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danieldwilliam) wrote2012-11-09 11:18 am
On Over Celebrating Mediocre GDP Growth
The government is trying to portray the UK’s recent return to growth as a vindication of their economic strategy of achieving growth through public sector austeriry leading to business confidence and lower interest rates. Recent growth figures of about 1.2% per annum, and fragile growth at that, don’t appear to me to be the signs of an economy that is returning to normal after a successful Treasury intervention.
There are some patterns in the UK economy over the last decades. You might argue that the current sitution is so unprecidented that previous patterns are of no use nor interest. You might be right, but they are what we have. I’m proposing to use them as a bench mark. If the benchmark is appropriate then I conclude we are lower than expectation. If the benchmarks I’m using are no longer valid, then we have bigger problems ahead of us than we currently imagine.
UK long term trend growth is about 2.4% to 2.5%. That is, each year on average since the Second World War our GDP has grown by about 2.4%. There have been periods of recession, periods of slower growth. There have been compensating periods of faster growth. More often than not when the economy suffers a shock and falls into recession it shrinks, has a spurt of strong growth, muddles about a bit, then shrinks again before growing strongly for a period then returning to trend. Double Dip Recessions are the norm, rather than the exception. The pattern from previous larger period of economic stagnation is that the period of muddling about is protracted before growth returns and when it returns it is stronger and faster for a longer period.
The basic pattern is that something goes wrong, we stumble and then grow more quickly until we are about back where we would have expected to be had we not had the shock in the first place.
So, if we were expecting our GDP in 2020 to return to the same levels we would have expected to see if our 2007 GDP had continued to grow at 2.4% what kind of growth rate would we be expecting? I calculate we would need to see a growth rate of 4%. That puts the annualised UK GDP growth figure for Q3 2012 of 1.2% starkly into context.
And remember, to return to the position we would have expected to be in by 2020 we need growth of 4% every year for the best part of a decade. That’s about half of what China is expecting.
For us to return to expectation by 2017, the end of the OBR’s medium term forecast, we need annualised growth of 5% in 2013, 2014, 2015, 2016 and 2017.
At current forecast growth rates we only return to our peak GDP from Q2 2008 in Q2 2014. Essentially we are expecting 6 years of an average of zero economic growth. That’s based on OBR forecast growth rates of 2.00% and 2.70% in 2013 and 2014. That’s about double what we are seeing today. If growth continues at the much heralded 1.2% we don’t return to pre-crisis peak for another year and a bit after Q 2014.
1.2% growth is better than a poke in the eye with an austere stick but it is much much less then we would typically expect to see if we were coming out of a period of economic turbulence. If the Treasury's expecation is that we will return to our previous long term trend and eventually catch up with ourselves then we are still far off that pace, now and in OBR forecasts for future years. If the Treasury think that we have permanently lost output from 2008 and that our longer term growth rates are now permanently lower than 2.4% then I think we all have some bigger problems than perhaps we realise.
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There are certainly good reasons to move away from GDP as a metric of the performance of economy. (I am in this camp.)
There are also good reasons why one might not see continued economic growth as a good thing. (I am not in this camp. So far.)
But as one of the main reasons we obsess about economic growth is to avoid working out what to do with all the people who would not have a job if we didn’t have economic growth we probably need to be concerned if we aren’t going to see any before we’ve figured out what to do with (mainly) low skilled workers.
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The rest of the world is catching up with us, and while part of that will come from them increasing very quickly, part of it will come from us increasing more slowly. Thankfully, our standard of living is already pretty darn high, overall, if badly distributed.
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Long term trend for quarter on quarter growth looks like 0.7 going back to the 50’s.
Trend from 1990 to 2008 was 0.69.
Trend from 2000 to 2008 was 0.75.
They looked a little better than the preceding decades and on a higher base.
The reason we catch up isn’t magical it’s linked to the idea of the supply side capacity of the economy and, I think, ultimately, to the root cause of the recession.
There is a theory that, at any one time, there is an upper limit to the potential GDP of an economy. This is different from the actual GDP being produced. The theoretical maximum can change over time as more capital, labour or technology is added but over the short term (in economic terms) is practically fixed. That addition of labour, capital or technology is GDP growth.
In most cases a recession causes some production that would usually have taken place to not take place. People don’t buy some consumer good. A firm doesn’t refurbish its factory. GDP drops or becomes negative. Then confidence returns and people buy the stuff they were going to, invest in the machines they were going to and the actual economy grows quite quickly until it approaches the leading edge of the theoretical maxima. At this point growth slows towards the long term trend.
Some argue (and I have some sympathy) that what we have now is slightly different and that the trajectory of theoretical maxima we thought we were going to have was a) wrong all along or b) broken and so our economy is permanently less than we thought it would be. This being the second of my bad news alternatives. Either we are still growing way below what we would expect or our expectation is wrong.
I see that fact that the rest of the world is catching up with us as a good thing. Endogenous growth theory is not my main strength but I think the fact that other economies are approaching their own theoretical GDP maximum as they load in technology and capital to their economies is good news for us and for our own longer term growth rates. Firstly, their new richer consumer mean demand for our goods and services. Secondly, it is currently very lucrative to invest in developing nations infrastructure and this diverts funds from investing in our own. As their infrastructure gets built out there is more investment available to refurbish or extend our own. Thirdly, as developing nations reach their output frontier they start pushing it by developing technology too. Which means more technology being created and available for us to use.
There are still a few decades to go before this is the case I think.
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Which isn't to say that we won't still grow, but I think that our growth will be lower than it was.
I do agree that the rest of the world catching up is a good thing. Both for them (for obvious reasons) and for us because it increases the size of the total markets we operate in, and will force a change in how the world operates.
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But the implications of your view being correct are not fun. Mainly because I think we have already spent all the extra money your lower growth assumption brings in and maybe a bit more besides.
As a tangent I worry that holders of capital couldn’t find some assets more productive to invest their surplus cash in than a series of bubbles. I think that’s a bit of a worry for the labour forces of the West mainly, but also the East.
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Of course, the holders of capital (pension funds, etc.) need to outpace inflation, preferably by several percent, in order to not be in rampant arrears all the $%^$^% time, because of the way they're structured (and the fact that we need to support ourselves for 30 years after retirement, having only worked for 40 years). So they invest in whatever is seen as safe, and also gives a high rate of return. So when the credit ratings agencies say "Packaged sub-par mortgages? Totally AAA!" they all pile in.
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http://www.guardian.co.uk/commentisfree/2012/nov/14/austerity-here-to-stay
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Nor do I share Ryan Bourne of the Centre for Policy Studies response that low-tax, low-regulation policy responses are the only answer or an entire answer.
http://www.cps.org.uk/blog/q/date/2012/11/15/there-is-no-global-race-and-prosperity-is-not-zero-sum/
The OECD report on which both of these articles are based see UK GDP trend growth to 2011 as 2.3%. Over the next few decades they forecast 1.9% then rising for the three decades to 2060 2.2%.
For per capita GDP growth the figures are 1.9%, 1.3% and 1.8%..
1.9% GDP growth on average over the next two decades is okay. I’ll take that. Compared to the effectively zero growth we’ve seen for the last few years 1.9% growth is going to feel like paradise.
Big assumption in the OECD forecast is that people continue to retire at 65. Which I personally just don’t see happening. Either structurally in terms of the rules or through individual choice.
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I think Labour had a kind of bargain with the ultra-rich - they would bring in The Money at high rates, and in exchange inequality would be swept under the carpet. With a low rate of growth, I hope that they'll be willing to make the same deal.
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