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17 July 2019updated 07 Jun 2021 2:36pm

To escape the next recession, we need to move beyond boom and bust

By Grace Blakeley

On 14 July the Resolution Foundation released a report warning that the UK is on the cusp of another recession. Uncertainty about both the domestic and international economy is driving the kind of pessimism that tends to deliver economic downturns. Add to this that the UK tends to experience a recession every 10 to 15 years, and the signs do not look good.

Many early political economists assumed that recessions were only ever caused by external shocks such as natural disasters and wars. Later, Marx argued that capitalism was inherently prone to crises  – whether due to overproduction, underconsumption or speculative manias.

But JM Keynes argued that the business cycle was powered by expectations about the future – and therefore by optimism and pessimism. Boom and bust was, for Keynes, an inherent feature of the capitalist model.

This insight was driven by his ingenious two-price theory. For Keynes, the costs of a business investment – say, the land and resources needed to build a factory – is determined by the economy today. But the returns – the estimated profits that factory will generate – will be determined by what is likely to happen tomorrow.

Investors have no certain knowledge about the future – there could be a recession, or a war. In the absence of reliable knowledge, their expectations are led by current trends.

During the good times, optimistic optimistic capitalists invest lots, which stimulates the economy, vindicating their decision to invest in the first place. But eventually credit dries up and spending and investment slow down. Some businesses may become insolvent – they’ll sell assets to pay debts, pushing prices down even further. Eventually, a fear-driven recession grips the economy.

Keynes believed that states needed to save capitalism from itself. During the upswing, they should take measures to limit credit creation and tax the returns from investment so that, during the downswing, they can ease credit conditions and spend to get the economy going again.

This advice has been ignored by successive governments in the UK. As a result, since the financial crisis, the economy has been growing at a historically low rate of around 2 per cent per year – in 2018 it slowed to just 1.4 per cent. The average worker has not had a pay rise since 2007 and productivity has been stagnant.

The UK economy’s growth is largely due to low interest rates, which have encouraged borrowing, and quantitative easing (QE), which has pushed up asset prices for the rich. The result has been a fragile recovery, associated with high debt levels, inflated asset prices, and political instability.

Confidence in such a fragile system was bound to dry up eventually. As the Resolution Foundation pointed out, low interest rates and the Bank of England’s failure to end QE mean that, when the next recession comes, it will be very difficult to boost the economy using monetary policy.

That leaves fiscal policy: tax and spending. Keynes’s insights give us an indication of the utility of tax cuts during a recession – when confidence is low, people aren’t going to spend and businesses aren’t going to invest, no matter how many tax cuts you give them. Tax cuts for the rich, who spend less of their extra income, are even less helpful – notwithstanding the protests of both Tory leadership candidates.

Government spending, on the other hand, can provide the boost needed to keep the economy moving. But this option increases the power of workers, and reduces that of bosses. Low unemployment and high spending on public services give workers more confidence to argue for the pay they deserve. The taxes imposed on the wealthy to support this spending, coupled with the financial regulation needed to make it work, constrain the power of capital. This, rather than any intellectual commitment to the free market, is why governments have imposed economically self-defeating austerity on the country since 2010.

Our economy is broken because of who runs it: wealthy elites. Moving beyond boom and bust is therefore about more than simply changing how we think about the economy – it’s about changing who has the power.

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This article appears in the 17 Jul 2019 issue of the New Statesman, The Facebook fixer