There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’!
One of the main underlying problems of the 2008 financial crisis was that household debt had been increasing to unsustainable levels, egged on by banks only too willing to lend, whether as personal loans, on credit cards or through mortgages. When the recession hit, many people sought to reduce their debts by cutting back on spending. This further fuelled the recession.
What the government and most economists hoped was that there would be some rebalancing of the economy, with less reliance on consumer spending to drive economic growth. Instead it was hoped that growth would be driven by a rise in investment and exports. Indeed, the 25% depreciation of sterling exchange between 2007 and 2009 was seen as a major advantage as this would boost the demand for exports and encourage firms to invest in the export sector.
But things haven’t turned out the way people hoped. The recession (or lack of growth) has been much deeper and more prolonged than previous downturns in the economy. Today, real GDP per head is more than 7% below the level in 2007 and many people have seen much bigger declines in their living standards.
But also, despite the austerity policies, the economy has not been ‘rebalanced’ towards exports and investment. Exports are 3% lower than in 2006 (although they did grow between 2009 Q2 and 2011 Q1, but have since stagnated). And investment is 27% lower than in 2006. Household consumption, however, has grown by about 2% and general government consumption by around 9% since 2006. The chart shows the figures, based on 2006 Q1 = 100.
(Click here for a PowerPoint of the chart.)
And recent evidence is that consumption is beginning to grow faster – not because of rising household incomes, but because of falling saving rates. In 2008, the household saving ratio had fallen to nearly 0% (i.e. households were on average saving about the same as they were borrowing). Then the saving ratio rose dramatically as people reined in their spending. Between 2009 and 2012, the ratio hovered around 7%. But in the first quarter of 2013, it had fallen to 4.2%
So the good news is that aggregate demand is rising, boosting economic growth. But the bad news is that, at least for the time being, this growth is being driven by a rise in household borrowing and a fall in household saving. The videos and articles consider whether this is, however, still good news on balance.
Webcasts
Britain’s imbalanced economy The Economist, Zanny Minton Beddoes and Richard Davies (4/7/13)
Britain’s Export Drought: an enduring disappointment The Economist, Andrew Palmer and Richard Davies (9/2/13)
‘Green shoots’ of economic recovery in Rugby BBC News, Paul Mason (12/6/13)
Articles
Is the UK economy seeing the ‘wrong kind’ of green shoots? BBC News, Stephanie Flanders (3/7/13)
The export drought: Better out than in The Economist (9/2/13)
Exports and the economy: Made in Britain The Economist (21/1/12)
The economy: On a wing and a credit card The Economist (6/7/13)
Unbalanced and unsustainable – this is the wrong kind of growth The Telegraph, Jeremy Warner (8/7/13)
The UK economy’s looking up – but no one’s told manufacturers The Guardian, Heather Stewart (10/7/13)
Data
Quarterly National Accounts, Q1 2013 (27/6/13)
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury (June 2013)
ISM Manufacturing Report on Business® PMI History Institute for Supply Management
Questions
- What are forecasters expecting to happen to economic growth in the coming months? Why?
- What factors determine investment? Why has it fallen so substantially in the UK?
- Explain what is meant by the ‘accelerator’. Is the rise in consumption likely to lead to an accelerator effect and, if so, what will determine the size of this effect?
- Why have exports not grown more rapidly despite the depreciation of sterling after 2007?
- What will determine the rate of potential economic growth in the UK economy? How will a rise in real GDP driven by a rise in consumption impact on potential GDP and potential economic growth?
- What supply-side policies would you recommend, and why, in order to increase potential economic growth?
The Clean Energy Bill has been on the agenda for some time and not just in the UK. With climate change an ever growing global concern, investment in other cleaner energy sources has been essential. However, when it comes to investment in wind farms, developers have faced significant opposition. The balancing act for the government appears to be generating sufficient investment in wind farms, while minimising the negative externalities.
The phrase often thrown around with regards to wind farms, seems to be ‘not in my backyard’. That is, people recognise the need for them, but don’t want them to be built in the local areas. The reason is to do with the negative externalities. Not only are the wind farms several metres high and wide, creating a blight on the landscape, but they also create a noise, both of which impose a third party effect on the local communities. These factors, amongst others, have led to numerous protests whenever a new wind farm is suggested. The problem has been that with such challenging targets for energy, wind farms are essential and thus government regulation has been able to over-ride the protests of local communities.
However, planning guidance in the UK will now be changed to give local opposition the ability to override national energy targets. In some sense, more weight is being given to the negative externalities associated with a new wind farm. This doesn’t mean that the government is unwilling to let investment in wind farms stop. Instead, incentives are being used to try to encourage local communities to accept new wind farms. While acknowledging the existence of negative externalities, the government is perhaps trying to put a value on them. The benefits offered to local communities by developers will increase by a factor of five, thus aiming to compensate those affected accordingly. Unsurprisingly, there have been mixed opinions, summed up by Maria McCaffery, the Chief Executive of trade association RenewableUK:
Maria McCaffery, chief executive of trade association RenewableUK, said the proposals would signal the end of many planned developments and that was “disappointing”.
Developing wind farms requires a significant amount of investment to be made upfront. Adding to this cost, by following the government’s advice that we should pay substantially more into community funds for future projects, will unfortunately make some planned wind energy developments uneconomic in England.
That said, we recognise the need to ensure good practice across the industry and will continue to work with government and local authorities to benefit communities right across the country which are hosting our clean energy future.
The improved benefits package by the energy industry is expected to be in place towards the end of the year. The idea is that with greater use of wind farms, energy bills can be subsidised, thereby reducing the cost of living. Investment in wind farms (on-shore and off-shore) is essential. Current energy sources are non-renewable and as such new energy sources must be developed. However, many are focused on the short term cost and not the long term benefit that such investment will bring. The public appears to be in favour of investment in new energy sources, especially with the prospect of subsidised energy bills – but this positive outlook soon turns into protest when the developers pick ‘your back yard’ as the next site. The following articles consider this issue.
Residents to get more say over wind farms The Guardian, Fiona Harvey and Peter Walker (6/6/13)
Local communities offered more say over wind farms BBC News (6/6/13)
Locals to get veto power over wind farms The Telegraph, Robert Winnett (6/6/13)
Wind farms are a ‘complete scam’, claims the Environment Secretary who says turbines are causing ‘huge unhappiness’ Mail Online, Matt Chorley (7/6/13)
New planning guidance will make it harder to build wind farms Financial Times, Jim Pickard, Pilita Clark and Elizabeth Rigby (6/6/13)
Will more power to nimbys be the death of wind farms? Channel 4 News (6/6/13)
Locals given more ground to block wind farms Independent, Tom Bawden (6/6/13)
Questions
- What are the negative externalities associated with wind farms?
- Conduct a cost-benefit analysis as to whether a wind farm should be constructed in your local area. Which factors have you given greatest weight to?
- In question 2 above, were you concerned about the Pareto criterion or the Hicks-Kaldor criterion?
- If local communities can be compensated sufficiently, should wind farms go ahead?
- If the added cost to the development of wind farms means that some will no longer go ahead, is this efficient?
- Why is there a need to invest in new energy sources?
- To what extent is climate change a global problem requiring international (and not national) solution?
At a cost of €1 trillion to EU states, tax evasion is undoubtedly an area in need of attention. With government finances in deficit across the world, part of the gap could be plugged by preventing tax revenues from going unpaid. Well-known companies and individuals have been accused of tax evasion (and avoidance), but part of the problem is the existence of countries that make such activities possible.
Tax havens not only offer favourable tax rates, but also have in place regulations that prevent the effective exchange of information. That is, they are able to keep the identity and income information of depositors a private affair and are not required to share that information with other governments. This means that other tax authorities are unable to demand the tax revenue from income earned, when it is held in some of these countries. This can deprive the government’s coffers of substantial amounts of money.
In 2000, the OECD produced a report naming so-called ‘uncooperative tax havens’, including Monaco, Andorra, Liechtenstein and Liberia. Since then, all nations on this list have pledged their cooperation and been removed and in a recent step, Andorra has announced a proposal to implement its first ever income tax. This move is partly in response to pressures from EU governments to tackle tax evasion. Furthermore, talks between the finance ministers of tax havens, such as Switzerland and Liechtenstein have been agreed with the aim of improving the flow of bank account information and thus combating tax evasion. The Council of the European Union said:
The decision represents an important step in the EU’s efforts to clamp down on tax evasion and tax fraud”
Countries, such as Switzerland (a non-EU member) are likely to find requests for information difficult to ignore, if they want to have access to EU financial markets. However, any concessions on information provision will come at a significant cost for a country that has long regarded its banking secrecy as an ‘honourable policy.
Reforming policy on tax havens is essential, not only to help tackle tax evasion and thus government deficits, but also to generate investment into countries that don’t offer such favourable tax rates. Investors naturally want to invest in those countries with low tax rates and as such, could it be that countries like the UK suffer from a loss of investment and that the only way to encourage it is to offer similarly low tax rates? International agreement is certainly needed to tackle the worldwide issue of tax evasion and at the moment, it seems as though pressure is building on secretive countries. The following articles consider this controversial issue.
Clock ticks on Swiss banking secrecy BBC News, Imogen Foulkes (21/5/13)
Andorra bows to EU pressure to introduce income tax The Telegraph, Fiona Govan (2/6/13)
Andorra to introduce income tax for first time BBC News (2/6/13)
Andorra to introduce income tax for the first time Economy Watch (3/6/13)
Swiss have no choice but to bow to US ultimatum – Ackermann Reuters, Katharina Bart> (3/6/13)
Austria out front as EU zeroes in on tax evasion The Budapest Times (29/5/13)
EU to start talks with non-EU countries on tax evasion BBC News (14/5/13)
Questions
- What is tax evasion?
- Using game theory, explain why an international agreement on tax evasion might be needed?
- When an income tax is imposed in Andorra, what will be the impact on government revenues?
- How might the labour supply incentive change once an income tax is imposed?
- How do tax havens affect investment in other countries?
- Is there an argument that countries such as the UK should cut its tax rates to encourage investment?
The new Japanese government under Shinzo Abe, which took office on 26 December 2012, has been pursuing a policy of weakening the yen. Using a combination of low interest rates, quantitative easing, expansionary fiscal policy and a declared aim of depreciation, the government has succeeded in driving down the value of the yen.
Since mid-November last year, the yen has depreciated by 28% against the dollar, 30% against the euro and 21% against sterling. The effective exchange rate index has fallen by 22% (see first diagram below: click here for a PowerPoint of the diagram).
But will this depreciation succeed in stimulating the Japanese economy and will it improve the balance of trade? The hope is that the falling yen will boost export sales by making them cheaper abroad, and will reduce the demand for imports by making them more expensive in Japan. The balance of trade will thereby improve and higher exports (an injection) and lower imports (a withdrawal) will stimulate aggregate demand and economic growth.
Traditionally Japan has run balance of trade surpluses, but since July 2012, it has been running monthly deficits – the longest run of deficits since 1980. But depreciation cannot be expected to turn this position around immediately. Indeed, theory suggests that the balance of trade is likely to deteriorate before it improves. This is known as the J-curve effect and is illustrated in the second diagram below. As page 768 of Economics, 8th edition states:
At first a devaluation or depreciation might make a current account deficit worse: the J-curve effect. The price elasticities of demand for imports and exports may be low in the short run (see Case Study 25.1 in MyEconLab). Directly after devaluation or depreciation, few extra exports may be sold, and more will have to be paid for imports that do not have immediate substitutes. There is thus an initial deterioration in the balance of trade before it eventually improves. In Figure 25.12 [the second diagram], devaluation takes place at time t1. As you can see, the diagram has a J shape.
Evidence suggests that the first part of the ‘J’ has been experienced in Japan: Japan’s balance of trade has deteriorated. But there is debate over whether the balance of trade will now start to improve. As the article by James Saft states:
But a look at the actual data shows Japanese companies, like British ones during a similar bout of currency weakness in 2008, appear to be more eager to use a newly competitive currency to pad profits through higher margins rather than higher export volumes. Thus far, Japanese exporters appear to be doing just that. Despite yen falls the price of Japanese exports in local currency has barely budged.
“Japanese companies have not actually cut the foreign currency prices of their exports. Just as with the UK exporters, the Japanese have chosen to hold foreign prices constant, maintain market share, and increase the yen value and thus the yen profit associated with yen depreciation,” UBS economist Paul Donovan writes in a note to clients.
The extra profits earned by Japanese companies from export sales may be stockpiled or paid out in dividends rather than reinvested. And what investment does take place may be abroad rather than in Japan. The net effect may be very little stimulus to the Japanese economy.
As stated by Saft above, the UK had a similar experience in the period 2007–9, when sterling depreciated some 27% (see the second diagram). The balance of trade improved very little and UK companies generally priced goods to markets abroad rather than cutting overseas prices.
But times were different then. The world was plunging into recession. Now global markets are mildly growing or static. Nevertheless, there is a danger that the upward slope of the J-curve in Japan may be pretty flat.
Articles
Weak yen a boon for investors, not Japan Reuters, James Saft (14/5/13)
Japan’s Trade Data Suggest Even Lower Yen Needed Wall Street Journal, Nick Hastings (22/5/13)
2 Misunderstandings About Japanese Trade Seeking Alpha, Marc Chandler (22/5/13)
Japanese trade deficit widens Financial Times, Ben McLannahan (22/5/13)
Data
BIS effective exchange rate indices Bank for International Settlements
Japan’s balance of trade Trading Economics
UK Trade, March 2013 ONS
Questions
- Explain the J-curve effect.
- Why is there some doubt about whether the Japanese balance of trade will improve significantly?
- What will be the consequences for Japanese growth?
- If foreign currency prices of Japanese exports do not change, what will determine the amount that Japan exports?
- What other measures is the Japanese government taking to stimulate the economy? What will determine the size of the multiplier effects of these measures?
- Using data from the ONS plot the UK’s quarterly balance of trade figures from 2007 to the present day. Explain the pattern that emerges.
In the blog The global economy we considered the economic performance of countries across the globe, including the UK. In the first estimate of UK economic growth for the first quarter of 2013, the economy grew at 0.3%, thus avoiding a triple-dip recession. This first estimate is always subject to change, but in this case, the data was confirmed.
The April 2013 figure provided by the ONS of 0.3% growth has been confirmed, once again indicating the slow recovery of the UK economy. Despite these more positive signs for the economy, the IMF has raised concerns of the weak performance of the UK and has urged the government to invest more in projects to stimulate growth. Although the economy has started to grow, economic growth has continued to remain weak since the onset of the financial crisis and recession. Martin Beck, an economist at Capital Economics said:
With employment and average earnings both dropping in the first quarter on their level in the previous quarter, the foundations for a sustained recovery, even one driven by consumers, still look pretty rickety.
Initial estimates by the ONS are always updated and there is still time for the 0.3% growth figure to be changed, as more data becomes available. (Click here for a PowerPoint of the chart.) This latest figure, although unchanged, has given a more concrete indication of where the UK economy is continuing to struggle. Consumer spending increased by only 0.1%, investment and exports declined, but in further signs of a weak economy, the building up of stocks by companies was a big contributor to the UK economic growth – a contribution of 0.4 percentage points. The service sector continued to growth with a 0.6 percentage point contribution to GDP.
So, what does the future look like for the UK? Although the estimate of 0.3% figure did prevent a triple-dip recession and the IMF did comment on the ‘improving health’ of the economy, signs of recovery remain weak.
Crucial to the recovery will be government spending, but more than this, the government spending must be in key growth industries. Data suggests that the UK invests less than other G8 countries as a percentage of GDP and this is perhaps one of the key factors that has prevented the UK recovery from gathering pace. The future of the UK economy remains uncertain and government policy will be crucial in determining this future course. The following articles consider the latest growth data.
Signs of weakness mar UK economic growth Reuters, Olesya Dmitracova and William Schomberg (23/5/13)
UK first quarter growth unchanged BBC News (23/5/13)
Concerns over underlying health of UK economy as 0.3% growth confirmed The Guardian, Philip Inman (23/5/13)
Statisticians confirm 0.3% UK growth for first quarter of 2013 Financial Times, Claire Jones and Sarah O’Connor (23/5/13)
UK GDP: concerns about underlying economy as 0.3pc growth confirmed The Telegraph, Philip Aldrick (23/5/13)
Britsh economy returns to growth in first quarter The Economic Times (23/5/13)
U.K. households not loosening purse strings Wall Street Journal, Ainsley Thomson and Ilona Bllington (23/5/13)
IMF: UK should push for economic growth BBC News (22/5/13)
Questions
- Why are numerous estimates of GDP made by the ONS?
- How is GDP measured? Is it an accurate measure of economic growth? What about economic development?
- Why does 0.3% growth in the first quarter of GDP not necessarily imply that the UK economy is recovering?
- Why have certain aspects of the UK economy performed better or worse than others?
- What areas should the government invest in, according to the IMF?
- Why would government spending in investment create economic growth? Is this likely to be short term or long term?
There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’! 
