Short-run stabilisation policies will not do: the case for a Keynesian New Deal at the European and global level

Eckhard Hein

The world economy is still struggling with its most severe crisis since the Great Depression of the late 1920s and 1930s. On the one hand, the present crisis began as a financial crisis which started with the collapse of the subprime mortgage market in the US in summer 2007, which then gained momentum with the breakdown of Lehman Brothers in September 2008 and reached another climax with the Euro crisis in early to mid 2010. On the other hand, the present crisis began as a real crisis well before the financial crisis, with an economic downswing in the US. The financial crisis and the real crisis reinforced each other, and the world economy was hit by a decline in real GDP in 2009 – something not seen for generations. Major regions in the world are only slowly recovering from this decline, in particular the Euro area, the UK and Japan. Furthermore, none of the economies which have been hit severely will have returned to the pre-crisis growth path by the end of 2010. Therefore, massive underutilisation of productive capacity, high unemployment and a downward pressure on wages will have to be tackled in the future.

Beyond inefficient regulation of financial markets, increasing inequalities in income distribution and rising current account imbalances at the global scale and within the Euro area are the main underlying causes for the severity of the global financial and economic crisis and for the recent euro crisis. The US and Germany are two important complementary examples of current account imbalances, the US being the major current account deficit country and Germany one of the important current account surplus countries.

The credit-financed consumption boom in the US prior to the crisis was highly fragile because it was set against a background of rising inequalities and a falling labour income share. Domestically the US had to rely on rising property prices in order to allow for increasing indebtedness to fuel steady increases in consumption demand. Regarding the relationship with the rest of the world, a sharp depreciation of the US-dollar, which would have been required in order to improve international price competitiveness of US producers and thus the current account, had to be avoided in order to guarantee steady capital imports without having to raise domestic interest rates. The erosion of such a constellation in the subprime mortgage crisis and the following downswing not only affected the US, but also the rest of the world, in particular the current account surplus countries. On the one hand, if their capital exports were into highly speculative US markets they were devalued by the financial crisis, and therefore the financial crisis quickly infected these surplus countries. On the other hand, the markets for exports collapsed and the current account surplus countries were thus infected by the real crisis as well.

While the dynamic consumption-driven model of the US had to rely on the willingness and the ability of private households to go into debt – and of the rest of the world to supply credit – the stagnating German neo-mercantilist model aiming at increasing net exports by means of wage moderation, in particular, had to rely on the willingness and the ability of the rest of the world to go into debt. This German model was thus as fragile as the US model. The moderate growth rates were dependent on the dynamic growth of export markets, while increasing capital exports carried the risk of contagion in the case of a financial crisis.

The German strategy was not only suboptimal for Germany; it has also been a major reason for the current account imbalances within the Euro area which are at the roots of the Euro crisis in 2010. Germany’s consistently weak domestic demand growth, as well as its rising international competitiveness due to extremely moderate wage developments, has been a drag for other Euro area economies which had to accept negative current account balances, in some countries (Spain, Ireland) mainly associated with private sector deficits, in others (Greece, Portugal) also with public sector deficits. In the course of the crisis, public sector deficits and debts in these countries increased because of fiscal stabilisation, making liberalised financial markets speculate about the sustainability of this process. Of course, the housing price bubbles, particularly in Ireland and Spain, as well as too expansive fiscal policies and wage developments in the deficit countries have also contributed to the current account imbalances within the Euro area.

The breakdown of the world economy in the financial and economic crisis could finally be halted by monetary policy interventions providing liquidity on a massive scale and, in particular, by massive fiscal expenditure programmes. A collapse of the Euro area could be prevented in the short run by the intervention of the IMF in cooperation with the other Euro area countries bailing out Greece. However, due to the underlying imbalances, the world economy is unlikely to return to its pre-crisis growth path. In particular, the US will not be able to act as the driver of world demand any longer. The European Union or the Euro area are far from replacing the US as a world demand engine and rather suffer from their internal contradictions, mainly caused by the German neo-mercantilist economic policy strategy. Therefore, major parts of the world economy are presently threatened by a period of deflationary stagnation, high unemployment and pressure on wages; in particular when fiscal expansion comes to an end and governments attempt to reduce public deficits and debt. For the Euro area this will be accompanied by the threat of disintegration.

What is required in the present constellation in order to turn towards a sustainable growth path with (close to) full employment and to rescue the Euro area is a Keynesian New Deal at the European and the global level. The policy package of a Keynesian New Deal should address the three main causes of the severe crisis: inefficient regulation, increasing inequality in income distribution and imbalances at the global and the European scale. It should thus consist of three pillars:

(i) Re-regulation of the financial (and the real) sector. This includes measures, which increase transparency and reduce asymmetric information and thus uncertainty in financial markets, generate incentives for long-run growth, and contain systemic instability.

(ii) Re-orientation of macroeconomic policies along (post-)Keynesian lines. Monetary policies by central banks should target low real interest rates and should care for stability of the financial sector. Wage and incomes policies should take over responsibility for stable inflation rates and stable income shares, which implies that nominal wages should rise at a rate given by the sum of economy wide productivity growth trend plus the inflation target. Fiscal policies should take care of real stabilisation in the short and the long run and of a more equal distribution of income and wealth. The latter implies active redistribution policies by means of tax and social policies. The former requires that governments run permanent deficits (surpluses) in order to maintain aggregate demand at a level consistent with full employment, stable inflation, and a roughly balanced current account in the long run, and that they actively fight short-run shocks by means of counter-cyclical fiscal policies.

(iii) Re-construction of international macroeconomic policy co-ordination – in particular on the European level – and a new world financial order. On the European level, the institutional setting of the ECB and its monetary policy strategy have to be modified such that the ECB is induced to pursue a long-run monetary policy of low real interest rates. The Stability and Growth Pact has to be replaced by a means of coordination of national fiscal policies which allows for the short- and long-run stabilising role of fiscal policies. External stability, i.e. sustainable external balances, should be a primary target, and member countries should be symmetrically induced to correct for current account surpluses and deficits. The orientation of labour market and social policies towards deregulation and flexibilisation will have to be abandoned in favour of re-organising labour markets, stabilising labour unions and employer associations, and Euro area-wide minimum wage legislation. On the global level, the return towards a world financial order with fixed but adjustable exchange rates, symmetric adjustment obligations for current account deficit and surplus countries, and regulated international capital markets, as suggested by Keynes’s (1942) proposal for an International Clearing Union, should be attempted in order to cope with the imbalances that have caused the present crisis.

---

Download this article as pdf

---

Eckhard Hein is a Professor of Economics at the Berlin School of Economics and Law.

---

Further reading
Eckhard Hein and Achim Truger (2010): Finance-dominated capitalism in crisis – the case for a global Keynesian New Deal, Berlin School of Economics and Law, Institute for International Political Economy, Working Paper 6/2010:
http://www.ipe-berlin.org/fileadmin/downloads/working_paper/ipe_working_paper_06.pdf

Taxing financial transactions: the right thing to do when you owe $600bn a year and have lost control over global finance

Pierre Habbard

For those who had placed some hope in the G20 process to start re-regulating global finance the result, so far, has been utterly disappointing. Governments and central banks have been as eager to bail out the bankers and take on their ‘toxic assets’ as they have been reluctant to move decisively on financial regulation. At every G20 Summit since the first one in November 2008 in Washington, we have been told that a revamped and enhanced Financial Stability Board (including the IMF, the OECD, the BIS and other key financial organisations) would lead the way with concrete deliverables to bring the focus of global finance back to the real economy. We have seen instead a long series of reports on what-went-wrong and “high level” principles and “guidance”, but with no teeth when it comes to enforcement. If anything, these reports reveal the extent to which supervisory authorities are exposed to a “significant lack of information” on “where risks actually lie” (FSB & IMF 2009). They tell us that, two years into the crisis, the “current state of analysis limits the extent to which very precise guidance can be developed” (BIS, FSB & IMF 2009) and that “considerable work remains” (SSG 2009) in the areas of banks’ internal controls and regulatory infrastructure.

At the G20 Summit in Pittsburgh (G20 2009) in September 2009 however, some hope emerged that at last something tangible could be agreed upon in the near future. G20 leaders called on the IMF to undertake research to determine a “fair and substantial contribution” that the financial sector could make to pay “for any burdens associated with government interventions to repair the banking system”. They further asked the IMF “to strengthen its capacity to help its members cope with financial volatility, reducing the economic disruption from sudden swings in capital flows.” Read together, the two mandates were seen as an opening to an old policy issue that had been long neglected by governments and international financial institutions: the creation of a global Financial Transaction Tax (FTT).

In its original proposal by James Tobin in the 1970s (TUAC 1995), the economic justification for an FTT starts with the acknowledgement of the harmful effects of short-term speculation producing strong and persistent deviations of asset prices from their theoretical equilibrium levels. Such “overshooting” in prices lead to speculative bubbles over the long run. A measured and controlled increase in transaction costs implied by an FTT (from 0,02% up to 0,5%) would slow down trading activities so as to align capital flows with economic fundamentals and the real economy, while freeing up new sources of financing for global public goods. Since then, the FTT has been developed in different ways by economists and civil society groups, each putting different weight on the twin objectives of curbing financial speculation and freeing up new sources to finance global public goods. In fact, some proposals had such a strong focus on financing for development that in most cases they explicitly excluded the initial objective of Tobin to curb speculation, targeting a minimalist tax rate of 0.005% to avoid “producing market distortions” (HILLMAN et al. 2007) or “disrupting the market” (SCHMIDT 2007).

Unlike in the pre-crisis literature, the FTT has now gained considerable traction, both as a financial stability instrument and as a solution for financing development. There is a strong case for this. Regarding financial stability, it would be hard to contest that at least part of the crisis we face today has been triggered by a speculative bubble in the derivatives markets and by global imbalances of current accounts between regions and within regions. As Stephan Schulmeister (SCHULMEISTER 2009) puts it, the size of the trading in derivative products is just much too big to be accounted for by its original purpose: to hedge against price volatility or credit default risk. On the revenue side, OECD governments still have to deliver on their past commitments to finance global public goods, including the Millennium Development Goals (MDG), but also on ‘new’ demands regarding climate change adaptation and mitigation measures for developing countries (the financing of which was a major contributory factor in the failure of the Copenhagen Summit). According to TUAC estimates (TUAC 2010), the global public good resource gap that would emerge would be in the range of $324-336bn per year between 2012 and 2017 ($156bn for financing climate change measures in developing countries, $168-180bn for Official Development Assistance to reach 0.7% of GNI).

To make matters worse, the very same OECD governments are running budget deficits at unprecedented levels as a result of the global crisis, including the bailing out of the banking sector. According to the OECD, the size of the fiscal consolidation that would be needed in the 2012-2017 period to bring deficits back to normal levels (below 2%) is projected at $300-370bn per year - on top of the above resource gap for public goods. Unsurprisingly, the OECD experts would want to fund this gap with cuts in public expenditure, “long overdue reforms” to public pensions and regressive tax reforms that would hit working people front on. In the absence of new tax revenues, such a fiscal scenario would have working families pay twice for the crisis: first through rising unemployment and falling incomes and secondly as a result of cuts in public and social services.

Against this background – “heavily indebted rich countries” whose supervisory authorities have lost control over global finance – then surely now is the time to take the FTT option seriously. This is what many unions have been campaigning for, together with social movements, as seen in recent initiatives in the US, Europe and Asia. For its part, the TUAC has been working on a paper (TUAC 2010) on the parameters of a FTT together with the ITUC. Based on recent contributions by Dean Baker (BAKER et al 2009), Stephan Schulmeister (SCHULMEISTER 2009), and Bruno Jetin (JETIN 2009), the paper shows that an FTT could be designed with different rates per counterparty (large banks, other financial institutions including hedge funds, and non-financial corporations) and per market (‘traditional’ foreign exchange markets, exchange-traded derivatives, over-the-counter derivatives). Such a multi-tiered tax regime would help hit where it really hurts and target the counterparties (e.g. large banks and hedge funds) and transactions (e.g. derivative products) that are more prone to speculative trading than others. The revenues generated would be in the range of USD200-600bn per year if the tax is applied on a global scale.

Following the G20 summit in Pittsburgh, the IMF was quick to publicly dismiss the FTT (IMF 2009) as an option to be considered in the commissioned report (forthcoming, April 2010). The sceptical reaction of the IMF is not surprising. Ever since 1995, when the Tobin tax became a “global issue”, the IMF has not seriously considered the issue. The main objections are with the negative impact that the reduction in trading volume would have on price volatility and market liquidity. Other objections relate to the potential transfer of the added transactions cost to “middle class investors”, the opportunities for tax avoidance or the more economic theory textbook argument that tax should apply to value added, not to transactions. Dean Baker (BAKER 2010) has published a solid set of responses to those criticisms as has Stephan Schulmeister. Overall, the single most important aspect to keep in mind in considering the pros and cons of an FTT is the need to look at the specific problems associated with the FTT (in contrast to generic problems that would also be encountered by comparable regulatory options). IMF and OECD concerns about feasibility clearly belong to the latter category: yes, implementing an FTT would be complicated, but would it be more complicated to implement than an alternative solution that would deliver comparable financial stability and global public good financing? On that, the IMF has argued for the creation of a “global banking insurance scheme” as an alternative to an FTT. However the two instruments differ in terms of both revenues (which would not be available for public goods under an insurance scheme) and the handling of risk. Regarding the latter, the insurance scheme in fact would be more onerous for regulators than the FTT. A pre-requisite for any insurance scheme is the ability to price the risk associated with the banks’ balance sheets, which in turn presupposes the ability of the insurer (the regulator) to conduct proper risk assessment of the insured (the banks) and to do so at reasonable costs. And yet it appears that such a basic requirement has become a step too far for financial authorities.

An FTT, unlike the insurance proposal, would provide governments with a powerful regulatory tool which would not depend on the ability of the supervisory authorities to price or assess risk. It would be no panacea for the much broader agenda on financial re-regulation, but it would offer government a ‘low-cost’ instrument for tackling volatility in asset prices and for downsizing the global banking industry, particularly at a time when the international financial supervisory framework is in tatters and will take a decade to reform. It would free up new sources of financing for global public goods at a time when public services and welfare are at threat.

Download this article as pdf

---

Pierre Habbard is a Senior Policy Advisor at the Trade Union Advisory Committee (TUAC) to the OECD.

Riding Your Luck and Adopting the Right Policies: Why the Australian Economy is Rebounding Strongly

Bob Kyloh

The global economic crisis that commenced in 2008 has had devastating effects across rich and poor nations. But the impact on growth, employment and incomes has not been uniform across countries. Economic performance has depended critically on the policy response adopted by governments. Other authors writing for this Column have made a convincing case for an income led growth strategy in response to the recession. At least one country has clearly demonstrated the benefits of this approach.

Australia is often referred to as the “lucky country”. The recent economic performance of this resource rich nation has helped reinforce this notion. Indeed recent economic achievements down-under may be partly due to the good fortune of rebounding commodity prices and expanding Asian markets. But the terms of trade actually moved against Australia in the last eighteen months and net exports detracted significantly from economic growth in 2009. Economic recovery is actually the result of public policies that boosted the disposable incomes of low and middle income families when aggregate demand was plummeting.

The Australian economy has performed better than any other advanced economy since the onset of the global financial crisis. Real GDP increased by 1.1 % in 2008-09 in year-average terms. The economy remained resilient and recorded moderate growth when most other advanced economies were experiencing a deep recession. Looking ahead (in early November 2009) the Australian Treasury was forecasting economic growth of 1.5% in 2009-10, 2.75% in 2010-11 and projected growth of 4% over the period 2011-12 to 2014-15 before returning to trend growth of 3% in 2015-16.

The Australian labour market is rebounding strongly. Employment increased in the latter months of last year, creating 95,000 additional jobs between September and December 2009. There are now grounds for optimism that the unemployment rate, may have peaked.  As of December 2009 the national unemployment rate stood at 5.5%, having declined 0.3 percentage points since October. If unemployment has peaked at this relatively moderate level this will be a remarkable achievement. Back in May 2009, when the National Budget for 2009-10 was announced, the Government had projected that unemployment could peak at around 10% without any stimulus measures. But because of the actions taken by the Government the unemployment rate was expected to reach a high point of 8.5% in 2010. This forecast was cut to 6.75% in early November 2009. Since this last projection was released conditions have again improved across the economy and in the labour market in particular with the recovery gaining significant traction. All indicators now suggest that the jobs market has stabilised – 136,000 jobs have been created since the labour market upturn began in August 2009. A significant proportion of these new jobs (60/40) are full-time and average working hours have recovered from a recent trough. This is important because much of the contraction in labour demand in 2008-09 had taken the form of declines in average working hours rather than increases in open unemployment. These trends and other partial indicators have prompted several independent economic observers to suggest that the labour market has passed a turning point and consequently incomes, consumption expenditure and aggregate demand may strengthen more than anticipated in the official Government forecasts of November 2009.

The Australian Government introduced fiscal stimulus measures in three stages: in October 2008, February 2009 and May 2009. The total package contained a variety of measures which can be summarised under three headings:  first, increased transfer payments to low and middle income groups which were rapidly disbursed and had an almost immediate impact on consumption expenditure, retail sales and economic growth; second, relatively rapid investments in social infrastructure including schools, health and housing; and third major new investments in economic infrastructure which are more medium term in nature.  The stimulus measures adopted were broadly consistent with proposals made by the Australian Council of Trade Unions.

A striking feature of the Australian response to the crisis, compared to most other countries, has been the emphasis placed on increasing the disposable incomes of low and middle income groups with a high marginal propensity to consume. This approach is in complete conformity with the key aspects of the ILO Global Jobs Pact with its emphasis on income led growth and improvements in the social floor.

The initial substantive fiscal response to the global financial crisis was a 10.4 billion Australian dollar package of measures announced on the 14 October 2008. This package was tightly targeted at sectors of the economy showing particular weakness in the early stages of the downturn - household consumption and dwelling investment. In the second quarter of 2008 household consumption expenditure had recorded its first decline in 15 years. This package included one-off additional payments to pensioners of $A1400 for singles and $A2100 for couples. (Australia has a universal pension scheme with flat rate benefits funded by general taxation. This is supplemented by private contributory pensions or what is called “superannuation”). The package also included additional payments of A$1000 to eligible persons providing care to the aged or disabled and for each child in families receiving the Family Tax Benefit (which is a means tested transfer payment received by low and middle income families).

This package of measures generated significant multiplier effects as the payments were timed to be received by credit constrained families in the lead-up to the year-end holiday period, thus limiting the leakages expected through increased savings.  In Australia, like other advanced economies, consumption expenditure comprises around 60 % of GDP and has important implications for other areas of expenditure, including private investment. At the time of its announcement the Government projected that the above Strategy would boost real GDP growth by between 0.5% and 1% over a period of several quarters.

In early February 2009 the Government announced a second 42 billion Australian dollar fiscal stimulus package.   This included over 12 billion Australian dollars to fund a range of additional one-off transfer payments targeted at a variety low and middle income groups. Well over half the population of Australia received payments of just under a thousand dollars as part of this initiative.  These one-off increases in transfer payments were supplemented by major revisions to the aged pension system and other social security benefits in May 2009. These reforms have resulted in substantial permanent increases in welfare payments. The net impact of these revisions will be to increase expenditure on pensions and related social security payments by A$14.4 billion over the next 4 years.

The above mentioned increases in transfer payments, along with reduced interest rates resulting from monetary easing, helped retail sales remain buoyant in Australia when  economic and employment growth were at their weakest. In November 2009, retail turnover was 7.3% higher than in the pre-stimulus levels of November 2008, having remained largely flat throughout 2008. The contrast in retail spending trends between Australia and other advanced economies is depicted below.

The stimulus measures, and in particular the direct payments to low and middle income households, have also had a significant impact on business and consumer confidence. Consumer confidence is now around 40% higher than the pre- stimulus levels of October 2008, while business confidence is at its strongest level in over seven years.

The effects of the first stage of the stimulus packages, involving increased transfers, are now abating. But the second and third phases of the stimulus - involving significant investments in what was colloquially referred to as “shovel ready” social infrastructure projects and longer term national building projects like roads, rail networks and energy conservation, are now underway. One critical aspect of the social infrastructure projects involved a A$14.7 billion investment in school infrastructure and maintenance. This was part of the February 2009 stimulus package and included resources to: build or upgraded libraries and halls in every primary school and special school in the country; to significantly expand the number of schools with science laboratories and language learning centres; and to ensure every Australian school has resources to maintain and renew its buildings. Further substantial investments in universities and tertiary education were provided in the May 2009 measures, thus furthering the education revolution in Australia.

Deep economic contractions can permanently reduce an economy’s growth prospects through the erosion of skills and capital. The public investments in education plus other social and physical infrastructure were designed to mitigate these effects and position Australia for economic recovery by raising productivity and expanding the supply side potential. Fortunately, with the downturn now expected to be shallower and the labour market recovering rapidly the long term output loss should be mild and the economy should return to capacity sooner than expected.

Australia is in the vanguard of the economic recovery among advanced economies because it took swift and concerted action to boost the disposable incomes of working families and welfare recipients, who spent rather the saved these payments and thus sparked recovery. Australia has demonstrated the potential of an income led growth strategy as advocated by the ILO.  It pays to be lucky and also adopt the right strategies.

Download this article as pdf

---

Bob Kyloh is a Senior Economic Advisor in the Integration Department of the ILO. He has previously worked for the Bureau of Workers Activities in the ILO and the Australian Government.

Beyond “Stimulus” - Fiscal Policy after the Great Recession

(by Andrew Jackson)

As the communiqué from the Pittsburgh G20 summit put it, “it worked”. Unprecedented macro-economic stimulus in the form of ultra low interest rates and large government deficits has pulled the global economy back from the abyss, at least for now. But what comes next? Conventional economic wisdom is setting the stage for deep and damaging cuts to public expenditures if labour and the progressive left do not win the argument for public investment led growth and increased fiscal capacity.

Now is definitely not the time for a quick return to budget balance. Not only is the recovery very fragile, interest rates are likely to remain low. This means we can finance public expenditures which create jobs now while raising our productive potential and the future tax base. Debt incurred today to create a larger economy tomorrow is no burden on future generations.

The IMF, the OECD and most governments accept that stimulus should continue a bit longer while awaiting convincing evidence of a sustained revival of private sector demand. But spending cuts are clearly on the agenda. Citing the need to stabilize public debt in the context of rapidly ageing societies, the International Monetary Fund recently (November 3, 2009) painted a grim fiscal outlook for the advanced industrial countries, calculating that the primary budget balance (the surplus of revenues over program expenditures) will have to be increased by a hefty 8 percentage points of GDP from 2010 levels to bring government debt down to a tolerable 60% of GDP by 2030. The conventional view is that this move back to balanced budgets will have to come much more from deep cuts to public spending than from tax increases.

The dominant view is that both fiscal and monetary policy should tighten over what already promises to be a very sluggish recovery. That is a pretty dismal prospect. It translates into continued very high unemployment and substantial slack in the economy. Operating below capacity means low levels of public and private investment, which in turn lowers the potential for future growth. In human terms, an economy bumping along bottom means no jobs for young people, rising inequality and rising poverty. Moreover, fiscal retrenchment will translate into an unwelcome combination of public sector job cuts, cuts to public services and cuts to income support programs, all of which are central to the well-being of working people.

Workers face the imminent prospect of paying for the economic crisis twice, first in the form of job and wage losses, and second in the form of cuts to the already inadequate public services and social programs which existed in most countries before the recession.

While interest rates should remain low, there are major problems with any combination of fiscal austerity and loose monetary policy. Ultra low interest rates and major injections of liquidity into the banking system are already fuelling new financial asset price bubbles. Led by major institutional investors, the shift back into equities and other assets has got well ahead of any recovery in the real economy. Meanwhile, low interest rates alone will not revive private sector demand. In most advanced industrial countries, especially the US, the UK and Canada, households are already deep in debt. Because of global over-capacity and unbalanced trade with Asia, real private sector investment in the advanced industrial countries is likely to remain very depressed.  Thus fiscal austerity combined with monetary ease will not fix the underlying problem of stagnation.

One way out of this problem is to more closely control the credit process.  We could and should be limiting highly leveraged financial investments and controlling unsustainable credit flows. The other way out of the problem is to run productive fiscal deficits to ensure that the impact of low interest rates is felt through higher public investment. It is desirable that the overall credit creation process should be driven by investment rather than by speculation and debt financed consumption and, under today’s circumstances, this requires high levels of public investment.

Now is the time to launch major medium and long term public investments to drive job creation, and also to create new investment opportunities for industrial sectors which remain in deep crisis. We must address long-standing investment deficits in basic municipal infrastructure; build new urban and inter city transportation systems; invest in energy conservation; dramatically expand non-carbon based energy sources; expand basic public services such as not-for-profit child care and elder care; and invest much more in public education at all levels as well as in workers’ skills.

Well selected investments can yield very high rates of return on a number of fronts. For example, investment in transit and passenger rail can have large positive job impacts, significantly cut carbon emissions, and also generate high rates of return to individuals and businesses in terms of reduced travel time and reduced road congestion. We know that all of these investments – especially those in public services and energy efficiency – are labour intensive and create many more jobs than increased consumer spending, and simultaneously promote our environmental, community development and social justice goals.

What we need is a period of public investment led growth to drive the whole economy. Good public infrastructure and good public services are key drivers of private sector productivity. Public sector investments drive investment by private sector suppliers, especially if twinned to coherent industrial strategies. The key point is that deficits can and should be incurred so long as they are twinned to public investment programs which can be demonstrably linked to increasing overall economic potential and to furthering environmental and social goals. The challenge for labour and the left is to move from talking about temporary “stimulus” to promoting a pro active, longer term public investment agenda.

But how are we going to pay for major new public investments when deficits and debts are, supposedly, already too high? In the short-term, low interest rates make viable a huge raft of potential public and environmental investments which will more than pay for themselves over time. In the longer term, a decade and more of expensive and wasteful tax cuts mainly in favour of corporations and those with very high incomes means that there is ample room to increase government fiscal capacity to balance budgets without cutting spending, and without undermining the living standards of working people.

Labour and the left have to recognize that decent levels of public services and social programs ultimately have to be paid for from a high, comprehensive and fairly flat tax base including consumption and payroll taxes. If we want Scandinavian type welfare states, we will have to pay Scandinavian level taxes as a share of GDP. This reality is often ignored at our peril. In low tax countries like Canada, the US and the UK, we have to make the argument that we are all better off if we enhance fiscal capacity by raising money from a comprehensive tax system, and spending the proceeds on a broad array of equalizing public services and social programs. We have to make the case for a shift from private consumption to public services and public investment, rather than pretend we can deficit finance permanent increments to the social wage.

To be sure, we also need to enhance the progressive elements of the overall tax system. We could and should gain useful amounts of revenue by levying higher rates of income tax on the very affluent. True, the rich are few in numbers, but they do have a high and rising share of personal income in most countries. This should be reduced by raising their taxes and redistributing the proceeds as equalizing transfers. Corporations could also pay more, though there is a case for redirecting higher corporate tax revenues into more effective ways of supporting real economy private investment rather than into general revenues. The G20 agenda should include co-ordinated upward harmonization of taxes on all forms of capital and on high incomes, as well as a financial transactions tax which would hit unproductive but highly profitable financial sector hyper-activity.

To conclude, we will soon be entering a major debate in most countries over the pros and cons of fiscal austerity. The right will argue that we need to cut quickly and deeply in the name of future generations. Our argument has to go beyond the need for temporary “stimulus”. We must call for a deliberate strategy of public investment led growth, and the gradual enhancement of fiscal capacity to pay for a more equal society.

Download this article as pdf

---

Andrew Jackson is Chief Economist and National Director of Social and Economic Policy with the Canadian Labour Congress (CLC), where he has worked since 1989. He is also a Research Professor in the Institute of Political Economy at Carleton University, a Research Associate with the Canadian Centre for Policy Alternatives, and a Fellow with the School of Policy Studies at Queen’s University. He has written numerous articles for popular and academic publications, and is the author of Work and Labour in Canada: Critical Issues, published by Canadian Scholars Press (2005).

Profits, banks, and the state: How to get investment going again

(by Engelbert Stockhammer)

The world is still experiencing the worst economic crisis since the 1930s. While the economic forecasts have brightened up recently, the overall picture is still gloomy. The collapse has been stopped, but the recovery is likely to be muted. This is for three reasons. First, US households, which have been the most dynamic source of demand in the past decade, are deeply in debt – and their houses, the biggest part of their wealth, are worth a lot less. Thus they are not likely to resume spending in the near future. Second, the banks are still in a lot of trouble. The big bank crash after Lehman Brothers has been avoided, but their balance sheets are still loaded with dubious assets and most make their money from trading, i.e. speculating, rather than from extending credit to businesses. It will be hard to get credit for a while. Thirdly, government expenditures that have prevented the meltdown are being rolled back. After the panic of late 2008, normalcy has returned to economic policy making. And in a neoliberal world it is considered normal that states have to balance their books, rather than help the economy or the poor. In short, while the worst is over, the bad is still to come. In particular, unemployment is still rising and will continue to do so.

So how could we get the economy going again? The key component of growth in a healthy economy is investment. Investment is an important source of demand, but it also provides the capital stock needed for future production. There are two types of investment: private and public. Private investment depends on business expectations about demand and profitability and on the availability of credit. Given the extent of the present crisis, it’s unsurprising that businesses are reluctant to invest. Academic research has clearly identified demand as the single most important determinant of investment. Indeed, who would invest if they think they can’t sell the output? The lesson for policymakers is clear: stabilise demand or the private sector won’t invest.

Obviously capitalism is about making money, so firms are unlikely to invest unless they expect to make a profit. However, the importance of profits for investment is often overstated. Indeed, one of the great puzzles of the past decades is why firms (at least outside China) have not invested more, given their abundant profits. Looking at the USA and the EU, in 1980 around two thirds of profits were reinvested, while in 2007 only half were reinvested. Why don’t firms invest when they are sitting on all this cash? The short answer is shareholder value orientation and globalisation. Firms now distribute a lot more money to their shareholders through dividend payments or through share buy-backs. Firms are run to the benefit of shareholders. Globalisation means that a lot of firms outsource production, reducing investment at home. This has mixed effects in the countries of the South and the East: it increases production there, but this is often in enclaves that are badly connected to the local economies and it often increases inequality.

The take-home from this is that the problem is not a lack of profits. Profits have been buoyant in the past without much investment taking place. Wage moderation will thus not help investment. Indeed, it will make matters worse. In particular, in countries with a large enough domestic market, such as Germany, wage moderation will depress domestic (consumption) demand further, creating an environment that is detrimental to investment. In a recent study (with Özlem Onaran and Stefan Ederer) we found that in Europe a redistribution of 1000 € from wages to profits will lead to about 100 € more of investment, but to 35 € less consumption. (Stockhammer et al 2009)

Access to credit is a more legitimate cause to worry about for businesses. Banks with problems on their balance sheets will be reluctant to lend. Monetary policy has so far helped to restore bank profitability, but has not been effective in ensuring that banks lend. Simply put, banks can earn a lot of money now, taking credit from the central banks and buying government bonds. There is no need to bother with old-fashioned business credit. Perversely, governments in many industrial countries now own substantial parts of the banks. But they are reluctant to interfere with their policy. Instead they have provided capital for the big banks in need and now watch how they are run in the interest of shareholders again.

All this may sound like there is little that governments can do to stimulate investment. But this is far from the truth. There is not only private, but also public investment. In the 1930s, public investment projects were used on a massive scale to revitalise the economy. However, today there is great reluctance to do so. Indeed, the IMF and the OECD are eager to push governments to turn to a more restrictive policy. Now with the shock of the imminent collapse over, business is returning to normal – and this means a small state. As if nothing had happened in the past two years! Much of this approach is a legacy of the neoliberal domination that has preached the superiority of private investment over public activity. But the near-meltdown of the financial sector in the 2008 should have made it clear that the private capitalist sector does not possess the miraculous properties of efficiency. Sure, governments often fall prey to corruption and may serve petty interests, but so does the private sector. Remember Bernard Madoff? Or Enron?

How should public investment be financed? Of course the largest demand effect will arise if government expenditures are credit financed. However this will also increase public debt. If expenditures are financed by raising taxes, ways to do so in a progressive manner include closing tax havens, establishing wealth taxes and a financial transactions tax. All of these could raise substantial amounts without negative effects on demand. Closing overseas tax havens has been estimated to have the capacity to generate global additional revenues of US$100-billion (Cavanagh et al 2009). A recent study found that a (worldwide) financial transactions tax of 0.1% would raise about 1.5% of world GDP (Schulmeister et al 2008).

Thus the pragmatic question should be whether there is a material need for investment projects in public infrastructure that the private sector is unlikely to provide. And the answer is a clear yes. From modernising (or building) public transportation to investing in energy-saving technology and from spending on education to housing projects, there are plenty of areas where the social return to public investment is large enough to justify spending. Now is the time.

Further readings and references:

Cavanagh, J, Collins, C, Goldberg, A, Pizzigati S. (2009): Reversing the Great Tax Shift: Seven Steps to Finance Our Economic Recovery Fairly  http://www.ips-dc.org/getfile.php?id=356

Jetin, B, Denys, L, 2005. Ready for implementation. Technical and legal aspects of a currency transaction tax and its implementation in the EU. Berlin: WEED http://www2.weed-online.org/uploads/CTT_Ready_for_Implementation.pdf

Pollin, Robert, Heintz, James, Garrett-Peltier, Heidi, 2009. The Economic Benefits of Investing in Clean Energy. June 2009. http://www.americanprogress.org/issues/2009/06/pdf/peri_report.pdf

Schulmeister, Stephan, Schratzenstaller, Margit, Picek, Oliver, 2008. A General Financial Transaction Tax: Source of Finance and Enhancement of Financial Stability. Presentation at the European Parliament in Brussels on April 16, 2008 http://www.greens-efa.org/cms/default/dokbin/231/231075.a_general_financial_transaction_tax_sour@en.pdf

Stockhammer, E, Onaran, Ö, Ederer, S. 2009. Functional income distribution and aggregate demand in the Euro area.   Cambridge Journal of Economics 33 (1): 139-159. The working paper version can be downloaded at http://www.wu-wien.ac.at/inst/vw1/papers/wu-wp102.pdf

Download this article as pdf

---

Engelbert Stockhammer is working at the Vienna University of Economics and Business. His research interests include macroeconomics, income distribution, financial systems. He recently wrote "The Rise of Unemployment in Europe" (Elgar 2004) and "Wither Mainstream Economics?" (co-editor, Metropolis 2009).

Don’t waste the crisis: The case for sustained public investment and wage-led recovery policies

(by Frank Hoffer)

Returning to the pre-crisis world after timely, targeted and temporary government interventions as advocated by the OECD and others is risky and a waste of public funds. Structural changes in income distribution, taxation and capital markets are needed to address the fundamental causes of the crisis and put social justice and decent work at the centre of a crisis response.

Root Causes of the Global Economic Crisis

In recent decades, wages and transfer incomes have not grown in line with productivity in most countries. In fact, institutional and legal capital and labour market changes, combined with aggressive, short-term profit-maximisation strategies enabled the owners of private enterprises and financial capital to appropriate most of society’s productivity gains. Moreover, threats of relocation or disinvestment resulted in labour market deregulation and casualisation of employment. Such global capital mobility led to the rise of tax havens, transfer pricing and tax competition, reducing the ability of governments to tax capital, thus driving down tax rates and regulation levels. Meanwhile, the high profit rate in the financial industry put pressure on the real economy to produce similar results for shareholders. Thus, the profits of the financial bubble economy became the benchmark for the real economy.

In sum, while income differentials have widened, the tax burden has shifted to employees and consumers, further reducing purchasing power of the people. Throughout the world indecent, precarious and informal employment is increasing.

In many countries, open capital markets overly constrain government’s ability to pursue expansionary fiscal policy, as any increase in inflation would trigger capital outflows and ultimately risk a currency crisis. These capital market constraints, combined with the declining ability to tax, reduced governments’ space for public expenditure, while low wages limited private consumer demand. Nevertheless, overall demand stayed high as rapidly growing private deficit spending backed by asset bubbles disguised the long-term unsustainability of growing imbalances in distribution and trade. It created the illusion that consumption can rise despite a declining wage share, and that wage increases below productivity growth are “only” a problem of social justice, not an economic policy issue.

As long as asset prices go up, a bubble seems to be a free lunch where everybody gains. However, the bubble, like any pyramid scheme, can only continue if more and more people join. The bubble itself creates a need to loosen credit criteria further: as the ratio between actual income and asset prices grows, credit conditions need to be softened to draw new entrees in the (real estate) market. Financial irresponsibility has to grow.

When the bubble burst, it did not just hit the bubble economies; countries with an export surplus-led strategy, priding themselves on their solid financial policies, also saw their “beggar thy neighbour” policies collapsing. They could no longer offset their lack of internal demand through ever-growing export surpluses. The export machines came to a standstill. The export champions realised that they had exchanged real goods against fancy but toxic pieces of paper. Instead of sharing productivity gains fairly in society, they were wasted.

Saving the financial system by bailing out the irresponsible banks is insufficient to address the underlying imbalances and to increase aggregate demand. During the economic downturn, private investment will remain sluggish. Over-indebted consumers cannot continue to spend beyond their means. There is no alternative to continued substantial counter-cyclical monetary and fiscal state intervention.

But state intervention can only be lastingly successful if accompanied by policy measures to correct the dysfunctional wage developments of the past decades, to build a genuinely fair and progressive tax base and change the dysfunctional global capital markets.

A Decent Work Response

In a global economy, coordinated global responses are the optimal solution. This requires national and international rules for capital and labour markets. The ILO’s Global Jobs Pact offers a policy framework to meet these needs.

Investing in the Future, Creating Employment and Increasing the Social Wage

Under the conditions of a slump, public investment has a higher employment intensity than tax cuts. The provision of universal quality public services and infrastructure is key to reducing inequality, building inclusive societies and increasing opportunities for the poor. Universal quality education, health service, affordable housing, and other freely accessible public services reduce the need for individual savings and increase the proportion of people’s disposable income.

Preventing Wage Deflation and Promoting Wage-led Recovery

Increased public investment must be complemented by institutional measures to avoid wage deflation, reduce wage inequality, ensure that productivity gains translate to higher wages, and thus to ensure a sustainable consumption pattern. Combining centralised or coordinated collective bargaining with minimum wage legislation is most suitable to establish a wage floor and compress wage differentials. Increasing the wage share and strengthening the wages of low-income workers in particular leads to an increase of overall consumption, as poor households spend a higher share of their income. Simultaneously, precarious employment relationships must be limited as they have been used to circumvent labour rights and collective bargaining agreements. Labour clauses in public contracts must require contractors and sub-contractors to pay the prevailing collective bargaining wage rate. Moreover, public sector employment must be increased and public sector wage levels must be maintained to serve as an additional wage anchor.

The state has to combat employer’s aggression against the desire of workers to form or join a trade union. It needs to level the playing field through legal mechanisms of extending collective bargaining coverage and worker representation at the workplace. Any bailout or state subsidies must hinge on worker participation in the restructuring through collective bargaining processes and agreements.

Maintaining and Extending Social Protection

Social security systems are the fastest and most efficient way to provide income replacement for workers in a crisis situation. Comprehensive social security systems act as automatic stabilisers and must be extended during an economic downturn to stabilise income levels and overall consumer demand.

In developing countries without comprehensive social security systems, a social floor that includes a basic pension, child benefits, access to healthcare and temporary employment guarantee schemes or cash transfers for the under- and unemployed is urgently needed to lift millions of people out of poverty. It contributes to increasing demand and is a necessary complement to any effective minimum wage legislation.

Finally, governments must protect retirement savings. Pay as you go systems are clearly less vulnerable through capital market volatility. Any pension scheme - private or public - must be legally obliged to guarantee at least a minimum rate of return equivalent to government bonds.

Making the Necessary Global Structural Changes

The suggested measures will be difficult to implement and impossible to sustain without restructuring the global financial system that has propelled the failed economic regime.

Regaining the ability to tax capital

Tax havens must be closed. To solve this issue, banks that work in tax havens, either directly or through subsidiaries, or that engage in other tax theft operations, should be barred from major US or EU financial centres. Requiring multinationals to report their global profits and pay a unitary tax; treating as a unit all the business that is done under one ownership, then estimate what proportion of its income was earned in a specific country and apply its national tax to that income. Transfer pricing and financial dislocation would become rather unattractive. Wealth and heritage taxes and marginal tax rates on high income must be increased to rebalance the tax burden in society and increase the purchasing power of ordinary citizens. Property taxes on high value real estate would be a first step that could be introduced relatively easily even at the national level.

Downsizing speculative and high risk activities of the financial industry

A small tax on stock market transactions would abolish unproductive financial market speculation based on minimal margins and high leverage. A high capital gains tax on short-term profits would reduce incentives for speculative trade in financial markets. Higher reserve requirements for banks and more conservative rules for mortgages reduce the probability of asset bubbles. Banks can only be allowed to operate as private enterprises if they bear the risks of their investment and never become too big to fail. A diverse banking system - incorporating state-guaranteed savings banks, clearly mandated public development banks and private banks - is needed to reduce the institutional lobby and blackmail power of the financial industry. Rating agencies that are fully independent from the financial industry has to ensure better risk assessment. Investor protection against toxic products must be provided through compulsory state certification of all financial products. Risk-taking by pension funds needs to be limited by insisting on a guaranteed minimum rate of return.

Conclusion

Without structural changes as proposed above, we risk wasting today’s crisis. The unconditional promise of governments for universal bailouts after the collapse of Lehman Brothers has indeed increased the moral hazard problem. Pumping money into the system without addressing the causes of global imbalances is dangerous and unsustainable, and may soon lead us into another financial crisis. However, governments will have much less financial firepower, then, because the ammunition was used for another Wall Street firework display instead of closing the casino.

Further links:
Recovering from the crisis - The ILO Global Jobs Pact
The Financial and Economic Crisis: A Decent Work Response

Download this article as pdf

---

Frank Hoffer is senior research officer at the Bureau for Workers' Activities of the ILO. He writes in his personally capacity.