Tuesday, 2 November 2010

UK’s Q3 GDP figures were -an endorsement of government spending, not austerity

By Michael Burke

The UK GDP data for the 3rd quarter have received more than usual attention, with many commentators claiming that the 0.8% growth rate provides room for the government’s ferocious cuts in government spending – even that they provide a justification for them.

The BBC’s Stephanie Flanders leads the way, arguing not only that the data will cheer the Cabinet but that these are the strongest 3rd quarter numbers in a decade- precisely one of the lines advanced by George Osborne. If we concede that it is the BBC’s economic editor who is writing the Chancellor’s script, not the other way around, it is certainly a happy coincidence for the government to have such a like-minded and highly visible commentator. Even the Tory-supporting media were generally more circumspect than the BBC, with the exception of The Times, which declares that, ‘the deficit reduction strategy appears to be working’. Countering Nobel Laureate economist Paul Krugman’s assessment of ConDem policy that, ‘premature fiscal austerity will lead to a renewed slump’, The Times’ leader writers argue ’the evidence so far suggests that the Government’s approach is not endangering recovery’.

The essence of the Osborne/Flanders/Times argument is based on the following propositions:

  • The data is strong and reflects the impact of current government policy

  • This strength will mean that the private sector is well able to withstand cuts in public spending

  • Because the cuts boost the confidence of the private sector

All three propositions are entirely false.

The last argument is thoroughly demolished by another Nobel Laureate Joseph Stiglitz specifically referring to Britain, where he argues that Britain cannot afford austerity and needs another stimulus package, focused on investment in education, infrastructure and technology. SEB will deal here with the first two propositions.

Impact of Policy

The first estimate of GDP is an output measure, while later assessments are based on incomes and expenditures. As such, the initial estimate can be, and frequently is revised substantially. For the time being the data shows that the recovery has been in place for a year and that the economy has grown by 2.8%, only a little more than its 2.5% long term trend growth rate. This follows a 6.4% decline over six quarters, so that the economy is still nearly 10% below its pre-recession trend growth.

One of the more absurd claims is that this recovery is in response to current government policy, since the first three quarters of the recovery took place before it came to office. Further, £6bn in cuts were announced in June and are only just being implemented. Yet the latest GDP data show direct government spending rising in both this quarter and in the 2nd quarter, when the economy expanded by an even stronger 1.2%.

These rises in government spending represent the outcome, with a time lag, of the spending decisions of the previous Labour government in its 2009 Budget. This direct spending on government services has made a contribution to growth in both the recent quarters and cannot possibly be attributed to current government policy.

But, despite some uncertainty about the data, the biggest single contribution to growth is made by the construction sector as Gavyn Davies, former global chief economist for Goldman Sachs has pointed out. Construction, together with government services comprises more than half the entire rise in GDP in the latest 2 quarters. With in construction activity, public spending accounts directly for 42% of the overall increase. Yet its impact is actually much greater, and plays a determining role in the construction sector’s contribution to growth- in what might be described as a textbook example of the leading role of the State in the whole economy. The table below shows the year-on-year growth rate of different components of construction and the source of spending.

Table 1

10 11 02 Table 1


The public sector led the way in the strongest growth categories of construction (including infrastructure, where it predominates), and is actually the source of the entire rebound. Where the public sector activity was weak, in housing repair, the private sector did not supplement that weakness with anything more than reasonable strength of its own.

The strength of current data, which is actually modest, reflects the increased spending of the Labour government in 2009.

Economic Outlook

This increased government spending is already fading away. The year-on-year growth of direct government spending, as well as in areas where it contributes to spending such as construction, is at or close to zero. New construction orders for example, fell by 13.9% in the 2nd quarter. Reflecting the disastrous impact of Alistair Darling’s March 2010 ‘worse than Thatcher’ Budget, it is public demand that has led the way, with public housing orders down a scandalous 22.7% in the 2nd quarter alone.

This is before the Coalition sets to work. The table below is reproduced from the Comprehensive Spending Review (CSR) which shows the Departmental capital spending cuts. The final column shows the real terms decline after inflation, although even this is an underestimate as it comprises both a favourable inflation estimate and ignores depreciation. The roll call of savage cuts is relentless.

Table 2

10 11 02 Table 2

There has been much discussion of whether this will provoke a ‘double-dip’ recession. It is entirely possible, but this should not be the litmus test of policy. It is quite possible, for example, that a collapse in demand arising from this policy, both for consumption and investment goods leads to a slump in imports. Statistically, this would provide a boost to GDP even while the economy is decimated. As Stiglitz says, cutbacks ‘will spell lower growth – and lower revenues. Indeed, higher unemployment itself, especially if it is persistent, will result in a deterioration of skills, in effect the destruction of human capital, a phenomena which Europe experienced in the eighties.’

It is this destructive force of government policy, especially as manifested by the persistence of falling incomes, job losses and long-term unemployment which will be the true measure of its effect. And, from Keynes’ dictum that ‘take care of the unemployed and the deficit will take care of itself’, there can be no confidence that the purported aim of government policy to reduce the deficit will be advanced in any significant way.

The Destruction of Employment

The Lib Dems’ chief secretary to the Treasury Danny Alexander leaked to the press that there would be 490,000 job losses arising from the CSR. This is to manage expectations lower; the Guardian had already obtained a Treasury estimate of 500,000 to 600,000 public sector and 600,000 to 700,000 private sector job losses. This is not the same as unemployment, as there is a trend growth in the labour force of around 30,000 per month, implying that employment has to grow at that rate simply to stabilise the unemployment level.

The chart below shows the total jobs in the British economy since the beginning of 1978. The first peak in employment during that period was 27.4mn jobs at the end of 1979. Thatcherism destroyed 2 million jobs by the beginning of 1993 and the previous peak level in jobs was not recovered until the end of 1987, 8 years later. Meanwhile, the workforce had grown by a further 2million, leading to mass long-term unemployment which hit youth, women and black and other ethnic minority communities especially hard. A new peak in employment was reached in mid-1990, at 29.2mn jobs. But 1.8 million jobs were lost over the next 3 years, so that by mid-1993 there were actually 30,000 fewer jobs than the total Margaret Thatcher had inherited in 1979. This new peak of 29.2mn jobs was not recovered until the 2nd half of 1999.

Chart 1

10 11 02 Chart 1


The most recent recession began in 2008 and in terms of severity was almost as great as the 1980 and 1990 recessions combined - output fell by 6.4% compared to a combined decline of 7.1%. However, the total decline in jobs was 1.05mn. This is very severe loss of jobs, but not on the same scale as the total of 3.8mn lost jobs in the 1980s and 1990s. In the most recent quarter there were a net 71,000 jobs created, although these were overwhelmingly part-time jobs.

As shown in the chart below total hours worked (a measure which removes all the distortions by shifts between full-time and part-time work, as well as those introduced by repeated changes to the unemployment register) grew by 2% in the latest 2 quarters.

Chart 2

10 11 02 Chart 2
It is absurd of the Government Ministers and their supporters to claim credit for a job rise that took place even before they took office. Their handiwork will only become apparent in employment totals next year.

In fact, given that the employment decline has already halted, there will be no-one to blame for the destruction in jobs next year except this government.

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