Britain’s shrinking economy may have been blamed on the snow at the end of last year, but another factor must also be blamed: the collapse in investment. During the recession gross domestic product shrank by £88.6 billion. The year-long recovery clawed back £32 billion of that lost output, to leave it £56.6 billion below its previous peak. The renewed contraction in Q4 of £6.2 billion means that output is now £62.8 billion, or still 70 per cent below its peak level.
The role of fixed investment (gross fixed capital formatio, or GFCF) has been decisive. Within the recession, it accounted for £43.6 billion or nearly half the total decline in GDP. But taking the recession and recovery together the decline in GFCF accounts for £31.5 billion, or 56 per cent of the total in lost output. The decline in investment has once more led the way, accounting for more than 60 per cent of the contraction in Q4 GDP, £3.8 billion of £6.2 billion. For the whole period from the recession to date and including the Q4 contraction, the slump in investment accounts for £35.4 billion of a total in lost output of £62.8 billion – that is, 56 per cent of the total decline.
Investment has two sources, the government and the private sector. Although ONS does not present the data in this way, it is possible to construct the differing effects of these two sources on the trends in investment.
Government investment rose by £9.9 billion during the recession. It rose further until Labour left office, to £11.2 billion. Under the Tory-led coalition, it has fallen by £4.2 billion.
If GFCF has been falling in total and the government component has been rising, it follows that the private sector is entirely responsible for the fall in investment – and that it is greater than the decline in investment as a whole. In the recession, the fall in private sector investment was £52.9 billion. This is 60 per cent of the entire fall in GDP in the recession. Because private sector investment has grown even more slowly than GDP during the recovery, it has acted as a further drag on growth. From the pre-recession peak to the end of the recovery phase in Q3 2010 private sector investment fell by £39.7 billion, or over 70 per cent of the total decline in output. Investment fell by £3.8 billion again in Q4, which is once more of the bulk of the decline in total output during the quarter, which amounted to £6.2 billion. Private sector investment fell by £2.1 billion in Q4, so that it now stands £41.8 billion below the pre-recession peak. The decline in private investment is responsible for exactly two-thirds of the total loss of output.
The dominant characteristic of the current slump is a private sector investment strike, which accounts for two-thirds of lost output. The Labour Government attempted to negotiate this strike by a moderate increase in its own investment. This offset some of the worst effects of the recession and finally encouraged the private sector to increase its own investment for a brief period. In the three quarters from the end of 2009 to Q3 2010, private sector investment rose by £16.6 billion, and was itself responsible for two-thirds of the recovery during those three quarters. The private sector was encouraged to increase its own investment in response to the persistent rise in government investment.
The public sector led the way for the much larger increases in private sector investment. Conversely, a recent survey for the Institute for Chartered Accountants in England and Wales shows that 45 per cent of all firms expect their turnover to fall as a result of the Government’s spending cuts, up from 21 per cent which already report falling turnover.
While economic ideologues talk about “expansionary fiscal contraction” and the “private sector taking up the slack”, it has been left to accountants to show how the relationship between the public and private sectors actually works. It is clear that the cuts will have a negative impact on the prospects of the private sector. But the survey also shows the dynamic effect of reduced public sector inputs on the output of the different parts of the private sector, almost a “ripple effect” with first those firms supplying directly to government being hit, then those firms which only indirectly supply to government, and finally but increasingly those firms who have no obvious relationship to government but whose businesses will suffer from the general economic downtrend, including consumer demand and demand for business services.
The role of government has been decisive in determining the trends in the economy. In the course of the recession and subsequent recovery, total government spending, including its contribution to GFCF rose by £18.1 billion, and so was directly responsible for more than half the recovery of £32 billion. It was also responsible for inducing the brief recovery in private sector investment which itself accounted for two-thirds of the recovery during its three quarters of expansion.
Reversing the rise in government investment has produced a renewed downturn in economic activity. But it should be pointed out that the government will find it much more difficult to reverse the upward trends in its own current spending. As governments in Athens, Lisbon and Dublin are demonstrating, cuts to welfare entitlements will not reduce welfare spending if the numbers on welfare are rising at a greater rate than entitlements are being slashed.
In relation to unemployment, the ICAEW survey shows that 47 per cent of private sector employers have already reduced the number of permanent staff because of the impact on their businesses arising from the cuts, while 36 per cent have reduced the numbers of temporary or contract staff.
The most recent recession was deeper than the recession of the early 1990s under John Major and the recession of the early 1980s presided over by Margaret Thatcher. Output fell by 6.4 per cent in 2008-09, while it fell by 2.5 per cent in 1990-91 and 4.6 per cent in 1980-81. The recovery has also been slower now. However, the outcomes in terms of unemployment have been markedly different. Although the most recent recession was much more severe than either the Thatcher or Major recessions, the fall in employment was markedly lower. This is despite the fact that the recovery is also weaker.
One chilling statistic within these comparative data is from Thatcher onwards in 1979 total employment in the British economy stood at 24,716,000 jobs and did not regain that level until Q1 1998, in Labour’s first term.
These comparisons are relevant because employment is falling once more as a consequence of the coalition’s growth-damaging policies. The numbers in employment have been falling since August 2010, and are likely to accelerate in both the public and private sectors under the impact of government policy.
Given the link between growth and government finances, which are mainly sensitive to taxation receipts, it s no surprise that a similar pattern is evident in relation to the public sector deficit. While Labour’s increased spending produced a moderate recovery, the public sector deficit fell. The Treasury had projected the public sector deficit as high as £178 billion in the financial year just ended. However, up to January of this year, the 12-month rolling total for the deficit had fallen to £141 billion, and had been falling for exactly a year on this measure. This positive trend was reversed in February this year, mirroring the renewed deterioration in the economy, with a small time lag. In February, the 12-month rolling total for the deficit rose to £143.3 billion. The OBR now forecasts it will be £145.9 billion in the current financial year.
In a damning indictment of this Government’s policy, the OBR is also now forecasting significantly higher deficits in subsequent years than it did in either the June 2010 Budget or following the Comprehensive Spending Review in November. Compared to June 2010, in the midst of a Government investment-led recovery, the OBR is now forecasting cumulatively worse public sector deficits of £51 billion over the period to 2015-16. Of this, the overwhelming majority of the projected worse outcome is the lower growth the OBR is now forecasting.
It is a mistake to view these changes, lower growth, lower employment and higher borrowing, as anything other than the natural consequences of the policy which has been adopted. The collective authors of these policies have read Keynes and some of them have even read Marx. They are surely aware of what happened when the same policies were pursued under the cloak of monetarism and the “disciplines of the exchange rate mechanism” at an overvalued exchange rate in the 1980s and ’90s.
But lowering the public sector deficit now is no more the real goal of policy than controlling the supply of money was under Thatcher. The deficit is rising once more, and is projected to increase versus previous projections. A government solely committed to this end would change policy. Nor is this an “ideological” government in the sense that an adherence to a smaller state overrides all other objectives. Actual rather than budgeted military spending is suddenly increasing, as the projection of state power over the oilfields of Libya is now very important.
To grasp the dynamic of government policy, it is necessary to understand what policy is actually achieving. In a capitalist economy, this means addressing what is happening to capital and to labour. In recessions, profits fall faster than wages. A firm sells widgets for £3 million and pays £1.8 million in wages. Its gross profits, before any taxes are levied, are £1.2 million. But demand contracts by, say, 5 per cent. Total sales have declined to £2.85 million. If wages are unchanged, the widget makers’ profits have fallen to £1.05 million. In this case, a 5 per cent decline in the economy has led to a 12.5 per cent fall in profits. From this comes the drive to restore profits – lowering wages, cutting workers, removing regulations on business and lowering their taxes. Businesses have enacted the first of these two and the government has enacted the second two. There is also the hope that lower wages in the public sector and reduced benefits will push wages lower in the private sector. Mainstream economists have a name for this: the “demonstration effect”.
Taking only the data for Q4 2010 compared to the previous year, the compensation of employees rose by 2.1 per cent, while the profits of private on-financial corporations rose by 12.7 per cent. In addition, “other income”, the income of the professionally self-employed and rental income on property, rose by 9.9 per cent. Only the profits of the private financial corporations fell, by 28.1 per cent, which is why it is insisted they must be bailed out by taxpayers. Given that inflation rose by 2.7 per cent in the year, this means that real wages fell by 0.6 per cent over the period, while “other income” rose by 7.2 per cent and
non-financial profits rose by 10 per cent.
This is the achievement of the Tory-led coalition. Since the low point of the recession, just 40 per cent of the increase in value created has accrued to labour and 60 per cent has accrued to capital. As Adam Smith says in The Wealth of Nations, all value is created by labour (and each economy’s participation in the division of labour). This still leaves the renewed growth in capital below its pre-recession levels.
But the Tory-led coalition believes it is doing the right thing in sticking to Plan A. This involves the restoration of profits by transferring incomes from labour to capital. We shall see in the immediate period ahead whether even this goal can be met. The downturn in the economy at the end of last year was the result of £9.4 billion in spending cuts and tax increases. This financial year, that total will rise to £41 billion. Unemployment and the deficit will certainly rise as a result. It is not clear that either GDP or profits will grow.
Like many European countries before it, Britain in 2011 will provide a testing ground for the ultimate rationale of a reactionary economic policy – whether profits will actually grow. If not, more cuts, lower wages, inferior services and benefits, greater deregulation and privatisations will be the new policy.
Michael Burke is a former senior international economist with Citibank
