This blog has moved to Project Syndicate’s website: my inaugural blog post, “Sweden – a false icon for Thatcherites” is available now.
Transatlantic viewers have been riveted by a TV series called Downton Abbey, about a British pre-First World War stately home with dozens of servants. The below-the-stairs intrigues, jealousies and rivalries of the servants have gripped viewers quite as much as the goings-on of the aristocratic owners of Downton Abbey.
What is the connection between Downton Abbey and the current economic crisis? Well, it starts with a puzzle. The puzzle is: why is unemployment seems to be going down (though not by much) at the same time as the economy is shrinking? On past expectations, unemployment should be growing. In the last quarter of 2012, GDP declined by 0.3%, but unemployment fell by 0.1%.
But this puzzle is not a large one. The reason is that today, with a more flexible labour market, a fall in output is not necessarily, or immediately, reflected in a fall in employment. It may simply lead to a movement of workers into lower-paid, part-time or intermittent jobs or work training schemes, none of which count towards recorded unemployment. This has certainly been happening. It also explains why the Government can claim success in increasing private sector employment faster than the public sector is shedding employment.
If the free market fanatics had their way, the Chancellor of the Exchequer should be cutting even faster and deeper than he is. What would be the result? Those of us left with decent jobs or incomes will be able to have as many drivers, gardeners, trainers, cleaners, nannies, domestic servants, chefs, butlers and waiters as we can possibly want, and, no doubt, at the equivalent of Victorian wage levels. In other words, back to the world of Downton Abbey. It took the British a century of growth to escape the world of Downton Abbey. Now it beckons us as a wonderful solution to the unemployment problem.
In his autumn statement, George Osborne sang the praises of his new scheme to boost bank lending to small and medium enterprises: ‘with the Bank of England, we are directly addressing the problem of tight credit through the Funding for Lending scheme’. Funding for Lending (F4L), launched in August 2012, is the latest in a string of schemes designed to improve credit conditions. Under this scheme, banks can borrow up to 5% of the value of their outstanding loans directly from the Bank of England at below market rates. If banks increase their net lending, the amount they can borrow from the Bank of England increases at the same rate. So a bank that has £100m of lending outstanding can borrow £5m from the Bank, but if it increases its net lending to £105m, it can borrow £10m. Lowering bank’s funding costs means that they can in turn lower rates for borrowers, which remain stubbornly high despite rock-bottom Bank rate and £375bn of quantitative easing.
The problem with the Funding for Lending scheme is that it has no mechanism for ensuring banks pass the reduction in their funding costs on to borrowers. The National Loan Guarantee Scheme failed precisely because it required banks to pass on these savings, which they proved unwilling to do. But in the worst case scenario for F4L, the Bank lends £80bn (5% of total outstanding loans) to banks at below market rates without banks lending a penny more. There are also losers from the scheme: the liquidity provided by the Bank means that banks no longer have to compete so hard for savings deposits, and can therefore slash rates on savings accounts. Since the launch of the scheme, rates on savings accounts have fallen by over 1%.
The logic is that if Funding for Lending improves credit conditions, the economy will get a boost, benefiting savers in the long run. But, as Andrew Bailey of the Bank’s Monetary Policy Committee pointed out in evidence to the Treasury Select Committee, the jury is still out on whether F4L is actually increasing bank lending. There are some signs of success: the Bank’s Credit Conditions Survey finds that 26% of banks say they are supplying more mortgages. Large companies were also benefiting from easier access to credit. But small and medium-sized enterprises – the policy’s intended target – were seeing little improvement in their access to credit. Demand for loans from SMEs declined further in the last quarter of 2012, as many gave up on even approaching their banks for accommodation. So far, F4L’s success seems to consist in re-inflating the housing market, but something more than Funding for Lending is needed to revive the languishing business sector.
Last Friday we had a debate in the House of Lords on the Leveson Report on the “culture, practices and ethics of the press”. My speech dealt mainly with technical points. But the real challenge, which Leveson ducked, is how to regulate the digital press, from traditional news websites, to blogs, to ordinary people on Twitter. We have already seen what a Wild West free-for-all on the internet can do; look at the publication of photos of Prince Harry, the Duchess of Cambridge and the hounding of Lord McAlpine. A 21st century system of press regulation cannot ignore new media emerging online.
The problem is one of jurisdiction. There is precious little international agreement on which country’s laws should apply to a website, and the nature of the internet means that websites can easily relocate to evade national systems of press regulation. The EU has tried to establish the principle that websites are subject to the jurisdiction of the country in which their physical infrastructure – crudely speaking, their servers – are established. But the rise of “virtual servers” (which mean that a single website can no longer be traced to a physical location) and the complexity of the supply chain in web hosting will soon make these judgements more difficult. The US claims jurisdiction over all websites with “.com” or “.net” web addresses, but in practice it has serious difficulty enforcing its claims. Even in clear-cut instances of law-breaking – pirate websites, for example – getting a website shut down permanently is almost impossible. In the absence of any international agreement on the right to privacy, protecting people from intrusion on the internet will prove literally impossible.
I dashed off a letter in response to a rather odd article by Jeffrey Sachs in yesterday’s FT [£] (We must look beyond Keynes to fix our problems), which mixed a sensible call for increased investment with an assault on the Keynesian ideas which underpin it:
Every British Keynesian would agree with Jeffrey Sachs that the UK needs “increased infrastructure and educational investments” and that spending cuts should not be the main tool of deficit reduction.
But why does Professor Sachs insist on setting out his sensible stall in opposition to what he calls the “Keynesian model”?
Is it the odium theologicum of economics that makes natural allies attack each other?
Keynes said one very simple thing. An economy hit by a serious shock to demand may remain stuck in a low investment trap. In these circumstances, the government needs to boost investment spending. Why does Prof Sachs find this so shocking? It’s exactly what he says!
The British government has congratulated itself on the employment figures released two days ago: 628,000 more jobs in the private sector, compared to 127,000 fewer in the public sector over the past year. There is a big discussion going on as to why the total number of unemployed has fallen slightly, from 8% to 7.8, even while the economy has been sliding. The most popular current explanation – though these explanations change from day to day – has to do with the unexpected flexibility of the British labour market. Real wages have fallen as money wages failed to keep pace with inflation. This is how neoclassical economists expect full employment to be regained. However, there is a snag, which Keynes pointed out. A reduction in real wages – i.e. an increase in profits – also reduces employees’ spending power. So the real question is whether the confidence created by the increase in business profits offsets the effects of the reduction overall in demand.
We have to take something else into account. Aggregate demand is not only being reduced by lower real wages, but also by the government’s deficit reduction programme. So we have another condition: recovery depends on confidence in the government’s fiscal policy being sufficient to offset the reduction in spending power which fiscal austerity produces.
The hopes of recovery seem to me to be disturbingly over-dependent on psychological factors, while ignoring the common sense view that if total demand is being reduced, there economic slide will continue and, moreover, unemployment will start rising again.