By Ann Pettifor and Jeremy Smith
Ann was on the BBC’s Today programme where she was asked to comment on today’s retail sales numbers – due out this morning.
We thought we would share with our readers some of the data that underpins the “Alice in Wongaland” theory of the economy.
But first that quote she used from the Chancellor about the need for “A New Economic Model” delivered before the election, on the 24th February, 2010. We chose it because it chimes with our analysis that it is the overhang of private debt that continually chokes off the ‘green shoots’ the ‘confidence fairy’ and ‘recovery’. In his Mais Lecture that day, the Chancellor said:
“The overhang of private debt in our banking system and our households weighs heavy on future prosperity.
“We need to head in a completely new direction.
“We have to move away from an economic model that was based on unsustainable private and public debt.
“And we have to move to a new model of economic growth that is rooted in more investment, more savings and higher exports.
“This will require new policies and new institutions.”
He was right then, but wrong now. The British economy today, under his guidance, going in the very opposite direction to that set out in his 2010 ‘new model’. The overhang of UK household debt is still at “140% of gross domestic product compared with 100% in 2000, while real incomes have fallen for six consecutive years” as Simon Nixon noted in the Wall St. Journal on the 13th August.
Many economists – including those at the Office for Budget Responsibility – argue that household debt is not high relative to the value of household assets, notably property. But people do not repay debt by selling the roof over their heads. They repay debt from income. And when incomes are falling it becomes harder to repay debts/mortgages which do not fall in value. Indeed relative to falling incomes debt rises in value.
Given the Chancellor’s analysis back in 2010, it is extraordinary that the idea of “a new model….rooted in more investment, more savings and higher exports” was allowed to gather dust on Treasury shelves. Since the election, the Coalition government has effectively sat on its hands, and adopted a do-nothing-approach because, they argued, cutting public-spending alone, would spur on-private-sector activity, seen as the economy’s only source for recovery. Despite all the evidence of huge spare capacity and high unemployment, the Treasury still stuck to the thesis that public spending ‘crowds out’ private investment.
As a result economic activity has progressively decelerated. The increase in GDP in 2010 was a relatively poor 1.7%; in 2011 this slipped back to 1.1% and in 2012 it required a magnifiying glass to see it at all, being just 0.4%.
Meanwhile the private sector, shaken by the crisis and lacking customers and business, took its lead from government in substantially cutting back investment in capital projects. Indeed, private sector capital investment in the first quarter of 2013 was around 9% lower than when the Coalition government came into office.
The Chancellor’s 2010 quest for “more savings” has also proved illusory. According to the OECD, UK household net saving was negative in the run-up to the ‘debtonation’ of 2007. It was -1.7% of disposable income in 2004 and a startling -4.3% by 2007. Thereafter UK households began to cut back on borrowing and to save. By 2010 net household saving had risen 2.0% of disposable income, but by 2011 Britons had started to spend again, and net saving fell to 1.3% of disposable income.
So not much ‘rebalancing’ at household level, as household debt was hardly de-leveraged.
And as Duncan Weldon in his Touchstone Blog noted:
“between Q1 2012 and Q1 2013 household consumption rose by around £10.6bn, but household incomes rose by less than £2.0bn. The difference was a £8.7bn fall in gross household savings. (Note – these numbers are all in current prices).”
As for re-orienting towards “higher exports” the trade balance – particularly in goods, but also taking into account services – stubbornly failed to improve, despite a substantial fall in sterling, leaving the UK with the biggest trading deficit in the whole of the EU.
By late 2012 therefore the Treasury had failed to deliver on all three elements of the Chancellor’s proposed ‘new model’ of “more investment, more savings and higher exports.”
At this point the next election began to loom on the political horizon, and politicians began to panic. At this point the Coalition government suddenly proved willing to deploy taxpayer resources into stimulating economic recovery. But the resources were aimed, not at increasing investment in productive activity, but rather at subsidising the weakened banking system and e.g. buy-to-let investors speculating on future house price inflation. This is being achieved through the Funding for Lending scheme and also the proposed “Help to Buy” scheme due to be launched in January, 2014.
This intervention will inflate house prices (and indeed is already doing so), increase household borrowing, and create yet another asset price bubble. At the same time it will encourage already-indebted consumers to borrow more!
They will do so because this initiative has already revived the ‘confidence fairy’ from her languor – and armed with such confidence, consumers have raided their piggy banks, and gone shopping. Current retail sales were already (before today’s announcement) some 1.8% higher than a year ago.
This confidence is not soundly based, because real incomes and wages are continuing to fall, and, as we noted above, debts are repaid out of income, not by the sale of assets.
Britain’s economy as a whole is today driven by a ‘payday borrowing’ culture encouraged by the ‘guardians of the nation’s finances’ – the public authorities. This ‘payday borrowing’ culture leads consumers to pop on to the internet to borrow a couple of hundred quid– a process we are told takes no more than 15 minutes – in order to fund (at an unusustainable rate of interest) that day’s consumption.
This is the delusional, debt-fuelled, short-term approach that the Chancellor so decried back in 2010. It led to the gigantic crash of 2007-9.
So far from moving “to a new model of economic growth that is rooted in more investment, more savings and higher exports” Britain is rapidly becoming an “Alice in Wongaland” economy.
12 Responses
I agree with pretty much all of this, except the bit about rising house prices. That is obviously the Government intention, and in London and its environs where its most important for their votes, it is undoubtedly the case that prices are rising. But, that is not the case in much of the rest of the country. Where I live near Stoke, even the expensive houses in the village where I live are selling at 25-30% discounts from the asking prices, and they are staying on the market for 18 months and more even so.
Recently the Council here sold off 35 houses for £1 each, but it could not even then sell 8 of them! According to Rightmove prices actually fell by 1.8% nationally last month, but the house price indices are totally fraudulent. They are indices of asking prices that are not adjusted when those asking prices are reduced, for instance. But, check on Zoopla or any site where you can compare selling with asking prices, and you will see that selling prices are massively lower than asking prices.
Osborne’s “Help To Buy” scam is partly designed to buy them votes at the next election, but its main job is to try to stop house prices collapsing, because as the failure of the Co-op Bank, and the need for nationwide to recapitalise (at least) shows, nothing has changed since Northern Rock, other than to get worse. Banks Balance Sheets are a fiction based on massively inflated property prices – just as they were in Spain, Ireland and the US. When they collapse, so will the banks. So Osborne is doing everything he can to stop them dropping.
But we have 300,000 people not paying their mortgages at all! Despite the lowest interest rates in history. We have 260,000 people with interest only mortgages who have no way of repaying their capital sum, with an average shortfall of £71,000, we have the banks scared witless to foreclose on the huge number of people in forbearance because it would cause a property collapse, and we have £3 trillion of debts on banks books – not counting the massive exposure to derivatives to hide it all. According to one report Deutsche Bank has exposure to global derivatives equal to the entire global GDP, and it has these derivatives to hide its exposure to European property debt. But, Britain is only second behind France in exposure by its banks to European private debt as well as its exposure to UK private debt.
Perhaps, Osborne’s next idea will be for the Uk banks to start getting pay day loans from Wonga too.
I fear we are in a Weimar Republic.
I enjoyed this very much. Being an orphan now that Dr Tim Morgan (Read this: “Perfect storm – energy, finance and the end of growth”) is between posts I needed some sane commentary about our phoney so-called recovery.
The tragedy of course is the longer Osbo pursues this policy the more deskilled we become, he’s kicking the can of rehabilitation yet further down the road…
Thank you all for these kind words, and great comments. Jayarava, that blindingly obvious point about debt being repaid out of income is, for some strange reason, ignored by many economists. So thanks for hammering it home. Kevin, I am not at all sure if Payment Protection Insurance has made any substantial contribution to the rise in retail sales…can’t believe that the compensation has been that generous. But I may be wrong…And Steve D you are right. I think that the Opposition’s ‘summer of silence’ is another reason the comments and article resonated: it was just so quiet out there…
Great article, but surely the opposition should be raising all of the points stated in the article more forcefully. I would even suggest they are neglecting their responsibilities by allowing the current government to go unchallenged in this area. I am even thinking that the opposition accept the conservative monetory reasoning.
You are right the Labour Party (Very Laughable), is so scared of voicing an alternative realistic viewpoint, not helped by the weakness of their leader Ed Miliband.
Strikes me Osborne’s desire to encourage the private sector to pile on the debt is a direct result of his deficit phobia, which he shares with the economic illiterates at the IMF, OECD, Rogoff, Reinhart etc. Ann rightly attacked Osborne’s deficit phobia in her book “The Economic Consequences of Mr Osborne”.
That is, Osborne won’t effect stimulus via more deficit, so he goes for the only alternative: getting the private sector to borrow and spend. And that leads to the absurdity that is QE, Help To Buy and so on.
Great to hear Ann for the first time this morning, I thought during the day I must have been still dreaming while going to work,so I put on the today program on the bbc to catch up and hey ho, I did hear someone telling the economic truth, she nailed it, if winning a tennis match, having a royal baby is all it takes, let’s reform the beatles, the 1966 world cup team, and just to make sure Noel’s house party,that should do it….
thanks Ann
like Jayarava, I heard this early in the morning and had to track it down. I thought Ann was very, very clear and I would like to hear the Chancellor’s answer.
A very interesting piece with a superb title ‘Alice in Wongaland’ – it’s an apt description.
May I ask a question?
To what extent, if any, has the recent increase in consumer spending been facilitated by PPI compensation?
I ask this because as I understand things the sums involved in PPI redress are substantial, and an individual receiving an unexpected windfall is likely to spend the money.
Thanks. As a non-economist I find this kind of argument so refreshing and straight forward. Govt says it will do X, and has failed to do X, for these reasons and with those consequences. It’s not rocket science, but a well structured and informed argument that anyone ought to be able to follow.
What a shame Ann was on at the relatively early time of 6:15am. She ought to be on in prime-time and debating George Osborne. Unfortunately where such well constructed arguments appeal to me, the politicians and the general public seem oblivious to facts or logic. With the house price inflation well under way I’m reminded that Osborne is not only Chancellor but also Tory Party election strategist and is facing an election in less than 2 years with nothing much to show for his time in office. And home owners whose houses are going up in value cannot see the wider implications of their good fortune (their un-earned increase in wealth).
I think this point, “debt is repaid out of income, and incomes are falling”, is something that we ought to repeat ad nauseum. Both wage and GDP increases are less than inflation and debts both public and private are increasing. This cannot be good!
Payday borrowing is a fantastic way of explaining the whole principle behind National Insurance contributions. Those in work today cover the cost of retirement. Unfortunately we now have more retired than working and the system cannot handle it.
If you run a business, I cannot understand for the life of me why you get tax breaks for taking on debt to grow your business and then taxed on your earnings. This only encourages debt. Take 2 buy to let landlords. One has no mortgage debt and pays tax on ALL income received from tenants. The other for example has 80% gearing and can offset the mortgage interest against his rental income before paying tax and this just seems plain wrong to me. The second landlord is shifting income tax to the capital account and you get different tax free allowances for income and capital gains tax for instance.
The tax system needs to change; the business model needs to change; individuals need to be encouraged to invest (probably tax breaks) and invest for the long run. I do find it odd that most people invest out of taxed income, only then to pay more tax on the income or capital that the investment makes. Is that really fair?