It’s private debt, stupid: Has the Growth Commission learned from the 2008 crash?

Ben Wray

As part of our week of content looking at the legacy of the 2008 economic crisis, David Jamieson speaks to economists Steve Keen and Laurie Macfarlane about whether the Growth Commission’s economic plan for an independent Scotland has understood the lessons of that era

WHEN the banking crisis arrived in 2008, it momentarily silenced two decades of jubilation from apologists of the global economic order.

Far from a freak occurrence or a mere cyclical correction, the crisis exposed a deep rot in the world’s leading economies. It revealed a model of finance led growth which was heavily dependent on growing private indebtedness and a housing market inflated beyond any reasoned assessment of its real value.

Early assumptions were that the crisis itself would serve as a corrective to neoliberal economic orthodoxy, just as the crisis of the post-war consensus economies, which saw greater room for state support and planning in national industry, in the 1970’s had given way to the economic liberals of the early 1980s.

But with few notable exceptions, the fundamentals of ‘neoliberal’ orthodoxy have remained firm.

Even from a first glance, the Sustainable Growth Commission report, commissioned by the SNP, looks like it reflects that orthodoxy.

Whilst it establishes many criticisms of the current condition and structure of the UK economy, it goes on to outline an economic prospectus for an independent Scottish economy that reflects it in many ways.

One of the most disorientating aspects of the official response to the 2008 crisis in the UK and around the world was the way in which the supposed cure was also the disease – the creation of massive private debt.

Cutting public spending to reduce public debt “sounds really sensible” says Steve Keen, Head of Economics, History and Politics at Kingston University London, and one of the few economists to see the crisis coming years in advance, raising regular alarms about the growth of private debt.

“If you save money what that means is your expenditure is less than your income. There’s a problem with doing that at a national level and that is expenditure is income.”

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A fixation on driving down public debt, by cutting public expenditure and therefore GDP, wages, benefits, public services, employment and much else naturally means a greater reliance on private debt to keep the economy going.

While the Growth Commission acknowledges that the UK’s rising consumer debt is “unsustainable”, it does not back this analysis up in policy terms – the tight fiscal constraint it offers will, according to Keen, increase the pressure on private debt to make up the shortfall in the money supply, especially as an independent Scotland is likely to start life with a trade deficit.

“I would worry far less about the fiscal balance and worry far more about the private banking sector,” Keen argues. “I would be trying to ensure that the banks you set up didn’t finance and asset bubble, you don’t want an Irish housing bubble in Scotland.

“Breakaway from the fiscal madness of the British because austerity, particularly when you are in the aftermath of a financial crisis, austerity actually reduces GDP and makes your problem worse.”

Laurie Macfarlane, economics editor at Open Democracy who has worked alongside Marriana Mazzucato on the Scottish Government’s new Scottish National Investment Bank, was even more critical of the approach to fiscal policy in the Growth Commission.

“If you look at the GC plan what’s striking is that the fiscal projections in the report are very much a continuation if not an acceleration of the trajectory that we have under the UK Government.

Read more: 10 years since the crash: Where did banking go wrong, and how do we fix it?

“They amount to a cut of about 6 per cent in spending relative to GDP. That’s a cut in the size of the state, public expenditure growing less than GDP year on year.

“It’s worth mentioning as well that’s based on a pretty optimistic forecasting of economic growth. The GC says public spending should be one per cent less than GDP growth, which means it would be real terms rise of about 0.5 per cent a year. Of course if GDP growth isn’t 1.5 per cent, which is what they assumed, it’s less than that, then you are talking real terms cuts in public expenditure.”

It is precisely these kinds of austere fiscal regimes which have reinflated private debt in the UK. Having benefited from the extension of financial deregulation, the effort of Tory and New Labour government alike, British banks lent huge amounts of money, much of which helped to inflate the housing market.

Just as the GC is a close reflection of UK fiscal policy, it also vows a “mirroring”, in the words of the report, of the UK’s system of financial regulation.

This matters, Macfarlane says, because “Scotland itself has a large financial sector”, and also because calls for even moderate banking regulation UK wide after the 2008 crash quickly dissipated under pressure from the banking sector.

“So I think it’s slightly worrying in the context of Scotland that the GC, with these very timid watered-down proposals, are basically saying we are just going to import them wholesale and not really do anything different.

“There is no proposal in the GC that says ‘we are going to take a significantly different approach’ to either the regulation or the structure of the financial sector. There is a cursory mention of the new Scottish National Investment Bank which has been proposed by the Scottish Government, which I think is a great great thing and there’s a real opportunity there to re-orientate the case for moving towards a fundamentally different economic model in Scotland, and much more investment led public led approach.”

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The problems of a fixation on deficit reduction and underegulation are grossly elevated, in terms of vulnerability to financial crisis, by the GC’s most infamous proposal: that Scotland should keep the pound after independence without any formal agreement with the Bank of England, foregoing the normal monetary powers enjoyed by sovereign economies.

The clear problem with this scheme, according to Macfarlane, is that it ignores one of the key lessons from one of the worst disaster zones of the crisis after 2008 – the Eurozone.

“One of the big lessons, huge lessons to take from the last ten years on the Eurozone is, firstly, the importance of having what is sometimes referred to as monetary soveriegnty, ie having your own currency and your own central bank, and being able to borrow in your own currency rather than a foreign currency.”

The countries associated with the worst suffering of the economic crisis after 2008 – Greece, Ireland, Portugal – had given up monetary sovereignty and shared the European Central Bank with other Eurozone countries.

“And what became very clear very quickly in these countries was that when a crisis hit places like Greece, the usual mechanisms that countries have at their disposal to offset the effects of a crisis really weren’t there.”

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Without the ability to, for instance, devalue their currency, Greece resorted to ‘internal devaluation’ – running down Greek society in a futile bid to restore economic health. Without it’s own central bank, the country was “at the mercy of financial markets” and faced major increases in the cost of borrowing without the ability to be its own lender of last resort.

For Keen, who authored a book last year on whether we can avoid another financial crisis, the lack of an independent currency or a Scottish Central Bank only exasperates the problem of trying to balance the economy between public and private debt.

“This is part of the thinking that is absent from the Growth Commission report ironically – that a growing economy over time clearly needs a growing amount of money over time. And the question is how do you create that money?”

“I have three ways that I see have the potential to create money.

“You export more than you import. The government can spend more than it takes back in tax. And the banks can lend more than they get back in repayments.

Looking at those three ways of doing it, if you don’t have a trade surplus, which is the UK situation, then you’ve actually got to compensate for the effective reduction of money in the economy out of running a trade deficit.”

“So lets just imagine start with a zero trade deficit as a ballpark way of thinking.

“Then you’ve got the two other ways. The banks can create more money than they take back in repayments. That gives you an eventual private debt bubble.

Read more: Parties back new investment bank at Holyrood, but squabble over what and who is to blame for economic weaknesses

“Or the government can spend more than it gets back in taxation. That gives you increasing public debt.

“If you have your own treasury and your own central bank and your own currency, effectively government’s getting in debt to itself. The whole performance of QE (Quantitative Easing) is an indication that actually the government doesn’t have to sell bonds to the private sector to finance stuff at all.”

When choosing between the two “domestic” options, which is more dangerous to the security of the national economy – public debt or private debt?

“With the Growth Commission’s complete avoidance of the discussion of private debt, they are saying ‘oh it’s got to be public debt that’s dangerous.’

“If you include them both, the historical record is, its much more dangerous to have high levels of private debt,” Keen says.

As Keen’s graph of household and corporate debt below shows, whereas public debt is relatively unexceptional, corporate and household debt remains at historic highs. To misquote Bill Clinton: it’s private debt, stupid.

But Macfarlane warns the Scotland of the Growth Commission, having made itself vulnerable through public debt suppression and private debt growth, having left its financial institutions without the necessary regulations, would be in even less of a strong position to cope with the fallout of another financial crisis.

“What’s worrying from my perspective about the sterlingisation proposal that’s put forward in the GC is that it is, I think, even one step further,” he says.

Places like Greece and Portugal did at least have a central bank, the ECB. Though it proved mainly an impediment in practice, acting “politically” to defend the financial interests at the head of European society, it could, at least in theory, perform the tasks of a central bank in a time of crisis.

“In the case of Scotland under sterlingisation, there is no central bank,” Macfarlane explains.

“You are using the currency of the rest of the UK. The Bank of England has no mandate to set monetary policy in the interests of Scotland at all.

“If a crisis did hit shortly after this arrangement was put in place, and there was a significant recession or a significant downturn, there are very limited options to how the government could respond. It couldn’t devalue its exchange rate because it doesn’t have its own currency.

READ MORE: ‘Naïve’ Growth Commission policies won’t improve Scottish growth or productivity, pro-indy economists argue

“It couldn’t ease monetary policy, reduce interests rates or undertake QE because it doesn’t have a central bank. It couldn’t even use fiscal policy that much because, a) it’s set out significant targets for deficit reduction, but also b) because you are basically reliant on borrowing from financial markets you’d need to say ‘ok, please can we borrow some money from you’ and they’d say ‘well you know your economy isn’t looking too good so we’ll charge you a 10 per cent interest rate’ or whatever. You can end up in a very dangerous spiral of greater indebtedness and you are building up debt in a currency you don’t control.”

“And that’s where you get really, really dangerous situations.”

Perhaps a decade on from the dramatic events of the banking collapse, the authors of the GC have come to view the 2008 crisis as an item of history. But for the millions of Scots who will vote on a future Scottish economic prospectus, the crisis is a daily lived reality. A reality of private debt and an inaccessible housing market, of jobs that don’t pay and pay-day lenders who do. As the private debt pile builds up again, with the Bank of England warning it is already returning to dangerous levels as it runs well ahead of stagnant wages, the shallow debt-fuelled recovery from the last crisis sows the seeds for the next one. But the Growth Commission appears to be looking the other way. 

Picture courtesy of Stewart Williams

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