Do we need economic growth in a modern economy?

real-gdp-1955

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 …

Read moreDo we need economic growth in a modern economy?

Economic Growth UK

  • Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP)
  • In 2016 the UK economy grew by 1.8% –  (compared to 2.2%) in 2015.
  • In the first half of 2017, the economy has grown by just 0.5% (annualised growth of 1%) Q1 0.2% | Q2 0.3%
  • The peak to trough fall of the economic downturn in 2008/2009 is now estimated to be 6.0%
  • Figures for Q2 2017 show the economy is reliant on consumer spending, with industrial output and construction in decline.
  • Real GDP per capita (economic growth/population) is growing at slower rate, due to population growth
  • Updated July 28th, 2017

Recent UK Economic Growth

  UK-growth-since-2007

Source: ONS GDP chained volume | Raw data: real GDP (IHYQ) quarterly Real GDP per Capita (IHXW)

GDP-per-capitaEconomic growth per capita – slightly slower than real GDP

Economic growth per GDP

With population growth averaging around 0.6 – 0.8% a year (about 50% of population growth is caused by net migration), real GDP is boosted by this growth in population. Real GDP per capita and average incomes are growing at a slower rate.

real-gdp-vs-real-gdp-per-capita

Recent history of economic growth

  • Since the recession of 1992 ended, the UK experienced a long period of economic growth – it was the longest period of economic growth on expansion. Also, the growth avoided the inflationary booms of the previous decades. However, the credit crunch of 2007-08 hit the UK economy hard and caused a steeper drop in real GDP than even the great depression of the 1930s. Helped by a loosening of monetary and fiscal policy, the UK experienced a partial recovery in 2010 and 2011. But, by Q1 2012, the UK was back in recession.
  • The second double dip recession was caused by a variety of factors including European recession, lower confidence caused by austerity measures, continued weakness of bank lending and falling real incomes.
  • Since the start of 2013, the UK economy has experienced positive economic growth – one of the relatively best performances in Europe. However, real GDP is still fractionally below its pre-crisis peak of 2007.
  • Faltering recovery? The recovery has been stronger in the service sector than manufacturing and industrial output. There are fears the UK recovery is still unbalanced – relying on consumer spending, service sector and ultra-loose monetary policy.
  • Also, real wage growth has been weak, due to low wage growth, and spike in inflation due to devaluation.

It is worth bearing in mind that sometimes economic growth statistics get revised at a later stage.

Read moreEconomic Growth UK

Recent economic growth compared to trend growth

These are a few interesting graphs which give different perspective on the same situation. i.e. recent economic recoveries – looking at both UK and Spain. Firstly, UK economic growth in the past four years. After weak / negative growth in 2011 and 2012, the UK has been growing at a quarterly rate of approx 0.6%. …

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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 and France since 2010 The …

Read moreFrance vs UK recovery

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.

Read moreThe recession is over but not the depression

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.

Read moreThe Great Moderation

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

Read moreWhat Explains Differences in Economic Growth Rates?

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:
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