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Sunday, 20th April 2014

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Sovereign debt is a capitalist issue

The claim that ‘big government’ or ‘state overspending’ is the cause of our ills puts on a mask of truth by reference to the worsening problem of sovereign debt, which threatens not only the Eurozone but the global economy. The reality, however, is at odds with the right wing explanation.

Despite having to pitch camp at the second-best location of St Paul’s, despite that only a few hundred people have been directly taking part, and despite (as pundits continually assert) the incoherence of their demands, the Occupy London Stock Exchange movement- alongside the many similar protests around the world- has achieved something of great importance: breaking through the official and media line that the current debacle is about excessive government spending, and reminding us that the ongoing economic crisis, the rising inequality, unemployment and impoverishment are the results of capitalism.

Nevertheless the discourse of ‘profligate’ state expenditure and the ‘bloated’ public sector remains dominant- providing not only political protection for the system which caused and is still causing the current destructive and dangerous crisis, but also a level of public acquiescence on the further rolling back of the welfare state, one of the key aspects of the drive to reform our economic and social system closer and closer towards the classical capitalist model.

Lest we forget, it was only through massive state welfare that the global private sector economy was rescued from its headlong plunge to complete self-destruction during 2007,  2008 and 2009; in its most obvious form the hundreds of billions handed to the financial corporations to bail them out of the implosion caused by deregulated capitalist growth.

To that should be added two other indirect state factors which were also crucial in preventing full-scale economic collapse:-

Firstly the activities of the public sector, and firms contracted to and supplying the public sector, which kept going at their usual pace (and in the UK actually slightly increased their output) regardless of the implosion of the markets which began in 2007. This could happen because public sector organisations are not directly market-dependent- they do not rely primarily on loans from banks, private sector investments, or consumer spending, all of which slumped during and following the credit crunch. Thus while production and consumption in the private sector began to nosedive, the public sector provided a degree of desperately needed stability to the overall economy.

Secondly the state benefits system, which carried on paying out its in-work and out-of-work benefits to its previously existing recipients irrespective of the economic crash, and began paying out to hundreds of thousands of newly unemployed; thus providing an overall benefits income increase on a national scale which was then re-cycled by being spent in the shops, on utility bills, on rent and mortgages etc, and thereby helping to maintain private sector businesses despite the drop in market-based income.

But  barely had the banking system- and with it, the privately owned ‘real economy’- been stabilised by the involvement of the state, than it was presented that it is the public sector and ‘big government’ which was and is the problem; a problem which must be solved by the slashing of state provision.

As I noted in 2010, following the formation of the Tory-Liberal coalition government in the UK:

So, not only were hundreds of billions of pounds of the debt of the capitalist financial system transferred to the public sector in order to avert the catastrophe engendered by the ‘free market’; it transpires that the blame for the economic debacle and its financial consequences has also been transferred to the public sector. And by that miracle, the free market right wingers, who desire nothing less than the fruition of Margaret Thatcher's uncompleted project for a return to full-blooded capitalism, unencumbered by the ‘welfare state’, have been delivered their marvellous opportunity.

The current state debts of the ‘Western’ countries can be divided into three portions in terms of their origins. One part (a) is the level of soveriegn debt which already existed in 2007, and with which the various countries entered the credit crunch.

On top of that there are two aspects which vastly widened the state budget deficit (ie, the gap between income and spending) thus leading to massive rises in public debt. Those are, (b) the cost to the state of bank bailouts and stimulus measures (for example in the UK, the nationalisation and recent re-privatisation of Northern Rock, at a minimum loss of £400 million to the public); and (c) the effects of, on the one hand, the loss of government taxation income due to the ongoing effects of the crisis, and on the other hand the increased spending on benefits due to higher unemployment.

The big expansion of sovereign debt as the result of a private sector crisis is nothing new. As The Economist magazine observed in June 2009:

History suggests that a big build-up of public debt is all but inevitable given the magnitude of the recent crash. A study of 14 severe banking crises in the 20th century by Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard University shows that public debt rises by an average of 86% in real terms in the years after big financial busts, as economies flag and governments are forced into serial attempts to revitalise them.

In the first two years of the current crisis, the suddenly yawning gap between state income and expenditure is illustrated by the following examples (+ shows budget surplus, - shows deficit, in percentages of GDP):

                 2007     2009

Ireland        +0.1     -14.3
Greece        -5.4     -13.5
UK              -2.7     -11.3
Spain          +1.9     -11.2
USA            -2.8     -11.0
Portugal       -2.7     -9.4
Iceland        +5.4     -9.1
Belgium        -0.2     -6.1
Italy            -1.5     -5.2
France         -2.7     -7.6
Germany       -0.2    -3.3
Japan           -2.4    -7.2

Source: OECD.

The 2007 level of sovereign debt differed widely among the nations affected by the crisis; to take a few Eurozone examples, Spain’s state debt in 2007 was a respectable 36.1% of the country’s GDP, Ireland’s was a mere 25%, Italy’s was comparatively high at 103%, Greece’s was slightly higher at 107.4%, Germany and France quite high at 64.9% and 63.9% respectively, Belgium’s was 84.2%. The Eurozone average was 59% of GDP.

It is only the pre-crisis levels of sovereign debt (and deficit) that, by any stretch of logic, could be blamed on state ‘profligacy’. Notably, neither the harshness with which the crisis has been subsequently experienced, nor the interest rates on government debt demanded by the markets, have any direct relationship with the state debt levels which preceded the crisis.

Ireland was one of the first countries to be made subject to a bailout (of 82 billion euros in November 2010), and Spain’s official unemployment level has shot from 7.6% in 2006 to its present 21.5%, the highest in the Eurozone, with its level of youth unemployment at a shocking 45%; at its bond auction on 17th November 2011, Spain was forced to pay the very high rate of almost 7% annual interest on 10-year bonds.

Both of these countries were among those particularly hard-hit, because their ‘free-market’ economic booms which preceded the credit crunch included rampant property bubbles on which their banks invested- and eventually blew- scores of billions of euros.

Britain’s sovereign debt to GDP ratio in 2007 was comparatively moderate at 44.1%, not only well below the Eurozone average, but by a considerable margin the lowest of the five largest advanced capitalist economies (the others being France, Germany, Japan and the USA). Despite this, the UK is leading the pack in cutting wages, social benefits and public services.

None of which amounts to a case for sovereign debt being a benign phenomenon. It is a means by which wealth is transferred from the public (all of whom pay tax, and within which the tax burden has been shifting more and more onto the backs of the poorer citizens, eg through rises in VAT) via varyingly exorbitant interest rates to financial institutions, the recipients of whose profits are, disproportionately, the rich.

Worse, as the current phase of the crisis is exposing, state debt is bought and sold in markets, in which speculators- who earn their huge incomes by betting on and thereby helping to create or accentuate changes in price- have the controlling interest. Markets in which speculators participate (and speculation is, and always has been, an intrinsic part of capitalism) are institutions which magnify instability, making crisis management by governments- the very same governments which rush to the defence of the capitalist system- almost impossible.

‘Big government’ slashed the debt

A look at the longer term history of Britain and the other advanced capitalist countries contradicts the ‘big government’ explanation for high state debt, except (for the period up to the mid-20th century) insofar as warfare is a government responsibility.

The UK’s sovereign debt varied up and down prior to the mid 20th Century, mainly according to the costs of wars against the other big powers. In the initial and classical capitalist period, there was little or no state welfare, and the income and wealth of the rich was barely taxed; British sovereign debt was over 100% of GDP from 1750 to 1850, spiking at 250% of GDP in 1815 following the war against France. During the late 19th Century and until 1914, the national debt continued to fall fairly steadily, even though this was the period in which the beginnings of the modern public sector emerged and expanded, with for example free and compulsory schooling for children, the road network, sewage, the water supply, gas and even telecommunications being arranged by the state at national or local level. Subsequently, the cumulative effect of two world wars and the intervening massive economic crisis sent UK’s sovereign debt back up to two and a half times GDP at the close of the Second World War.

It was then that what could be decribed as ‘big government’ was established in peacetime conditions. The utilities and much of industry was nationalised (with compensation paid to previous owners), and the main institutions of the welfare state were set up and expanded- to the extent that by the mid-1970s, government-managed expenditure (including transfers, ie benefit payments and interest) was almost half of national production, and state spending on investment and services- ie, excluding transfers- had risen to 27% of GDP by 1975- compared to between 10% and 12.5% during most of the years between WW1 and WW2.

Yet at the same time as this huge growth in ‘government’, the sovereign debt was reduced so rapidly that between 1946 and 1975 it fell from 252% to 45% of GDP.

A similar story emerges when the combined national debt levels of the G7 major capitalist countries are considered; their gross sovereign debt fell from 80% of GDP in 1950 to 35% in 1974, although the state was increasingly involved in owning or otherwise directing the economy, and overall state spending rose very steeply during that period.

After the 1970s, during widespread privatisation and deregulation, and with the growth of public expenditure considerably reduced (despite higher levels of unemployment) the sovereign debt of the G7 countries climbed back up to 80% of GDP in 2007. In the case of the UK, the sovereign debt ratio hovered around the 45% level- despite the proceeds from privatisation, the revenue from North Sea oil, and the increasingly lucrative activities of the City of London, which since the 1980s has been by far the world’s most prominent centre for financial speculation.

There are various factors involved in this failure of the advanced capitalist countries, after the 1970s, to continue the post-WW2 pattern of reducing state debt. One is the higher (on average) interest rates compared to the rate of inflation in the later period, representing the rising power of financial capital in the increasingly deregulated global economy. Another is the lower (on average) GDP growth in the later period, attesting to the overall inefficiency (despite the claims of neo-liberal economists) of privatised and deregulated capitalism.

Tax competition- a race to the bottom

Another factor is also crucial. Across the rich ‘Western’ countries as a whole, the period from World War Two to the late 1970s was one of reduced, and reducing, inequality of income and wealth. However, beginning in the USA and the UK, then spreading internationally, that trend was reversed. Alongside a rise in the ratio of corporate profits to workers’ wages, the incomes of the richest and highest paid increased hugely, while incomes stagnated for the majority. However, after the 1980s this did not result in increases in the proportion of company profits and the incomes of wealthy people going to the state- rather the reverse.

Noting that the UK and USA took the lead by starting the process of making major structural changes to their tax systems in 1984 and 1986 respectively, the OECD paper entitled ‘Tax Reform Trends in OECD Countries’ observes:

In the mid-1980s many OECD countries had top marginal personal income tax rates in excess of 65%. Today, most top rates are below, and in some cases substantially below, 50%...

Similarly, the top statutory corporate income tax rates in the 1980s were rarely less than 45%. In 2011, the OECD average was below 26%.


... profits are usually taxed both at the corporate level (where the assumption is that they bear the statutory corporation tax rate) and again when they are distributed as dividends [...] on average, the top marginal tax rate on dividends in OECD countries was reduced by 8.1 percentage points between 2000 and 2011, from 49.1% to 41%.

To which must be added the effect of government toleration of tax evasion and avoidance by corporations and the wealthy.

Thus those who gained the most from privatisation and deregulation, and who were in the best position to contribute via taxation to an improvement in the finances of the state, had their tax obligations cut dramatically.

This was not purely the result of self-interest, ideology, and the disproportionate political power of the rich within each country at a national level- although these are very important factors. There is also the pressure of tax competition between countries, an aspect which has become increasingly crucial since deregulation and capitalist globalisation have made it much easier for firms to move their headquarters, factories or even merely virtual property from one country to another according to financial expediency.

KPMG’s Corporate Tax Rates Survey for 2006 noted the ongoing downward trend, particularly among EU countries:

Among nations that changed their statutory corporate income tax rates over the past 12 months, the overwhelming majority cut them, continuing a trend towards lower rates that has persisted for several years.

Rate reductions were most pronounced in Europe where the average statutory corporate income tax rate fell from 25.32 percent to 25.04 percent, thanks to rate cuts in six EU member states. The reduction in the EU average rate compares with a reduction in the OECD’s average rate from 28.55 percent to 28.31 percent. This has had the effect of widening the gap between the EU and OECD averages slightly from 3.23 to 3.27 percentage points.

This may reflect intensifying tax competition within the EU as a result of the accession of 10 new member states last year and the encouragement EU law and jurisprudence has been giving to capital mobility within the EU.

Under the sub-heading ‘Balancing the government books’, the KPMG survey then looked frankly at some of the complexities involved in tax competition:

Conspicuously low headline tax rates can help a country to increase, or at least to maintain, revenue if they expand the tax base (attract additional investment) sufficiently to offset the revenue effects of those low rates. This becomes less effective, however, as other countries begin to employ competitive rate-cutting.

The progressive lowering of trade barriers particularly in the EU, and the increasingly sophisticated supply chain options available to large, global companies provide credible alternatives for locating investments so exerting constant downward pressure on headline rates.

So, cutting corporate tax rates- like other ‘race to the bottom’ policies- only benefits those who cut first or most; though giving others little apparent alternative but to follow, and when they follow, the initial advantages begin to dry up. However, KPMG emphasised that reducing ‘headline’ tax rates is not the only game in town:

An apparently high tax jurisdiction can be attractive for investment if its effective rate is significantly lower than its statutory rate.

Other tools in government armories include special regimes for particular types of investment, such as headquarter companies, treasury companies and research and development, and shifting the burden to indirect taxes. More subtle competitive variables include the attitude of governments and their tax authorities to corporate tax payers, ranging from aggressive policing to promoting business collaboration; tax certainty or the lack of it (deriving from such factors as complexity of tax law and the availability of binding agreements) and the efficiency or otherwise of tax administration and the costs it imposes on tax payers. In time as tax competition progressively erodes differences in rates such factors are likely to assume more importance and one of the keys to tax competitiveness could become the “business friendliness” of a nation’s tax environment.

In the UK, HMRC (the government department which enforces the collection of tax revenue) has had its staffing reduced by 30,000 since 2005, with a further 10,000 to be cut by 2015; this is despite the official figure of £35 billion per year lost due to tax evasion- the estimate by the Tax Justice Network is twice that level.

Thus advanced countries in the 21st century undercut each other, acting as increasingly desperate bidders in the global marketplace for corporate investment, competing not only by means of low tax rates and various tax-reducing exclusions, but also by how “business friendly”- ie, ineffective- is the policing of tax payment.

Crisis as usual

And conversely, also in the name of appeasing or impressing the markets, the leaders of rich nations chop away at the public sector, wages and social benefits, and force slightly less rich nations to slash their social framework to an even greater extent- thus decreasing the economic and human defences against the anarchic power of... the markets.

Since 2007 with the start of the present economic crisis, the living standards of the majority have been falling rapidly, insecurity rising, and prospects- for students, potential and actual workers, and future pensioners alike- diminishing. During which, the crisis has been a changing and unpredictable ‘work in progress’ taking various forms, from the original credit crunch, through the insolvency of the banking system and the contraction of the real economy, to the sovereign debt debacle, with further impacts on the real economy, currently reverberating from Europe to China.

And there is no particular end in sight. This, apparently, is what 21st century capitalism looks like.