Some commentators have seen the victory of Donald Trump and, prior to that, the Brexit vote as symptoms of a crisis in capitalism. Much of the campaigning in the US election, both by Donald Trump on the right and Bernie Sanders on the left focused on the plight of the poor. Whether the blame was put on immigration, big government, international organisations, the banks, cheap imports undercutting jobs or a lack of social protection, the message was clear: capitalism is failing to improve the lot of the majority. A small elite is getting significantly richer while the majority sees little or no gain in their living standards and a rise in uncertainty.
The articles below look at this crisis. They examine the causes, which they agree go back many years as capitalism has evolved. The financial crash of 2008 and the slow recovery since are symptomatic of the underlying changes in capitalism.
The Friedman article focuses on the slowing growth in technological advance and the problem of aging populations. What technological progress there is is not raising incomes generally, but is benefiting a few entrepreneurs and financiers. General rises in income may eventually come, but it may take decades before robotics, biotechnological advances, e-commerce and other breakthrough technologies filter through to higher incomes for everyone. In the meantime, increased competition through globalisation is depressing the incomes of the poor and economically immobile.
All the articles look at the rise of the rich. The difference with the past is that the people who are gaining the most are not doing so from production but from financial dealing or rental income; they have gained while the real economy has stagnated.
The gains to the rich have come from the rise in the value of assets, such as equities (shares) and property, and from the growth in rental incomes. Only a small fraction of finance is used to fund business investment; the majority is used for lending against existing assets, which then inflates their prices and makes their owners richer. In other words, the capitalist system is moving from driving growth in production to driving the inflation of asset prices and rental incomes.
The process whereby financial markets grow and in turn drive up asset prices is known as ‘financialisation’. Not only is the process moving away from funding productive investment and towards speculative activity, it is leading to a growth in ‘short-termism’. The rewards of senior managers often depend on the price of their companies’ shares. This leads to a focus on short-term profit and a neglect of long-term growth and profitability – to a neglect of investment in R&D and physical capital.
The process of financialisation has been driven by deregulation, financial innovation, the growth in international financial flows and, more recently, by quantitative easing and low interest rates. It has led to a growth in private debt which, in turn, creates more financial instability. The finance industry has become so profitable that even manufacturing companies are moving into the business of finance themselves – often finding it more profitable than their core business. As the Foroohar article states, “the biggest unexplored reason for long-term slower growth is that the financial system has stopped serving the real economy and now serves mainly itself.”
So will the election of Donald Trump, and pressure from populism in other countries too, mean that governments will focus more on production, job creation and poverty reduction? Will there be a movement towards fiscal policy to drive infrastructure spending? Will there be a reining in of loose monetary policy and easy credit?
Or will addressing the problem of financialisation and the crisis of capitalism result in the rich continuing to get richer at the expense of the poor, but this time through more conventional channels, such as increased production and monopoly profits and tax cuts for the rich? Trump supporters from among the poor hope the answer is no. Those who supported Bernie Sanders in the Democratic primaries think the answer will be yes and that the solution to over financialisation requires more, not less, regulation, a rise in minimum wages and fiscal policies aimed specifically at the poor.
Articles
Can Global Capitalism Be Saved? Project Syndicate, Alexander Friedman (11/11/16)
American Capitalism’s Great Crisis Time, Rana Foroohar (12/5/16)
The Corruption of Capitalism by Guy Standing review – work matters less than what you own The Guardian, Katrina Forrester (26/10/16)
Questions
- Do you agree that capitalism is in crisis? Explain.
- What is meant by financialisation? Why has it grown?
- Will the policies espoused by Donald Trump help to address the problems caused by financialisation?
- What alternative policies are there to those of Trump for addressing the crisis of capitalism?
- Explain Schumpeter’s analysis of creative destruction.
- What technological innovations that are currently taking place could eventually benefit the poor as well as the rich?
- What disincentives are there for companies investing in R&D and new equipment?
- What are the arguments for and against a substantial rise in the minimum wage?
The pound has fallen to its lowest rate against the euro since July 2013 and the lowest rate against the US dollar since 1985. Since August 2015, the pound has depreciated by 23.4% against the euro and 22.2% against the dollar. And since the referendum of 23 June, it has depreciated by 15.6% against the euro and 17.6% against the dollar.
On Sunday 2 October, at the start of the Conservative Party conference, the Prime Minister announced that Article 50, which triggers the Brexit process, would be invoked by the end of March 2017. Worries about what the terms of Brexit would look like put further pressure on the pound: the next day it fell by around 1% and the next day by a further 0.5%.
Then, on 6 October, it was reported that President Hollande was demanding tough Brexit negotiations and the pound dropped significantly further. By 7 October, it was trading at around €1.10 and $1.22. At airports, currency exchange agencies were offering less than €1 per £ (see picture).
With the government implying that Brexit might involve leaving the Single Market, the pound continued falling. On 12 October, the trade-weighted index reached its lowest level since the index was introduced in 1980: below its trough in the depth of the 2008 financial crisis and below the 1993 trough following Britain’s ejection from the European Exchange Rate Mechanism in September 1992.
So just why has the pound fallen so much, both before and after the Brexit vote? (Click here for a PowerPoint of the chart.) And what are the implications for the economy?
The articles explore the reasons for the depreciation. Central to these are the effects on the balance of payments from a possible decline in inward investment, lower interest rates leading to a net outflow of currency on the financial account, and stimulus measures, both fiscal and monetary, leading to higher imports.
Worries about the economy were occurring before the Brexit vote and this helped to push sterling down in late 2015 and early 2016, as you can see in the chart. This article from The Telegraph of 14 June 2016 explains why.
Despite the short-run effects on the UK economy of the Brexit vote not being as bad as some had predicted, worries remain about the longer-term effects. And these worries are compounded by uncertainty over the Brexit terms.
A lower sterling exchange rate reduces the foreign currency price of UK exports and increases the sterling price of imports. Depending on price elasticities of demand, this should improve the current account of the balance of payments.
These trade effects will help to boost the economy and go some way to countering the fall in investment as businesses, uncertain over the terms of Brexit, hold back on investment in the UK.
Articles
Pound Nears Three-Decade Low as May Sets Date for Brexit Trigger Bloomberg, Netty Idayu Ismail and Charlotte Ryan (3/10/16)
Sterling near 31-year low against dollar as May sets Brexit start dat Financial Times, Michael Hunter and Roger Blitz (3/10/16)
Sterling hits three-year low against the euro over Brexit worries The Guardian, Katie Allen (3/10/16)
Pound sterling value drops as Theresa May signals ‘hard Brexit’ at Tory conference Independent, Zlata Rodionova (3/10/16)
Pound falls as Theresa May indicates Brexit date BBC News (3/10/16)
The pound bombs and stocks explode over fears of a ‘hard Brexit’ Business Insider UK, Oscar Williams-Grut (3/10/16)
Pound Will Feel Pain as Brexit Clock Ticks Faster Wall Street Journal, Richard Barley (3/10/16)
British Pound to Euro Exchange Rate’s Brexit Breakdown Slows After Positive Manufacturing PMI Halts Decline Currency Watch, Joaquin Monfort (3/10/16)
7 ways the fall in the value of the pound affects us all Independent (4/10/16)
The pound and the fury: Brexit is making Britons poorer, and meaner The Economist, ‘Timekeeper’ (11/10/16)
Is the pound headed for parity v US dollar and euro? Sydney Morning Herald, Jessica Sier (5/10/16)
Flash crash sees the pound gyrate in Asian trading BBC News (7/10/16)
Flash crash hits pound after Hollande remarks Deutsche Welle (7/10/16)
Sterling mayhem gives glimpse into future Reuters, Swaha Pattanaik (7/10/16)
Sterling takes a pounding The Economist, Buttonwood (7/10/16)
Government must commit to fundamental reform The Telegraph, Andrew Sentance (7/10/16)
Data
Interest & exchange rates data – Statistical Interactive Database Bank of England
Questions
- Why has sterling depreciated? Use a demand and supply diagram to illustrate your argument.
- What has determined the size of this depreciation?
- What is meant by the risk premium of holding sterling?
- To what extent has the weaker pound contributed to the better economic performance than was expected immediately after the Brexit vote?
- What factors will determine the value of sterling over the coming months?
- Who gain and who lose from a lower exchange rate?
- What is likely to happen to inflation over the coming months? Explain and consider the implications for monetary and fiscal policy.
- What is a ‘flash crash’. Why was there a flash crash in sterling on Asian markets on 7 October 2016? Is such a flash crash in sterling likely to occur again?
The UK government has finally given the go-ahead to build the new Hinkley C nuclear power station in Somerset. It will consist of two European pressurised reactors, a relatively new technology. No EPR plant has yet been completed, with the one in the most advanced stages of construction at Flamanville in France, having experienced many safety and construction problems. This is currently expected to be more than three times over budget and at least six years behind its original completion date of 2012.
The Hinkley C power station, first proposed in 2007, is currently estimated to cost £18 billion. This cost will be borne entirely by its builder, EDF, the French 85% state-owned company, and its Chinese partner, CGN. When up and running – currently estimated at 2025 – it is expected to produce around 7% of the UK’s electricity output.
On becoming Prime Minister in July 2016, Theresa May announced that the approval for the plant would be put on hold while further investigation of its costs, benefits, 
security concerns, technological issues and safeguards was conducted. This has now been completed and approval has been granted subject to new conditions. The main one is that the government “will be able to prevent the sale of EDF’s controlling stake prior to the completion of construction”. This will allow the government to prevent change of ownership during the construction phase. Thus, for example, EDF, would not be allowed to sell its share of Hinkley C to CGN, which currently has a one-third share in the project. EDF and CGN have accepted the new terms.
After Hinkley the government will have a ‘golden share’ in all future nuclear projects. “This will ensure that significant stakes cannot be sold without the Government’s knowledge or consent.”
In return for their full financing of the project, the government has guaranteed EDF and CGN a price of £92.50 per megawatt hour of electricity (in 2012 prices). This price will be borne by consumers. It will rise with inflation from now and over the first 35 years of the power station’s operation. It is expected that the Hinkley C will have a life of 60 years.
Critics point out that this guaranteed ‘strike price’ is more than double the current wholesale price of electricity and, with the price of renewables falling as technology improves, it will be an expensive way to meet the UK’s electricity needs and cut carbon emissions.
Those in favour argue that it is impossible to predict electricity prices into the distant future and that the certainty this plant will give is worth the high price by current standards.
To assess the desirability of the plant requires an assessment of its costs and benefits. In principle, this is a relatively simple process of identifying and measuring the costs and benefits, including external costs and benefits; discounting future costs and benefits to give them a present value; weighting them by their probability of occurrence; then calculating whether the net present value is positive or negative. A sensitivity analysis could also be conducted to show just how sensitive the net present value would be to changes in the value of specific costs or benefits.
In practice the process is far from simple – largely because of the huge uncertainty over specific costs and benefits. These include future wholesale electricity prices, unforeseen problems in construction and operation, and a range of political issues, such as pressure from various interest groups, and attitudes and actions of EDF and CGN and their respective governments, which will affect not only Hinkley C but other future power stations.
The articles look at the costs and benefits of this, the most expensive construction project ever in the UK, and possibly on Earth..
Articles
Hinkley Point: UK approves nuclear plant deal BBC News (15/9/16)
Hinkley Point: What is it and why is it important? BBC News, John Moylan (15/9/16)
‘The case hasn’t changed’ for Hinkley Point C BBC Today Programme, Malcolm Grimston (29/7/16)
U.K. Approves EDF’s £18 Billion Hinkley Point Nuclear Project Bloomberg, Francois De Beaupuy (14/9/16)
Hinkley Point C nuclear power station gets government green light The Guardian, Rowena Mason and Simon Goodley (15/9/16)
Hinkley Point C: now for a deep rethink on the nuclear adventure? The Guardian, Nils Pratley (15/9/16)
Hinkley Point C finally gets green light as Government approves nuclear deal with EDF and China The Telegraph, Emily Gosden (15/9/16)
UK gives go-ahead for ‘revised’ £18bn Hinkley Point plant Financial Times, Andrew Ward, Jim Pickard and Michael Stothard (15/9/16)
Hinkley Point: Is the UK getting a good deal? Financial Times, Andrew Ward (15/9/16)
Hinkley Point is risk for overstretched EDF, warn critics Financial Times, Michael Stothard (15/9/16)
Hinkley C must be the first of many new nuclear plants The Conversation, Simon Hogg (16/9/16)
Report
Nuclear power in the UK National Audit Office, Sir Amyas Morse, Comptroller and Auditor General (12/7/16)
Questions
- Summarise the arguments for going ahead with Hinkley C.
- Summarise the objections to Hinkley C.
- What categories of uncertain costs and uncertain benefits are there for the project?
- Is the project in EDF’s interests?
- How will the government’s golden share system operate?
- How should the discount rate be chosen for discounting future costs and benefits from a project such as Hinkley C?
- What factors will determine the wholesale price of electricity over the coming years? In real terms, do you think it is likely to rise or fall? Explain.
- If nuclear power has high fixed costs and low marginal costs, how does this affect how much nuclear power stations should be used in a situation of daily and seasonal fluctuations in demand?
- How could ‘smart grid’ technology smooth out peaks and troughs in electricity supply and demand? How does this affect the relative arguments about nuclear power versus renewables?
The UK has voted to leave the EU by 17 410 742 votes (51.9% or 37.4% of the electorate) to 16 141 241 votes (48.1% or 34.7% of the electorate). But what will be the economic consequences of the vote?
To leave the EU, Article 50 must be invoked, which starts the process of negotiating the new relationship with the EU. This, according to David Cameron, will happen when a new Conservative Prime Minister is chosen. Once Article 50 has been invoked, negotiations must be completed within two years and then the remaining 27 countries will decide on the new terms on which the UK can trade with the EU. As explained in the blog, The UK’s EU referendum: the economic arguments, there are various forms the new arrangements could take. These include:
‘The Norwegian model’, where Britain leaves the EU, but joins the European Economic Area, giving access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. Another possibility is ‘the Swiss model’, where the UK would negotiate trade deals on an individual basis. Another would be ‘the Turkish model’ where the UK forms a customs union with the EU. At the extreme, the UK could make a complete break from the EU and simply use its membership of the WTO to make trade agreements.
The long-term economic effects would thus depend on which model is adopted. In the Norwegian model, the UK would remain in the single market, which would involve free trade with the EU, the free movement of labour between the UK and member states and contributions to the EU budget. 
The UK would no longer have a vote in the EU on its future direction. Such an outcome is unlikely, however, given that a central argument of the Leave camp has been for the UK to be able to control migration and not to have to pay contributions to the EU budget.
It is quite likely, then, that the UK would trade with the EU on the basis of individual trade deals. This could involve tariffs on exports to the EU and would involve being subject to EU regulations. Such negotiations could be protracted and potentially extend beyond the two-year deadline under Article 50. But for this to happen, there would have to be agreement by the remaining 27 EU countries. At the end of the two-year process, when the UK exits the EU, any unresolved negotiations would default to the terms for other countries outside the EU. EU treaties would cease to apply to the UK.
It is quite likely, then, that the UK would face trade restrictions on its exports to the EU, which would adversely affect firms for whom the EU is a significant market. 
Where practical, some firms may thus choose to relocate from the UK to the EU or move business and staff from UK offices to offices within the EU. This is particularly relevant to the financial services sector. As the second Economist article explains:
In the longer run … Britain’s financial industry could face severe difficulties. It thrives on the EU’s ‘passport’ rules, under which banks, asset managers and other financial firms in one member state may serve customers in the other 27 without setting up local operations. …
Unless passports are renewed or replaced, they will lapse when Britain leaves. A deal is imaginable: the EU may deem Britain’s regulations as ‘equivalent’ to its own. But agreement may not come easily. French and German politicians, keen to bolster their own financial centres and facing elections next year, may drive a hard bargain. No other non-member has full passport rights.
But if long-term economic effects are hard to predict, short-term effects are happening already.
The pound fell sharply as soon as the results of the referendum became clear. By the end of the day it had depreciated by 7.7% against the dollar and 5.7% against the euro. A lower pound will make imports more expensive and hence will drive up prices and reduce the real value of sterling. On the other had, it will make exports cheaper and act as a boost to exports.
If inflation rises, then the Bank of England may raise interest rates. This could have a dampening effect on the economy, which in turn would reduce tax revenues. The government, if it sticks to its fiscal target of achieving a public-sector net surplus by 2020 (the Fiscal Mandate), may then feel the need to cut government expenditure and/or raise taxes. Indeed, the Chancellor argued before the vote that such an austerity budget may be necessary following a vote to leave.
Higher interest rates could also dampen house prices as mortgages became more expensive or harder to obtain. The exception could be the top end of the market where a large proportion are buyers from outside the UK whose demand would be boosted by the depreciation of sterling.
But given that the Bank of England’s remit is to target inflation in 24 month’s time, it is possible that any spike in inflation is temporary and this may give the Bank of England leeway to cut Bank Rate from 0.5% to 0.25% or even 0% and/or to engage in further quantitative easing.
One major worry is that uncertainty may discourage investment by domestic companies. It could also discourage inward investment, and international companies many divert investment to the EU. Already some multinationals have indicated that they will do just this. Shares in banks plummeted when the results of the vote were announced.
Uncertainty is also likely to discourage consumption of durables and other big-ticket items. The fall in aggregate demand could result in recession, again necessitating an austerity budget if the Fiscal Mandate is to be adhered to.
We live in ‘interesting’ times. Uncertainty is rarely good for an economy. But that uncertainty could persist for some time.
Articles
Why Brexit is grim news for the world economy The Economist (24/6/16)
International banking in a London outside the European Union The Economist (24/6/16)
What happens now that Britain has voted for Brexit The Economist (24/6/16)
Britain and the EU: A tragic split The Economist (24/6/16)
Brexit in seven charts — the economic impact Financial Times, Chris Giles (21/6/16)
How will Brexit result affect France, Germany and the rest of Europe? Financial Times, Anne-Sylvaine Chassany, Stefan Wagstyl, Duncan Robinson and Richard Milne (24/6/16)
How global markets are reacting to UK’s Brexit vote Financial Times, Michael Mackenzie and Eric Platt (24/6/16)
Brexit: What happens now? BBC News (24/6/16)
How will Brexit affect your finances? BBC News, Brian Milligan (24/6/16)
Brexit: what happens when Britain leaves the EU Vox, Timothy B. Lee (25/6/16)
An expert sums up the economic consensus about Brexit. It’s bad. Vox, John Van Reenen (24/6/16)
How will the world’s policymakers respond to Brexit? The Telegraph, Peter Spence (24/6/16)
City of London could be cut off from Europe, says ECB official The Guardian, Katie Allen (25/6/16)
Multinationals warn of job cuts and lower profits after Brexit vot The Guardian, Graham Ruddick (24/6/16)
How will Brexit affect Britain’s trade with Europe? The Guardian, Dan Milmo (26/6/16)
Britain’s financial sector reels after Brexit bombshell Reuters, Sinead Cruise, Andrew MacAskill and Lawrence White (24/6/16)
How ‘Brexit’ Will Affect the Global Economy, Now and Later New York Times, Neil Irwin (24/6/16)
Brexit results: Spurned Europe wants Britain gone Sydney Morning Herald, Nick Miller (25/6/16)
Economists React to ‘Brexit’: ‘A Wave of Economic and Political Uncertainty’ The Wall Street Journal, Jeffrey Sparshott (24/6/16)
Brexit wound: UK vote makes EU decline ‘practically irreversible’, Soros says CNBC, Javier E. David (25/6/16)
One month on, what has been the impact of the Brexit vote so far? The Guardian (23/7/16)
Questions
- What are the main elements of a balance of payments account? Changes in which elements caused the depreciation of the pound following the Brexit vote? What elements of the account, in turn, are likely to be affected by the depreciation?
- What determines the size of the effect on the current account of the balance of payments of a depreciation? How might long-term effects differ from short-term ones?
- Is it possible for firms to have access to the single market without allowing free movement of labour?
- What assumptions were made by the Leave side about the economic effects of Brexit?
- Would it be beneficial to go for a ‘free trade’ option of abolishing all import tariffs if the UK left the EU? Would it mean that UK exports would face no tariffs from other countries?
- What factors are likely to drive the level of investment in the UK (a) by domestic companies trading within the UK and (b) by multinational companies over the coming months?
- What will determine the course of monetary policy over the coming months?
In the blog post, Global warning, we looked at the use of unconventional macroeconomic policies to deal with the slow pace of economic growth around the world. One of the articles was by Nouriel Roubini. In the linked article below, he argues that slow economic growth may be the new global norm.
At the centre of the problem is a fall in the rate of potential economic growth. This has been caused by a lack of investment, which has slowed the pace of innovation and the growth in labour productivity.
The lack of investment, in turn, has been caused by a lack of spending by both households and governments. What is the point in investing in new capacity, argue firms, if they already have spare capacity?
Low consumer spending is partly the result of a redistribution of income from low- and middle-income households (who have a high marginal propensity to consume) to high-income households and corporations (who have a low mpc). Low spending is also the result of both consumers and governments attempting to reduce their levels of debt by cutting back spending.
Low growth leads to hysteresis – the process whereby low actual growth leads to low potential growth. The reason is that the unemployed become deskilled and the lack of investment by firms reduces the innovation that is necessary to embed new technologies.
Read Roubini’s analysis and consider the policy implications.
Article
Has the global economic growth malaise become the ‘new normal’? The Guardian, Nouriel Roubini (2/5/16)
Questions
- Explain what is meant by ‘hysteresis’ and how the concept is relevant in explaining low global economic growth.
- Why has there been a reduction in the marginal propensity to consume in recent years? What is the implication of this for the multiplier and economic recovery?
- Explain what Roubini means by ‘a painful de-leveraging process’. What are the implications of this process?
- How important are structural reforms and what forms could these take? Why has there been a reluctance for governments to institute such reforms?
- ‘Asymmetric adjustment between debtor and creditor economies has also undermined growth.’ Explain what Roubini means by this.
- Why are governments reluctant to use fiscal policy to boost both actual and potential economic growth?
- What feasible policy measures could be taken to boost actual and potential economic growth?
All the articles look at the rise of the rich. The difference with the past is that the people who are gaining the most are not doing so from production but from financial dealing or rental income; they have gained while the real economy has stagnated.
So will the election of Donald Trump, and pressure from populism in other countries too, mean that governments will focus more on production, job creation and poverty reduction? Will there be a movement towards fiscal policy to drive infrastructure spending? Will there be a reining in of loose monetary policy and easy credit?
