Monday, May 28, 2012

3D economics, Disposable income, Demand and Debt.

A diagram illustrating how "austerity reduces aggregate
demand and damages the economy.
Thanks to their pushing through of ideologically driven neoliberal policies under the guise of "austerity" the Tory led Coalition government have dumped the UK economy back into recession. It is not like they were not warned, even the Labour party opposition that were daft enough to deregulate the banks and then oversee the inflation and implosion of the biggest speculative bubble in UK history had the wits to point out to the Tories that "cutting too deep and too fast would be bad for the economy". Plenty of people predicted that Tory austerity would be self-defeating, but they had already set out their ideological stance that the only solution to the economic crisis must be "more of the same" neoliberal dogma that caused it in the first place, a position heavily reliant on the "great neoliberal lie" that state spending, not reckless financial sector gambling caused the crisis.

Why was it so obvious that the Tory austerity drive would be so counterproductive? To explain it in simplistic terms that even Tories can understand, I propose that the current economic chaos should be considered in terms of the 3Ds of economics; Disposable income, Demand and Debt. I am then going to consider whether these "cut now, think later" austerity policies have come about due to economic incompetence and if not, what the real unstated reasons for inflicting them might actually be.

Disposable income, Demand and Debt

It is stunningly obvious that reducing the amount of disposable income in the system through "austerity measures" and stagflationary central bank policies (money printing whilst keeping interest rates ridiculously low) will cause dramatic reductions in economic demand. If people have less disposable income to spend, they tend to reduce expenditure. On a small or short-term scale this wouldn't be too bad, but if government policy forces millions of people to simultaneously cut back spending, the wider economy suffers, as reduced sales cause relatively static production overheads to take up greater proportions of production costs. This means that the private sector is forced to either cut dividends or reduce salaries (by laying off the workforce or imposing pay freezes) both of which create further reductions in disposable income and therefore reductions in economic demand, potentially triggering an economic death spiral. The other option for private sector enterprises is to cut expenditure on research and development, modernisation and training, damaging the long-term economic prospects of the business, and harming future economic productivity.

The other consequence of imposing economic strategies that reduce disposable income is an increase in the amount of personal debt in the system as millions of families are forced to borrow more (in order to keep the rooves over their heads, clothes on their kids and food in their bellies). When people do rely on borrowing, this further eats into the amount they can spend in the "real economy" by increasing the proportion of their disposable income that goes towards making interest repayments. A Consumer Credit Council Service study recently found that over 24% of UK household disposable income is spent on nothing more than interest repayment. The rising levels of personal debt in the UK and the rapid spread of parasitic ultra-high interest payday lenders has already been documented. It seems that the Tories have refused to learn the lessons of the financial crisis; that predatory lending, high levels of debt and unsustainable borrowing are a recipe for a catastrophic economic meltdown.

Large scale systematic reductions in disposable income have the consequential effects of reducing demand and increasing debt within the system. At a time when the government should be taking decisive measures to stimulate economic growth and reduce the amount of debt in the economy, they are pursuing an ideologically driven austerity agenda which is doing the exactly the opposite.

After two years of economic stagnation and the recent return to the status of "technical recession" it is clear that the Tory "austerity drive" has harmed the UK economy in the way that I have described. The Tories have overseen a large reduction in household disposable income, leading to a fall in demand and a rise in personal debt. Other ideologically driven policies from the Tories look set to intensify the Disposable Income/Demand/Debt economic decline, especially their reforms of student finance which look set to lumber millions of low-mid income students with an "aspiration tax" to be subtracted from their disposable income, preventing them from investing it in economically beneficial activities such as starting their own businesses, collecting savings, making investments, contributing to pension funds or simply spending it.

The Tories have demonstrably created a massive reduction in the amount of disposable income in the economy via massive public sector layoffs and pay freezes, pension attacks and welfare cuts, all exacerbated by  huge above inflation rises in utility and transport costs and the Bank of England's stagflationary fiscal policies.

George Osborne, the archetypal example of
the incompetent over-promoted rich boy.
Either the Tories are so economically illiterate that they just don't even understand the consequences of their own policies or they are doing it deliberately and just don't care about the long term social and economic damage they are causing. The case for economic incompetence is a reasonably strong one, you only have to look at the man who is nominally in charge of the UK economy to get the impression that he an archetypal example of the over-promoted rich-boy, who should never, under any circumstances have been let anywhere near the levers of power. There is plenty of economic evidence that the Tories don't know what they are doing too, the incompetent botch job the previous Tory administration made of rail privatisation (the creation of privatised, subsidy junkie regional monopolies), their failure to calculate that the introduction of £9,000 a year fees would necessitate a vast amount of government borrowing to pay out the loans, the brazen incompetence of their meddling in the Royal Navy F-35 fighter jet procurement and their failure to understand how unpopular their granny tax measures would be with one of their key demographics (pensioners). Despite the strong case to be made for Tory incompetence we must also consider the case that they are deliberately attacking disposable income, reducing economic demand and increasing levels of personal debt in order to suit their political agenda.

Even though the case for Tory incompetence is a reasonably strong one, the fact that similar ideologically driven "austerity" schemes are being pursued across the rest of Europe and much of the rest of the western World suggests that this seemingly insane adherence to destructive self-defeating austerity is not just an affliction suffered by the English upper classes. This leaves us with the important question; if these policies are not driven by sheer economic incompetence, what would would make the Tories want to pursue such an socially and economically destructive strategy?

Potential alternative explanations

1 Neoliberal orthodoxy: After three decades of "neoliberal orthodoxy" the political classes are incapable of thinking outside the orthodox paradigm of more privatisation, less regulation, less labour rights, more tax cuts for the rich, etc. The fact that their beloved neoliberal economic theories were completely invalidated by the neoliberal economic meltdown which demonstrated firstly that deregulated financial sector markets do not self-regulate ("the invisible" hand is a myth) and secondly that state intervention is necessary (rather than "evil") because without it the neoliberalised financial sector would have collapsed entirely, taking the relatively tiny "real economy" down with it. The problem with this idea that if the political classes are sticking with the defunct paradigm of neoliberalism because they are incapable of "thinking outside the box", this is pretty much the same as the argument we are trying to counter; that they are clueless and incompetent.

With most of the UK's largest export markets also embracing austerity,
and the US in danger of joining them should the Republicans win,
demand for imports from the UK is going to be diminished.
2. Increased competitvity: One possible explanation is that the Coalition are trying to address Britain's appalling trade deficit by increasing competitivity. By devaluing the currency and reducing labour costs and employment conditions they are attempting to increase exports and improve the balance of trade.

This explanation is backed up by Tory justification of their much criticised regional pay plans, that by reducing public sector pay in poorer areas, the private sector will face less wage competition in these areas, allowing them to offer poorer wages and working conditions and therefore create more jobs.

The problem with this competitivity drive explanation is the fact that the Coalition have provided £40bn to the IMF in order to impose similar austerity measures through Structural Adjustment conditions on their loans in other European economies such as Spain, Greece and Ireland. The effect of these austerity measures is to reduce demand in Europe meaning that there will be no improvements in the balance of trade. If all of the western economies impose the same kind of cost cutting measures simultaneously, these socially and economically damaging cuts wont actually improve competitvity or the balance of trade at all, since demand is going to be reduced across the board.

3. The China block: One theory that is doing the rounds is that these austerity policies are actually a coordinated western government strategy to curb Chinese economic expansion and their growing domination of global trade. The theory is that these austerity policies are a deliberate strategy to reduce household disposable income in order to deter consumer spending on Chinese manufactured goods. The problem with this explanation is that Chinese factories produce an awful lot of cheap crap, and in times of economic turmoil and reduced disposable income, consumers are much more likely to buy cheaper alternatives than quality branded goods. One area of the UK economy that has been booming since the global economic meltdown is the "Pound Shop sector" which is based on the model of selling cheap low quality Chinese goods at bargain basement prices.

To give a hypothetical example; if Mum has been made redundant and Dad has suffered four consecutive years of pay freezes, they are much more likely to buy cheap Chinese manufactured birthday presents for their kids than high quality British or European manufactured branded toys like a Hornby railway set or a pack of Lego (even if they do choose branded European goods, manufacturers such as Hornby are still actively shifting their production to China too!). Since Chinese factories produce the kind of cheap, poor quality goods that people tend to buy when they can't afford to let quality or ethical reasons determine their choices, reducing household disposable income is likely to harm the Chinese manufacturers much less than it actually harms local manufacturers.

4. Debt creation: The introduction of the highest public university fees in the World for English students has demonstrated that the Coalition government have absolutely no qualms about driving people into enormous amounts of debt. Perhaps their attacks on disposable income are actually intended to drive more people into debt? If people find that their household disposable income is being eroded away, they can either make cutbacks or they can take on more debt in order to make ends meet. The beneficiaries of increased borrowing would be the financial sector who could generate huge profits by lending on the Central Bank super-low interest "giveaway loans", and their Quantitative Easing windfalls at eye watering interest markups.

The fact that the majority of Tory party donations come from the financial sector and that one of their biggest donors (Adrian Beecroft) is the director of a private equity fund that owns the predatory lender gives some credence to this theory, however the main reason that the economy is in such a mess in the first place is that the financial sector inflated a vast speculative bubble built on "easy credit" and unsustainable debt. The narrative of the economic crisis has been all about recapitalisation of the banks and the difficulty in obtaining credit. Incentivising people to borrow more money in order to maintain lifestyles that they cannot afford or just so they can make ends meet (in the cases of poverty stricken families) is exactly the opposite of sustainable recapitalisation. It is not beyond the realms of possibility that the Tories are trying to recapitalise the financial sector by driving millions of people to take out high interest loans whilst the Bank of England and European Central Bank provide the financial institutions with an almost limitless supply of cheap money to lend out at huge markups, however this cannot be seen as a sustainable economic policy.

5. Reduce social mobility: The biggest barriers to social mobility are low disposable income (lack of ability to accumulate capital), debt and lack of education. All three of these seem to be deliberate Coalition policies. The reasons a Tory led government would want to favour establishment interests ahead of the interests of ordinary working people or the wider interest of creating long term economic stability are as manifest as they are obvious. The financial sector provide the majority of Tory party funding, most of the rest of their funding comes from other capitalists and their traditional base, the landed gentry. The Tory party is riddled with people that went through the establishment training system of public school education and they boast a cabinet of multi-millionaires.
The Tories have repeatedly demonstrated their absolute contempt for the interests of the the ordinary working people that they have been known to refer to as "the enemy within". The desire to protect the old establishment of landed gentry and the public school old boy network is one of the deepest Tory desires, protecting their own personal financial interests and those of their corporate and financial sector backers are also core Tory motivations. The best way to prevent the downwards mobility of over-promoted public school old boys, reckless financial sector gamblers and greedy corporate fat cats is to prevent the upwards mobility of talented and hard working ordinary people.

Several of the coalitions policies can already be seen as blatant attacks on social mobility. The student fees hike which will lumber hundreds of thousands of kids from low-middle income families with vast unpayable debts and end up disincentivising thousands more that are rightly put off by the prospect of racking up £50,000 or more in debt that will grow at well above the rate of inflation unless they manage to poach themselves a £50,000 a year job from under the noses of the public school old boy network. Regional pay plans will lower pay in poor areas and look set to damage vital public sector services in these areas by incentivising staff to move to more affluent areas in search of better pay. George Osborne's tax changes look as if they are designed to transfer even more of the burden of taxation from capitalists (corporation tax cuts) and the super rich (cutting the 50p rate for earnings above £150,000) to consumers (hiking the VAT rate).

The suspicion that the Tories are deliberately slashing the incomes of ordinary working people and driving millions into debt as a deliberate policy to protect the interests of the establishment elite by reducing the social mobility of the "lower orders" is backed up by the fact that in 2011 the richest got richer, whilst the majority suffered the austerity.


It is fairly obvious that the increased competitively and the "China block" explanations are worthless. If reducing aggregate demand was about increasing exports and closing the trade gap then funding the IMF to impose similar policies across the UK's main export markets would be utterly self-defeating. If austerity is a western conspiracy to confront Chinese manufacturing might, it isn't going to work because squeezed consumers are more, not less likely to buy cheap, low quality Chinese goods. Protectionism in the form of trade tariffs would make a much more effective western plot to slow down China's economic growth than a set of policies that result in creating recessions across their own economies.

The government are still keen neoliberals, even though many of the central neoliberal principles have been repeatedly and comprehensively invalidated, the Tories are so enraptured by the ideology that they are even determined to privatise the police forces that were more than happy to work as Margaret Thatcher's private militia in the early days of the neoliberal revolution. That the Tories are so obsessed with imposing defunct ideologically driven neoliberal pseudo-economics is pretty much the same as being incompetent and economically illiterate, but the question still remains. Why are they so determined to stick with invalidated neoliberal dogma? I think the answer lies in proposals four and five. The Tories are determined to protect the interests of their own class, they are after all the party of the establishment. The best way to protect the interests of the establishment is to reduce the upwards social mobility of the "lower orders" by restricting their access to capital (disposable income) by driving them into debt and by disincentivising them from getting higher education or making them pay up to 9% of what should be their disposable income in an "aspiration tax" that the children of the establishment elite can easily avoid. Driving ever more people into debt would have the added bonus of helping out the financial sector gamblers that are the main source of Tory party funds.

The Tories are the party of the establishment, their party is riddled with millionaires and public school establishment trainees and they take the vast majority of their party funding from establishment sources. The following flow diagram gives an illustration of how several government policies reduce social mobility, decrease disposable income, increase  public debt and protect establishment interests.The fact that these reductions in disposable income and the increases in debt serve to reduce economic demand and damage the wider economy doesn't seem to matter to the Tories, since their core objective is only to protect establishment interests rather than to run a stable economy for the benefit of everybody.

See also

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