To what extent did EU recession cause UK recession?

Readers Question: to what extent did the EU recession cause the UK recession?

In economics often several factors occur at the same time, and it is difficult to give a weighting to the importance of each factor. To some extent, people will emphasise the factors which best suits their outlook / beliefs.

It is no surprise that the government prefer to blame the double dip UK recession on ‘unavoidable weakness in the European economy’. It is similarly no surprise the opposition blame the government’s austerity approach adopted in 2010.

eu-recession

Source: EU GDP

In theory, the European recession of 2012, will effect the UK economy in the following ways:

  • Lower export demand. With Europe entering recession, they will buy less goods and services, including less demand for UK exports. UK exports to Europe account for around 13% of GDP and so it is reasonably significant. Lower export demand to Europe can have a knock on effect to other related industries, and a possible negative multiplier effect – causing a bigger final fall in real GDP.
  • Reduced confidence. Europe sliding into recession will harm business and consumer confidence. With our main trading partner struggling, firms are less likely to invest in increasing capacity. Also the financial instability in Europe is making banks more nervous and reluctant to lend.
  • Lower inward investment. A recession in Europe will create a disincentive for European firms to invest in the UK leading to lower growth.

 

Evaluation

But, how important a factor is the European recession?

1. Exports to Europe have not fallen significantly

exports-eu-non-eu

UK exports to the EU increased between 2009 and 2012  by 6.5%. Exports to non-EU countries increased at a faster rate. During this period, the UK current account deficit increased – because demand for imports increased at a faster rate, and if Europe had not gone into recession, we may have seen a bigger increase in exports. But, overall this still suggests that falling exports to Europe were not the main cause of the recession. 

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UK industrial and manufacturing output 2013

  • In Jan 2013, UK industrial production was 2.9% lower than Jan 2012.
  • Manufacturing on a seasonally adjusted basis fell by 3.0% in January 2013 compared with January 2012.
  • Industrial production is over 15% lower than at the start of the recession in 2007.

percent-change-industry-manufacturing

  • Industrial output (production industries = Mining + manufacturing + energy + water)
  • Industrial output has been particularly hit by a decline in mining. Mining tends to be more volatile. Arguably manufacturing gives a better guide to the underlying strength of the economy.

industrial-manufacturing-index-2007-12

Industrial production is lower than the 2009 low. Manufacturing output is struggling to recover. Industrial production is more than 15% lower than at the beginning of the crisis.

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Paradox of toil

effect-increased-supply-wages

The paradox of toil states that under certain conditions if people wish to work longer hours, this can cause falling real wages and rising unemployment. The paradox is that individuals have an incentive to work longer, but if everybody wants to work longer hours, it can actually cause unemployment. The paradox of toil only works …

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8 policies to kickstart the UK economy

In the past five years, the UK has experienced an unprecedented period of stagnant economic growth. The fall in real GDP is longer than even the great depression.  Given the unusually depressed nature of the economy, what policies could the UK pursue to boost economic growth and recovery? Here are eight possible policies with their pros and cons.

1. Government spending on infrastructure

With low borrowing costs, the government should be increasing spending on public sector investment projects to provide an injection into the economy and help get unused resources active. Traditionally spending on infrastructure has a large multiplier effect (knock on benefits to related industries) so there could be a significant boost to economic growth from higher public sector investment.

Furthermore, government spending on public sector investment projects can help reduce business costs and boost productive capacity. This doesn’t necessarily have to be high profile projects like HS2, there are many smaller projects which can give a good rate of return (e.g. potholes in roads, need for more rail carriages e.t.c)

If the government announced a series of new investment projects it will also help improve consumer and business confidence. This would be better than concentrating on the need for austerity and ‘things will get worse’. High profile investment projects would create a greater sense of dynamism and hope. By contrast, the recent austerity measures caused a fall in consumer confidence.

  • Evaluation: Some say that given the size of UK budget deficit, we can’t afford to borrow any more. But, bond yields are very low and concerns over the UK debt are partly driven by lack of growth as much as the actual deficit. Counter cyclical spending to boost economic growth, could help reduce the cyclical deficit.  At worst, spending on public investment could be financed by spending cuts which have less negative impact on growth.

2.  Public Investment Bank

Despite low interest rates, bank lending in the UK has been very low since the credit crunch. Banks are seeking to improve their balance sheets and many firms struggle to gain finance for even moderate expansion plans. In the absence of normal commercial bank lending. A public investment bank could make greater lending facilities available to small and medium term firms. The UK is the only G8 country not to have a public investment institute. (see: case for public investment bank)

  • Evaluation: Critics may argue that the government doesn’t have the expertise to evaluate whether loans are desirable, and it may lead to government failure. Also, in the short term, it would be costly if the government gave out loans.

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The monopoly power of Amazon

In the late nineteenth century, firms with great monopoly power were the US railroads and oil companies. These days we have a new set of monopolies, companies like Google, Amazon.  For example, Amazon has over 30% of the online retail of books and DVDs.  Also, a firm with a monopoly selling power like Amazon can often create monopsony buying power. If you are an author, there are only a limited number of firms who will take your e-book and sell it for you. Given the little choice of firms to retail your product, puts authors and publishers in a weak position, meaning Amazon can dictate the amount they pay to authors – especially small independent authors.

Amazon market share of books in US

If you want to sell e-books, Amazon is a dominant firm. In 2012 in the US, Amazon has 27% of the market share for selling book units (traditional and e-books). (book publisher).

Share of online books, DVDs & music

Online Books DVDs & Music Sales
Source

For online sales, Amazon’s position is greater. With online sales, rising to 36% of the market.

Market Share of e-Book sales

For sales of e-books, Amazon’s share of the market is 60% in 2012 – (down from 90% in 2007). (link) Apple has 10%, and Barnes & Nobel 25%.

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Why is the stock market doing well when the economy is doing badly?

Readers question: Why is the stock market peaking when the economy is doing badly? There is an old saying that the stock market has predicted 10 out of the last three recessions. Similarly, you could argue the stock market has been predicting several recent economic recoveries which haven’t really materialised. How to explain why the …

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Impact of fiscal consolidation on debt levels

In recent years, I’ve frequently stated that fiscal consolidation can actually increase debt levels. It may seem a paradox because fiscal consolidation aims to reduce the budget deficit by increasing taxes and cutting spending. Yet, under circumstances, policies to reduce debt levels can actually cause a rise in debt to GDP. This seems to be …

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The bizarre logic of deficit reduction increasing UK growth

The Prime Minister has got into a bit of pickle by trying to maintain the view that deficit reduction policies have not reduced economic growth, and in fact have had the opposite effect.

“They (are) absolutely clear that the deficit reduction plan is not responsible (for low growth); in fact, quite the opposite.” (link)

There is an economic logic to arguing that given the size of  the UK budget deficit, the government need to consider policies to reduce it. Economists will disagree over the timing of deficit reduction. Some economists argue that the deficit shouldn’t be reduced whilst we are still in a recession. Others may argue, we have no luxury of waiting.

I favour the former view that recovery should come before austerity. But, I can at least understand the argument that we should cut the deficit now. However, what I can’t understand is the belief that if you cut public spending in the middle of a recession, that it will have not have some negative impact on economic growth – and in fact spending cuts will have the opposite effect in boosting economic growth. It is really a bizarre logic to hope that cutting spending at the present time will increase economic growth. With falling output, falling construction output  there is no evidence of any ‘crowding in’ in the UK economy. There is however plenty of alternative evidence, e.g. IMF reports, that austerity has caused a negative multiplier effect and reduced growth.

I wonder if there are any economists who really believe that cutting government spending during a period of private sector deleveraging will actually increase economic growth? If David Cameron wrote an A-level essay on ‘discuss the impact of a fall in government spending’ – he would really struggle to get an E grade, and would probably fail.

Has the UK responded to news of public sector wage freezes and lower government spending by rejoicing at the planned reduction in the budget deficit and gone on a spending spree to celebrate?

UK consumer confidence

The impact on confidence has been the opposite. Relatively minor spending cuts have created pessimistic expectations. There has been no confidence fairy miracle. As you would expect spending cuts in an already depressed economy have further reduced real GDP.

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