GDP – time travel and little green men
Today’s truly shocking economic numbers – which showed a 0.7% decrease in gross domestic product (GDP) in the second quarter – may have come as a surprise to the pundits, but the political response has been all too predictable.
Government spokesmen, visibly shell-shocked, have scratched around for mitigating factors. Thus far, possible culprits mentioned have included the Eurozone crisis, the stronger pound, the rain and the extra Bank Holiday, though there has been no attempt – yet, anyway – to blame it on little green men from outer space.
Labour, equally predictably, has repeated the tired mantra about cutting public spending “too far, too fast”. Since spending cuts have had little impact thus far, it seems high time that Labour rationalised its economic stance – by finding more rational arguments.
The further sharp fall in construction activity highlighted (for those willing to look) an explanation that we have set out many times before. The essential problem with the British economy is structural.
Ten years of reckless private borrowing built up construction, real estate and finance just as a decade-long surge in public spending boosted health care, education and public administration. Together, these sectors – which depend on now-defunct drivers – account for 59% of the economy. Add in a retailing sector beleaguered by a combination of falling real incomes and excessive household indebtedness, and 70% of the economy is ex-growth. This cannot be fixed with minor tweaks to the system.
Thus seen, politicians’ prescriptions amount to a desire for time-travel. ‘Why don’t we’, they seem to say, ‘go back in time to the days of high private borrowing, and public spending largesse?’ The government wants banks to lend more to households (as well as to businesses). Labour wants to go back to high public spending. Both arguments are futile.
What politicians (of all hues) don’t want the public to know is that they’ve already tried almost every policy in the macroeconomic book – including deficit finance, devaluation, near-zero policy rates and printing money – without success. These tools, effective in destocking downturns, simply do not function in a deleveraging recession, which is what we have now.
Britain should examine some of the money-saving moves used in – for example – Spain, but with the critical difference that, instead of simply reducing the deficit, Britain could use savings in current spending to boost capital investment, of which the building of more social housing should be top of the list. Second, when macro has failed, try microeconomic reforms – free up businesses by cutting away at the thickets of excessive regulation.
Would the possibility of “building of more social housing” by the public sector be considered to be too risky bearing in mind that private sector house prices are falling and likely to for years to come? Or are public and private sector housing “different”?
Barry: Yes, different in many fundamental respects. First, there is no doubt that social housing is very much needed. Second, the depression in the building industry should mean that government can get new houses built pretty cheaply. Third, these homes become national assets – the homes would be rented, not sold. Fourth, history has shown repeatedly that house-building has very good knock-on effects into related industries and trades – think electricians, plumbers, builders’ merchants and so on. The extra taxes paid by these companies and workers – and the removal of large numbers of people from unemployment – would produce a significant offset to the Treasury. Fifth, the vast majority of this programme would be placed with domestic suppliers, not imported.
Your earlier articles talked in some ways about the government getting out of the way of private enterprise to make our current system better. If there is too much waste in the system we can improve it by performing better and generating better benefits from cost.
It seems that this is difficult for the government to do.
This article, however, looks at a different approach. Instead of the government reducing what it does, it is spending to eventually reduce the costs it has to incur. So, if the government has to spend money on social housing, why not spend more to create more social housing and therefore reduce the eventual cost.
Public works and infrastructure projects have been tried before, but have they been thought of as something to reduce the costs for the government?
Philip: Good points.
Let me come at this another way – please bear with me starting with the obvious here.
If you increase demand, without increasing supply, you drive prices up. To drive down costs, on the other hand, you need to increase supply, without driving up demand. This is clear, basic economics.
Now, paying housing benefits drives UP demand – the result, of course, being that you drive up costs, in this case market rents, and hence the cost of providing housing.
To drive costs DOWN instead of up, you need to increase supply, not increase demand – this is Economics 101. In this instance, increase supply by building homes. This will have economic benefits (as well-targeted capital spending does), but it will also push DOWN the cost of market rents, saving money overall.
Incidentally, Obamacare makes the same mistake – to get cost-effective healthcare, the US government should have increased supply, not added to demand.
So – we should build council houses, not just to boost the economy, but to drive down future costs by increasing supply. Pretty simple, one would think.
Final thought – why do governments find even the most basic principles of economics so difficult?