Modelling For Growth

Growth forecasts have been downgraded continuously since the government set out its economic strategy in 2010. The so-called long term economic plan is not producing the predicted results. The failure of the economy to respond to government policy suggests that the wrong economic model is being used. Essentially the model doesn’t place enough emphasis on the effects of low demand on economic activity.

Osborne’s model emphasizes supply-side rather than demand-side economics. The argument is that high levels of inequality provide both the opportunity and the incentive to invest. It is good, therefore, we are told, to allow private corporations to hang on to high levels of retained earnings, rather than taxing those earnings away for spending on infrastructure development, local services and to alleviate poverty.

Investment is the goose that lays the golden eggs, or so the story goes. We must not kill off the goose. We must continue to feed the fatted cow. Inequality provides the funds. Inequality also provides the incentives. Inequality fuels the system, or so we have been led to believe.

However, when we look at the facts we see that private corporations have been holding record levels of liquid funds for some time. The problem is that despite the high levels of liquid assets sloshing around in the system would-be entrepreneurs are not investing in the real economy. This is because the return on this type of long term investment is simply not attractive enough. What we see is a high preference for short-term, speculative investments in the economy. Short-term speculative investments do little to fuel the system, they merely lead to over-inflated and, therefore potentially unstable, bubbles in the prices of fixed assets and to asset-stripping, and cost-reduction exercises.

Given these conditions monetary policy is not going to be effective in raising long-term fixed investment to the levels required for expansion of productivity in the economy. Supply-side arguments are simply not persuasive in this economic environment. Interest rates are at an all time low. They can hardly go any lower.

What then can government policy do to kick start real investment in the real economy? The answer lies in addressing the fundamentals, in using economic policy to boost skill levels, infrastructure development and the level of demand for UK goods and services. In other words, what is holding back real investment is the nuts and bolts of the real economy.

Inequality does nothing to encourage investment because of the depressing effect on domestic demand. High levels of inequality stifle growth because the relatively less well off in society have a much higher marginal propensity to consume.The Resolution Foundation, an independent economic think tank founded by a Tory ex-MP, admits that “progress has been much slower than expected”, while noting that “underlying pay growth remains disappointing”. (Resolution Foundation Report. Feb. 2016 p. 3) It seems clear that there is a causal link between these two observations and this explains at least in part Osborne’s failure to meet his own targets.

It is not unreasonable to judge that there is a link between the poor growth performance of the economy and the dire prospects for the most disadvantaged amongst us, yet this government persists with taking from the poor and giving to the rich. It takes a while for the data on inequality to materialise. While statistical measures of inequality are notoriously contentious, what the OECD data for 2012 shows is that income inequality in Britain, as measured by the gini coefficient, is amongst the worst in the world. By most accounts income and wealth inequality in Britain is getting worse not better.

Osborne’s neoclassical economic model does not give enough emphasis to the negative effect of high inequality on economic growth. The assumption that high levels of retained earnings will bring about a high level of investment in the real economy is not holding water.  More austerity for some and more champagne for others is not bringing with it a faster pace of economic recovery, it is actually dragging the economic recovery backwards. The long term economic plan is simply not working. It is time to look at the facts, cross-exomine the assumptions, and switch to a new model.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s