During the 1970s, commentators often referred to the ‘political business cycle’. As William Nordhaus stated in a 1989 paper. “The theory of the political business cycle, which analyzes the interaction of political and economic systems, arose from the obvious facts of life that voters care about the economy while politicians care about power.”
In the past, politicians would use fiscal, and sometimes monetary, policies to manipulate aggregate demand so that the economy was growing strongly at the time of the next election. This often meant doing unpopular things in the first couple of years of office to allow for popular things, such as tax cuts and increased government transfers, as the next election approached. This tended to align the business cycle with the election cycle. The economy would slow in the early years of a parliament and expand rapidly towards the end.
To some extent, this has been the approach since 2010 of first the Coalition and now the Conservative governments. Cuts to government expenditure were made ‘in order to clear up the mess left by the previous government’. At the time it was hoped that, by the next election, the economy would be growing strongly again.
But in adopting a fiscal mandate, the current government could be doing the reverse of previous governments. George Osborne has set the target of a budget surplus by the final year of this parliament (2019–20) and has staked his reputation on achieving it.
The problem, as we saw in the blog, Hitting – or missing – the government’s self-imposed fiscal targets is that growth in the economy has slowed and this makes it more difficult to achieve the target of a budget surplus by 2019–20. Given that achieving this target is seen to be more important for his reputation for ‘sound management’ of the public finances than that the economy should be rapidly growing, it is likely that the Chancellor will be dampening aggregate demand in the run-up to the next election. Indeed, in the latest Budget, he announced that specific measures would be taken in 2019–20 to meet the target, including a further £3.5 billion of savings from departmental spending in 2019–20. In the meantime, however, taxes would be cut (such as increasing personal allowances and cutting business rates) and government spending in certain areas would be increased. As the OBR states:
Despite a weaker outlook for the economy and tax revenues, the Chancellor has announced a net tax cut and new spending commitments. But he remains on course for a £10 billion surplus in 2019–20, by rescheduling capital investment, promising other cuts in public services spending and shifting a one-off boost to corporation tax receipts into that year.
But many commentators have doubted that this will be enough to bring a surplus. Indeed Paul Johnson, Director of the Institute for Fiscal Studies, stated on BBC Radio 4’s Today Programme said that “there’s only about a 50:50 shot that he’s going to get there. If things change again, if the OBR downgrades its forecasts again, I don’t think he will be able to get away with anything like this. I think he will be forced to put some proper tax increases in or possibly find yet further proper spending cuts”.
If that is the case, he will be further dampening the economy as the next election approaches. In other words, the government may be doing the reverse of what governments did in the past. Instead of boosting the economy to increase growth at election time, the government may feel forced to make further cuts in government expenditure and/or to raise taxes to meet the fiscal target of a budget surplus.
Articles
Budget 2016: George Osborne hits back at deficit critics BBC News (17/3/16)
George Osborne will have to break his own rules to win the next election Business Insider, Ben Moshinsky (17/3/16)
Osborne Accused of Accounting Tricks to Meet Budget Surplus Goal Bloomberg, Svenja O’Donnell and Robert Hutton (16/3/16)
George Osborne warns more cuts may be needed to hit surplus target Financial Times, Jim Pickard (17/3/16)
6 charts that explain why George Osborne is about to make austerity even worse Independent, Hazel Sheffield (16/3/16)
Budget 2016: Osborne ‘has only 50-50 chance’ of hitting surplus target The Guardian, Heather Stewart and Larry Elliott (17/3/16)
How will Chancellor George Osborne reach his surplus? BBC News, Howard Mustoe (16/3/16)
Osborne’s fiscal illusion exposed as a house of credit cards The Guardian, Larry Elliott (17/3/16)
The Budget’s bottom line: taxes will rise and rise again The Telegraph, Allister Heath (17/3/16)
Reports, analysis and documents
Economic and fiscal outlook – March 2016 Office for Budget Responsibility (16/3/16)
Budget 2016: documents HM Treasury (16/3/16)
Budget 2016 Institute for Fiscal Studies (17/3/16)
Questions
- Explain the fiscal mandate of the Conservative government.
- Does sticking to targets for public-sector deficits and debt necessarily involve dampening aggregate demand as an election approaches? Explain.
- For what reasons may the Chancellor not hit his target of a public-sector surplus by 2019–20?
- Compare the advantages and disadvantages of a rules-based fiscal policy and one based on discretion.
It doesn’t seem long ago that we were looking at the prospects of Brazil for hosting the Football World Cup. Now, we turn to the same economy, but this time for the Olympics. It is often the case that hosting big global sporting events can give a boost to the host nation, but is Brazil prepared for it? Did the World Cup bring the expected economic boosts? Some argue that the Olympics is just what Brazil needs, but others suggest it will only worsen the economic situation in the world’s seventh largest economy.
Brazil’s economic performance in the past year was not good. In fact, it was one of the worst performing nations of any major economy, with GDP falling by 3%. This is a very different country from the one that was awarded this biggest of sporting events. Despite these difficult times, Brazil’s government maintains that the country is ready and that the games will be ‘spectacular’.
Key to hosting a sporting event such as the Olympics is the infrastructure investment and as a key component of aggregate demand, this should be a stimulant for growth and job creation. However, with the economy still struggling, many are concerned that the infrastructure won’t be in place in time.
Other benefits from this should be the boost to growth driven by athletes and spectators coming from around the globe, buying tickets, memorabilia, accommodation, food and other items that tourists tend to buy. A multiplier effect should be seen and according to research has the potential to create significant benefits for the whole economy and not just the local regions where events take place. You can look at similar analysis in blogs written about Tokyo: 2020 Tokyo Olympics and London: The London Olympics legacy: a cost–benefit analysis and Does hosting the Olympics Games increase economic growth?
But, is this really likely to happen, especially given the somewhat lacklustre boost that the Brazil World Cup gave to the economy? The following articles consider this.
Rio 2016: Can Games bounce back from Brazil economic woes? BBC News, Bill Wilson (11/03/16)
Does hosting the Olympics actually pay off? It’s the economy, Binyamin Applebaum (5/08/14)
Rio Olympics no help to Brazil economy based on World Cup Bloomberg, Raymond Colitt (16/01/15)
The economic impact of Brazil’s 2014 World Cup and 2016 Olympics Saxo Group, Trading Floor, Sverrir Sverrisson (27/08/12)
Special Interview: Cost–benefit analysis of hosting the World Cup, Olympics Al Arabiya, Ricardo Guerra (3/7/14)
Questions
- How might you carry out a cost–benefit analysis to decide whether to host a big sporting event?
- Are there any externalities that might result from hosting the Olympics? How easy is it to estimate their monetary value? Should this be taken into account by a country when making a decision?
- Why might there be a boost to aggregate demand prior to the Olympics?
- Why might there be a multiplier effect when a nation hosts the Olympics or another sporting event?
- Might there be benefits to Brazil’s neighbours from its hosting the Olympics?
As most developed countries continue to experience relatively low rates of economic growth by historical standards, governments and central banks struggle to find means of stimulating aggregate demand.
One explanation of sluggish growth in demand is that people on higher incomes have enough of most things. They have reached ‘peak stuff’. As the Will Hutton article linked below states:
Around the developed world consumers seem to be losing their appetite for more. Even goods for which there once seemed insatiable demand seem to be losing their lustre. Last week, mighty Apple reported that in the last three months of 2015 global sales of the iPhone stagnated, while sales of iPads tumbled from 21m units in 2014 to 16m in the same three months of 2015. In the more prosaic parts of the economy – from cars to home furnishings – there are other warnings that demand is saturated.
People on lower incomes may still want more, but with income inequality growing in most countries, they don’t have the means of buying more. Indeed, a redistribution from rich to poor may be an effective means of increasing aggregate demand and stimulating economic growth.
It’s important to clarify what is meant by peak demand for such products. It is not being said that people will stop buying them – that future demand will be zero. People will continue to buy such products. In the case of durables, people will buy replacements when products such as furniture, fridges and cars wear out; or upgraded versions as new models of televisions, smartphones or, again, cars come out; or new music tracks or films as they become available for download, or clothing as new fashions appear in shops. In the case of foodstuffs, concerts, football matches and other consumables, they too will continue to be purchased. The point is, in the case of peak demand, the demand per period of time is not going to grow. And the more products there are that reach peak demand, the harder it will be for companies and economies to grow.
If peak demand has generally been reached, it is likely that the demand for material resources will also have peaked. Indeed, we could expect the demand for material resources to be declining as (a) there has also been an increase in the efficiency of production, so that a lower volume of material inputs is required to produce any given level of output and (b) there has been a general switch towards services and away from physical goods. The graph shows domestic material consumption in the UK in millions of metric tonnes. Domestic material consumption is defined as domestic extraction of resources minus exports of resources plus imports of resources. As you can see, domestic material consumption peaked in 2004.
But, although peak demand may have been reached in some markets, there are others where there is still the potential for growth. To understand this and identify where such markets may be, it is important to step back from simple notions of consumption to satisfy materialistic demand and focus on the choices people might make to increase their happiness or wellbeing or sense of self worth in society. Thus while we might have reached peak red meat, peak sugar, peak cars, peak furniture and even peak electronic gadgets, we have not reached peak demand for more satisfying experiences. The demand for education, health, social activities, environmental conservation and a range of fulfilling experiences may have considerable potential for growth.
There are business opportunities here, whether in the leisure industry, in building networks of like-minded people or in producing niche goods that satisfy the demands of people with specific interests. But without greater equality there may be many fewer business opportunities in the mass production industries producing standardised goods.
This is not a world in which goods and services are produced at scale as conventionally measured, but a honeycomb economy of niches and information networks whose new dynamics we barely understand, even if we have a better grasp of its values.
Articles
- If having more no longer satisfies us, perhaps we’ve reached ‘peak stuff’
The Guardian, Will Hutton (31/1/16)
- Steve Howard, Ikea Exec, Says The World Has Hit ‘Peak Stuff’
Huffington Post, Zi-Ann Lum (20/1/16)
- We’ve hit peak home furnishings, says Ikea boss
The Guardian, Sean Farrell (18/1/16)
- Peak stuff: the ‘growth’ party is over. So what next?
The Ecologist, Bennet Francis and Rupert Read (22/1/16)
- Have we reached peak ‘stuff’?
The Mancunion, Tristan Parsons (22/2/16)
- Ikea senses room to grow amid ‘peak stuff’
Financial Times, Aliya Ram and Richard Milne (18/1/16)
- Peak Stuff
ifs insights, Janet Hontoir (21/2/16)
- UK retail sales soar as Brits splash their cash on ‘fun stuff’
The Telegraph, Szu Ping Chan (19/2/16)
- How less stuff could make us happier – and fix stagnation
The Guardian, Katie Allen (26/4/16)
Questions
- What are the implications of countries reaching ‘peak stuff’ for (a) the marginal utility of mass produced goods; (b) the marginal propensity to consume and the multiplier?
- Give some examples of goods or services where peak stuff has not been reached.
- If peak stuff has only been reached for certain products, does this mean that there may still be considerable potential for stimulating aggregate demand without a redistribution of income?
- Would it be in the interests of companies such as Asda to make a unilateral decision to pay their workers more? Explain why or why not.
- Why may we be a long way from reaching peak demand for housing, even without a redistribution of income?
- Make out a case for and against tax cuts as a way of stimulating (a) economic growth and (b) a growth in wellbeing? Do your arguments depend on which taxes are cut? Explain.
- The Ecologist article states that “Attaining one-planet living will probably involve in due course achieving degrowth in countries such as ours: building down our economy to a safe level.” Could such an objective be achieved through a mixed market economy? If so, how? If not, why not?
- Does the Telegraph article suggest that peak stuff has not yet been reached as far as most UK consumers are concerned?
Sustained economic growth in Japan remains elusive. Preliminary Quarterly Estimates of GDP point to the Japanese economy having contracted by 0.4 per cent in the final quarter of 2015. This follows on from growth of 0.3 per cent in the third quarter, a contraction of 0.3 per cent in the second and growth of 1 per cent in the first quarter. Taken as a whole output in 2015 rose by 0.4 per cent compared to zero growth in 2014. The fragility of growth means that over the past 20 years the average annual rate of growth in Japan is a mere 0.8 per cent.
Chart 1 shows the quarter-to-quarter change in real GDP in Japan since the mid 1990s (Click here to download a PowerPoint of the chart). While economies are known to be inherently volatile the Japanese growth story over the past twenty or years so is one both of exceptional volatility and of repeated bouts of recession. Since the mid 1990s Japan has experienced 6 recessions, four since 2008.
Of the four recessions since 2008, the deepest was that from 2008 Q2 to 2009 Q1 which saw the economy shrink by 9.2 per cent. This was followed by a recession from 2010 Q4 to 2011 Q2 when the economy shrunk by 3.1 per cent, then from 2012 Q2 to 2012 Q4 when the economy shrunk by 0.9 per cent and from 2014 Q2 to 2014 Q3 when output fell another 2.7 per cent. As a result of these four recessionary periods the economy’s output in 2015 Q4 was actually 0.4 per cent less than in 2008 Q1.
Chart 2 shows the annual levels of nominal (actual) and real (constant-price) GDP in trillions of Yen (¥) since 1995. (Click here to download a PowerPoint of the chart). Over the period actual GDP has fallen from ¥502 trillion to ¥499 trillion (about £3 trillion at the current exchange rate) while GDP at constant 2005 prices has risen from ¥455 trillion to ¥528 trillion.
Chart 2 reveals an interesting phenomenon: the growth in real GDP at the same time as a fall in nominal GDP. So why has the actual value of GDP fallen slightly between 1995 and 2005? The answer is quite simple: deflation.
Chart 3 shows a protracted period of economy-wide deflation from 1999 to 2013. (Click here to download a PowerPoint of the chart). Over this period the GDP deflator fell each year by an average of 1.0 per cent. 2014 and 2015 saw a pick up in economy-wide inflation. However, the quarterly profile through 2015 shows the pace of inflation falling quite markedly. As we saw in Japan’s interesting monetary stance as deflation fears grow, policymakers are again concerned about the possibility of deflation and the risks that poses for growth.
As Chart 4 helps to demonstrate, a significant factor behind the latest slowdown in Japan’s growth is household spending. (Click here to download a PowerPoint of the chart). In 2015 household spending accounted for about 57 per cent by value of GDP in Japan. In the last quarter of 2015 real household spending fell by 0.9 per cent while across 2015 as a whole real household spending fell by 1.3 per cent. This follows on from a 0.8 per cent decrease in spending by households in 2014.
The recent marked weakening of household spending is a significant concern for the short term growth prospects of the Japanese economy. The roller coaster ride continues, unfortunately it appears that the ride is again downwards.
Data
Quarterly Estimates of GDP Japanese Cabinet Office
Japan and the IMF IMF Country Reports
Economic Outlook Annex Tables OECD
Articles
Japan’s economy contracts in fourth quarter BBC News, (15/2/16)
Japanese economy shrinks again, raising expectations of more stimulus Telegraph, Szu Ping Chan (15/2/16)
Japan’s economy shrinks again as Abenomics is blown off course Guardian, Justin McCurry (15/2/16)
Japan’s economy contracts in latest setback for Abe policies New Zealand Herald, (15/2/16)
Japan’s ‘Abenomics’ on the ropes as yen soars, markets plunge Daily Mail, (15/2/16)
Japan economy shrinks more than expected, highlights lack of policy options CNBC, Leika Kihara and Tetsushi Kajimoto (15/2/16)
Questions
- Why is the distinction between nominal and real important in analysing economic growth?
- How do we define a recession?
- Of what importance is aggregate demand to the volatility of economies?
- Why are Japanese policymakers concerned about the prospects of deflation?
- What policy options are available to policymakers trying to combat deflation?
- Why is the strength of household consumption important in affecting the path of an economy?
- Why has Japan experienced an increase in real GDP but a fall in nominal GDP between 1995 and 2015?
In our recent blog constructing growth without production: The UK growth paradox we saw that the provisional estimate of economic growth in the UK in the final quarter of 2015 was 0.5 per cent. This was buoyed by service sector growth of 0.7 per cent. Meanwhile, construction sector output was estimated to have fallen by 0.1 per cent and production in the production industries by 0.2 per cent. The ONS Index of Production released on 11 February suggests the decline in production activity in the final quarter might have been has much as 0.5 per cent further pointing to unbalanced industrial growth.
The production industries today account for about 15 per cent of UK output which is small in comparison to the roughly 79 per cent from service-sector industries. Chart 1 shows the quarterly rate of growth in UK industrial production since the 1980s. (Click here for a PowerPoint of the chart). Over this period the average quarterly rate of growth in industrial output has been a mere 0.1 per cent compared with 0.5 per cent for total economic output and 0.7 per cent for the service sector. As a result, the importance of the production industries as a driver of economic output has declined.
Across 2015 industrial production rose by 1 per cent while the total output of the economy grew by 2.2 per cent. Industrial output comprises four main components. Of these, output from mining and quarrying grew in 2015 by 6.6 per cent, water, sewerage and waste management by 3.1 per cent, electricity, gas, steam and air conditioning by 0.3 per cent, while manufacturing output contracted by 0.2 per cent.
Chart 2 shows the path of industrial output since 2006. (Click here for a PowerPoint of the chart). In particular, it allows us to analyse the effect of the financial crisis and the global economic downturn. Whereas the total output of the economy surpassed its 2008 Q1 peak in 2013 Q2, driven by the service sector, total industrial output in 2015 Q4 remains 9.9 per cent below its 2008 Q1 level. Among its component parts, output in mining and quarrying is 31 per cent lower, electricity, gas, steam and air conditioning output is 12.2 per cent lower and manufacturing 6.5 per cent lower. Only the output of water, sewerage and waste management is greater – some 7.4 per cent higher.
The data point to the industrial composition of UK remaining heavily skewed towards the service sector and, hence, to service-sector industries driving economic growth. A key talking point is the extent to which this matters. On one hand we might point to the deindustrialisation captured by the data. This has had profound implications for certain regions of the United Kingdom and in particular for living standards in certain communities. Industrial change poses challenges for the UK labour force and for policymakers trying to affect the skills of workers needed in a changing economy. It has had a profound impact on the country’s balance of trade in goods: we consistently run a balance of trade deficit in goods. On the other hand we might argue that the UK does services well. We might be said to have a comparative advantage in this area. Whatever, your view point the latest industrial production data show the fragility of UK industrial output.
Data
Index of Production Dataset December 2015 Office for National StatisticsIndex of Production, December 2015 Office for National Statistics
Articles
UK industrial production shrank in 2015 Guardian, Phillip Inman (10/2/16)
December UK industrial output falls sharply BBC News, (10/2/16)
Manufacturing output fall dents UK growth hope Sky News, (10/2/16)
Industrial production’s worst monthly fall since 2012 Belfast Trelegraph, Holly Williams (11/2/16)
GDP growth picks up to 0.5% but only the services sector comes to the party Independent, Ben Chu (29/1/16)
Questions
- What is meant by industrial production? How does it differ from the economy’s total output?
- Would you expect the index of production to be less or more volatile than total output? Explain your answer.
- What factors might explain the volatility of industrial production?
- Do the different rates of growth across the industrial sectors of the UK matter?
- Discuss the economic issues that might arise as the industrial composition of a country changes.
- Why is the distinction between nominal and real important when analysing economic growth?
During the 1970s, commentators often referred to the ‘political business cycle’. As William Nordhaus stated in a 1989 paper. “The theory of the political business cycle, which analyzes the interaction of political and economic systems, arose from the obvious facts of life that voters care about the economy while politicians care about power.”
