From the TUC

All in this together? The UK’s twin track economy

30 Jan 2012, by Guest in Economics

It has become an iron rule of recessions that it is the lower and middle-paid sections of the workforce that bear the heaviest burden of the fallout.  Of course, with the economic cake shrinking by 7%, pain was inevitable after 2008. Living standards on average were bound to slide. This recession, however, was meant to be different. “We are all in this together” became the much voiced refrain of coalition leaders. This time, it was claimed, the impact would be more evenly shared that in the past.

A new report that I’ve written for Touchstone, called “All in this together?“, shows just how empty those words have proved to be. Just as in the 1980s and early 1990s, it is those in the bottom half of the income distribution that are bearing the brunt of the rise in unemployment and the cuts in real wages. Those most likely to have lost their jobs have been skilled and unskilled workers in the lowest pay brackets.

It is similar story on pay. On average, real wages fell by 3.6% in the year to June 2010 and then by a further 3.8% in the year to June 2011. But those facing some of the deepest cuts in pay have been those on already low wages working in voluntary organizations, especially those working in social care. Cuts in real pay are also only part of the story. Across the public, voluntary and private sectors, longstanding conditions of work are being eroded, with staff contracts re-written to impose longer hours, poorer sickness and pension provision and fewer holidays.

Moreover, for most, pay levels and conditions are unlikely to return to pre-recession levels, even after recovery. The UK is heading further in the direction of a low-paying economy with weakened employment conditions. The last thirty years have already seen a continuing fall in the share of output accruing to wage-earners. One of the key effects of the crisis is to have fuelled this long-term trend. This is officially recognized by projections by the Office for Budget Responsibility which show that labour’s share of economic output will have fallen even further by four percentage points between 2009 and 2016.

Britain’s twin-track economy, a fast-track for the rich and a slow-one for nearly everyone else, has become more firmly entrenched since 2007. Far from accepting a fair share of the pain, those at the top have found ways of firewalling their own incomes and wealth. Indeed, a small corporate and financial elite has continued to grow its share of the cake through the downturn.

This is not just an issue of fairness. These same trends are also torpedoing the chances of recovery. If the share of output going in wages was the same today as it was in the late 1970s before the thirty-year long wage-squeeze began, UK consumers would now have around £60 billion more in their pockets. Instead the lifeblood of the economy is being further squeezed.

It was the increasingly skewed distribution of the national economic cake that was one of the key, if mostly ignored, factors leading to the 2008 Crash. The same factors are now driving an apparently relentless slide into near-permanent slump.  If the division of the cake now stood at its level of three decades ago, much of the human cost would have been avoided, and we would be well on our way out of this mess.

GUEST POST: Stewart Lansley is the author of the Touchstone Extra, All In This Together?He is a visiting Fellow at Bristol University and the author of  The Cost of Inequality, published by Gibson Square.

3 Responses to All in this together? The UK’s twin track economy

  1. All in this together? The UK’s twin track economy « Act of Defiance
    Jan 30th 2012, 12:54 pm

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  2. sweetness_light
    Jan 30th 2012, 7:31 pm

    Don’t fall for the idea that tax revenue are required to pay-off government debt. In fact, it is a myth that taxes “pay” for any government spending.

    When an economy is at ‘full capacity’, (i.e. very low unemployment and all resources in the economy being used productively), a government may wish to spend say £20Bn on something everyone agrees is needed – it could be repaying govt debt, defending the country, building hospitals, whatever. When it spends this money it inevitably causes inflation – this is because you have more spending chasing the same amount of goods and services. The amount of goods and services does not change because the economy is already at full capacity.

    To enable the government to spend without causing an inflationary spiral, the government taxes by an equal amount to prevent the private sector spending by the same amount -so overall the spending (public and private) remains roughly constant, so no inflationary spiral.

    So the extra tax is to prevent an inflationary spiral when the economy is at full capacity – it is not required to “finance” govt spending. This is why govt economics is nothing like household economics.

    However, when an economy is the position ours is in with excess capacity, spending by government is permissible without taxation as it doesn’t cause inflation.

    Given that our economy has not been at full capacity for over 30 years (hence the high unemployment), the government does not need to increase taxes or cut spending elsewhere to “pay” the interest on govt debt or to “pay” for anything.

    The big question is why does the government issue bonds at all and pay interest to private investors? Why doesn’t the govt just create the money at the mint or Bank of England – this won’t be inflationary as there is spare capacity.

    An answer often given is that when governments issue bonds someone has to surrender money to the government. If it wasn’t for the bond that money would probably have gone into the banking system instead. This is called a ‘reserve drain’ and was clearly necessary when we had the Gold Standard/Bretton Woods or some other type of Fixed Exchange Mechanism.

    The argument given now is that debt is a better way to stimulate the economy. Supposedly there is a problem with a liquidity trap in the banking system. By issuing bonds the government can take money away from the banking system and make sure that it is being spent.

    However, it’s pretty obvious that for countries with their own floating currency, deleveraging banks and with economies working at way, way below spare capacity that you can use QE to clear government debt at will without any inflationary effects.
    This is obviously in the UK since there is £275 billion sitting in the Asset Purchase Facility. This money was bought using reserve crediting in 2010/11 and the result of the purchases was deflationary – M4 last year after £200 billion of QE had hit stall speed with growth at only 2% (more than 5% growth is needed to prevent the economy contracting).

    So the Tories are moaning about the huge and “unaffordable” government credit card bill. At the same time over a third of the debt they are moaning about is stuck in the government owned Bank of England with no hope of it ever being anything other than cancelled and retired. To add to the hilarity the Treasury, through a wholly government owned agency called the Debt Management Office pays interest on the £200 billion in the APF to the wholly government owned APF. This money is just building up and will eventually (as all profits for the Bank are) be returned to the taxpayer. You couldn’t make this up.

    So clearly in economic circumstances such as now you can print money directly, buy outstanding government debt and retire it with no inflationary consequences. Nevertheless Governments are continuing to use an explanation built up at a time of Bretton Woods with full employment, fixed exchange rates and no deleveraging to explain why they don’t use the QE to clear down debts

  3. sweetness_light
    Jan 30th 2012, 7:32 pm

    There are only two ways to create money in the UK economy:-

    1) The normal process of credit creation carried out by banks – banks lending out more money that they charge interest on. Apart from minting coins or printing notes this usually creates over 95% of the money (called M4) in the economy.

    2) QE – The Bank of England crediting its reserves with money and then using the credits to buy assets or outstanding government debt from banks.

    Since 2008 banks have largely shut down credit creation. M4 which normally grows at over 5% per year is only growing at 2% per year. Expansion of below 5% pa means the economy contracts. This is by and large, as in all recessions after a financial crash, why the world and UK economies are in such a mess.

    The line that our Government (and now several others) are giving us is that There Is No Alternative to austerity and cuts. They are justifying massive tax rises and catastrophic cuts in public spending because they say excess government debt, built up due to the massive worldwide recession in 2008 and the cost of bank bail outs, must be paid down.

    This is obviously false as Governments can use QE to buy up government debt from the banks that are holding it and retire it. This is happened to a massive degree already in the UK with over a third (over £275 billion) of the UK’s government debt is currently sitting in the wholly publicly owned Asset Purchase Facility.

    But what about inflation? Wont retiring government debt in this way cause inflation? No- if there was inflation it would happen when the Bank of England bought the government debt up from the banks. This is the moment reserve credits are released and there is an increase in bank liquidity. We have done £275 billion of QE (equivalent to about 20% of UK GDP) since 2009 and M4 has contracted and we are at risk of deflation rather than inflation. Quite simply no matter what we say to them banks don’t want to lend enough to get the economy growing.

    So it is perfectly safe to retire government debt when banks aren’t creating enough credit in the economy. If this is a natural phenomena because the banks don’t want to lend (they are deleveraging) it is safe to retire government debt. As long as the money supply is kept at around 5% all is well – the economy neither contracts too quickly causing inflation or collapses causing a depression.

    It is also perfectly safe at a happier time in the economic cycle. Say in 5 years time when the economy is expanding, banks are lending too much. At this point we would want to use QE to expand the money supply as we would want to restrict bank lending to ensure we never get another crunch like 2008. When eventually we need to increase the capital adequacy levels in banks (to make them safe) we will need some mechanism to ensure the money supply is kept expanding at the needed rate (5%) we will need to use QE to retire government debt.

    The most depressing thing about this is that the current Government is misleading people so badly about how the money supply and economy work. The analogy of a National economy and household one is – the only word I can think of is evil. This is an action of people who represent their corporate funders and want to mislead you to prevent you questioning in who’s interest they are acting.