policy, once the theory of ‘expansionary
fiscal contraction’ was exposed as statistical nonsense.
How was QE supposed to work? Look at this B of E handout from 2011. ).
[Taken from David Miles, Asset Prices, Savings, and the Wider Effects of
Monetary Policy, B of E 1st of March 2012, p.5)]
CHART. 3. QE CHANNELS
According to this view, QE operates through two channels –the bank lending
channel and the portfolio rebalancing channel. (I abstract, as the Bank did,
from the foreign exchange channel).
It is clear that the bank lending channel failed to direct lending to SMEs
where it was most needed. That is to say, reconciliation of lender and
borrower risk in the current state of expectations produced interest rates too
high to allow for a recovery of investment.
The bank lending channel has been partially unblocked by special schemes to
subsidise mortgage lending. From the economic, though not the political, point
of view, a renewed bout of house price inflation is the last thing needed. It
threatens a return to the pre-recession situation when populations became, in
Martin’s own earlier words, ‘highly leveraged speculators in a fixed asset’.
(Martin Wolf, FT 9 September 2008).
Today’s adherents of QE place their main hope on the ‘wealth’ effect of
portfolio switching. QE has almost certainly pushed up the price of assets and
probably the luxury spending of their owners. The crucial question is whether
it has pushed up the rate of investment. The jury is out on this: but the
outcome is not impressive. Business investment has remained flat through
two bouts of QE; ONS reports that it decreased by 8.5% in the 2nd quarter of
2013 compared to the same quarter the previous year. The reason for this is
perfectly understandable to a Keynesian. Investment depends on the
expected return from selling the extra output which the investment makes
possible. There is no reason for a businessman to increase his investment if
he is facing a reduced demand for his products.
In the Treatise on Money Keynes made a useful distinction between the
‘industrial’ and the ‘financial’ circulations (TM, v, 222-3). The industrial
circulation supports current output, including investment; the financial
circulation flows into speculation and swopping titles to existing assets.
Keynes thought that in the downturn the financial circulation steals money
from the industrial circulation.
To prevent this ‘theft’ Keynes said that the Central Bank should feed the
financial circulation all the money it requires. Evidently QE was not on a big
enough scale to reduce the ‘hoarding’ of banks and corporations.
Further, the way QE was done chiefly benefitted asset holders at the expense
of everyone else, ie., it enriched the already rich. In macro terms, it directed
money towards those with the lowest propensity to consume. Insofar as it
raised the inflation rate from what it would have been it contributed to the
decline in real earnings. (Though reduced earnings were also caused by the
fall in the exchange rate.) The TUC estimates that average real pay has fallen
by 7.5% since 2008: a reduction in effective demand not offset by any wealth
effect.
The criticism of the QE programme is thus twofold: there wasn’t enough of it,
and the new money was directed to the wrong places.
Martin agrees that monetary policy could have been more successful, but has
a curious suggestion l for improving it in the future. He endorses the idea of
100% reserve banking. The whole, or bulk, of credit creation would be
transferred from the banks to the state, which would issue money to ‘finance
itself permanently’, presumably to what ever extent it wanted.
I support the thought behind this, but offer three quick comments. First, it is
surely wrong, from a history of ideas standpoint, to bracket the Austrians with
Fisher and the Chicago School. The Austrians certainly wanted to abolish
fractional reserve banking, but they did not want the government, or central
bank, to take over credit creation. They regarded credit creation as bad, full
stop. They would have abolished central banking, and if that proved
impossible, restore a full gold standard, ie 100% gold reserves against
currency notes. This was never Milton Friedman’s position.
Secondly, I am puzzled about how the system would work in practice. Would I
be able to take out a loan from my bank? What does it mean to say that ‘credit
would be …operated via investment and unit trusts’? Would they invest in
small businesses? And what are the ‘new means’ to be developed ‘of
financing the private sector’? It would have been good to hear more about all
this.
Thirdly, a less drastic remedy would surely be to adopt a reform like that
proposed by Charles Calomiris for a 20% equity, 20% reserve requirement.
This would improve the quality of bank lending without crippling it. (Calomiris,
2012, ‘How to Regulate Bank Capital’, National Affairs, 10.)
There are several other things I would love to discuss –including the dilemma
he poses of ‘less globalised finance or more globalized regulation’ (p.11), but I
need to rush to my final set of comments.
These concern the impact of ideas on policy. Here I endorse everything
Martin says, but think that he is too optimistic. A gap has obviously developed
between the ideas of the policy-makers as they try to deal with the crisis and
its aftermath, and the ideas of mainstream academic economists who, in thrall
to their DSGE models, taught generations of students that no such crisis was
possible; or more accurately was so unlikely, as not worth bothering with.
Thus the current mainstream view that Keynes’s General Theory was not
general: it was a special theory for a once in a century event.
The starting point of economics is still in the wrong place. It lies in the Platonic
world of perfect markets rather than the real world of markets as they
actually work in the human and social world.
But I see little sign of that ‘ferment of ideas’ Martin hopes for, at least in the
academic world. INET, which should have been the fulcrum of the ferment,
has been captured by members of the economic establishment whose minor
deviations from orthodoxy run along well established lines. The whole
apparatus of academic promotion through publication in journals controlled by
the Chicago School remains intact; the growing formalisation, hence
abstraction, of economics continues apace. There are signs of ferment,
mainly from students, like those involved in the Post-Crash Economics
movement at Manchester. But while their dissatisfaction with what they are
being taught is palpable, it is unfocussed. The professors don’t give them a
lead.
Martin hopes for an ‘intellectual upheaval reminiscent of the response to
depression in the 1930s’. The truth is that this depression has not been
anything like as severe-certainly not enough to shake a proud, established
discipline like economics to its foundations. We have to experience many
more crashes for that to happen. They are sure to do so. (1901)