GDP Data Show UK Stagnation Is Home Grown & Due to Government Policy

By Michael Burke

Publication of the latest estimate of GDP data shows that the recession was much sharper than previously thought. The revision shows that GDP contracted by 7.1% rather than the 6.4% previously estimated. The recovery which began in the 3^rd quarter of 2009 was also slightly stronger than previously estimated, the economy expanding by 2.8% until the 3^rd quarter of 2010. From that time onwards the economy has stagnated completely, with zero growth in the three  quarters since. The result is that the British economy is 4.4% below its peak level before the recession, which is now estimated to have begun in the 2^nd quarter of 2008.

George Osborne and other Tories as well as their supporters in the media are now promoting the idea that the stagnation of the British economy is a function of the turmoil in the Eurozone economy and financial markets. The main channel for economic weakness in the Eurozone to be expressed in British economic activity is via exports. But the British economy has not grown over the last 9 months - while the first dip in exports has occurred only in the latest quarter. This is highlighted in the chart below, which shows the level of total domestic expenditure versus exports. Domestic demand began to contract as soon as the current government took office. Evidently, the stalling of British economy has not been caused by the turmoil in the Eurozone.

Chart 1

In fact the opposite is the case. The British economy comprises 14.5% of the entire EU economy, in OECD terms approximately $2trn of a total $13.8trn (in Purchasing Power Parities). Yet even before the latest downward revisions to GDP by the Office of National Statistics are included, the OECD data show that the entire loss in EU GDP was $355bn, of which British economic weakness is 21.4% of the total, equivalent to $76bn. As the chart below shows, the British economy has been a brake on the Eurozone economy, not vice versa.

Chart 2

Stagnation

Returning to the ONS release, the total loss of output since the UK recession began is £65.2bn. The total loss of investment (Gross Fixed Capital Formation) over the same period was £43.3bn, that is almost precisely two-thirds of the entire recession. But the latest data also represent a turning point. The total loss in household consumption during the recession was larger at £51bn, over three-quarters of the total contraction in the economy. The fall in household consumption began to outstrip decline in investment in the 1^st quarter of this year.

This loss in consumption has therefore not been the catalyst of recession. The decline in investment preceded the recession by 6 months. Declining investment was the driving force of the recession. But it does indicate that there is a new and significant and pressure on household spending in the British recession. Other components of the national accounts have risen over the same period, notably government current consumption and net exports.

It is also no longer the case that the private sector fall in investment exceeds the total decline in investment. Previously, this had been the case as government investment had risen. As a result the fall in private sector investment had amounted to 80% of the total lost output through the course of the recession. Now the decline in private sector investment amounts to £36.5bn - 56% of the total decline in output.
But government investment is now falling. In total, government investment has fallen since the recession began, down £6.8bn. But this is entirely a function of the current government’s policy. Since the Tory-led government took office, government investment has fallen by £12.2bn, more than reversing the very modest rise in investment of the previous Labour government. The direct effect of the government decision to reduce investment is to cut GDP by 0.9%.

Recovery Derailed

These are only the direct effects of declining government investment. It is now commonplace to speak of a continuous recession from the 1st quarter of 2008. Cameron and Osborne routinely speak of their dire inheritance from the Labour government. The actual inheritance of the Tory dominated government was actually an economic recovery underway, which after the latest revisions is now stronger and longer than previously estimated. The economic recovery lasted 5 quarters and GDP expanded by 2.8%, whereas previously it was estimated at 4 quarters long and a recovery of 2.5%.

The Labour government did not begin to increase investment until the 4^th quarter of 2008. From that time until the new government took office government investment rose by £27.2bn. But this had an indirect effect primarily by encouraging private sector investment so that the economy expanded by £38.7bn in total.
On the same ratio the current government’s decision to reduce its own investment will have led to a total decline in output of £17.4bn, or 1.3% of GDP.

Conclusion

The UK economic stagnation is a home-grown one due to the policies of the present government. It began before there were any negative effects from the Eurozone’s turmoil. It is primarily a function of the government decision to reduce its own investment. The British economy is stagnating because of policy made in Downing Street and nowhere else.

Economic downturn in the UK now twice as bad as in the Eurozone due to government deficit cutting

By John Ross

One of the more factually inaccurate pictures being spread by supporters of the policies of the present UK government - with its priority to budget deficit reduction - is that UK economic performance during the financial crisis is superior to that of the evidently crisis hit Eurozone. A typical version of this appears in an article on 3 October in the Daily Telegraph by its international business editor Ambrose Evans-Pritchard.

Evans-Pritchard states: ‘My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse [the Eurozone] by foolish elites.’ Presumably Evans-Pritchard's sympathy goes to the inhabitants of the Eurozone, rather than his own country the UK, because he believes the UK has been doing better than the Eurozone.

The factual situation is the exact opposite of the impression presented by Evans-Pritchard. Judged by economic performance, the average citizen of the UK far more needs Evans-Pritchard’s sympathy than the average citizen of the Eurozone - i.e. the UK’s economic performance during the financial crisis is much worse than that of the Eurozone. This may be seen in Figure 1 – which shows UK GDP compared to that of the Eurozone since the peak of pre-financial crisis output. Comparison is straightforward as in both the Eurozone and the UK the peak of the previous business cycle was in the 1st quarter of 2008.

By the 2nd quarter of 2011, that is 14 quarters after the peak of the previous cycle, Eurozone GDP was 2.0 per cent below its previous peak level whereas UK GDP was 3.9 per cent below its previous peak - i.e. UK economic performance was almost twice as bad as that of the Eurozone.

Figure 1

Equally striking is the clear way in which present government’s policies made UK economic performance worse than in the Eurozone. It may be seen from Figure 1 that while the initial decline in UK GDP was greater than in the Eurozone - the greatest decline in UK GDP being 6.4 per cent registered in the 3rd quarter of 2009, compared to a maximum Eurozone drop of 5.5 per cent in the 2nd quarter of 2009 - recovery in the UK was also initially more rapid. This may be clearly seen in Figure 2, which shows year on year GDP changes.

The UK and the Eurozone reached their 1st quarter 2008 peaks with almost exactly the same economic momentum behind them – 1.9 per cent growth in the previous year in the UK and 2.0 per cent in the Eurozone. However by the 3rd quarter of 2010, the one immediately following the departure of the  previous government, UK GDP was rising at 2.5 per cent compared to 2.0 per cent in the Eurozone. Eurozone recovery subsequently slowed somewhat to 1.6 per cent by the 2nd quarter of 2011.

However UK GDP growth under the new government, which gave priority to budget deficit reduction, dropped astonishingly, by more than two thirds, from 2.5 per cent to 0.7%. Under the new government the year on year growth of UK GDP therefore fell from being higher than that of the Eurozone to being less than half that of the Eurozone!

Figure 2

The present author is not a supporter of the present constitution of the Euro. On the contrary I predicted the current events unfolding in Greece and other countries in advance due to fundamental weakness in the design of the Euro. Writing in 1996, i.e. fifteen years ago:’ [the Treaty of] Maastricht’s proposals are … disastrous. It proposes to create the most fundamental features of a common state — a single currency and a central bank. But it does not create any state budget which can deal with the huge regional and sectoral implications of this. The process that would unfold with the creation of a single currency by this method may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join.There will be sharply deepening regional imbalances and inequalities.’There is evidently no reason to revise that analysis.
It is therefore all the more striking that UK economic performance is actually worse than in the Eurozone. And a substantial reason it is worse is clearly due to the policies of the present government with their priority to budget deficit reduction.

In any discussion of the relative economic performance of the Eurozone and the UK two fundamental facts must be held in mind against unsubstantiated myths:

• UK economic performance during the financial crisis is substantially worse, almost twice as bad, as that of the Eurozone.
• And the reason it is that bad is because the present government, through its priority to cutting the budget deficit, reduced the UK’s rate of economic recovery from substantially above that of the Eurozone to less than half that of the Eurozone.

This factual situation evidently has a more general economic significance than merely for the UK and the Eurozone. For reasons dealt with frequently on this blog a policy of simply running budget deficits is inadequate to deal with the consequences of the present financial crisis as it does not tackle its driving force - the decline in investment. But under conditions of private sector weakness any rapid reduction in the budget deficit will lead to rapid economic slowdown or contraction. This is sharply illustrated by the fact that the UK government, by such policies, has reduced the UK's rate of economic recovery to less than half that of the openly crisis struck Eurozone.

Other countries thinking of embarking on immediate deficit reduction policies, such as those advocated by the Republicans in the US, should look at the UK and draw the appropriate negative conclusions. Do not be totally distracted by financial fireworks: the policies of the present UK government are so bad they have produced an economic recovery which is only half that of the Eurozone!

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This article originally appeared on Key Trends in Globalisation.

Move towards some sensible ideas from Samuel Brittan

By Michael Burke

The Financial Times’ veteran economics commentator Samuel Brittan has recently argued for the state’s holdings in the banks to be used as the basis for creating a new state bank focused on productive investment.

Echoing calls from Adam Posen, he argues that the disastrous fall in both the money supply and bank lending needs to be corrected by decisive state action. Posen is perhaps the sole member of the current Bank of England Monetary Policy Committee who understands the gravity of the current situation and is not constrained by official orthodoxy in seeking remedies l.

These are similar ideas as those outlined in the recent pamphlet, ‘A Brighter Economic Vision for Britain. Brittan says his own proposal, ‘...is to use the state-owned banks as the nucleus of Mr Posen’s proposed state lending bank for small and medium enterprises. Who knows what obstacles well-paid lawyers could think up? But in principle this could start next week. The main thing needed would be a Treasury directive to these banks to replace profit maximisation with a requirement to promote economic recovery.’

One reason for the renewed slump in the share price of leading British banks is their exposure to the sovereign debt crisis. Yet Lloyds-TSB Bank, for example has seen the price of its shares fall from 74p at the time of the government’s share-buying programme to 34p as at the close of trading on September 23. This compare to the collapse of RBS’ share price to 22p compared to the government purchase price of 52p – despite the fact that (aside from the US and Britain) Lloyds has no significant exposures to sovereign debt markets at all.

This highlights the fact that the main driver of the slump in banks’ shares is not primarily the debt crisis, severe though that it is. The share prices have collapsed because of economic weakness and the deterioration in the banks’ existing loan book, personal, business, mortgage and other loans.

Therefore it is possible to differ with Brittan’s analysis in two respects. First, the banks’ refusal to lend is driving both the fall in profits and the share price on which it rests. They are not ‘maximising profits’ but hoarding capital in order to preserve it. A government instruction to lend is the only way to break the lending and investment strike. Secondly, it is a widespread misconception that small and medium-sized enterprises (SMEs) are the key to growth. In reality, outside the personal services sector they mainly provide inputs to much larger firms. Bundling up loans to SMEs will not create the investment demand for smaller firms’ output. The largest firms show no intention of increasing their own investment – which is what is required.

Instead, only government can break the log-jam by initiating investment in housing, in infrastructure, in transport and in education. The private sector would benefit. These contracts would mainly be awarded to large firms but they tend to sub-contract or purchase inputs from SMEs and individuals. It is this process which creates employment at the SMEs.

But this is a disagreement only about the nature and direction of the required policy. The basic thrust of the Brittan analysis is correct. Bank lending and money supply are collapsing along with the banks’ share prices. The banks contain the resources to correct the slump, yet refuse to do so. They are in public ownership. All that is required is a government instruction to fund the large-scale investment that is required to produce a recovery.

Eurozone rescue packages will continue to fail until they deal with the central issue in Europe's recession

By John Ross

The international financial system is passing through the agony of a new round of the Eurozone debt crisis for the simple reason that European governments, like that in the US, refuse to deal with the core of the economic recession in Europe for reasons of economic dogma.

Anyone who looks at the economic data for the Eurozone without wearing ideological blinkers can see the situation at once – it is charted in Figure 1. The Eurozone recession is due to a collapse in fixed investment. Taking OECD data, at inflation adjusted prices and fixed parity purchasing powers (PPPs), then between the last quarter before the recession, the 1st quarter of 2008, and the 2nd quarter of 2011 Eurozone GDP fell by $204bn. But private consumption declined by only $29bn while the net trade balance increased by $32bn and government consumption rose by $91bn.

However fixed investment fell by $290bn – i.e. the recession in the Eurozone was wholly due to the fixed investment decline

Figure 1

Equally evidently, due to its scale, until this fall in investment is reversed it will take a prolonged period for the recession to be overcome. Therefore to restore growth, which by now is generally realised is the core to turning round the budget deficit problem, the fixed investment decline must be overcome.

Nor is there anything mysterious about how to do this – the state has entirely adequate means. To take the most decisive international case China made the core of its stimulus package direct state investment particularly aimed at infrastructure and housing – the result being that China’s economy has grown by over thirty per cent in three years.

Europe and the US clearly do not have the scale of state sector, nor the political willingness, to act on the scale China did. But US history shows that even without proceeding to a socialist scale of measures direct state intervention on investment is entirely possible.

Roosevelt expanded US state investment from 3.4% of GDP to 5.0% between 1933 and 1936 (data from US Bureau of Economic Analysis Table 1.5.5). Jason Scott Smith, in his study of New Deal public spending, summarises such investment as including 480 airports, 78,000 bridges, 572,000 miles of highway - which, in addition to its immediate effect in stimulating demand, reinforced the productive position of the US economy. Roosevelt, it is superfluous to point out, was neither a socialist nor a communist (despite claims to the contrary by the US right!).

Quarterly, up to date, data is regrettably not available on what is occurring across the Eurozone for state investment, but it is available for the US and there is no reason to suppose, with  current policies, that the situation in Europe is any better. Between the peak of the previous US business cycle, in the 4th quarter of 2007, and the 2nd quarter of 2011 US private fixed investment fell from 15.8% of GDP to 12.2% - i.e. a decline of 3.6% of GDP. Yet in the same period US state investment did not compensate but also fell marginally – from 3.3% of GDP to 3.2% of GDP. Therefore while Roosevelt expanded the weight of US state investment current US administrations have been letting it fall.

Instead of directly addressing the core issue of the investment fall European administrations are either attempting to stimulate it indirectly – which, as it is ineffective, has led to fiscal/sovereign debt crises, or are acting via expansion of the money supply – which, in a situation whereby companies and households are paying down debt, is merely the famous ‘pushing on a piece of string’.
The most favourable outcome of such a situation is that eventually the debt will be paid down, but only after several years of stagnation. The less favourable variant, of course, is that the banking system breaks under the strain and renewed recession is further propelled by fiscal cutbacks. All these problems simply arise from the fact that, under the rubric of the dogma ‘private equals good, state equals bad’, European governments refuse to use the state tools available to deal with the investment fall which is at the core of the Eurozone recession.

Some European politicians are now beginning to call for state measures to increase investment, UK Business Secretary Vince Cable being one. But the action they envisage so far is inadequate to deal with the scale of the investment fall.

China's economy, which does not have such ideological inhibitions, will continue to expand while the Eurozone remains relatively stagnant for a significant period - and as long as economic stagnation continues there will be no resolving of the Eurozone debt crisis.

A Brighter Economic Future For Britain

By Michael Burke

‘A Brighter Economic Future for Britain’ is the title of a new pamphlet co-written by the present author and Professors George Irvin and John Weeks. In the Guardian we set out the rationale for the publication:

‘The UK depression has already lasted three years, and NIESR argues that is likely to last five years or more – longer than that of 1930s.

Yet economic debate is dominated by counterproductive attempts to reduce the deficit through cuts in public spending, which are now the single most important cause of the depression.’

The full article can be read here.

In an argument that will be familiar to regular readers of SEB, the pamphlet argues that public spending cuts are counter-productive both in terms of reviving growth and in reducing the public sector deficit. This is because the deficit itself is primarily a product of the depression.

Further the underlying cause of the depression is a private sector investment decline, which by the end of the 1^st quarter of 2011 accounted for 80% of the total lost output since the economy began to contract 3 years earlier – that, is £44.9bn of a total of £56.3bn.

Therefore breaking that investment strike is a pre-requisite to any sustained recovery. By investing in areas such as housing, transport, infrastructure and education, the government can lead an economic recovery that meets acute economic needs and reverses the rise in joblessness.

The pamphlet puts forward two related solutions to the crisis- the creation of a state-owned Investment Bank and using the excess capital at the state-owned banks to fund the needed investment.

Importantly, this analysis is beginning to win political support. In welcoming the attempt to turn the debate towards an investment-led recovery Jon Trickett MP argues in a foreword to the pamphlet,

‘Collapsing investment hits current growth and long-term productivity.....Working on the premise that we must tackle investment and long-term competitiveness the authors argue that one way forward which would increase demand in the economy, and raise both employment and productivity, would be to take action now to address this issue.....The pamphlet sets out one idea from the authors to tackle this collapse investment; a National Investment Bank, using the government’s majority stake in Lloyds-TSB and RBS.....There are those who would argue that this would indeed be poetic justice.’

The continued economic stagnation in Britain and some other leading economies will force a reconsideration of policy even among the architects of the current crisis and their supporters. In Britain , though, a Tory economic ‘Plan B’ is likely to include privatisation, deregulation as well as attacks on social protections such as maternity/paternity leave, pensions and an abuse of youth ‘training’ programmes to provide unpaid labour. But none of this will alter the basic problem that private firms are sitting on hoards of cash that they refuse to invest, while also leading to further impoverishment for the overwhelming majority of the population.

Likewise, since at least the ‘worse than Thatcher’ New Labour Budget of 2010 there are many now on the opposition benches who fundamentally agree with the ‘austerity’ policy. They merely advocate slower, shallower, more anguished cuts. But as the economy has already stalled under the impact of less severe cuts than they would now be implementing, the Labour supporters of cuts are also obliged to look for a ‘Plan B’. Whether they move towards Osborne, or in the direction of state investment to generate recovery remains to be seen.

In any event, as the pamphlet argues there can be no suggestion of a sustained recovery without replacing the policy of cuts with a government-led investment recovery.