The quarter 2 UK GDP growth figures were published at the end of July. They show that real GDP grew by a mere 0.2% over the quarter, or 0.7% over 12 months. These low growth figures follow 2010Q4 and 2011Q1 growth rates of –0.5 and 0.5 respectively, giving an approximately zero growth over those six months. The recovery that seemed to be gathering pace in early 2010, now seems to have petered out, or at best slowed right down. According to an average of 27 forecasts, collated by the Treasury, GDP is expected to grow by just 1.3% in 2011 – below the potential rate of economic growth and thus resulting in a widening of the output gap.
With such a slow pace of recovery, current forecasts suggest that it will be 2013 before the economy returns to the pre-recession level of output: just over five years after the start of the recession in 2008. This chart from the National Institute of Economic and Social Research compares the current recession with previous ones and shows how the recovery is likely to be the slowest of the five recessions since the 1930s.
The Confederation of British Industry (CBI) in its latest Economic Forecast says that the economic outlook has become more challenging.
The intensification of euro area sovereign debt pressures has added to the downside risks facing the UK economy – although the agreement reached at the recent summit appears to represent an initial step towards resolving the issues.
Meanwhile the global economy is going through a soft patch, partly as a result of the previous surge in commodity prices, which has put pressure on household budgets and raised costs for businesses.
Against this backdrop confidence appears to have wilted somewhat.
The opposition blames the slow pace of recovery on the austerity measures imposed by the government. The depressing of aggregate demand by cutting government expenditure and raising taxes has depressed output growth. The problem has been compounded by a lack of consumer spending as real household incomes have been squeezed by inflation and as consumers fear impending tax rises and cuts in benefits. And export growth, which was hoped to lead the country’s recovery, has been hit by weak demand in Europe and elsewhere.
With weak growth, the danger is that automatic fiscal stabilisers (i.e. more people claiming benefits and lack of growth in tax revenues) will mean that the government deficit is not cut. This may then force the Chancellor into further austerity, which would compound the problem of low demand. The opposition has thus been calling for a (temporary) cut in VAT to stimulate the economy.
The government argues that rebalancing the budget is absolutely crucial to maintaining international confidence and Britain’s AAA rating by the credit rating agencies, Moody’s, Fitch and Standard and Poor’s (S&P). Any sign that the government is slacking in its resolve, could undermine this confidence. According to George Osborne, while other countries (including the USA and many eurozone countries) are facing a lot of instability, “Britain is a safe haven. We have convinced the world that we can deal with our debts, bring our deficit down, and that’s meant that interest rates, for British families, for British businesses, are lower than they would otherwise be; it means that our country’s credit rating has been affirmed … and it means that we have that crucial ingredient of any recovery – economic stability.”
What is more, the government claims that the essence of the UK’s problem of low growth lies on the supply side. The focus of growth policy, it maintains, should be on cutting red tape, improving efficiency and, ultimately, in reducing taxes.
What we are witnessing is a debate that echoes the Keynesian/new classical debates of the 1980s and earlier: a debate between those who blame the current problem on lack of aggregate demand and those who blame it on supply-side weaknesses, including weaknesses of the banking sector.
So what should be done? Is it time for a (modest) fiscal expansion, or at least a reining in of the fiscal tightening? Should the Bank of England embark on another round of quantitative easing (QE2)? Or does the solution lie on the supply side? Or should policy combine elements of both?
Articles
UK economy grows by 0.2% BBC News (26/7/11)
Economic growth stalls – and slump will carry on until 2013 Independent, Sean O’Grady (27/7/11)
GDP figures mean Britain will miss its economic growth targets Guardian, Julia Kollewe (26/7/11)
UK GDP figures show slower growth of 0.2% BBC News (26/7/11)
UK growth forecast looks unrealistic after GDP fall Independent, Sean O’Grady (27/7/11)
UK set for low growth as the mood ‘darkens’ Independent, Sean O’Grady (1/8/11)
No sign of a U-turn – but there may be a minor course change Scotsman, John McLaren (27/7/11)
George Osborne vows to stick with ‘plan A’ despite UK GDP growth slowdown The Telegraph, John McLaren (27/7/11)
Weak growth may force Chancellor into further austerity The Telegraph, Jeremy Warner (26/7/11)
UK households squeezed harder than US or Europe The Telegraph, Philip Aldrick, and Emma Rowley (30/7/11)
UK Government will have to act if growth remains weak, warns CBI The Telegraph, Philip Aldrick (1/8/11)
UK economy GDP figures: what the experts say Guardian, Claire French (26/7/11)
My plan B for the economy Guardian, Ed Balls, Ruth Lea, Jonathan Portes, Digby Jones and Stephanie Blankenburg (27/7/11)
Not much of a squeeze The Economist, Buttonwood’s notebook (26/7/11)
Some safe haven The Economist (30/7/11)
UK growth – anything to be done? BBC News, Stephanie Flanders (26/7/11)
IMF report on UK: main points The Telegraph, Sarah Rainey (2/8/11)
Families to be £1,500 a year worse off, IMF warns The Telegraph, Philip Aldrick (2/8/11)
IMF casts doubt on UK deficit plan, Financial Times, Chris Giles (1/8/11)
Data and reports
GDP Growth (reliminary estimate) ONS
Gross domestic product preliminary estimate: 2nd Quarter 2011 ONS (26/7/11)
World Economic Outlook Update IMF
OECD Economic Outlook No. 89 Annex Tables OECD (see Table 1)
United Kingdom: IMF Country Report No. 11/220 IMF (2/8/11)
Prospects for the UK economy National Institute of Economic and Social Research (3/8/11)
Questions
- What special ‘one-off’ factors help to explain why the underlying growth in 2011Q2 may have been higher than 0.2%?
- Why is the output gap rising? How may supply-side changes affect the size of the output gap?
- Why is the recovery from recession in the UK slower than in most other countries? Why is it slower than the recovery from previous recessions?
- How may automatic fiscal stabilisers affect (a) economic growth and (b) the size of the public-sector deficit if the output gap widens?
- Distinguish between demand-side and supply-side causes of the slow rate of economic growth in the UK.
- Compare the likely effectiveness of demand-side and supply-side policy measures to stimulate economic growth, referring to both magnitude and timing.
With a mounting crisis in the eurozone, heads of government met in an emergency meeting in Brussels on 21 July.
The task was a massive one: how to tackle Greece’s growing debt crisis and stave off default; how to protect other highly indebted countries which have already had to seek emergency bailouts, namely Ireland and Portugal, from falling market confidence and thus rising interest rates, thereby making their debts harder to service; how to prevent speculative pressures extending like a contagion to other highly indebted countries, such as Spain and Italy; how to prevent speculation against the euro and even to prevent its break-up; how to reduce the size of budget deficits at a time of low growth without jeopardising that growth. A problem is that Greece has already adopted the required austerity measures for it to receive a second bailout from the EU agreed at the end of June, and yet its debt burden is likely to rise as growth remains negative.
Eurozone leaders recognised that the stakes were high. Failure could see contagion spread, interest rates soar and perhaps one or more countries leaving the euro. No agreement was not an option. As it turned out, the agreement was more comprehensive than most commentators had expected. Markets reacted positively. Stock markets in Europe and around the world rose and the euro strengthened.
So what was the agreement? Has it solved the Greek and eurozone crises? Will it prevent contagion? Or has it merely put the problem on hold for the time being? Will more fundamental measures have to be put in place, such as much fuller fiscal union, if the eurozone is to function as an effective single currency area? The following is a selection of the hundreds of articles worldwide that have reported on the summit and the agreement.
Articles
Greece thrown lifeline by eurozone leaders BBC News, Chris Morris (22/7/11)
A Marshall plan with ‘haircuts’: The draft agreement Guardian, Chris Morris (21/7/11)
Banks forced to share pain of bailout for Greece Independent, Sean O’Grady and Vanessa Mock (22/7/11)
EU leaders agree €109bn Greek bail-out Financial Times, Peter Spiegel, Quentin Peel, Patrick Jenkins and Richard Milne (21/7/11)
Greece to default as eurozone agrees €159bn bailout The Telegraph, Louise Armitstead and Bruno Waterfield (21/7/11)
Europe steps up to the plate The Telegraph, Ambrose Evans-Pritchard (21/7/11)
Greek bailout boosts global markets Guardian, Julia Kollewe, Ian Traynor and Lisa O’Carroll (22/7/11)
Greek bailout deal: What the experts say Guardian (22/7/11)
Bailed out – again. Eurozone throws Greece €109bn lifeline Guardian, Ian Traynor (22/7/11)
New package for Greece must match last year’s if it is to stave off default Sydney Morning Herald, Malcolm Maiden (22/7/11)
Russian or Belgian roulette? The Economist, Charlemagne’s notebook (21/7/11)
Saving the euro: A bit of breathing space The Economist, Charlemagne’s notebook (22/7/11)
Europe’s ‘safe haven’: corporate bonds Financial Times, Demetrio Salorio (21/7/11)
Summit that saved the euro? Financial Times, John Authers and Vincent Boland (21/7/11)
Greece aid package boosts stock markets BBC News (22/7/11)
Q&A: Greek debt crisis BBC News (22/7/11)
Timeline: The unfolding eurozone crisis BBC News (22/7/11)
Eurozone summit: It may be a solution, but doubts remain Guardian, Larry Elliott (21/7/11)
German taxpayers are being asked to socialise Europe’s debts The Telegraph, Jeremy Warner (22/7/11)
The eurozone is not a nation state Financial Times blogs, Gavyn Davies (20/7/11)
One step back from the abyss BBC News blogs, Stephanie Flanders (22/7/11)
For long-term gain, the EU will have to share the pain Independent, Sean O’Grady (22/7/11)
Greek debt deal ‘not the last word’ BBC Today Progrgamme, Stephanie Flanders and Sir John Gieve (22/7/11)
Questions
- Outline the measures agreed at the eurozone heads of government summit on 21 July.
- Explain what is meant by a ‘haircut’ in the context of debts. What types of haircut were agreed at the summit?
- How big a reduction in Greece’s debt stock will result from the deal? Why may it not be enough?
- Explain how the European Financial Stability Facility (ESFS) works? How will this change as a result of the agreement?
- What vulnerabilities remain in the eurozone?
- What are the arguments for closer fiscal union in the eurozone? Is more required than merely a return to the Stability and Growth Pact?
In 2009, Nudge: Improving Decisions about Health, Wealth, and Happiness was published. This book by Richard Thaler and Cass R. Sunstein examines how people are influenced to make decisions or change behaviour.
According to Thaler and Sunstein, people can be ‘nudged’ to change their behaviour. For example, healthy food can be placed in a prominent position in a supermarket or healthy snacks at the checkout. Often it is the junk foods that are displayed prominently and unhealthy, but tasty, snacks are found by the checkout. If fashion houses ceased to use ultra thin models, it could reduce the incentive for many girls to under-eat. If kids at school are given stars or smiley faces for turning off lights or picking up litter, they might be more inclined to do so.
The UK government has been investigating the use of ‘nudges’ as a way of changing behaviour, and the House of Lords Science and Technology Committee has been considering the question. It has just published its report, Behaviour Change. The summary of the report states that:
The currently influential book Nudge by Richard Thaler and Cass Sunstein advocates a range of non-regulatory interventions that seek to influence behaviour by altering the context or environment in which people choose, and seek to influence behaviour in ways which people often do not notice. This approach differs from more traditional government attempts to change behaviour, which have either used regulatory interventions or relied on overt persuasion.
The current Government have taken a considerable interest in the use of “nudge interventions”. Consequently, one aim of this inquiry was to assess the evidence-base for the effectiveness of “nudges”. However, we also examined evidence for the effectiveness of other types of policy intervention, regulatory and non-regulatory, and asked whether the Government make good use of the full range of available evidence when seeking to change behaviour.
The report finds that nudges
… used in isolation will often not be effective in changing the behaviour of the population. Instead, a whole range of measures – including some regulatory measures – will be needed to change behaviour in a way that will make a real difference to society’s biggest problems.
So is there, nevertheless, a role for nudges in changing behaviour – albeit alongside other measures? Read the report and the articles below to find out!
Articles
Lords report calls for regulation over persuasion to improve public health Wales Online, David Williamson (19/7/11)
Government’s ‘nudge’ approach to health is not enough, according to House of Lords and Work Foundation HR Magazine, David Woods (20/7/11)
How can I tell if I’ve been nudged Independent, Natalie Haynes (20/7/11)
Healthier behaviour plans are nudge in the wrong direction, say peers Guardian, Sarah Boseley (19/7/11)
‘Nudge’ is not enough, it’s true. But we already knew that Guardian, Jonathan Rowson (19/7/11)
Nudge not enough to change lifestyles – peers BBC News, Nick Triggle (19/7/11)
Why a nudge is not enough to change behaviour BBC News, Baroness Julia Neuberger (19/7/11)
House of Lords findings: why green Nudges are not enough The Green Living Blog, Baroness Julia Neuberger (19/7/11)
Lords Science and Technology Sub-Committee publish report on Behaviour Change YouTube, Baroness Julia Neuberger (14/7/11)
Report
Press Release Lords Science and Technology Select Committee (19/7/11)
Behaviour Change Lords Science and Technology Select Committee (online version) (19/7/11)
Behaviour Change Lords Science and Technology Select Committee (PDF version) (19/7/11)
Questions
- When may a nudge (a) be enough, (b) not be enough to change behaviour?
- What instruments does the government have to change behaviour?
- Distinguish between a ‘technical’ and an ‘adaptive’ solution to changing behaviour. Give examples.
- Why might adaptive solutions provide more of a challenge to policymakers than technical solutions.
- Can a nudge ever be transformative?
Economic assessment of real-world issues relies heavily on data. It is the same with economic policy recommendations. Both public- and private-sector organisations gather data, which are then used for analysis, often presented in a report. These reports are then often used as the basis for policy, whether by the government, local authorities or the private sector. Sometimes the data are those collected by national statistical agencies, such as the Office for National Statistics (ONS) in the UK; sometimes they are collected by private agencies; sometimes by individual researchers.
Clearly the analysis and the suitability of any policy recommendations depend on the quality of the data. But how much can we rely on the data? A problem is that people have an interest in gathering and/or selecting data that support their opinions. As a result, the data used for analysis and policy recommendations may be unreliable and incomplete.
This is not to say that the data collected by reputable agencies such as the ONS are wrong. Rather, it is the selective use of them that can be highly misleading. Sometimes, however, the data that some agencies produce may indeed be unreliable, with too small or unrepresentative samples. If they rely on surveys, the survey questions may be poorly framed or lead the respondent into giving a particular answer.
Newspapers make use of data and reports all the time to make a particular case – a case in line with the newspaper’s political stance. The lesson for economic students is that we need to be alert all the time as to just how reliable data are; and to whether the conclusions drawn from them are correct.
The following two articles by Ben Goldacre, from the Guardian’s Bad Science series, look at the misuse of data. The first looks at the case of the Health Service; the second at the possibility of savings by local government in their procurement activities.
Articles
How far should we trust health reporting? Guardian, Ben Goldacre (17/6/11)
Misleading money-saving claims help no one Guardian, Ben Goldacre (24/6/11)
Report
Realising Savings through Procurement Optimisation Opera Solutions
Questions
- According to the first article above, how much newspaper reporting based on the use of data is unreliable?
- What are the reasons for the unreliability of newspaper reporting?
- For what reasons might the ONS and other reputable agencies periodically have to amend time series data?
- “Council incompetence ‘costs every household £452 a year'”. Critically examine this claim by the Daily Mail.
- Why may Opera Solutions be seen as not wholly independent in reporting the possibilities of cost savings by local government?
- In the absence of reliable data, can any economic policy conclusions be drawn from economic models? Explain.
Taxes are a key element in redistributive policies: taxes on the rich can be spent on benefits to the poor. The more progressive the taxes (i.e. the more steeply they rise with rising incomes), the bigger will be the redistributive effect and hence the more equal will post-tax incomes be.
But high and steeply progressive taxes can act as a disincentive to work longer, or to go for promotion or to move to a better paid job. High corporate taxes and income taxes can act as disincentive to inward investment and may encourage a ‘brain drain’ and capital flight with people and capital leaving the country for lower tax regimes abroad.
Raising taxes has two effects. First there is the substitution effect: people may work less and substitute it with leisure – after all, work is now less rewarding. People may also substitute working abroad for working at home. But the second effect works in the opposite direction. This is the income effect. As taxes are raised and people’s take-home pay is thereby reduced, they may feel the need to work longer hours or try harder for promotion in order to make up the lost income and maintain their living standards. Thus the effect of higher taxes is not clear-cut. It is an empirical question of which of the two effects is the stronger.
One important determinant of the effects of different tax rates is their relative position compared with other countries. Another is the international mobility of labour and capital. The greater the mobility, the greater the elasticity of supply with respect to changes in tax rates.
The following report and articles look at relative tax rates between different countries and the effects on output and factor movements
Articles
Wide tax gaps among countries, UHY study finds UHY International, Press Release (10/6/11)
Britain’s most talent workers flee to avoid high tax rates The Telegraph, Myra Butterworth (13/6/11)
UK tax rate ‘one of the highest’ Belfast Telegraph (13/6/11)
Data
Tax Rates Around the World – Comparison UHY Worldwide-tax.com
Effects of taxes and benefits on household income National Statistics
(see especially Data: The effects of taxes and benefits on household income, 2009/10)
Questions
- Why may relative income tax rates between countries give only a partial picture of the international competitiveness of these countries? What else would need to be taken into account?
- Does making taxes more steeply progressive necessarily act as a disincentive to output? Explain.
- What factors are likely to determine the relative size of the income and substitution effects of tax changes?
- How progressive are income taxes in the UK compared with other countries? Give examples.
- What externalities (positive and negative) might result from steeply progressive income tax rates?
- What determines the international elasticity of supply of labour?
- What is the Laffer curve? How will the shape of the Laffer curve be affected by the international mobility of labour and international tax rates?
