Transcript Extract 1 Part 2x

Building an Economic Case for Fiscal Austerity
• Fiscal conservatives argue that strong action is needed to lower the
deficit both in absolute terms and also as a share of GDP.
1. Lower borrowing means that the UK economy will retain a high
credit rating and this will mean lower interest rates on
government debt and newly-issued corporate bonds.
2. Less interest paid on debt frees up more money to be reinvested
in key public services such as health or education
3. Reducing debt opens up the possibility of consumer and business
tax cuts – thereby stimulating fresh growth in the private sector
4. Tighter control of government spending / a lower fiscal deficit
means that the Bank of England can keep policy interest rates low
• Some economists claim that growth is lower on average among
countries with government debt/GDP ratios above 90%. They point
to the debt crunch faced by several struggling EU nations.
Alternative to Austerity – Keynesian Stimulus Policies
Keynesian economists favour the active use of fiscal policy as the
may way of managing demand and economic activity
Active measures
needed to inject
extra demand can
drag the economy
out of a recession
Keynesians favour
labour-intensive
projects e.g.
transport
infrastructure and
new housing
Counter
cyclical
policies
Higher
government
capital
spending
Targeted
direct and
indirect tax
changes
Tax cuts for lower
income groups
with higher
propensity to
spend boosts AD
Government
borrowing
can pay for
itself
Depending on the
size of the fiscal
multiplier –
borrowing will
create more tax
revenues
Extract 1: Views of Liam Halligan
Page 5
• “We remain locked in the most feeble economic recovery in our history.”
This chart from the National Institute of Economic and Social Research shows a profile of
recession and recovery in the months after previous recessions in our economic history. It
supports Liam Halligan’s view in that (as of May 2014), many months after the start of the
recession in 2008, real GDP was still lower than at the peak of the cycle. Recovery from
the 2008-2010 recession has been shallower than after the Great Depression:
Key discussion question: Why has UK economic recovery (until recently) been so slow?
Analysis: Why was UK recovery delayed and slow?
Domestic demand-side factors:
Weak consumer demand, low business capital
investment, cuts in real level of government spending
Domestic supply-side factors:
Low supply of bank credit to businesses, falling labour
productivity (output per worker) + high energy prices,
External demand-side factors:
Weak growth in key overseas markets, hitting UK export
sales e.g. Euro Area, + too few exports to Asian region
External supply-side factors:
Rising world food and energy prices, keeping UK inflation
high and causing a fall in real disposable incomes
Extract 1: Views of Liam Halligan
Page 5
• Beyond the headline numbers, real wages continue to fall as inflation
erodes purchasing power. Including population growth, UK real GDP per
head is actually some 7% below its 2007 peak.
• This has been a key
feature of the 20112015 recovery.
• Consumer prices
have been rising
faster than wages
leading to lower real
wages.
• Weak recovery and
an expanding
population has seen
real GDP per capita
decline.
Understanding Real Incomes and Economic Activity
Real income measures the purchasing power of a given amount of
nominal (money) income – i.e. nominal income adjusted for inflation
Year
2008
2009
2010
2011
2012
2013
Earnings
Consumer
(Wages, Bonuses Price Index
and Overtime)
% annual
% annual change
change
4.7
3.0
1.9
2.3
2.1
3.7
0.4
4.5
1.6
3.0
2.2
2.4
Real
incomes
Rising
Falling
Falling
Falling
Falling
Falling
Year of recession
Almost a double dip
Signs of recovery
In recent years, the annual growth of earnings for people in work has
been less than inflation – causing real incomes to fall
Analysis: Why have real wages been falling in the UK?
• Real wages have been falling because the annual rate of change of
wages / earnings from jobs has been slower than the increase in
consumer prices
• Some reasons for slow wage growth:
1. Tough pay restraint in the public sector e.g. NHS workers have
seen as 10% decline in real wages since the start of the recession
2. Many private sector businesses have introduced pay freezes (and
in some cases, pay cuts) as an alternative to bigger job cuts
during the recession
3. Trade union bargaining power has been hit by economic
problems at home and forces of globalisation
4. For much of the last five years, consumer price inflation has been
above the 2% target measure, not least because of big increases
in fuel and energy prices.
5. Labour productivity has been disappointing – businesses find it
harder to fund wage rises if output per person employed is flat
Read Linda Yueh on the slow growth of global wages
What are the consequences of a fall in GDP per head?
According to the Office for National Statistics: Nominal wage growth below the rate of price
inflation has resulted in real wages falling for the longest sustained period since at least 1964
• Average living standards decline (falling per capita incomes)
• More workers need a second job to supplement their
incomes – now more than 1 million people with second jobs
• Less consumer demand for goods & services
• Reduced incomes per capita may cause GDP growth to remain
slow – making the recovery more fragile
• Lower incomes and low net savings makes many more people
reliant on (expensive) consumer debt e.g. pay day loans
• Becomes much harder for people to reduce the debts
accumulated during the growth years including mortgages
• The government receives lower-than-expected tax revenues
– making it a lot harder to reduce the fiscal deficit
Limitations of GDP per capita as measure of SOL
Human Happiness
Beyond Markets
External Costs
Quality of Life
Non Market Activities
Environmental Factors
Shadow Markets
Growth Sustainability
The Make up of GDP
Informal Economy
The Long Run View
Balance of spending
Alternatives to Real GNI Per Capita as measure of SoL
Many other published indicators and surveys are now available taking in
economic, social, humanitarian and environmental aspects
Happy Planet Index
Genuine Progress Indicator
OECD Better Life Index
Human Development Index
Extract 1: Views of Liam Halligan
Page 5
• “In addition, there has been no sign of the ‘rebalancing’ away from
consumption and towards exports and investment that the
Coalition Government said it wanted.”
• “Back in 2010, Osborne declared his confidence in ‘a march of the
makers’, claiming that manufacturers would power growth via a
surge in exports. It hasn’t happened.”
1.
2.
3.
4.
What is meant by re-balancing?
Which policies might be effective in achieving this re-balancing?
To what extent has UK manufacturing output recovered?
Which UK manufacturing businesses and industries have done
well since the end of the recession?
What is meant by re-balancing of the economy?
• Re-balancing describes changing the balance of aggregate demand,
output, jobs and investment in an economy.
1. Re-balancing away from consumption and imports towards exports
and business capital investment
2. Re-balancing away from dependence on the housing market
towards manufacturing as a source of new wealth
3. Moving away from debt-fuelled consumption towards more private
saving including occupational pensions and other savings schemes
4. Re-balancing away from dependence on financial services towards a
greater role for manufacturing, life sciences and creative services
5. Improving regional balance i.e. more investment and jobs in areas /
regions with persistently higher unemployment and lower incomes
6. Re-balancing away from high levels of government spending,
taxation and borrowing towards a great share of national output
flowing from the private sector
Analysis: Which policies can re-balance the economy?
Currency depreciation (A fall in sterling)
• A boost to UK export price competitiveness
• Improved net trade balance (after time lags)
• Higher exports creates positive multiplier & accelerator effects
Supply-side support policies for industry
• Active regional growth policies, more infrastructure spending
• Establish many more technology innovation centres
• Increase graduates and apprentices in technical subjects
Improving the supply of credit
• Funding for Lending Scheme (especially if QE has not worked)
• Introducing stronger competition in retail banking system
• Green Investment Bank for renewable investment schemes
Extract 1: Views of Liam Halligan
Page 5
• “Despite the pound falling some 20% against our main trading
partners in recent years, UK exports have slumped, doing nothing
to foster growth, improve our national accounts, or tackle the
chronic job insecurity felt by millions. The UK’s external sector
remains a drag on growth, adding to our ever-deepening
indebtedness.”
1.
2.
3.
4.
5.
6.
7.
8.
Why did the pound fall by 20%?
How does a weaker pound help UK export industries?
Have UK exports of goods and services actually slumped?
What evidence is there of chronic job insecurity?
Analysis the likely economic effects of job insecurity
Why is the UK’s external sector a net drag on growth?
How is indebtedness measured?
What is the evidence on the scale of debt in the UK economy?
Understanding: Exports of Goods and Services (X)
Exports are goods and services sold to other countries. Exports are
an injection into the circular flow of income and spending
Relative Prices
of exports in
World Markets
The exchange
rate – a
stronger
currency makes
exports more
expensive
Non-Price
Demand
Factors e.g.
Design and
branding
Strength of
Aggregate
Demand in Key
Export Markets
Many factors affect the
level of demand for a
nation’s exports – some of
these are shown in the
graphic on the left
Data: Have UK Exports “Slumped”?
Selected components of UK demand, annual % change at constant 2011 prices
2008
2009
2010
2011
2012
2013
Consumer
Spending
Capital
Investment
-0.5
-3.3
0.5
-0.1
1.5
1.7
-4.7
-14.4
5.9
2.3
0.7
3.4
Exports of
Goods and
Services
1.6
-8.2
6.2
5.6
0.7
1.5
Imports of
Goods and
Services
-1.8
-9.8
8.7
1.0
3.1
1.4
Real GDP
-0.3
-4.3
1.9
1.6
0.7
1.7
1. Exports fell sharply in 2009 – they were hit hard by the effects of a
global economic recession and the slump in the EU economy
2. They recovered quite strongly in 2010 and 2011 (growing by more
than 5% in each year) but slowed down again in 2012 and 2013
3. Commentators puzzled over the causes of slow growth of exports
Analysis: Some reasons for slow growth of UK exports
The weaker pound caused higher import prices –
offsetting some of competitiveness gains from a
lower exchange rate
Many businesses reported that they were
finding it hard to get export finance / credit from
the commercial banks
The UK’s major export market (the EU) was
experiencing it’s own financial and economic
crisis – causing falling overseas demand
Competitiveness is not just about cost and price
– innovation / design counts too – did the UK
have sufficient non-price advantages?
Read Robert Peston on the causes of the UK’s structural trade deficit
Analysis: Economic Policies to Reduce a Trade Deficit
• Demand management: A tightening of fiscal and/or monetary
policy reduces real spending power of consumers and leads to
lower spending on imports (fall in M improves trade balance)
• Lower exchange rate reduces foreign price of exports and
makes imports more expensive – causes changes in demand
• Supply-side improvements:
• Policies to raise labour productivity and encourage startups with export potential e.g. Life sciences, digital etc
• Investment in human capital to boost productive capacity
and competitiveness in high-value industries such as biotechnology, engineering, medicine, tourism
• Protectionist measures such as import quotas and tariffs (NB:
limited by global trade agreements e.g. EU and WTO rules)
Will an Exchange Rate Depreciation improve the BoP?
The diagram below shows the “J Curve effect” – it shows the time
lags between a falling currency and an improved trade balance
Trade
surplus
Currency
depreciation
here
Trade deficit may
grow in initial
period after
depreciation
Trade
deficit
Time period after
depreciation
Net improvement
in trade provided
certain conditions
are met
Understanding: What is meant by “indebtedness”?
• Public sector debt is owed by central and local
government and by public (state-owned) corporations
– Debts owed by state-owned banks are included in national debt
• Private sector debt is owed by private businesses and
households.
– Companies may have borrowed to finance investment
(corporate sector debt)
– Households have loans for example credit card debt and
mortgages on properties.
• Financial debt is also part of the private sector – this is
the outstanding (unpaid) debts of banks and financial
corporations - for example the level of bad debts on
loans to businesses and to the housing market
Understanding: High Levels of Debt in the UK Economy
• In the spring of 2013, household
and non-financial firms’ debt
amounted to 208% of UK GDP –
down to levels last seen in mid2007, but significantly higher than
they were a decade ago (170pc of
GDP) and 15 years ago (128pc of
GDP).
• The UK private debt/GDP ratio is
high by historical and international
standards, and far above the 160%
level used by the EU Commission
as a threshold for gauging
imbalance in debt to income levels
for EU member states.
For more data on UK household debt –
visit the Office for National Statistics
Why is a high level of “indebtedness” a problem?
• Debt acts as a constraint on future spending power.
– Millions of people in the UK are saddled with many thousands of
pounds of debt and the interest payments on this debt reduces
their effective disposable income
• Banks have high debt and this restricts their willingness and ability to
make fresh loans to businesses and households who want to borrow
• The economy is at risk with a high debt-to-GDP ratio
– If price deflation happened, falling consumer prices and incomes
would make the debt problem even worse in real terms
– If and when nominal interest rates increase, many households –
especially mortgage payers - are at risk and might struggle to meet
repayments. This could cause a recession in the housing market.
Explore: Trouble in store: the grave future of British public and private debt
(Guardian, July 2014)
Is a High Level of Public Debt Bad for the Economy?
Public debt is the total stock of debt issued by a government that
has yet to be re-paid – also known as the National Debt
• The Government may have to offer higher interest rates
on new debt – increasing the cost of servicing debt
• This interest burden has an opportunity cost for less
spent on interest payments could free up extra
spending on services such as health and education
• A sizeable increase in the national debt is likely to cause
higher taxes in the future. This will cut the disposable
incomes of tax payers and leave less money for private
sector expansion
• It might be considered unfair if the rising tax burden
falls more heavily on future generations of tax payers
rather than people who benefit from government
spending now.
UK Debt Data
UK government
debt reached
94% of GDP in
2013. This is
lower than the
average of
advanced
economies
(109.3%).
Japan’s gross
debt is 245% of
GDP in 2013,
while Greece’s is
179% of GDP.
Government Debt Ratios – A Cross Country Comparison
Country
Gross Government Debt (% of GDP)
Australia
20.5%
Chile
12.8%
China
22.4%
France
92.2%
Germany
76.9%
Greece
174.9%
India
67.8%
Italy
132.6%
Japan
227.2%
Mexico
36.9%
Poland
57.0%
Singapore
105.5%
South Korea
33.8%
Spain
92.1%
Turkey
33.0%
United Kingdom
90.1%
United States
101.5%
Extract 1: Views of Liam Halligan
Page 5
• “So, yes, the UK economy has grown for two consecutive quarters.
Yet, by 2015, Osborne will have borrowed more in five years than
Gordon Brown did in over a decade.”
• “The UK’s national debt is now £1100bn, up from £580bn in 2008
and set to soar above £1500bn over the next few years.”
1. Distinguish between government borrowing & the national debt
2. At what point will national debt as a share of GDP start to fall?
3. Why has government borrowing remained high during the early
years of the economic recovery?
4. To what extent is a high level of national (government) debt a
cause for concern?
Chart: UK Government Spending and Taxation
Highest budget deficit
G = 45% of GDP
T = 36% of GDP
Result – deficit close to 10%
Most of the fiscal deficit
reduction is coming from cuts
in government spending – tax
revenues remaining flat as
share of GDP
Awareness: UK Coalition’s Fiscal Austerity Policies
• The UK coalition government has a deficit-reduction policy with the
emphasis on cutting government spending in some areas in real
terms and a series of direct and indirect tax increases:
• Key policies for deficit reduction:
1. Rise in VAT to 20%
2. Rise in employee national insurance contributions
3. Deep cuts in real government spending e.g. for local authorities
4. Welfare caps including £26k pa cap on welfare for each family
Some taxes have been cut
1. A series of cuts to corporation tax
2. Freezing of fuel duties (meaning a cut in real terms)
3. Increases in the real value of the income tax free allowance
4. Freezing of council tax (so that council tax falls in real terms)
Government also helped by lower interest rates on newly issued debt
UK Economy is affected by many External Factors
In extract 1, when assessing the UK, keep in mind that – as an open
economy – many outside factors impact on key macro indicators
Real GDP growth in BRICs, MINTs and other highgrowth emerging nations
Continued economic problems in the Euro Area
including slow growth and deflation
Changes in world commodity prices such as food, oil
& gas and hard metals e.g. the slump in world oil
prices in the Winter of 2014-15
Fluctuations in exchange rates e.g. $, Yen and Yuan
and the Euro e.g. the Euro has fallen sharply in 2015
Selection of Suggested Questions for Extract 1
1.
2.
3.
Describe two causes of an economic recovery
Describe two factors that affect the growth of exports
With the aid of a diagram, explain how a rise in real GDP can help to
reduce unemployment
4. Distinguish between the employment rate and the unemployment rate
5. Comment on the impact that job insecurity can have on the behaviour
of consumers
6. Comment on the argument that the Coalition’s fiscal austerity is
“reckless” for the health of the UK economic recovery
7. To what extent does the UK government have an effective economic
growth plan?
8. Comment on the policies likely to be most effective in reducing long
term unemployment
9. Evaluate the extent to which a lower exchange rate has helped to rebalance the UK economy
10. Discuss the impact that falling real wages might have on economic
recovery in the UK