The Real Economy

Causes of recidivism and waste in economic practice - a note

Hector McNeill¹
SEEL

High government spending on initiatives such as infrastructure and training is often justified in terms of the economy growing as a result and therefore tax returns will help pay for the original outlays. In a perfect world this could be the case. However, we live in a world where economic practice hovers between poor, low productivity activities and difficult-to-achieve best practice associated with high productivity.

Even when components of change can be shown to raise the productivity of a process by a significant amount, the contribution of that process to the associated process in a production or service ecosystem can be so small as to reduce that productivity gain to insignificance. The contribution of IT, for example, where advancing hardware power and programming paradigms represent significant gains in terms of reduce costs and raised processing power, there are very variable impacts on the productivity of a production or service company. Many so-called "tech" companies initial public offerings have failed as a result of audits showing that the IT element makes up a tiny proportion of the critical processes that determine overall productivity which were almost entirely non-IT-related.

Across the economy the track record shows that gaining grants or living in a country with lavish infrastructural and training investment, the impact is always less than expected in terms of productivity increases. There is a very high degree of relapsing into close-to-previous practice once money is spent resulting in a disppointing productivity outcome. This recidivism represents lost opportunity and a wast of resources. It does not have to be this way. With logical planning and a bent for the practical government investment can revolutionise national ptoductivity levels, improve real income levels and theirdistribution and sustainable medium to long term real growth. This note clarifies some aspects of this problem and points to solutions.

KMS policies

I initiated work on the Real Incomes Approach in 1975 because of the abject failure of KMS (Keynesian, Monetarist & Supply Side Economics) policies to secure or to avoid the creation of winners, losers and those who appear to remain in a policy neutral impact state. The policy instruments in the macroeconomic toolkit were also incapable of "solving" problems without prejudicing some segments of the constituency. Both Labour and the Conservatives in government, at different times, applied such solutions resulting, in each case, with around 2 million people losing their homes. Of course this is not admitted and excuses are whisked up, usually blaming the opposing party. However, it is more rational to point out where the gaps in policy create such unforgivable fiascoes caused by the application of totally flawed theories in practice. This is a technical issue not a partisan one.

Economic growth

The first problem is the much applied term "economic growth". This term used as a measure of rising or declining economic turnover measured in currency units. In terms of constituents, however, what is important is individual or family participation in that growth, how do their economic circumstances change? To determine this it is necessary to convert any changes in income into real changes by adjusting for the constant fall in purchasing power of the currency resulting from inflation. The economic growth in an economy, expressed as currency units, is the growth in the sum total of economic transactions in goods and services calculated as the product of units sold and their unit prices. However, real incomes, that is the actual worth of growth, is the number of products and services that can be consumed for a any level of income, ignoring unit prices. Therefore, inflation, which accounts for much of the estimate of economic growth, is a fantasy growth in terms of the actual economic status of constituents.

Government investment

Both the Conservatives and Labour have announced their intention to undertake major investments in infrastructure and services. There will therefore be a major influx of money into the economy which, in Keynesian terms, means there will be an increase in demand for the services of companies used to bring about the changes set out in such policies. As a result economic growth, measured in terms of currency units, will rise as will the levels of employment of those who are asked to undertake this work. Now, if all that one is looking at is headline indicators such as aggregate economic growth or unemployment levels, then a policy might be deemed a success. However, from the standpoint of the constituent, what is important is take-home real disposable income. Government infrastructural initiatives tend to operate in waves so there is a considerable amount of nominal economic growth at the beginning but, as time passes, five critical indicators become important in terms of what is happening to the economic status of constituents, on behalf of whom, we are led to believe, policies are introduced:

inflation
productivity
corporate margins
individual income levels and distribution
sustainability

Inflation control is a matter of providing incentives for decisions taken at the transactional levels of the economy so as to moderate unit price rises. This can only occur if there are also incentives for companies to invest or modify techniques and organization to increase productivity. The growth in margins arising from increased price-moderated productivity increases, supported by market penetration, needs to be distributed in a rational fashion between shareholders and those employed in order to help secure an adequate level of income distribution. In this way the levels of feasible real consumption (demand) will also rise. This impetus from rising wages is the main factor in helping to transform a one off investment and one off ballooning economic growth into a more sustainable growth pattern.

This mechanism is very much tied to microeconomic organisation and decision-making whereas policy operates at a higher level of abstraction. So in order to bring this analytical discussion into a practical focus there are some specific pertinent questions.

So what are the key questions?

What steps will be taken in association with government investments to:

moderate inflation
raise productivity
ensure a more proportional distribution of rising real incomes
generally maintain economic, financial and environmental sustainability

It is often a waste of time to in fact attempt to secure rational replies to these questions. The track record of KMS policies on all of these questions is lamentable. It is notable that at this level of analysis politicians are particularly bad an providing convincing replies and they tend to resort to the escape clause: "the market will resolve this issue" or in the case on monetarists, "the effect will work out in the long run, believe me!" Markets can, indeed, resolve many of these issues but there is a need to select regulations that do not restrict the pattern of operational relationships desired, as mentioned above, but that more restrictive regulations be applied to the current practice of ever-continuing increasing disparity in wealth and real income levels and distribution which in reality is depressing real incomes.

Public service and the nobody's money syndrome

One of the eternal notions is that public services lack efficiency and effective management. This is bound to be the case because few public services contain mechanisms that provide incentives for costs control, productivity enhancement and sustainable operations. The absence of such mechanisms is used in part as the justification for privatising public services and utilities. However, the track record shows that having private companies participate or take over public services and utilities has resulted in price-gouging, invoicing for goods and services that have not been delivered and sometimes corrupt relationship between procurement officials and supply companies. There is also the problem of corporate lobbies pressuring political parties in government to swing tender results. A lot of this takes place because there are no incentives provided for government service employees to secure basic efficiency and value for money. Outside the ability of pubic service employees to manage private services effectively are the introduction on non-market principles such as private public partnerships that guarantee private suppliers fixed incomes irrespective of consumption, or demand for their products and services and the contractual condition that any changes in government policies that impact the income and or profits of companies enable such companies to sue the government, usually for extraordinary sums. Lastly the track record of the associated private funding initiatives (PFI) have tended to result in the government paying far higher interest rates that would be the case if they had raised funds directly. This apparent sloppy management of pubic funds which today can be witnessed in many failing Health services facing excessive interest payments.

Broadly speaking there are two conflicting ideological approaches to public services. One that favours its expansion and one that favours gradual de-funding, as witnessed during the last nine years, to create a crisis to justify privatization as a "solution". In other words, in the case of the National Health Service anyone can state sincerely that it will remain in government hands and will never be "sold". This semantics is simply a cover for ensuring that the government and tax payers remain on the hook for the funding of the £200 billion turnover while intending to increase the share of that "market" by the private sector. The paradox is that the discussions raging on this topic have defaulted into an apparent conflict between "capitalism" and "socialism" which boils down to who gets to receive government money. With socialism being associated with government funding we have an absurd contrast of the options of "Socialism for the constituency" or "Socialism for companies". The reality is that the socialism and capitalism no longer possess any precise meaning, they are whatever any opposing faction wishes them to mean. This is an important reality and a cause for much nonsense in opposing party exchanges. The result is that it is difficult to identify options untainted by a good dose of imprecise rhetoric.

The most difficult areas and where private profit-based participation in public provisions do not as yet appear to be adequate is in "caring services". These include, health, social services, policing and prisons where there is a greater need for professionals who enter such professions motivated by a sense of vocation as opposed to companies carrying out such services on the basis of profit maximisation.

A secondary and important problem with private corporations being involved in "caring services" is their lobbying to encourage changes in legislation to increase the demand for their services as opposed to legislation that is more oriented towards protecting constituents. Examples are the massive increase in prisonable offenses that has occurred since private "security" firms have become involved in prisons².

Schumpeter on profit

Joseph Schumpeter made an important observation that the significance of profit is that it is the guarantee of future activities (through investment) and of future employment (through a rational choice of technologies). This has been cited by Peter Drucker in a paper published in Forbes in 1983. If this became the exclusive purpose of profits then the Marxist analysis concerning excess production and the general consensus that capitalism isn't working, would have no basis in fact.

This rationale supports what I have called the profit paradox in that this aspect of Schumpeter's view is at odds with current concepts of the role of profit. The concept of profit is poorly defined and its role divisive in terms of the operational efficiency and transparency of the economy. In my opinion, limiting the role of profit to the aspects expressed by Schumpeter's observation is entirely valid and it opens a doorway to the resolution of this confused resource allocation issue that circulates around profit.

This is achieved by substituting the quest for profits by a quest for real incomes.

Systemic conflict

There are significant difficulties facing companies who wish to secure a more rational and profitable basis for operation that sustains a better distribution of wealth and incomes. These difficulties arise from a central systemic conflict created by constraints imposed by contradictory regulatory frameworks which make such a transformation very difficult. While government revenue-seeking through tax creates a motivation to raise profits, aiming for better post-tax status or to hide them. The accounting framework, in the hands of accountants, contains ways and means to reduce tax obligations but more significantly it creates a conflict between prices and profit margins on the one hand and minimizing the wage bill, on the other. This is because wages (income) are classified as costs. Otherwise creative accounting and payments transfer and re-pricing is used to hide profits while continuing to squeeze wages. The increasing transition under globalisation and offshore operations has resulted in many "successful" British companies exporting manufacturing jobs abroad to reduce their "wage bill". This has resulted in a continual decline in employment in the "industrial" reaches in the centre of the UK, that were contributors to the 18th-19th Century, industrial revolution. Combining this with monetary policy which has created a purchasing power depreciation of 18% each decade by attempting to sustain a 2% inflation rate, one ends up with wage earners being very much at the bottom of the social and economic pecking order existing in a precarious position with a high dependency on the state of economic growth. Currently the regulatory frameworks and macroeconomic policies work together to stack the deck against wage earners. Wage earners make up the majority of our national constituency, and accordingly economic policy design should prioritise actions that enhance their relative real income status. This state of affairs represents a significant constitutional issue in that surely economic policy needs to serve the national constituency and yet regulations and legislation prevent this being a feasible proposition.

Much of the intended government investment supported by the Conservatives and Labour faces an up hill battle because of a conflict between macroeconomic and microeconomic objectives and inappropriate frameworks supporting government revenue-seeking, accountancy norms and standards and a declining currency value which always combine to transform much of any economic growth into a mirage.

So that is the baseline reality, it will be interesting to review to what extent Labour and Conservative proposals address the issues raised.

¹ Hector McNeill is the director of SEEL-Systems Engineering Economics Lab.

² McNeill, H.W.,"The Briton's quest for freedom..Our unfinished journey...", Chapter 18, "A Final Transition", Section: "Effectiveness & the rise of the punishment business", 418 pp., HPC, 2007, ISBN: 978-0-907833-01-7

Posted November 2019