This week I appeared on Newsnight with Gillian Tett of the FT and Louise Cooper of BGC Partners. We discussed our graphs of 2011 (see mine below) and wider questions around the global financial crisis this year – and how ecnomists and policy makers need to respond.

Watch the show on iPlayer for the next 5 days here. Our discussion begins at 33 mins.

Below is my slideshow from the talk:

'Standard & Poor’s is just following events, not shaping them.' Photograph: Stan Honda/AFP/Getty Images

Published in the Guardian Cif alongside responses from Jonathon Freedland and Sheila Lawlor:

Ed Balls said sorry for Labour’s record on ultra-light-touch financial regulation, and that must be acknowledged.

But apologies are just not enough. He and Ed Miliband must stop attacking his electoral base, “hardworking families”, many of whom are trades unionists.

As Balls recognises, unless urgent action is taken, this may be the gravest economic crisis in history – given the global integration of finance and the growth of world population.

So Balls must go further.

First, he must declare loudly and forcefully that Labour will never again be captive to neoliberal central bankers like Alan Greenspan; or private bankers like Sir Fred Goodwin of RSB.

Labour must never again be seen to be in the pockets of the finance sector.

Balls and Miliband must give the Labour party back to its electoral base, to its members.

They must both distance themselves from Labour leaders that profit from links to the global finance sector.

Second, Balls must stop talking about the deficit; about “tough decisions on tax and spending” – the last thing the economy needs. It is private debt – 469% of British GDP and six times the public debt – that is the real crisis facing Britons. It is debt-deflation, and debt-deleveraging, and collapsing private investment that pose the gravest threat to us all.

Given this, there is an urgent need for government spending on environmentally sound projects to generate economic activity – jobs, the income, the savings that will help protect us from Armageddon.

Until he does, his apologies will count for nothing but special pleading.

Read the original article on Cif here >

Tonight, Wednesday 3 August 2011 at 08.00pm BST (GMT +1), BBC Radio 4 will broadcast a debate which took place at the London School of Economics (LSE) on 26 July.  This broadcast will be repeated on Saturday, 6 August, at 10.15 p.m BST (GMT +1).

Along with my colleagues Prof. Victoria Chick and Douglas Coe at PRIME  we have written the following response to the debate:

Debaters considered whether Keynes or Hayek had the solution to the present financial crisis. The economist George Selgin and philosopher Jamie Whyte spoke for Hayek; Keynes’s biographer Robert Skidelsky and the economist Duncan Weldon spoke for Keynes.

On the one hand we are pleased that the BBC and the LSE now acknowledge rival positions to the present austerity policies of Western governments. On the other  we are concerned that the debate might have served mainly to reinforce existing prejudices, rather than to clarify the substance of the matters under discussion, matters which – there can be no doubt – are of the most profound importance.

Lord Skidelsky provocatively but justly reminded the audience that in the early 1930s, the same orthodoxy driving western austerity policies directed the actions of Germany’s 1931 Bruning government and paved the way for the rise of Nazism. These actions – vigorously opposed by Keynes – were the final straw for a Germany crushed by defeat and the disastrous boom-bust cycle that followed their return to the gold standard. Reparations were easily circumvented by wildly excessive borrowing from financial interests around the world, in a manner that even Keynes did not anticipate. It was these financial and fiscal policies that brought Hitler to power.

With financial interests still firmly in the ascendency and reactionary right-wing forces increasing their grip in the United States and much of the Western world, we must not forget these lessons from history, which formed the background to the original debate between Keynes and Hayek themselves. The stakes are high indeed.

Keynes shared with Hayek a preference for the economy to be primarily the province of the private sector. However, he recognised that ‘the market’ did not always best serve the common good and therefore that state intervention was necessary – and not just during a slump. In this he was diametrically opposed to Hayek.

For Keynes, the market’s major flaws were rooted in monetary arrangements that favoured speculation and excess consumption rather than productive activity. In addition, in a slump, the pessimistic outlook of producers and investors allowed the slump to persist and needed the stimulus of public works expenditure.

The LSE debate neglected the subtleties of the respective positions of Hayek and Keynes and reinforced many of the most common and most dangerous fallacies about Keynes’s contribution – and even established some new ones.  While both economists were misrepresented to some extent, our main concern must be to rectify distortions about Keynes. There are eight misrepresentations that we want to bring out.

1.   Hayek as “an opponent of financial excess”

From 1971 through the early 1980s, restraints on the financial sector were steadily unwound. These actions were prompted by Hayekian ideals of liberalism, as is well known.  The Hayek supporters at the LSE debate dissociated themselves from this liberalisation, the cause as we now know, of the rapid expansion of the money supply before the crash. Hayek might not have predicted this consequence of liberalisation, but its disastrous consequences are now plain to one and all. Perhaps this is why the debaters dissociated themselves from this aspect of Hayek’s position. Instead they castigated the conduct of the liberalisation policy rather than the policy itself. Indeed the ideal of liberalisation was scarcely mentioned, for to do so would be to acknowledge the existence of an alternative: Keynes’s managed financial system.

2.   Keynesian policy as “promoting the big state”

Keynes’s most substantial legacy was a financial system managed by the state.  This system prevailed from the end of the gold standard until the 1970s. This management ensured that on the one hand low long-term interest rates facilitated both private and public sector investment; on the other, restraints on

banks and capital mobility kept speculation and excessive consumption at bay. Keynes had devised and helped implement a financial system that was conducive to production and investment rather than speculation and consumption.  A larger state rightly prevailed than in the 1920s or 1930s, but ironically Keynes’s state was still smaller than the state that prevailed after the counter-revolution of financial liberalisation

The post-war world was one in which the state and the private sector operated powerfully in tandem, supported by a greatly revised monetary architecture.

As we have stressed, Keynes was concerned mainly with the effective operation of the private economy.

3.   The inflation of the 1970s as “the fault of Keynesian policies”

The inflation of the 1970s began just after the Keynesian post-war mechanisms for the regulation of finance started to be dismantled. In Britain, controls on banking and capital mobility were relaxed, and liberalised arrangements were restored, beginning with Competition and Credit Control (1971) (evaluated as “all competition, no control” by most economists). The root cause of the inflation of the 1970s was the massive expansion of the money supply that followed the deregulation of credit control, as both Friedman’s monetarism and Keynes’sGeneral Theory, Ch. 21, predict.

The inflation of the 1970s was not the consequence of Keynes’s policies but of the dismantling of his policies for restraining the finance sector. In the past, the inflationary 1970s would have been understood as a ‘bankers’ ramp’.

4.   Keynes as “advocate of deficit spending”

While the importance of Keynes’s monetary policies is scarcely recognised, even his fiscal policies are severely misrepresented. Most prominent and pernicious of all is the idea that he advocated deficit spending. From his earliest contributions to the debate on fiscal policy, Keynes was concerned to establish how public works expenditure would pay for itself and would constitute a relief rather than a burden to the public finances. As we have shown in ‘The economic consequences of Mr Osborne’,[i] the outcomes of public expenditure policies over the last century vindicate his analysis. It remains a puzzle why even Keynes’s most ardent champions neglect the evidence.

5.   Keynes as “a supporter of wasteful expenditures”

This morning I joined the Guardian’s panel of Martin Kettle, Len McCluskey and Matthew Oakley to give our verdict on today’s GDP numbers:

Ann Pettifor:

“The Chancellor must eat humble pie”

The statisticians, clutching at straws, blamed the victims – the British people – for the measly 0.2% growth in GDP. It turns out we are too fond of holidaying (the royal wedding effect) and basking in “warm weather”.

But this cannot explain the fall in manufacturing by 0.3% and the 3.2% fall in electricity, gas and water supply. Nor does it explain the rise by 0.7% in “business services and finance”. The fact is the economy remains unbalanced, and the coalition government is doing very little to restore some balance, and with it the potential for recovery.

And without economic recovery, there can be little hope for the public finances. The fact is, the chancellor cannot cut the deficit if the economy does not recover. Today’s numbers offer little succour. GDP is still lower than it was in 2006 – four years after the crisis “debtonated” in August 2007.

The chancellor’s budgetary outcome depends on the plans of the entire economic system and its reactions to the Treasury’s policies. Right now the British economy is responding to the government’s determination not to provide a stimulus to the very weak private sector – by faltering.

The argument is that Britain “cannot afford” a fiscal stimulus. That we “cannot afford” to boost the private and public sectors, create jobs, generate income and restore hope to 2.5 million unemployed people.

But we could, apparently, afford to bail out the banking system.

The coalition government’s determination not to stimulate the creation of employment, and with it the income that will generate recovery – will be viewed negatively not just by the powerful rating agencies, but by the British people too.

The fact is that just as work makes things affordable for individuals, so employment makes recovery affordable for the economy as a whole. And until the chancellor eats humble pie, and absorbs this economic lesson, neither the economy, nor the public finances will recover.

Martin Kettle:

“The chancellor is a weakened figure”

The longer the British economy continues to show no real signs of growth, the weaker George Osborne’s political stock looks. So aQ2 growth figure of 0.2% is clearly bad news for the chancellor’s authority. It could, of course, have been worse, and it very nearly was. A little growth is disproportionately better than no growth at all. But the fact is that growth has fallen over the quarter and has only risen by the same tiny amount of 0.2% since the spending review in the autumn. Osborne will still blame Labour for this underlying weakness, but the passage of time gradually weakens that argument, while Labour can point to the fact that growth was rising when Alastair Darling handed over in May 2010.

This figure puts a lot of pressure on the economy’s ability to reach the 1.7% annual growth forecast over the next six months, and this in turn increases pressure on Osborne to respond with new measures. No chancellor likes to be in this position at any time, and Osborne is particularly at risk from the economy’s negligible pick-up, since his whole strategy is based on the argument that strict fiscal disciplines will aid growth, of which there is no evidence so far. Yet Osborne cannot easily take any of the quick-fix measures – like cutting taxes or interest rates – either. The chancellor is a weakened figure now and his enemies and rivals will scent opportunities.

• Martin Kettle is associate editor of the Guardian

Len McCluskey:

“The price we pay for neo-liberalism”

Set alongside Britain’s moribund economy, Monty Python’s parrot would look like Usain Bolt. The growth figures show our country still stuck in nought-point-something land while other European states, most notably Germany, power ahead.

There are three related reasons for this.

Most immediately, the government’s exclusive reliance on savage public spending cuts are sucking the air out of the economy and depressing demand when a stimulus is clearly needed.

Second, we have allowed our manufacturing base to shrivel while relying over-much on a bloated and now semi-bankrupt financial services sector, for which “growth” still mainly means bigger bonuses. The axe currently hanging over Britain’s last train-building plant in Derby suggests that little has changed in official thinking here.

Third, there is no plan for growth beyond an entirely dogmatic trust in the private sector. The possibilities of, for example, using the state’s stake in major banks to drive investment are simply ignored.

Today’s figures are the price we pay for having a government trying to tackle the crisis of neo-liberal economics with essentially neo-liberal tools. The new thinking needed to build a vibrant 21st century economy which delivers for everyone, not just the elite, most likely requires a new government.

• Len McCluskey is general secretary of Unite

Matthew Oakley:

“It’s about sticking to plan A”

This relatively gloomy GDP data is not unexpected and should not be a cause for panic. However, it does underline that the government needs a more coherent and ambitious approach to growth. This would not mean spending more: the government must stick to its budgetary plans. Not doing so would see us return to an approach based on borrowing and government spending, which we have seen to be unsustainable. Instead it must undertake fundamental reform that focuses on the long term.

Policy Exchange will soon be publishing a report outlining how a new pro-growth approach to planning and urban development could stop central and local government control constricting the growth of our cities and towns, and hindering business development. To back this up, the UK also needs to accelerate reform to its welfare system and to transform transport infrastructure investment to bring in more private sector involvement and improve our creaking networks.

Finally, a clearer approach to industrial policy is needed. This is not about picking winners but about being clear on where growth comes from and where the UK has a comparative advantage. It is then about ensuring that structural reform facilitates growth in these areas and encourages seed funding for innovative businesses, while encouraging robust competition.

Reform in each of these areas would not be about snap decisions based on one or two poor quarters of growth, nor would it be about making headlines with policies that sound good but deliver little. It is about sticking to plan A and backing that up with a greater focus on structural reform that allows the UK to grow now and in the future.

• Matthew Oakley is head of enterprise, growth and social policy at Policy Exchange

The austerity brigade is rattled. Young Daniel Knowles over at the Daily Telegraph is so worried, he has had to rise to the defence of the Treasury and Office for Budget Responsibility – and then resorts to proposing Greece’s economic strategy for the UK. Why? Because orthodox economic ideology has been challenged by none other than Daniel’s ‘hero’ that notorious womaniser, President Bill Clinton.

Bill gets it. On the deficit that is.  Thanks to Left Foot Forward and Mehdi Hasan we have all read Clinton’s  speech:

“(the) UK’s finding this out now. They adopted this big austerity budget. And there’s a good chance that economic activity will go down so much that tax revenues will be reduced even more than spending is cut and their deficit will increase.”

Daniel Knowles challenges his hero, on these grounds:

1. “The government cannot spend so much that net revenues actually increase. By Clinton’s logic we should increase spending until our deficit goes away. ”
2. “The Office of Budget Responsibility..using a Keynesian model, estimates that the fiscal multiplier is about .35”……that means that…overall the deficit is will be smaller than it would have been without cuts….. (Note: Knowles Update:  I actually made a mistake with that statistic – 0.35 is the estimate for the multiplier for VAT. Estimates of the fiscal multiplier overall, including those of the OBR, IMF and others, are closer to 0.)
3. Greece: spending cuts have reduced the deficit from 15.4% of GDP in 2009 to 9.5% now.

The first two points are rightly, morphed together in Knowles’s argument. The first is to do with the impact of government spending. In a slump – which we are living through now – it is vital for the government to spend to fill the investment vacuum created by an over-indebted and extremely nervous private sector, desperately trying to de-leverage its debt. Right now the UK private sector is busily hoarding cash, because they are – rightly – worried about their levels of debt; and because they fear – rightly – that if they do invest, customers (both private and corporate) will not walk through the door – because customers too, are heavily indebted and worried about the threat of unemployment and falling house prices.

So given these circumstances of widespread fear and paralysis in the economy – what the ONS calls ‘flat-lining’ –  say the government invests £1 billion in libraries. What would happen next?

The Office for Budget Responsibility has adopted a model of the economy with a ‘multiplier’ – which is supposed to tell us how much the government would get in return for that investment. The OBR, according to Knowles, reckons the return would be a measly 0.35 on VAT, 0.0 on government spending overall. This model implies that an investment of £1billion in an investment in e.g.  libraries, would return nil to the Treasury. In other words, the multiplier delivers a negative return: a lot less than the £1 billion invested.

The OBR model, Daniel Knowles, is most definitely not Keynesian. In fact it is an insult to the work of Keynes and Richard Kahn – who developed the multiplier - to describe it as such. It is the very reverse of what Keynes and Richard Khan argued (for more see appendix 1 of ‘The Cuts Won’t Work‘)

For Keynes, the multiplier at the very least must be 1. That is, it must return, at the very least, £1 billion to the Treasury. This will happen because, for example,  private contractors will be hired to build the library. They will buy bricks from a supplier, who will pay taxes to the Treasury on the profits he makes from selling bricks. The construction company will pay taxes on the profits they make from building the library. And their employees will pay taxes on their income – generated by working on the library build. Then the employees may e.g. walk into  a home insulation company, and buy home insulation – to ensure greater energy efficiency at a time when gas prices are rising. The home insulation company will pay taxes on that – and employ more people to insulate homes – all of whom will be on PAYE (unless evading tax). They too, will use their income to walk through the doors of heavily indebted companies….and so on.

At the same time, the Treasury will stop doling out dole money to unemployed construction and home insulation workers.

So for Keynes and Kahn the multiplier could be at 2. In other words, with public works expenditures the Treasury could expect to get £2 billion back (in tax revenues and reduced unemployment benefit payments) for their investment. This explains why government spending, unlike the spending of an individual or company, could pay down the government’s monthly ‘overdraft’, the deficit, and in time pay down the government’s ‘mortgage’ – the public debt. Our paper, cited above, provides evidence from records of the national accounts that this is precisely what has happened in the past.

Now I don’t understand why the OBR has set the multiplier at 0.0 – and indeed will write to Robert Chote, head of the OBR to seek clarification. But anyone can see how helpful such a low multiplier is to the argument about austerity. An investment of £1billion that generates a negative return – i.e. costs the Treasury without any hope whatsoever of a return – explains precisely why the government can’t be bothered to invest in  libraries, or energy efficiency or de-carbonisation of the economy.  All of these investment could revive the economy….but why should the government bother to try and revive the economy, and with it the private sector – at a negative of return for government expenditure on public works? A return which does not even pay for the investment – and indeed is modelled not to pay for a return on the investment.

That’s not to deny that there are circumstances in which the multiplier may not work. If government spending goes into tax cuts – and if consumers choose not to spend those tax cuts – then returns to government may well be negative.  And if government spending – is invested in say, Siemens, Germany – it will leak out of the country, and returns on British public investment will go to the German government, not the UK government. That is a risk, and may explain why the OBR’s multiplier is negative. They don’t expect government to invest in Britain.

But if the investment goes into public works here in the UK – productive expenditure that improves our quality of life, employs people, generates income both for the private sector, the employed, but also for government – AND reduces the deficit – why on earth should it not do that?

Finally the unlikely point made by Knowles that thanks to cuts in government spending,  the deficit is falling in Greece.

Frankly, I can’t get my head around Greece’s numbers for its deficit – which are continuing to be revised up by actors such as the EU.. First of all, as is well-documented, with the help of Goldman Sachs and with officials at the EU and the ECB turning a blind eye, the previous Greek government ‘cooked the books’. They lied about their deficit – and hid parts of it in complex products invented for them by the bankers at Goldman Sachs. So before 2009 they claimed that the deficit was 5% of GDP. When finally EUROSTAT/ the EU/IMF got their act together and looked at the books, they estimated the deficit at 15%. Since then it has apparently come down to 10%. I find this all very dodgy.

Second: remember the government deficit can be compared to an overdraft. The public debt can be compared to a mortgage. (Although please: there is no way that government spending can be compared to individual or even corporate spending; that we can draw macroeconomic conclusions from microeconomic reasoning!)

But just for illumination: Greece’s ‘overdraft’ or deficit will, of course, be volatile. Large sums of money are being transferred by the ECB and other institutions into the government’s bank account to help with the crisis. At that point in time the ‘overdraft’ will look good. But it’s the ‘mortgage’ that we should worry about, and whether or not the ‘mortgage’ is being paid down or rising.

It’s the economy stupid.  The deficit will only recover, when the Greek economy recovers. And not before. If the ‘overdraft’ or deficit gets a boost from a one-off deposit – is that helping the Greek economy recover, so that government can collect tax revenues from an active private sector and pay down both the deficit and the debt?

Right now, I am not in a position to tell why the Greek deficit has apparently fallen. But to be honest, my major concern is whether the economic recovery in Greece is in place, and is sustainable over the long term.

And I suspect that even Daniel Knowles can see what I can see: Greece is going downhill….Is that really the model Britain should follow?

This article was simultaneously posted on LeftFootForward and PRIME >

Have just been told that my post on the Left Foot Forward on Ed Balls’s speech  crashed the site “under weight of people wanting to read it”…so here it is for those of you that may have missed it….

David Cameron was delighted when the formidable Ed Balls walked straight into his framing of the debate on the deficit – and was promptly trapped.

That framing goes as follows. We (the government) have spent beyond our means. And the way to pay for it, is by cutting (public sector) jobs, and raising taxation - like VAT.

Ed Balls’s speech concedes (as Labour has done since Alastair Darling’s time at the Treasury) the deficit-reduction-emphasis agenda set by his opponents. And by so doing – implicitly concedes the need to cut public sector jobs.

But I am being unfair.  Balls began his speech by mentioning Labour’s “emphasis on jobs and growth” But the speech immediately morphed into Labour’s concession to the Coalition: that what is needed is “a steady and balanced approach to halve the deficit in four years”. The implication being that cuts must be matched by ‘jobs and growth’.

But the highlight of the speech – the sound-byte that his spin doctors no doubt intended the media to emphasize-  is a call for a cut in VAT “to boost consumer confidence and jump-start the economy.”

Cameron flashed back his retort: ”slashing taxes” he argued, would only make the UK’s fiscal deficit worse.

And so Balls is trapped.

The debate now centres on whether the deficit can be financed by increasing or cutting taxes, in particular VAT. For most people, Cameron has the upper hand.  ’Of course the deficit can only be financed by increased taxes’ is the consensus. Because we have ‘spent beyond our means’ – we have to raise taxes, like VAT.   “Slashing” VAT – when it’s higher VAT returns that are paying down the deficit – is unacceptable to the Coalition, to the Treasury, to orthodox economists and to the bulk of the British public.

But that’s only because most have been drilled in the propaganda: “the deficit is like a credit card”. We need to pay it down. To do so, we have to mobilise/hoard ‘savings’ – i.e. higher taxes – to pay down the ‘credit card’.

But the government’s deficit is not like a credit card. And nor do we need ‘savings’ to pay it down.

The only surefire way of paying down the deficit is not by government cutting the deficit – which I and others have argued it cannot do -  but by employment.

Put 2.43 million people back to work, and hey presto! the deficit will vanish.

Get 2.43 million people – including thousands of skilled and unskilled workers, clever and talented student graduates –  to address Britain’s very real insecurities in energy, food and health – and hey presto, the deficit will be financed.

How? By the tax revenues that will pour into the Treasury’s coffers, either directly or indirectly – and by the savings that will be made on welfare benefits.

However, keep 2.43 million people unemployed, keep them feeling insecure, with their purses firmly shut, and you can guarantee an ever-rising government deficit (April’s deficit numbers were the highest on record for that month).

And 2.43 million unemployed is sure to make British ‘confidence’ fall and the recession deepen.

Ed Balls has to face this fact: cutting VAT on falling retail sales will do little to ‘restore confidence’. Confidence is evaporating, and retail sales are falling, not just because of VAT – but because of the fear of unemployment.

The only thing that will restore confidence will be: employment. And while it is encouraging that the private sector created 88,000 jobs between February and April, that still leaves 2.43 million people economically inactive, unemployed and lacking in confidence. Many millions more are worried about their job security, rising fuel and food prices.

So Ed Balls’ speech should have gone like this.

Jobs will cut the deficit.

Look after unemployment – and the budget will take care of itself.

And if the private sector can only create 88,000 jobs in 3 months - while 2.43 million people remain economically inactive, depriving the Treasury of tax revenues, costing the Treasury dear in welfare benefits – and causing the deficit to rise even higher – then government must step in and spend on public works, to create jobs.

Jobs will cut the deficit – and simultaneously create the ‘confidence’ the private sector needs to invest – to create more jobs.

That framing would have put David Cameron on the defensive – would have pleased Labour’s base, and would have encouraged insecure voters. It would have put Ed Balls and Ed Miliband in a ‘winning state of mind’.

Instead we are back on sterile, old territory: the centrality of the deficit to all of political debate, and economic policy-making, and the eclipse of the subject of unemployment.  Paying down the deficit as Labour’s leadership and its right-wing constantly concedes, is REALLY IMPORTANT. For the Coalition it is is far more important than creating jobs, and getting 2.43 million people back into meaningful work.

So let’s go on emphasizing the deficit, and ignoring the unemployed. But please, spare us the tears and anguish of politicians and economists when the deficit keeps rising!

It goes without saying, I hope, that of course I support ‘clamping down on tax avoidance and evasion’ – but do not support ‘raising taxes’. I had asked the originators of the letter if we could debate this point, and later the words “those best able to pay” was added, without informing me. Even then, I may not have signed it. The fact is that with the UK’s rate of unemployment; with businesses facing a very hard time because of the rise in VAT and the cuts in government spending, and with banks effectively refusing to lend to SMEs and others (except at very high rates of interest)….this would not be the moment to raise taxes.

But I want to make a bigger point. By calling for taxes to be raised, the letter implicitly suggests that the deficit can be financed through increased taxation. In this sense, it echoes the orthodox line: that government expenditure is like a personal or corporate budget and that ‘savings’ (i.e.cuts or increased taxes on e.g. VAT) have to be found to finance it. That ‘we cannot afford to spend’. That the ‘money has run out’ and we need to find more – from somewhere, preferably taxation.

I strongly disagree. First, to reiterate: the government’s budget is not at all like individual, household or corporate budgets. Individuals cannot engage in ‘quantitative easing’. The Bank of England, on behalf of government, can, and indeed has done so, in order to support the financing of the UK government’s deficit. Individuals and corporates do not necessarily generate income from spending. The government can generate income from investment in public works. It’s a form of income called tax revenues. Third, individuals and corporates can go bankrupt. The government cannot – not even Zimbabwe.

Given these facts, the best way to finance the govermemt’s budget is by increasing, not cutting, the government’s  income – from increased economic activity. In this sense we can make a comparison between governments and individuals: as Prof Chick and I note in our latest update of “The economic consequences of Mr O” -

“Just as work makes things affordable for an individual, so too for society. A nation’s prosperity follows from its employment, not the other way around.”

What the VAT rise and cuts in government spending  do, is to cut economic activity – and therefore employment – and with it income from economic activity for the government.

And this, I fear,  is what raising taxes would do too. And I do not want to be party to that.

(Photo: REUTERS / Yiorgos Karahalis )
A Greek riot policeman stands in front of graffiti written on the wall of a bank during violent demonstrations over austerity measures in Athens, May 5, 2010. Greece faced a day of violent protests and a nationwide strike by civil servants outraged by the announcement of draconian austeristy measures.

Dear readers….Recovering from ‘flu and a trip down to Hay on Wye…Thought you might be interested in this piece I have written for Prime.

“We should note recent developments in political economy, that – while understated – are, we hope, of significance. Last week, the OECD published their latest World Economic Outlook, which features chapters on each developed economy as well as an assessment of the world economy as a whole.

The report is schizophrenic. It clumsily offers an outlook of excessive optimism; makes a selective assessment of ‘risks’; but continues adherence to an economic policy doctrine that is clearly making OECD economists very uncomfortable.

While the OECD report contains the expected justifications and support for the ‘austerity’ approach, nevertheless the organisation’s ‘cold feet’ are becoming apparent, even before the full extent of austerity programmes has begun to impact. There is no better example of this unease than their approach to the UK.

The report commends UK policymakers for their “current fiscal consolidation (which) strikes the right balance and should continue.”  At the same time, OECD economists hedge their bets by urging the UK government to embark on “higher infrastructure spending (that) would lower the short-term negative growth effects of consolidation without affecting its pace.”   At a press conference last week, the OECD chief economist warned that the UK should be prepared to cool austerity in the wake of weaker growth.

In parallel, President Obama was reported as disappointing the expectations of UK policymakers by failing to endorse the Government’s approach to economic policy. While Obama has not proved the champion of the better world that we had all hoped, – he is no FDR -  his stance is important and perhaps even brave.

In the second half of 2010 the world economy began to weaken, but this is greatly underplayed by OECD economists.  Instead they point to a perceived optimistic outlook ahead. But this outlook is thinly based. We are told that financial conditions are improving: but in the UK the latest assessments of project Merlin flatly contradict such a notion.

Source: www.telegraph.co.uk. Data: BBa / BIS / Bank of England

In the real economy, world trade has retreated substantially from the relatively rapid outturns at the start of 2010. The report recognises that this is a consequence of monetary policy tightening in emerging markets and the wearing off of stimulus packages in major economies. The retraction of earlier stimulus programmes by the US and EU is rather an understatement. Stimulus has not only been withdrawn, it has been replaced by austerity.

So what are the grounds for OECD optimism?   Especially given that their economists remain obsessed by inflation as the causa causans of all possible outcomes. Their overriding fear is that inflation will cause consumers to retrench. This threat is then used to justify tighter monetary policies – which would hurt over-indebted consumers, corporates and SMEs. But unemployment is a much more important driver of consumer behaviour. Wage earners snap their purses shut in the wake of what for many millions is the reality of, and for others the threat of, unemployment. Inflation is no doubt painful to the less well-off, but from a macroeconomic perspective ‘core inflation’ today is at low levels, no matter how much the OECD tries to play it up. Watch out as inflation falls rapidly over the next few months, in line with weakening economies.

The austerity and fierce monetary strategies embarked on by governments – already burdened by losses transmitted by the private banking crisis – have been directed by the civil servants of supra-national organisations: such as the OECD and IMF as well as the global central banking fraternity. These public employees enjoy immense influence, and as the the president of the European Central Bank, Jean-Claude Trichet indicated in a speech on 2 June, 2011 they wish to capture:

“a much deeper and authoritative say in the formation of the country’s economic policies….. A direct influence, well over and above the reinforced surveillance that is presently envisaged”

Given the ECB’s role in exacerbating the crisis in Greece (described by Nouriel Roubini as ‘throwing good money after bad – to bail out, rather than bailing in, reckless creditors….a giant Ponzi scheme”)  such “authoritative” advice  by supra-national organisations has crucified economies “in a struggle which is certain to prove futile” –  to quote Keynes.

But the OECD’s latest report hints that minds might be changing. It contains the beginnings of the admission that the world is being forced down a desperate path that has no justification in economic reason and the evidence of history. The experience of the great depression stands before us. It was only enlightened monetary policies and expansionary fiscal policy that restored the US and UK not only to health but to a position to resist reactionary forces and fascism.  The current strategy is likely to make us more vulnerable to reactionary political forces – in the EU and the US.

Some might like to celebrate the previous timid stimulus for e.g. car scrappage schemes etc, under both Alastair Darling and the Larry Summers White House.  But in the light of present events, it is clear that their approach was designed not to save society but to preserve a financial system that has palpably failed the vast majority of the citizens of the world.

We at PRIME economics have repeatedly called for something greater and more just. Perhaps the foot-shuffling of the OECD indicates recognition that imposing austerity policies at a time of global economic weakness is indeed a futile struggle – soon to be abandoned?”