To try to put some positive spin on the British government’s avowed austerity policy which is pushing thousands of people (including 1 in 6 children) into poverty, the Secretary of State and his spinners have been misrepresenting the DWP data.

On April 24, 2013, the Secretary of State released the annual report – Social Justice: transforming lives – one year on – published by the Department of Work and Pensions.

In the forward to the Report, he wrote:

Around one million people have been stuck on a working-age benefit for at least three out of the past four years, despite being judged capable of preparing or looking for work.

The British Tabloid press had a field day with the Secretary of State’s release producing lurid headlines and by-lines leaving the reader in no doubt that the latest data from DWP had found a bevy of bludgers who were living it up on government pensions when they could easily be out there working.

Even the sycophantic (to neo-liberalism) British Labour Party was quoted via MP Liam Byrne issued a – Statement – saying “we need to get these people off benefits and into jobs.” As if the claims by Duncan Smith were accurate.

This was in the context of the Labour Party’s compulsory Jobs Guarantee proposal. I support a Job Guarantee (but not the British Labour Party’s model) but realise that it would only work for those who are fit to work. If a person is not capable of working then they deserve as a right of citizenship (and a member of the human race) to be supported in a manner by the rest of us such that they are not socially excluded.

So the Labour Party was buying into the Duncan Smith narrative and claiming to have a niftier way of getting the bludgers to work and off the job seekers allowance.

The Full Fact site (which aims to promote accuracy in public debate) asked the question on April 24, 2013 – Are a million people fit to work yet living on benefits?.

It found that the evidence provided in the official DWP statistics do not support such a claim.

The UK Guardian (April 24, 2013) – Is Britain a nation of lazy scroungers? – also did some checking and found that:

… about 1 million spent three to four years on benefits. However, 600,000 of these claimants are people not able to work – by the government’s own definition.

The Guardian also noted that:

Duncan Smith is employing a linguistic sleight of hand. He says he is only counting those on working-age benefits who are “judged capable of preparing or looking for work”. But almost everyone’s capable of preparing for work.

So the only people who are capable of looking for work, who Duncan Smith must think have been unwittingly fostering a sense of dependence on the state, are the 395,000 people who found themselves unemployed in March 2012 and had spent between three to four years beforehand on benefits.

But I would have gone further than the Guardian – rather than conceding the last point.

The latest Office of National Statistics data to construct the UV ratio is available – HERE.

The following graph shows the UV ratio since 2001 (up to the March-quarter 2013). In the March-quarter 2013, there were 2.5 millions workers unemployed in the UK with only 503 thousand unfilled vacancies.

You will also note that the ratio jumped sharply in early 2009 as aggregate demand crashed in the UK and real output plunged.

As a note for those inexperienced in dealing with economic data, when I see sudden jumps in a time series that has exhibited relative stability for a lengthy period I am looking for a shock to help me explain the jump.

Shocks can either be demand-side or supply-side in origin (although one can feed into the other quickly enough). To be consistent with the neo-liberal claim that there are a million bludgers out there over the last four years one would expect to see some notable shift in the income support entitlements around 2008-09 which induced such a supply shift (as evidenced in the data).

No such evidence is forthcoming. What we know (unambiguously) is that the British economy encountered a massive negative demand shock which drove the output gap up and unemployment along with it.

The persistence of that output gap, now being perpetuated by the Government’s own policy stance, is locking people into entrenched unemployment.

The other part of this narrative is that the vacancy rate has fallen dramatically since the crisis began. Vacancies are now 26 per cent per cent lower than were in December 2007 (the most recent peak).

Remember my epithet – The unemployed cannot find jobs that are not there!.

And never forget the following Case Study.

Case study: the parable of 100 dogs and 92 bones

Imagine a small community comprising 100 dogs. Each morning they set off into the field to dig for bones. If there enough bones for all buried in the field then all the dogs would succeed in their search no matter how fast or dexterous they were.

Now imagine that one day the 100 dogs set off for the field as usual but this time they find there are only 92 bones buried.

Some dogs who were always very sharp dig up two bones as usual and others dig up the usual one bone. But, as a matter of accounting, at least 8 dogs will return home bone-less.

Now imagine that the government decides that this is unsustainable and decides that it is the skills and motivation of the bone-less dogs that is the problem. They are not skilled enough. They are idlers, bludgers and “bone-shy”.

So a range of dog psychologists and dog-trainers are called into to work on the attitudes and skills of the bone-less dogs. The dogs undergo assessment and are assigned case managers. They are told that unless they train they will miss out on their nightly bowl of food that the government provides to them while bone-less. They feel despondent.

Anyway, after running and digging skills are imparted to the bone-less dogs things start to change. Each day as the 100 dogs go in search of 92 bones, we start to observe different dogs coming back bone-less. The bone-less queue seems to become shuffled by the training programs.

However, on any particular day, there are still 100 dogs running into the field and only 92 bones are buried there!
You can find pictorial version of the parable here (for international readers this version was very geared to labour market policy under the previous federal regime in Australia and was written around 2001). I first screened this at a presentation that preceded a talk by Tony Abbot, the then Federal Employment Minister now Opposition leader gave at the University as my guest.

In the UK there are about 92 bones for every 100 dogs and in Spain 72 bones for every 100 dogs!

The point is that fallacies of composition are rife in mainstream macroeconomics reasoning and have led to very poor policy decisions in the past.

There are simply not enough jobs.

More recently, the DWP published their latest poverty data – Households Below Average Income (HBAI) – which bears scrutiny.

The full publication – Households Below Average Income (HBAI) 1994/95-2011/12 – was published on June 13, 2013.

I will leave it to you to learn about how the different measures are computed and what they can be legitimately used for. The publication explains in some detail with references to external sources of information these matters.

An acknowledged measure of poverty is the threshold – 60 per cent of Households Below
Average Income (HBAI).

1. “someone is considered to be in relative low income if they receive less than 60 per cent of the average income”.

2. “someone is considered to be in absolute low income if they receive less than 60 per cent of average income1 in 2010/11 adjusted by inflation”.

We learn that:

1. “Average income decreased by 3 per cent in 2011/12 in real terms compared with 2010/11, similar to the decrease in 2010/11.”

2. “The percentage of individuals in relative low income, Before Housing Costs (BHC), was 16 per cent … unchanged from 2010/11 … because, in the main, real incomes for households near the bottom of the income distribution fell by roughly the same rate as real incomes for households at the average”. That is, widespread real losses.

The other significant aspect here is that the overall decline in average real income biases the poverty measures downwards. A simple calculation shows, for example, that if the average income from 2010-11 was used instead of the current year, then poverty rates rise sharply.

3. “… the population falling into absolute low income rose”.

4. “income inequality is now at levels last seen in the middle of the last decade having reached historic highs in recent years”.

The really frightening aspect of the data release related to the rising incidence of child poverty in the UK, which is covered in Chapter 4 of the publication.

We learn that (BHC = Before Housing Costs):

The percentage of children in absolute low income BHC increased by 2 percentage points, or 300,000 children, between 2010/11 and 2011/1219. This was the first percentage point increase since the early 1990s, BHC. The recent increase was driven by a reduction in real terms income. The absolute low income threshold was uprated by RPI inflation and so the population falling into low income increased.

Apropos of Point 2 (immediately) above, the Report presents Tables for benchmarks against “contemporary median income” and 2010-11 median income, to allow us to assess the impact of generalised real income declines are having on these measures at the bottom of the income distribution.

So the proportion of UK children living below 60 per cent of the contemporary median income was 27 per cent in both 2010-11 and 2011-12 and the proportion below 70 per cent was a static 37 per cent across both years.

However, when we calibrate against median income in 2010-11, the proportion of UK children living below 60 per cent of the median income rose from 27 per cent to 29 per cent in 2011-12 and the proportion below 70 per cent rose from 37 per cent to 39 per cent.

So in terms of absolute numbers, using contemporary 2011-12 median income as the benchmark there were 3.5 million children below 60 per cent and 4.8 million below 70 per cent.

Using 2010-11 real median income, the numbers were 3.8 and 5.1 million children, respectively in these categories.

Thus, when we consider the overall loss of real income, there were more than 300,000 British children entering absolute poverty in 2011-12 compared to 2010-11 (below 60 per cent).

The other finding that is of interest is that 63 per cent of children below the 60 per cent threshold are living in households where at least one adult is employed. If one examines earlier data, the conclusion is that the incidence of the working poor has risen dramatically since the mid-1990s. In 1996-97, this proportion was around 43 per cent.

The financial crisis and austerity drive has seen the acceleration in working poor households

The Report says that:

For children in workless families, the risk of being in relative low income reduced by 2 percentage points to 40 per cent between 2010/11 and 2011/12, BHC and by 1 percentage point to 67 per cent, AHC … because these workless families received a higher proportion of their income from state support than families with children who had at least one adult in work.

The Report consistently highlights the fact that higher levels of state support reduce the risk of child poverty among the unemployed, which means that attacks on income support schemes push more children into poverty.

Neo-liberalism began by increasing the unemployment pool to shift the balance of power away from workers so that capital could secure increasing shares of the real income generated.

The related phase has been to denigrate the unemployed and attack their income support.

The other prong in the strategy has been to impoverish those who work in the lower-paid occupations. This phase is in full swing.

The related phase is to extend that attack into what has typically been referred to as the middle-class – the 40-80 percentiles of the income distribution.

The neo-liberals are using the current crisis to wipe out the middle class. The only problem is that a significant proportion of that cohort are well-educated and will probably resist the demolition attempts.

At that point, perhaps some class consciousness will emerge and those in their McMansions will realise the bludgers they have been vilifying each time the Daily Telegraph or Daily Mail (or whatever Tabloid is relevant in the particular nation) claims there are millions who can work who refuse to, are more like them than that thought.

All cohorts are being impoverished at different rates.

Conclusion

The DWP datasets are very rich in detail and fascinating (once you suspend anger and misery for a while). They indicate to me that the current policy framework is severely undermining not only the current fortunes of people in Britain, but also, the future prosperity of the nation.

The intergenerational disadvantage is becoming worse and the children in poverty today are the low productivity workers of the future who inherit the disadvantages of their parents.

The evidence is very clear – children denied a chance to realise their potential tend to lead difficult lives with unstable work attachments (even when there are jobs on offer), unstable family lives, and higher incidence of drug and alcohol abuse, mental ill-health and other pathologies.

When the neo-liberals lecture us constantly about the burden that government debt will (allegedly) place on the grand kids and the need for surpluses to “save up” to accommodate the demands of an ageing population, they ignore the most obvious.

Apart from completely misunderstanding the monetary side of the discussion, before their very eyes are growing number of future workers losing attachment with society by being denied adequate education and training and the hope that impels us to achieve higher attainments.

Sure enough the grand children are going to bear a dreadful burden and the future is bleak enough – but that is all the making of the neo-liberal policies.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

The Report studied the evolution of real wages between 2007 and 2012 and found that “aggregate change was -5.3%”.

The UK Guardian article (June 12, 2013) – Workers suffer deepest cut in real wages since records began, IFS shows – also considered the Report and wrote that:

The report finds that since the start of the recession real wages have fallen by more than in any comparable five-year period. It also highlights an “unprecedented” drop in productivity as output has tumbled faster than employment.

The IFS Report also noted that:

The last time that such a high proportion of workers faced real wage cuts was between 1976 and 1977, when inflation exceeded 15%, while the proportions of nominal wage freezes and cuts are the highest since the series began in the mid 1970s … there is also strong evidence of substantial nominal and real wage reductions occurring within jobs.

Which means that the current period is undermining nominal wages received rather than inflation deflating the real value of those nominal wages (that is, nominal wages growth failing to keep pace with inflation). It is very rare that money wages are cut.

The IFS Report also investigated whether the real wage cut was due to “compositional factors” – that is, “on the basis of changes to the characteristics of individuals in the workforce and the jobs that they do”.

They found that when compositional changes are controlled for they “would have expected wages to increase by 3.3%, all other things being equal”.

Which means that:

… none of the aggregate wage fall can be explained by changes to the composition of the workforce on the basis of characteristics that we observe and hence must instead all be due to changes to the parameter values associated with (or returns to) particular characteristics instead.

The Report investigates why workers are “so much more likely to have experienced nominal wage freezes or cuts during this recession compared to previous recession”.

They find that there has been a “dramatic decline in trade union membership over the last 30 years … accompanied by a reduction in the proportion of employees covered by collective bargaining, which appears to have made it easier for employers to hold constant or reduce insiders’ wages”.

This is a world-wide trend and one of the defining characteristics of the neo-liberal period – that relentless attack on the capacity of the workers to translate productivity growth into real wages growth.

A reasonable hypothesis at present is that the austerity attacks on public services and pay and conditions has nothing at all to do with establishing “fiscal sustainability”. The British government along with most governments has created a massive smokescreen by dragging in the mainstream macroeconomics myths about public deficits and public debt to justify their withering attacks.

The question has always been whether the fiscal austerity is the act of religious zealots who genuinely believe the postulates of the mainstream macroeconomists despite the evidence base that is overwhelmingly unsupportive of those postulates or whether there is something else going on.

Clearly, the religious commitment to the austerity is undoubted. The minds of these politicians and more particularly their advisors (both political and bureaucratic) are obviously addled by the flawed logic served up to them by the mainstream of my profession. There is a high proportion of true believers among this cohort.

I deal with them often in the course of a week and have a fairly good understanding of what they think and know about economics.

However, at a deeper level, there are others who seek to influence this cohort who don’t operate at the level of economic theory. They are purely interested in furthering their class interests and see austerity as a way of inflicting massive damage on the capacity of the working class to enjoy a fair share of the economic growth.

This elite group are also willing to sacrifice the interests of their peers in small business and other sectors who are also damaged by austerity.

So, in a way, trying to make progress via a debate about the validity of economic theory is only a partial strategy when seeking a change to this erosion of worker welfare.

Showing the economic flaws in the arguments used to justify austerity hopefully helps a bit to turn the political tide away from neo-liberal policy options.

There is evidence that some progress is being made. The IMF, for example, is severely compromised now and the mixed messages it is pumping out regularly is evidence of that. They have been so discredited by the their own failures and the millions of jobs that have been lost as a result that they now are almost advocating an anti-austerity message.

What we learned in the pPost Second World War period up to the mid-1970s was that although the elites hated full employment and worked to undermine the politics that supported it, the collective will of the voters in favour of strong employment and a highly supportive Welfare State was compelling.

Political parties, even the conservative side of politics, were forced by the sway of votes to act as mediators in the class struggle between wages and capital rather than take sides, as they are doing now (in favour of capital).

That is why I think political pressure rising from the weight of evidence is still relevant and that is why I write the blog. But I am not naive enough to assume that this nasty echelon of elites will go any time soon.

Anyway, what about evidence? I was curious about the IFS Report and wanted to find out at the sub-aggregate (industry) level what has been happened to real hourly earnings and employment since the start of the crisis and, in particular, since the election of the current British government.

By way of background, please read my blog – Keynes and the Classics – Part 4 – for an introduction to the British Treasury view of the 1930s, which has resurfaced in the current crisis.

The Classical view of the 1930s expressed by the British Treasury (which became known as the Treasury View) centred on whether a person could become involuntary unemployed.

The “Treasury View” denied the existence of involuntary unemployment and argued that fiscal policy (government spending) could not enhance national prosperity by creating employment.

In his 1929 budget speech – (delivered Monday, April 25, 1929 – see Hansard. (1929) HC Deb 15 April 1929, vol. 227, cc53–6 for details), the then British Chancellor of the Exchequer, Winston Churchill outlined the “Treasury View” and denied that fiscal policy would deliver lasting employment gains:

… the orthodox Treasury doctrine … has steadfastly held that, whatever might be the political or social advantages, very little additional employment and no permanent additional employment can in fact and as a general rule be created by State borrowing and State expenditure.

The Treasury View considered that unemployment (beyond the frictional level) was caused by real wages being above the equilibrium level, principally because money wages were downwardly rigid.

Accordingly, the cure for unemployment was simple – allow money wages to fall in the face of the excess supply of labour – so that the real wage could adjust to the “full employment” productivity level. The only role for government in this process was to ensure that wage flexibility was possible.

John Maynard Keynes disputed this reasoning and outlined a new approach to the labour market, which provided an explanation for mass unemployment that was independent of whether wages were flexible or not. In other words, he set out to show that the existence of mass unemployment was not related to the question of wage flexibility.

But the Treasury View is still taught to students as the mainstream explanation for unemployment – under the guise of marginal productivity theory.

The current period in the UK is very interesting – if I put on the dispassionate researcher hat (which is hard to do – remain dispassionate that is) – because it is providing an excellent laboratory for assessing the validity of a number of key mainstream propositions.

We already have enough data in to reject the fiscal contraction expansion” claims offered up by the David Cameron and all (including the European Commission, the ECB and the IMF).

Upon election, the current British government claimed that budget deficits are not required to achieve growth. They rejected the view that government deficits could stimulate production by increasing overall spending when households and firms were reluctant to spend. This is classic Treasury View.

In his 1929 budget speech – Churchill said:

The orthodox Treasury view, and after all British finance has long been regarded as a model to many countries, is that when the Government borrow in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process it raises the rent of money to all who have need of it.

In modern terms, students are told that public spending crowds out private spending – this is straight from the Treasury View of the 1930s dressed up a bit in modern language.

David Cameron and George Osborne told the British people that the economy could achieve an “expansionary fiscal contraction” – despite all logic and evidence pointing to the absurdity of this notion.

They held fast that by cutting public spending, more private spending will occur. To justify that inanity, they appealed to the notion that is deeply ingrained in mainstream macroeconomics but rarely fully understood – “Ricardian Equivalence”. The name is fancy but the idea is, in fact, simple – like most of mainstream economics. The substance is thin but the jargon is complex – which hides the lack of substance.<

The idea is this: Consumers and firms are allegedly so terrified of higher future tax burdens (needed, the argument goes, to pay off those massive deficits) that they increase saving now to ensure they can meet their future tax obligations. So increased government spending is met by reductions in private spending—stalemate.

But, as the neoliberals argue, if governments announce austerity measures, private spending will increase because of the collective relief that future tax obligations will be lower and economic growth will return.

Please read my blog – How are the laboratory rats going? – for a detailed critique of this assertion.

We also know that the 5 odd years of relatively high deficits and massive central bank reserve operations have not led to escalating interest rates, hyperinflation (or even accelerating inflation), or mass uprisings of those amorphous (but apparently dangerous and ever-present) bond vigilantes.

None of those myths have held water.

As the data series expand in length we are getting more information that will allow us to more formally (using econometric and other statistical techniques) test some of the key propositions that mainstream economists use to justify the austerity push, which the sneaky elites see as a way of finishing off the agenda so rudely interrupted by the crisis.

Anyway, I have been examining the recent trends in industry employment and real hourly earnings in Britain and here are some of the things I have found to date.

As a warning, the analysis that follows is not a formal attack on Classical employment theory. Graphical analysis helps us frame ideas and get a feel for what more sophisticated statistical analysis reveals. But it only takes us so far. So be cautious in the way you read the next section.

The bottom line though is that with massive real wage cuts in most industry sectors in the UK over the last 5 years one would expect there to be strong positive employment outcomes if the orthodox marginal productivity theory was correct. I realise that productivity has been moving around and so simple cross plots of real wages and employment growth may just be dotting so-called “equilibrium” points (demand equals supply) for a whole map of shifting supply and demand curves (the so-called identification problem).

But my experienced eye tells me that notwithstanding that possibility, the productivity shifts that have been going on do not stop me from concluding that the Classical relationship between real wage movements and employment at the industry level are not present in the data available from the British Office of National Statistics.

The first graph shows real hourly earnings (sourced from – ONS and deflated with the All Groups CPI) for the public and private sectors in Britain from March-quarter 2001 to the March-quarter 2013.

The data is indexed at 100 at the March-quarter 2008 (the turning point in the cycle). The real wage cuts have been harsh in both sectors.

The next graph shows the evolution of employment in the public and private sectors in Britain from March-quarter 2001 to the March-quarter 2013. Prior to the crisis there was steady employment growth in both sectors (as real hourly earnings also rose).

The current state is that there have been no effective employment gains since the onset of the crisis – the public index is at 99.3 and the private index is at 100.5 – despite the massive real wage cuts.

The following Table summarises the employment situation (in thousands) since March 2001 in Britain by sector (total, public, private) and industry (SIC one-digit level).

You can see which sectors have gone backwards since 2008 and which have managed to make some gains. I have also computed the change in employment between 2008-2013 and 2010-2013.

Don’t forget yesterday’s blog – Full employment is still low unemployment and zero underemployment – where I produced a graph showing the plunge in the the employment-population ratio in Britain since the 1970s.

In 2008, the employment-population ratio in the UK was 59.9 per cent. In 2013, it is now below 58.3 per cent. Considering the growth in the Working Age population over that time (1.5 million persons) the drop in the ratio amounts to more than 800 thousand jobs having been lost compared to what would have been the case when the current government took office.

So when the UK government says that 888 thousand jobs have been created since 2010, it is not something that they should celebrate. That is less than 60 per cent of the net new jobs that would have been necessary to keep up with underlying population growth. Of-course, a larger population will typically be associated with more jobs.

But one has to scale the employment growth to the underlying population growth to gain a good idea of what is going on.

The other point to note is that productivity growth has been abysmal in the UK which has attenuated the employment losses that would have occurred given the real output losses. While that is good in the short-run for workers it also damages their future prospects because it undermines the capacity of the economy growth in real living standards overall (irrespective of how the growth is distributed).

So UK workers have two big problems – rising inequality (meaning the distribution is biased against them) and falling future real living standards (due to the sluggish productivity growth). Neither is an attractive mix when combined with the disastrous unemployment and underemployment.

The next Table shows the indexes for employment and real hourly earnings for the March-quarter 2010 and 2013 (noting that the base-quarter is March 2008=100).

Real wages have plummetted in several industries along with employment but the pattern is complex (and certainly productivity movements that I haven’t shown are part of the story).

The following (very long) graph is provided to give you an idea of the relationship between real hourly earnings (horizontal axis) and employment (vertical axis) from March-quarter 2001 to March-quarter 2013 (indexed to 100 in March-quarter 2008) for most of the sectors and industries in the UK.

The manufacturing graph is only from March-2008 to eliminate the strong downward sectoral trend.

The point is that the relationship between the two variables at the sectoral level is anything but classical. More sophisticated analysis is coming another day.

Conclusion

Now that you have made it past that very long graph you will probably appreciate that claims that cutting real wages will improve employment prospects are ill-founded.

That could only happen if somehow the lower real wages reduced the non-government desire to save and stimulated aggregate demand. That is not a likely occurrence.

To learn more about that statement please read the blog – What causes mass unemployment?.

Anyway, chipping away at it still ….

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

It clearly blames fiscal deficit reduction attempts both within the US and abroad (“a weak external environment”) for the “tepid growth” in the US over the last year.

In modelling likely political developments in the US it notes that its is assuming the:

… the general government deficit will decline by over 2½ percent, subtracting between 1¼–1¾ percentage points from growth in 2013 … On the fiscal front, the deficit reduction in 2013 has been excessively rapid and ill-designed. In particular, the automatic spending cuts (“sequester”) not only exert a heavy toll on growth in the short term, but the indiscriminate reductions in education, science, and infrastructure spending could also reduce medium-term potential growth.

That sort of narrative was also levelled at the UK recently and so we conclude the IMF is now making the case that it denied for so long – that there can be a fiscal contraction expansion – under present circumstances.

But, from an educational perspective, I thought the following statement was of interest. In cataloging the role of monetary policy at present, the IMF said that:

The prolonged low-interest rate environment could sow the seeds of future financial vulnerabilities as investors and financial institutions aggressively search for yield—despite the increased regulatory and supervisory focus on financial stability risks.

Just wait for the financial press reaction when treasury bond yields, which are currently very low, start to rise because the investment bankers start diversifying in search of higher yields (and higher risk).

We will be flooded with claims that the cost of government spending has risen (it will not have!) and the road to government insolvency is fast reaching its end (the road is infinite – that is, not defined).

On myths that persist, I thought the UK Guardian article (June 12, 2013) – The politics of full employment are the progressive answer to austerity – was interesting.

Regular readers will know that I have devoted my academic career to researching, in a variety of ways, the concept of full employment.

I currently define a full employment state in Australia as being satisfied if:

1. The official unemployment rate is between 2 and 3 per cent, leaning towards the lower edge of the band. So remaining unemployment is of a frictional nature – moving between jobs.

2. There is zero underemployment – that is, no part-time workers signals they desire more hours of work.

3. There is zero hidden unemployment – that is, participation rates are at their peak.

We can debate the qualitative aspects of that quantitative definition, which bears on the quality of jobs defined under Criterion 1 and the lack of skills-based underemployment under Criterion 2.

I think that is an important debate and aspiration. Regular readers will note that I consider “loose” full employment, which is defined as a market-determined outcome supplemented with a Job Guarantee, is the minimum state that a nation should tolerate.

This state does not necessarily eliminate skills-based underemployment (especially during a serious downturn. The extent to which this type of economy (with a Job Guarantee buffer stock) eliminates skills-based underemployment will thus depend on the state of the economic cycle.

At periods of high pressure, there will be very little skills-based underemployment but at other times there will be more. The introduction of a Job Guarantee provides an incentive to employers to upgrade the quality of their job offerings anyway to make sure they can profitably function above the Job Guarantee wage, which would become the wage floor.

Clearly, loose full employment is the minimum state. The currency-issuing government should use its fiscal policy capacity to ensure that it pilots the labour market to achieve high quality employment within the inflation constraint. A high-wage, high productivity economy will provide better jobs (both within the public and private sectors) than a nation that feeds at the bottom of the productivity and wage levels.

That is the context in which I read the UK Guardian article.

The writer, Gavin Kelly considers that the notion of full employment should not be seen as the natural preserve of the Labour party in the UK (or elsewhere) and that the notion of:

Full employment is not fantasy economics, but debate is squashed by economic complacency and fatalism …

The UK Guardian article delves into history and reminds us that in the UK the same circumstances that are apparent now (untrusted Labour leadership, insecure Conservative backbenchers sensing electoral defeat, “a recession-wearied public agitated about welfare bills and a stubbornly high deficit, and a welfare secretary seeking to focus public debate on the alleged failings of claimants” were operating 20 years ago
in Britain.

Gavin Kelly says that:

These familiar circumstances confronted the last mid-term Conservative chancellor two decades ago. Ken Clarke’s response – to the surprise of many – was to remake the argument for full employment and a strong welfare state as key pillars of a properly functioning market economy. How times change.

The point is that while it is “in Labour’s genes to believe this issue is its own”, previous Conservative politicians have “insisted that Tory manifestos be committed to maintaining full employment as the ‘first aim of a Conservative government’”

The reason no one talks about full employment now is according to the Guardian article due to “the troubling mix of economic complacency and fatalism that dominates much of today’s economic discourse”.

Apparently, Brits are complacent because “the UK jobs market has performed better than many predicted with unemployment rising less than expected given the fall in output”.

Really? At least the article notes the “2.5 million unemployed and 3 million under-employed” and points out that when politicians (all over the world” make statements such as they have overseen a “record numbers of jobs” created they also fail to emphasise the increase in the “adult population” over the same period.

Of-course the labour market is bigger in most nations now – but good performance is about ensuring employment growth absorbs the population growth – that is, the employment-population ratio does not fall.

In Britain the employment-population ratio has plunged since the 1970s, when the nation last enjoyed full employment.

Here is a graph produced by the – St Louis Fred Data showing the British employment to population ratio since the early 1970s.

It is fair to say that the nation never really recovered from the Thatcher assault on full employment.

The Guardian article also notes that eliminating large employment gaps not only helps the unemployed gain work but also helps improve the fortunes of those currently employed:

… those with jobs desperately need it too. In the post collective-bargaining era, a tight jobs market – where employers chase applicants as much as the other way around – is the best wages policy available to low and middle earners.

Which makes you wonder why the neo-liberals have been able to divide and conquer the workers into two broad groups – the robust workers and the lazy unemployed.

How have they done that? – Ignorance fuelled by misinformation. See below.

The Guardian claim that there is a “fatalistic mindset” in Britain based on the belief:

… that the UK is afflicted with such intractable problems that to cast ahead to the possibility of full employment is to indulge in fantasy economics.

That is, neo-liberalism is TINA. Margaret Thatcher lives on.

Inasmuch people perceive TINA, the problem is a lack of political leadership and an unquestioning willingness of lazy politicians to accept the flawed mainstream economics doctrines.

The Guardian does acknowledge that the “the policy environment is shifting”.

The IMF introduction is evidence of that. The doomsayers are running out of credibility even among those that might have believed their lies five years ago and never bothered to, for example, think of what has been going down in Japan for 20 years or more.

We are seeing that “only the economically paranoid would discern inflationary risk emerging from our labour market any time soon” and that interest rates are not going through the roof despite the on-going deficits.

I would put the “complacency/fatalism” in different words. There is a systematic conspiracy among the elites to prevent governments from pursuing full employment. The elites comprising the captains of industry and the establishment politicians who feed off the largesse provided through the lobbyists working from the captains hate full employment.

Why? Because it shares the real income around more equitably and shifts the balance of power back to the majority.

So their approach is two-fold:

First, they lie by suggesting that they all love full employment but that the level of labour slack which now defines full employment has risen – due to this and that.

Please read my blog – The dreaded NAIRU is still about! – for more discussion on this point.

Second, they drown the populace in a swathe of mis-information to reinforce the lie. So all the austerity myths:

• The government has run out of money.
• Deficits will drive up interest rates.
• Deficits will cause hyperinflation.
• Deficits will rack up unsustainable debts on our grandchildren.
• Bond markets will punish governments who run continuous deficits.
• Deficits undermine growth because the private sector thwarts their intent by increasing saving to pay for higher implied taxes in the future.
• Direct job creation creates unreal jobs that are worthless.
• A Job Guarantee would undermine the capacity of private employers to attract labour and drive down productivity.
• ETC, the list goes on.

We are continually being drawn towards conclusions that unemployment is not really a problem because people choose to remain jobless. The culprit is singled as the income support system which subsidises those choices. Or depending on the day of the week, the other culprit is excessive real wages. Or then, on another day, it might be hiring and firing protections. ETC.

That if the labour market was deregulated and the income support system abandoned then we would quickly eliminate unemployment. Put people on the margin of starvation and they will work out of desperation.

We see that approach in the poorest nations where families scavenge through rubbish and sewerage heaps for the barest scraps of food. That is what desperation and a lack of jobs ends up leading to.

And meanwhile, there is mass (preventable) disease and high rates of infant mortality. The market working at its best.

The Guardian article says that “(g)etting back on the path towards full employment” will require a major shift in policy – and are:

… likely to involve an expansionary macro-policy tempered by measures that puncture potential asset bubbles; a revamped childcare system that makes it worthwhile for both parents to work; and tax reform that makes hiring labour more attractive and sitting on cash piles less so.

It will require an abandonment of the neo-liberal mindset – a return to collectivism and a fundamental shift in the balance of power towards workers again.

Cutting through all that cant and misinformation, the concept of full employment is simple – create enough jobs and working hours to satisfy the preferences of the available labour force.

That might put some upward pressure on wages – so the “captains of industry” who have been waxing fat on the massive redistribution of real income to profits under the neo-liberal era will have to be told that things have changed. That workers are going to, once again, enjoy their share of productivity growth.

That is the first return to normality that is required. The neo-liberal period, which has systematically suppressed the capacity of workers to gain real wages growth in line with labour productivity growth, was atypical and unsustainable. That has to change.

It might lead to higher imports and cause the exchange rate to depreciate a little, which means that elites will pay more for their imported luxury cars than they do right now and face more expensive ski trips to the Alps. Tut tut! What a shame that would be.

It might lead to private employers having to restructure their workplaces to ensure they can produce at higher levels of productivity to meet the wages that would be required to attract labour out of the Job Guarantee pool in times of expanding investment. That would be a national disgrace, no!

Think about Norway. From its – Labour Force Survey – we note that it currently has an unemployment rate of 3.7 per cent and largely resisted the great recession.

For example, juxtapose all the austerity rhetoric that we read these days in British government narratives (Budget Papers, OBR documents etc) with this commentary that appeared in the recent Norwegian Statistics publication (April 30, 2013) – Economic Survey 1/2013 – (Chapter on Cyclical developments in Norway 1-2013).

This is an English version of the quarterly business cycle report from Statistics Norway. “It includes an analysis of recent trends in the Norwegian economy and a forecast two-three years ahead”.

Box 5 on Page 20-21 analyses “The importance of immigration for the functioning of the Norwegian economy”. The analysis estimates the economic benefits that arise:

… where investments in public administration increase equivalent to 1 per cent of the mainland GDP each year.

The analysis is based on “two versions of Statistics Norway›s macro-econometric model, KVARTS”. The first assumes that immigration is inversely affected by the level of unemployment while the second assumes that immigration is invariant to the “changes in the Norwegian economy”.

The overall modelling concludes that:

Higher public investments lead to an increase in demand for labour regardless. The pressure on the labour market therefore increases and unemployment falls. Higher employment and wages lead to an increase in demand from households, and the higher level of domestic activity also contributes to an increase in industry investments. From the second year onwards, mainland GDP increases by more than the initial impulse

This is very realistic modelling – it has strong public expenditure multipliers which crowd-in private economic activity.

The IMF models, recall, that were used to justify the austerity programs assumed exactly the opposite. At least the IMF now have admitted they were wrong on this.

I will leave it to you to read the results of the simulations, which are all credible.

The point is that this sort of analysis is eschewed in the rubbish that the OBR and its likes produce to support the austerity machine.

The difference we can see easily – Norway is much closer to full employment than nearly anywhere else.

Please read my blogs – Norway … colder than us but … and Norway and sectoral balances – for more discussion on this point.

Conclusion

And need I add my appalled vote to those who would dismantle the Greek government forthwith for their decision (presumably supported by the EC and the IMF) to close its public broadcasting services down.

What goes on in the mind of these maniacs – they are not even subtle about their attempts to purge democracy – of which, information is an essential aspect. The problem is that Stalin and Hitler and others who are less obvious than these tyrants and who live in the West, didn’t have the Internet to deal with.

We know more things now, more quickly and more of us learn of things than in the past.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

We are told that a country is running a very small external deficit and that the private domestic sector is spending less overall than it is earning but relative to GDP this balance is smaller than the external deficit. Without knowing the relative magnitudes of these balances, we cannot conclusively determine whether the government is in deficit or surplus.

The answer is False.

This question requires an understanding of the sectoral balances that can be derived from the National Accounts. But it also requires some understanding of the behavioural relationships within and between these sectors which generate the outcomes that are captured in the National Accounts and summarised by the sectoral balances.

Refreshing the balances – we know that from an accounting sense, if the external sector overall is in deficit, then it is impossible for both the private domestic sector and government sector to run surpluses. One of those two has to also be in deficit to satisfy the accounting rules.

The important point is to understand what behaviour and economic adjustments drive these outcomes.

The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.

From the sources perspective we write:

GDP = C + I + G + (X – M)

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).

From the uses perspective, national income (GDP) can be used for:

GDP = C + S + T

which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.

Equating these two perspectives we get:

C + S + T = GDP = C + I + G + (X – M)

So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.

(I – S) + (G – T) + (X – M) = 0

That is the three balances have to sum to zero. The sectoral balances derived are:

• The private domestic balance (I – S) – positive if in deficit, negative if in surplus.
• The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
• The Current Account balance (X – M) – positive if in surplus, negative if in deficit.

These balances are usually expressed as a per cent of GDP but that doesn’t alter the accounting rules that they sum to zero, it just means the balance to GDP ratios sum to zero.

A simplification is to add (I – S) + (X – M) and call it the non-government sector. Then you get the basic result that the government balance equals exactly $-for-$ (absolutely or as a per cent of GDP) the non-government balance (the sum of the private domestic and external balances).

This is also a basic rule derived from the national accounts and has to apply at all times.

So what economic behaviour might lead to the outcome specified in the question?

If the nation is running an external deficit it means that the contribution to aggregate demand from the external sector is negative – that is net drain of spending – dragging output down. The reference to a “small” external deficit was to place doubt in your mind. In fact, it doesn’t matter how large the external deficit is for this question.

Assume, now that the private domestic sector (households and firms) seeks to increase its overall saving (that is, spend less than it earns) and is successful in doing so. Consistent with this aspiration, households may cut back on consumption spending and save more out of disposable income. The immediate impact is that aggregate demand will fall and inventories will start to increase beyond the desired level of the firms.

The firms will soon react to the increased inventory holding costs and will start to cut back production. How quickly this happens depends on a number of factors including the pace and magnitude of the initial demand contraction. But if the households persist in trying to save more and consumption continues to lag, then soon enough the economy starts to contract – output, employment and income all fall.

The initial contraction in consumption multiplies through the expenditure system as workers who are laid off also lose income and their spending declines. This leads to further contractions.

The declining income leads to a number of consequences. Net exports improve as imports fall (less income) but the question clearly assumes that the external sector remains in deficit. Total saving actually starts to decline as income falls as does induced consumption.

So the initial discretionary decline in consumption is supplemented by the induced consumption falls driven by the multiplier process.

The decline in income then stifles firms’ investment plans – they become pessimistic of the chances of realising the output derived from augmented capacity and so aggregate demand plunges further. Both these effects push the private domestic balance further towards and eventually into surplus

With the economy in decline, tax revenue falls and welfare payments rise which push the public budget balance towards and eventually into deficit via the automatic stabilisers.

If the private sector persists in trying to net save then the contracting income will clearly push the budget into deficit.

So we would have an external deficit, a private domestic surplus and a budget deficit.

There will always be a budget deficit at any national income level, if the private domestic sector is successfully spending less than it earns and the external sector is in deficit.

The following blogs may be of further interest to you:

• Barnaby, better to walk before we run
• Stock-flow consistent macro models
• Norway and sectoral balances
• The OECD is at it again!

Question 2:

Government bonds constitute a form of wealth held by the non-government sector. But it remains that overall non-government sector wealth does not rise if the government issues bonds to match its deficit spending as against the central bank just buying the bonds and crediting bank accounts.

The answer is True.

This answer relies on an understanding the banking operations that occur when governments spend and issue debt within a fiat monetary system. That understanding allows us to appreciate what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a budget deficit without issuing debt?

In this situation, like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.

The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet). Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.

This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.

When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.

What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.

The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If it debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).

There is no difference to the impact of the deficits on net worth in the non-government sector.

Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.

However, the reality is that:

• Building bank reserves does not increase the ability of the banks to lend.
• The money multiplier process so loved by the mainstream does not describe the way in which banks make loans.
• Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.

So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.

This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.

It is totally fallacious to think that private placement of debt reduces the inflation risk.

You may wish to read the following blogs for more information:

• Why history matters
• Building bank reserves will not expand credit
• Building bank reserves is not inflationary
• The complacent students sit and listen to some of that
• Saturday Quiz – February 27, 2010 – answers and discussion

Question 3:

When a government records a budget surplus which means it is withdrawing more purchasing power from the economy than it is adding, we know that it is seeking to attenuate the growth in aggregate demand to avoid the risk of inflation.

The answer is that False.

The actual budget deficit outcome that is reported in the press and by Treasury departments is not a pure measure of the fiscal policy stance adopted by the government at any point in time. As a result, a straightforward interpretation of

Economists conceptualise the actual budget outcome as being the sum of two components: (a) a discretionary component – that is, the actual fiscal stance intended by the government; and (b) a cyclical component reflecting the sensitivity of certain fiscal items (tax revenue based on activity and welfare payments to name the most sensitive) to changes in the level of activity.

The former component is now called the “structural deficit” and the latter component is sometimes referred to as the automatic stabilisers.

The structural deficit thus conceptually reflects the chosen (discretionary) fiscal stance of the government independent of cyclical factors.

The cyclical factors refer to the automatic stabilisers which operate in a counter-cyclical fashion. When economic growth is strong, tax revenue improves given it is typically tied to income generation in some way. Further, most governments provide transfer payment relief to workers (unemployment benefits) and this decreases during growth.

In times of economic decline, the automatic stabilisers work in the opposite direction and push the budget balance towards deficit, into deficit, or into a larger deficit. These automatic movements in aggregate demand play an important counter-cyclical attenuating role. So when GDP is declining due to falling aggregate demand, the automatic stabilisers work to add demand (falling taxes and rising welfare payments). When GDP growth is rising, the automatic stabilisers start to pull demand back as the economy adjusts (rising taxes and falling welfare payments).

The problem is then how to determine whether the chosen discretionary fiscal stance is adding to demand (expansionary) or reducing demand (contractionary). It is a problem because a government could be run a contractionary policy by choice but the automatic stabilisers are so strong that the budget goes into deficit which might lead people to think the “government” is expanding the economy.

So just because the budget goes into deficit doesn’t allow us to conclude that the Government has suddenly become of an expansionary mind. In other words, the presence of automatic stabilisers make it hard to discern whether the fiscal policy stance (chosen by the government) is contractionary or expansionary at any particular point in time.

To overcome this ambiguity, economists decided to measure the automatic stabiliser impact against some benchmark or “full capacity” or potential level of output, so that we can decompose the budget balance into that component which is due to specific discretionary fiscal policy choices made by the government and that which arises because the cycle takes the economy away from the potential level of output.

As a result, economists devised what used to be called the Full Employment or High Employment Budget. In more recent times, this concept is now called the Structural Balance. As I have noted in previous blogs, the change in nomenclature here is very telling because it occurred over the period that neo-liberal governments began to abandon their commitments to maintaining full employment and instead decided to use unemployment as a policy tool to discipline inflation.

The Full Employment Budget Balance was a hypothetical construction of the budget balance that would be realised if the economy was operating at potential or full employment. In other words, calibrating the budget position (and the underlying budget parameters) against some fixed point (full capacity) eliminated the cyclical component – the swings in activity around full employment.

This framework allowed economists to decompose the actual budget balance into (in modern terminology) the structural (discretionary) and cyclical budget balances with these unseen budget components being adjusted to what they would be at the potential or full capacity level of output.

The difference between the actual budget outcome and the structural component is then considered to be the cyclical budget outcome and it arises because the economy is deviating from its potential.

So if the economy is operating below capacity then tax revenue would be below its potential level and welfare spending would be above. In other words, the budget balance would be smaller at potential output relative to its current value if the economy was operating below full capacity. The adjustments would work in reverse should the economy be operating above full capacity.

If the budget is in deficit when computed at the “full employment” or potential output level, then we call this a structural deficit and it means that the overall impact of discretionary fiscal policy is expansionary irrespective of what the actual budget outcome is presently. If it is in surplus, then we have a structural surplus and it means that the overall impact of discretionary fiscal policy is contractionary irrespective of what the actual budget outcome is presently.

So you could have a downturn which drives the budget into a deficit but the underlying structural position could be contractionary (that is, a surplus). And vice versa.

The question then relates to how the “potential” or benchmark level of output is to be measured. The calculation of the structural deficit spawned a bit of an industry among the profession raising lots of complex issues relating to adjustments for inflation, terms of trade effects, changes in interest rates and more.

Much of the debate centred on how to compute the unobserved full employment point in the economy. There were a plethora of methods used in the period of true full employment in the 1960s.

As the neo-liberal resurgence gained traction in the 1970s and beyond and governments abandoned their commitment to full employment , the concept of the Non-Accelerating Inflation Rate of Unemployment (the NAIRU) entered the debate – see my blogs – The dreaded NAIRU is still about and Redefining full employment … again!.

The NAIRU became a central plank in the front-line attack on the use of discretionary fiscal policy by governments. It was argued, erroneously, that full employment did not mean the state where there were enough jobs to satisfy the preferences of the available workforce. Instead full employment occurred when the unemployment rate was at the level where inflation was stable.

The estimated NAIRU (it is not observed) became the standard measure of full capacity utilisation. If the economy is running an unemployment equal to the estimated NAIRU then mainstream economists concluded that the economy is at full capacity. Of-course, they kept changing their estimates of the NAIRU which were in turn accompanied by huge standard errors. These error bands in the estimates meant their calculated NAIRUs might vary between 3 and 13 per cent in some studies which made the concept useless for policy purposes.

Typically, the NAIRU estimates are much higher than any acceptable level of full employment and therefore full capacity. The change of the the name from Full Employment Budget Balance to Structural Balance was to avoid the connotations of the past where full capacity arose when there were enough jobs for all those who wanted to work at the current wage levels.

Now you will only read about structural balances which are benchmarked using the NAIRU or some derivation of it – which is, in turn, estimated using very spurious models. This allows them to compute the tax and spending that would occur at this so-called full employment point. But it severely underestimates the tax revenue and overestimates the spending because typically the estimated NAIRU always exceeds a reasonable (non-neo-liberal) definition of full employment.

So the estimates of structural deficits provided by all the international agencies and treasuries etc all conclude that the structural balance is more in deficit (less in surplus) than it actually is – that is, bias the representation of fiscal expansion upwards.

As a result, they systematically understate the degree of discretionary contraction coming from fiscal policy.

The only qualification is if the NAIRU measurement actually represented full employment. Then this source of bias would disappear.

So a government could still be adopting an expansionary discretionary stance yet record a budget surplus because the automatic stabilisers are so strong.

The following blogs may be of further interest to you:

• A modern monetary theory lullaby
• Saturday Quiz – April 24, 2010 – answers and discussion
• The dreaded NAIRU is still about!
• Structural deficits – the great con job!
• Structural deficits and automatic stabilisers
• Another economics department to close

• Case Study – British IMF loan 1976 – Part 1

Case Study – The British IMF loan in 1976

[CONTINUING]

The definitive historical chronicle of the IMF between 1945 and 1965 is provided by the three-volume hardback publication – The International Monetary Fund, 1945-1965: Twenty Years of International Monetary Cooperation.

The Purposes of the IMF are outlined in Article 1 of the – Articles of Agreement of the International Monetary Fund – which were adopted at the United Nations Monetary and Financial Conference, Bretton Woods, New Hampshire, July 22, 1944 and became enforced from December 27, 1945.

Article I outlines a number of purposes including “To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation” and (Section (v)):

… to give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

Before the growth of the financial services sector and the massive mobilisation of international capital in the 1970s and beyond, the IMF was a major source of finance for governments seeking funds to support their exchange rates under the Bretton Woods agreement.

During this period, the IMF primarily made advances to industrial countries to provide them with the means to address “short-term trade fluctuations” which threatened their capacity to maintain a stable currency value as per the Bretton Woods agreement (see Lending by the IMF).

With the collapse of the Bretton Woods system in 1971, advanced nations have been able to access capital on international capital markets and the target of IMF lending has shifted to “lower- and lower-middle-income countries” including transition nations as the Soviet system collapsed.

Article V (Section 2a) of the IMF Articles of Agreement define the limitations on the IMFs capacity to provide funding assistance:

Except as otherwise provided in this Agreement, transactions on the account of the Fund shall be limited to transactions for the purpose of supplying a member, on the initiative of such member, with special drawing rights or the currencies of other members from the general resources of the Fund, which shall be held in the General Resources Account, in exchange for the currency of the member desiring to make the purchase.

First, assistance is not properly conceived of as being a “loan”. Nation seeking assistance agreed to buy “special drawing rights or the currencies of other members” from the IMF using their own currency.

A – Special Drawing Right (SDR) is:

… an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves … The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.

Initially, the SDRs were valued in terms of the amount of gold that would exchange under the convertible currency system for one US dollar. When the Bretton Woods system collapsed, the SDRs lost relevance but were valued in terms of a basket of currencies (euro, US dollar, yen and pound sterling).

During the last years of the Bretton Woods system, the SDRs were introduced to help member nations maintain a stable exchange rate. Each nation needed stocks of official reserves (either foreign currencies or gold) which they could use to buy its own currency in foreign exchange markets at times when there was downward pressure on their exchange rate.

By the late 1960s, the IMF determined that there wasn’t enough gold or US dollars in circulation to allow governments to maintain exchange rate stability as international trade and financial capital flows expanded dramatically.

As a result, the IMF introduced SDRs as a new international reserve currency. The funding arrangements between the IMF and the member-states were thus exchanges of currencies rather than loans in the normal meaning of the term.

Second, the nation has to agree to repurchase its own currency back under the terms of funding agreement.

Third, the IMF is deemed a passive player. The member-nation seeking assistance had to approach the IMF and make a case for the funding.

Article III Quotas and Subscriptions of the IMF Articles of Agreement define the funding responsibilities of the member states to the IMF and the extent to which they can draw on the IMF for financial assistance.

A system of Quotas was established and defined how much each nation would have to contribute. These quotas were adjusted from time to time.

The agreed quotas were specified in Schedule A of the Articles of Agreement and are reproduced in the following Table.

Within a given year, each nation could draw up to 25 per cent of its quota and there was a cumulative limit of 100 per cent of the quota. This limit has changed over time.

The IMF thus agreed to fund current account deficits for a time but only within limits that were designed to reflect a nation’s capacity to repay the reserves advanced.

The IMF also progressively imposed so-called “conditionality” on the use of drawings by member-states. Prior to the 1970s, the conditionality was designed to correct chronic balance of payments disequilibria. Since that time, the conditionality has reflected a much more explicit ideological perspective, which eschews government regulations, public enterprise and broad-based public social welfare provision.

The conditionality was scaled by four so-called credit tranches each defined in terms of the quota. The first credit tranche, which was equivalent to 25 per cent of the member-nation’s quota were relatively unconditional. The next three “upper” credit tranches were subjected to increasingly stringent assessments and conditionality.

While there are many different funding programs that the IMF has offered by way of assistance, and these have evolved over time, the so-called – Stand-By Arrangements (SBA) – which were established in June 1952, have been the IMFs main funding instrument for nations that call upon it for assistance.

The SBA advance funds at rates that are typically “lower than what countries would pay to raise financing from private markets” and usually are in operation for periods of 12-24 months. They are intended to address short-term balance of payments issues.

The IMF would require these governments to demonstrate that their economic policy stances were consistent with a stable currency. This typically translated into a policy of domestic deflation for a country with an external deficit.

The 1976 request by the British government for an IMF Standby-Arrangement has been constructed as a recognition by a desperate government that it had to tailor domestic policies to meet the constraints imposed on it by international capital markets.

However, the reality is that the British government had drawn on such arrangements several times in the preceding two decades. Prior to the increased focus on conditionality, Britain borrowed in both 1948 and 1949.

The British government had previously sought access to the arrangements in 1956, 1961, 1962, 1967 (associated with the subsequent devaluation) and 1974-75.

[MORE DISCUSSION HERE NEXT WEEK]

Figure 1 shows the Current Account balance as a per cent of GDP for Britain from 1948 to 2012.

[MORE HERE NEXT WEEK ON THESE DATA]

Figure 1 UK Current Account % of GDP

Source: UK Office of National Statistics – Balance of Payments Dataset

Figure 2 shows the evolution of the Sterling exchange rate against the US dollar from 1945 to 2011.

[MORE HERE NEXT WEEK ON THESE DATA]

Figure 2 UK Exchange Rate, 1945-2011

Source: Lawrence H. Officer, “Exchange Rates Between the United States Dollar and Forty-one Currencies,”, MeasuringWorth, 2013, http://www.measuringworth.com/exchangeglobal/

[TO BE CONTINUED]

Conclusion

NEXT WEEK WE WILL CONSIDER THE LEAD UP TO 1976.

THIS WILL PLACE THE BRITISH REQUEST TO THE IMF IN ITS CORRECT CONTEXT.

Saturday Quiz

The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

• Employment increased 1,100 (0.4 per cent) with full-time employment falling by 5,300 and part-time employment rising by 6,400.
• Unemployment decreased by 3,600 (0.5 per cent) to 682,900 as a result of the decreasing participation.
• The official unemployment rate remained steady at 5.5 cent
• The participation rate fell by 0.1 points to 65.2 per cent.
• Aggregate monthly hours worked decreased by 11.5 million hours (-0.7 per cent).
• The quarterly ABS broad labour underutilisation estimates (the sum of unemployment and underemployment) rose by 0.4 points to 12.9 per cent. Underemployment was estimated to be 7.4 per cent or 908.6 thousand persons.

The ABC news headline was – Employment figures surprise with tiny jobs gain – and readers were informed that:

Official figures show unemployment eased slightly to 5.5 per cent, but with almost no new jobs created … The fall in unemployment was driven more by a 0.1 percentage point fall in the participation rate than it was by an increase in jobs.

Which is highly misleading given that the virtually zero gain in employment was well below the underlying population growth.

The data today shows that the labour market is stuck with the trend in employment being weak and insufficient to absorb the underlying population growth.

Further, the weak employment growth is dominated by part-time employment.

The trend in unemployment is up and the broad labour underutilisation rate is rising.

The weak participation rates also mean that people are dropping out of the labour force, which is keeping the official unemployment rate estimate lower than otherwise.

Overall, a very weak situation – not one of collapse as yet but trending towards a worsening situation.

Employment growth – virtually zero

The May data shows that employment growth was virtually zero. Total employment rose by 1,100 (0.1 per cent) to 11,663,300. Full-time employment fell by 5,300 while part-time employment rose by 6,400.

Today’s data reasserts the message that the labour market data is switching back and forth regularly between negative employment growth and positive growth spikes. This monthly behaviour is producing a weak positive trend, although not too much should be read into one month’s results.

There have been considerable fluctuations in the full-time/part-time growth over the last year with regular crossings of the zero growth line.

The following graph shows the month by month growth in full-time (blue columns), part-time (grey columns) and total employment (green line) for the 12 months to May 2013 using seasonally adjusted data.

Today’s results just repeat the topsy-turvy nature of the data over the period shown.

While full-time and part-time employment growth are fluctuating around the zero line, total employment growth is still well below the growth that was boosted by the fiscal-stimulus in the middle of 2010.

The following table provides an accounting summary of the labour market performance over the last six months. The monthly data is highly variable so this Table provides a longer view which allows for a better assessment of the trends. WAP is working age population (above 15 year olds). The first three columns show the number of jobs gained or lost (net) in the last six months.

The conclusion – overall 98.9 thousand jobs (net) have been created in Australia over the last six months (heavily influenced by the February and April 2013 results). Over the last six months, full-time employment has risen by only 15.9 thousand jobs (net) while part-time work has grown by 83 thousand jobs.

Over the last 6 months, a staggering 83.9 per cent of the net employment opportunities created have been part-time, which explains the sharp rise in underemployment (see below)

The Working Age Population has risen by 178 thousand in the same period while the labour force rose by 138.6 thousand. The weak employment growth has thus not been able to keep pace with the underlying population growth and unemployment has risen as a result (by 40 thousand).

To put the recent data in perspective, the following graph shows the movement in the labour force and total employment since the low-point unemployment rate month in the last cycle (February 2008) to May 2013. The two series are indexed to 100 at that month. The green line (right-axis) is the gap (plotted against the right-axis) between the two aggregates and measures the change in the unemployment rate since the low-point of the last cycle (when it stood at 4 per cent).

You can see that the labour force index has largely levelled off and now falling and the divergence between it and employment growth has been relatively steady over the last several months with this month showing some improvement.

The Gap series gives you a good impression of the asymmetry in unemployment rate responses even when the economy experiences a mild downturn (such as the case in Australia). The unemployment rate jumps quickly but declines slowly.

It also highlights the fact that the recovery is still not strong enough to bring the unemployment rate back down to its pre-crisis low. You can see clearly that the unemployment rate fell in late 2009 and then has hovered at the same level for some months before rising again over the last several months.

The gap shows that the labour market is still a long way from recovering from the financial crisis that hit in early 2008. There hasn’t been much progress since January 2010, when the fiscal stimulus started to run out.

Teenage labour market – remains in a parlous state

Full-time employment for teenagers rose by 1.6 thousand in May 2013 and part-time employment fell by 2.3 thousand. Overall, teenage employment fell by 700 (net) jobs.

The following graph shows the distribution of net employment creation in the last month by full-time/part-time status and age/gender category (15-19 year olds and the rest)

If you take a longer view you see how poor the situation is.

Over the last 12 months, teenagers have lost 5.4 thousand jobs while the rest of the labour force have gained 129.8 thousand net jobs. Remember that the overall result represents a very poor annual growth in employment.

Even more disturbing is the attrition of full-time jobs among teenagers – losing 20.5 thousand over the last year.

The teenage segment of the labour market is being particularly dragged down by the sluggish employment growth, which is hardly surprising given that the least experienced and/or most disadvantaged (those with disabilities etc) are rationed to the back of the queue by the employers.

The following graph shows the change in aggregates over the last 12 months. Australian teenagers are going backwards which is a trend common around the world at present.

To further emphasise the plight of our teenagers I compiled the following graph that extends the time period from the February 2008, which was the month when the unemployment rate was at its low point in the last cycle, to the present month (May 2013). So it includes the period of downturn and then the “recovery” period. Note the change in vertical scale compared to the previous two graphs.

Since February 2008, there have been 865.5 thousand (net) jobs added to the Australian economy but teenagers have lost a staggering 84.3 thousand over the same period. It is even more stark when you consider that 93.2 thousand full-time teenager jobs have been lost in net terms. Even in the traditionally, concentrated teenage segment – part-time employment – there have been only 8,900 jobs (net) gained even though overall some 456.7 thousand part-time jobs have been added.

Overall, the total employment increase is modest. Further, around 53 per cent of the total (net) jobs added since February 2008 have been part-time, which raises questions about the quality of work that is being generated overall.

Overall, the performance of the teenage labour market remains poor. It doesn’t rate much priority in the policy debate, which is surprising given that this is our future workforce in an ageing population. Future productivity growth will determine whether the ageing population enjoys a higher standard of living than now or goes backwards.

The longer-run consequences of this teenage “lock out” will be very damaging.

The Government’s response is to push this cohort into endless training initiatives (supply-side approach) without significant benefits. The research shows overwhelmingly that job-specific skills development should be done within a paid-work environment.

I would recommend that the Australian government announce a major public sector job creation program aimed at employing, in the first instance, all the unemployed 15-19 year olds.

It is clear that the Australian labour market continues to fail our 15-19 year olds. At a time when we keep emphasising the future challenges facing the nation in terms of an ageing population and rising dependency ratios the economy still fails to provide enough work (and on-the-job experience) for our teenagers who are our future workforce.

Unemployment

The unemployment rate fell from 5.56 per cent to 5.53 per cent but when rounded there was no change for May 2013. Official unemployment fell by 3,600 but that was due to the fall in the participation rate.

Overall, the labour market still has significant excess capacity available in most areas and what growth there is is not making any major inroads into the idle pools of labour.

The following graph updates my 3-recessions graph which depicts how quickly the unemployment rose in Australia during each of the three major recessions in recent history: 1982, 1991 and 2009 (the latter to capture the 2008-2010 episode). The unemployment rate was indexed at 100 at its lowest rate before the recession in each case (January 1981; January 1989; April 2008, respectively) and then indexed to that base for each of the months as the recession unfolded.

I have plotted the 3 episodes for 68 months after the low-point unemployment rate was reached with the current episode now in its 64th month. For 1991, the end-point shown is the peak unemployment which was achieved some 38 months after the downturn began although the recovery was painfully slow. While the 1982 recession was severe the economy and the labour market was recovering by the 26th month. The pace of recovery for the 1982 once it began was faster than the recovery in the current period.

It is significant that the current situation while significantly less severe than the previous recessions is dragging on which is a reflection of the lack of private spending growth and declining public spending growth.

The graph provides a graphical depiction of the speed at which the recession unfolded (which tells you something about each episode) and the length of time that the labour market deteriorated (expressed in terms of the unemployment rate).

From the start of the downturn to the 64-month point (to May 2013), the official unemployment rate has risen from a base index value of 100 to a value 138.7 – peaking at 148 after 17 months. After falling steadily as the fiscal stimulus pushed growth along (it reached 122.8 after 35 months – in January 2010), it has been slowly trending up for some months now. Unlike the other episodes, the current trend, at this stage of the cycle, is upwards.

The gains that emerged in the recovery as a result of the fiscal stimulus in 2009-10 have now been lost.

At 64 months, 1982 index stood at 154.9 and was wavering while the 1991 index was at 148.2 and was also falling. It is clear that at an equivalent point in the “recovery cycle” the current period is more sluggish than our recent two major downturns.

It now appears that the recoveries are converging, which tells us that the current policy has failed to take advantage of the fact that the latest economic downturn was much more mild than the previous recessions. In other words, the policy failure is locking the economy into a higher unemployment rate than is desirable and otherwise attainable.

Note that these are index numbers and only tell us about the speed of decay rather than levels of unemployment. Clearly the 5.4 per cent at this stage of the downturn is lower that the unemployment rate was in the previous recessions at a comparable point in the cycle although we have to consider the broader measures of labour underutilisation (which include underemployment) before we draw any clear conclusions.

The notable aspect of the current situation is that the recovery is very slow.

Broader labour underutilisation

The ABS published its quarterly broad labour underutilisation measures in this data release.

Total underemployment rose to 7.3 per cent (from 7.1 per cent) in the May-quarter and the ABS broad labour underutilisation rate rose sharply by 0.3 points to 12.9 per cent (the sum of unemployment and underemployment). There are now 908.6 thousand workers underemployed in Australia.

If hidden unemployment is added to this figure the best-case (conservative) scenario would see a 14.1 per cent underutilisation rate. Please read my blog – Australian labour underutilisation rate is at least 13.4 per cent – for more discussion on this point.

The following graph shows the same type of indexes as the previous graph except it uses the ABS broad labour underutilisation rate (unemployment plus underemployment). It also is in terms of quarters rather than months.

We also show the full evolution of the the 1982 and 1991 episodes from the low-point (= 100) through the peak and back to the next low-point. In the case of the 1982 recession the index had risen to a peak of 172.8 in May 1983 (a broad underutilisation rate of 14.4 per cent) and then fell back to 9.8 per cent by November 1989 (index value 117.4).

At that point, the cycle turned down again signalling the beginning of the 1991 recession. That cycle reached a peak of 185 (or 18.1 per cent in November 1992) and it took until February 2008 for it to reach the low-point of 9.9 percent (an index value of 100.9). That point marked the beginning of the next cycle.

That should tell you how severe the 1991 recession was and how asymmetric the labour market response is on either side of the cycle. From its start in November 1989 it took 74 quarters (18.5 years) to return to more or less that level.

In terms of the three recession comparison, at the same period in the recovery (using quarterly data), the broad labour underutilisation rate (unemployment plus underemployment) had an index value of 142.5 in the 1982 recession (absolute value of 11.9 per cent); an index value of 158.1 in the 1991 recession (absolute value of 15.5 per cent); and an index value of 130.9 in the current period (absolute value of 12.9 per cent).

So while the level of unemployment is much lower now than in the 1982 recession (at a comparable stage), underemployment is now much higher and so the total labour underutilisation rates is higher. Further, the 1982 recovery in broad underutilisation terms was more robust than the current stagnating situation.

Commentators who think of the 1982 recession as severe, rarely see it in these terms. Joblessness is probably worse than underemployment but both mean that labour is wasted and income earning opportunities are being foregone. For a worker with extensive nominal commitments, the loss of income when hours are rationed may be no less severe than the loss of hours involved in unemployment, if the threshold of solvency is breached.

Aggregate participation rate fell – held down the implied rise in unemployment

The participation rate fell by 0.1 percentage points in May continuing the decline which was punctuated by improvements in February and April. It is now at 65.2 per cent. The fall in participation meant that unemployment would have been 16.6 thousand persons higher than the official level had the labour force remained static and given the actual employment growth.

We can assume that hidden unemployment has risen by something close to 34.7 thousand persons in March 2013 as the employment prospects for workers continue to diminish. The participation rate is still substantially down on the most recent peak in November 2010 of 65.9 per cent when the labour market was still recovering courtesy of the fiscal stimulus.

In the current month, the unemployment rate fell to 5.53 per cent from 5.56 per cent. What would have the unemployment rate been had the participation rate not fallen?

The labour force is a subset of the working-age population (those above 15 years old). The proportion of the working-age population that constitutes the labour force is called the labour force participation rate. So changes in the labour force can impact on the official unemployment rate and so movements in the latter need to be interpreted carefully. A rising unemployment rate may not indicate a recessing economy.

The labour force can expand as a result of general population growth and/or increases in the labour force participation rates.

The following Table shows the breakdown in the changes to the main aggregates (Labour Force, Employment and Unemployment) and the impact of the rise in the participation rate.

In May 2013, employment fell by 1.1 thousand while the labour force contracted by 2.6 thousand persons. As a result, unemployment fell by 3.6 thousand.

The labour force fall in May was the outcome of two separate factors:

• The underlying population growth added 16.6 thousand persons to the labour force. The population growth impact on the labour force aggregate is relatively steady from month to month; and
• The fall in the participation rate meant that 19.1 thousand workers left the labour force (relative to what would have occurred had the participation rate remained unchanged).

So while employment growth failed to keep pace with the underlying population growth, the falling participation took the pressure off somewhat (by 19.1 thousand) as workers exited the labour force and were taken out of the official unemployment count.

If the participation rate had not have fa;;em, total unemployment, at the current employment level, would have been 798.3 thousand rather than 682.0 thousand as recorded by the ABS – a difference of 115.5 thousand workers.

Thus, without the rise in the participation rate, the unemployment rate would have actually risen to 6.5 per cent rather than its current value of 5.5 per cent.

The conclusion is that hidden unemployment rose and this attenuated the rise in the official unemployment rise. In functional terms this signals a much worse deterioration in the conditions than signalled by the current official unemployment rate.

There is considerable monthly fluctuation in the participation rate but the current rate of 65.2 per cent is a long way below its most recent peak in November 2010 of 65.9 per cent.

The following graph tells us what that means in terms of the unemployment rate. The blue line is the official unemployment since its most recent low-point of 4 per cent in February 2008. It is currently at 5.5 per cent.

The red line starts at November 2010 (the peak participation month). It is computed by adding the workers that left the labour force as employment growth faltered (and the participation rate fell) back into the labour force and assuming they would have been unemployed. At present, this cohort is likely to comprise a component of the hidden unemployed (or discouraged workers).

These workers would take a job immediately if offered one but have given up looking because there are not enough jobs and as a consequence the ABS classifies them as being Not in the Labour Force.

Note, the gap between the blue and red lines doesn’t sum to total hidden unemployment unless November 2010 was a full employment peak, which it clearly was not. The interpretation of the gap is that it shows the extra hidden unemployed since that time.

As the participation rate dropped over the period, the gap rose. The adjusted unemployment rate would now be 6.5 per cent instead of the official rate of 5.5 per cent.

Hours worked plunge in May 2013

Aggregate monthly hours worked decreased by 11.5 million hours (-0.7 per cent) in seasonally adjusted terms. The fall in hours worked this month continues the trends over several months of growth being interspersed with contraction with the trend switching back and forth between positive and negative.

The sharp rise in underemployment in the second-quarter 2013 is indicative of a trend away from full-time employment.

The small swings up and down in monthly hours worked each month since the beginning of 2011 is being driven by similar fluctuations in full-time employment.

The following graph shows the trend and seasonally adjusted aggregate hours worked indexed to 100 at the peak in February 2008 (which was the low-point unemployment rate in the previous cycle). The rising trend which marked the early recovery courtesy of the fiscal stimulus is now clearly gone.

The next graph shows the monthly growth (in per cent) over the last 12 months. The green linear line is a simple regression trend – slightly positive after this month’s gains. You can see the pattern in working hours that is also portrayed in the employment graph – zig-zagging across the zero growth line. The economy is now starting to slow down as private spending growth is slowing and being exacerbated by the fiscal contraction.

Once again the data doesn’t support the notion of a fully employed labour market that is bursting against the inflation barrier.

Conclusion

Overall, today’s data was a terrible result after last month’s more positive signs. In general, we always have to be careful interpreting month to month movements given the way the Labour Force Survey is constructed and implemented.

The labour market is very weak and deteriorating.

It has not yet started to collapse (with unemployment rising sharply) in the face of significant terms of trade adjustments (down) and the fiscal contraction that is continuing but it is weakening.

The most striking aspect of a sad picture remains the appalling performance of the teenage labour market. Employment has collapsed for that cohort since 2008. I consider it a matter of policy urgency for the Government to introduce an employment guarantee to ensure we do not continue undermining our potential workforce.

The data certainly doesn’t support the Federal Government’s current macroeconomic settings, which are biased towards contraction. More fiscal stimulus is definitely needed but will not be forthcoming given the government’s neo-liberal biases.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

The UK Guardian article (June 12, 2013) – Workers suffer deepest cut in real wages since records began, IFS shows – wrote that:

The report finds that since the start of the recession real wages have fallen by more than in any comparable five-year period. It also highlights an “unprecedented” drop in productivity as output has tumbled faster than employment.

The amazing thing is that most of these losses have been avoidable. If the government had not baulked at its responsibilities and provided sustained stimulus to allow the private debt issues to work their way out over time the economy would not have entered the massive slump.

A reading of the IFS Report reveals that:

The last time that such a high proportion of workers faced real wage cuts was between 1976 and 1977, when inflation exceeded 15%, while the proportions of nominal wage freezes and cuts are the highest since the series began in the mid 1970s.

So this is an attack on the nominal wages received rather than inflation deflating the real value of those nominal wages (that is, nominal wages growth failing to keep pace with inflation).

The Report studied the evolution of real wages between 2007 and 2012 and found that “aggregate change was -5.3%”.

The UK Guardian article (June 12, 2013) – Workers suffer deepest cut in real wages since records began, IFS shows – notes that normally “real wages rise by 2% a year”, which reflects productivity growth.

In other words since 2007, “people are more than 15% worse off than they would have been if the pre-crisis wage trends had continued”. And that doesn’t take into account the massive wealth losses that have occurred.

The IFS Report investigated whether the real wage cut was due to “compositional factors” – that is, “on the basis of changes to the characteristics of individuals in the workforce and the jobs that they do”.

They found that when compositional changes are controlled for they “would have expected wages to increase by 3.3%, all other things being equal”.

Which means that:

… none of the aggregate wage fall can be explained by changes to the composition of the workforce on the basis of characteristics that we observe and hence must instead all be due to changes to the parameter values associated with (or returns to) particular characteristics instead.

What does that mean?

It means that the massive real wage cuts in the UK over the course of the recession have not been compositional in nature – that is are “not just being driven by individuals being made redundant and having to take lower paid jobs”. The Report finds that:

… there is also strong evidence of substantial nominal and real wage reductions occurring within jobs.

The Report investigates why workers are “so much more likely to have experienced nominal wage freezes or cuts during this recession compared to previous recession”.

They find that there has been a “dramatic decline in trade union membership over the last 30 years … accompanied by a reduction in the proportion of employees covered by collective bargaining, which appears to have made it easier for employers to hold constant or reduce insiders’ wages”.

This is a world-wide trend and one of the defining characteristics of the neo-liberal period – that relentless attack on the capacity of the workers to translate productivity growth into real wages growth.

I have noted the consequences of this in the past. I recently gave a talk in Darwin about this and the working paper to support the presentation is available here – Full employment abandoned: the triumph of ideology over evidence

The deregulation in the labour markets not only created increased job instability and persistently high unemployment but also led to large shifts in national income from wages to profits.

The following graph shows the relationship between real wages and productivity growth in Australia from 1978 to 2012. An recent ILO Report written by Englebert Stockhammer – Why have wage shares fallen? A panel analysis of the determinants of functional income distribution – reports similar trends in other advanced OECD nations.

[Reference: Stockhammer, E. (2013) Why have wage shares fallen? A panel analysis of the determinants of functional income distribution, International Labour Office, Geneva]

First, the wage share in national income has fallen significantly over the last 35 years in most nations.

Second, in the Anglo nations, “a sharp polarisation of personal income distribution has occurred” (Stockhammer, 2013: 2), with the top percentile and decile of the personal income distribution substantially increasing their total shares. The munificence gained at the expense of lower-income workers manifested, in part, as the excessive executive pay deals that emerged in this period.

Up until the early 1980s, real wages and labour productivity typically moved together. As the attacks on the capacity of workers to secure wage increases intensified, a gap between the two opened and widened. The widening gap between real wages and productivity growth manifested as the rising profit share.

In 1975, the Australian wage share was around 62.5 per cent of factor income. By the end of 2012, it was around 54 per cent. Australian government aided this redistribution in a number of ways: privatisation; outsourcing; harsh industrial relations legislation to reduce union power; National Competition Policy and such.

We know what happened next. Imbued with the, now discredited, efficient markets hypothesis, promoted by University of Chicago economists, policy makers bowed to pressures from the financial sector and introduced widespread financial deregulation and reduced their oversight on the banking sector.

This not only led to a massive expansion of the financial sector, but also, set the stage for the transformation of banks from safe deposit havens to global speculators carrying increasing, and ultimately, unknown risks. The massive redistribution of national income to profits provided the banks and hedge funds with the gambling chips to fuel the rapid expansion of the ‘global financial casino’ expanded.

Increasingly, the Gordon Gekkos strutted the stage as celebrities and were cast as important wealth generators. Private returns were high and the lemming rush unstoppable.

But the reality was different. The vast majority of speculative transactions that occur every day in the financial markets are unproductive, in that they are unrelated to the real economy and advancing our welfare.

A substantial portion of the “wealth” generated was illusory and we subsequently discovered that the socialised losses were enormous as the huge, unregulated gambling casino collapsed under its own hubris, criminality and incompetence.

Hark back to the introduction – those poor dears who are now struggling a little with massive private school fees and their ski holidays in the US Rocky Mountains.

But the two arenas of deregulation created a new problem – one that Marxists would call a “realisation” problem. The capitalist dilemma was that real wages had to typically grow in line with productivity to ensure that the goods produced were sold.

So how does economic growth sustain itself when labour productivity growth outstrips the growth in capacity to purchase (the real wage)? This was especially significant in the context of the increasing fiscal drag coming from the public surpluses, which squeezed private purchasing power in many nations during the 1990s and beyond.

The neo-liberal period found a new way. The ‘solution” was found in the rise of so-called ‘financial engineering’, which pushed ever increasing debt onto households and firms. The credit expansion not only sustained the workers’ purchasing power but also delivered an interest bonus to capital while real wages growth continued to be suppressed. Households, in particular, were enticed by lower interest rates and the vehement marketing strategies of the financial engineers. It seemed to good to be true and it was.

The increasing private sector indebtedness – both corporate and household – is another marked characteristic of the neo-liberal period.

In Australia it manifested mostly as increasing household indebtedness. The debt to disposable income ratio stood at 69.1 per cent in March 1996 and by September 2008 had risen to a staggering 153.1 per cent.

Governments, their central banks, and so-called financial industry experts played down any sense of alarm during the pre-crisis period claiming that wealth was growing along with the debt. When the debt bubble burst, significant proportions of the ‘wealth’ vanished leaving many borrowers with massive debts but few assets.

In the UK, over the period 2007 and 2012, there has also been a productivity slowdown due, in part, to the “sharp reduction in business investment over the course of the recent recession, which has been significantly larger than in previous recessions”.

So much for the hoped for Ricardian response that the conservatives claimed justified the imposition of fiscal austerity. There was meant to be an outpouring of private spending as the government announced plans to cut the budget deficit.

Any reasonable observer predicted exactly the opposite – that rising unemployment, real wage cuts, falling wealth and declining sales would kill growth in both consumption and investment.

That is what has happened.

The IFS Study meshes with the evidence provided in a recent report (June 3, 2013) from the International Labour Organization (ILO) – World of Work Report 2013, Repairing the economic and social fabric.

The ILO unfortunately is now a schizoid organisation – still championing workers’ rights to decent work and real wages growth on the one hand, but on the other – buying into the whole “fiscal consolidation” myth.

In the same way that the IMF keeps raving on about “growth friendly austerity” (when there is no such thing), the ILO talks about achieving “a better balance between employment and other macroeconomic objectives” to “achieve a lasting and inclusive recovery”.

The problem is that fiscal consolidation is code for austerity and the ILO appears incapable of understanding that it undermines workers’ rights to decent work and conditions.

In the – World of Work 2013: Country Brief on the United Kingdom – the ILO said that:

An export-led recovery is unlikely in light of the Euro crisis and global economic slowdown, domestic demand becomes particularly important. However, real private sector wage growth has been negative since the onset of the crisis … Yet, CEO pay in the United Kingdom remains elevated and close to levels attained in 2007 … In 2011, CEOs of the 15 largest firms in the United Kingdom earned on average 238 times the annual earnings of the average UK worker. For the average executive this figure stood at 113 times average earnings.

Further, in relation to the weak domestic demand:

Investment, which in 2012 stood at just over 14% of GDP is among the lowest in advanced economies and has fallen by more than 3 percentage points since 2007. The United Kingdom is caught in a vicious spiral of weak aggregate demand and lack of productive investment. Stagnating wages are adversely affecting demand, which in turn is dampening real investment, leading to poor job creation – reinforcing weak demand and so on

However, the ILO cannot make the obvious connection between these correct observations and their advocacy of fiscal consolidation.

They want to:

1. “stimulate investment in the real economy” – yes, that would be good.

2. “Ensure the financial sector acts as an enabler of the real economy” – yes, an essential aspect of any recovery.

3. “Improve design of executive compensation” – yes, but not in the way they suggest (more another day on that).

4. “Improve effectiveness of minimum wage policies” – yes, it would boost the incomes of low wage workers and help arrest the slump in spending.

But where is the elephant?

If domestic demand is the problem (and the solution) and the private sector is locked in a “vicious spiral of weak aggregate demand” because of “stagnating wages” and poor “real investment” then there is only one sector that can provide the spending leadership.

Which means that fiscal consolidation is the opposite to what is required.

The other obvious lesson to be drawn from these studies is that the mainstream macroeconomics idea that private spending responds positively to fiscal austerity (Ricardian Equivalence) is once again shown to be a massive lie.

The concept is so discredited yet is still wheeled out by governments seeking some sophistry to justify their spending cuts.

Conclusion

The point is that the spending cuts and austerity cannot be seen in isolation. They are part of an historical strategy to undermine the gains made over the C20th by workers in terms of real living standards etc.

The neo-liberals have this weird idea that they can take more off the workers and this will further the interests of the few (the takers). What they cannot seem to understand is that the period leading up to the crisis was historically atypical.

Growth was only really possible because of the credit explosion. That will not occur again any time soon. The more they try to deprive the workers of access to productivity growth and at the same time cut fiscal spending the more stagnant the advanced nations will become.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

So the proverbial grain of salt hangs perilously over this exercise.

From the perspective of the educator, the results are worrying in the extreme. There is very little “knowledge” indicated in the responses with respect to the economy and the government budget.

A lot of opinions are expressed but once you consider them in detail the only possible conclusion is that American college students (inasmuch as this is a representative sample) are hopelessly mis-educated on these matters – like the rest of the population.

Which means that it is little wonder when things get a little complex – like handling a massive private sector debt meltdown – the policy responses are poor.

Of-course, ideology gets in the way of reason all the time. I use the term ideology to refer to that component of our focus that resists evidence by continually recasting it to suit our own priors and framing questions in such a way we selectively screen out possible facts. We all do it. However, I always thought that education was a means of providing some balance whereby when rogue facts come along we question our priors rather than deny the facts.

In other words, we change our views as we traverse the road from ignorance to knowledge.

I don’t intend to analyse the document in detail because it doesn’t deserve that attention. But it serves to demonstrate how our so-called progressive political leaders have failed us badly over the last few decades.

Despite all the hype that the youth generation is all about entrepreneurship and have long eschewed the concept of worker and boss that the rest of us still consider is a reasonable depiction of what goes on everyday in between when we leave our homes and return, mostly in the dark, 37 per cent of the respondents said that “economy and jobs” was the top issue. Other top issues included environmental protection, gay marriage

16 per cent more respondents thought the Democrat economic policies were superior to those proposed by the Republicans.

Representative of the confusion in the respondent’s answers though is the table on Page 32, which itemises the reasons that young people considered “played the biggest role” or “played a major role” in the recession with percentage scores against each item. I have reproduced that Table below.

The information presented is not finely-grained enough to determine the overlapping responses or what was actually asked. I guess I could find out by E-mailing the survey providers but it wouldn’t alter things anyway.

The Table demonstrates a mixture of pure ideology (fed to the students by their parents and Fox News), folksy intuition (a very dangerous thing to rely on) and, probably, kernels of insight into what is actually going on.

Quite clearly some of the same respondents who answered that “Too much government spending” was to blame also thought that “Republican economic policies” were the biggest or major cause of the crisis.

Later on in the report you find that the main myths paraded by both major parties figure as central points of agreement among the respondents (see Table on Page 77). So “We need to reform Social Security and Medicare now so that the next generation isn’t left cleaning up a huge mess down 90% the road” (90 per cent agree); need deregulation (86 per cent agree); “We need to make tough choices about cutting government spending, even on some programs some people really like, because the national debt is simply out of control” (82 per cent agree) and 72 per cent think that “We need to reduce the size of government, because it is simply too big” (that is, pure ideological response).

If you try to marry the logic that might lead to these responses, given that a very high proportion of respondents believe these propositions, you will come to a screeching halt.

Just like several of the propositions in the previous table (above) there is so much internal inconsistency in the responses.

For example, the responses about banking all point to a failure of regulation (insufficient, poorly administered etc) just as the
“way forward” the respondents want less government and less regulation.

They clearly don’t like GOP policies but then advocate as the “way forward” central GOP policy myths.

Extraordinary levels of illogicality not to mention ignorance.

But don’t blame the students, their teachers and political leaders let them down too.

If I was to ask a moderate economist (that is, one who was not totally confused by Chicago logic) whether there was a private debt issue in most advanced nations right now I imagine a large majority would agree.

There would be ums and ahs about the debt being backed by wealth and the primacy of private choice and all the rest of it. But most would agree that this crisis started as a private debt explosion after years of growth driven by unsustainable private credit expansion.

The facts surrounding the banking behaviour – the pursuit of profits in the sub-prime markets, the inability to assess the extent of risk on their books etc – are broad areas of agreement.

The fact that private sector spending has been cautious since the crisis relates to the recognition that balance sheets have to be repaired and brought back into the realm of sustainable debt positions. The massive increase in joblessness has also put a dampener on spending enthusiasm.

So I imagine I could get agreement on those issues – and, indeed, I do. Even among economists who I would term to be thoroughly mainstream.

If I have have started the questioning with something like “do you think government budgets should be balanced over the economic cycle?” I would also get broad agreement.

Some economists (the lunatic Chicago fringe) would never agree and would argue that government should be very small and run surpluses most nearly all the time irrespective of the business cycle.

But the broader mainstream would think that deficits at times of deep crisis are inevitable (even if they thought they were undesirable).

I could tease those responses out somewhat and the logic would go that the budget will typically go into deficit when the automatic stablisers respond to a major private spending collapse. The task is then to get the deficit down as quickly as possible and as private spending growth recovered to push it back into increasing surpluses “to pay for the deficits”.

This logic is almost a folksy rendition of reality – which means it probably totally ignores reality. Apparently, unless the deficits are “paid back” there will be rising interest rates and an explosion of public debt.

The fact that deficits are flows and that flows are never “paid back” is too finer detail at this level of argument. The fact that reversing a deficit flow in some future period takes purchasing power off the private sector is also ignored just as the fact that the deficit in the first place provided purchasing power – income.

The emphasis is on the stock implications of the flows – the public debt. If you try to get the economists to then consider what might happen if there was no matching debt issued they roll their eyes and start hyperventilating – or hyperinflatilating.

That is, despite the other fact that there is no increased inflation risk from government deficit spending with matching debt-issuance when compared to the same spending with matching debt-issuance.

The inflation risk is in the spending impact on aggregate demand and the monetary operations that the government (treasury and central bank) choose to accompany the spending is somewhat irrelevant.

But note that if I was having this discussion with a mainstream economist all the lateral thinking would be too subtle and the discussion would concentrate on debt and inflation.

If I then brought the two questions together, private debt and budget deficits, the majority of the same economists would claim that all debt had to be brought down for a recovery.

Those who favour austerity would prioritise public debt retrenchment while those who were against austerity but still held mainstream views about deficits (that is, the so-called deficit doves) would umm and ahh and conclude that you need a mix of retrenchment.

Modern Monetary Theory (MMT) proponents would strongly argue that if private debt is the problem then larger deficits are required if the external sector is in deficit and therefore draining growth.

More about that in a moment.

I was at a dinner the other night where two economists were speaking about the challenges and opportunities for Australia in Asia (the so-called Asian Century that the Government is beating up at present). In the question and answer session they were asked to comment on the obsession with budget surpluses that dominate the way governments (and the conservative pushers) think these days.

The two in question are hardly at the right of the spectrum. The substantive view reflected by both of them was that there were times when the budget could be in deficit (as the automatic stabilisers responded to a major private spending collapse) but that the government should aim to balance the budget over the cycle or err on the side of surpluses over the cycle.

There was some recognition that where we start and end the cycle is a matter of debate but the substantive principle was strongly expressed – deficits have to be paid back with surpluses.

The point is that the way macroeconomics is taught in mainstream departments students do not get exposed to the frameworks that allow them to see the reality.

If I asked a second-year macroeconomics student taught in a mainstream program the following question they would stare at me and not know where to start:

If a nation is running an external deficit, can the private and public sectors both run simultaneous surpluses?

If I also noted that a nation that runs an external deficit over the cycle, can only run a balanced budget over the cycle if it accepts that the private domestic sector will run a deficit exactly (dollar-for-dollar) equal to the external deficit over the same cycle, I wouldn’t get much recognition from the respondent.

If I also teased out the flow-stock implications of these various flow conjectures their eyes would soon glaze over.

The fact is that the mainstream macroeconomics program doesn’t build analytical capacity which allows the students to understand the major relationships between these sectoral balances.

It is all in there somewhere but never brought together to an internally consistent whole.

That is why economists can say that both private domestic debt and public debt are problems, and both have to be reduced, with the prescription for government action being to run surpluses (to buy back the debt).

But when there is an external drain on demand occurring (external deficit), a government cannot run a surplus, without severely damaging economic growth, unless the private domestic sector takes on increasingly large volumes of debt.

That is the pre-crisis model for most nations. It is unsustainable because the private domestic sector cannot take on increasingly large volumes of debt – and run its debt build-up faster than its income growth (so that the debt to disposable income ratio rises indefinitely).

The failure of even professional economists (the two at the dinner, for example) to realise that is symptomatic of the whole problem.

The knowledge generating frameworks in mainstream macroeconomics are irretrievably flawed.

The fact is that if an economy is running an external deficit, the government has to be in deficit, if the private domestic sector desires to run a surplus (that is, spend less than it is earning).

Most governments ran continuous deficits for years before the crisis because the private domestic sector does not seek to run on-going and increasing deficits and most nations do not run external surpluses.

The flawed macroeconomics education also produces politicians that have little idea of the capacity their policy tools provide or the best way they can be used.

A few weeks ago I made reference to the statements by the Opposition Chancellor in the UK, which were reported in the UK Guardian article (June 3, 2013) – As Labour’s iron man, Ed Balls could do the trick.

The article related how Ed Balls would cut spending hard under a Labour government. So-called progressive journalist Polly Toynbee assessed his contribution as being an “impressive speech set out a credible economic plan, tough as titanium – too tough for some Labour tweeters”. Which at the time I concluded told me that she also knows nothing about economics.

Given the economic circumstances in the UK at present, there can be no reasonable case made for cutting net public spending if you desire to increase employment and reduce poverty rates – an alleged ambition of the Labour Party there.

In fact, the UK needs a substantial increase in the Budget deficit at present and under the current economic trajectory, that will not alter by the time the people vote to elect the next national government.

I note that the British Labour leader gave a speech last week advocating putting a cap on welfare spending in the UK if the was elected.

The UK Guardian article (June 6, 2013) referred to the speech he gave on Thursday as:

… reframing of the welfare debate and an attempt to unify the country after Tory attempts to divide people over the issue …

Which is code for moving further to the neo-liberal right to buy votes instead of showing leadership and disabusing the British people of the basis of these neo-liberal fallacies about welfare and austerity.

The whole package he unveiled – welfare caps, wage subsidies to increase employment, user-pays welfare, more harsh activity tests for the unemployment etc – are all neo-liberal mainstays.

An assessment of the way the Labour Party in Britain is approaching policy development in opposition was provided in this UK Guardian
article (June 7, 2013) – Ed Miliband’s austerity-lite is already out of date.

The journalist said:

The worrying context of Miliband’s speech is the acceptance of the austerity paradigm – as in Ed Balls’s speech earlier this week. Again, time has moved on. In 2010 Labour gave the intellectual space to the Tories to allow them to define the cause of the economic crisis and it is now failing to appreciate the world is rapidly moving on from austerity solutions.

An economic crisis provides the space for major changes in the political narrative. Leadership is required to articulate that change but if there was ever an opportunity to demonstrate the poverty of the neo-liberal approach it has been this drawn-out crisis where advanced economies go from one negative piece of data to the next, and the extolling of the austerity-polity looks increasingly wan.

This is why:

Increasingly, people are angry at the cesspit of corruption that our corporate sphere has become. The lingering disgust at bankers’ bonuses is daily reinforced by new revelations about corporate tax scams and the price-fixing of our energy bills, while privatised former public services are used as the vehicles for large-scale profiteering. Labour’s politics of austerity-lite look like irrelevant party political triangulation when more radical systemic change is coming on to the agenda.

The problem is that British Labour hasn’t the capacity to provide that leadership. They need to jettison the neo-liberal economics framework that they seek security within. They think that poking their heads out of the austerity paradigm and advocating a few “progressive” embellishments (like abandoning the ridiculous and cruel ATOS disability tests) will demonstrate leadership.

The problem is that they haven’t understood the big picture – the monetary system. So austerity lite is only slightly less worse than austerity central.

The British people have no-one credible to vote for. All sides of politics are now infested with the neo-liberal disease of ignorance and malice.

In 2007, the Australian Labour Party won office in a landslide. The electorate categorically rejected the neo-liberal policy positions that had finally started to undercut their real wages growth and had promoted increased inequality. There were other elements as well – an inhumane treatment of refugees, indigenous Australians and a denial of climate change. But it was the economic policies that were the clincher.

The ALP had a massive chance to re-educate the public that was drowning in private debt after the credit binge, which allowed the federal government to run increasing surpluses and squeeze the hell out of the economy.

It started badly – arguing that it would continue to run surpluses because there was a massive inflation threat. There had been some price rises due to a major drought then floods. Further, world oil prices were pushing up the cost of petrol. Neither of these temporary price impulses had anything to do with the small rise in inflation at the time.

As soon as they started on that tack, inflation started to fall anyway (as food prices started to fall).

Then the crisis hit and they were forced into deficit. It is true they chose to implement a fiscal stimulus program, which was well-timed but not large enough to stop unemployment and underemployment from rising.

But almost as soon as they implemented the stimulus they apologised and started on their obsessive budget surplus rhetoric and the austerity began. The consequences are that they undermined the nascent growth the stimulus had created and they (treasury and the RBA) grossly over-estimated the growth impacts of the mining boom.

Very few economists argued in 2009, 2010 and 2011 that the government should increase its deficit. I was pretty much alone in that regard (there were a few others perhaps – but then they adopted highly qualified positions). It was surplus or bust.

I predicted bust. Bust is what we have at present. The government undermined its own aspirations because they failed to appreciate that the austerity would destroy growth and that would kill their revenue base.

The point is that this was a period that the Government could have dramatically changed the debate by educating the population on the need for deficit and assuring the voters that the sky wasn’t about to fall in any time soon. Instead they chose to perpetuate the deficit myths and that window of opportunity for a major shift in the debate was lost.

Now we are mired in a austerity downward spiral just like the rest of the nations where neo-liberals are in charge.

I agree with the sentiment (if not some of the detail) in Paul Krugman’s column yesterday (June 10, 2013) – The Big Shrug – where he says that:

… our policy discourse is still a long way from where it ought to be … Why isn’t reducing unemployment a major policy priority …

So the US students are just following the adults – it is just that it is the future prosperity of the students that is being undermined by the neo-liberals. And the former are too poorly educated to understand that.

Conclusion

At the same dinner I mentioned above, I was involved in a conversation as to whether MMT was left-wing or not. My standard comment is that it is neither left- or right-wing it just is. Is, in this case, is a framework for describing and understanding the mechanics of monetary systems and the consequences of various policy choices.

The left- or right-wing elements then enter the frame when we discuss the objectives that a government should pursue and how it might go about achieving those objectives.

So it might be construed as being a right-wing position if a person advocates running a budget surplus even though the private sector is clearly attempting to run a surplus and the external sector is in deficit.

The person advocating that position would, if they understood MMT (and hence the way the monetary system operates), have to admit that they preferred higher unemployment, more inequality and increased poverty rates to the alternative and that is why they advocated that economic policy stance.

They would not be able to engage in sophistry about reducing the burden of debt on grandchildren, or saving up for the future, or taking the pressure off interest rates or any of the other nonsense that the right-wingers deploy to hide what their underlying value positions are when they advocate surpluses under the circumstances noted above.

A left-wing position would clearly not tolerate unemployment above the frictional level and so would advocated increasing deficits under the circumstances noted above.

So MMT is not a statement of values but could underpin an extreme right-wing, free market approach or the polar opposite, or … plenty of positions in-between.

As soon as we get over that myth – that MMT is left-wing – the sooner more serious debate can occur.

By the way, I also don’t think it is a left-wing position to advocate low unemployment. That benefits all sectors. The problem is that the right-wingers are so ingrained with class conflict thinking that they cannot tolerate workers have stable jobs and growing real incomes.

Congratulations

To all Phd students I know who submitted their dissertations today! Congratulations. Brilliant effort. x

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

The US Bureau of Labor Statistics also put out an excellent publication (May 4, 2012) – Employment from the BLS household and payroll surveys: summary of recent trends – which is worth reading.

The BLS say that:

Both the payroll and household surveys are needed for a complete picture of the labor market. The payroll survey provides a highly reliable gauge of monthly change in nonfarm payroll employment. The household survey provides a broader picture of employment including agriculture and the self employed.

You should also read the Employment Situation Frequently Asked Questions, which explains a number of things including why the payroll data is revised so much between months.

The point is that the two concepts are different.

The “household survey has a broader employment definition than the payroll survey” and so the former is always higher than the latter. They move in a similar cyclical pattern though with very similar turning points (troughs and peaks).

Focusing on the Household Labour Force Survey data, the seasonally adjusted labour force rose by 420 thousand in May 2013, while employment rose by 319 thousand with the labour force participation rate constant at 63.4.

Unemployment rose by 101 thousand and the unemployment rate edged up from 7.51 per cent to 7.56 per cent.

Employment growth has to absorb the increase in the labour force to ensure unemployment doesn’t rise. The task that economies typically face in a recovery from a deep recession is that the labour force growth, itself accelerates (due to the hidden or discouraged workers re-entering the labour force) and there is a huge residual pool of unemployed as to be absorbed.

Usually, employment growth is insufficient in the early stages of the recovery to absorb the unemployment quickly and so we observe the distinct cyclical asymmetry in the behaviour of unemployment over the economic cycle. It quickly rises but only falls slowly again.

In the case of the US labour market, the labour force pressure that typically slows the reduction in unemployment has not been visible in the recovery
not visible. In fact, as we will see below, the labour force participation rate continues to stagnate at below its pre-crisis peak, which takes pressure of the employment growth. But, of-course, that is not a good sign.

While employment growth fell by 0.14 per cent, the labour force declined by 0.32 per cent, which means that unemployment fell by 290 thousand even though employment also declined.

The following graph gives you an idea of what has been going on in the US since December 2006 (the low-point unemployment rate month of the last cycle). All series shown are indexed to 100 at December 2006. The graph shows the evolution of the labour force (blue), total employment (red) and what the labour force would have been (in index numbers) if it had have grown at its average rate over the period December 2001 to December 2006 (0.094 per cent per month).

The difference between the blue and red line is the growth in unemployment since December 2006, while the difference between the blue and green lines is the growth in hidden unemployment (as a result of falling participation).

In terms of actual numbers, the gap between the green and blue lines is equivalent to 8.5 million workers as at May 2013.

So you get an idea of how massive this recession has been for the US labour market. The sluggish labour force growth (1.9 per cent over the period since December 2006) is only slightly higher than the 1.4 per cent employment contraction. If the labaour force had have maintained its average growth as noted above then it would have grown by 7.5 per cent over the period covered by the graph.

The unemployment devastation would have been massive if not for the sluggish labour force growth. I will come back to the falling participation rate later.

The following graph shows the monthly employment growth since the low-point unemployment rate month (December 2006). The red line is the average labour force growth over the period December 2001 to December 2006 (0.094 per cent per month). The unemployment rate rises if the employment growth is below the labour force growth rate.

What is apparent is that a strong positive and reinforcing trend in employment growth has not yet been established in the US labour market since the recovery began back in 2009. The labour market has definitely not set a sail for sustained recovery yet and remains in a very fragile state.

As a matter of history, the following graph shows employment indexes for the US (from US Bureau of Labor Statistics data) for the five NBER recessions since the mid-1970s.

They are indexed at the NBER peak (which doesn’t have to coincide with the employment peak). We trace them out to 64 months or so, except for the first-part of the 1980 downturn which lasted a short period.

It was followed by a second major downturn 12 months later in July 1982 which then endured. The current downturn has lasted 65 months and employment is still below the starting point of 100 (currently the index stands at 98.4).

Falling participation

What really is striking about the last few years in the US is the falling participation rate. The following graph shows the labour force participation rate (the proportion of those above 16 years of age that are in the labour force – that is, employed or officially unemployed) since January 2001.

Clearly, there has been a trend decline in the labour force underpinning the sharp cyclical acceleration from late 2007.

Examining participation rates provides us with information about what is happening on the margin of civilian working age population and the labour force. If, for example, the participation rises, unemployment can rise even though employment growth is strong. That is a virtuous sign because it means that the economic situation is improving and discouraged workers are coming back into the labour force as the jobs market looks more hopeful.

We juxtapose that situation with one where the participation rate is falling – which suggests discouraged workers are giving up on job search because of the dearth of vacancies available and even though unemployment might actually fall, the signs are bleak. All that sort of economy is doing is trading official unemployment for hidden unemployment. The weakness just leaves the labour force.

The fall in participation since December 2006 has been stark – from 66.4 per cent to 63.3 per cent in March 2013. What does that mean in numbers?

You can compute how much larger the labour force would be if the participation rate now was at its recent (December 2006) peak by working out the current working age population and multiplying it by the peak labour participation rate.

The difference between the actual labour force now and the “potential” labour force represents the number of workers that have given up looking for work as a result of the lack of job opportunities available, upon the assumption that there have been no sharp rise in retirements.

This difference is approximately what we might call the rise in hidden unemployment and in the case of the US is equal to 7,623 thousand workers.

If we added them back into the labour force and considered them to be unemployed (which is not an unreasonable assumption given that the difference between the two categories – unemployment and hidden unemployment is due to whether the person had actively searched for work in the previous month) – then the unemployment rate would rise to 11.9 per cent rather than the current official unemployment rate of 7.6 per cent.

So there is a huge degree of slack not counted among the official unemployed in the US and tells us that the unemployment rate is likely to be a very misleading indicator of how the US economy is faring.

In other words, a lot of the continuing slack is being hidden in the not in the labour force category. If employment growth speeds up then we can expect to see unemployment rise as the participation rate rises due to improving opportunities for employment. That is not happening yet as the participation rate is continuing to fall.

Long-term unemployment

The BLS report that the average duration of unemployment is now 36.9 weeks and continues to rise. In December 2006 it was 16.1 weeks.

The upshot is that the US labour market has for the first time a serious long-term unemployment problem. The following graph shows the evolution of this proportion (those unemployed for 27 weeks or more as a percentage of the total unemployed) since January 1948. The previous recessions are indicated by the spikes up to around 25 per cent.

The most recent recession is an outlier in terms of severity with the proportion peaking at 45.6 per cent in June 2010. In May 2013, the proportion was 37 per cent.

Many mainstream economists consider the problem in the US to be structural and conclude that the long-term unemployed are largely “unemployable”. This perspective goes back to the start of the neo-liberal onslaught.

The rising long-term unemployment has allowed the neo-liberal assertions that were highly influential in the design of the 1994 OECD Job Study to resurface – this time (and for the first-time) in the context of the US debate. The long-term unemployment rates have always been higher in Europe and Australia.

The Jobs Study was the bible for governments everywhere, which were intent on abandoning their commitment to full employment and, instead, concentrate labour market policy on supply-side initiatives. This was the so-called activism agenda – the pursuit of “employability” rather than ensuring there were enough jobs available. It was claimed that persistent unemployment was due to poor attitudes and lack of training.

The principle claim was that long term unemployment possessed strong irreversibility properties. Irreversibility is sometimes referred to as hysteresis and suggests that the long term unemployed constitute a bottleneck to economic growth which can only be ameliorated through supply-side (rather than demand-side) policy initiatives.

The OECD considered that only by “market-based” developments – privatising public employment services, harsh welfare-to-work changes, tightened activity tests, reductions in the real value of income support for the unemployed etc – that this alleged irreversibility would be alleviated.

The problem is that the facts never supported the ideologically-obsessed narrative that the neo-liberals pushed, which were used to justify the dismantling of the public sector and the privatisation of labour market programs. Unemployment did not fall until there was strong enough growth in aggregate demand.

The reason? Please read my blog – What causes mass unemployment? – for more discussion on this point.

In earlier work that I have done studying the rise in long term unemployment I found no evidence that there had been any major structural shifts in the relationship between long-term unemployment and total unemployment in most nations.

The sharp rises in long-term unemployment occur as a consequence recessions. In the next graph you can see this very clearly. The long-term unemployment rate (LTUR) rises with a slight lag with the official unemployment rate (UR). The lag is because it takes 27 weeks in the US classification system before a person who becomes unemployed today is counted as being long-term unemployed.

So during a prolonged downturn, the flows into short-term unemployment feed longer duration spells of unemployment which then cascades over into long-term unemployment. All the dynamics of the LTUR are demand-driven. I have never been able to construct them as steady structural shifts driven by behavioural supply side changes.

The next graph compares the relationship between the official unemployment rate (horizontal axis) and the long term unemployment rate (vertical axis) for two cycles coinciding with the 1982 recession (green markers – low-point unemployment rate – November 1979 was 5.9 per cent) and the current downturn (blue markers – low-point unemployment rate – December 2006 was 4.4 per cent). The data for the 1982 recession shows that the economy started with a higher unemployment rate which rose sharply and drove a rise in the long-term unemployment rate.

In the recovery phase, the long-term unemployment rate dropped (in a lagged pattern) with the improvements in the official unemployment rate.

The current recession started from a better position but has endured for longer even though the unemployment rate only rose to 10 per cent rather than 10.8 per cent in November 1982. It is the persistent of the slackness that accounts for the continuing rise in the LTUR.

But if you compare the actual slope of each of the recoveries (one the LTUR peaks and starts to fall again) they are almost identical. So just as the LTUR fell to low levels as the 1982 recovery strengthened, I would expect the same to happen in the current period. However, the longer the recovery is stalled the worse the consequences are for those who remain long-term unemployed.

We can add a bit more graphical insight to this discussion given the excellent data provided by the BLS.

You can see that more clearly in the following graph which shows the same time series from December 2006 (the low-point unemployment rate month of the last cycle) to May 2013 of the unemployment rate (%) by duration segments in weeks. The marked feature of this recession compared to earlier downturns (not shown) is the extent of the rise in those unemployed for longer than 27 weeks as a proportion of the labour force.

That is a guide to the entrenched nature of the event and the fact that employment growth in the recovery has been insufficient to eat in to the pool of unemployed that built up in 2008-09.

The sequence of movement through the duration categories is very evident as the recession deepened and the employment response was weak. The US government should have intervened earlier and with more significant employment-orientated stimulus packages to prevent that duration wave occurring.

Once you see long-term rising like that the losses mount and the labour market recovery becomes more difficult because not only have the people been dislocated from paid employment for a long time but their skills and capacities start to atrophy, which then introduces an additional problem.

Gross Flows Analysis

To fully understand the way gross flows are assembled and the transition probabilities calculated you might like to read these blogs – What can the gross flows tell us? and More calls for job creation – but then. For earlier US analysis see this blog – Jobs are needed in the US but that would require leadership

The data is available from these extremely cludgy – Data Retrieval App – from the BLS. Please bring back the capacity to access the large historical text-file dump for the entire gross flows data – please!!!

Transition probabilities are calculated from Gross labour flows data which is available from the Data Retrieval App – provided (against better judgement) by the US Bureau of Labor Statistics. By way of refreshing your understanding, gross flows analysis allows us to trace flows of workers between different labour market states (employment; unemployment; and non-participation) between months. So we can see the size of the flows in and out of the labour force more easily and into the respective labour force states (employment and unemployment).

The various inflows and outflows between the labour force categories are expressed in terms of numbers of persons which can then be converted into so-called transition probabilities – the probabilities that transitions (changes of state) occur. We can then answer questions like: What is the probability that a person who is unemployed now will enter employment next period?

So if a transition probability for the shift between employment to unemployment is 0.05, we say that a worker who is currently employed has a 5 per cent chance of becoming unemployed in the next month. If this probability fell to 0.01 then we would say that the labour market is improving (only a 1 per cent chance of making this transition).

The following table shows the schematic way in which gross flows data is arranged each month – sometimes called a Gross Flows Matrix. For example, the element EE tells you how many people who were in employment in the previous month remain in employment in the current month. Similarly the element EU tells you how many people who were in employment in the previous month are now unemployed in the current month. And so on. This allows you to trace all inflows and outflows from a given state during the month in question.

The transition probabilities are computed by dividing the flow element in the matrix by the initial state. For example, if you want the probability of a worker remaining unemployed between the two months you would divide the flow (U to U) by the initial stock of unemployment. If you wanted to compute the probability that a worker would make the transition from employment to unemployment you would divide the flow (EU) by the initial stock of employment. And so on.

So for the 3 Labour Force states we can compute 9 transition probabilities reflecting the inflows and outflows from each of the combinations.

Analysing movements in these probabilities over time provides a different insight into how the labour market is performing by way of flows of workers.

The next graph shows the transitions for EU and UE from December 2007 (when the crisis hit the US labour market) up to May 2013.

The probability of an American (in general) losing their job if employed (blue line) rose throughout 2008 (peaking at 2 per cent in February 2009), slowly evened out and is now slowly falling (1.2 per cent in May 2013).

In December 2009, the chance of an unemployed American worker gaining employment was 27 per cent. This probability fell to a low of 15.4 per cent in October 2009, and scudded along at around 17 per cent through much of 2010-2011. It peaked again in September 2012 at 19.2 per cent, but as the impacts of the fiscal retreat started to impact, it fell to 17.6 per cent.

It has risen again in recent months and is now around 19.3.

This is not a rapid recovery and there is no definite pattern of growth visible as yet. The US labour market appears to be stuck in a vicious cycle of flat private spending and confidence and an unwillingness of the US government to stimulate sufficiently to fill the gap and create work.

The second graph compares the US transition probabilities for various months during the crisis up until May 2013 (see the accompanying Table for values). I have also jigged the vertical and horizontal scales to allow the changes in the columns to be seen more clearly. That is one of the reasons I also provided the raw data.

Several points by way of interpretation can be made.

First, the data shows that the EE probability is now stable – that is, the likelihood an employment person will remain employed in the next month (not necessarily with the same employer though) – is about what is was at the start of the crisis. That is a good sign.

Second, the EU probability (employment to unemployment) has fallen since the early days of the crisis but is now steady at 14 per cent.

Further, the EN probability has risen marginally indicating that employed workers are now increasingly likely to flow out of the labour force once they lose their jobs – that is, they become hidden unemployed.

Third, the likelihood of a new entrant getting a job (NE) is fairly flat after some initial improvement in 2010. But it still remains that new entrants are more likely to become employment (NE) than enter the labour force unemployed (NU).

Fourth, the probability of an unemployed worker remaining unemployed (UU) continues to improve, although the likelihood that such a worker will leave the labour force (UN) is higher than the likelihood of them getting a job (UE) and the former probability has risen over the last 2 years, which is not a good sign (and is consistent with the continued deterioration in the participation rate).

Overall, the Gross Flows data suggests the slight improvement in the US labour market during 2012 is now tapering. There is a lot of statis in the data, which can be interpreted as the economy is approaching a switch point.

Growth is not strong enough to budge the inertia and there are signals that it is slowing and a reversal of the gains made to date might be coming.

Conclusion

While the political impasses in the US Congress have been comical and the conservatives are doing their best to impose austerity on the nation, the fact that the austerity is only partial to date (and the Democrats are certainly not “expansionists”).

This has kept a budget deficit large enough to support growth and allow some confidence to be regained in the private sector.

The results is that there is a very weak recovery going on that is barely filtering into the labour market.

The problem is that the bulk of the sequestration cuts will start impacting over the next 12 months at a time when the recovery is fragile and the economy appears to be on a knife edge.

The labour market data published last week by the BLS certainly indicates that a switch-point might have been reached. The improvement is slowing and many indicators have become stuck.

The labour force data for May 2013 and the on-going disaster the other side of the Atlantic should be sending a strong signal to all US politicians that fiscal austerity is the last thing the economy needs at present

In that sense, they might read a Bloomberg editorial (June 6, 2013) – Austerity Principles, or How to Save an Economy in Crisis.

The analysis has problems but it is absolutely correct when it concludes:

Studies, including some completed in recent weeks, show no correlation between debt today and growth tomorrow. And there certainly is no special number at which debt becomes crippling, such as the 90 percent debt-to-GDP ratio that some attribute to Reinhart and Rogoff …

Fiscal expansion works …

Fiscal contraction can backfire … the idea of expansionary fiscal contraction is a contradiction. No place illustrates this better than the euro area, where austerity budgets have been imposed on debt-laden countries. The result is that the euro zone is mired in recession for the sixth consecutive quarter …

Currencies matter. One important factor is whether a country controls its currency …

Sounds almost like they are proponents of Modern Monetary Theory (MMT)!

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.