So QE3 here we come. The Bank of England is going to pump another £50 billion into the economy, taking the total amount of extra liquidity since 2009 to £325 billion.

It’s not a surprise, and neither should anybody be shocked that interest rates will remain at 0.5 per cent. Everybody was expecting the Bank to engage in another round of money printing. But will it make any difference?

The measures taken by the Bank of England and the European Central Bank over the past year to ease credit conditions have had little positive effect. The ECB’s programme of reducing the cost of its loans to banks has led to banks borrowing £500 billion from the ECB since the start of the year.

But while the central banks have undoubtedly helped banks improve their balance sheets, these emergency measures are precisely that – emergency. They have done little to help the ailing economic situation. Instead, without lending requirements, the banks have continued their post-credit crunch over-reaction in refusing to lend.

The Bank has rightly argued that the scheme of printing new money and buying government assets with it has helped keep a lid on borrowing costs and inflation. But there is little evidence that banks have passed on the effects to businesses.

In fact, QE has actively hit pensioners’ incomes by depressing annuity rates by up to 25 per cent. What we have, is a situation where extra money worth around 20 per cent of our annual GDP has been printed, yet lending is stagnant as is the UK economy. The stand-off between government, the banks and customers continues.

Stimulating lending is one of the most important tasks in staving off a prolonged double-dip recession. Many businesses are already feeling the pinch, with the likes of clothing-chain Peacocks just the latest high-street shop to close down. Without sustained bank lending, more will have to close their doors.

In fact, Ernst and Young’s Item Club has actually forecast total bank loans to reduce by 2.2 per cent in 2012, with just a marginal improvement of 0.9 per cent in 2013, having increased by an estimated 4.3 per cent in 2011.

The Item Club’s Neil Blake said that 2012 will see:

“The first time there will be an annual contraction in total loans since 2009, when the UK economy was still suffering from the immediate effects of the global financial crisis.”

Rather than rely that enough money will be printed to keep the economic wheels turning, the government or Bank of England should insist that lending targets to small businesses are kept to. There is no excuse for failure, particularly from RBS and Lloyd’s where the taxpayer is the largest shareholder. If necessary, failure to hit the ‘Project Merlin’ targets should result in fines.

Indeed, the reaction of TUC general secretary Brendan Barber to today’s announcement is bang on the money, arguing that the new liquidity must get through to companies if it is to have a positive impact.

Barber commented that:

“More needs to be done to ensure that this latest injection of cash actually reaches the businesses that need it, rather than just gathering dust on banks’ balance sheets. The failure of banks to increase net lending to businesses, despite £275bn of quantitative easing, is holding back growth in the real economy.”

The government and the Bank of England must make sure that the extra liquidity announced today benefits the real economy. There is no value in allowing it to slosh around on the banks’ balance sheets.

See also:

• ConHome: Neuter the Health Bill – Daniel Elton, February 10th, 2012

• The Financial Times comes out against the NHS bill – Alex Hern, February 9th 2012

• Don’t believe the spin – the health reforms are Cameron’s just as much as Lansley’s – Shamik Das, February 8th 2012

• Miliband goes on attack as fight to save the NHS stepped up – Shamik Das, February 6th 2012

• Sign my petition to drop Lansley’s monster – Dr Kailash Chand OBE, November 24th 2011

Josh Ryan-Collins is senior researcher on monetary reform at the New Economics Foundation

As the economy slides towards recession, the Bank of England today announced today it was creating a further £50bn worth of ‘quantitative easing’ (QE).

If you read articles on the topic in the media, you will see statements like “the Bank is ‘printing’ money” or the Bank  will “pump a further £50 billion in to the economy”.  Both these statements are misleading.

QE actually involves the Bank of England buying financial assets – usually government bonds – belonging to institutional investors and sitting in Banks. The Bank buys these assets with newly created central bank reserves.  These reserves can only be held by banks – they do not and cannot go to businesses the real economy.

As explained in nef’s Where Does Money Come From?, central bank reserves are used by commercial banks to settle payments with each other.

By ‘pumping’ more reserves in to the intra-bank clearing system the idea is that banks will feel more confident about making loans to the real economy because they will know that other banks are in a stronger position to settle with them.

In addition, by buying up ultra-safe government bonds in vast quantities and thus pushing down the yield (the interest received on holding) on these assets, the central bank hopes to encourage investors to buy higher yielding corporate bonds – which again provides money for real businesses.

QE may reduce long-term interest rates, but there is little evidence it has stimulated commercial banks to start lending more to businesses, in particular small businesses, or soften the conditions banks are attaching to loans.

In fact the most recent figures published by the Bank show that net lending – the amount of loans minus the amount repaid – to small businesses has contracted by six per cent in the year to November 2011. And this despite the banks being given small business lending targets by the government through ‘Project Merlin’.  Not much wizardry there then.

The hard truth is that commercial banks are still in a process of ‘de-leveraging’, more keen on getting their loans repaid and building up their capital base than making new loans to productive businesses in what is perceived to be a risky real economy.

Evidence suggests the additional funds provided by QE are more likely to be used by banks to create more speculative credit, not least commodity speculation,  that provides shorter term returns.  As a result, the money supply in the real economy is contracting just at the point where new investment is most needed.

But there are alternatives. The central bank, working with the government, could find ways of channelling newly created central bank money more directly in to the economy.

In a pamphlet released today, economist Richard Werner, who coined the term quantitative easing whilst commentating on the Japanese economy in the 1990s, and Green Party leader Caroline Lucas, argue that the Bank of England needs to rethink its strategy.

They suggest a massive ‘green quantitative easing’ program, involving the creation of a new entity – or a beefed up green investment bank perhaps – that could issue corporate equity or bonds purchased by the Bank of England and then use the funds to embark on a £70 billion green QE program for solar PV and energy efficiency in homes.

According to the calculations in the report, this would create 200,000 jobs and save households up to £250 per annum in reduced electricity bills. On top of this, green QE could finance the £16 billion green deal energy efficiency program for homes the government is planning, creating 65,000 jobs in insulation and construction by 2015.

If the Bank of England objected to buying corporate instead of government assets, the Treasury could guarantee them much as Obama’s administration guaranteed green loans in the United States to help kick-start the economy following the financial crisis.

Pension funds should also be happy to buy up such assets given the long term (25 year) secure returns generated through the Feed-in-Tariff and household repayment of energy efficiency loans by households met through the savings on heating bills.

The government and Bank of England needs to accept the fact that our banking system is not currently longer fit for purpose – assuming the purpose is getting money in to the real, productive economy.  It could take decades to restructure our banks so that they become functional again.

In the meantime, we should abandon ‘orthodox’ QE and find better ways of exploiting the Bank of England’s power of money creation.  Creating hundreds of thousands of jobs, tackling climate change and fuel poverty and improving energy security seems like a reasonable place to start.

See also:

• We’re all economists now, part one – Ben Mitchell, February 4th 2012

• Will quantitative easing work this time? – George Irvin, October 9th 2011

• Quantitative easing: The latest windfall from us all to “country London” – Ranjit Sidhu, October 8th 2011

• Could earnings-based rent-control replace quantitative easing? – Peter Morgan, September 26th 2011

• Osborne set to U-turn on QE – so why not on Plan B? – Shamik Das, September 12th 2011

While both Germany and Japan have reported bad news on trade in recent days, the UK’s export performance has picked up. New figures released today undermine George Osborne’s claims that the Eurozone was to blame for the contracting British economy.

Trade figures released this morning by the Office for National Stastics show that the UK’s trade deficit was £1.1 billion in December compared with a deficit of £2.8 billion in November. This is the smallest deficit in nine years.

The deficit in traded goods to the European Union fell from £3.9 billion to £3.4 billion while the deficit in goods to the rest of the world fell from £5.0 billion to £3.7 billion. These changes were primarily driven by a drop in imports but exports were up by £200 million – with an equal contribution to the EU and elsewhere.

Last month’s figures for growth in the fourth quarter of 2011 showed that overall economic activity had fallen by 0.2 per cent. At the time, George Osborne blamed the Eurozone crisis for the decline but figures released by the House of Commons library a few days earlier had shown that over the course of 2011, growth in trade was all that kept Britain growing.

As Guido Fawkes has noted,

“It is a myth that the decline in GDP has anything to do with the €uro-crisis leading to a decline in exports to the €urozone. The barriers to growth are a domestic problem.”

The Bank of England remain sufficiently worried about the economy to announce a further £50 billion of quantitative easing. According to the Telegraph, the ONS indicated today that the positive trade figures and a boost for manufacturing were not enough to change the first GDP estimate for the fourth quarter of 2011, which showed the economy shrank by 0.2 per cent.

But they do make it less likely that Britain has avoided a technical recession by growing in the first quarter of 2011. For once, the OBR may find that their predicted rise in GDP of 0.1 per cent in this quarter is accurate. The chancellor will certainly hope so.

See also:

• Economic Update – February 2012: Double dipped – Tony Dolphin, February 7th 2012

• US grew almost twice as fast as UK in 2011 – Will Straw, January 27th 2012

• The double-dip begins – Tony Dolphin, January 25th 2012

• Hopes of an export and manufacturing-led recovery recede – Tony Dolphin, August 9th 2011

• What an export-led recovery may mean for the world – Nick Dearden, January 25th 2011

The UK economy may be back in recession, on the technical definition of two consecutive quarters of declining real GDP. UK Gross Domestic Product contracted by 0.2 per cent in the final quarter of 2011 and many economists think that it will contract again in the first quarter of this year.

The chancellor said the drop in output in the final quarter of 2011 ‘was not entirely unexpected’ and this is true in the sense that economists have been predicting it for the last few months.

But just six months ago, there were very few forecasters expecting the UK to return to recession.

It is convenient for the government to blame the deepening euro zone crisis for this development, and it has probably had some effect on consumer and business confidence, and thus on investment spending and hiring.

But exports have been relatively resilient and weak domestic spending is the main problem. This is due to the squeeze placed on household spending power by higher commodity prices, the increase in VAT and the government’s cuts in public sector employment.

Provisional figures show the UK economy contracted by 0.2 per cent in the final quarter of 2011.

As a result, growth for the full year was 0.9 per cent. Growth over the four quarters to the final quarter of 2011 was 0.8 per cent, though this figure is flattered by comparison with the final quarter of 2010 when output was hit by bad weather in December. Underlying growth over the last four quarters was probably as low as 0.3 per cent.

Various explanations for this poor performance have been put forward and most economists believe some combination of them is to blame. They include: the fact that recoveries from recessions caused by the bursting of asset bubbles tend to be weak, the effect of high food and energy prices on households’ spending power, the euro zone crisis and the speed with which the government is choosing to cut its deficit.

What happens next appears to depend primarily on developments in the eurozone. At best, growth in the UK economy during 2012 will be a little better than in 2011 (i.e. better than 0.3 per cent over the year to the fourth quarter) as lower inflation eases the squeeze on households.

At worst, a deepening of the euro zone crisis could lead to a renewed credit crunch and reversal of recent increases in business confidence, turning what could be a mild recession (if it is a recession at all) into something more serious.

These increases in business confidence – in manufacturing and in the service sector – are intriguing. Despite a collapse in consumer confidence and no let up in the gloom coming out of Europe, they suggest companies have started 2012 in a more optimistic frame of mind. This is certainly not consistent with the notion of the economy being in recession.

1. GDP declined by 0.2 per cent in the fourth quarter: Preliminary figures show real GDP was down 0.2 per cent in the final quarter of 2011. Output of production industries contracted by 1.2 per cent, construction was down 0.5 per cent and service sector output was unchanged.

Few details are available but it is likely that destocking by manufacturing companies was the main factor behind the fall in GDP. Over the last year, excluding the bounce back from last December’s bad weather, growth has been just 0.3 per cent.

2. Retail sales volumes have improved as inflation has eased: The volume of retail sales increased by 1.1 per cent in the final quarter of 2011 (making it unlikely that lower consumer spending was a factor contributing to the fall in GDP), while the value of sales was up 1.7 per cent.

Despite low wage inflation and rising unemployment, households are still willing to increase their spending on the high street and the internet.

The increase in prices – 0.6 per cent – in the final quarter was lower than recent experience, so this extra spending converted into the strongest quarterly growth in sales volumes since the second quarter of 2010.

3. Consumer confidence is at a near record low: Consumer confidence is at near record low levels, reflecting worries about rising unemployment and the euro zone crisis and a deteriorating outlook for the housing market. On previous occasions when confidence has been this low, the economy has been in recession.

4. Business surveys improve in January: Contrasting with the gloom among consumers, business confidence started 2012 on a more buoyant note. The purchasing managers’ survey of manufacturing recorded a jump in confidence, output and new orders in January, lifting the overall index to 52.1, which suggests the sector is expanding again.

The latest CBI monthly survey showed a similar picture. Meanwhile, the service sector index rose to 56.0 – a ten-month high. In the past, confidence around these levels has been consistent with the economy growing at around its trend rate – about 0.6 per cent a quarter.

5. Manufacturing output is weak: Manufacturing output fell by 0.2 per cent in November and was 0.6 per cent lower than a year earlier. The trend in output has been flat to lower for several months. Performance has become mixed across sub-sectors, with output down in seven and up in six over the last year.

6. Modest increase in employment: Employment in the latest three months, to November 2011, was 18,000 higher than in the previous three months and 26,000 higher than a year earlier. However, the number of employees fell by 93,000 over the last year, while the number saying they were self-employed increased by 138,000.

It is not clear whether some of this increase in self-employment represents hidden unemployment. There are also over 1.3 million people working part-time because they cannot find a full-time job.

7. Unemployment reaches 17-year high: On the Labour Force Survey (LFS) measure, unemployment is now 2.68 million – the highest level since the three months ending in August 1994 – and the unemployment rate is 8.4 per cent – the highest since the three months to November 1995.

Over the last quarter unemployment increased by 118,000. The claimant count measure has gone up for ten consecutive months, though in recent months the scale of the increase has been falling and in December it was just 1,200.

8. Price inflation eased to 4.2 per cent: Consumer price inflation fell back from 4.8 per cent in November to 4.2 per cent in December (and from 5.2 per cent to 4.8 per cent on the retail price measure).

There will be a further big fall in January when last year’s increase in VAT drops out of the calculation and cuts energy charges will help push inflation even lower in coming months. By the end of 2012 consumer price inflation could be below its two per cent target rate.

9. Wage inflation stuck close to 2 per cent: Average earnings increased by 1.9 per cent and regular pay was also up 1.9 per cent over the year to the three months ending in November 2011. Regular pay in financial and business services was up 3.5 per cent, while pay in other sectors only increased by around 1.5 per cent.

10. Government borrowing is below last year’s path: In the first nine months of the 2011/12 fiscal year, public sector net borrowing (excluding financial interventions) was £103.3 billion, down from £114.6 billion a year earlier. It appears that borrowing for the whole year is set to come in lower than in 2010/11 despite weak economic growth.

This is the result of discretionary fiscal tightening by the government, but higher price inflation will have helped. The OBR’s latest forecast for borrowing in the full year 2011/12 is £127 billion; this may be undershot.

11. Interest rates remain at 0.5 per cent; QE at £275 billion: The Monetary Policy Committee left interest rates at 0.5 per cent in January and the scale of quantitative easing at £275 billion. With the economy possibly back in recession and inflation now falling, there is speculation that the MPC will increase the scale of quantitative easing, perhaps as soon as at its February meeting.

12. Government bond yields close to historical lows: The 10-year UK government bond yield rose a little in January, but remains not far from 2%. This reflects the poor outlook for growth and the improving outlook for inflation, Bank of England buying of bonds to implement quantitative easing, and the ever-receding prospects of higher interest rates in the UK.

13. Sterling little changed in January: There was little movement in any of the main exchange rates during January.

See also:

• We’re all economists now, part two - Ben Mitchell, February 5th 2012

• We’re all economists now, part one - Ben Mitchell, February 4th 2012

• Look Left – Wonga’s student ‘scam’ comes unstuck - Shamik Das, January 13th 2012

• Economic update – January 2012: Outlook not all bad - Tony Dolphin, January 9th 2012

• “We are spiralling into a prolonged and ghastly depression”: The economy in 2012 - Ann Pettifor, January 6th 2012

The Financial Times has responded to our November article in which we broke the news that George Osborne is set to borrow millions more than he slated Alistair Darling for proposing to before the election.

Kiran Stacey writes:

This was always likely to be a tenuous claim to make, as comparing Osborne’s 2011 plan (the black line) with Darling’s 2010 plan (the red line) was pretty unfair.

Even if Labour’s plan had less impact on growth and so resulted in a smaller increase in borrowing, it is fanciful to think that given the eurozone crisis and weakness in the US, the economy would have grown at the rate being forecast in 2010 if they were in power.

In an attempt to pre-empt our response, he writes:

Labour would respond that their plans would mean more growth, which has not been factored in to these forecasts. Perhaps – but as the IFS says:

The error in estimating the size of the policy impact would have to be implausibly large to lead one to conclude that borrowing would actually have been lower in the absence of the additional tax rises and spending cuts that have been announced since May 2010.

It is important to note that all these discussions are based, broadly, on the same model, the OBR’s, which links growth and the deficit. Using that model, the facile conclusion is that more taxes and less spending will lead to a higher deficit, unless the increase in growth is enough to counteract that.

The IFS accept the OBR’s estimations of the growth impacts of all the governments policies, and conclude that the OBR would have to be very wrong indeed for Labour’s plan to have led to less borrowing.

And it’s not like that’s ever happened.

Earlier this month, Tony Dolphin produced a comparison between the recovery from this recession and from previous ones:

For the FT’s argument to hold water, the unique stagnation experienced from the fifth quarter onwards would have to be entirely due to an external shock, one which a Labour government would have suffered equally from - the Eurozone crisis or weakness in the US, for instance, or the wrong kind of snow.

The problem they have is that slowing predated their preferred excuses, the Eurozone crisis and the weakness of the USA. The UK basically stopped in growing Q3 2010, but the rest of the world carried on for quite some time. Indeed, both UK exports to the Eurozone and Eurozone growth were higher than the OBR predicted, and neither of them helped shrink the deficit.

The UK is unique in experiencing this stagnation, and the Eurozone simply could not have caused it.

The international events are not sufficient to explain the five per cent difference between the recoveries in 1981 and 1992 and the stagnation now. Neither, unless you are George Osborne, is blaming transient national events like snow or a wedding.

The onus is on the FT to explain why the UK experienced poor growth a year before the USA, Germany, France, or the Eurozone as a whole. If they cannot do that, then they must accept that it is due to the cuts and their damaging effect on demand, as has been detailed on these pages ad nauseam.

And a five per cent difference in growth is, according to George’s Marvelous Deficit Calculator, a 4.8 per cent difference in the deficit. Easily enough to leave the Darling plan ahead of the Osborne reality, Eurozone crisis or not.

See also:

• Growth revision shows economic recovery is off track – Tony Dolphin, January 9th 2012

• Economic update, December 2011 – UK teeters on brink of recession – Tony Dolphin, December 5th 2011

• Daniel Elton, November 29th 2011 – Whatever Osborne’s growth forecasts today, the reality is probably worse

• Osborne set to borrow billions more than Darling was projected to – Daniel Elton, November 16th 2011

• UK set for among slowest growth in EU – Will Straw, November 11th 2011

Economics Nobel Laureate Paul Krugman has attacked the “austerity debacle” taking place in Britain and elsewhere, pointing out the UK is “nowhere close” to regaining ground lost during the recession, with the country doing much worse than it had after the 1930s Depression and 1973, 79 and 90 recessions.

In his latest NY Times column, he notes:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart [see Chart 1 below] comparing the current slump with past recessions and recoveries.

It turns out that by one important measure – changes in real G.D.P. since the recession began – Britain is doing worse this time than it did during the Great Depression.

Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s – and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

Chart 1:

He goes on to take aim at British economic policy in particular, accusing the coalition of resorting to “ideologically convenient wishful thinking”, and throwing “hard-won knowledge” gleaned over the past 80 years “out the window”, mocking the idea of expansionary fiscal contraction:

Haven’t we learned a lot about economic management over the last 80 years? Yes, we have - but in Britain and elsewhere, the policy elite decided to throw that hard-won knowledge out the window, and rely on ideologically convenient wishful thinking instead.

Britain, in particular, was supposed to be a showcase for “expansionary austerity,” the notion that instead of increasing government spending to fight recessions, you should slash spending instead – and that this would lead to faster economic growth.

“Those who argue that dealing with our deficit and promoting growth are somehow alternatives are wrong,” declared David Cameron, Britain’s prime minister. “You cannot put off the first in order to promote the second.” How could the economy thrive when unemployment was already high, and government policies were directly reducing employment even further?

As Krugman concludes:

The infuriating thing about this tragedy is that it was completely unnecessary. Half a century ago, any economist – or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” – could have told you that austerity in the face of depression was a very bad idea.

But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.

See also:

• George Osborne is the downgraded chancellor of a deflationary government – William Bain MP, December 8th 2011

• Balls mocks “Panglossian” Osborne over Bullingdon, growth and Boris – Shamik Das, December 7th 2011

• Krugman: Coalition is “bleeding” Britain dry – Alex Hern, December 1st 2011

• Ex-Cabinet Office chief economist: slower cuts are “common sense” – Will Straw, August 25th 2011

• Coalition cuts are deeper and faster than Tea Party’s – Will Straw, August 2nd 2011

Real GDP in the UK fell by 0.2 per cent in the final quarter of 2011 according to figures released today by the Office for National Statistics.

Growth in 2011 as a whole was 0.9 per cent. Growth over the four quarters ending in 2011 Q4 was 0.8 per cent, though this figure is flattered by comparison with the final quarter of 2010, when output was hit by particularly bad weather. Underlying growth over the last four quarters may have been as low as 0.3 per cent.

In the final quarter of 2011 output of production industries fell by 1.2 per cent, probably as a result of large-scale destocking (there are very few details available at this point). Output of construction industries was down 0.5 per cent, while output in the service sector was unchanged.

The recovery from the 2008/09 recession continues to be slow and uneven. Real GDP has increased by 3.5 per cent since the second quarter of 2009. Over comparable periods after the last two recessions, real GDP increased by 7.1 per cent in the 1980s and by 8.8 per cent in the 1990s.

There are various explanations for this poor performance.

First, this is a different type of recession and recovery. Economists have shown that recoveries after recessions that are caused by the bursting of debt and asset bubbles tend to be relatively slow. The present UK experience is adding another case study to their collection.

Second, higher commodity prices during 2011 squeezed households’ spending power and reduced domestic demand growth.

Third, the government’s belief that it could cut its deficit aggressively because the private sector would fill the gap has proved wrong, as the latest employment figures show. While public sector employment fell by 67,000 in the latest quarter (to September), the private sector created only 5,000 net new jobs.

Unsurprisingly, despite the government’s optimism, the more the government talked of austerity, the more reluctant companies have been to step up recruitment or make new investments.

Fourth, the euro zone crisis has also affected business confidence, particularly of exporters. Again, this will have been bad for jobs and bad for investment.

In the short term, as I have been warning for some time, things are unlikely to get much better.

There is some good news: energy firms are bringing down their charges and petrol prices have fallen. This will ease the squeeze on households’ spending power.

But, as the IMF warned only yesterday, when it revised its forecast for growth in the euro zone in 2012 down from +1.1 per cent to -0.5 per cent, the euro zone crisis is an increasing threat to the global economy. Meanwhile, the government is sticking stubbornly to its deficit reduction plans, meaning further cuts in public sector jobs and taking more demand out of the economy.

With public sector austerity at home and a potential crisis in the euro zone on their doorstep, it seems unlikely the private sector will step up its recruitment or investment plans any time soon.

Together, these GDP figures and the short term outlook suggest the UK economy has slipped back into recession. The feared ‘double-dip’ began in the final quarter of 2011.

See also:

• When the private sector collapses for a second time – Cormac Hollingsworth, January 19th 2012

• Manufacturers still fear a double-dip recession in 2012 – Tony Burke, December 23rd 2011

• More grim news: Economists predict UK will be back in recession in 2012 – Alex Hern, December 12th 2011

• Stories from the economy, or: The prospects for young people, and other grim tales – Richard Exell, November 17th 2011

• IMF boss repeats call for Plan B – Will Straw, September 5th 2011

Joe Coward is a research and communications assistant for Resolution Foundation

This morning Liam Byrne and David Laws launched a new Resolution Foundation report, Squeezed Britain, which sets out the economic position of the squeezed middle in forensic detail, offering some pointers towards what will be the key political issues over the next few years.

The report focuses on people on low to middle incomes, who the Resolution Foundation define as working-age households who are living largely independent of the state but with incomes below the median (middle).

This group of 10.1 million adults and 5.8 million households comprises approximately one third of the working age population, living on an average household income of £20,500 after tax.

It is now well established that low to middle income households (LMIs) are experiencing a big squeeze on living standards, and previous Resolution Foundation research has highlighted that this squeeze started long before the recession.

But this report sheds new light on how long the squeeze might last, and when incomes might recover.

It shows that, on the basis of existing forecasts from the OBR, LMI household income is expected to reach a low of £20,100 in 2014-15. But it also sets out two scenarios for what could happen beyond this period:

• If income growth returns to the strong rates recorded in the period 1996-97 to 2003-04, LMI household income would return to its 2007-08 peak by 2020-21;

• If, however, income growth returns to the weak rates recorded in the period 2003-04 to 2008-09, LMI household income would remain stagnant, creeping up to just £20,200 in 2020-21, leaving households no richer than in 2001-02.

The report also tells us how many areas of life are now being affected by this new economic environment. One key implication is that home-ownership is now out of reach for many people on low to middle incomes. In the 1980s and 1990s it typically took a first time buyer 3-5 years to save for a deposit – today it would take 22 years.

As social housing is now predominantly targeted at the most vulnerable in society (and rightly so), this means that the private rental sector is far more than a stop-gap for many low to middle income households.

Indeed, it is now the most common form of tenure for LMI households aged under 35, many of whom are raising children in the private rental sector. Despite record-low interest rates this trend shows no sign of abating.

At today’s event some policy responses were mooted – Liam Byrne hinted at current Labour thinking by suggesting that if government wants to support childcare (and female employment) it may well get a bigger bang for its buck by providing services rather than cash benefits.

Meanwhile David Laws reiterated the Liberal Democrats’ commitment to increasing personal tax allowances for the lowest paid whilst suggesting that generous tax reliefs and allowances for higher rate taxpayers could be curtailed. Wherever, the policy debate ends up, one thing’s for sure – the politics of living standards is here to stay.

See also:

• When the private sector collapses for a second time – Cormac Hollingsworth, January 19th 2012

• In Daily Telegraph-ese, the “squeezed middle” means the very rich – Daniel Elton, July 28th 2011

• Miliband’s “squeezed middle” message gains ground – Dominic Browne, March 25th 2011

• Squeezed middle includes top-rate taxpayers – Will Straw, November 29th 2010

• Battle for the ‘squeezed middle’ rumbles on – Liam R Thompson, October 13th 2010

The squeezed middle is making many sacrifices on the promise that this would sustain economic growth. They accepted that the recession was caused by the bloated public sector.

They were lied to.

The recession was caused by a collapse in the private sector. Because the private sector was the cause, source and ground zero of the collapse, it was the pubic sector that stabilised the private sector, and its support should not have been cut too soon. And now, despite all their sacrifices, the private sector is about to collapse again, and the lie will be exposed.

For the first time since 2009 there are two clear flashing red warning signals that the private sector is about to collapse.

The first is that International Energy Agency has downgraded the demand for energy in the final quarter of 2011.

This is very unusual, as the FT reported, such falls are rare: over the last decade oil demand has posted drops only in the financial crisis.

The IEA’s comment was that they were:

“flagging that there are clearly downside risks to the global economy.”

The second is the collapse in global price of freight, down 43 per cent in the last month. Global trade is slowing at such a rate that you can now hire freight at the same price as the depths of the financial crisis in 2008.

It’s a tenet of the conservative dismantling of our welfare state that it was the bloated public sector that caused the collapse. If that were the case, then the largest cuts in public sector spending should solve the economic problem and growth should accelerate.

Confident that the private sector would accelerate once public spending was reduced, their promise was that there would not be another collapse.

At the time in 2008/9 it was hard to present the needed evidence for people that the collapse was within the private sector not in the public sector. Now we have the evidence, and the best is the employment data. During the 12 months from July 2008, the private sector shed 747,000 jobs.

To put this into context, total employment rose in the 2000’s by 1.5 million, 1.1 million in the private sector, and 400,000 in the public. The collapse of the private sector from July 2008 destroyed half of all the jobs created from 2000 to 2007.

With that level of economic shock, there was always going to be a hole in the government finances. And it was going to take time to remove the problem. And as Duncan Weldon showed, the vast majority of rise in borrowing was a fall in receipts, not a rise in spending. And receipts were not going to rise until the economy began to grow and jobs created.

The annual job creation of the economy was, on average, 260,000 places (190,000 in the private sector), so it was going to take a minimum of three years to get these people back into jobs. If the trough of the crisis was Q1 2009, high government borrowing to support the private sector was inevitable until Q1 2013 at a minimum.

But, in Q1 2011, two years too early, the government withdrew the support for the economy and started the largest pre-war cuts to government spending. They promised that this would unleash the private sector, but instead it precipitated the impending crash.

There are recent UK indicators that confirm this view.

For example, last month labour productivity growth rose above one per cent for the first time for four years. Rising productivity is normally good, but that’s with a backdrop of a growing economy. With no growth in output, rising productivity can only happen if employment falls.

In a flat-lining economy such as ours, a rise in productivity signals that struggling companies are shedding staff to try and keep going.

Three years after the crash you might wonder why this hasn’t happened until now, but companies have been keeping hold of staff in the hope of a quick recovery in the economy. They’ve decided there’s no recovery coming, and are now starting to lay people off.

The shedding of staff will be much worse and the coming slump will throw out of work all those people who went along with the cuts in spending that they thought guaranteed another slump wouldn’t happen.

The squeezed middle is going to be pretty pissed.

See also:

• Manufacturers still fear a double-dip recession in 2012 – Tony Burke, December 23rd 2011

• Unless pay gaps are reduced, we’ll end up with Victorian levels of inequality – Shamik Das, November 22nd 2011

• Without growth will we even halve the deficit? – Cormac Hollingsworth, September 20th 2011

• Borrowing figures make grim reading for Osborne – Duncan Weldon, July 21st 2011

• Economists warn of risk of double dip following poor growth figures – Claire French, January 25th 2011

Ed Balls defended Labour’s new direction on the deficit last night, saying he would not make promises he couldn’t keep, stressing the need for pay restraint and insisting Labour could be trusted to make the big decisions.

The shadow chancellor reiterated the line from his Fabian speech on Saturday and Ed Miliband’s comments in a series of interviews yesterday, and also attacked George Osborne’s failure to deal with the deficit and the lack of jobs and growth.

Watch the interview in full:

Balls said:

“We can’t now make commitments on spending, on tax rises, to reverse what the Conservatives are doing, but nor can we say with any credibility, in the next two years, we think that higher pay for public sector workers should come before jobs, we can’t make that argument… I’m afraid there is now no choice, if we’re gonna keep unemployment down in the future, that jobs should come over pay…

“Labour cannot from opposition change that till we’re in government, and to be in government we’ve got to set out an alternative, but it’s got to be a credible alternative… what we’ve got to do is say there is a better way, a fairer way, to get the deficit down, to get the economy moving, to get growth and jobs back, our five-point plan for jobs and growth, tough decisions on pay, but also doing it in a fair way…

“We can’t make our policy on the basis of now, we’ve got to make our policy on what will be the best way forward for the country, and what could show Labour, in a credible way, can make the difficult decisions when we will be faced with clearing up a very difficult Tory economic mess, which we see all around Britain at the moment…

“I am saying today, as I said a year ago and two years ago, the deficit must come down, there have to be hard choices on tax and spend, but if you go too far and too fast, as I warned consistently over the last year-and-a-half, the danger was it wouldn’t work, the economy would flatline, unemployment would go up, and in the autumn statement George Osborne had to admit, not only all that, that he’s borrowing £158bn more.

“The problem I’ve got is that I can’t wave a magic wand, and sort of just blow away that inheritance, our task as Labour will be to clear up George Osborne’s economic mess…”

He was then asked:

“You’re adopting the view that there is no alternative to these cuts?

Replying:

“That is 100 per cent, emphatically, wrong. I think George Osborne should change course now, his cuts are too far and too fast, he’s crushing growth. The reason our interest rates are so low is cos he’s getting it wrong. Unemployment is going up. He should have now as we’ve advocated, a temporary cut in VAT, increased public investment, repeat the bank bonus tax…

“Len McCluskey is plain wrong. I argued for action now to boost growth and jobs, and I argued for long term reform to make our economy stronger and fairer…

“What I can’t do is make a commitment now that I will know how much money we have, when there will be less money in three years’ time…

“George Osborne is doggedly sticking with a plan that is failing, he should have changed course six months ago, he still can today, he still can in the run-up to the budget and I will say to him, day-by-day, week-by-week, the approach he is taking, too far and too fast, is unfair and is not working. The longer he persists, the bigger the pain, the bigger the damage and the greater the damage in inheritance we will face because of his mistakes…

“The VAT rise last year to 20 per cent was an unfair tax rise which choked off the recovery and has flatlined the recovery, will probably lead to, has led to more borrowing in the economy. It was the wrong thing to do, they shouldn’t have done it, we’re calling for a temporary VAT cut now, but can I say to you today and to your viewers, “I promise as shadow chancellor, in three years’ time, we can definitely reverse that”?

“I will not make uncosted commitments I can’t afford until I know the state of the economy…

“As the shadow chancellor, I’ve got to know that our manifesto is being properly costed in the context of the times and can be paid for…

“I think what they’re doing on disability allowance is a big mistake and it’s unfair, the benefits cap will lead to more homelessness the way it’s been designed, I think the abolition of the Future Jobs Fund will make youth unemployment higher, the taking tax credits away from families on £25,000, hitting women harder, is unfair, wrong and damaging, but the question you’re asking me is can I, to your viewers, make promises now, about three years’ time.

“Nick Clegg made promises, remember that promises not to raise VAT, he broke his promises straight after the election. I’m not going to make that mistake cos that is wrong, and not the right way to do politics, I won’t make that mistake.”

Meanwhile, in today’s Guardian, Balls’s predecessor Alan Johnson hits back against the trade union leaders who have criticised the new direction, saying the union movement is at risk of plunging back to the “fantasy utopias” of the 1970s, and calling the likes of Unite general secretary Len McCluskey and GMB boss Paul Kenny the “delusional left”.

He writes:

“McCluskey’s article in the Guardian reminded me of the ‘culture of betrayal’ that I thought the movement had escaped. According to Len, by trying to position Labour as a credible alternative to the coalition, Ed Miliband has set it on a path to ‘destruction’.

“Stuck in a familiar groove, Len goes on to suggest that all the ills that he claims are befalling Labour are because of actions of so called ‘Blairites’ – those terrible people who introduced the minimum wage and increased the number, the stature and indeed the pay of public sector workers across the country.”

Adding:

“Ed has stated a simple fact; that a Labour government will not be able to reverse as many of the cuts the current government is making unless it can show where the money is to come from.

“The difference between Len’s position and Ed’s is that Len believes a political party can win an election on a platform of promising no cuts, no job losses and continued levels of public expenditure. That is the policy of the delusional left who will never again win the public’s trust.”

“The trade union movement lost its way in the late 1970s when it opposed the minimum wage and supported the closed shop. It needs to recognise that Ed Miliband’s vision of a better future requires a change of mindset throughout the party if we’re to spend one term in opposition rather than a decade.”

Miliband is expected to face further scrutiny of his position today from David Cameron and his Tory backbenchers at Prime Minister’s Questions.

See also:

• Memo to Osborne: Jobs and growth will cut the deficit. Please listen – Cormac Hollingsworth, January 17th 2012

• Balls throws down the gauntlet: “We are going to have to keep all these cuts” – Shamik Das, January 14th 2012

• Economic update, December 2011 – UK teeters on brink of recession – Tony Dolphin, December 5th 2011

• Commons to vote today on Labour’s five-point plan for jobs – Shamik Das, October 12th 2011

• Vindicated Balls gives absent Osborne an economics lesson – Shamik Das, September 15th 2011