Colin Hay's book, The Failure of Anglo-Liberal Capitalism (2013), offers a powerful account of the origins and implications of Britain's current economic malaise. Hay argues that the roots of the recent economic crisis lie in Britain's complicity in the rise of an unstable Anglo-American model of capitalism that sustained consumption and economic growth via the acquisition of private debt. Critical of British governments of all parties, Hay outlines a new economic agenda for a more sustainable and inclusive model of growth. Renewal gathers here four reflections on the book, and a response from Colin Hay.
The right central premise
Nicola Smith, Head of the Economic and Social Affairs Department of the TUC
The starting premise of Colin Hay's analysis is that the roots of the financial crisis can be found in the years preceding the crash. This is a presumption that few in the current government would disagree with, although their assessment would likely be different to Hay's. While the Coalition narrative presents our current fiscal challenges as a consequence of years of irresponsible public sector over-expenditure, Hay's assessment is that without significant change in the composition of UK growth we face on-going future economic risks.
There is much to agree with in this headline analysis, and while my own assessment contains shades of difference to Hay's, his central premise that the crisis revealed the need for significant change in the UK economy is surely the right one.
A crisis of credit?
In brief, the starting point of Hay's argument is that those countries where consumption relied to the greatest extent upon rising household debt were first affected by the crisis, which, given the global nature of both financial markets and trade, then went on to impact on other nations.
In part, this analysis is accurate. As credit markets froze and recession began, consumers with high debt obligations reigned in their spending or found they could no longer access the loans that were funding their purchases. On-going uncertainty meant others reduced their inclination to borrow.
But Hay's position is arguably also partial in so far as it places insufficient focus on the extent to which high levels of private debt were indicative of out of control financial sectors, and on the relationship between the size and nature of nations' financial services industries and the consequent impacts of the crisis on their economies. In the UK, for example, banks' balance sheets tripled in size over the five years from 2002. Capital buffers were low, and new funds tended to be short-term in nature rather than new deposits. The assets of RBS were worth (on paper) 150 per cent of UK GDP (Economist, 2013). The high leverage, short-term funding and limited regulation that characterised the sector (all of which had acted to support the consumer borrowing boom) meant that the financial crisis hit the UK hard.
The impacts of the crisis were also perhaps wider ranging than Hay's analysis acknowledges. As banks' balance sheets disintegrated, both consumer and business lending were squeezed (and with the latter having shown barely no recovery since 2008 this sharp fall in business finance is still having a significant impact on the UK's economic prospects). Investment, consumption and confidence plummeted and as trade was so far from able to make up the gap (even before the rest of the world had entered recession) the downturn took hold.
Hay is right to draw attention to the UK's dependence on consumer debt, but a broader approach to analysing the causes of the crash, and its multiple and on-going impacts, would strengthen his analysis.
But Hay is undoubtedly right that high private debt remains a substantial downside risk for the UK economy. The latest Bank of England financial stability report (2012) suggests that 40 per cent of the UK's outstanding mortgages are now interest only (a proportion that rises to 50 per cent in some regions) and that around three quarters of interest only mortgage holders are reliant upon the sale of the home as their repayment plan. While household debt ratios have fallen in the UK since the financial crisis, rates remain significantly higher than a decade ago, and well above 150 per cent of income. The Bank concludes that 'an unexpected rise in interest rates would increase debt-servicing burdens and might induce a fall in property prices', which underlines the fragility of our recovery.
Hay is also right to point out that the UK's over inflated housing market remains an on-going challenge. In the years running up to 2008 the rate of house price growth in the UK outpaced many other developed economies, and undersupply seems to have been the most significant factor in preventing a crash of the sort that the US market has suffered. With prices still so far removed from incomes, the potential for further price falls (at least outside of London) remains real, with clear potential implications for house-hold financial health.
However, Hay's assessment neglects to mention a key part of the puzzle--the extent to which rising reliance on debt financed expenditure has been a consequence not only of a house price boom, and unrestricted access to credit, but also of stagnating household incomes driven primarily by declining real wages and now considered by the ONS to be a key factor contributing to current slow growth in household spending.
In recent research from the IMF research department Michael Kumhof and Romain Ranciere (2010) found that financial liberalisation helps workers smooth consumption, but at the cost of higher household debt and larger current account deficits (as savings ratios are low). But crucially, when looking across different countries, they also identify rising income inequality as a key driver of these trends, and point to the need to distribute the rewards of growth more fairly as a prerequisite for stronger future outcomes. Stronger and fairer wage growth is central to their suggested solutions.
The UK is a perfect case study for this analysis. The wages of middle income Britain grew by an average of just 56 per cent between 1978 and 2008, despite GDP increasing by 108 per cent over the same period, and for some workers real income growth was far less (Lansley, 2011). The reasons behind this concerning trend are complex, reflecting both growing pay inequalities and slowing rates of real pay increases for workers on lower and middle incomes, along with occupational change across the UK jobs market (put simply, a rise in lower paid jobs in parts of the service sector accompanied by a fall in better paid middle income jobs in areas including manufacturing and administration). But its impacts are clear: stagnant living standards where spending is more likely to be supported by lending and equity release rather than rising real incomes.
Hay could therefore strengthen his critique of the sustainability of UK consumption if he focused as much on the poor state of real pay growth as on the extent to which spending has been supported by rising house prices and wider borrowing.
A fair assessment of Labour's performance
While Hay is right that it may well have been economically convenient for all governments to hope the bust was never going to come, he is perhaps too harsh when he claims that the previous administration actively pursued a strategy of asking house prices to fill the gap left by a residualised welfare state. While single unemployed people certainly saw little improvement in their real incomes (as Hay's analysis of benefit replacement ratios shows), some groups (most significantly families with children) saw real benefits from the introduction of tax credits, and the Pensions Commission's recommendations paved the way for some strengthening of provision in retirement. A fairer critique would be that the policy community experienced a collective failure to see the risks inherent in the bubble (and in the UK's growing wealth and income disparities), rather than presenting the government as having overseen an explicit strategy to replace social security with property equity.
On the other hand, Hay is perhaps too optimistic in saying that Labour have 'avoided the blame' for the crash. The challenge of presenting the electorate with a compelling vision of a new economy which both meets public concerns and can be delivered in straightened financial times is significant, and public trust that any political party can deliver substantial economic change, while also getting the public finances back on track, is low. While things could undoubtedly be worse for progressives, there is little room for complacency about public opinion.
Where next for the UK economy?
Hay concludes that we face a number of significant medium-term risks, and that moves towards a new economy will be difficult. He's right, particularly given the current government's aspirations to secure increased private saving and to improve Britain's trade and investment performance appear to have been abandoned. Instead, while real household incomes continue to plummet, austerity Britain is pinning its growth expectations on another house price boom.
But again perhaps the focus of Hay's conclusions is too narrow. He is right that we need to recognise that growth is the best way to get the deficit down and that we need an internationally co-ordinated stimulus. And he's also correct that banks need to lend more (the lack of net lending targets was a significant government mistake) and that there's a case for both greater public investment and national and regional banking structures to more effectively channel private investment into the real economy.
But, as he acknowledges, these changes are far from sufficient. The substantial shifts that we need to see in the overall investment share of the economy will need banking, corporate governance, and public sector reform working in combination. Raising living...