In The global economy we note the mixed picture contained within the latest British growth numbers. With the first estimate of growth for Q1 of 2013 pointing to an increase in real GDP of 0.3 per cent, the UK economy appears to have missed the ignominy of a triple dip recession. However, the overall economy remains fragile with different sectors of the economy performing quite differently.
A patchy picture is perhaps the fairest assessment. This helps to explain the quite different perceptions amongst economists, business people, journalists and the wider public about the current state of the economy. Here we consider in a little more detail the growth numbers for the UK from the latest preliminary GDP estimates. (Click here for a PowerPoint of the chart).
The British economy is thought to have grown by 0.3 per cent in the first quarter of 2013. This follows a contraction of 0.3 per cent in the final quarter of 2012. Compared with the first quarter of 2012, the output of the British economy was 0.6 per cent higher. However, as Chart 2 helps to show, the British economy has some way to go before it returns to the levels seen prior to the financial crisis. Real GDP peaked in the first quarter of 2008 when GDP at 2009 prices was estimated at £372.7 billion. In the first quarter of 2013, GDP at constant 2009 prices is estimated at £362.9 billion. This means that the economy is still 2.6 per cent smaller than its 2008-peak. Click here for a PowerPoint of the chart.
The patchy nature of British growth is illustrated nicely by the contrasting rates of growth across the different industrial sectors in the first quarter of the year. While service sector output rose by 0.6 per cent, output across the production industries rose by only 0.2 per cent and agricultural output declined by 3.7 per cent. Within the production industries, mining and quarrying output rose by 3.2 per cent, but manufacturing output shrunk by 0.3 per cent and construction output shrunk by 2.5 per cent.
Chart 3 compares the output of agriculture, the production industries and the service sector between the first quarter of 2008 and the first quarter of 2013. (Click here for a PowerPoint of the Chart). It shows the dramatically different experience of the service sector compared with agriculture and the production industries. While output in the service sector is now 0.8 per cent higher, output across agriculture and the production industries is almost 13.5 per cent lower. Within the production industries, output in mining and quarrying is 38 per cent lower, in the construction sector 19 per cent lower and 10 per cent lower in manufacturing. It is perhaps not surprising then that we get such different messages about the state of the economy. The devil really is in the detail.
Data
Preliminary Estimate of GDP – Time Series Dataset Q1 2013 Office for National Statistics
Statistical Bulletin: Gross Domestic Product Preliminary Estimate Q1 2013 Office for National Statistics
Articles
UK avoids triple-dip recession with better-than-expected 0.3% GDP growth Guardian, Heather Stewart (25/4/13)
UK economy shows 0.3% growth Financial Times, Claire Jones (25/4/13)
UK avoids triple-dip recession with 0.3pc GDP growth Telegraph, Szu Ping Chan (25/4/13)
Osborne claims UK economy is ‘healing’ Financial Times, George Parker and Claire Jones (25/4/13)
UK narrowly escapes triple-dip recession as GDP figures show 0.3% growth in first three months of year Independent, Ben Chu (25/4/13)
UK economy avoids triple-dip recession BBC News (25/4/13)
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- How would we identify a recession in either of the first two charts?
- What is a double-dip recession? What is a triple-dip recession?
- The UK economy in Q1 2013 was 2.6 per cent smaller than in Q1 2008. What factors do you think help explain why after 5 years UK real GDP is still lower?
- Why if output in the production and agricultural sectors is 13.5 per cent lower in Q1 2013 compared to Q1 2008 is the economy’s total output only 2.6 per cent lower?
- Economic growth rates fluctuate quite significantly. Can economic theory help to explain why this is the case?
The latest growth data for the UK is somewhat difficult to interpret. It’s positive, but not that positive. The Conservatives say it shows that the economy is moving in the right direction. Labour suggests it is evidence that the Coalition’s policies are not working. With a return to positive growth, the UK has avoided the triple dip recession and here we take a closer look at the economic performance of other key nations.
In the final quarter of 2012, the US economy grew at 0.4%, but in the 3 months to March 2013, economic growth in America picked up to 2.5%. Consumer spending significantly increased, growing at an annualized rate of 3.2%, according to the Commerce Department. This figure helped boost the growth rate of the US economy, as consumer spending accounts for around two thirds of economic activity.
However, the growth figure was lower than expected, in part due to lower government spending. Furthermore, there are suggestions that the positive consumer spending figures are merely a positive blip and spending will fall as the US economy moves through 2013.
If this does prove to be the case in the USA, it will do little to further boost UK economic growth, which was recorded at 0.3% for the first 3 months of 2013. The Chancellor has said that the growth figures are encouraging and are evidence that the government’s policies are working.
Today’s figures are an encouraging sign the economy is healing … Despite a tough economic backdrop, we are making progress. We all know there are no easy answers to problems built up over many years, and I can’t promise the road ahead will always be smooth, but by continuing to confront our problems head on, Britain is recovering and we are building an economy fit for the future.
While the USA and UK have recorded positive growth, expectations of growth throughout Europe remain uncertain. Spain has revised its forecasts downwards for 2013, expecting the economy to shrink by over 1%. Even after 2013, growth is expected to remain very weak, forecast to be 0.5% in 2014 and 0.9% in 2015. To make matters worse, Spain’s unemployment continues to move in the wrong direction, with data for the first 3 months of 2013, recording an unemployment rate of 27.2% – the highest on record.
However, it’s not just Spanish unemployment that is on the rise. Figures for March show that in France, 3.2 million people were out of work, a 1.2 % rise compared to February. In the UK, 2.56 million people were recorded as unemployed, representing just under 8% of the working population. The German economy continues to outperform its European partners, but eurozone growth continues to look weak for the rest of 2013.
Despite much bad news in Europe, growth in other parts of the world remains buoyant. South Korea has recorded economic growth that is at its highest level in 2 years. Economic growth was just under 1%, but construction and investment both increased, perhaps a sign of an economy starting its recovery.
The Chinese economy has seemed relatively unaffected by the economic downturn, yet its economic growth has slowed. Averaging over 10% per annum for the last decade, the growth for January – March 2013 was only 7.7%. This is a decline on the previous 3 months and is lower than expected. If the Chinese economy does begin to slow (relatively speaking), this could present the global economic recovery with an unwelcome obstacle.
Many Western economies are reliant on exports to boost their growth figures and with such high demand in China, this is a key export market for many countries. If the Chinese economy continues to slow, consumer spending may even fall and this could mean a reduction in Chinese imports: that is, a reduction in other countries’ exports to China. However, for China’s competitors, the news is better, as with China’s move from a low to middle-income country, other countries will now see an opportunity to grasp a competitive advantage in the production of cheaper products. David Rees from Capital Economics said:
Trade data show that Chinese imports of commodities, and industrial metals in particular, have been falling in recent months … That is bad news for those emerging markets in Latin America, the Middle East, and Africa that predominately export commodities to China. It is not all bad news … To the extent that China’s structural slowdown reflects its transition from low to middle-income status, opportunities will present themselves for other EMs as China moves up the value chain. We are particularly upbeat on the manufacturing-based economies of South East Asia, along with Mexico, Poland, and Turkey.
News is better in Japan, where growth forecasts have been raised to 2.9% over the same period and the economy is expected to grow by 1.5% throughout both 2013 and 2014. Furthermore, suggestions that inflation may also reach 0.7% have boosted confidence. This might be the end of Japan’s troubles with deflation.
So, we have something of a mixed picture across the world, although the IMF predicts a global rate of growth of 3.5% for 2013, which would be an improvement on 2012 figures. The following articles consider the global situation.
Spain slashes economic growth forecast Sky News (26/4/13)
UK avoids triple-dip recession with better than expected 0.3% GDP growth The Guardian, Heather Stewart (26/4/13)
US economy grows 2.5% on buoyant consumer spending BBC News (26/4/13)
Poor French and Spanish jobs data but UK economy returns to growth – as it happened The Guardian, Graeme Wearden and Nick Fletcher (25/4/13)
UK economy avoids tiple-dip recession with 0.3pc GDP growth The Telegraph, Szu Ping Chan (25/4/13)
South Korea economic growth hits two year high BBC News (25/4/13)
S. Korea economy grows at the fastest pace in two years Bloomberg, Eunkyung Seo (25/4/13)
Spain revises down its economic forecast BBC News (26/4/13)
US economy sees broad growth Financial Times, Robin Harding (25/4/13)
Germany’s private sector shrinks as Eurozone decline continues – as it happened The Guardian, Graeme Wearden and Nick Fletcher (23/4/13)
China economic growth lower than forecast BBC News (15/4/13)
China’s slowing economy: what you need to know Bloomberg Business Week, Dexter Roberts (25/4/13)
Modest Growth Pickup in 2013, Projects IMF International Monetary Fund (23/1/13)
Questions
- How is economic growth measured?
- What is meant by a triple-dip recession?
- What has caused the small increase in growth in the UK? Do you think this signifies the start of the economic recovery?
- In the USA, what has caused the growth rate to reach 2.5% and why is it lower than expected?
- Why are growth rates in countries across the world relevant for UK forecasts of economic growth?
- Which factors have allowed the Chinese economy to achieve average growth rates above 10% for the past decade?
- Using an AD/AS diagram, illustrate the desired impact of the Coalition’s policies to boost economic growth.
- With unemployment rising in countries like Spain and France, how might Eurozone growth be affected in the coming months?
- Japanese growth is looking positive and inflation is expected to reach about 0.7%. Why is it that Japan has suffered from deflation for so many years and why is this a problem?
An excellent learning exercise for students of economics is to take a journal article that uses data to model the economy and then try to replicate the authors’ results. You may well be given an assignment like this in future years of your degree.
One such exercise is used on the University of Massachusetts Amherst’s doctoral programme in economics. Thomas Herndon is a student on that degree and chose to examine a well-known and highly influential paper, Growth in a Time of Debt by Carmen Reinhart then of the University of Maryland and Kenneth Rogoff of Harvard University and former chief economist of the IMF. Professors Reinhart and Rogoff used new data on 44 countries spanning about 200 years.
A key finding of their paper, published in 2010 in the American Economic Review Papers and Proceedings, is that once a country’s government debt exceeds 90% of GDP, growth rates fall considerably: the median across countries by about 1% and the mean considerably more.
The paper has been hugely influential. It has been used to justify the austerity programmes being pursued in many countries, including the UK and the eurozone. Cutting the government deficit to GDP ratio, and ultimately the government debt to GDP ratio, has been seen as a way of achieving higher growth over the longer term, and justifies the adverse effect on short-term growth from the dampening of aggregate demand.
Well, this seemed an interesting paper for Thomas Herndon to examine, and he was keen to show just how Reinhart and Rogoff’s data led to their conclusions. But try as he might, he could not replicate their results. His initial reaction was to think he had made an error, but each time he checked he came back with the same conclusion: they must have made errors in their calculations.
His supervisor at Amherst, Professor Michael Ash, after Thomas had checked and checked again, realised that something was wrong. He encouraged Thomas to write to Reinhart and Rogoff to request sight of their dataset. They duly obliged and it was then that Thomas spotted various errors. These are explained in the articles below, but the overall effect was to alter the conclusion. Although high debt may undermine growth to some extent, the effect is much less than Reinhart and Rogoff concluded, and there are several exceptions to this rule.
On 15 April 2013, Thomas, along with his supervisor, Michael Ash and his colleague, Robert Pollin, published a response to the Reinhart and Rogoff paper. In the abstract to their paper, Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff they state that:
… coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. They find that when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not –0:1 percent as published in Reinhart and Rogoff. That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower.
The authors also show how the relationship between public debt and GDP growth varies significantly by time period and country. Overall, the evidence we review contradicts Reinhart and Rogoff’s claim to have identified an important stylized fact, that public debt loads greater than 90 percent of GDP consistently reduce GDP growth.
So could this be you in the future? Will you take a famous paper and, by re-examining and reworking the data, find that its conclusions are wrong? Could you end up changing the world? Exciting stuff!
Podcasts
Austerity: A Spreadsheet Error? BBC, More or Less, Tim Harford (20/4/13)
Austerity justification study ‘inaccurate’ BBC Today Programme, Robert Pollin (18/4/13)
Articles
UMass Student Exposes Serious Flaws in Harvard Economists’ Influential Study The Atlantic Wire, J.K. Trotter (18/4/13)
Shocking Paper Claims That Microsoft Excel Coding Error Is Behind The Reinhart-Rogoff Study On Debt Business Insider, Mike Konczal (16/4/13)
How a student took on eminent economists on debt issue – and won Economic Times of India (19/4/13)
Meet the 28-Year-Old Grad Student Who Just Shook the Global Austerity Movement New York Magazine, Kevin Roose (19/4/13)
An economist’s mea culpa: I relied on Reinhart and Rogoff Confessions of a Supply-Side Liberal blog, Miles Kimball (22/4/13)
The Rogoff-Reinhart data scandal reminds us economists aren’t gods The Guardian, Heidi Moore (18/4/13)
Reinhart, Rogoff… and Herndon: The student who caught out the profs BBC News Magazine, Ruth Alexander (20/4/13)
George Osborne’s case for austerity has just started to wobble The Guardian, Polly Toynbee (18/4/13)
The error that could subvert George Osborne’s austerity programme The Guardian, Charles Arthur and Phillip Inman (18/4/13)
The Excel depression Sydney Morning Herald, Paul Krugman (19/4/13)
Europe: Retreat from austerity BBC News, Gavin Hewitt (23/4/13)
Guest post by Thomas Herndon
The Grad Student Who Took Down Reinhart And Rogoff Explains Why They’re Fundamentally Wrong Business Insider, Thomas Herndon (22/4/13)
Papers
Growth in a Time of Debt NBER working paper, Carmen M. Reinhart and Kenneth S. Rogoff (January 2010)
Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogo ff PERI Working Paper 322, Thomas Herndon, Michael Ash and Robert Pollin (April 2013)
Questions
- What were the particular errors made by Reinhart and Rogoff?
- How has their paper been used as a basis for the design of macroeconomic policy?
- What are the limitations of using even accurate time-series data as the basis for policy measures?
- How might the work of Herndon change the direction of future macroeconomic policy?
- In his guest post in Business Insider (see link above), Herndon wrote: ‘The implication for policy is that, under particular circumstances, public debt can play a key role in overcoming a recession.’ What might this role be?
- Why might we have to be cautious in drawing policy conclusions from Herndon’s work?
Inflation is measured as the percentage increase in the Consumer Prices Index (CPI) over the previous 12 months. The index is constructed from a basket of goods that is supposed to represent the buying habits of an average UK household. This basket is updated each year as tastes change and as technology moves forward. The basket contains approximately 700 items, with 180,000 individual prices collected each month.
As certain goods become more popular and trends change, the ONS have the responsibility of identifying these changes and updating the basket of goods. The CPI then looks at how the weighted average price of this basket of goods changes from one month to the next. As the CPI gives us the main measure of UK inflation, it is essential that the basket of goods used does represent current consumer demands. If the basket of goods used 20 years ago was still in place, we wouldn’t see thing like mobile phones and ipads being included. This is one sector that has seen significant growth in recent years and the basket of goods has been adapted in response. A new addition to the measure is e-books, which have seen a significant growth in popularity.
However, just as new products have been added to the CPI measure, other goods have been removed. In the most recent update, we’ve seen the removal of champagne and Freeview boxes from the basket of goods. With rapid changes in technological products, such as the ipad, kindle and e-books, products that were new additions only a few years ago are now old news, being replaced by the latest gadgets. Other changes to the basket of goods are less about reflecting consumer trends and more about making certain categories more representative, such as fruits and hot drinks.
So, can the changes in the basket of goods tell us anything about the impact of the recession on buying habits? One notable exclusion from the basket of goods is champagne sold in restaurants and bars. In an economic downturn, you’d expect luxury products to see a decline in consumption and the trend in champagne consumption certainly seems to support the theory. The trends suggest that consumers have instead switched to cheaper alternatives, with things like white rum bought from shops increasing.
Many people may look at the basket of goods and think that it doesn’t reflect what you buy in your average shop. But, the purpose of the CPI is to try to reflect the average consumer and the different items in the basket are given different weightings to give some indication of the amount spent on each good. The articles below look at the changes in the CPI basket of goods and what, if anything, we can take from it.
Inflation basket: E-books added by ONS BBC News (12/3/13)
Inflation basket – what does it say about you? Channel 4 News (12/3/13)
The fizz has fallen flat – champagne cut from inflation basket Independent, Martin Hickman (13/3/13)
E-books added to inflation basket, as champagne dropped The Telegraph, Philip Aldrick (13/3/13)
UK inflation basket: e-books in, champagne out The Guardian, Marking King (13/3/13)
Champagne tipped out of inflation basket Financial Times, Hannah Kuchler (13/3/13)
Champagne out, ebooks in as inflation basket updated Reuters (13/3/13)
Questions
- What is inflation and why is it such an important variable?
- How is the CPI calculated? Is it different from the RPI?
- What impact has technological change had on the basket of goods used to calculate the CPI?
- Can you identify any other economic or business trends from the products that are in and out of the CPI basket of goods?
- Given the importance of technology and the speed of change, do you think the review of the basket of goods should become more or less frequent?
- Has the economic downturn had any effect on the basket of goods used to calculate the CPI?
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
- 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?
- 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?
- 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.
- Why are firms reluctant to invest at the moment? What policy measures could the government adopt to increase investment?
- With interest rates so low, why don’t consumers borrow and spend more, thereby aiding the recovery?
