#15. The economy, the cost of living and the continuing legacy of Labour

The UK  Economy

Ministers are entitled to relish today’s GDP growth data, and what they may enjoy most is the discomfiture of their opponents.

It’s worth remembering quite how wrong Labour have been about the economy. Labour’s line, if you remember, was that cutting public spending in a recession was a form of madness that would be practised only by benighted souls ignorant of the Gospel according to St John of Keynes. Labour’s strong preference was that Britain should borrow her way out of a debt problem, a strategy which was akin – as I said at the time – to handing a bottle of scotch to an alcoholic.

The basic problem with the Labour prescription was that Britain was undergoing a deleveraging recession, not a destocking one. And, whilst fiscal stimulus might reverse the latter type of downturn, it could not counter a deleveraging slump, because the only effect of exchequer largesse would be to transfer debt from the private to the public balance sheet.

Electorally, of course, these latest figures are an incomplete success. The gross value of the economy may be improving but, thus far anyway, living standards are not. In 2013, average wages are likely to have risen by about 0.9%. The government will hope that wage rates will pick up, and will overtake CPI inflation (now 2%, and falling) in time for the election.    

The government’s attempts to use Survey data to disprove Labour’s “cost of living crisis” are unlikely to succeed, because Labour isn’t going to focus on CPI (consumer price index) inflation in its electioneering. Rather, Labour will emphasise the cost of household essentials, where inflation remains well ahead of wage growth. One does not need a crystal ball to foresee television images of Ed Miliband waving utility bills at the watching voters.

Can the government counter this bill-waving? I think they can – and here’s how.   

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There is no point in denying that the cost of household necessities has risen far more rapidly than wages. People know this, so there’s no point in pretending it hasn’t happened. Between December 2007 and December 2013, the TM UK Essentials Index, which tracks the weighted cost of non-discretionary outgoings such as fuel and power, food, travel fares and utility bills, rose from 132.9 to 179.3, an increase of 35%. At 10%, average wage growth over the same period was far lower than this, and even CPI, up by 17%, exceeded wage growth. If you earned the average weekly wage throughout that period, your earnings declined by 6% relative to inflation, but by 18% in relation to the cost of essentials, over that period.

How can the Conservatives and the Liberal Democrats counter this? First, they can point out that the slump in real wages began under Labour. Second, they can explain that things are getting better now.

In 2010 – Labour’s last year in office – the cost of essentials increased by 6.7%, whilst wages rose by only 1.3%. That’s a difference of 5.4%.

By the end of 2013, this gap was down to 1.9% (essentials +2.8%, wages +0.9%). That’s real progress.

In any case, the escalating real cost of essentials was caused by Labour’s failed economic management. From peak-to-trough, the economy contracted by 6%, and there is simply no way in which living standards can be insulated from a slump of that magnitude.

In recognition of Britain’s – meaning Labour’s – aggregate indebtedness, deficit and skewed economy, the pound lost more than 20% of its value in the latter months of Labour’s tenure. That automatically pushed up the sterling cost of commodities such as energy and food, essential purchases which are priced on international markets.

Moreover, Labour dithered over energy policy, most notably by dropping the ball on replacing Britain’s ageing fleet of nuclear reactors. A government which was pushing public spending up by £30-35bn annually somehow couldn’t afford to invest in nuclear reactors which, at that time, would have been far cheaper than they are now.    

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What the government also needs to do is to counter the generally accepted narrative of Labour’s conduct of the economy. That accepted narrative tends to be that (a) the economy grew under Labour until 2008, and then (b) slumped because of a global (rather than a local) financial crisis.

In reality, neither of these points is true. To be sure, and expressed at constant values, the economy was larger (by 25%) in 2007-08 (£1.61 trillion) than it had been in 2000-01 (£1.29 trillion). But the “growth” difference between those numbers is £321bn – yet individual and government debt increased by £1,140bn. It’s a fair bet that, if someone gave you an extra £321 you’d be pleased – until you found out that your debts had risen by £1,140.

That’s not growth – it’s simply the inefficient spending of borrowed money.

Much the same was true of the ensuing slump. This, Labour insisted, wasn’t their fault – it was a global setback, with the banking system tottering under the weight of reckless lending. But, amongst the major economies, which country (and which government) was the most irresponsible borrower? You guessed it.

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It won’t surprise you that I’m not totally convinced by the recovery. I think it’s fragile (a view seemingly shared by the Bank of England), and that much more needs to be accomplished (a view seemingly shared by the chancellor). I need to wait for some debt data which will confirm (or not) that the recovery is being earned, not simply borrowed. I wonder about the role of PPI compensation in stimulating consumption.

These are grounds for legitimate doubt. But it’s a long way from that to buying Labour’s line. A caveat-hampered recovery is better than no recovery at all – and, where the “cost of living crisis” is concerned, that can be traced straight back to Labour’s disastrous handling of the economy before, as well as during, the financial crisis.

#14. A brief guide – and a packet of SEEDS

Surplus Energy Economics

Shortly after the publication of Life After Growth, I undertook to produce a Brief Guide to surplus energy economics – and here it is, available for free download. In this article, I discuss some of the findings of the data system that I’ve built to track and predict energy returns, energy costs and economic performance on a worldwide basis.     

Brief guide

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Compiling the guide has taken quite a while, because I decided to complete my EROEI database first.

Called “SEEDS” (which stands for ‘Surplus Energy Economics Data System’), this has been a big undertaking.

The first imperative was to track, so far as available information allowed, the course of EROEI in the past, and to project this forward into the future. I found that I was able to go back as far as the 1960s, and the projections go out to 2030. EROEI is tracked by fuel, covering oil, natural gas, coal, nuclear, hydroelectric, wind, solar, biofuels and other forms of renewable energy, with oil and gas further divided between conventional and unconventional sources such as tar sands and shales.

Next, I needed to compile data for consumption, production and net exports, by fuel type, for each of the 43 selected countries – more will be added – together with aggregations for five regions and the overall global picture. This gave me, for each country, data from which two other time series could be plotted – the EROEI of consumption in each country or region, and the overall EROEI for each, after adjustment for net trade in energy.

The inverse of EROEI, of course, is the Energy Cost of Energy, or “ECOE”. Put together with various economic data series, this enabled me to track the “financial” and “real” economies of each country and region. It also enabled me to calculate each country’s legacy of “excess claims” – essentially, the extent to which the financial economy of money and debt economy has entered into commitments that the real economy is not able to meet. 

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Here are some of the findings of the SEEDS model.

First, overall EROEI has been declining since the 1960s, and has fallen from 55.7:1 in 1980, and 37.2:1 in 1990, to 24.3:1 in 2000 and 13.6:1 in 2013. Reflecting this, the trend in the Energy Cost Of Energy (ECOE) has risen to 6.8% in 2013, from 1.8% in 1980, 2.6% in 1990 and 3.9% in 2000.

Looking ahead, the model projects EROEIs of 10:1 in 2020 and 7.9:1 in 2025, equivalent, respectively, to ECOEs of 9.1% and 11.2%.

Globally, and expressed in constant (2012) dollars, this means that the real economy will decline pretty gradually, falling by 2.9% between 2013 and 2020, and by a further 5.9% between 2020 and 2025, leaving the real economy some 8.5% smaller in 2025 than it was in 2013.

Unfortunately, it’s going to feel rather worse than that, for two main reasons. First, of course, we’ve long become accustomed to growth. Second, the financial economy already exceeds the real one, because we are continuing to create “excess claims” at the rate of close to US$5 trillion annually. The global real economy of 2020 is projected to be almost 9% smaller than last year’s financial economy – and that’s going to hurt.

How much it will hurt, of course, depends on where you are. On a ranking of 1 to 43, the best-placed countries (in rank order) are Norway, Saudi Arabia, Russia, Indonesia, Australia and Switzerland. At the other end of the scale, the worst-affected countries are Greece (#43), Portugal (#42), Spain (#41), Italy (#40), Hungary (#39), Turkey (#38), Britain (#37), Japan (#36), Slovakia (#35) and India (#34).

Globally, there is huge scope for value destruction, because aggregate excess claims – monetary commitments, that is, which the real economy will be unable to satisfy – total US$63 trillion. This, I should stress, is a net number, with negative scores offset by the positive claims of countries which are net creditors of the system. These include Norway (US$1.8 trillion), Russia (US$2.7 trillion), Saudi Arabia (US$3.5 trillion) and other Middle East countries (in aggregate, US$4.3 trillion).

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The system identifies two critical thresholds. The lower of the two is the “viability threshold”, at an EROEI of about 6:1. At this point, energy costs absorb over 14% of economic output, making the economy barely viable at all.

Well before that point is reached, however, there is the “investment threshold”, set at an EROEI of 14:1. At this point, the cost of energy is 6.7%. Whilst the remaining 93% of output may suffice to keep the economy going, it is insufficient to fund net investment in new capital assets.

What would an economy look like at levels of EROEI below the 14:1 “investment threshold”?

Well, first and foremost, it would not be able to afford net capital investment. What this really means is that the economy’s consumption needs would not leave any scope for capital formation, which, in everyday parlance, means the economy could not afford to save.

So an economy in sub-threshold condition would have to have negative real interest rates, offering a negative return on savings, and deterring any rational person from saving – every available cent would be needed for day-to-day consumption, and it is probable that the sub-threshold economy would be borrowing extensively as well. At the same time, negative real interest rates would be imperative simply to keep the economy going, and to put off the evil day when “value destruction” – the destruction of “excess claims” – kicks in.

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Does this seem familiar? It should, because it describes a swathe of Western economies right now.

Plenty for us to ponder there, I think…..

Gross & net energy consumption

#13. Oh what a lovely row!

POLITICIANS AND THE FIRST WORLD WAR

As a keen student of history (and of military history in particular), I’ve become increasingly frustrated with the way in which politicians and historians have weighed in to the row over the First World War.

This isn’t because I don’t think it matters, because clearly it does – the better we understand the causes of a conflagration that killed millions, the greater the chance that we’ll avoid repeating such a disaster.

Rather, what has frustrated me is the seemingly universal misunderstanding about how the war was “won”. Nowhere in Blackadder, nowhere in Oh What A Lovely War, and nowhere in the pronouncements of Michael Gove and others will you find the reality about the Allied “victory” and the German “defeat” of 1918.

The simple fact is – and, if you find this surprising, please do some research on it – that nobody won or lost on the battlefields of France or Belgium. In that sense, the suffering in the trenches was as pointless as it was tragic.

Quite simply, Germany collapsed from within. She was literally starved into submission.  

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As any schoolboy knows (or should!), the naval arms race was one of the principal reasons why Britain ended up fighting Germany. The commissioning of HMS Dreadnought – the first all-big-gun battleship – in 1906 was a huge achievement for the British, though others were not that far behind.

But there was one consequence of this of which First Sea Lord Jackie Fisher, at least, was uncomfortably aware. By rendering every other battleship obsolete overnight, Britain’s naval supremacy, which hitherto rested on having a larger fleet than those of the next two biggest navies combined (the “two-power standard”) was reduced to a single ship. Before Dreadnought, Germany had had no realistic prospect of bridging the gap. As of 1906, however, just two ships would have given Germany naval supremacy over Britain.

The Admiralty may have continued issuing boarding cutlasses into the twentieth century, but the high command was not stupid, and fully appreciated that Britain’s naval supremacy had been reduced to a single ship. Well before war broke out, Fisher was even to contemplate emulating Nelson at Copenhagen by destroying the German fleet at its moorings before war was even declared. Meanwhile, the imperative was to build more and better Dreadnoughts, in obvious competition with the Kaiser.

The irony was that the battleship fleets assembled at such huge expense in the pre-war years were to clash only once, at Jutland. The Germans had made a very serious strategic blunder. They had assumed that the British fleet would loiter offshore German ports in a close blockade, and that their ships could isolate and destroy individual units, gradually reducing Britain’s slender numerical supremacy. This thesis, which was at the very heart of German strategy, proved to be founded on a misconception. Instead of close blockade, the British enforced a distant blockade, stringing a ring of steel from Scotland to Norway whilst using minefields and smaller vessels to close off the English Channel. Germany’s trade was strangled.  

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Since historians, as a point of principle, seldom agree on anything, there is no scholarly consensus on whether Germany really was starved into defeat, and some have argued that the starvation which followed the war was the result of disruption, not blockade.

But the facts seem pretty clear. Both Britain and Germany relied on imported food as well as on imported war materiel. Britain’s blockade was successful in cutting off Germany’s access to these supplies, whilst Germany’s retaliatory move – the U-Boat war – not only failed to achieve the same objective but also contributed significantly to the American entry into the war in 1917.

By 1915, Germany’s imports had been reduced by more than half. German civilian deaths caused directly by the blockade have been estimated at between 424,000 and 673,000. More importantly, in overall terms, Germans seem to have been existing on a daily nutritional intake of barely 1,000 calories, less than half the level required for effective functioning. Starvation clearly played a major part in the social unrest which erupted in Germany before the ink was even dry on the Armistice.

This being so, it is hardly surprising that the German high command gambled on the Spring Offensive, whose defeat marked the military end of the war. That offensive was born of desperation, not calculation. Although intended, in part, to defeat the British and the French before large numbers of American soldiers could arrive, this gamble was imposed on the Germans by the desperate situation at home.   

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Given the critical role played by the blockade, could Britain have kept her armies at home? We shall probably never know. But there can be little doubt that the trench warfare of 1914-18 was an exercise in mutual futility. The British soldiers may well have been “lions led by donkeys”, but perhaps – just perhaps – neither the lions nor the donkeys needed to be there at all. Be that as it may, there can be no doubt that the despatch of the troops to France was inevitable in the militaristic climate of the day.

At the very least, the relative effectiveness of the blockade on the one hand, and trench warfare on the other, counsel a need to think strategically.