Wednesday, 5 October 2011

Paying Down the Credit Card - Inequality and the Growth Problem

David Cameron had planned to tell the country today that ordinary people should work to pay down their debt levels, a message that might chime with common sense, but which is representative of the contradictions of our current economic situation. As many have noted today, Keynes's paradox of thrift tells us that if everyone increases savings / pays down debt at the same time the net reduction in demand will cause job and income losses which will make saving harder. So should the consumer pay down their debt? And can they?

During a demand-led crisis large companies, the rich, wealth-holders in general will be risk-averse. This is because shares for example, are subject to the reality that companies face the prospect of low demand for their goods and services, and an uncertain environment in which sources of funding may be withdrawn or constricted at any time. Corporations hoard cash for precisely these reasons, failing to invest in capacity because they do not expect to use it.

The risks inherent in instruments of debt are plain by now. Foreign debts, those of banks and governments, are in some cases already suspect. Domestic debts are also risky, as a rise in the rate of default could swiftly follow any new turn for the worse in the economy. And UK company debt is subject to these same risks, that is why we are forever hearing that small and medium size enterprises have trouble gaining access to money. In fact, the main place that money has fled to, aside from Gold, is the government.

The rates of interest the government has to pay are exceptionally low, especially given the level of inflation in the economy, and this makes government spending the only real avenue for expanding demand, but the coalition government has shut the gates on that. Meanwhile, those who spend the most as a proportion of their income-- the very poorest-- are heavily indebted and their wages are outpaced by inflation. If they paid down their debts there'd be less money for consumption, for sales of UK products and services, and the rest of the economy would struggle further.

But they can't, can they? The thing about the poorest people in our society is that they have to spend their entire income just to meet their needs. There might be a few luxuries available to cut back on, here and there, but with food and energy prices rising, employment scarce and wages largely stagnant, there are a lot of people out there agonising over buying christmas presents for their families this year. Over the cost of the small things that matter to them.

So right now there is a huge amount of money at the top, and a huge amount of debt at the bottom. Those who spend the highest proportion of their income are suffering the most. What is needed is a debt restructuring within the economy, not merely between economies, and this could happen anyway if the economic climate gets worse, as a wave of defaults would produce the same effect-- but with dire consequences.

And in the long term this situation is not likely to solve itself on the current trajectory, not without defaults. The interest payments on that debt transfer money daily from the impoverished to the idle-rich. Salaries and bonuses at the top have soared, and wages at the bottom and in the middle have failed to even tread water. David Cameron said that fairness is about a link between what you put in and what you get out. The wealthiest pay most of the taxes, but they control almost all the wealth in the country, let us hope they cannot expect to get more from this government than they already do.

We have allowed inequality to grow for decades in this country, and inequality is both a symptom and a cause of the current troubles. It has grown out of the debt crisis, with low wages cushioned by easy credit, and through that debt the imbalance in the ownership of wealth has grown in turn. Yet for a country so dependent on consumer spending the consumer has been punished time and again, while the pay-day loan sharks, overdraft charges and credit card bills wait in the shadows.

 The Government needs to do more to help the poorest and most vulnerable, not merely out of a sense of social justice, or to diminish inequality, but because they are the engine of this economy. And we aren't going anywhere without them.

Monday, 3 October 2011

Comments on Osbourne's Speech 03/10/2011

The Conservatives are a well-oiled political machine when it comes to delivering a firm consistent message with little room for ambiguity. If you contrast today's speech with last week's furore over predator and producer companies-- which Osbourne picked up on today-- the comparison is clear: The Tories beat Labour hands down. There were even some new and genuinely interesting points hidden here and there between the tried, trusted and above all tired lines about the inheritance from Labour. Unfortunately for all the points it garnered on style, the speech did little to remedy Osbourne's economic failings.

He began with a short lecture on the "three causes" of the current crisis. This was more of a political message than an economic one, allowing him to blend in a little euroscepticism with a dash of Labour-bashing. So far, so effective. The public have largely accepted the austerity narrative. The real danger-- widely acknowledged by commentators-- will come if the facts change and they do not change their opinions, to borrow from Keynes. The goal was to gain fiscal credibility, make 'tough' choices and be rewarded by the voter at Parliament's end. If the data runs against them they will look obstinate and inflexible, as though they willfully continued despite the warnings and steered the country into disaster.

One of George Osbourne's central themes is the assurance that they are "fiscal conservatives" so that they can be "monetary activists". They are cutting the deficit to make it possible to keep interest rates low. It sounds good on the surface but there are two assertions contained within it, both of them wrong: The relationship between deficit cutting and interest rates is not at all simple and does not operate quite as he implies, and if he thinks low rates of interest alone will solve a crisis of this kind he should take a look at Japan.  The low rates are undeniably helping debt-drenched households to cope on a week to week basis, but that's a trap as well. Low interest rates are just one stage, you have to be able to raise them again later.

As long as households remain heavily indebted raising interest rates will not be possible, and there are only two ways(other than default) for ordinary people to reduce debt levels. They can pay them down by reducing consumption now, or inflation can diminish their value over time. Unfortunately while we have plenty of inflation, wages are not keeping pace, which means consumers can neither easily pay down debt, nor keep up demand for UK goods and services.

Osbourne might have hoped that devaluing the pound (and indeed wages in real terms) would improve our competitiveness. If so it has not been enough to help the recovery, and given the problems our major trading partners are experiencing in the US and Europe, it is unlikely to get much better.

In fact the so-called credit easing that the chancellor introduced, conceptually at least, in his speech is an attractive idea. You take low-yield government debt and translate that into low interest obligations for small and medium companies and give them the cash infusion they need (larger companies are cash-rich, as they are not willing to invest in a low-demand, low-confidence environment).

Unfortunately, without demand the effect of this kind of policy may be limited. Supply side measures will not be able to get a grip on the problem if there is no demand for the supply in question. Not here, not across the seas and oceans. That is the critical point, wages are low, households are indebted and unemployment is rife.

The chancellor's supply side policies are suited to a time of abundance. During a time of austerity regulations are not the big reason firms won't employ people, lack of demand for goods and services is.