A low-gear world

A low-gear world

It is now seven years since the Great Recession started across the major economies. As American leftist economist, Dean Baker recently pointed out when referring to best-performing major capitalist economy, the USA: “usually an economy would be fully recovered from the impact of a recession seven years after its onset. Unfortunately, this is not close to being the case now….It would still take another 7-8 million jobs to bring the percentage of the population employed back to its pre-recession level.” He continues: “it would take us more than four years to get back to pre-recession employment rates. This translates into roughly $700 billion a year being thrown in the garbage… That comes to more than $2,000 per year for every person in the country”.

It is a damning indictment. We could add to Baker’s list that, outside the US, unemployment rates have hardly fallen from high levels in most of Europe, GDP is still below the level of 2007 in many countries and GDP per person is even lower. Above all, real incomes for the average households have stagnated or fallen significantly in most counties including the US and the UK.

In 2014, the median average household income was still down 6.3% from its peak in 2008 and 5.7% from 2000. It had been as low as 9.6% down from 2000.

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But for the top 20%, income has risen 6% since 2008 in real terms and the top 5% of earners had an 8% jump. Indeed, inequality in incomes is just getting worse. In the period 2002-2012 the top 0.01% of earners in the US gained 76.2% in real terms, but the bottom 90% lost 10.7%. In 2012, the top 1% by income got 19.3% of the total. The only year when their share was bigger was 1928 at 19.6%!

According to one survey, 77% of all Americans are now living week-to-week or month to month on their pay, with nothing to spare for the unexpected. The official estimate is that 15% of Americans live in poverty. But the highest wage in the bottom half of US earners is only about $34,000. The number of Americans who earn between just one-half and two times the poverty threshold is 146 million.

Then there is wealth. Despite US households gaining $21trillion in household wealth since 2009 (from rising property prices), the average family is still poorer in what it owns than it was in 2007. According to research from economists William Emmons and Bryan North of the Center for Household Financial Stability, the mean average household’s inflation-adjusted net worth (assets after debt) is $626,800, 2% below its 2007 peak of $645,100. And this mean average is misleading because almost half of all Americans had no net assets at all in 2009 as their debts exceeded their assets.

These inequalities have worsened in the ‘recovery’ since 2009. The OECD reckons that “inequality has increased by more over the past three years to the end of 2010 than in the previous twelve,” with the US experiencing one of the widest gaps among OECD countries. According to the Economic Policy Institute, the wealthiest 1% of all Americans households on average has 288 times the amount of wealth that the average middle class American family does and more than the bottom 90% combined. Just 20 rich Americans made as much from their 2012 investments as the entire food assistance budget, which is designed to pay for families of four earning no more than $30,000 a year. The six heirs of Wal-Mart founder Sam Walton have a net worth that is roughly equal to the bottom 30% of all Americans combined!

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In Japan, it is a similar, but worse, story. For the first time since records were collected in 1955, Japan’s population is drawing down its savings and the savings rate (calculated as savings divided by disposable income plus pension payments) turned negative by 1.3% in 2014. It’s a dramatic change from when the Japanese saved nearly a quarter of their income (23.1%) when the savings rate peaked in 1975.

Japanese Prime Minister Shinzo Abe, who has just won another term of office, claimed that his so-called Abenomics would raise wages and employment to revive the economy and defeat deflation or price falls. Yet, earnings (adjusted for inflation) dropped 4.3% from a year earlier in November. It’s the steepest decline since the 2009 global crisis and marks the 17th month of falls. Inflation has clocked in at a 14-month low.

As for Europe, there has been an unprecedented post-war reduction in jobs, average incomes and wealth for the inhabitants of the so-called periphery of the Eurozone: Greece, Spain, Ireland, Portugal, Slovenia and Cyprus, while Italy’s economy has contracted steadily over the last few years.

These facts put a different perspective on the ‘exciting recovery’ that the capitalist media and mainstream economists claim started in the latter part of 2014. Sure, the latest figures for US real GDP growth seemed impressive. Apparently, in the third quarter of 2014, the US economy was expanding a 5% annual rate in real terms (after inflation of prices is deducted). Most analysts see this as a sign that the US economy is now set for sustained fast growth in 2015 onwards and at last we can talk about the end of weak ‘recovery’ since 2009.

But the 5% rate is misleading again. Real household spending was up from a 2.5% annual rate in Q2 2014 to 3.2%. But the bulk of this faster pace was because many households took out health insurance for the very first time under the so-called Obamacare scheme. Other consumer spending was pretty moderate. Without health insurance contributing 0.5% pts, consumer spending growth would have slowed from Q2.

Indeed, business investment grew at a slower pace (albeit at 8.9%) compared to Q2 (9.7%). The joker in the pack was government spending, which rose 9.9% compared to a decrease of 0.9% in Q2. And the main reason for this was a huge increase in defence spending, from 0.9% in Q2 to 16% in Q3! A huge dollop of spending on troops and arms came in Q3 as US troops returned from Iraq.

Government spending contributed 0.8% points of the annualised increase of 5% in Q3. The average contribution from government since 2010 has been less than zero. Without this big jump in arms expenditure, real growth would have been slower than in Q2 2014.

And annualised quarterly figures are misleading. They tell the current pace of change but not how much higher real GDP is compared to, say, a year ago. By the end of September 2014, the US economy was larger in real terms compared to a year ago by just 2.7%. That’s not bad compared to other major capitalist economies, but hardly a staggering pace – and still under the long-term average.

Moreover, the forecast growth rate for the final quarter of 2014 that ended on 31 December is expected to be much less than the 5% just announced. Data already out for that quarter show new home sales falling in November (as it is, investment in homes has been weak). Spending on business investment also fell in November. However, consumer spending may have picked up with the fall in gasoline prices from the oil price collapse.

If we assume, say 2.5% year-on-year (yoy) growth in Q4 (no figures yet), then annual growth in 2014 will end up about 2.4%. The graph below shows that this is pretty much where US economic growth has been since the end of the Great Recession, within a slowing trend in this century.

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More or less at the same time, the UK announced its revised figures for real GDP growth Q3 2014. This came in at 0.7%, up from Q2 (or an annualised 2.8%). Again not bad, but previous GDP figures going back a few years were revised down and, as a result, UK real GDP was reduced from the previous estimate of 3.0% yoy to 2.7% yoy – exactly the same as US growth. It is now clear that the UK did not achieve Chancellor Osborne’s boast of 3% growth in 2014 (again we’ll know when the Q4 data come in). Indeed, Osborne’s claim that the UK economy was the fastest growing of the top G7 economies in 2014 is now under challenge.

And it remains the case that the ‘recovery’ in the UK economy since the Great Recession remains the weakest of the last four recessions.

GDP quarter-on-quarter growth from peak (=100) for previous and latest economic downturns

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Of course, most commentators expect faster growth in 2015 for both the US and the UK. But this forecast primarily depends on household consumption staying firm and business investment growth accelerating. In the UK, in Q3, business investment increased by 5.2% compared with the same quarter a year ago, but fell compared to Q2 by 1.4%, with a significant fall in so-called intellectual property products (-1.3%).

The reality is that UK economic growth remains skewed towards a consumer boom based on cheap credit and government subsidies to the residential housing market. Rising home prices and rock-bottom borrowing rates have encouraged a level of spending by those in work. As a result, real GDP growth has been mainly driven by construction (homes and offices). Construction activity grew at double the rate of services in the third quarter, while manufacturing and production lagged.

UK house prices have grown at an annual rate of 8% or more for the last 12 months, according to Nationwide. This has pushed up land values and benefited the property developers who hire engineers and architects.

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Manufacturing growth has been weak and export growth has been terrible. In Q3, the UK racked up a huge deficit with the rest of the world (£27bn, or 6% of GDP), as consumer imports outstripped exports and income and investment from abroad dropped off.

Most important, UK business investment, while rising in real terms, is not recovering relative to GDP.

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As a result, productivity remains below the level achieved before the Great Recession.

So this is not a normal ‘recovery; it is not ‘a return to normal’. The Great Recession has morphed into what I call a Long Depression with real GDP growth in the major economies well below the historic trend average, led by really weak business investment.

The global economy is stuck in ‘low gear’. As the OECD puts it in its latest report (1), the world economy “is expected to accelerate gradually if countries implement growth-supportive policies”. Note the caveat, IF the G20 leaders adopt more ‘growth-supportive’ measures. The OECD reckons that global real GDP growth was just 3.3% in 2014, but will “accelerate” to 3.7% in 2015 and 3.9% in 2016. But even that will be “modest compared with the pre-crisis period and somewhat below the long-term average.”

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This mild acceleration, assuming it is achieved, and that is open to serious doubt, will be led by the US economy, says the OECD. The OECD recognises that Europe and Japan will be lucky to grow more than 1% over the same period. The stagnation in Europe, particularly the Eurozone, was also confirmed by the latest forecasts from the EU Commission, The Commission cut its forecasts yet again, saying the Eurozone would expand by only 0.8% in 2014, 1.1% in 2015 and by 1.7% in 2016 – the 2016 level the Commission said six months ago would be achieved in 2015. So once again, the Commission has cut its more optimistic forecasts: it always jam tomorrow.

The OECD commented in its report that “we have yet to achieve a broad-based, sustained global expansion, as investment, credit and international trade remain hesitant,” And the EU’s economics commissioner, Pierre Moscovici, repeated much the same thing: “There is no single and simple answer. The economic recovery is clearly struggling to gather momentum”.

Higher profits have enabled US corporations to hoard cash, buy back their own shares to boost the market value of the company and thus executive bonuses and share options, but it has also allowed a relatively faster rise in productive investment, albeit still poor compared with before the Great Recession. Investment in productive assets per head of population still has not reached the peak levels of 2007 in any of the major advanced capitalist economies, but at least the US has done better.

Total investment relative to GDP in the G7 economies stood at 19.3% in 2013 – a decline of 2.6 percentage points relative to 2007. Business investment (i.e. investment in machinery, equipment, transport, structures, and intangible assets) has been especially weak. In the second quarter of 2014, G7 private non-residential investment amounted to 12.4% of GDP, compared to the peak of 13.3% in 2008.

 

G7 private non-residential fixed investment

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This is despite that fact that capital in all the major economies has been squeezing wages and reducing employment to get profit margins and the mass of profit up to record levels.

That is why the IMF, the OECD and others are calling for programmes of infrastructure spending to replace the failure of business to invest. And the EU leaders have announced a new Europe-wide investment plan. The EU projects claims to create 1.3m new jobs over three years, by ‘seeding’ €21bn in public money to ‘spark’ €307bn ($383bn) of additional private investment. This is nonsense, of course. The public money had already been earmarked for projects in previous EU budgets so it is not new money but merely a transfer to this scheme. And it is very unlikely to inspire businesses to join in a public-private initiative. The EU Commission itself estimates that the annual investment gap in Europe stands between €230-370bn, while the plan only offers €100bn a year for three years.

But probably the newest aspect of the current ‘low-gear’ world economy is the spectre of global deflation. World inflation has been very low since the Great Recession, another indicator of the Long Depression that the world economy has been locked into. What inflation of prices there has been was mainly due to the sharp rise in energy prices since 2009. Non-energy price rises have been minimal. But now, with the sharp fall in energy and other commodity prices (metals, food etc), deflation is beginning to submerge economies.

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Oxford Economics finds that if oil prices were to fall to as low as $40 per barrell, then 41 out of 45 countries for which data is available would experience deflation. Some argue that this is good news. This is the line of some mainstream economists. For them, falling prices, particularly in energy and food, will raise consumer purchasing power, and help boost consumer demand and thus economic growth. But for profitability, it is bad news. Inflation of corporate producer prices has been a ‘counteracting tendency’ to the tendency of capital accumulation to experience falling profitability. If prices stop rising, then the downward pressure on profitability from any new technology investment will be greater as falling prices squeeze profit margins.

Profit margins are currently at record levels in the US. But the tendency for profitability to fall is still there. A recent paper by Barclays Bank on US corporate profitability explained: “higher profit margins are not leading to higher rates of return on capital. Indeed, profit margins have climbed steadily higher for nearly three decades. But return on capital measures such as return on invested capital (ROIC) and return on equity (ROE) have not.” Barclays’ economists offer an answer to this conundrum: “We believe the answer is less asset turnover, defined as the ratio of revenues to assets. If a company generates fewer revenues per unit of assets, then it must earn higher margins on those sales to maintain the same return on capital.”

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In other words, higher profit margins have not been enough to compensate for the cost of investing in assets and make them work fast enough to generate more profit. This is what Marx would have called a rising organic composition of capital (the cost of machinery outstripping the cost of employing labour) rising faster than any increase in the rate of exploitation of labour (margins). This is Marx’s law of the tendency of the rate of profit to fall – and it continues to operate in the US economy.

 

Why does the cost of accumulated investment in machinery, plant and technology outstrip the gain of record high profit margins? One of the reasons is that the vast majority of the value of the existing capital stock is in structures—houses, apartments, and offices—rather than equipment or ‘intellectual property’ (software etc). Advanced technology accounts for only a small fraction of the capital stock, and this fraction has been roughly stable over the last several decades.

 

Structures continue to comprise the vast majority of the private capital stock in the US—175% of GDP at current prices. The other components of private capital—equipment, intellectual property, and consumer durables—are much smaller, and within them the share of capital related to automation and the information revolution is smaller still. Within equipment, for instance, “information processing equipment” (computers, communication, medical, etc.) is only 8% of GDP, as compared to 27% of GDP for all other equipment. Software is 4% of GDP, versus 11% for other intellectual property. And technology-intensive consumer durables (computers, TVs, phones, etc.) stand at 3% of GDP, as opposed to 27% for other durables.

 

So the productivity-enhancing effect of investment in new technology and the holding down of wages and employment may boost the rate of surplus-value and profit margins. But even this is not enough to drive profitability back up to pre-crisis levels, especially when many businesses face higher debt levels and a slow growth economy.

Indeed, the huge cash hoards that the largest companies in the G7 economies built up in recent years by squeezing wages and jobs and not investing are now beginning to decline as companies buy back their own shares and pay out dividends to their shareholders.

G7 non-financial corporations’ net cash flows

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Debt in most mature capitalist economies remains. And as the EU Commission in its latest report (2) puts it: “recoveries following deep financial crises are more subdued than recoveries following normal recessions…recent estimates suggest that it would take about 6½ years (median) or eight years (mean) to return to the pre-crisis income level in the wake of a deep economic and financial crisis”… but in fact, “the recovery from the recession in 2008-09 has been slower than any other recovery in the post-World War II period on both sides of the Atlantic.”

So the global financial crash is the biggest factor in making the recovery slower than normal. The crash and the subsequent bailout by governments across the major economies, by incurring more debt, left a heavy burden of debt financing, despite near zero interest rates. As the OECD shows, overall debt levels in the main economies are higher now than they were in 2007. And China too has built up debt that is close to many advanced economies.

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The EU Commission makes the point that a possible reason why the US economy has recovered better is that “US corporations have cut debt more than those in the euro area. This has been supported by positive profitability trends providing companies in the US with the internal funds necessary for adjustment of balance sheets.” The EU Commission argues that “delayed deleveraging in Europe can be expected to weigh on investment activity and thus to explain partly the gap between the contributions to GDP growth in the euro area and in the US.”

Financial debt has shrunk as a result of the global financial crash but it has been replaced by a large rise in government debt used to bail out the banks.

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In any event, there are features of the current situation that make the large debt burden, public and private, a big risk to the ‘recovery’. Debt is high and economies are growing more slowly than before the crisis, so they are not generating the incomes to service the debt as rapidly as they were. Household incomes, company revenues and government tax receipts can rise or fall, but debt payments are often fixed. Low inflation, especially if it is lower than borrowers expected when they took their loan, weakens that process and leaves debt burdens heavier than they would have been. Outright deflation would be even more burdensome.

The whole situation reminds me of 1937 during the Great Depression. Then it appeared to the US authorities that the slump was over and it was time to ‘normalise’ interest rates. On doing so, however, the US economy promptly dropped back into a new recession that was only overcome when the US entered the world war in 1941. The reality was that the profitability of capital and investment had not really recovered and raising the cost of borrowing on still high debt tipped the economy back.

The key indicator is business investment. Where investment goes, so will growth. But investment follows profits. Profits call the tune. And in the US, where the economic recovery has been greatest relatively, corporate profit growth has now virtually ceased. If total corporate profits stop growing from here, investment will soon follow.

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And with investment closely correlated with GDP growth, the risk of recession in one year or so looks high. The world economy would then be in reverse gear.

 

Reports cited:

(1) Autumn forecast 2014: Slow recovery with very low inflation – European Commission

(2) Economic outlook, analysis and forecasts – OECD

 

Michael Roberts blogs at thenextrecession.wordpress.com

You can see a presentation by him of the long-term trends in the world economy made at last July’s Marxism festival in London:

https://www.youtube.com/watch?feature=player_embedded&v=85FMJQeK6Kw

or at the November Irish Marxism Festival: https://www.youtube.com/watch?v=TYZK2u2JkX8&app=desktop

Roberts has also just published a set of essays on the issue of Inequality in modern economies.

The print version is available at createspace: https://www.createspace.com/5078983;

and the Kindle version is at Amazon:

http://www.amazon.co.uk/s/?field-keywords=Essays%20on%20inequality%20%28Essays%20on%20modern%20economies%20Book%201%29&node=341677031).

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