Happy days are here again

Here's a shocking chart from the LSE's John Van Reenen:


This chart deserves to be seen by every adult in the UK. It charts all too clearly the true cost to them of the financial crisis and its aftermath.

It is clear that the financial crisis was severe. The sharp drop in GDP per capita in 2008 is unprecedented since 1970. That was bad enough. But what is far worse is the evidence that the UK still has not recovered. Even with recent encouraging growth, GDP per capita remains far below its long-term trend. Those who argue that the financial crisis simply eradicated debt-fuelled "bubble" income are clearly wrong, unless they think the whole of the last 45 years was a bubble.

So what exactly has caused this awful fall in per capita income? Was it due to Coalition policy, as some think, or were there other causes?

In the report from which this chart comes (pdf), John offers a balanced explanation:
The failure to recover lost output shown in Figure 1 cannot be attributed to UK austerity only. The eurozone crisis, the lingering effects of the banking crisis, higher commodity prices, and the decline of high productivity sectors like oil and gas should also be apportioned some part of the blame (Corry et al, 2012, offer an assessment). 
But what is striking is how much worse the UK performed during the first half of this Parliament when austerity bit hardest. Between 2010 and 2013, GDP per capita growth was worse than in the United States and Japan, both of which had independent currencies like the UK. UK performance was similar to the countries in the eurozone hit by even more severe austerity and a currency crisis.
So although the UK was hit by severe secondary shocks, the fiscal policy pursued by the Coalition government in its first three years contributed to the UK's poor recovery. The OBR estimates that Coalition fiscal consolidation cut GDP growth by 2% in 2010-12. John suggests the real figure may be higher because the OBR uses conservative multipliers and ignores hysteresis effects.

Using data from the OBR, John shows that in 2010-12, the UK's deficit reduction actually proceeded faster than planned:


But despite this front-loaded consolidation, the Coalition's intention of eliminating the current budget deficit by the end of this Parliament has not been achieved. John says that this is because the austerity programme has tailed off since 2013: in the current financial year there has been no fiscal austerity at all. Funny, that. As the election approaches, austerity diminishes.....

So having failed to deliver on their original mandate, the Conservatives now plan to repeat the whole exercise again. Severe austerity in the first three years of the next government (assuming they win the election), followed by relaxation in the last two years. The economic effect would be similar:
Explicit macroeconomic modelling of the impact of alternative paths of fiscal consolidation suggests that by 2019-20 output, employment and debt would be a bit higher under Labour and Liberal Democrat plans compared with the Conservatives (Kirby, 2015).  
I find it odd that the opposition parties are not shouting about the negative prospects for employment and per capita incomes in the short term that Conservative plans imply.

But the really scary part of all of this is the effect on investment. The Coalition government has achieved the majority of its deficit reduction by means of sharp cuts to investment: as the chart shows, public sector net investment has fallen from 3.3% of GDP before it came to power to 1.4% in the current financial year. The Autumn Statement committed the Conservatives to achieving an overall budget surplus by 2019-20, achieved through spending cuts alone. John points out that this leaves little room for investment:
By including public investment in plans for balance, this would prevent a future Conservative government from borrowing for additional public investment. The Autumn Statement pencils in public investment as just 1.2% of GDP from 2017-18 onwards.
 How is the "long- economic plan" going to create long-term economic prosperity if it includes little or no long-term investment in infrastructure, human capital and innovation?

Sadly, it seems increasingly unlikely that the public will hold the Conservatives to account for their part in the UK's poor economic performance in recent years. It seems unfair that the Conservatives can claim to have generated a recovery that they actually did their level best to prevent, but people have short memories. Recent fiscal relaxation coupled with giveaways for key voter groups has created a "feel-good factor": people whose real incomes are rising now after years of falls don't notice that they still are poorer than they were in 2007.

In the interests of balance, however, I should point out that Labour and the Liberal Democrats also plan further austerity after the election. The parties really only differ over the pace of consolidation and the means by which deficit reduction would be achieved. Whichever party wins, the next few years will be tough.

Happy days are here again....until the election.

Related reading:

Austerity: growth costs and post-election plans - Pieria
Be careful what you wish for, Mr. Cameron - Pieria
The Chancellor's incredible spending cuts - Pieria
What derailed the UK recovery?

Comments

  1. As I’ve been pointing out since the crisis started, the plonkers, ignoramuses and morons in high places can’t work out how to effect stimulus at the same time effecting consolidation (if that’s needed, which it isn't while interest rates are near zero).

    By “ignoramuses and morons” I’m referring as much to so called “professional” economists (e.g. Rogoff and Reinhart) as politicians. Many of those so called “professional” economists know as little about economics as the average politician.

    When it comes to consolidation, all the ignoramuses and morons can think of its: “cut public spending and/or raise taxes”. And that of course brings consolidation, but unfortunately also raises unemployment.

    The solution is to combine QE (which is stimulatory) with tax increases (which are deflationary). Mix the two in the right proportion, and net effect on unemployment is zero, meanwhile the debt declines.

    ReplyDelete
    Replies
    1. "When it comes to consolidation, all the ignoramuses and morons can think of its: “cut public spending and/or raise taxes”. And that of course brings consolidation, but unfortunately also raises unemployment."

      The 'ignoramuses and morons' were relying upon the deflationary effects of 'austerity' being 'offset' by a combination of monetary policy, supply side economics and the new voodoo economics, the Barro/Ricardo equivalence?
      “The effect on private sector confidence and spending: reassuring the private sector that concrete measures have been put in place to limit the rise in government debt could prompt households and companies to reduce precautionary saving, increasing consumption and investment relative to what they would have been otherwise.
      A simple comparison of the pre-Budget and Budget forecasts produced by the OBR suggests that fiscal consolidation will negatively affect the economy in the short term. However, the OBR has stressed that “it is potentially misleading to interpret the difference between the pre-Budget and Budget forecasts as the economic impact of the Budget measures.”
      The OBR note that interest rates would have been higher in the absence of the fiscal tightening announced in this Budget, and it has provided an illustrative calculation that long-term interest rates might have been 0.3 percentage points higher. Higher interest rates would negatively affect output and employment.”
      P 19 June Budget 2010.
      http://www.direct.gov.uk/prod_consum_dg/groups/dg_digitalassets/@dg/@en/documents/digitalasset/dg_188581.pdf

      B.M. provides evidence that it is ineffectual?
      "But we can also consider the model on the basis of how it stacks up in an empirical sense. When Barro released his paper (late 1970s) there was a torrent of empirical work examining its “predictive capacity”.
      It was opportune that about that time the US Congress gave out large tax cuts (in August 1981) and this provided the first real world experiment possible of the Barro conjecture. The US was mired in recession and it was decided to introduce a stimulus. The tax cuts were legislated to be operational over 1982-84 to provide such a stimulus to aggregate demand.
      Barro’s adherents, consistent with the Ricardian Equivalence models, all predicted there would be no change in consumption and saving should have risen to “pay for the future tax burden” which was implied by the rise in public debt at the time.
      What happened? If you examine the US data you will see categorically that the personal saving rate fell between 1982-84 (from 7.5 per cent in 1981 to an average of 5.7 per cent in 1982-84).
      In other words, Ricardian Equivalence models got it exactly wrong. There was no predictive capacity irrespective of the problem with the assumptions."

      http://bilbo.economicoutlook.net/blog/?p=15028 more-15028

      Delete
  2. While I basically agree with your point that this government probably mistimed and misapplied austerity to an extent, this habit of doing a simple regression on past GDP and declare it as trend growth is irritating and it seems to me not well founded.

    Surely you guys can use that argument every time there's a cyclical correction, but equally surely one day (be it today or later) you will be wrong because GDP growth is essentially population + technology, and both of these will sooner or later be flat (or go down), either permanently or for some period that spans multiple business cycles. It does not mean the growth period before a plateau is "45 years of bubble" but simply can reflect strands of technological change that take time to trickle down and/or happen concurrently but fortuitously.

    My suspicion is that *some* of that inflection -- which is universally observed to a degree or other regardless of government policies -- is explained by fundamentals.

    It's just an example, but I was part of UK GDP up to the peak, and I can tell you my colleagues and I weren't contributing anything useful to UK prosperity in net terms, working in a zero sum business that just sold delusions to customers who would have been better off had we not existed. But our generously compensated "work" was added to GDP. The UK is definitely better off that fewer of us (both in headcount and total pay) are now in that zero sum business, which is a clear benefit of the crisis but shows up in lower nominal GDP because the GDP deflator does not include the real life benefits of taking (some) zerosumers out of the game, and hopefully towards more productive endeavours.

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    Replies
    1. I agree that the pre-2008 trend may well have been too steep given demographic and technological changes, but you really can't argue that the sudden drop followed by a 3-year plateau is due to secular effects. Nor can you argue that because you and your colleagues weren't doing anything productive before the crisis therefore the UK as a whole was on an unsustainable trend growth path based upon illusory activity. That is what they call "generalising from the particular", otherwise known as the "fallacy of composition".

      To me it is clear that the UK has not yet found a post-crisis sustainable growth path. There have been real losses to the people of the UK which in my view are largely if not entirely due to negative shocks and a less-than-supportive policy mix. What the sustainable trend path will be in the future remains to be seen, and yes it may be flatter than the previous one. Until that trend is firmly established we will not know what proportion of the loss in recent years was due to the crisis and what proportion is due to secular trends.

      Delete
    2. So we agree on the difficulty of attribution, hence showing simplistic trendlines in charts "everybody should see" being somewhat misleading, no?

      Yes, you can't generalise from the particular, hence me saying it's just an example, but finance is a big industry and zerosum stuff is perhaps 3/4 of the activity, and it did grow hugely as a proportion of GDP in the US and the UK in the decade or so up to the crisis, with little to show for it (the net useful part of finance probably shrunk through automation during that period). I would guess that that such dead weight may have easily contributed something like 10% of GDP, which is pretty material when it shrinks.

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    3. In the absence of counterfactuals, I wouldn't like to say that the trend is necessarily non-linear. What may have happened is that the "deadweight" finance activities crowded out more productive functions: the finance activities have shrunk considerably since the crisis, but it takes time for other activities to grow to fill the space they left. You can see this effect to a lesser extent after each of the earlier recessions on the chart. It is evident that the 2008-9 collapse was much greater, so we might expect that the private sector would take longer to develop replacement activities, and I would argue that further negative shocks coupled with over-tight fiscal policy from 2010-13 actually delayed what we might call "crowding-in" of new activities. But that doesn't necessarily mean the long-term trend has changed.

      Delete
  3. The last 45 year are exactly a bubble, because 1970 is when the fully fiat global monetary system came into being. The whole 1970 to 2007 period is a repeated cycle of boom and bust based on increasing debt, each bust being caused by the pricking of the credit bubble du jour, and only grown out of by the addition of extra debt on top when animal spirits pick up again.

    There is a limit to how many times you can do that and still maintain the 1970-2005 growth trendline. It would be instructive to compare the trend growth rate of the 40-50 years prior to 1970 with that post 1970, and see if what were are experiencing now is more akin to that.

    ReplyDelete
  4. Investment only adds to costs without a issuance of new tokens.
    Check out the latest Iea energy stats for Europe.
    Nat gas consumption in Europe down 10%
    Something is gravely wrong with France with electrical consumption down 6.1% - the biggest decline seen in the Oecd.

    We can see the consequences of the monopoly of credit.
    The banks has always extract purchasing power.
    As there is no basic demand as seen above in basic energy consumption tfigures they subsequently dump the surplus typically via the creation of credit for yet more cars.
    This destroys the industrial surplus before it can be effectively used.
    The obvious policy is to maintain wealth concentration at all costs.

    Me thinks the social creditors have won all economic arguments.
    However censorship prevents people from understanding the true majesty of the banks malice.
    England as the center of the European usury experiment can no longer absorb the products of the European entrepreneurs as they are not optimised for true bottom up demand.
    The banks front load /destroy demand before it can be effectively used.
    The ever rising diesel consumption in Europe points to where the true problem is.
    Europe is nothing more then a racetrack economy / society.

    ReplyDelete
  5. Investment only adds to costs without a issuance of new tokens.
    Check out the latest Iea energy stats for Europe.
    Nat gas consumption in Europe down 10%
    Something is gravely wrong with France with electrical consumption down 6.1% - the biggest decline seen in the Oecd.

    We can see the consequences of the monopoly of credit.
    The banks has always extract purchasing power.
    As there is no basic demand as seen above in basic energy consumption tfigures they subsequently dump the surplus typically via the creation of credit for yet more cars.
    This destroys the industrial surplus before it can be effectively used.
    The obvious policy is to maintain wealth concentration at all costs.

    Me thinks the social creditors have won all economic arguments.
    However censorship prevents people from understanding the true majesty of the banks malice.
    England as the center of the European usury experiment can no longer absorb the products of the European entrepreneurs as they are not optimised for true bottom up demand.
    The banks front load /destroy demand before it can be effectively used.
    The ever rising diesel consumption in Europe points to where the true problem is.
    Europe is nothing more then a racetrack economy / society.

    ReplyDelete
  6. For year 2014 IEA
    UK electricity consumption down 5 %
    Nat gas consumption down 8.5%

    As a once keen amateur astronomer I am all in favour of shutting off the mordor like dull orange glow of sodium street lights
    But something other then this is happening
    At first I thought this was the end of the dash for gas liberalisation period but me thinks something far more fundamental is happening.

    ReplyDelete
  7. My only quibble is that the long term trend is an observation from the past, projected forwards. Can anyone show that we should expect the linear trend to continue upwards 'for ever'? Or flatten? Or fall?

    ReplyDelete
    Replies
    1. Continuation of a long-established linear trend is the "null hypothesis". You would need to show that despite its apparent linearity the trend is in fact non-linear. How would you prove that?

      Delete
    2. But the choice of the data period and a linear trend is itself a choice. I have taken the same data set but used the quarterly data from 1955 Q1 and mathematically fitted a polynomial curve of degree 4 to it and the trend fits the data much more closely than a linear trend - but unless I can explain why I should use 4 degrees it is just an exercise which reveals nothing about the underlying reality.

      Similarly the linear trend *must* fail at some point, if only because the underlying assumptions fail. My worry is that post-war growth may flatten because exploitation of people, resources and technology has exhausted possible unrealised gains. Perhaps Western economic performance will 'settle' like Japan's. Perhaps it has already. How will we know?

      Delete
  8. No need for England to invest if current euro dynamics persist.
    The very home of Dirigisme has imploded.
    As a consequence
    the channel elec connections have been running at full import capacity this past year.
    The restructuring of England in the 70s and 80s was clearly designed to absorb euro mercantile operations.

    ReplyDelete
  9. No need for England to invest if current euro dynamics persist.
    The very home of Dirigisme has imploded.
    As a consequence
    the channel elec connections have been running at full import capacity this past year.
    The restructuring of England in the 70s and 80s was clearly designed to absorb euro mercantile operations.

    ReplyDelete
  10. What if the bubble began in 1545 ?

    ReplyDelete
  11. Hi Frances

    The maths that kicks of the post is wrong. The fact there is no return to trend is not extraordinary. The previous recessions are included in the data that created the trend line , but the last recession is not included. And so the trend line is mathematically unrealistically steep in the context of what is possible for a recovery from the recession that is excluded from the data of the trend line.

    For example the graph does not return to pre recession trend line in 75 80 or 90 either when the appropriate pre recession trend lines are drawn in.

    However high the growth , in what is reasonably expected possible, after the recession years, a new trend line is created, and it isnt as steep as the the previous trend line growth after a significant fall. That applies to any growth line that you care to draw that excludes a significant downturn at the end.
    For example the graph does not return to pre recession trend in 75 80 or 90 either.

    ReplyDelete
    Replies
    1. Hmm no, Dinero. You want to incorporate volatility into the linear trend. But on a very long-run trend, volatility disappears. So the long-run trend is correct. The question, which others have asked, is whether the trend is in fact non-linear over an even longer time horizon. The Solow growth model suggests that this might be the case.

      If you want to take this up with John Van Reenen at the LSE yourself, please do. :)

      Delete
    2. OK thanks for the reference to John VR

      However -

      Volatility only dissapears as the change becomes insignificant . But this chart is used to demonstrate a significant recession on a chart and so However long the time scale is Its not mathematically possible to "return to trend" if the recession is a significant feature of the chart.




      The Y axis on that graph is a dimensionless logarithmic scale with equal spacing . Something I think inappropriate in Economics. Its not even used in applied sciences I think.
      And Its labelled linear trend when in fact it is linear slope on a log scale and so an exponential real trend.

      Delete
    3. i'm not an economist but i think it is quite common. it's gdp in market prices i.e the nominal gdp which is supposed to grow exponentially given there is inflation. log(gdp) is supposed to have a linear trend.

      So every 10 years log(gdp) picks up ~0.2 points or 50% or ~5% per year. Remove the inflation rate and you get an idea of the real gdp growth trend. It's convenient.

      Delete
  12. http://www.socred.org/blogs/view/social-credit-explained-in-7-points

    ReplyDelete
  13. http://www.socred.org/blogs/view/social-credit-explained-in-7-points

    ReplyDelete
  14. The social credit maxim, the true costs of production is reflected in consumption.

    The very reason for being is to justify usury in all its modern forms.
    The shock horror thingy does not cut any ice.
    They are fully aware of how the system exploits the industrial surplus.

    ReplyDelete
  15. The Lse that is
    They are intelligent people
    Even Dorks can figure this out

    Ps
    When will the Lse invite Oliver Heydon to a conference..........
    I guess he would be waiting several lifetimes

    ReplyDelete
  16. NGDP growth is in large part a function of inflation or the lack thereof. This chart would look a lot better if the UK had maintained 4% inflation over the past decade.

    ReplyDelete
  17. "The failure to recover lost output shown in Figure 1 cannot be attributed to UK austerity only. The eurozone crisis, the lingering effects of the banking crisis, higher commodity prices, and the decline of high productivity sectors like oil and gas should also be apportioned some part of the blame (Corry et al, 2012, offer an assessment). "

    What we do 'know'?

    “But, on the same basis, the recent recovery has actually been slightly faster than during Thatcher's hey-day. “ {July 2011}.

    Due to a quickly implemented stimulus package?

    http://www.telegraph.co.uk/finance/comment/liamhalligan/8672677/Why-Chancellor-George-Osborne-must-not-flinch-from-carrying-out-his-austerity-plan.html

    Then came 'austerity'?

    " . . . the current recovery in the UK is the slowest in 300 years . . . "

    http://bilbo.economicoutlook.net/blog/?p=30381

    ReplyDelete
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