NEF Economics Briefing: What’s the real threat to Britain’s ‘economic security’?

14/09/2015
CommonWeal

Prime Minister David Cameron has declared the Labour party a threat to the UK’s “economic security” after the election of left-winger Jeremy Corbyn. James Meadway, senior economist at the New Economics Foundation (NEF), argues in this week’s NEF Economics Briefing that the real threat to the economy comes from an economy that is unbalanced towards finance, unproductive and with high levels of personal debt

SUMMARY

1. The major risks to “economic security” for most of those in the UK arise from a combination of bad policy and longstanding weaknesses in the UK economy. Far from threatening security, more radical proposals are now necessary.

2. The UK’s recovery shows a similar pattern to growth before the crash, since it is driven by rising levels of debt. But this debt is now concentrating amongst poorer households, with one in eight UK of them now suffering from “problem debt”. Such a state of affairs is inherently more prone to crisis.

3. Because the UK has both a very large, internationally focused financial system, and a record current account deficit, it is also highly exposed to risks emerging in the rest of the world.

The election of Jeremy Corbyn as leader of the Labour Party has been greeted by Prime Minister David Cameron with the claim that he represents a threat to our “economic security”.

Criticism of “Corbynomics” over the course of Labour’s leadership campaign have focused on “People’s QE”, a novel proposal to revise the Bank of England’s existing Quantitative Easing (QE) programme by allowing the Bank to invest newly-created money in other assets than government bonds. Critics have suggested (principally) this will risk excess inflation, as money floods the economy, and undermines the Bank of England’s independence.

Neither criticism stands up. First, with UK inflation near record lows (and the ongoing risk of deflation), inflationary pressures are no bad thing. Second, “independence” for central banks like the Bank of England has not produced impressive results. Joseph Stiglitz has noted that countries with less independent central banks tended to be less damaged by the global financial crisis of 2007-8. “People’s QE” is not a magic bullet but nor would it be a disaster. The main risk to “economic security” over the next few years comes from, the weaknesses of the UK economy itself and the combination of policies currently being pursued.

o First, the recovery is being fuelled not by improving productivity or rising wages but a return to borrowing by households, in particular. Total debt is not yet back at the levels of 2008, but “unsecured lending” (borrowing outside of mortgages) has risen at the fastest rate over this year since 2007.

o Second, this rise in private sector debt has a direct relationship with austerity. As the government attempts to cut its own borrowing, borrowing rises elsewhere in the economy to compensate (see the economists’ letter below for details on this process).

o Third, the current account deficit is at around record levels. This means the UK is permanently spending more abroad (on imports) than we, collectively, earn from abroad (on exports and net investments). This requires financing, which means borrowing more from the rest of the world, or selling assets to the rest of the world. This is a major vulnerability since it is dependent on the willingness of the rest of the world to supply this financing. If that stops, the rest of the economy will crash.

Meanwhile, manufacturing output fell over the first six months of this year, largely on the back of falling exports. Productivity – the efficiency with which the economy can turn inputs (raw materials, labour, and capital) into output for sale – has stagnated since 2007, but may, just, have risen over the last few months.

The overall picture is of an economy good at producing debt, and little else. We are returning to the pattern established in the 2000s, of increasing (usually household) debt being used to pull the rest of the economy along.

That debt is unequally distributed. Up to the crash of 2007-8, households across the income distribution were borrowing more and more, reflecting a broadly-based consumer boom. Since the crash, richer households (the top 20%) have reduced their debt whilst poorer households (the bottom 20%) have increased theirs.

A TUC report, out last week, found that the number of households with “problem debt” (defined as having to spend 25% or more of income on unsecured debt repayments) has risen by 700,000, or 28%, since 2012. One in eight households (3.2m) are now suffering from “problem debt”.
The mechanism will not work the same way, but the financial crisis last time was triggered by widespread failures of very poor households to repay their “sub-prime mortgages”. Problem debt and rising debt burdens are one domestic possibility for a major crisis.

Looking further afield, thanks to the UK’s hugely internationalised financial institutions and its major borrowings from abroad, the UK is significantly exposed (for instance, UK financial institutions have loaned more money into China than those of any other Western country). Any wobbles in the rest of the world are liable to communicate themselves here rapidly.

The chances of an international crisis are widely believed to be rising. Recent analysis from Citigroup claims there is a 55% chance of a global recession, most likely centred on China, occurring over the next few years.

Far from being a risk to “economic security”, the weak and over-exposed UK economy now needs radical action to prevent (or at least lessen the consequences of) a further crisis.

FURTHER READING:

Trades Union Congress (8 September 2015), “Number of families with problem debt up by more than a quarter since 2012, new report finds”

Guardian letters (12 June 2015), “Osborne’s plan has no basis in economics”

Kennedy, S. (9 September 2015), “Citigroup sees 55% risk of global recession, centred on China” , Bloomberg