Comment on the Wincott Lecture

On 13th November Martin Wolf gave the 2013 Wincott Lecture. Robert Skidelsky provided the comment. You can read Martin Wolf’s lecture, and access charts for this comment, at

I propose to comment on Martin’s excellent lecture under three heads which all point to the central issue of how sustainable is the welcome recovery now taking place.

First, Martin poses the important question of whether ‘the losses in output and productivity are permanent or temporary’ (p.3) and concludes that there is no convincing reason for them to be permanent, though restoration of the previous position will take a long time.

Two comments: first, this argument ignores the loss of productive capacity through hysteresis. In an FT article earlier this year ( FT,18 Feb 2013 ‘Supply Matters but so Does Demand’) Marcus Miller and I, citing work by Brad de Long and Larry Summers, argued that prolonged unemployment destroys not just current but also potential output. If an output gap is allowed to persist, the effect of hysteresis on skills and infrastructure is to reduce the growth potential of the economy. We are, so to speak, consuming our human capital: there is less of it left.

This is the chief long run cost of fiscal austerity. Persisting conditions of semi –slump cast long shadows, diminishing supply as well as demand. I think something like this happened in the 1980s. Martin Wolf’s chart no 3 shows no break in trend of GDP per capita growth from 1950-2007. But if we take a chart of unemployment, we get a different picture.


The economy never returned to the levels of unemployment it experienced from 1950 to 1970. In the UK average unemployment went up from 1.6% a year between 1950 and 1970 to 7.5% between 1980 and 2008. And even after demand deficiency had been removed, structural unemployment was twice as high as it had been in the earlier period. In short, the ability of the UK economy to employ people to produce output seems to have been permanently impaired.

My second comment is this: I’m not sure there wasn’t after all, something illusory, or unsustainable, about GDP growth in the pre-recession years. Four features need to be noticed:

1. Growth (and employment) seems to have been driven disproportionately by the financial services and the public sector. Financial and insurance services grew as a proportion of total Gross Value Added (GVA) between the late 1990s and 2009 to a peak of around 10.4%. Between 1999 and 2007, public sector employment increased by 10.5%, while private sector employment increased by 7%.

Some of the value added by the financial services was plainly unsustainable, in that it was a bubble bound to burst. Expansion of the public sector partly reflected increased demand for the ‘caring’ services: but it also reflected the difficulty of job placement in the private sector. The public sector became the employer of last resort. Given the Coalition’s determination permanently to shrink the public sector, the private sector will have to generate a higher proportion of jobs than it did in the pre-recession years. Where will they come from?

2. Relative to other countries, UK productivity growth pre-recession was unimpressive. The expansion of the UK economy after 1997 was mostly driven by an increase in inputs rather than outputs (See ‘UK productivity during the Blair era’, Centre for economic performance). This reflects three factors: the growth of finance –which disproportionately benefits ‘high collateral/low-productivity projects’ (cited Wolf p.11), the growth of the public sector, where productivity gains are hard to achieve, and the transfer from more productive to less productive jobs, particularly to the lower end of the retail sector. So where will the productivity growth needed to achieve a sustained recovery in real earnings come from?

3. Not enough attention has been given to the fact that a sizeable proportion of British jobs depend on ‘in work’ benefits. These jobs have increased substantially since the schemes were started in the 1980s. The TUC estimates that the number receiving ‘in work’ benefits rose from 1.6m in 2003 to 2.1m in 2008; today 21.2% of all employed adults live ‘in a tax credit recipient family’. It’s true that ‘in work’ benefits are better than out of work benefits, better for their recipients and more productive for the country. But one has to ask: if these subsidies were withdrawn, what will happen to the jobs? Will the earnings of those receiving the benefits fall to the Chinese level? Or will the erstwhile recipients merely swell the ranks of the unemployed?

4., One should not ignore the increasing difficulty of the British economy in creating ‘good jobs’, by which I mean jobs which pay a decent wage; or more precisely, reverse the growing gap between mean and median incomes.


I would not deny that recession and fiscal austerity have aggravated these adverse factors. What I am suggesting is that in addition to the losses to productive capacity caused by prolonged unemployment, there were distinctively flaky elements in the ‘old’ normal which will make it very hard for the UK to regain the pre-recession trend of economic growth. The ‘new normal’ will be the ‘old’ normal stripped of illusions.

Secondly, Martin asks ‘Could [monetary] policy have been more successful?’ Remember QE came in two bites. The first, running from March 2009 to February 2010, which pumped £200bn into the banking system, was done to offset the credit crunch which followed the collapse of Lehman Bros. The second, of £175bn, which has run from October 2011, was intended to offset the effects of contractionary fiscal policy, once the theory of ‘expansionary fiscal contraction’ was exposed as statistical nonsense.

How was QE supposed to work? Look at this B of E handout from 2011. ). [Taken from David Miles, Asset Prices, Savings, and the Wider Effects of Monetary Policy, B of E 1st of March 2012, p.5)]


According to this view, QE operates through two channels –the bank lending channel and the portfolio rebalancing channel. (I abstract, as the Bank did, from the foreign exchange channel).

It is clear that the bank lending channel failed to direct lending to SMEs where it was most needed. That is to say, reconciliation of lender and borrower risk in the current state of expectations produced interest rates too high to allow for a recovery of investment.

The bank lending channel has been partially unblocked by special schemes to subsidise mortgage lending. From the economic, though not the political, point of view, a renewed bout of house price inflation is the last thing needed. It threatens a return to the pre-recession situation when populations became, in Martin’s own earlier words, ‘highly leveraged speculators in a fixed asset’. (Martin Wolf, FT 9 September 2008).

Today’s adherents of QE place their main hope on the ‘wealth’ effect of portfolio switching. QE has almost certainly pushed up the price of assets and probably the luxury spending of their owners. The crucial question is whether it has pushed up the rate of investment. The jury is out on this: but the outcome is not impressive. Business investment has remained flat through two bouts of QE; ONS reports that it decreased by 8.5% in the 2nd quarter of 2013 compared to the same quarter the previous year. The reason for this is perfectly understandable to a Keynesian. Investment depends on the expected return from selling the extra output which the investment makes possible. There is no reason for a businessman to increase his investment if he is facing a reduced demand for his products.

In the Treatise on Money Keynes made a useful distinction between the ‘industrial’ and the ‘financial’ circulations (TM, v, 222-3). The industrial circulation supports current output, including investment; the financial circulation flows into speculation and swopping titles to existing assets. Keynes thought that in the downturn the financial circulation steals money from the industrial circulation.

To prevent this ‘theft’ Keynes said that the Central Bank should feed the financial circulation all the money it requires. Evidently QE was not on a big enough scale to reduce the ‘hoarding’ of banks and corporations.

Further, the way QE was done chiefly benefitted asset holders at the expense of everyone else, ie., it enriched the already rich. In macro terms, it directed money towards those with the lowest propensity to consume. Insofar as it raised the inflation rate from what it would have been it contributed to the decline in real earnings. (Though reduced earnings were also caused by the fall in the exchange rate.) The TUC estimates that average real pay has fallen by 7.5% since 2008: a reduction in effective demand not offset by any wealth effect.

The criticism of the QE programme is thus twofold: there wasn’t enough of it, and the new money was directed to the wrong places.

Martin agrees that monetary policy could have been more successful, but has a curious suggestion l for improving it in the future. He endorses the idea of 100% reserve banking. The whole, or bulk, of credit creation would be transferred from the banks to the state, which would issue money to ‘finance itself permanently’, presumably to what ever extent it wanted.

I support the thought behind this, but offer three quick comments. First, it is surely wrong, from a history of ideas standpoint, to bracket the Austrians with Fisher and the Chicago School. The Austrians certainly wanted to abolish fractional reserve banking, but they did not want the government, or central bank, to take over credit creation. They regarded credit creation as bad, full stop. They would have abolished central banking, and if that proved impossible, restore a full gold standard, ie 100% gold reserves against currency notes. This was never Milton Friedman’s position.

Secondly, I am puzzled about how the system would work in practice. Would I be able to take out a loan from my bank? What does it mean to say that ‘credit would be …operated via investment and unit trusts’? Would they invest in small businesses? And what are the ‘new means’ to be developed ‘of financing the private sector’? It would have been good to hear more about all this.

Thirdly, a less drastic remedy would surely be to adopt a reform like that proposed by Charles Calomiris for a 20% equity, 20% reserve requirement. This would improve the quality of bank lending without crippling it. (Calomiris, 2012, ‘How to Regulate Bank Capital’, National Affairs, 10.)

There are several other things I would love to discuss –including the dilemma he poses of ‘less globalised finance or more globalized regulation’ (p.11), but I need to rush to my final set of comments.

These concern the impact of ideas on policy. Here I endorse everything Martin says, but think that he is too optimistic. A gap has obviously developed between the ideas of the policy-makers as they try to deal with the crisis and its aftermath, and the ideas of mainstream academic economists who, in thrall to their DSGE models, taught generations of students that no such crisis was possible; or more accurately was so unlikely, as not worth bothering with.

Thus the current mainstream view that Keynes’s General Theory was not general: it was a special theory for a once in a century event.

The starting point of economics is still in the wrong place. It lies in the Platonic world of perfect markets rather than the real world of markets as they actually work in the human and social world.

But I see little sign of that ‘ferment of ideas’ Martin hopes for, at least in the academic world. INET, which should have been the fulcrum of the ferment, has been captured by members of the economic establishment whose minor deviations from orthodoxy run along well established lines. The whole apparatus of academic promotion through publication in journals controlled by the Chicago School remains intact; the growing formalisation, hence abstraction, of economics continues apace. There are signs of ferment, mainly from students, like those involved in the Post-Crash Economics movement at Manchester. But while their dissatisfaction with what they are being taught is palpable, it is unfocussed. The professors don’t give them a lead.

Martin hopes for an ‘intellectual upheaval reminiscent of the response to depression in the 1930s’. The truth is that this depression has not been anything like as severe-certainly not enough to shake a proud, established discipline like economics to its foundations. We have to experience many more crashes for that to happen. They are sure to do so.