Rebalancing the Economy or Reforming British Capitalism?
The TUC has today published its latest Economic Report looking at the question of ‘rebalancing’.
It argues that, on the eve of the crisis, the economy had become unbalanced in four key areas – an overdependence on consumption over exports and investment, a regional imbalance, a sectoral finance and unbalanced in how the rewards of growth were distributed.
Over the past two years it finds there has been precious little achievement in dealing with any of these problems.
As it concludes:
Over the past two years the economy has stagnated and the government is set to miss its deficit reduction targets. It has also failed to achieve meaningful sort of rebalancing, whether measured by expenditure, sectors, regions or wages.
Growth alone is not enough; the UK economy needs the right kind of growth – higher investment, a better sectoral mix, a better regional balance and, above all, rising median wages. The TUC will continue to monitor progress with rebalancing against these four benchmarks. On the current consensus forecast the UK economy will be growing again by 2013, however all of the indicators are pointing to a return to an unbalanced economy rather than the sustainable growth we need for a stronger and more resilient economic future.
To me much of the current debate around the economy shows the limits of ‘traditional’ macroeconomic policy. We absolutely need a fiscal stimulus in the short term to get growth moving but just using the old levers of fiscal and monetary policy to kick start the economy is no longer enough, growth is clearly preferable to stagnation but what we need is the right kind of growth.
Growth that feeds through into rising living standards for those in the middle and below (unlike in 2003-2008), growth that is job rich, growth that is regionally balanced, growth that is less dependent on a few key sectors, grow which leads to more diverse and resilient public finances.
In many ways talk of ‘rebalancing the economy’ is a polite way of talking about ‘reforming British capitalism’. The old model is broken and it wouldn’t come back in any sort of sustainable manner.
Take, for example, the question of investment. John Plender argues in today’s FT (behind the paywall) that there has been a ‘subtle shift’ in the relationship between business and the state:
Historically, companies have run fiscal surpluses – that is, saved more than they invest – in recession, while going into deficit when they invest during the recovery. In the US and UK this long-standing pattern has strikingly changed over the past economic cycle.
This is the ‘corporate surplus’ that an earlier TUC Economic Report focused on. Plender argues that the poor corporate governance structures, a focus on short-term profits and the growth of performance related pay for executives (linked to short term performance) has led to under-investment.
And, as people such as Martin Wolf have long argued, if the private sector is determined to run a surplus then (in the absence of strong export growth (which isn’t happening in the UK)) then the consequence will be a public sector deficit.
No matter how much they insist otherwise, policy-makers can’t deal with a fiscal deficit without addressing the corporate surplus. They can certainly try, as the current government is attempting, but it leads to self-defeating austerity.
Whilst there may be fiscal policy actions that could start to address the question of excessive corporate saving (such as raising capital allowances on investment as proposed by the EEF), fundamentally the problem is one of excessive short-term focus fostered corporate governance and pay structures that reward short-term rather than long-term performance. That requires solutions outside of the traditional policy-makers tool kit.
Or to take another issue – the UK badly needs ‘wage-led growth’. For too long there has been a tendency amongst economists to view wages mainly as a cost of production rather than source of demand.
The UK is almost a text-book case of the Kumhof and Rancière model of how rising inequality and flat wage growth lead to rising personal debt and leave the economy more vulnerable to crisis.
As they concluded:
The key mechanism, reflected in a rapid growth in the size of the financial sector, is the recycling of part of the additional income gained by high income households back to the rest of the population by way of loans, thereby allowing the latter to sustain consumption levels, at least for a while. But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy. More importantly, unless loan defaults in a crisis are extremely large by historical standards, and unless the accompanying real contraction is very small, the effect on leverage and therefore on the probability of a further crisis is quite limited.
The overhang of personal debt presents a huge problem for the UK recovery, especially once some sort of ‘recovery’ does get underway – as the IPPR’s Nick Pearce has recently written. If growth returns on the old model, then as interest rates rise from historic lows the cost of debt servicing will increase – and many UK households are not in a position to cope with this.
As Nick writes:
In the medium term, however, the big question for the UK economy is how it can generate demand through high real wages rather than debt-financed consumption.
Or, to quote Kumhof and Rancière (and it’s worth reminding ourselves they are IMF economists) again:
By contrast, restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis.
Again the solution to our current economic woes lies not in the traditional levers of fiscal and monetary policy but in reforming how our model of capitalism works by boosting the ‘bargaining power’ of middle and low earners.
We of course need a stimulus now, but if are going to achieve lasting, sustainable, balanced growth then we need a lot more – industrial policy, banking reform, corporate governance reform and a wider look at the lessons we can learn from elsewhere.