Tag Archives | economic growth

France vs UK recovery

Useful post from Paul Krugman about a comparison between the French and UK recoveries.

It stems from comments by a Conservative cabinet minister that ‘the French economy is being run into the sand.’

For those who can’t get past the NY Times paywall, I’ll post the two graphs here.

UK-france480

UK and France since 2010

uk-france-2010

The French economy is forecast to grow by just 1 per cent this year, according to OECD forecasts, compared to 2.4 per cent for the UK.

There are a few observations to be made.

  • Quite often the bigger the decline in real GDP, the more scope there is for a strong recovery. If output falls 7%, it leaves more potential spare capacity. It can make the subsequent recovery appear more spectacular. Despite the depth of UK recession, the recovery has so far been relatively anaemic. For example, after Latvia GDP plunged 15%, they enjoyed a sharp recovery. But, you have to place the recovery in the context of how much GDP fell in the first place.
  • It is difficult to evaluate the success of a policy, such as austerity, solely using quarterly GDP statistics. There are many factors affecting economic recovery. For example, in the UK monetary policy has played a key role in lessening the impact of the relatively small tightening of fiscal policy. France, tied by monetary union has had much less flexibility than the UK in monetary policy.
  • The length of the UK recession was arguably needlessly long.  Even five years after the crisis, we are still to see real GDP return to its pre-crisis peak.
  • Despite the length of the recession and the unbalanced nature of the UK recovery, things are looking a lot more promising than on the continent. The UK economy does have several strengths (as well as weaknesses). See: UK economy in 2014.
  • French government spending accounts for 56% of GDP, the second highest in the Eurozone. French business have been calling for cuts in social security costs to business and lower regulation. Recently, the French government planned to actually reduce the pension age to 60, whearas the UK have been planning to increase the pension age. Given the size of government spending and demographic changes, the French decision was bizarre to put it politely.
  • French unemployment at 11% is y higher than UK unemployment of 7.1%. Part of this may be attributed to more flexible labour markets in the UK. There is a downside of flexible labour markets – zero hour contracts, part-time work, but employment rates in the UK have been increasing. Whearas high labour costs have discouraged employment in France.

Overall

At the present moment, the UK economy looks to be in a stronger position. Signs of UK growth are promising, especially signs of manufacturing growth in the north and improved confidence. Though it should be remembered the UK recovery is still weak, helped mainly by consumers spending and a fall in the savings ratio. The French economy by contrast is suffering the European-wide problem of stagnation and low growth.

France may well benefit from some free market reforms and lower government regulation. But, be wary of politicians exaggerating claims about the relative success of economies.

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The recession is over but not the depression

Some thought provoking analysis from NIESR. Firstly, they define recession and depression in an interesting way.

  • Recession – a period of time where output is falling.
  • Depression – The period of time where output is below it’s peak.

The UK economy is now growing, at a decent pace (0.8% in Q3). However, output is still significantly below the old 2008 peak. This means that the recession is over. But, with output still below the 2008 peak, the prolonged period of depression is still not over, according to this definition.

Also, if we compare this ongoing economic downturn (2008-2013) with other periods of serious economic stagnation, the UK economy is performing worse now than even the 1920s or 1930s.

NIERS - UK output

Source: NIERS

The NIERS don’t expect the 2008 GDP peak to be regained until 2015. Meaning, we will have a 7 year period of stagnating real GDP. An unprecedented length of economic stagnation. See also: more on comparison of different recessions

But, it doesn’t feel like a depression?

There are no commonly agreed definitions of what constitutes a depression. Most definitions tend to emphasise a significant fall in real GDP or a prolonged fall in GDP for a period of over 3 years. For example, if real GDP falls by over 10%, that would be classed as a depression. A depression also implies a very high rate of unemployment (perhaps greater than 15%).

The UK unemployment rate is relatively low by the standards of other recessions (helped by falling productivity and flexible labour markets) Therefore, with economic growth, and ‘reasonably’ low unemployment, it feels a different climate to the great depression of the 1930s.

On the other hand, although unemployment could be much higher, there has been a widespread fall in living standards, which is unprecedented in the post war period. Figures show UK living standards have dropped to their lowest in a decade after average real incomes fell a further 3 per cent last year. Continue Reading →

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The Great Moderation

The great moderation refers to a period of economic stability characterised by low inflation, positive economic growth, and the belief that the boom and bust cycle had been overcome. In retrospect, economists look back on the great moderation in a different light because although inflation was low, there was great volatility in financial markets and asset prices.

inflation-growth-90-12

The UK great moderation from 1992 to 2008 low inflation, positive economic growth.

Generally, the great moderation refers to the period 1986 – 2006.

In the UK, the great moderation is considered to be the period 1993-2007 because the UK had a classic boom and bust in late 1980s and early 1990s. The UK experienced 63 consecutive quarters of economic growth between the end of the 1991 recession and the recession in 2008 – the longest continued expansion on record.

Wage growth

wages-inflation-2000-2007

This was typical of wage growth during the great moderation. Average wage growth above CPI inflation causing a steady growth in living standards.

Before the great moderation – boom and bust trade cycles

 

inflation

In the post war period there seemed to be a fairly consistent business cycle. Economies would experience, high growth (a boom), but with high growth came inflation. After a period of inflation, the economy would slow down and sometimes go into recession  (see boom and bust). It appeared the business cycle was volatile and inflation difficult to bring under permanent control. The 1970s, saw even greater volatility with oil shocks causing high inflation.

Features of the great moderation

After the volatility of the 1970s and 1980s, the great moderation was seen as a welcome end to this volatile growth and inflation. The great moderation had various aspects.

US inflation

US inflation, after early 1980s, inflation generally stays close to target of 2.5%

  • Low inflation. The most prominent feature of the great moderation was persistently low inflation. It appeared that Central Banks could keep  inflation low – without compromising unemployment or economic growth. The Phillips curve had either shifted to the left or was no longer relevant. There was a certain excitement that we were seeing the end of boom and bust.
  • Stable growth. With low inflation, we avoided the boom and bust cycles. The UK had their longest period of economic expansion on record 1992-2007. Apart from a minor dip in 2001, the US economy grew strongly during 1986-2006.
  • The end of uncertainty and greater risk taking. The benign macro economic situation encouraged investment in both capital and financial investments. During the 1980s and 1990s, there was a period of financial deregulation which encouraged a growth in complex financial derivatives, such as credit default swaps. Financial institutions became willing to take on more risky investments because they were more confident that there wouldn’t be any major economic downturn. Banks became more highly geared as they lent out a greater % of their assets. For more on how macro stability increased risk taking – see Financial instability hypothesis
  • Rising asset prices. Asset prices, especially houses, saw a rapid growth in prices. House prices rose because of low interest rates, a stable macro-economy, and growth of mortgage lending. House prices rose faster than inflation, and even faster than incomes. Some were worried house prices were becoming overvalued, but others felt house prices weren’t overvalued because of either limited supply or the growth of new mortgages meant more people could now afford to get a mortgage.

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What Explains Differences in Economic Growth Rates?

Readers Question: Given the widely varying fiscal policies of countries, both left and right, how come their growth rates over the long term are so close?

real GDP per Capita

source: World Bank

To some extent growth rates are close; though it also depends which data and countries you use. However, from a very broad perspective, growth rates do share similar patterns and growth rates.

Why there are Similarities in Economic Growth Rates?

To some extent there are similarities in economic growth rates, especially amongst countries at a similar stage of economic development, and who are geographically close. There are a few reasons for these similar trends in economic growth rates.

  • Technological Developments. In the long term, a key factor in determining economic growth is the development and implementation of new technologies. Steam technology helped countries to industrialise; the assembly line enabled efficiency savings from the 1920s. In the post war period, all major industrial countries have benefited from similar improvements in technology – micro-computers, increased mechanisation, the internet and better transport. These technological improvements are generally available to every country, so they can all benefit from the same productivity growth. Also, the creation of new technology doesn’t really depend on government policy.
  • Globalisation and Multinationals. The world is increasingly globalised; big multinationals have operations in all major economies. If they improve their productivity and invest, it tends to be felt on a global scale, not just in a particular country.
  • Global Shocks. All major economies are subject to the same global shocks. For example, in the 1970s, a rise in oil prices hit all the main oil-importing economies. The global credit crunch of 2008, had a similar effect in pushing most major economies into recession.

Therefore, especially in the long run, economies are sharing similar developments, such as technology, improvements in education and the growing role of multinationals. These kind of factors are not really directly influenced by government policy. Whether the government is socialist or conservative – the internet has enable cost savings which will give the potential for improvements in productivity and efficiency for all economies in the world.

 

Why are there differences in economic growth rates?

If we look a bit closer at economic growth rates, we can still see there are significant differences in actual economic growth rates – especially in the short run.

real-gdp-per-capita-growth-193-2011 greece, uk, us, europe

source: World Bank – constant 2000 prices

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Do we need economic growth in a modern economy?

A look at whether we actually need economic growth in a modern economy.

Readers Question: When I compare my life with my fathers at that time the conditions are near identical in the greater things or life. I work the same hours, maybe more. I have the same holidays. I have a similar standard of material comfort (a washing machine, a car, heating, a beer when I want one) although with a lot more ‘stuff’ in terms of gadgets (TVs computers etc). My father retired at 60. I’ll have to work to 67.

There is much emphasis put on growth in the economy yet over this period a *doubling* in the size of the economy has not given me (and the vast majority of people like me) any major advantages in terms of free time or choice of what to do with my life.

Accounts I read on economic growth don’t address my fundamental question about why we should have a growing economy when such major changes in GDP over the medium term seem to have little effect on real people’s lives.

Increasing efficiency in production should lead to a reduced demand for labour and more free time or greater unemployment but never does. We need fewer people on the land, fewer people in our factories and now fewer people to administer things or even work in shops. Where are new jobs coming from? Are they all ‘make weight’ jobs designed to justify distribution of wealth created by a small section of the populous?

Put simply, other than consumer confidence, why do we need to have more valuable transactions tomorrow than today? It is easy to see why growth is necessary in a developing economy where basic need aren’t met and growth means more food but why do we need it in a modern western economy?

Firstly, it is true that economic growth in a developing (poor) economy can go a long way to improving living standards. When people are living in absolute poverty, they experience a deprivation of basic human needs, such as food, shelter, education, basic health care. Economic growth can enable many of these basic needs to be met – and this economic growth can radically increase living standards amongst those countries.

However, as you point out, when real incomes are already quite high, economic growth can have a very marginal (or even negative) impact on living standards. There is a strong diminishing marginal utility to extra income.

Why then do we need economic growth?

1. Inevitability of growth from technological improvements. Economic growth is driven by technological improvements, which reduce the costs of production and enable more to be produced. (greater efficiency). This technological progress in many ways feels an inevitability. How could you stop this technological progress? Technological improvements have particularly improved the productivity of agriculture and manufacturing. This means we can support ourselves with a smaller % of the workforce on agriculture and manufacturing. Many of new jobs are in service sector. (e.g. people far more likely to eat out, go to a cafe – than 20 years ago. I remember when I was a kid, you just didn’t go out for a meal or get a takeaway every week. But, now it is quite common.

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Why Do People Not Notice Economic Growth?

Readers Question: why does economic growth not get noticed by the man on the street?

  • Recently, the ONS released a report saying that real wages were 62% higher than in 1986. This is the result of sustained economic growth. (Real wages take into account inflation.)
  • In April 2011 the average full-time employee in the UK earned around £12.62 per hour excluding overtime.
  • This is a monetary (nominal) increase of 226% since 1986 when the average wage was £3.87 per hour.

Inequality of Real Income growth

  • The top 1 per cent had the biggest increase between 1986 and 2011, at 117%
  • The top 10 per cent saw an increase of 81%
  • The bottom 10 per cent had a 47 % increase.
  • The very poorest did better, with the lowest 1 per cent having a 70% increase.

 

However, in the period 2007-11, all income groups have seen a fall in real wages as nominal wage growth has failed to keep up with inflation.

real GDP

If we asked people do they feel better off than 1986, it is hard to know what people would say. I’m sure some would feel better off, but many may reply they don’t. Why don’t people notice economic growth? Some possible reasons:

  • Economic Growth and living standards. Economic growth measures the increase in real GDP (real output, real incomes). However, GDP  is often a poor reflection of living standards and peoples sense of well being. For example, despite rising real incomes, people may not feel as well off. This could be because:
    • Quality of life diminished by pollution or increased congestion
    • Increased fear of crime that may occur with economic growth. (Ironically, with more income, people have more to lose. Crime rates are higher in the UK, than in the 1930s – a period of greater poverty)
    • see also: difficulty in measuring living standards Continue Reading →

Econ Growth and Unemployment Stats – Countries with Own Currency

Readers Question I was wondering if you have any graphs plotting UK GDP and Unemployment against other economies which have monetary independence and their own currency. I often see graphs comparing the US with the UK. Are there any which include Sweden, Norway, Switzerland and other countries?

econ-growth-table-aus-nor-swe-swit-uk-us

click to enlarge

Economic growth rates for selected countries.

  • Australia has weathered the global recession well. Helped by strength of its commodity export market.
  • Sweden experienced one of the deepest recession (-5.0% in 2009), but also one of the quickest recoveries with very strong growth since 2010.
  • The Eurozone went back into recession in 2012, and the growth forecasts for 2013 may prove over-optimistic.

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The Importance of Increasing Income Per Head

Readers Question: Evaluate The importance of increasing income per head for an economy.

Higher income per head means that GDP per Capita is higher.

This means there is an increase in living standards as more people can consume higher levels of goods and services.

Increased GDP per Capita will improve government finances. This is because people will pay more income tax and more VAT; firms will pay more corporation tax. Also the government will spend less on income support and unemployment benefits. Therefore the budget deficit will decrease. Also the government could decide to spend more on investing into the economy. e.g. spending on better roads. This will enable higher rates of growth in the long term.

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The Rahn Curve – Economic Growth and Level of Spending

Readers Question: Does the Rahn Curve support the empirical evidence? If not, why not? Can you prove that there is a relationship between the level of Government Spending and GDP growth.

The Rahn Curve suggests that there is an optimal level of government spending which maximises the rate of economic growth.

Diagram of Rahn Curve

rahn-curve

Proponents of the rahn curve tend to use it as a tool to argue that government spending hinders economic growth. For example the Centre for Freedom and prosperity [link] point to empirical studies which suggest that the optimal level of government spending is between 15 and 25% of GDP. That page also shows links to other reports and empirical studies which would be worth investigating for your paper. However, you should bear in mind:

  • Government spending in US is approx 37% of GDP, in UK approx 43% of GDP, in western Europe some countries have more than 50%
  • The Centre for Freedom and prosperity has a clear ideological stance that they dislike government spending. It is not surprising they highlight studies which show results favourable to their belief in reducing the role of government
  • There is a rather tenuous link between growth rates and levels of spending. There are many factors that influence rates of economic growth and I am dubious that people can ever isolate just one factor (levels of government spending) to prove either higher or lower growth rates.

Continue Reading →