According to the theory of the political business cycle, governments call elections at the point in the business cycle that gives them the greatest likelihood of winning. This is normally near the peak of the cycle, when the economic news is currently good but likely to get worse in the medium term. With fixed-term governments, this makes it harder for governments as, unless they are lucky, they have to use demand management policies to engineer a boom as an election approaches. It is much easier if they can choose when to call an election.
In the UK, under the Fixed-term Parliaments Act of 2011, the next election must be five years after the previous one. This means that the next election in the UK must be the first Thursday in May 2020. The only exception is if at least two-thirds of all MPs vote for a motion ‘That there shall be an early parliamentary general election’ or ‘That this House has no confidence in Her Majesty’s Government.’
The former motion was put in the House of Commons on 19 April and was carried by 522 votes to 13 – considerably more than two-thirds of the 650 seats in Parliament. The next election will therefore take place on the government’s chosen date of 8 June 2017.
Part of the reason for the government calling an election is to give it a stronger mandate for its Brexit negotiations. Part is to take advantage of its currently strong opinion poll ratings, which, if correct, will mean that it will gain a substantially larger majority. But part could be to take advantage of the current state of the business cycle.
Although the economy is currently growing quite strongly (1.9% in 2016) and although forecasts for economic growth this year are around 2%, buoyed partly by a strongly growing world economy, beyond that things look less good. Indeed, there are a number of headwinds facing the economy.
First there are the Brexit negotiations, which are likely to prove long and difficult and could damage confidence in the economy. There may be adverse effects on both inward and domestic investment and possible increased capital outflows. At the press conference to the Bank of England’s February 2017 Inflation Report, the governor stated that “investment is expected to be around a quarter lower in three years’ time than projected prior to the referendum, with material consequences for productivity, wages and incomes”.
Second, the fall in the sterling exchange rate is putting upward pressure on inflation. The Bank of England forecasts that CPI inflation will peak at around 2.8% in early 2018. With nominal real wages lagging behind prices, real wages are falling and will continue to do so. As well as from putting downward pressure on living standards, it will tend to reduce consumption and the rate of economic growth.
Consumer debt has been rising rapidly in recent months, with credit-card debt reaching an 11-year high in February. This has helped to support growth. However, with falling real incomes, a lack of confidence may encourage people to cut back on new borrowing and hence on spending. What is more, concerns about the unsustainability of some consumer debt has encouraged the FCA (the financial sector regulator) to review the whole consumer credit industry. In addition, many banks are tightening up on their criteria for granting credit.
Retail spending, although rising in February itself, fell in the three months to February – the largest fall for nearly seven years. Such falls are likely to continue.
So if the current boom in the economy will soon end, then, according to political business cycle theory, the government is right to have called a snap election.
Gloomy economic outlook is why Theresa May was forced to call a snap election The Conversation, Richard Murphy (18/4/17)
What does Theresa May’s general election U-turn mean for the economy? Independent, Ben Chu (18/4/17)
It’s not the economy, stupid – is it? BBC News Scotland, Douglas Fraser (18/4/17)
Biggest fall in UK retail sales in seven years BBC News (21/4/17)
Sharp drop in UK retail sales blamed on higher prices Financial Times, Gavin Jackson (21/4/17)
Shoppers cut back as inflation kicks in – and top Bank of England official says it will get worse The Telegraph, Tim Wallace Szu Ping Chan (21/4/17)
Retail sales volumes fall at fastest quarterly rate in seven years Independent, Ben Chu (21/4/17)
Retail sales in Great Britain: Mar 2017 ONS (21/4/17)
- For what reasons might economic growth in the UK slow over the next two to three years?
- For what reasons might economic growth increase over the next two to three years?
- Why is forecasting UK economic growth particularly difficult at the present time?
- What does political business cycle theory predict about the behaviour of governments (a) with fixed terms between elections; (b) if they can choose when to call an election?
- How well timed is the government’s decision to call an election?
- If retail sales are falling, what other element(s) of aggregate demand may support economic growth in the coming months?
- How does UK productivity compare with that in other developed countries? Explain why.
- What possible trading arrangements with the EU could the UK have in a post-Brexit deal? Discuss their likelihood and their impact on economic growth?
Productivity has been a bit of a problem for the UK economy for a number of years. Earlier posts from 2015 have discussed the trend in Tackling the UK’s poor productivity and The UK’s poor productivity record. Although the so-called ‘productivity gap’ has been targeted by the government, with George Osborne promising to take steps to encourage more long-term investment in infrastructure and create better incentives for businesses to improve productivity, the latest data suggest that the problem remains.
The ONS has found that the UK continues to lag behind the other members of the G7, but perhaps more concerning is that the gap has grown to its biggest since 1991. The data showed that output per hour worked was 20 percentage points lower in the UK than the average for the other G7 countries. The economic downturn did cause falls in productivity, but the UK has not recovered as much as other advanced nations. One of the reasons, according to the Howard Archer, chief UK economist at IHS Global Insight is that it ‘had been held back since the financial crisis by the creation of lots of low-skilled, low-paid jobs’. These are the jobs where productivity is lowest and this may be causing the productivity gap to expand. Other cited reasons include the lack of investment which Osborne is attempting to address, fewer innovations and problems of finance.
Despite these rather dis-heartening data, there are some signs that things have begun to turn around. In the first quarter of 2015, output per hour worked did increase at the fastest annual growth rate in 3 years and Howard Archer confirmed that this did show ‘clear sign that UK productivity is now seeing much-needed improvement.’ There are other signs that we should be optimistic, delivered by the Bank of England. Sir John Cunliffe, Deputy Governor for financial stability said:
“firms have a greater incentive to find efficiency gains and to switch away from more labour-intensive forms of production. This should boost productivity.”
The reason given for this optimism is the increase in the real cost of labour relative to the cost of investment. So, a bit of a mixed picture here. UK productivity remains a cause for concern and given its importance in improving living standards, the Conservative government will be keen to demonstrate that its policies are closing the productivity gap. The latest data is more promising, but that still leaves a long way to go. The following articles consider this data and news.
UK productivity shortfall at record high Financial Times, Emily Cadman (18/9/15)
UK productivity lags behind rest of 7 BBC News (17/9/15)
UK’s poor productivity figures show challenge for the government The Guardian, Katie Allen (18/9/15)
UK productivity lags G7 peers in 2014-ONS Reuters (18/9/15)
UK productivity second lowest in G7 Fresh Business Thinking, Jonathan Davies (18/9/15)
UK is 33% less productive than Germany Economia (18/9/15)
UK productivity is in the G7 ‘slow lane’ Sky News (18/9/15)
AMECO Database European Commission, Economic and Financial Affairs
Labour Productivity, Q1 2015 ONS (1/7/15)
International Comparisons of Productivity, 2014 – First Estimates ONS (18/9/15)
- How could we measure productivity?
- Why should we be optimistic about productivity if the real cost of labour is rising?
- If jobs are being created at slower rate and the economy is still expanding, why does this suggest that productivity is rising? What does it suggest about pay?
- Why is a rise in productivity needed to improve living standards?
‘Employment has been strong, but productivity and real wages have been flat.’ This is one of the key observations in a new OECD report on the state of the UK economy. If real incomes for the majority of people are to be raised, then labour productivity must rise.
For many years, the UK has had a lower productivity (in terms of output per hour worked) than most other developed countries, with the exception of Japan. But from 1980 to the mid 2000s, the gap was gradually narrowing. Since then, however, the gap has been widening again. This is illustrated in Chart 1, which shows countries’ productivity relative to the UK’s (with the UK set at 100). (Click here for a PowerPoint.)
Compared with the UK, GDP per hour worked in 2013 (the latest data available) was 28% higher in France, 29% higher in Germany and 30% higher in the USA. What is more, GDP per hour worked and GDP per capita in the UK fell by 3.8% and 6.1% respectively after the financial crisis of 2007/8 (see the green and grey lines in Chart 2). And while both indicators began rising after 2009, they were still both below their 2007 levels in 2013. Average real wages also fell after 2007 but, unlike the other two indicators, kept on falling and by 2013 were 4% below their 2007 levels, as the red line in Chart 2 shows. (Click here for a PowerPoint.)
Although productivity and even real wages are rising again, the rate of increase is slow. If productivity is to rise, there must be investment. This could be in physical capital, human capital or, preferably, both. But for many years the UK has had a lower rate of investment than other countries, as Chart 3 shows. (Click here for a PowerPoint.) This chart measures investment in fixed capital as a percentage of GDP.
So how can investment be encouraged? Faster growth will encourage greater investment through the accelerator effect, but such an effect could well be short-lived as firms seek to re-equip but may be cautious about committing to increasing capacity. What is crucial here is maintaining high degrees of business confidence over an extended period of time.
More fundamentally, there are structural problems that need tackling. One is the poor state of infrastructure. This is a problem not just in the UK, but in many developed countries, which cut back on public and private investment in transport, communications and energy infrastructure in an attempt to reduce government deficits after the financial crisis. Another is the low level of skills of many workers. Greater investment in training and apprenticeships would help here.
Then there is the question of access to finance. Although interest rates are very low, banks are cautious about granting long-term loans to business. Since the financial crisis banks have become much more risk averse and long-term loans, by their nature, are relatively risky. Government initiatives to provide finance to private companies may help here. For example the government has just announced a Help to Grow scheme which will provide support for 500 small firms each year through the new British Business Bank, which will provide investment loans and also grants on a match funding basis for new investment.
OECD: UK must fix productivity Economia, Oliver Griffin (25/2/15)
The UK’s productivity puzzle BBC News, Lina Yueh (24/2/15)
OECD warns UK must fix productivity problem to raise living standards The Guardian, Katie Allen (24/2/15)
Britain must boost productivity to complete post-crisis recovery, says OECD International Business Times, Ian Silvera (24/2/15)
OECD urges UK to loosen immigration controls on skilled workers Financial Times, Emily Cadman and Helen Warrell (24/2/15)
OECD Economic Surveys, United Kingdom: Overview OECD (February 2015)
OECD Economic Surveys, United Kingdom: Full report OECD (February 2015)
- In what ways can productivity be measured? What are the relative merits of using the different measures?
- Why has the UK’s productivity lagged behind other industrialised countries?
- What is the relationship between income inequality and labour productivity?
- Why has UK investment been lower than in other industrialised countries?
- What are zombie firms? How does the problem of zombie firms in the UK compare with that in other countries? Explain the differences.
- What policies can be pursued to increased labour productivity?
- What difficulties are there in introducing effective policies to tackle low productivity?
- Should immigration controls be lifted to tackle the problem of a shortage of skilled workers?
GDP figures are often a poor measure of a country’s economic well-being. By focusing on production, they may not capture the contribution of a range of social and environmental factors to people’s living standards, including the various negative and positive externalities from production and consumption themselves. A case in point is internet innovation: an issue considered in the first linked article below by the eminent economist, Joseph Stiglitz.
The effects of innovations that directly lead to an increase in output are relatively easy to measure. Many innovations, however, may allow those with power to consolidate that power, resulting in less competition and a possible decline in welfare. If, for example, companies such as Amazon, invest in online retailing and gain a first-mover advantage, they may be able to use this power to drive out competitors. In other words, innovations may not simply lower the cost of production and hence prices: they may even lead to an increase in prices.
Then there are innovations, such as faster broadband, that result in higher quality. While higher quality in one sphere may lead to higher output elsewhere, in many cases it is just improving the experience of consumers without being reflected in a way that can be easily measured.
Some innovations may be judged as socially harmful. Thus improved gaming functionality and realism may encourage people to spend more time online. The social and health implications of this may be considered as undesirable and resulting in a reduction in well-being. Of course, many gamers would disagree!
The point is that technological innovations often result in a change in tastes. These changes in tastes may involve negative externalities, themselves very hard to quantify. Consequently, resulting changes to GDP may be a very poor indicator of changes in social well-being.
The articles below consider some of these issues. The Stiglitz article gives an example of innovation in financial services. Although highly profitable for many working in the sector – at least until the crash of 2008/9 – according to the author, these innovations led to both lower GDP growth and a net contribution to social welfare that was negative.
The benefits of internet innovation are hard to spot in GDP statistics The Guardian, Joseph Stiglitz (10/3/14)
Economist argues for happiness over GDP Yale Daily News, Joyce Guo (19/2/14)
‘GDP: A Brief But Affectionate History’ by Diane Coyle and ‘The Leading Indicators: A Short History of the Numbers That Rule Our World’ by Zachary Karabell Washington Post, Tyler Cowen (21/2/14)
Emerging Markets: Income Returns To Innovation (GDP Per Capita Vs. Innovation Index) Seeking Alphz, Jon Harrison (4/3/14)
- What does GDP measure?
- What factors affecting the welfare of society are not measured in GDP?
- What alternative indicators are there to GDP as a measure of living standards?
- How would you set about measuring the effects on living standards of a technological revolution, such as the ability to access 4G on the move on laptops and smartphones (e.g. on trains)?
- How should the net benefits of installing more ATMs (cash machines) be calculated?
- Revisit the blog Time to leave GDP behind? and answer question 8.
- Referring to the Jon Harrison article, how would you construct an innovation index? How is innovation related too GDP per capita?
Politicians often make use of economic statistics to promote their point of view. A good example is a claim made by the UK Prime Minister on 23 January 2014. According to the latest statistics, he said, most British workers have seen their take-home pay rise in real terms. The Labour party countered this by arguing that incomes are not keeping up with prices.
So who is right? Studying economics and being familiar with analysing economic data should help you answer this question. Not surprisingly, the answer depends on just how you define the issue and what datasets you use.
The Prime Minister was referring to National Statistics’ Annual Survey of Hours and Earnings (ASHE). This shows that in April 2013 median gross weekly earnings for full-time employees were £517.5, up 2.25% from £506.10 in 2012, and mean gross weekly earnings for full-time employees were £620.30, up 2.06% from £607.80 in 2012 (see Table 1.1a in the dataset). CPI inflation over this period was 2.4%, representing a real fall in median gross weekly earnings of 0.15% and mean gross weekly earnings of 0.34%.
But when adjustments are made for increases in personal income tax allowances, then, according to the government, except for the richest 10% of the working population, people had an average increase in real take-home pay of 1.1%.
But does this paint the complete picture? Critics of the government’s claim that people are ‘better off’, make the following points.
First, the ASHE dataset is for the year ending April 2013. The ONS publishes other datasets that show that real wages have fallen faster since then. The Earnings and Working Hours datasets, published monthly, currently go up to November 2013. The chart shows real wages from January 2005 to November 2013 (with CPI = 100 in December 2013). You can see that the downward trend resumed after mid 2013. In the year to November 2013, nominal average weekly earnings rose by 0.9%, while CPI inflation was 2.1%. Thus real weekly earnings fell by 1.2% over the period (click here for a PowerPoint of the chart).
Second, there is the question of whether CPI or RPI inflation should be used in calculating real wages. RPI inflation was 2.9% (compared to CPI inflation of 2.4%) in the year to April 2013. The chart shows weekly earnings adjusted for both CPI and RPI.
Third, if, instead of looking at gross real wages, the effect of income tax and national insurance changes are taken into account, then benefit changes ought also to be taken into account. Some benefits, such as tax credits and child benefit were cut in the year to April 2013.
Fourth, looking at just one year (and not even the latest 12 months) gives a very partial picture. It is better to look at a longer period and see what the trends are. The chart shows the period from 2005. Real wages (CPI adjusted) are 8.0% lower than at the peak (at the beginning of 2009) and 5.0% lower than at the time of the election in 2010. The differences are even greater if RPI-adjusted wages are used.
But even if the claim that real incomes are rising is open to a number of objections, it may be that as the recovery begins to gather pace, real incomes will indeed begin to rise. But to assess whether this is so will require a careful analysis of the statistics when they become available.
UK pay rising in real terms, says coalition BBC News (24/1/14)
Are we really any better off than we were? BBC News, Brian Milligan (24/1/14)
Government take-home pay figures ‘perfectly sensible’ BBC Today Programme, Paul Johnson (24/1/14)
Take-Home Pay ‘Rising Faster Than Prices’ Sky News, Darren McCaffrey (25/1/14)
David Cameron hails the start of ‘recovery for all’ The Telegraph, Peter Dominiczak (23/1/14)
Is take-home pay improving? The answer is anything but simple The Guardian, Phillip Inman and Katie Allen (24/1/14)
Cameron’s ‘good news’ about rising incomes is misleading says Labour The Guardian, Rowena Mason (24/1/14)
The Tories’ claim that living standards have risen is nonsense on stilts New Statesman, George Eaton (24/1/14)
FactCheck: Conservative claims on rising living standards Channel 4 News, Patrick Worrall (25/1/14)
Living standards squeeze continues in UK, says IFS BBC News (31/1/14)
Richest have seen biggest cash income squeeze but poorest have faced higher inflation IFS Press Release (31/1/14)
Average Weekly Earnings dataset ONS (22/1/14)
Annual Survey of Hours and Earnings, 2013 Provisional Results ONS (12/12/13)
Consumer Price Inflation, December 2013 ONS (14/1/14)
Inequality and Poverty Spreadsheet Institute for Fiscal Studies
An Examination of Falling Real Wages, 2010 to 2013 ONS (31/1/14)
- Why are mean weekly earnings higher than median weekly earnings?
- Explain the difference between RPI and CPI. Which is the more appropriate index for determining changes in real incomes?
- Find out what benefit changes have taken place over the past two years and how they have affected household incomes.
- How have gross weekly earnings changed for the different income groups? (The ASHE gives figures for decile groups.)
- Which is better for assessing changes in incomes: weekly earnings or hourly earnings?
- How would you define a change in living standards? What data would you need to be able to assess whether living standards have increased or decreased?