Has The Government Improved The Standard Of Living In The UK?

With General Election campaigns well under way and the speculative dust settled from the 2015 Budget the timing is right for an analytical look at the coalition and their five-year premiership so far. This piece is not aimed at dissecting each manifesto claim made by the Tories, rather a commentary on living standards in the UK today.

Have the government’s policies actually improved the living standards of the average UK citizen?

Measuring living standards and the statistics and data used is critical to illustrate an accurate portrayal of actual living standards for the average person. Undoubtedly aggregate figures are important, especially when making macro comparisons with other economies. Nonetheless individuals should also be made aware with stats and figures they can truly relate to; GDP Per Capita figures give a clearer indication of this because they show the average wage per person. Moreover, people can see what the average person earns; they can also use the figure and compare how they are doing in comparison.

To arrive at a GDP per capita figure we take the Gross Domestic Product, (the sum of all work, spending and production) and we divide that by the total population we then arrive at a GDP per capita figure. This figure is a more accurate representation of the living standards for the average Briton as it provides the mean wage for everyone in the nation. Like all stats, always take them with a pinch of salt and never consider them to be final or conclusive, rather a useful analytical tool used to portray the bigger picture.

If we go back to 2009 the UK and most advanced economies were in the midst of the worst financial crisis since the Wall Street crash of 1929. I have opined my thoughts on the matter here and here. Prior to the hung parliament and David Cameron assuming leadership, Gordon Brown, the Prime Minister at the time and his Chancellor Alastair Darling, sanctioned tax payer’s money to be used on “bailing out the banks.” The term often used to describe the process that saw taxes being deployed as a monetary safety net for the struggling banks; banks that would have been crushed by their own recklessness had the tax funded finance package not arrived.

It is worth mentioning the background to the crisis in some minor detail as Prime Minister David Cameron has described this election as the “most important in a generation.” This is because the Tories have structured their election campaign on their idea of economic recovery and why continuity rather than change is required for the citizens in the UK. In the pre-election Budget Chancellor of the Exchequer George Osborne claimed, “Our economy had suffered a collapse greater than almost any country.”

Britain’s GDP like other nations suffered as a result of the global financial crash but can The Chancellor truly suggest that the financial crisis hit Britain as hard as some of the less developed nations such as Ireland, Greece or Portugal? The UK is not a Eurozone member, so it does not have to adjust economic policy in line with eighteen other nations, unlike the mentioned nations. In addition, nations such as France and Germany have higher GDP and GDP per capita figures than the UK. Both are members of what is clearly an unbalanced monetary union and still have had a stronger recovery in living standard terms since 2009.

Mr. Osborne added:

“Five years ago, living standards were set back years by the great recession. Today, the latest projections show that living standards will be higher than when we took office.”

At a time when the electorate needed reassurances and tangible evidence of a recovery it seemed a little odd to refer to living standard projections rather than the subsequent record during the coalition’s time in office. The graph below highlights GDP per capita from 2007-2014:

World Bank

As you can see in 2009 when the coalition took office living standards where at the lowest point on the range displayed. This is no surprise as the aftermath of the banking crisis combined with the deficit reduction policies imposed by the government caused a shock to the economic system. Since then living standards have been the lowest among Britain’s adversaries, Germany and France respectively. So it remains unclear what the Chancellor meant when he proudly professed “Britain was walking tall again.”

According to ONS figures, unemployment in the UK ( February 5.7%) is lower than France (10.6%), Germany (4.8%) has a lower rate however; but the news was welcomed by the coalition. With French unemployment higher than the UK’s it highlights the importance of looking at the average wage per person as opposed to other figures because they do not portray a clearer picture of living standards.

Unemployment figures cannot account for underemployment. Underemployment looks at labour utilization (how productive workers are) as opposed to just labour (people in jobs). For example, a PHD holder working in a fast food restaurant is said to be “underemployed” because they posses a skill set that exceeds their requirements for the role, yet they are employed nonetheless. An extreme example yes but the idea is to look at situations where highly qualified individuals are accepting roles where their skills are not enhanced or utilized. This is a likely factor behind the UK’s laborious productivity and why it can have more people in jobs yet lower wages for those workers. According to the Bank of England in their Quarterly Bulletin 2014 Q2

“Since the onset of the 2007-08 financial crisis, labour productivity in the United Kingdom has been exceptionally weak. Despite some modest improvements in 2013, whole-economy output per hour remains around 16% below the level implied by its pre-crisis trend.”

In addition to that, Stephanie Flanders writing in the Financial Times suggests:

 “That the average UK worker, in Yorkshire or anywhere else, now produces less in five days than a French one does in four.”

Clearly the recovery is not close to pre-crisis levels so the government has not raised living standards for the average UK citizen. With slothful productivity levels systemic of what little recovery the nation has seen, it is difficult to fathom how the Chancellor could be so optimistic when clearly the past five years have been subdued. Political rhetoric should not be confused with economic reality and the reality is clear: living standards in the UK are not close to pre-crisis levels.

What actually happened? A brief look at the Global Financial Crisis.

How did the global financial crisis result in large government sector cuts?

The events of 2007 are very well documented. There has been a plethora of texts published, journal articles, books, magazine articles etc. dedicated to covering the horrific downturn of several leading financial markets in 2007. The crash ensured that several billions worth of Sterling, Dollars, Yen and so on were given to numerous financial institutions that were deemed “too big to fail.” The term “too big to fail” is theoretically questionable to say the least, a point I shall discuss further as this piece develops. The significance of the bailout funds were the fact that they were generated from taxes. What was clear however about the government bailouts, particularly in the UK, was the fact that institutions such as Northern Rock (now Virgin Money) and RBS would have collapsed had the government chosen to ignore their pleas and let them fail. It is worth remembering that between 1995-2006 a period of unfettered market capitalism allowed substantial financial products to penetrate several economies. A brand new phenomenon that several households had very little exposure nor knowledge too. It would become clear in the years to follow that this imperfect information would have devastating effects on the entire global economy. This period where credit was “pumped” into the economy was truly unique.

Stock crash

Austerity policies have been discussed in some depth on this blog, my pieces here and here are pieces I wrote, I attempt to ask certain questions about government policy and question the notion that government policy could actually be having an adverse effect on the UK economy. The UK (much like the rest of the areas affected heavily by the global banking crash) have adopted a set of rigid public sector cuts, designed to reduce the large dependency on government for goods and services and also because the current government deem the current debt-to-GDP too high. (86%)

If one were to assess austerity in the UK so far could anyone deem the set of policies a success? Of course, the government intends for their policies to have much longer effects, a legacy effect if you will, but that should not come at the peril of current generations, for governments should dictate policy for both now and the future. Moreover, economists such as Stiglitz, Krugman, Solow, Diamond, Sharpe, Skidelsky and several others all warned against excessive fiscal cuts. There is no empirical evidence of any large economy cutting its way to prosperity. Yet what could easily be described as a gamble or the set of ideologically driven policies have ensured that in the UK and much of the developed world have had their economies remain flat since 2011, having slumped from 2009-2011.

In 2009 the rhetoric around fiscal policy changed. If you go back to Tony Blair’s premiership I do not remember anybody on either side of the House quibbling about government spending, in fact the opposite. The then Shadow Chancellor of the Exchequer George Osborne stated that he would match Labour’s spending. Spending he would later tirade about once he became Chancellor. Moreover, Labour made several economic mistakes one of them was the heavy deregulation of the financial markets that actually allowed a steady and then volatile flow of cheap and available credit to flood the economy. Too many people binged on cheap and available credit and several institutions capitalised on this and were making substantial profits as a result. Making profits is part of our societal fabric and that is not my issue, but in the business world, if a firm does not make profit, eventually that business is driven out and replaced by one that will. This to me that is the essence of capitalism. Why then was RBS, Northern Rock or Lloyds bailed out? Okay, anybody with an account with those firms would have lost their money, which is very unfortunate, but in a market economy, an economy In which proponents of free-market capitalism constantly bombard against government interference, where more than happy to accept taxpayers money. Some clarity would be great because these are the same institutions that support, lobby and advocate for laissez faire policies yet accept the ultimate form of government intervention. This anomaly still baffles me and it is unfortunate that we are still paying the heavy price for the actions of a few financial institutions. Moreover it was the substantial bank bailouts, not excessive government expenditure that caused such a sharp rise in the high levels of public sector debt. Debt that is being tackled with austerity policies. Nothing should ever be “too big to fail” because that is the antithesis of a competitive free market, the kind of market that is encouraged in the UK. The government should have let the failing banks fail so other banks could learn that reckless and irrational behaviour should not be tolerated. It would have been a message of biblical proportions. Without bailing the banks out we would not need austerity and six years and more of lost or flat output. It appears that policy has not favoured the majority of the population who are still readjusting to the large structural changes that have taken place since 2009. The graph below is an economic outlook for the UK and makes for miserable reading.

My main qualm lies with blaming government spending. I have maintained from the outset that some government cuts are good, just like in a household or with your personal consumption; you assess what you are spending and cut what is not required. Fair enough. The extent at which the government in the UK and in several nations in the Euro Zone has undertaken huge public sector cuts and perhaps more importantly, the rate at which they have penetrated society is likely to have long lasting negative effects. So far they have proved highly ineffective in producing genuine economic growth as the graph above displays. It should be noted that anything above zero is “growth,” however, in reality people need what I call tangible growth. If more buildings go up, more roads are finished, more bridges and so on are completed then people up and down the nation will actually see growth for themselves. Obviously all those examples require large labour input. We have not had enough of that in the UK. Those examples also highlight investment and investment has what we call in economics a multiplier effect. Simply put, the government spends £1, that £1 generates more that the initial £1 invested say another £1, then the additional £1 can be reinvested on top of the original £1, so the good or service can generate a much higher multiplier, say £3 in the future. What is important is that it comes from the initial £1 investment. This period (2007-period day) of flat economic activity has needed and needs fiscal investment.

Even with an extremely accommodative monetary policy in the sense that the interest rate has been 0.5% since March 2009 the government’s reluctance to deviate away from an ineffective set of policies is detrimental to the economy. Now is as good a time than ever to undergo strategic and logical investment programmes. Instead, the large public sector cuts have actually been damaging to the government’s deficit reduction plan because unemployment is rising, therefore, transfer payments in the form of Job Seekers Allowances and Unemployment benefits have increased. If the government were to run public sector cuts with substantial investment programmes and run them simultaneously, shifting resources away from areas deemed to be wasting government funds and invest in areas with high returns this would be a better set of policies. Instead, we just have the negativity associated with public sector cuts, which has made the private sector less responsive as a result of the lack of economic activity and weak demand from majority of the public.

It is impossible to cut your way out of a recession; nations need to invest wisely in order to grow. America pulled itself out of recession because their production levels in the late 1930s and early 1940s substantially boosted their economy. The point is, they invested. There was an economic crash and the government invested. The New Deal (America’s recovery plan) took several years to have a noticeable effect on the economy, but it was investment that helped aid their recovery.

The government’s gamble still has not paid off and the UK does not appear to be changing any time soon. Governments need to spend in order to get a return. Without it, our economy shall remain sluggish for some time and this is a direct result of the aftermath of the global banking crisis, not excessive government expenditure.

How can the EMS crisis of 1992-93 crisis help the Eurozone today?

Norman Lamont on Black Wednesday

Learning from the past is often the best way to prevent future tragedies but the similarities between the EMS crisis of the early 1990s and the current Euro zone crisis is uncanny. I think there are certainly lessons that should have been learnt from that episode that should have reduced some of the damage the Euro zone is facing today. This is part one of a two part special on the lessons the EU should have learnt from the EMS crisis. 

The fundamental aim of the European Monetary System (EMS) was to consolidate the process of monetary integration amongst member states through monetary stability. Increased economic stability would ensure relatively smooth movement of capital, goods and services that would lead to increased intra-national trade. Additionally, the EMS was devised in order to establish a coherent system in which exchange-rate fluctuations were centralized and reduced in order to promote and maintain stability within the European Union. EU members were advocating for a system of governance that would establish economic cohesion, minimalize exchange-rate uncertainty and safeguard themselves from external shocks. The EMS system could be seen because of the failure of the Bretton Woods system that left many European nations somewhat disillusioned with a scheme that placed international monetary fundamentals in the direct control of the United States.

The EMS comprised of two main mechanisms, firstly there was the creation of an artificial unit of account named the European Currency unit (ECU) and a fixed exchange-rate system named the Exchange Rate Mechanism (ERM). The ECU was a unit of account rather than a medium of exchange, although, it shared the similarities of a common currency, no coins or notes were issued. In effect, it was an accounting unit, which all member currencies were expressed. Nations were allowed to fluctuate within the specific limits of ±2.25%. Additional features of the EMS included the Divergence Indicator and The System of available Credit Facilities. The Divergence indicator was measured in terms of ECU to enhance economic coordination. Hence, it measured the divergence of a nation’s given market rate with the central rate. Despite the system of available credit never coming to fruition, the ECU, ERM and the divergence indicator were mechanisms designed to enhance economic integration and more specifically exchange-rate stability amongst member states.

The importance of the ERM cannot be understated because the very nature of the EMS was to strengthen monetary integration by enhancing stability for member nations. Thus, the systemic failure of the mechanism is arguably the most significant factor contributing to the EMS crisis. The ERM adopted an asymmetrical system in which the Deutsche Mark became the reserve currency, in effect, the members of the ERM handed substantial monetary control to the German monetary authorities. Germany assumed a role similar to that of the United States in the Bretton Woods arrangement. Because monetary authority was effectively concentrated with Germany, when its own domestic interests conflicted with that of other ERM members, it caused severe economic shocks. Both Jones (2001) and Copeland (2005) concur to the suggestion that the domestic economic issues in Germany caused the greatest threat to ERM stability and thus the EMS came under severe threat.

“Because the DM was the linchpin of the system, the fate of the ERM was greatly influenced by developments in the German economy.” (Jones 2001, 56)

The reunification of both German states had severe economic consequences on the ERM members. Firstly, the amalgamation of a large and wealthy nation with a small and less economically developed one had an impact on West German current account. In order to make the transition function, the West German government transferred savings revenue to the East, and the government budget deficit rose from 5% to 13.2%. (Weerapana 2004, 4). This reduction in economic power as a result of the increased structural deficit forced the Bundesbank to increase interest rates in order to reduce inflationary pressure. Unemployment in the UK in 1990 (the year in which they joined the ERM) was 7.1% (Eurostat 1990). Because the UK had effectively handed monetary control to the German authorities in the sense that exchange-rates were determined by the ERM as oppose to the UK government, there was very little in terms of expansionary monetary policies that the UK could adopt.

Moreover, it is likely that the Conservative government at the time would have opted to devalue the Sterling in order to stimulate export demand, which would have increased economic growth through high levels of investment and thus job creation. However, this was not the case and it highlights one of the main problems with the ERM, conflicting monetary interests from nations with contrasting monetary agendas. The dominant German authorities had no incentive to reduce interest rates; the reunification process meant that saving revenue had to be released in order to bring the East German economy to a competitive level, hence high interest rates in order to reduce the internal government deficit. Furthermore, this is a clear example of one of the mechanism’s fundamental macroeconomic failures; it was created in order to establish economic cohesion through marginalizing exchange-rate fluctuations but it left the UK facing high levels of unemployment and high interest rates, due to the lack of economic stability because of a conflict in economic agendas.

On Wednesday 16 September 1992 the UK was forced to withdraw it’s currency from the ERM. Not only did this event drive market confidence extremely low, mainly because of the interest rate fluctuations, which in turn lead to speculative attacks[1] on the currency, it also had severe economic consequences for the domestic economy. McDonald and Dearden suggest the UK currency was increasingly vulnerable to speculative attacks:

”For the UK, international investors watched as growing political pressure to address the recession forced the Government into a series of interest-rate cuts between October 1990 and September 1992.” (McDonald and Dearden 2005, 90)

There are various similarities with the present crisis. If Greece were to leave the Eurozone and affectively the EU, the costs of such a decision may be politically detrimental, but economically beneficial. When the UK left the ERM the decision damaged their economy in the short-run, unemployment levels were high and investment confidence was low, the years following however, saw the economy recover rapidly. Figure1.1 displays the steady fall in unemployment after 1992.

Eurostat.

Monetary integration had always been an objective for European nations. In order to establish and maintain economic stability within Europe and particularly the EMS zone, domestic nations had to merge monetary policies in order for their goals to be achieved. Hitiris suggests that four fundamental principles were adopted in order for this process to occur; “free trade in goods and services and free mobility of capital and labour.” (Hitiris 2003, 128) Domestic currencies could therefore be viewed as a barrier to achieving these economic goals. The realization of an economic monetary union was perhaps best formulated in Jacques Delors[2] report of 1989. The report made several recommendations to improve the efficiency of European monetary affairs through the convergence of macroeconomic affairs. The general theme of the Delors report was clear, the extension of a united economic European union, with little or no barriers preventing the flow of capital between member states.

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[1] The most famous example of an individual profiting on short-sell Sterling was George Soros who profited just over $1billion on ‘Black Wednesday.

[2] Jacques Delors was the President of the European Commission from 1985-1995. It was under his premiership that a proposal for a common European

currency and more importantly, a European monetary union was to established. He was the first President to serve three terms.

 

Government Debt and the effects on UK Unemployment.

There has been no secret of the coalition’s economic policies. That has been to reduce the deficit, i.e. the amount of money the government looses each year. The government has also aimed to reduce the burden of high levels of government debt. How it implements these policies has a drastic effect on the UK economy and in particular, unemployment.

Clintons are one of many well known brands to feel the strain of these tough economic times

Government debt management affects all aspects of the economy. The substantial reductions in government spending have led to several members of the population forced to find alternative employment. George Osborne was confident that the private sector would compensate for the jobs lost through the government policies. It is therefore vital to analyse how government debt management has affected the rate of unemployment. UK unemployment is currently 2.53 million, which is 7.9% of the population, which has fallen from the previous is sixteen year high. Last year unemployment peaked at 8.4%. This was an increase by 118,000 from September to November 2011 and a further 28,000 from November to January 2012. Clearly the government’s policies have not had the desired effect.

OECD Economic Outlook 2011

Above is a graphical depiction of the rise in unemployment from 2008, with both jobs losses in the public and private sector also depicted. Despite the claim in the November 2010 Budget, Osborne claimed that the private sector would compensate for the jobs lost in the public sector, the evidence is clearly contrasting to the government’s claim.  The Chancellor claimed,

“Public-sector job creation would far outweigh the job losses in the public-sector.”

Unemployment in the UK continues to rise to record levels and the jobs being lost in the public sector are a direct result of government policy. When The Chancellor made the premature assumption that the private sector would compensate for the jobs lost through the public sector it may have highlighted an inadequacy in government policy. High and rising levels of unemployment is detrimental for economic growth because it places a financial strain on those working as transfer payments such as Job Seekers Allowance (JSA) and benefits. The number of individuals claiming JSA has risen by 28,000 from November 2011 to January 2012. With further increases expected for the rest of 2012 and 2013.  Moreover, there has been an increase in part-time employment as jobseekers have been desperate to earn some income, but it is proving insufficient to make a substantial difference in terms of contributing towards substantial economic growth.

In addition, the higher than target inflation, those in work will have less disposable income and the government will have to increase transfer payments out to those affected by unemployment. Secondly, tax revenue will also decrease simply because less people are in work, the government must therefore create employment in order to raise taxes so it can finance expenditure that can later contribute to economic growth.

Unemployment is therefore the greatest challenge facing the UK economy because it does not appear to declining. By making such large expenditure cuts, the government may have undermined any recovery effort and may find it very difficult to reduces its debt obligations. The most effective method to reducing government debt is establishing sustained economic growth, however, sustained economic growth in the UK is some considerable way away. Although the UK economy is no longer in recession, rising unemployment will continue to place a severe burden on those in work due to the inflationary and tax restraints already in place, with lower disposable income, growth is likely to remain very low. Moreover, the method in which the government has chosen to reduce its debt may have exacerbated the problem because of the sharp rise in structural unemployment.