Follow the money

There is one simple rule that most economists agree on:

prosperity = productivity

The Chancellor understands this – productivity was mentioned 10 times in his recent Spring Budget speech. He said:

Simply put, higher productivity means higher pay.

and went on to say that Britain’s problem is a productivity problem

We are 35% behind Germany and 18% behind the G7 average. And the gap is not closing.

So what is going wrong and who is to blame? Is it the 99% or the 0.1%? I would say the latter. Let me explain why.

Economists are very fond of a concept called equilibrium which for the layman translates as balance. Market forces are supposed to mean that prices adjust such that supply and demand remain balanced. Except that it does not always work like that. Sometimes the price mechanism fails and unbalanced flows persist. Assets prices keep on rising, even though turnover isn’t. CEO salaries keep on rising, even though productivity isn’t. This builds a pressure that eventually has to give – unbalanced flows cannot last forever. The end game of these market failures is crisis, and the trouble with crises is that they are unpleasant – completely unlike the orderly return to balance predicted by economist’s equilibrium theories. Moreover, the recovery from a crisis tends to be long and painful, as we know all too well.

To avoid crises we need to correct imbalances before it is too late. Detecting them is easy – just follow the money.

Think of money as something that flows. If the flow stops or stalls, money ceases to fulfil its function just like the blood in our veins. The blood analogy isn’t perfect because the amount of money tends to increase, but we shall come back to that. The flow of money like all the other flows in economics needs to balance because unbalanced flows end in crisis. If all the money flows to one place like in Monopoly, the game is over.

The only flow that does not need to balance relates to new money. A growing economy needs a growing amount of money and someone – the government or banks – needs to keep adding new money to match the amount of new activity. However, once money is injected the way it flows between people or companies needs to balance. If there is an unbalanced trend, like rising inequality – a steady flow from poor to rich – it is just a matter of time before a crisis hits.

Related to inequality are unbalanced flows from labour to capital or from households to companies. In the US, companies are sitting on enormous cash piles. Apple’s ‘headache’ over its $180 billion stashed offshore is how to bring it home without paying the tax.

In the UK, companies are also sitting on capital. If we look at the sectoral balances data again obtained from the Office of National Statistics, we find that before 2002 companies (the purple shading in the lower graph) were sometimes in surplus and sometimes in deficit, which is healthy.


But after 2002, they were mostly in surplus. By 2015, households (the red bars on the top graph) were no longer saving and most of the government deficit was ending up directly on company balances sheets – the government deficit equals private company surplus. Your taxes either directly or indirectly end up in the hands of private companies. This is not sustainable and it is not how capitalism is supposed to work. As the economist Richard Koo likes to say, we live in a very very strange world! Government is supposed to provide public goods, not pay rent to the private sector. Companies are supposed to borrow money to invest, not sit back and collect rent. Gradually over time, rent extraction has crowded out real production, as chronicled in the recent book Makers and takers.

Why are companies not investing, not increasing productivity? Is this the inevitable end game of shareholder capitalism with it’s emphasis on shareholder value – the World’s dumbest idea – where even a growth company like Apple eventually resorts to share buy backs? Have companies run out of ideas? Or ambition? Have the 0.1% become lazy? Or has it just become too easy to live off the rent? You decide.

Seventy years ago, the Chancellor Hugh Dalton said that we should act

on the side of the active producer and against the passive rentier.

During the ’50s, ’60s and ’70s, the UK enjoyed the fastest productivity growth and the highest wages growth of any era. But gradually, with the help of subsequent Chancellors, the rentiers fought back.

2008 was a wake up call, but we overslept. The solution is known. Spread the word.

PS. If you did not see the Danish TV series, it’s great fun!


  1. Sean Danaher -

    as you will know my training is in Physics but I am also a Chartered Electrical Engineer and indeed many physicists end up in engineering jobs. As such I know many people in the engineering sector. There is an almost universal agreement in the circles I inhabit that engineers/scientists need to be in charge of major technology companies. Once (with respect to a certain Richard Murphy) the accountants and bean counters take over the company looses its dynamism and goes into gradual decline. I’m sure the same argument holds for “creative” people as well.

    Apple was a success because of its personnel; in particular Steve Jobbs and Jonathan Ive. Jobbs of course is very well known. Ive (English, a mechanical designer and an alumnus of Northumbria University -shameless plug) conceived a computer as a thing of beauty and went on to design the ipod, ipad and iphone. These were revolutionary at the time.

    I understand Germany uses a somewhat different model where much more of the profit goes back into engineering and innovation rather than being syphoned off by shareholders.

    1. Geoff -

      Thanks Charles,
      Post like this help my layman’s understanding no end. Easy to understand, informative and enjoyable as well. Thank you.

      1. Charles Adams -


    2. Charles Adams -

      Sean, you are right. We could learn from Germany on this one. Their technology/engineering base is much much stronger. According to the World Bank figures on investment in
      R and D as a percentage of GDP

      German 2.87% and rising
      UK 1.70% flat

      I have lived and worked in Germany and the difference is stark.

  2. Jeni Parsons aka havantaclu -

    Sean and Charles

    Years ago I used to work for the Inland Revenue as a Tax Collector (plenty of stories there!). At one point I was in charge of the work being done to work out tax and NIC which would have been due to be paid by bankrupts and by insolvent Companies – not only for our office but for another that needed assistance. We had access to the Companies House register – often there was useful information available that allowed us to decide our actions.

    It was clear from that information that the primary purpose of every Company was to maximise returns for their shareholders. Not to optimise – to maximise. There is a difference, isn’t there? Optimisation would involve investment in technology, in skills, in making the Company more efficient. But that wasn’t what was required, apparently. And the results were clear from the Company accounts for the years before the insolvency. The shareholders got their profits, whether the Company was efficient or not.

    Until this country turns itself away from a policy of maximisation to one of optimisation, its inequalities will continue to fester.

    1. Charles Adams -

      Is it short term vs. long term? Long term optimisation vs. short term maximisation.

      It’s like the examples in game theory where everyone playing a rational strategy leads to a worse outcome overall.

  3. Richard Murphy -

    No need to apologise Sean.

    Most accountants a haven’t a clue how business works so all they do is cut and avoid tax.

    Then when it all goes wrong they liquidate, or with luck sell out.

    Few professions have so little idea of what they think they know.

Comments are closed.