It’s the economy, stupid!

by Mark

It has probably not escaped your attention that there is some sort of international economic crisis going on. You probably don’t know, however, exactly why or how this happened. I’m going to attempt to explain in broad terms my understanding of exactly what is going on, how it started, and a little bit of history to give you some context. Take a deep breath…

The current situation basically developed because some investment bankers decided that a nice, ethical way to make money would be to push loans on people who had no hope of ever paying them off (commonly known, rather euphemistically, as “sub-prime”), insure themselves against this outcome for a whole shit-ton of money, and wait for the cash to roll in1.

Of course, lots of people lost their homes and any prospect of living a normal life ever again, and the poor bastards who invested their money in these loans (mostly conservative pension funds) lost everything. Anyone who had any money left sensibly decided that they wanted to have it back while they still could. They sold their stocks and shares and the market collapsed. Then to really compound this clusterfuck, the insurance companies and hedge funds that provided the insurance on all this bad debt found themselves in a situation where they suddenly owed a lot more than they could afford to pay. They all went bust and the banks didn’t get their money back either. But the bankers responsible for these risky deals made a hell of a lot of money.

So why did we have to bail the greedy fuckers out? What happened?

Essentially, as a nation we have become far too reliant on banking to provide economic growth2 and before the bubble burst the banks were making a huge amount of money and they knew that if they could only break free from the shackles of what turned out to be sensible regulations, they would make an awful lot more3. The view of the government, and particularly then-Chancellor Gordon Brown, was that under his prudent stewardship the days of “boom and bust” were over4. Under pressure from the banks and the free-market advocates in the Conservative party, and sensing the prospect of an enormous tax windfall5, they relaxed the rules allowing the banks to make riskier investments. For a while this worked great. Everybody enjoyed the benefits of credit they couldn’t really afford, the banks made a fortune, and so did the state. But it turned out that Brown was wrong; the days of boom and bust were not over at all.

Because of the fact that we got complacent and (to use an excruciatingly overwrought analogy) put all our golden eggs in the banking basket, allowing our industry (such as it was) to wither, we now find ourselves in a difficult situation. If the banks (which provide almost 7% of GDP by themselves) go to the wall, so does the British economy.

In an outrageous and ironic twist, all the libertarian bankers who had argued so vociferously against state intervention in the form of regulations, came and shamelessly begged the government to help them in their hour of need6. It was at this point, just after the nick of time, that Brown and his advisors lost confidence in the free-market and found solace in the teachings of John Maynard Keynes.

Keynes argued, back in the 1930s (during the Great Depression), against the traditional idea that the job market was just the same as any other market, and subject to the same simple rules of supply and demand. He proposed that because the workers (the supply) are also buyers (the demand) — they spend their salaries on the things that other workers are employed to make — the supply and demand model breaks down7. His theories were widely accepted after the second world war and proved very successful until the 1970s when a different approach espoused by Milton Friedman, highly critical of Keynes and all but the lightest of government intervention, caught the attention of Reagan in America, and Thatcher in Britain. His ideas provided the basis for Thatcherism, and the enduring Conservative philosophy that governments should be small with minimal levels of tax and public spending (from whence comes the unconvincing euphemism of “Big Society” that is so central to their current manifesto), and markets should be free and unregulated.

This ideology led to the privatisation of all kinds of public services, and the crushing of the pesky trade unions (who argued against the will of the markets in advocating higher wages for workers), and successive governments, including New Labour (departing from old Labour socialist ideals), continued to operate in this way, until the recession hit and the likes of America and Britain, under Obama and Brown, were forced to intervene in a big way to prevent the implosion of pretty much the entire global economy.

Having bailed out the banks and kept things afloat, Brown was faced with a situation where the wheels of the economy, the banks, were paralysed by fear and needed some serious grease. In what must have been a living nightmare for the Conservative party, he decided to nationalise the banks (everyone else could enjoy the irony of nationalising these paragons of private enterprise), and essentially print money by injecting billions of pounds into the monetary system.

It’s important to note, with an election fast approaching in which the biggest issue by far is the economy, that whatever happened in the past to get us into this situation8 the Labour party ended up doing the right thing, and now is on generally the right track to lead us on the road to recovery in investing more now so that the economy becomes strong enough to walk by itself. The Liberal Democrats are following basically the same agenda. This is anathema to the Conservatives, however, and all the ideas that their current crop of MPs has grown up with. They are facing an ideological cataclysm and are really struggling to face up to a situation where the state must intervene to prevent stagnation.

As such, they are absolutely the worst candidates to marshall the country back into the black.

But you don’t just have to take my word for it. On Tuesday April 27th (yesterday, as I write this) the Institute for Fiscal Studies, an economic think tank, published a report9 which, as well as examining the effects of Labour’s 13 years of government, ran the rule over the three main parties’ financial policies. It was highly critical of all the parties, suggesting that they are not being clear enough about where they plan to make savings, and are leaving voters in the dark with which way to vote. Some of the interesting findings are:

  • The Liberal Democrats’ proposed raising of the tax-free personal allowance to £10,000 would provide a stronger incentive for people currently on unemployment benefits to find work, and a stronger incentive for those earning less than £10,000 to earn more, than the Conservatives’ planned cut to National Insurance. This means that levels of unemployment would be reduced.
  • Because the Tories plan to raise taxes the least (and indeed give tax breaks to millionaires10) they need to cut public spending the most. In fact these cuts will be the most severe in post-war history. The burden of these cuts will fall mainly on the poor.
  • Although none of the parties has set out how it will tackle the budget deficit in full (blaming Labour’s refusal to carry out a pre-election spending review), the Lib Dems have identified 25% of the measures required, compared with the Tories’ 17% and Labour’s 13%.

Scrutinise the manifestos as much as you like, we don’t have much to go on here. At least three-quarters of the savings are a mystery even to the parties (or perhaps they are just afraid to tell us). We can only try to get a feeling for the inclination of each party to have any idea of what they might do. The final leader’s debate, focussing on the economy, should provide our best opportunity to answer some of these questions, and I will be watching closely.

  1. This is called a Credit Default Swap, or a Derivative, which are terms you might have heard. The process behind this is actually pretty complex and I’m not going to go into detail but there’s a really simple explanation of the principles here which should help you get your head around it. ↩
  2. Banking, despite producing nothing tangible at all, contributes £70 billion to the UK’s GDP. Source: http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=469&a=7447&artpage=all ↩
  3. We are perhaps too obsessed with the idea that we need perpetual economic growth at all, but that’s another argument ↩
  4. Source: http://www.guardian.co.uk/politics/2008/sep/11/gordonbrown.economy ↩
  5. Banking provides 25% of corporation tax income. Source: http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=469&a=7447&artpage=all ↩
  6. Most notably (and disgustingly) Matt Ridley, the chairman of Northern Rock, which was totally nationalised. ↩
  7. This is as far as I’m going to go in explaining Keynesianism, but I highly recommend that you read this “brief” explanation of it by Aaron Swartz. It is really superbly written and helped me to understand macroeconomics! It sounds dull but money really does make the world go round and it’s super interesting (at least, it is to me) to understand the driving forces behind it. Ok, there’s an even shorter version too. ↩
  8. For the record, Labour were the governing party but the Conservatives were complicit in the deregulation, and even pushed for yet more relaxing of the rules. For the Liberal Democrats, Vince Cable famously warned, against the prevailing wisdom, that the British economy was becoming too reliant on credit and that deregulation might lead to problems. ↩
  9. The report itself can be read here: http://www.ifs.org.uk/election/ebn_summary.pdf ↩
  10. As I explained last time. ↩