The Economy: it’s not a house it’s a business

After encouragement by an old flatmate http://twitter.com/#!/oh_henry/status/52014511967846400 to write something on the state of the economy, as a card-carrying Labour supporting entrepreneur, I was goaded into action by reading some of the hokey left-wing analysis of the ‘cuts’ in the press over the last week.

Why should you listen to what I’ve got to say rather than anyone else?  Well you shouldn’t, you shouldn’t take anyone’s views for gospel, but rather take a genuine hard look at all the facts and statistics and make up your own mind.  In a world of Twitter, Facebook and journalists under pressure to file more stories than ever before, we are bombarded by never-ending un-researched, irresponsible and unbalanced reports that we believe wholesale.

I’ve got a lot of smart friends, but yet hardly any of them understand what is going on with the ‘cuts’ and, more importantly, the difference between the concepts and words ‘debt’ and ‘deficit’.  If some of my bright Oxbridge-educated friends don’t even get it, then what hope is there for everyone else whipped up into a frenzy by wrong-headed, badly researched and just plain wrong analysis by the likes of for example Falseeconomy.org.uk (http://falseeconomy.org.uk/cure/how-big-is-the-problem) and the liberal darling, Independent writer Johann Hari (http://johannhari.com/2011/03/29/the-biggest-lie-in-british-politics)?  Worse still, most leave no room for comment to clarify, debate and correct.  And as such we are not having the national debate we should be having on how to grow our way out of this crisis and create the future society we need.  Labour avoided it during the election and as a consequence, we have no basis for an argument today…and it pains me.

Let’s take the opportunity to teach people about how businesses work

Most of the problems stem from using the analogy of a home and a mortgage for explaining the economy.  We can pass the mortgage (national debt) on for future generations, we can increase the mortgage…it will all be fine as we’ve done it before and can do it again. Both parties are guilty here, most probably because, with the majority of people affected being public sector workers with little experience of private sector business, the mortgage analogy resonates better.

This analogy is misleading.  The economy is actually more like a business – GB Plc. Debts are loans and credit built up by the business (maybe it would help to think of football clubs like Man Utd and previously Liverpool with their big debt mountains and all the hooha that created).  Deficits on the other hand are annual losses made by GB Plc, i.e. the gap between costs of running a business and its annual turnover.  So – and here’s the key point – debts are an accumulation of deficits/losses.  You cannot even begin to pay off your debt until you’ve stopped making losses and start making profits.  The government today is trying to stem the annual losses.  All the while, the debt is growing and won’t stop growing until after the life of this parliament, i.e. we won’t stop making losses and the national debt won’t stop growing until 2015.  The cynical will say, hold on a minute, that’s just in time for the government to make a potentially election-winning budget-busting giveaway, and the cynical will be right, but if the shoe was on the other foot, we’d have that same political problem anyway.

The real question should be about why we are making all these losses.  Firstly, we doubled the amount of spending on public sector services from £300bn to £600bn over the course of the labour government (http://www.hm-treasury.gov.uk/d/pesa_2010_chapter4.pdf).  And now spending has  risen by a further £100bn in this recession to almost £700bn, as you can see in the link.  As someone who remembers the almost daily tabloid headlines about hospital waiting lists during the 90s, much of this spending was for the greater good (http://www.ft.com/cms/s/0/a1d3d258-41ce-11da-a45d-00000e2511c8.html#axzz1Idd5ngGi).

But there was a problem.

The amount we were ‘producing’ (remember that business analogy) wasn’t enough to cover the amount we were spending and – to make matters worse –  this was whilst the UK economy was booming, with a finance sector as the engine for our service sector growth, the biggest and most successful global product we were selling. Keynes himself said we should make surpluses during boom time years and then invoke borrowing and fiscal stimuli during recessions to smooth out the pain.  In terms of a business this means that you should save some of your profits during the good times rather than spending them all, for example on paying your staff more or buying fancier offices, so that when the bad times come you have a buffer to then use some of that cash to invest in the business and borrow to keep things going when times are bad.  Apple has £60bn in cash in the bank, which is growing year on year as profits grow.  It faces constant calls to spend the money from shareholders, but is wisely holding on to the money for the moment when its growth falters and it might then have to buy other companies or aggressively invest to drive forward growth again.  But we were still borrowing all through the boom years, creating a structural deficit on the basis that times would keep on getting even better and that the cycle of ‘boom and bust’ had been eradicated for good.  A structural deficit is a deficit that exists even when an economy is at its full potential.  From a business perspective this is like starting a business and then realising that for the product you want to build no matter what you do, your costs will always be more than the money you can make from it leading to eventual failure.  Actually this point about continuing deficits is even clearly shown on False Economy’s Deficit page, where you can see that deficits (the gap) persisted even through the boom years 2000-2007 (http://falseeconomy.org.uk/cure/what-is-the-deficit). Paying debt was cheap then because the global economy was a saver, so even in good years we allowed ourselves the luxury of a higher standard of living than we could afford because ‘things would only get better’.

What happened next? The ‘credit crunch’.  The world finally realised that lending to people ‘on the never never’ who couldn’t afford it was a bad idea, and the banking system almost collapsed.  We had been gradually extending levels of credit and how much people could borrow for the extra-long years of the boom times until the bubble burst. It may have started with sub-prime mortgages in America, as home owners went from fixed-term mortgages of 1.5% to 4.5%, which they then couldn’t pay, but here in the UK we were also culpable, with unlimited credit cards and even 125% mortgages.  We went from a world where (for argument’s sake) banks could lend 30 times what they had to more like 12 times; a huge deleveraging event, the industry term for this scenario.  This meant that they could either recall loans fast to reduce the amount lent or increase the amount of money they had to cover the lending, or both.  They’ve done both and fast…and in most cases, it was our governments who supplied the amount of money to cover the gap in the first instance.

Should you blame a loan shark for your debts?

But money from where..? Isn’t the government already in debt? Doesn’t it already lend from the very same bank markets?  And hadn’t the banking sector been our engine for growth, the product we were selling the world?

Yes – with our biggest product, banking, failing and retracting, the negative effect on GB Plc.’s ‘profitability’ was significant.  GB Plc.’s losses widened hard and fast.  The banking sector had, until then, paid for the boom times by providing tax revenues to pay for the improving public sector services.

So what do we have now?  We have both a broken banking sector that we need to reform, and have lost the great product that paid for all the good times.  I agree that the disproportionate incomes that bankers can earn are obscene for something that never really seemed to me like it added value to the world….hence as an economics graduate after a university internship pushing paper around, I finally ignored the gravy train of the City and started my own company. And this entrepreneurial route is going to be our way out of our structural deficit hole. To understand our way out of this problem, and how to grow the economy again, we need to understand that – as well as being the catalyst for the bust – banking was also firmly behind the boom in the first place.

The structural deficit – the losses being made by GB Plc. – won’t go away until we work out what products we are going to be selling to cover all the lovely state benefits and services we want.  The private sector pays the taxes to cover these publicly provided services and products.  What needs to be understood is that public sector workers are paid for by private sector workers.  They are the product of private sector efforts to provide the services we all want.

We can’t keep making losses if we have no end-product to wow the world with.  My investors would cut off my funding if they lost faith in my potential to produce long-awaited cutting-edge and world-leading products.  Looking at the bigger picture, what is going to be GB Plc.’s ‘new product’? How are we going to grow out of recession?  The banking sector will not be the same again and won’t produce the same tax income, and as mentioned anyway, we were already spending more than we made.

We have the opportunity now to focus on the story and hope for growth, and on how we are going to do it.  Comments like ”Britain’s national debt has been higher than it is now for 200 of the past 250 years” from Johann Hari don’t help, because our historical approach was to go out and conquer other nations and pillage their resources to pay for it: imperialism.  Along with the fallacious ‘mortgage’ analogy, comparing our economy to other economies is as useful as comparing Google to Marks & Spencer or Toyota.  We all have different make-ups, sizes and products to sell.

Going for growth

Unlike in the past, nowadays we can only conquer the world with our products.  We allowed ourselves to get too focused on the banking sector, and on public services we couldn’t afford.  If we want those public services back we need to rebuild our manufacturing and technology base, and the signs are there that the opportunities exist to do so.  Let’s take clothing manufacturing.  With rising wages in China, higher transport costs and an obsession for fast low volume fashion, the price gap between UK and Chinese manufacturing no longer exists and the clamour is finally growing to bring back the UK clothing manufacturing industry (http://www.drapersonline.com/news/sir-philip-green-i-will-try-to-bring-manufacturing-back-to-uk/5023535.article).  Who else is going to take up arms to produce the new and improved GB Plc. products?

Foxconn in China employs 1m people and 500,000 are in just one of its high-end technology plants, where most of your Apple products are made.  Tech publications such as Wired (http://www.wired.com/magazine/2011/02/ff_joelinchina/) point to their highly publicised employee suicides, but when you compare the stats of 17 employees from 1m workers as opposed to the norm of 17 per 100,000 people in the UK…this starts to look more like lazy China-bashing from the press. Plastic Logic is arguably one of the most interesting innovation developments in the UK, born in Cambridge, yet almost a $1bn of manufacturing investment has been pumped (http://www.plasticlogic.com/)not into the UK, but into plants first in Dresden ($250m) and, announced this month, Zelenograd, Russia ($700m).  You read that right; it has indeed attracted $1bn in investment with none of that going into the UK.

There are people out there now debating the right question and, indeed, a friend of mine pointed me to a recent IPPR booklet he’d contributed to, called ‘Going for growth’, which takes on the challenge of debating the real question: how we can generate growth and structure the economy and government to achieve it?  Go and read it and ask yourself the difficult question of whether you would sacrifice nurses for railways today if that meant more jobs for all: http://www.ippr.org.uk/publicationsandreports/publication.asp?id=804

As an entrepreneur my predisposition is towards hope, and you need it to start a business in the worst recession in living memory.  I’m investing heavily in R&D and innovation to give my company the edge to adequately compete in the market place, and to give it a chance of becoming a global player.  If we are to get the country moving and create the rebalanced economy we need for the next 10-20 years then we need to move the debate on from ‘cuts’ to the plan for growth.  We need to invest and innovate to build new products.  Remember: GB Plc. is a business and not a house.  We need new products to sell, not a new lick of paint.

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