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Articles for the ‘Economics for Business 6e: Ch 31’ Category

Gloomy assessments of the global economic outlook

In two posts recently, we considered the pessimistic views of Robert Peston about the prospects for the global economy (see Cloudy skies ahead? and The end of growth in the West?). In this post we consider the views of Christine Lagarde, Managing Director of the International Monetary Fund, and Lord Adair Turner, the former head of the Financial Services Authority (FSA) (which was replaced in 2013 by the Financial Conduct Authority and the Prudential Regulation Authority).

Christine Lagarde was addressing an audience at Georgetown University in Washington DC. The first four links below are to webcasts of the full speech and subsequent interviews about the speech. She gives a more gloomy assessment of the global economy than six months ago, especially the eurozone economy and several emerging economies, such as China. There are short- to medium-term dangers for the world economy from political conflicts, such as that between Russia and the West over Ukraine. But there are long-term dangers too. These come from the effects of subdued private investment and low infrastructure spending by governments.

Her views are backed up by the six-monthly World Economic Outlook, published by the IMF on 7 October. There are links below to two webcasts from the IMF discussing the report and the accompanying datasets.

In the final webcast link below, Lord Turner argues that there is a “real danger of a simultaneous slowdown producing a big setback to growth expectations.” He is particularly worried about China, which is experiencing an asset price bubble and slowing economic growth. Other emerging economies too are suffering from slowing growth. This poses real problems for developed countries, such as Germany, which are heavily reliant on their export sector.

Webcasts
The Challenges Facing the Global Economy: New Momentum to Overcome a New Mediocre IMF Videos, Christine Lagarde (full speech) (2/10/14)
Christine Lagarde downbeat on global economy BBC News Canada, Christine Lagarde interviewed by Katy Kay (2/10/14)
IMF’s Lagarde on Global Economy, Central Banks Bloomberg TV, Christine Lagarde interviewed by Tom Keene (2/10/14)
Lagarde: Global economy weaker than envisioned 6 months ago, IMF to cut growth outlook CNBC (2/10/14)
IMF Says Uneven Global Growth Disappoints IMF Videos, Olivier Blanchard (7/10/14)
Time Is Right for an Infrastructure Push IMF Videos, Abdul Ablad (30/9/14)
China slowdown poses ‘biggest risk to global economy’ The Telegraph, Adair Turner (4/10/14)

Articles
Global Growth Disappoints, Pace of Recovery Uneven and Country-Specific IMF Survey Magazine (7/10/14)
Global economy risks becoming stuck in low growth trap The Telegraph, Szu Ping Chan (2/10/14)
American Exceptionalism Thrives Amid Struggling Global Economy Bloomberg, Rich Miller and Simon Kennedy (4/10/14)
World Bank cuts China growth forecast for next three years BBC News (6/10/14)
Beware a Chinese slowdown The Guardian, Kenneth Rogoff (6/10/14)
IMF says economic growth may never return to pre-crisis levels The Guardian, Larry Elliott (7/10/14)
IMF goes back to the future with gloomy talk of secular stagnation The Guardian, Larry Elliott (7/10/14)

Data
World Economic Outlook Database IMF (7/10/14)
World Economic Outlook IMF (October 2014)

Questions

  1. What are the particular ‘headwinds’ facing the global economy?
  2. Why is the outlook for the global economy more pessimistic now than six months ago?
  3. Why are increasing levels of debt and asset price rises a threat to Chinese economic growth?
  4. Why may China be more able to deal with high levels of debt than many other countries?
  5. In what ways are commodity prices an indicator of the confidence of investors about future economic growth?
  6. What are the determinants of long-term economic growth? Why are potential economic growth rates lower today than in the 2000s?
  7. How might governments today boost long-term economic growth?
  8. What are the arguments for and against governments engaging in large-scale public investment in infrastructure projects? What would be the supply-side and demand-side effects of such policies?
  9. If confidence is a major determinant of investment, how might bodies such as the IMF boost confidence?
  10. Why does the IMF caution against over-aggressive attempts to reduce budget deficits?
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Cloudy skies ahead?

Now here’s a gloomy article from Robert Peston. He’s been looking at investors’ views about the coming years and sees a general pessimism about the prospects for long-term economic growth. And that pessimism is becoming deeper.

It is true that both the UK and the USA have recorded reasonable growth rates in recent months and do seem, at least on the surface, to be recovering from recession. But, according to investor behaviour, they:

seem to be saying, in how they place their money, that the UK’s and USA’s current reasonably rapid growth will turn out to be a short-lived period of catch-up, following the deep recession of 2008-9.

So what is it about investor behaviour that implies a deep pessimism and are investors right to be pessimistic? The article explores these issues. It does also look at an alternative explanation that investors may merely be being cautious until a clearer picture emerges about long-term growth prospects – which may turn out to be better that many currently now predict.

The article finishes by looking at a possible solution to the problem (if you regard low or zero growth as a problem). That would be for the government to ‘throw money at investment in infrastructure – to generate both short-term growth and enhance long-term productive potential.’

Note that Elizabeth also looks at this article in her blog The end of growth in the west?.

The end of growth in the West? BBC News, Robert Peston (26/9/14)

Questions

  1. What is meant by the ’25-year yield curve for government bonds’? Why does this yield curve imply a deep level of business pessimism about the long-term prospects for UK economic growth?
  2. What are the determinants of long-term economic growth?
  3. Looking at these determinants, which ones suggest that long-term economic growth may be low?
  4. Are there any determinants which might suggest that economic growth will be maintained over the long term at historical levels of around 2.6%?
  5. Do demand-side policies affect potential GDP and, if so, how?
  6. What policies could government pursue to increase the rate of growth in potential GDP?
  7. What current ‘dramas’ affecting the world economy could have long-term implications for economic growth? How does uncertainty about the long-term implications for the global economy of such dramas itself affect economic growth?
  8. Is long-term growth in real GDP an appropriate indicator of (a) economic development and (b) long-term growth in general well-being?
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Plus ça change, plus c’est la même chose

The French economy is flatlining. It has just recorded the second quarter of zero economic growth, with growth averaging just 0.02% over the past 12 months. What is more, the budget deficit is rising, not falling. In April this year, the French finance minister said that the deficit would fall from 4.3% in 2013 to 3.8% in 2014 and to the eurozone ceiling of 3% in 2015. He is now predicting that it will rise this year to 4.4% and not reach the 3% target until 2017.

The deficit is rising because a flatlining economy is not generating sufficient tax revenues. What is more, expenditure on unemployment benefits and other social protection is rising as unemployment has risen, now standing at a record 10.3%.

And it is not just the current economic situation that is poor; the outlook is poor too. The confidence of French companies is low and falling, and investment plans are muted. President Hollande has pledged to cut payroll taxes to help firms, but so far this has not encouraged firms to invest more.

So what can the French government do? And what can the EU as a whole do to help revive not just the French economy but most of the rest of the eurozone, which is also suffering from zero, or near zero, growth?

There are two quite different sets of remedies being proposed.

The first comes from the German government and increasingly from the French government too. This is to stick to the austerity plans: to get the deficit down; to reduce the size of government in order to prevent crowding out; and to institute market-orientated supply-side policies that are business friendly, such as reducing business regulation. Business leaders in France, who generally back this approach, have called for reducing the number of public holidays and scrapping the maximum 35-hour working week. They are also seeking reduced business taxes, financed by reducing various benefits.

Increasingly President Hollande is moving towards a more business-friendly set of policies. Under his government’s ‘Responsibility Pact’, a €40 billion package of tax breaks for business will be financed through €50 billion of cuts in public spending. To carry through these policies he has appointed an ex-investment banker, Emmanuel Macron, as economy minister. He replaces Arnaud Montebourg, who roundly criticised government austerity policy and called for policies to boost aggregate demand.

This brings us to the alternative set of remedies. These focus on stimulating aggregate demand through greater infrastructure investment and cutting taxes more generally (not just for business). The central argument is that growth must come first and that this will then generate the tax revenues and reductions in unemployment that will then allow the deficit to be brought down. Only when economic growth is firmly established should measures be taken to cut government expenditure in an attempt to reduce the structural deficit.

There are also compromise policies being proposed from the centre. These include measures to stimulate aggregate demand, mainly through tax cuts, accompanied by supply-side policies, whether market orientated or interventionist.

As Europe continues to struggle to achieve recovery, so the debate is getting harsher. Monetary policy alone may not be sufficient to bring recovery. Although the ECB has taken a number of measures to stimulate demand, so far they have been to little avail. As long as business confidence remains low, making increased liquidity available to banks at interest rates close to zero will not make banks more willing to lend to business, or businesses more willing to borrow. Calls for an end, or at least a temporary halt, to austerity are thus getting louder. At the same time, calls for sticking to austerity and tackling excessive government spending are also getting louder.

Articles
Hollande entrusts French economy to ex-banker Macron Reuters, Ingrid Melander and Jean-Baptiste Vey (26/8/14)
France’s new Minister of the Economy Emmanuel Macron described by left-wingers as a ‘copy-and-paste Tony Blair’ Independent, John Lichfield (28/8/14)
Merkel praises France’s economic reform plans after Berlin talks with PM Valls Deutsche Welle (22/9/14)
French economy flat-lines as business activity falters Reuters, Leigh Thomas (23/9/14)
French public finances: Rétropédalage The Economist (13/9/14)
French employer group urges ‘shock therapy’ for economy Reuters (24/9/14)
Last chance to save France: loosen 35-hour week and cut public holidays, say bosses The Telegraph (24/9/14)
‘Sick’ France’s economy is stricken by unemployment ‘fever’ The Telegraph (17/9/14)
France’s economics ills worsen but all remedies appear unpalatable The Observer, Larry Elliott and Anne Penketh (31/8/14)
The Fall of France The New York Times, Paul Krugman (28/8/14)
Why Europe is terrified of deflation Salon, Paul Ames (20/9/14)
Europe’s Greater Depression is worse than the 1930s The Washington Post, Matt O’Brien (14/8/14)
Worse than the 1930s: Europe’s recession is really a depression The Washington Post, Matt O’Brien (20/8/14)
Eurozone business growth slows in September, PMI survey finds BBC News (23/9/14)
Europe must ‘boost demand’ to revive economy, US warns BBC News (21/9/14)
Valls says France would never ask Germany to solve its problems Reuters, Annika Breidthardt and Michelle Martin (23/9/14)
The euro-zone economy: Asset-backed indolence The Economist (11/9/14)

Data
Annual macro-economic database (AMECO) Economic and Financial Affairs DG, European Commission
Business and Consumer Surveys Times Series Economic and Financial Affairs DG, European Commission
StatExtracts OECD
Statistics database European Central Bank

Questions

  1. What types of supply-side reforms would be consistent with the German government’s vision of solving Europe’s low growth problem?
  2. How could a Keynesian policy of reflation be consistent with getting France’s deficit down to the 3% of GDP limit as specified in the Stability and Growth Pact (see)?
  3. What is meant by (a) financial crowding out and (b) resource crowding out? Would reflationary fiscal policy in France lead to either form of crowding out? How would it be affected by the monetary stance of the ECB?
  4. Give examples of market-orientated and interventionist supply-side policies.
  5. What is meant by the terms ‘cyclical budget deficit’ and ‘structural budget deficit’. Could demand-side policy affect the structural deficit?
  6. Using the European Commission’s Business and Consumer Surveys find our what has happened to business and consumer confidence in France over the past few months.
  7. How important is business and consumer confidence in determining economic growth in (a) the short term and (b) the long term?
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Keeping a Minsky-eye on credit

The instability of the economy was clearly demonstrated by the events of the late 2000s. Economists have devoted considerable energies to understanding the determinants of the business cycle. Increasing attention is focused on the role that credit cycles play in contributing to or exacerbating cycles. Therefore, data on lending by banks is followed keenly by policymakers who wish to avoid the repeat of the pace of growth in credit seen in the period preceding the financial crisis. Interestingly, the latest data from the Bank of England show that lending by financial institutions to households (net of repayments) rose in July to its highest level since November 2009.

The idea of credit cycles is not new. But, the financial crisis of the late 2000s has helped to reignite analysis and interest. Many economists have revisited the work of Hyman Minsky (1919–1996), a Belarus-born American economist, who argued that financial cycles are an inherent part of the economic cycle and contribute to fluctuations in real GDP. Notably, he argued that credit extended to households and businesses is pro-cyclical so that flows of credit extended by banks are larger when the growth of the economy’s output is stronger. Since credit flows are dependent on the phase of the business cycle, they are said to be endogenous to the path of output. The key point here is that there is an inherent mechanism within the economy which is potentially destabilising.

Banks, it is argued, may use the growth of the economy’s output as an indicator of the riskiness of its lending. Households and businesses may undertake a similar assessment. After a period of sustained growth banks and investors become more confident about the future path of the economy and, consequently, in the returns of assets. This means that there is a role for psychology in understanding the business cycle.

If we look at the chart, this period of heightened confidence may correspond with the period starting from the late 1990s. Between 1998 and 2007 the average monthly net flow of credit to private non-financial corporations and households was £9.4 billion. In other words, households and businesses were acquiring a staggering £9.4 billion of additional debt from banks each month. But, this was as high as £14.0 billion per month in 2007. (Click here for a PowerPoint of the chart.)

What helped to fuel the impact of heightened confidence on credit provision was financial innovation. In particular, the bundling of assets, such as mortgages, to form financial instruments which could then be purchased by investors helped to provide financial institutions with further funds for lending. This is the process of securitisation. The result was that during the 2000s as households and businesses began to acquire larger debts their financial well-being became increasingly stretched. This was hastened by central banks raising interest rates. The intention was to dampen the rising rate of inflation, partly attributable to rising global commodity prices, such as oil. Suddenly, euphoria was replaced with pessimism.

Some argue that a Minsky moment had occurred. Many countries then witnessed a balance sheet recession. As individual households and businesses try and improve their own financial well-being they collectively contribute to its worsening. For instance, large-scale attempts to sell assets, such as shares or property, only help to cause their value to decline.

A global response to the events of the financial crisis has been for policy-makers to pay more attention to the aggregate level of credit provision. The chart shows that lending in 2014 is more robust than it has been form some time. Across the first seven months of 2014 the average monthly net flow of credit extended by banks to households and businesses (private non-financial corporations) has been £2.2 billion.

However, the 2014-rebound of credit is wholly attributable to lending to households. Net lending to households has averaged £2.7 billion per month while businesses have been repaying credit to banks to the tune of £437 million per month – something that businesses have collectively done in each year from 2009. While net lending to households remains considerably lower than pre-financial crisis levels, it will be something that policymakers will be watching very closely. This, in turn, means that they will be paying particular interest to the housing and mortgage markets.

Articles
Appetite for loans picks up again, say major banks BBC News (23/9/14)
Business lending by UK banks is down by £941m Herald Scotland, Ian McConnell (27/8/14)
How bank lending fell by £365 BILLION in five years… much to the delight of controversial payday loan firms Mail, Louise Eccles (7/09/14)
U.K.’s Big Banks Cut Lending by $595 Billion, KPMG Says Bloomberg, Richard Partington (8/9/14)
UK banks’ home loan approvals fall to 12-month low – BBA Reuters, Andy Bruce and Tom Heneghan (23/9/14)

Data
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. What is meant by the term the business cycle?
  2. What does it mean for the determinants of the business cycle to be endogenous? What about if they are exogenous?
  3. Outline the ways in which the financial system can impact on the spending behaviour of households. Repeat the exercise for businesses.
  4. How might uncertainty affect spending and saving by households and businesses?
  5. What does it mean if bank lending is pro-cyclical?
  6. Why might lending be pro-cyclical?
  7. How might the differential between borrowing and saving interest rates vary over the business cycle?
  8. Explain what you understand by net lending to households or firms. How does net lending affect their stock of debt?
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A mini-stimulus for China

The growth of China over the past decade has been quite phenomenal, with figures recorded in double-digits. However, in the aftermath of the recession, growth has declined to around 7% – much higher than Western economies are used to, but significantly below the ‘norm’ for China. (Click here for a PowerPoint of the chart.)

The growth target for this year is 7.5%, but there appear to be some concerns about China’s ability to reach this figure and this has been emphasised by a recent Chinese policy.

A mini-stimulus package has been put in place, with the objective of meeting the 7.5% growth target. Government expenditure is a key component of aggregate demand and when other components of AD are lower than expected, boosting ‘G’ can be a solution. However, it’s not something that the Chinese government has had to do in recent years and the fact that this stimulus package has been put in place has brought doubts over China’s economic performance to the forefront , but has confirmed its commitment to growth. Mizuho economist, Shen Jianguang, said:

It’s very obvious that the leaders feel the need to stabilise growth…Overall, the 7.5 per cent growth target means that the government still cares a lot about economic growth.

Data suggest that growth in China is relatively weak and there are concerns that the growth target will be missed, hence the stimulus package. In the aftermath of the 2008 financial crisis, there was a large stimulus package in place in China. This latest investment by the government is in no way comparable to the size of the 2008 package, but instead will be on a smaller and more specific scale. Mark Williams of Capital Economics said:

It’s a bit of a rerun of what we saw last year – something less than a stimulus package and more of piecemeal measures to ensure they reach their growth target.

It is the construction of public housing and railways that will be the main areas of investment this time round. A sum of $120–180bn per year will be available for railway construction and $161bn for social housing, and tax breaks are being extended for small businesses.

The 2008 stimulus package saw debt increase to some 200% of GDP, which did cause growing concerns about the reliance on debt. However, this latest package will be financed through the issue of bonds, which is much more similar to how market economies finance spending.

The fact that the government has had to intervene with such a stimulus package is, however, causing growing concerns about the level of debt and the future of this fast growing economy, though the new method of financing is certainly seen as progress.

It should be noted that a decline in growth for China is not only concerning for China itself, but is also likely to have adverse consequences other countries. In the increasingly interdependent world that we live in, Western countries rely on foreign consumers purchasing their exports, and in recent years it has been Chinese consumers that have been a key component of demand. However, a decline in growth may also create some benefits – resources may not be used up as quickly and prices of raw materials and oil in particular may remain lower.

It is certainly too early for alarm bells, but the future of China’s growth is less certain than it was a decade ago. The following articles consider this issue.

China’s new mini-stimulus offers signs of worry and progress BBC News, Linda Yueh (3/4/14)
China puts railways and houses at hear of new stimulus measures The Guardian (3/4/14)
China unveils mini stimulus to to boost slowing economy The Telegraph (3/4/14)
China stimulus puts new focus on growth target Wall Street Journal, Bob Davis and Michael Arnold (3/4/14)
China embarks on ‘mini’ stimulus programme to kick-start economy Independent, Russell Lynch (3/4/14)
China takes first step to steady economic growth Reuters (2/4/14)
China unveils fresh stimulus The Autstralian (3/4/14)
China’s reformers can triumph again, if they follow the right route The Guardian, Joseph Stiglitz (2/4/14)

Questions

  1. How has Chinese growth reached double-digits? Which factors are responsible for such high growth?
  2. The BBC News article suggests that the stimulus package is cause for concerns but also shows progress. How can it do both?
  3. Using a diagram, illustrate how a stimulus package can boost economic growth.
  4. What are the advantages and disadvantages of high rates of growth for (a) China and (b) Western economies?
  5. Why does the method of financing growth matter?
  6. Railway and housing construction have been targeted to receive additional finance. Why do you think these sectors have been targeted?
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The London magnet

While much of the UK is struggling to recover from recession, the London economy is growing strongly. This is reflected in strong investment, a growth in jobs and rapidly rising house prices.

There are considerable external economies of scale for businesses locating in London. There is a pool of trained labour and complementary companies providing inputs and services are located in close proximity. Firms create positive externalities to the benefit of other firms in the same industry or allied industries.

London is a magnet for entrepreneurs and highly qualified people. Innovative ideas and business opportunities flow from both business dealings and social interactions. As Boris Johnson says in the podcast, “It’s like a cyclotron on bright people… People who meet each other and spark off each other, and that’s when you get the explosion of innovation.”

Then there is a regional multiplier effect. As the London economy grows, so people move to London, thereby increasing consumption and stimulating further production and further employment. Firms may choose to relocate to London to take advantage of its buoyant economy. There is also an accelerator effect as a booming London encourages increased investment in the capital, further stimulating economic growth.

But the movement of labour and capital to London can dampen recovery in other parts of the economy and create a growing divide between London and other parts of the UK, such as the north of England.

The podcast examines ‘agglomeration‘ in London and how company success breeds success of other companies. It also looks at some of the downsides.

Podcast
Boris Johnson: London is cyclotron on bright people BBC Today Programme, Evan Davis (3/3/14)

Articles
London will always win over the rest of the UK The Telegraph, Alwyn Turner (2/3/14)
Evan Davis’s Mind The Gap – the view from Manchester The Guardian, Helen Pidd (4/3/14)
London incubating a new economy London Evening Standard, Phil Cooper (Founder of Kippsy.com) (10/2/14)

Reports and data
London Analysis, Small and Large Firms in London, 2001 to 2012 ONS (8/8/13)
Regional Labour Market Statistics, February 2014 ONS (19/2/14)
London Indicators from Labour Market Statistics (11 Excel worksheets) ONS (19/2/14)
Annual Business Survey, 2011 Regional Results ONS (25/7/13)
Economies of agglomeration Wikipedia

Questions

  1. Distinguish between internal and external economies of scale.
  2. Why is London such an attractive location for companies?
  3. Are there any external diseconomies of scale from locating in London?
  4. In what ways does the expansion of London (a) help and (b) hinder growth in the rest of the UK?
  5. Examine the labour statistics (in the links above) for London and the rest of the UK and describe and explain the differences.
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Abenomics – one year on

It is one year since the election of Shinzo Abe in Japan. He immediately embarked on a radical economic policy to stimulate the Japanese economy, which had suffered from years of stagnation. There have been three parts (or three arrows) to his policy: fiscal policy and monetary policy to stimulate aggregate demand and supply-side policy to increase productivity.

As the previous post explains:

“The first arrow is monetary policy. The Bank of Japan has engaged in extensive quantitative easing through bond purchases in order to drive down the exchange rate (see A J-curve for Japan?), stimulate expenditure and increase the rate of inflation. A target inflation rate of 2% has been set by the Bank of Japan. Part of the problem for the Japanese economy over the years has been stagnant or falling prices. Japanese consumers have got used to waiting to spend in the hope of being able to buy at lower prices. Similarly, Japanese businesses have often delayed stock purchase. By committing to bond purchases of whatever amount is necessary to achieve the 2% inflation target, the central bank hopes to break this cycle and encourage people to buy now rather than later.

The second arrow is fiscal policy. Despite having the highest debt to GDP ratio in the developed world, Japan is embarking on a large-scale programme of infrastructure investment and other public works. The package is worth over $100bn. The expansionary fiscal policy is accompanied by a longer-term plan for fiscal consolidation as economic growth picks up. In the short term, Japan should have no difficulty in financing the higher deficit, given that most of the borrowing is internal and denominated in yen.

The third arrow is supply-side policy. On 5 June, Shinzo Abe unveiled a series of goals his government would like to achieve in order to boost capacity and productivity. These include increasing private-sector investment (both domestic and inward), infrastructure expenditure (both private and public), increasing farmland, encouraging more women to work by improving day-care facilities for children, and deregulation of both goods, capital and labour markets. The prime minister, however, did not give details of the measures that would be introduced to achieve these objectives. More details will be announced in mid-June.”

In the webcast and article below, Linda Yueh, the BBC’s Chief Business Correspondent, considers how effective the policies are proving and the challenges that remain.

Webcast
Has Abenomics fixed Japan’s economic fortunes? BBC News, Linda Yueh (16/12/13)

Articles
Why Abenomics holds lessons for the West BBC News, Linda Yueh (13/12/13)
Japanese business confidence hits six-year high, Tankan survey shows The Guardian (16/12/13)

Data
World Economic Outlook Database IMF (Oct 2013)
Bank of Japan Statistics Bank of Japan
Economic Outlook Annex Tables OECD
Country statistical profile: Japan 2013 OECD (15/11/13)

Questions

  1. Demonstrate on (a) an aggregate demand and supply diagram and (b) a Keynesian 45° line diagram the effects of the three arrows (assuming they are successful) in meeting their objectives.
  2. Why has Japan found it so hard to achieve economic growth over the past 20 years?
  3. How has the Japanese economy performed over the past 12 months?
  4. What lessons can be learnt by the UK and eurozone countries from Japan’s three arrows?
  5. Why is the second arrow problematic, given the size of Japan’s general government debt? Does the proportion of Japanese debt owed overseas affect the argument?
  6. In what ways do the three arrows (a) support each other; (b) conflict with each other?
  7. Why is the structure of the labour market in Japan acting as a break on economic growth? What policies are being, or could be, pursued to tackle these structural problems?
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0.3% confimed – good or bad news?

In the blog The global economy we considered the economic performance of countries across the globe, including the UK. In the first estimate of UK economic growth for the first quarter of 2013, the economy grew at 0.3%, thus avoiding a triple-dip recession. This first estimate is always subject to change, but in this case, the data was confirmed.

The April 2013 figure provided by the ONS of 0.3% growth has been confirmed, once again indicating the slow recovery of the UK economy. Despite these more positive signs for the economy, the IMF has raised concerns of the weak performance of the UK and has urged the government to invest more in projects to stimulate growth. Although the economy has started to grow, economic growth has continued to remain weak since the onset of the financial crisis and recession. Martin Beck, an economist at Capital Economics said:

With employment and average earnings both dropping in the first quarter on their level in the previous quarter, the foundations for a sustained recovery, even one driven by consumers, still look pretty rickety.

Initial estimates by the ONS are always updated and there is still time for the 0.3% growth figure to be changed, as more data becomes available. (Click here for a PowerPoint of the chart.) This latest figure, although unchanged, has given a more concrete indication of where the UK economy is continuing to struggle. Consumer spending increased by only 0.1%, investment and exports declined, but in further signs of a weak economy, the building up of stocks by companies was a big contributor to the UK economic growth – a contribution of 0.4 percentage points. The service sector continued to growth with a 0.6 percentage point contribution to GDP.

So, what does the future look like for the UK? Although the estimate of 0.3% figure did prevent a triple-dip recession and the IMF did comment on the ‘improving health’ of the economy, signs of recovery remain weak.

Crucial to the recovery will be government spending, but more than this, the government spending must be in key growth industries. Data suggests that the UK invests less than other G8 countries as a percentage of GDP and this is perhaps one of the key factors that has prevented the UK recovery from gathering pace. The future of the UK economy remains uncertain and government policy will be crucial in determining this future course. The following articles consider the latest growth data.

Signs of weakness mar UK economic growth Reuters, Olesya Dmitracova and William Schomberg (23/5/13)
UK first quarter growth unchanged BBC News (23/5/13)
Concerns over underlying health of UK economy as 0.3% growth confirmed The Guardian, Philip Inman (23/5/13)
Statisticians confirm 0.3% UK growth for first quarter of 2013 Financial Times, Claire Jones and Sarah O’Connor (23/5/13)
UK GDP: concerns about underlying economy as 0.3pc growth confirmed The Telegraph, Philip Aldrick (23/5/13)
Britsh economy returns to growth in first quarter The Economic Times (23/5/13)
U.K. households not loosening purse strings Wall Street Journal, Ainsley Thomson and Ilona Bllington (23/5/13)
IMF: UK should push for economic growth BBC News (22/5/13)

Questions

  1. Why are numerous estimates of GDP made by the ONS?
  2. How is GDP measured? Is it an accurate measure of economic growth? What about economic development?
  3. Why does 0.3% growth in the first quarter of GDP not necessarily imply that the UK economy is recovering?
  4. Why have certain aspects of the UK economy performed better or worse than others?
  5. What areas should the government invest in, according to the IMF?
  6. Why would government spending in investment create economic growth? Is this likely to be short term or long term?
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Margaret Thatcher: seeking a calm assessment

Much has been written on Margaret Thatcher following her death at the age of 87 on April 8. But getting a calm assessment of both her time in office and her legacy is not easy. And it’s clear why: she created both stronger loyalty and stronger opposition than any other UK Prime Minister.

As economists, however, we should try to be as dispassionate as possible in assessing the effects of policies. There is always a normative question of the relative desirability of different economic outcomes – and you will have your own views on the relative importance of objectives such as economic growth, greater equality and greater social cohesion – but to determine cause and effect, or at least correlation, requires a careful examination of the evidence. Also, drawing lessons for future policy requires a careful modelling of the economy and the effects of changing economic variables.

The following articles have been selected from the hundreds that have appeared in the press in the past few days. Whilst they cannot be claimed to be totally ‘objective’, taken together they give a good overview of her economic policies and her economic legacy.

You may well have been surprised by the amount of coverage of her death and at the fervour of her supporters and critics. But this bears witness to the huge effect she had on both the political scene and on the UK economy – for good or bad.

Articles
Margaret Thatcher’s timeline: From Grantham to the House of Lords, via Arthur Scargill and the Falklands War Independent (8/4/13)
Overhauls Are Still Felt, Debated Decades Later Wall Street Journal, Charles Forelle (9/4/13)
Margaret Thatcher’s Four Ages of Monetary Policy EconoMonitor, David Smith (10/4/13)
How Mrs Thatcher smashed the Keynesian consensus The Economist (9/4/13)
Margaret Thatcher: The economy now and then BBC News, Stephanie Flanders (10/4/13)
Did Margaret Thatcher transform Britain’s economy for better or worse? The Guardian, Larry Elliott (8/4/13)
A look back at Margaret Thatcher’s economic record Washington Post, Dylan Matthews (8/4/13)
Margaret Thatcher’s legacy for business and economics—the world weighs in Quartz, Gwynn Guilford (8/4/13)

Data
Economic Data freely available online The Economics Network, see especially sites 1, 2, 3, 6 and 9

Questions

  1. Summarise the macroeconomic policies followed by the Thatcher government from 1979 to 1990.
  2. Chart economic growth, unemployment and inflation over Margaret Thatcher’s time in office. How does the performance of each of these indicators compare with the period from 1990 to 2007 and from 2008 to the present day?
  3. What is meant by ‘monetarism’? Did the Thatcher government follow pure monetarist policies?
  4. What is meant by the ‘Big Bang’ as applied to the financial sector in 1986? Assess the long-term consequences of the Big Bang.
  5. What elements of ‘Thatcherism’ were retained by the Labour government from 1997 to 2010?
  6. To what extent can the current Coalition government be described as ‘Thatcherite’?
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A balancing act

The UK economy is suffering from a lack of aggregate demand. Low spending in real terms is preventing the economy from growing. A simple solution would seem to be to stimulate aggregate demand through fiscal policy, backed up by even looser monetary policy. But this is easier said than done and could result in undesirable consequences in the medium term.

If increased borrowing were to be used to fund increased government expenditure and/or cuts in taxes, would any resulting growth be sufficient in the medium term to reduce the public-sector deficit below the initial level through automatic fiscal stabilisers? And would the growth be sustainable? The answer to this second question depends on what happens to the supply side of the economy. Would there be an increase in aggregate supply to match the increase in aggregate demand?

This second question has led many economists to argue that we need to see a rebalancing of the economy. What is needed is an increase in investment and exports, rather than an increase in just consumer expenditure funded by private borrowing and government current expenditure funded by public borrowing.

But how will exports and investment be stimulated? As far as exports are concerned, it was hoped that the depreciation of the pound since 2008 would give UK exporters a competitive advantage. Also domestic producers would gain a competitive advantage in the UK from imports becoming more expensive. But the current account deficit has actually deteriorated. According to the EU’s AMECO database, in 2008 the current account deficit was 1% of GDP; in 2012 it was 3.7%. It would seem that UK producers are not taking sufficient advantage of the pound’s depreciation, whether for exports or import substitutes.

As far as investment is concerned, there are two major problems. The first is the ability to invest. This depends on financing and things such as available land and planning regulations. The second is the confidence to invest. With not little or no growth in consumer demand, there is little opportunity for the accelerator to work. And with forecasts of sluggish growth and austerity measures continuing for some years, there is little confidence in a resurgence in consumer demand in the future. (Click here for a PowerPoint of the above chart. Note that the 2013 plots are based on AMECO forecasts.)

So hope of a rebalancing is faint at the current time. Hence the arguments for an increase in government capital expenditure that we looked at in the last blog post (The political dynamite of calm economic reflection). The problem and the options for government are considered in the following articles.

Articles
Budget 2013: Chancellor’s rebalancing act BBC News, Stephanie Flanders (11/3/13)
Why George Osborne is failing to rebalance the economy The Guardian, Larry Elliott (17/3/13)
Economy fails to ‘rebalance’ Financial Times, Sarah O’Connor (27/2/13)
Analysis – Long haul ahead for Britain’s struggling economy Reuters, William Schomberg (3/3/13)
Can banks be forced to lend more? BBC News, Robert Peston (12/3/13)
Budget 2013: What the commentators are saying BBC News (13/3/13)

Data
UK Trade, January 2013 (ONS) (12/3/13)
Business investment, Q4 2012 ONS (27/2/13)

Questions

  1. Draw a diagram to illustrate the effects of a successful policy to increase both aggregate demand and aggregate supply. What will determine the effect on the output gap?
  2. For what reasons has the UK’s current account deteriorated over the past few years while those of the USA and the eurozone have not?
  3. Using ONS data, find out what has happened to the UK’s balance of trade in (a) goods and (b) services over the past few years and explain your findings.
  4. Why are firms reluctant to invest at the moment? What policy measures could the government adopt to increase investment?
  5. With interest rates so low, why don’t consumers borrow and spend more, thereby aiding the recovery?
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