‘Austerity’ seems to be the buzzword, as more and more countries across Europe make steps towards reducing substantial budget deficits. The UK has implemented £6.2 billion of cuts, with cuts of £50 billion expected by 2015 to tackle a budget deficit of over 10% of GDP. Portugal’s deficit stands at 8% of GDP and this will be tackled with rises in income, corporate and VAT tax, together with spending cuts aimed at halving the budget deficit by next year. Ireland’s austerity package includes public-sector pay cuts of up to 20%, plus reductions in child benefit, tax rises, and several key services facing cuts in employment, including emergency service and teachers. And, of course, we can’t forget Greece, with a budget deficit 12.2% of GDP, a national debt of 124.9% of GDP, and a forecast to remain in recession this year and the next. The Greek economy faces hard times with a huge austerity drive, including 12% civil service pay cuts, a large privatisation programme, and substantial pension cuts.
Greece is already in receipt of a €110bn rescue package. The Hungarian economy has already received €20bn aid from the EU, IMF and World Bank and spending cuts have been implemented, as markets began to fear that Hungary would become the next Greece. Germany is the most recent country to announce austerity measures, including plans to cut €10 billion annually until 2016.
But, what does this all mean? For years, many countries have spent beyond their means and only with the global recession did this growing problem really rear its ugly head. The only way to eliminate the budget deficit and restore confidence in the economy and ensure future prosperity is to raise taxes and/or to implement spending cuts. As the German Finance Minister said: “The main concern of citizens is that the national deficit could take on immeasurable proportions”. Unfortunately, this has already happened in some counties.
Although austerity measures are undoubtedly needed over the medium term in order to get deficits down, the impact of them is already being felt across the EU. Strikes have already occurred in massive proportions across Greece in response to the austerity package and tens of thousand of workers in Spain and Denmark also took to the streets in protest. There was anger from industry, trade unions and the media in response to €86 billion of cuts ordered in Germany between 2011 and 2014. The UK has already seen a number of strikes and more could be to come with further spending cuts in the pipeline. The Public and Commercial Services Union is threatening to re-launch strikes which began in March involving 200 000 civil servants (the action was suspended for the election.) A spokesman said: “If the cuts are anything like what is being suggested, industrial action by the unions is not only likely, it’s inevitable.”
EU governments have announced public spending cuts of €200 billion, together with a €500 billion safety blanket for the euro. Although these cuts are unlikely to have any positive effects for the everyday person for perhaps many years to come, in order to restore confidence and ensure a future economy that is both prosperous and stable, these austerity measures are deemed by many as essential. As Guy Verhofstadt (the former Belgian Prime Minister) said: “We’re entering a long period of economic stagnation. That will be the main problem for years. Europe is the new Japan.”
But will reduced aggregate demand resulting from the cuts lead to a double-dip recession and a (temporarily) worsening deficit from automatic fiscal stabilisers? We wait with baited breath.
EU austerity drive country-by-country BBC News (7/6/10)
Europe embraces the cult of austerity but at what cost? The Observer, Toby Helm, Ian Traynor and Paul Harris (13/6/10)
Germany joins EU austerity drive with €10bn cuts Guardian, Helena Smith (6/6/10)
G20 to endorse EU crisis strategy Reuters (28/5/10)
The Global recovery? It’s each state for itself Guardian, Jonathan Fenby (9/6/10)
Austerity angers grow in Europe AFP (9/6/10)
Austerity Europe: who faces the cuts? Guardian, Ian Traynor and Katie Allen (12/6/10)
Is this the end of the European welfare state? New Statesman (10/6/10)
Questions
- Are spending cuts or tax rises the best method to reduce a budget deficit? Explain your answer.
- What are the economic costs of the austerity packages across Europe?
- Who is likely to gain from the debt crisis in Europe?
- If austerity packages had not been initiated to the extent that they have, how do you think the rest of the world have reacted?
- Using the BBC News article and the Guardian article ‘Austerity measures: who faces the cuts?’, which country do you think is (a) in the best state and (b) in the worst state?
- How will you be affected by the austerity measures?
The second estimate of UK output for Q1 2010 from the Office for National Statistics reports that the economy grew by 0.3%. The first estimate, based on limited data, put growth in Q1 at 0.2%. But, it appears that more recently available data picked up evidence of stronger growth in the latter stages of the quarter, particularly in the production industries, such as manufacturing, as well as in capital spending by firms.
When analysed in terms of the composition of demand for our firms’ goods and services, there has been something of a rebound in investment expenditure. This follows a marked collapse during 2008 and the first half of 2009. In 2010 Q1 investment volumes increased by 4.2% on the back of a 2.4% rise in the last quarter of 2009.
This rebound in the investment figures across the last two quarters has partly been driven by firms running down their stockpiles of finished goods at a considerably slower rate. When firms build up their stocks of inventories for sales in future periods they are deemed to be engaging in investment. When firms then ‘tap into’ these inventories, as they have been since Q4 2008, they are disinvesting. It is now the case that the pace of disinvestment through running down inventories is slowing. This reflects a pick up in the demand for firms’ goods and services and, hopefully, an expectation of stronger future demand.
More encouragingly, the rebound in investment volumes in Q1 also reflected an increase in gross fixed capital formation, i.e. an increase in the purchase of non-financial fixed assets used in production, such as machinery. Gross fixed capital formation increased in Q1 by 1.5%. This was the first quarter since Q2 2008 in which there has been an increase in the volume of capital purchases by firms. Again, this is likely to reflect increased optimism about future demand since these assets are purchased to do one thing – to produce goods and services!
The improvement in the investment numbers is such that the volume of investment in Q1 2010 was 0.6% higher than it was in Q1 2009. This is largely the impact of a slower rate of disinvestment by firms through running down inventories since despite the rise in gross capital formation in Q1 2010 it still came in 5.7% lower than in Q1 2009. Nonetheless, it will be interesting to see whether the recent improvement in the UK’s investment numbers is maintained as we go forward.
Of particular concern is whether the volume of capital purchases can continue to grow. Can these purchases help to both boost growth now and our economy’s potential output in the medium term? Some of the key issues in determining the answer to this are likely to include: (i) the extent to which aggregate demand grows; (ii) the impact of fiscal consolidation measures on both firms and consumers; (iii) sentiment (confidence) across firms – especially of their own medium-term prospects; and (iv) the ability of firms to access credit from financial institutions. One can undoubtedly add many other issues to this list. One thing is for sure, these are very uncertain times indeed!
Articles
The economy: GDP growth revised up The Times, Grainne Gilmore (26/5/10)
Manufacturing pushes up economic growth The Independent, Sarah Arnott (26/5/10)
UK economic growth revised up to 0.3% BBC News (25/5/10) )
Economy tracker: GDP BBC News (25/5/10)
Boost for UK as GDP growth revised up Telegraph, Edmund Conway (25/5/10)
UK GDP growth revised upwards to 0.3% Financial Times, Daniel Pimlott (25/5/10)
UK first-quarter GDP revised higher Wall Street Journal, Natasha Brereton (25/5/10)
Data
Latest on GDP growth Office for National Statistics (25/5/10)
UK output, income and expenditure, Statistical Bulletin, 1st Quarter 2010 Office for National Statistics (25/5/10)
UK Output, Income and Expenditure, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- Why do the National Accounts record a positive change in inventories as investment and a negative change in inventories as disinvestment?
- What factors might explain the running down of inventories across firms in the UK since Q4 2008? Why didn’t this start in Q2 2008 when the UK economy went into recession?
- In Q1 2010 the running down of inventories was worth, at 2005 prices, some £1.347 billion. This was considerably less than the £4.883 billion in Q3 2009 and the £2.596 billion in Q4 2009 (again at 2005 prices). Why might the pace of disinvestment be slowing?
- Of what importance do you think, firstly, the change in inventories and, secondly, gross capital fixed formation are for an economy’s potential output?
- What arguments do you think there are for distinguishing between different types of investment goods and services when considering our future economic growth?
The OECD published its latest interim assessment of the world economy on April 7. This showed a world gradually bouncing back from recession, with growing GDP (albeit at variable speeds in different countries), rising industrial production, increasing business confidence, a stabilising of financial markets, an easing of credit conditions and yet continuing low inflation.
The UK is forecast to have an annualised rate of growth of GDP in quarter 2 of 3.1%. This is the second highest of the G7 countries, behind only Canada. This would seem like good news – an economic spring for the UK.
Despite continuing growth in the OECD countries, in most of them recovery is fragile. The OECD thus recommends caution in removing the stimulus measures adopted in most countries and hence caution in embarking on measures to cut public-sector deficits. As the report states:
Despite some encouraging signs on activity, the fragility of the recovery, a frail labour market and possible headwinds coming from financial markets underscore the need for caution in the removal of policy support. Central banks have already begun to rein in the exceptional liquidity stimulus injected during the recession. Further action in this area will need to be guided by financial conditions. The normalisation of policy interest rates should be carried out at a pace that will be contingent on the strength of the recovery in individual countries and the outlook for inflation beyond the near-term projection horizon. As for fiscal policy, the sharp increase in government indebtedness in the OECD area during the downturn calls for ambitious, clearly communicated medium-term consolidation programmes in many countries. Consolidation should start in 2011, or earlier where needed, and progress gradually so as not to undermine the incipient recovery.
The following webcast from the OECD presents the report.
Webcast
Interim Assessment OECD, Pier Carlo Padoan, OECD Chief Economist (7/4/10)
Report
Portal to report and webcast OECD
What is the economic outlook for OECD countries? An interim assessment OECD, Pier Carlo Padoan (7/4/10)
Articles
Economy set to speed up and beat UK’s rivals, says OECD Independent, Sean O’Grady (8/4/10)
Economy poised for rapid expansion Financial Times, Norma Cohen and Daniel Pimlot (8/4/10)
OECD sees slower growth in US, Europe, Japan Sydney Morning Herald (8/4/10)
UK business confidence ‘hits four-year high’ BBC News (12/4/10)
British companies confident of recovery but need investment, BDO warns Telegraph, Angela Monaghan (12/4/10)
Questions
- What are the main findings in the report?
- What are the policy implications of the findings?
- What are the implications of developments in financial markets? What are the possible ‘headwinds’?
- What factors could threaten the recovery of the UK economy?
Is there finally cause to celebrate? Government borrowing is lower than expected. Initially, public sector net borrowing for 2009-2010 was forecast in the Pre-budget Report to be £178bn, but official public figures have reduced this to £170 bn. The fall in government revenues has not been as big as predicted and as a result, borrowing this year is likely to be between £5bn and £10bn less than expected. But, let’s not crack open the champagne quite yet, as February’s figures for public sector net borrowing are still about 41% higher in 2010 than in the same month last year.
Whilst the UK is predicted to under-shoot its public-sector net cash requirement made in the Pre-Budget Report for 2009-2010, government borrowing remains at a record high and the level of the deficit is still a worrying 12% of GDP. It is, therefore, hardly surprising that the European Commission wants the UK to bring its deficit down faster than the current government plans – and the Commission is not alone. There is considerable debate at the moment between those who want the government to bring the deficit down quicker to appease the market and those who want the government to start taking strong measures only when the recovery is well established. Their fear, very much in the Keynesian school, is that cutting too soon, by reducing aggregate demand, would push the economy back into recession.
If government spending is to be restrained, can we rely on export-lead growth? The fall in the value of our currency over the past two years should have meant a boost for exports. With a weaker pound, export growth was expected to be strong and allow us to export our way out of recession. See the news blog Expecting too much from exports. However, with figures in January 2010 showing the biggest trade deficit since August 2008 (£3.8bn) and with the volume of exports down by 8%, this may not be the case. Whilst the credit rating of the UK remains at AAA, experts say that the government should be aiming to reduce the deficit more quickly in order to retain this rating. So, although there is some good news (government borrowing will only be £170bn!) and exports are likely to increase as the global economy recovers from recession, significant problems in the UK economy still remain.
Articles
Row over leaked EU deficit report AFP news (17/3/10)
Government borrowing less than forecast BBC News (18/3/10)
Borrowing update cheers Treasury Financial Times, Chris Giles (19/3/10)
UK trade deficit widens to biggest in 17 months BBC News, Stephanie Flanders (9/3/10)
Government borrowing: what the economists say Guardian (18/3/10)
Darling to use higher revenues to cut debt Financial Times, Chris Giles and Jean Eaglesham (19/3/10)
Data
Public sector finances. February 2010 Office for National Statistics
Questions
- Why have government revenues been falling?
- What is the difference between the public-sector net cash requirement and public-sector debt?
- Why is a weak pound good for exports?
- As the global economy recovers, UK exports should begin to rise. Illustrate this idea with a circular flow of income diagram for the UK and the rest of the world.
- What are the arguments (a) for and (b) against reducing the government deficit now?
- Should the Treasury be celebrating these latest figures, or is the UK economy still in a bad way?
We have all heard about the troubles of Greece, but are things really that bad? It does have huge debts, which is costing about 11.6% of GDP to service; and estimates suggest that government borrowing will need to be €53bn this year to cover budget shortfalls. Furthermore, its situation could spell trouble for the eurozone and in particular for certain countries. However, as the article below discusses, Greece still has some trump cards to play.
Advantage Greece BBC News blogs, Stephanomics, Stephanie Flanders (3/3/10)
Questions
- “The single most important factor propping it (Greek debt) up in the past year has been that it can be swapped for free money at the ECB.” How does this prop up Greek debt?
- If Greek debt does fall in value, how will other members of the Eurozone be affected?
- Why are countries such as France and Germany hostile to a loan to Greece from the IMF?
- If Greece was to collapse, which countries do you think could potentially follow? Which factors have influenced your answer?