Thursday, May 02, 2013

Austerity bites

I'm not an economist, as I've mentioned once or twice before. As a result, I sometimes struggle to understand even the terms of the debate. Paul Krugman, and now the IMF, clearly believe that UK austerity is hurting the economy, and should be replaced by a policy of substantial fiscal stimulus. I can understand the logic behind this - if consumption is down, then Government spending can replace it. Since GDP = C+I+G+(X-M), there's a certain mathematical simplicity about this that I understand.

Where I struggle though is at a more macro level. Apart from consumption (which I think can be at least partly explained by the fact that people are trying to deleverage their enormous household debts) the sluggish GDP growth can be put down to three principal causes: diminished production of North Sea oil and gas; depressed activity in the financial sector, and huge falls in construction.

These are all principally supply-side problems, and demand-side measures (like fiscal policy) aren't really going to sort them out. By way of illustration - there's no shortage of demand for houses in most of the UK. Problems in the construction sector must therefore be on the supply-side. I can envisage Government led solutions to this (planning reform, planning reform, planning reform) but I don't really see that an increased deficit is the most efficient way to deal with it.

Similarly with the financial sector, much of the fall in activity has been the equivalent of blowing the froth of a cappuccino. As such it's a decline in illusory production (and has indeed been partly policy-led). This surely isn't a failure than needs to be (or could be) corrected by greater public spending.

As to oil and gas - much of the fall in production is the inevitable result of an ageing oil field with diminishing reserves. More is the result of catastrophically short-sighted tax policies initiated by Gordon Brown and exacerbated by George Osborne (marginal tax rates on some fields are now as high as 81%). When you tax something, you get less of it. When you tax something punitively, you get much less of it. Here at least is a candidate for Government intervention, if only by cutting rates.

However, for all three sectors, there are signs of good times ahead. For oil and gas, capital investment is at an all time high, and production is forecast to start rising again. For the financial sector, the recapitalised banks are returning to profitability. Even construction is showing signs of stabilising. I'm not sure that any of these are really determined by fiscal policy. Austerity didn't cause their decline, and stimulus wouldn't trigger their recovery. I sometimes get the feeling that the policy battles over austerity vs stimulus are really a proxy for something else.


Anonymous Anonymous said...

I think there are some things here to be wary of. Firstly the current economic woes of the UK needn't have a single, simple cause. Some supply side problems does not preclude demand side issues as well.

Of the issues you discus I think that the construction industry is maybe the most significant.

The crash hit financial services hard and financial services may have been growing in an unsustainable way but it is very difficult to output at above capacity for a significant length of time. Oil and gas output is also clearly not solely responsible for the decline in the economy - obviously it is a worldwide trend and obviously it is a longer term issue not a sudden shock (although your implied point that a big boom in the sector would be helpful is still true).

I think that construction is key to understanding the slow recovery, not because of construction itself but because of what it says about the credit market. There is demand for housing but it is not being met. Much of construction is credit financed so difficulty securing loans due to perceived risks is a big deal in the sector. In this sense the supply side issue is credit. This doesnt mean that sorting out planning application deadlocks is unimportant - there may be areas of the country where this is a limiting factor but the bigger issue is credit.

From a perspective of stimulus/demand side policies there is something we can do. Lending is low because of a high risk of default and high loss given default in much of the market. More security for incomes, due to higher demand/lower unemployment will in turn lower the risk of investment (whether in housing, factories or even in education) and close the spread between banks interest rates/supply of credit and BoE terms.

In general all recessions come to an end at some point (although some might argue that Japan is still waiting) and much of this is an argument for what should have been done a few years ago if we believe the future is better. As it is, we are right to worry about premature fiscal consolidation - it isn't too late to learn the lessons of the USA in the late 1930's.

9:56 pm  

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