Economic Policies for an Incoming Labour Government (Part 6 of 9)

An incoming Labour government could and should stimulate the economy by restoring all the benefits (worth about £20 bn a year) which the Coalition Government has reduced or denied to the low-paid, the sick, the disabled, the poor and the underprivileged. The case for doing so is based not only on social justice and on restoring the integrity of our society but on making good the deficiency of demand that has handicapped our economy as a consequence of austerity.

This would be achieved by creating £20 bn of consumer credit at the Bank of England to fund the policy during that first year. The costs of that credit creation for Government expenditure would be nil and the benefits would be immense. If we assume the average UK tax take of about 42%, government income would rise by about £8.4 bn; but because much of the extra purchasing power might be spent on food and other non-taxed necessities, the tax take might be about half of that – say 21%. On the other hand, the extra spending would have a multiplier effect of about 2, so that the total effect on the UK economy would be a stimulus of about £40bn. Even allowing for a lower than average tax take, the Government would still gain revenue of £8.4 billion, the economy would receive a stimulus of £40 billion (a likely addition to economic growth of about 2.6%) and many of the dire effects of the Coalition’s austerity programme would be negated. The financial condition of Britain’s poorest would be ameliorated; the poor would be more able to afford to eat, heat their homes, pay their bills, and live better lives without worrying where the next penny was coming from.

That policy could be continued in the following years but as the additional government taxes came in from economic recovery the credit required to be created would reduce accordingly eventually becoming nil within the lifetime of the parliament as economic growth increased due to investment credit economics.

The Credit Restoration of the Royal Bank of Scotland

The bad debts of the Bank of Scotland should be immediately purchased in their entirety by the Bank of England, using targeted quantitative easing. Again, it would cost the Government nothing. The Government would have bought assets worth (say) 50% of their book value for nil expenditure. The total bad debts of the RBS are estimated at £38 billion, so the Government would gain assets of about £19 billion in return for no appreciable cost whatsoever. Furthermore, the RBS would cease rejecting loan applications from SMEs, where they are urgently needed but where about three out of four are currently being turned away. There is no good reason why the RBS should continue to do this, when normal business could be resumed immediately.

Through this means, which could be applied to stabilise other British banks as necessary, one of the main and continuing consequences of the Global Financial Crisis – the overhang of bad debts that inhibit the banks from lending – can be negated. Interestingly, one of Richard Werner’s major findings from his inquiry into the reasons for the Japanese stagnation over recent decades was the inhibiting effect of bad debts on the willingness of the Japanese banking system to maintain an adequate level of credit creation and therefore of liquidity. In this instance, we have the chance to learn from Japanese mistakes. We should be clear that the objection based on moral hazard pales into insignificance by comparison with the huge economic advantages from pursuing this course.

Many of those who call themselves economists and many politicians who imagine themselves to be competent will be stunned by these proposals, if the past is any guide. As Keynes commented, “the difficulty lies not so much in developing new ideas as in escaping from the old ones, which ramify, for most of us brought up as we have been, into every corner of our minds.” And as John Kenneth Galbraith, who was a member of the FDR administration when the investment credit creation policy was adopted by the US Government, has said, “the creation of money is so simple that the mind is repelled.”

We should remind ourselves that there is nothing new about the creation of credit by the Bank of England. No less than £375 bn of credit was created to stabilise the liquidity and preserve the operation of British Clearing Banks and £80 bn of such credit was created to support Vince Cable’s proposal to extend business loans to industry.

The novel aspect (in British terms at least) of our proposals is that the proposed credit is to be focused on useful social and economic objectives – on the establishment of more prosperity among the poor and disadvantaged, upon the minimal cost fixing of the RBS and other banks and upon the creation of the kind of bank support for industry and commerce that has existed for centuries in Germany, for about a century in Japan and for about a third of a century in China.

The Mechanisms

The primary objective of the incoming Labour Government’s reforms should be the establishment of a United Kingdom of abundant capital resources and the placement of Britain’s future industries on a sound economic footing. Inseparable from that first objective is the reformation of the British banking system to ensure its future stability and effectiveness. Another objective would be the fulfilment of the Government’s duty of care to the people – the relief of the groups disadvantaged by the actions of the recent Coalition Government and the restoration of full employment as a government objective. Finally, measures should be taken to ensure the permanence and continuity of these reforms through major changes in the machinery of Government. We set out now our proposals for achieving these objectives.

The re-nationalisation of the Bank of England

The Bank of England should be brought once again under Government control. It is unwise for any government to allow any natural monopoly to be fully independent, and the control of credit creation is such a central aspect of government policy that direct control is required.

The operating objectives of the Bank of England, as a central departmental agency of government policy, will be redefined as the promotion of economic growth and the control of inflation within the guidelines of a national industrial and social development plan.

Gordon Brown’s proclamation of the “independence” of the central bank was widely applauded at the time and remains a cardinal – and unchallenged – element in policy today. Yet handing monetary policy over to the tender care of a central bank is simply a reinforcement of the current and increasingly discredited orthodoxy that inflation is the only concern and proper focus of monetary policy and that its treatment is simply a technical matter that is properly the preserve of unaccountable bankers, and is not to be trusted to politicians. Quite apart from the undemocratic nature of this approach, we have paid a heavy economic price for allowing the bankers’ interest to prevail over the interests of the economy as a whole.

It is easy to see why the bankers – and the economists who work for them – should support this. It is less easy to see why the politicians should so readily have accepted it. Yet the answer is fairly clear. It has suited the politicians well to be able to argue that the travails of the economy arise as a consequence of inexorable economic forces which must kept in check and marshalled by expert technicians. Our governments have thereby been able to disclaim any responsibility for policies for which they should be ultimately responsible.

As a matter of interest, this very issue was succinctly discussed by members of the Japanese Committee on Financial System Research (Kinyu Seido Chosa Kai) as it considered whether to revise the 1942 Japan Law that established the Bank of Japan’s primary objective as the promotion of economic growth. On that Committee, Dr Shimomura represented the Ministry of Finance, while his opposite number was Mr Shigeo Matsumota, representing the Bank of Japan.

Dr Shimomura is reported as having “stressed the inevitable subordination of the central bank to the government from two standpoints – that the policy of the central bank should be managed and operated in full coordination with the general economic policy of the Government and that the Government on its part is called upon to hold itself responsible to the nation for the outcome of its financial policy.”

Mr Matsumoto on the other hand “emphasised the necessity of maintaining the independence or neutrality of the central bank from the Government on the ground that the central bank is first of all assigned with the task of contributing to the stabilisation of the currency value’.” [1]

What is clear is that an economic policy that breaks the shackles of current orthodoxy would necessarily have to be removed from the exclusive and self-interested control of bankers. It would need to be driven by politicians who saw the need to ensure that the wider interest is carried into policy and is an essential element in setting its direction and gaining for it the necessary support.

© Bryan Gould and George Tait Edwards 2015

1. From “The Political Economy of Japanese Monetary Policy” by Thomas E Cargill, Michael M Hutchinson and Takatoshi Ito, The MIT Press, Cambridge Massachusetts and London, England, p24.

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This post was written by Bryan Gould and George Tait Edwards

Economic Policies for an Incoming Labour Government (Part 5 of 9)

In studying what actually happened and then testing various explanations for consistency with the observed data, Professor Richard Werner of Southampton University has placed himself firmly in the first tradition in Western economic thought. That first tradition, dating from the time of Adam Smith, derives economic conclusions from detailed observation and inductive reasoning based upon the observed facts and data analysis. The second tradition, most highly developed in the 20th century with the development of mathematical economic models and more lately computers, develops a body of deductive reasoning based upon stated theoretical propositions.

The “bottom up” tradition of observing what is happening, building economic understanding on the foundation of the observed circumstances or measured data, and arguing from the observations or the data to the economic theory is exemplified by Adam Smith’s, The Wealth of Nations. An example of his technique is his reference to the productive power of specialisation, which he establishes by referring to the workers in a pin factory, and demonstrating how, by breaking down the elements of production into their constituent parts, a few specialised workers can create thousands of pins a day when one man could hardly produce one pin per day on his own. Smith’s book is a major illustration of the major scientific principle – revived in the Renaissance – of learning by observation, extracting the particular principle from the general, and basing theory upon precise, real-world, observation.

The one common factor in the work of Adam Smith, and of John Maynard Keynes, Osamu Shimomura, Kenneth Kurihara and Richard Werner is that they all belong to the first tradition in economics, the derivation of valid theory from detailed observation. Smith in the pin factory; Keynes in his observation that labour markets, left to market forces, do not produce full employment; Shimomura deriving the economic model for Japan from his observation of the productive force of credit creation in the USA from 1938-44; the Japanese-American Kurihara – examining and discussing the Japanese economic miracle in close-up while acting as the Fulbright Professor to Tokyo University in 1965; the German-born and Japanese-fluent Werner in Tokyo, working from the Bank of Japan financial data about credit creation in Japan, and analysing it into its three key functions of investment credit, financial credit and the presence (or lack of) consumption credit, and then proving the predictive linkages using Granger causative analysis – the work of all these economists is located in the great inductive tradition of economics.

The second and more recent tradition in Western economics is the “top-down” approach. This starts from explicitly stated but theoretical assumptions and then proceeds logically from these to policy recommendations, using deductive reasoning and highly developed mathematics. A number of assumptions are made – that consumers and investors act within perfect markets, with access to perfect information, in a world in which perfect information has leveled out local differences. On this basis, deductive logic arrives at economic models which appear to have great logical validity but which – as Keynes asserted – may bear little relation to reality. In view of the imperfect outcomes of this second approach, as evidenced by the declining fortunes of many western economies, there is much to be said for a return to the methods used by Adam Smith and his great successors.

Three Practical Illustrations of the Use of Credit Creation

As we have seen, if credit creation is left to the tender mercies of self-interested commercial banks, credit will be largely devoted to gambling on property creating a housing and other asset bubbles so as to maximize profits for private shareholders while the real economy languishes for want of adequate liquidity and investment capital, and the economy as a whole is handicapped by a shortfall in effective demand.

An incoming Labour government, however, fully understanding the use of credit creation in the public interest, could resolve many outstanding problems. We provide three examples of the way in which this would work to achieve quite different kinds of objectives.

The Acceleration of British Economic Growth Through Higher Investment

This aspect of central bank credit creation is by far the most potent policy within a government’s control. It would allow the government to create earmarked investment credits, cost-free, for use by SMEs and other private companies to ensure the fulfilment of the Government’s economic, social and environmental policies.

The provision of these funds would be directed by the Bank of England, reflecting advice from the Treasury – a technique described as “Window Guidance” when used by the Bank of Japan in using similar mechanisms in the 1960s and 1970s. There would need to be a bank which was, or ideally a number of banks which were, prepared to use its local branches as taps for local investment (as the Sparkassen in Germany are) and not just as currently occurs – as drains to collect local saving, taking it away for whatever fashionable policy use the London HQ decides.

The initial creation of credit could be at the level of about 10% of GDP, that is about £150 bn a year; multiplier effects might create an eventual new level of commercial and industrial funding of about £300 billion. We would expect these funds to be initially used to provide an improvement of about £100 billion in business liquidity, about £100 billion in early new plant and equipment investment and about £100 billion in funding higher levels of raw materials, working capital and work in progress. If the usual level of tax take of 42% applies to the new investment and to work in progress, government revenue receipts could increase by about £84 billion – an excellent return to government in addition to the overall benefit to the economy as a whole. Furthermore, that new investment would produce a permanent increase in output of about an extra £100 billion a year, equal to a permanent increase in GDP of about 6.7%, and a permanent rise in government revenue of about £42 billion a year. We think these changes would occur within about two years.

Some economists have traditionally argued that, because an extra job in manufacturing industry has historically created another job in the service industries, the final effect could be twice the initial stimulus. It is indeed likely that placing the economy on a higher growth path will enable the under-performing assets and spare capacity in our industries to respond to the higher levels of demand created by this stimulus.

The experience of other countries shows that investment credit economics works by creating wealth in the productive sector of the economy. The loans made are almost completely repaid (the failure rate is typically about 2.5%) out of the growth of the economy resulting from the additional investment. The failure rate of these loans matters little in any case because the loans cost nothing to create; their consequences matter, however, because they produce their targeted effect in reducing poverty, stabilising the banking system, and creating widespread prosperity through many flourishing private industries in all the areas of the country. 

The increase in output would obviously negate the risk that a substantial increase in the money supply could be inflationary, as Keynes recognized and as the Japanese experience in particular demonstrates. The consequence of the increased money supply could well be a fall in the international value of the pound, which could only be helpful in ameliorating the competitiveness problem of British industry and in ensuring readily available markets for increased British production.

Unemployment will fall to a low level. Social security payments will automatically reduce as fuller employment becomes the norm and Government income will cease to be disappointing, ending the need for austerity in government expenditure and bringing to an end all of its ill effects for our people.

© Bryan Gould and George Tait Edwards 2015

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This post was written by Bryan Gould and George Tait Edwards