I have noted before that the longer the economic crisis continues and the more data that comes out from national statistical agencies the easier it is to see how crazy the political elites who are driving austerity in their lands are. A few years ago it was a contest of ideas – austerity or not – and so anti-austerity arguments could be dismissed as “old fashioned”, “worn out”, Keynesian ideas. As the years pass the contest of ideas is being clarified by the relentless data releases from the agencies. Then those who advocate austerity have to not only explain at a conceptual level how a government can cut spending when non-government spending growth is weak and still forecast rapid growth but also have to somehow come to terms with the data that tells them their bets were wrong.
On March 23, 2011, the British Chancelor of the Exchequer George Osborne was still firmly in control of the debate. It was his second budget in government and the economy was still being supported by the budget deficits that the previous government had allowed to grow in the face of the crisis, which emerged in late 2007, early 2008.
The data hadn’t turned against the Government by this time. The economy was still in recovery mode although the signs were ominous.
On that day, the Chancelor delivered his – Budget Speech – and early on in that Speech he said that he was introducing a:
… Budget that encourages enterprise. That supports exports, manufacturing and investment. That is based on robust independent figures. A Budget for making things not for making things up. Britain has a plan. And we’re sticking to it.
I am sure he used the term “support” in a positive way although as the data has evolved it would have been a correct statement if he indicating his budget would contribute to the demise of exports, manufacturing and investment. One might say challenge my view and suggest that the external economy is mostly affected by developments elsewhere, which is true.
But those developments are of the same ilk as the fiscal austerity being imposed in Britain. Further, if the external environment is weak, then it is the responsibility of the national government to stimulate the domestic production and allow manufacturing exporters to switch to local markets inasmuch as they can.
The Chinese switch to strengthening their domestic demand in 2008 is a classic example of what to do if export markets falter.
Anyway, in his 2011 Speech and after outlining the continuation of his plans for imposing fiscal austerity on the economy he ended with a barrage of jingoist triumphalism:
We are only going to raise the living standards of families if we have an economy that can compete in the modern age.
So this is our plan for growth.
We want the words:
‘Made in Britain’
‘Created in Britain’
‘Designed in Britain’
‘Invented in Britain’
To drive our nation forward.
A Britain carried aloft by the march of the makers.
That is how we will create jobs and support families.
We have put fuel into the tank of the British economy.
The march of the makers hasn’t been a long one. In fact, it hasn’t been much of a march at all.
The latest data from the British Office of National Statistics published yesterday (March 27, 2013) is summarised in the following Table.
In 2011, the Current Account deficit was £24.1 billion. This rose to £36.1 billion in 2012. The breakdown of that change is as follows:
- The balance of trade on goods was in deficit to the tune of £100.2 billion in 2011. In 2012, this deficit rose to £106.3 billion.
- The balance of trade on services was in surplus to the tune of £76 billion in 2011. This dropped to £70 billion in 2012.
- Taken together the trade deficit rose by around 50 per cent in 2012 from its balance in 2011.
The following graph shows the Current Account balance as a percent of GDP from the first-quarter 2007 to the fourth-quarter 2012. The March of the Makers appears to be absent.
An increasing Current Account balance should not cause alarm if domestic policy settings are sound – why? – because it means that Britain is enjoying a quantum of real imports without having to ship an equivalent real value of its resources (embodied as exports).
But from the the perspective of the logic used by the British government to explain its policy approach, the latest data represents a monumental failure of its policy strategy.
As Larry Elliot said in the UK Guardian article (March 27, 2013) – March of the makers? Balance of payment figures make dismal reading:
The balance of payments figures for 2012 make dismal reading … The situation in the eurozone – Britain’s trading partner – has clearly not helped matters. It is not, however, the whole story. Britain’s manufacturing base has been hollowed out by the three big recessions since the early 1980s, and that has resulted in a reduced capacity to take advantage of a falling currency. What’s more, part of the competitive advantage from the 25% drop in the value of the pound from its pre-crisis level has been eroded by the UK’s poor productivity record in recent years.
The hollowing out of the manufacturing capacity, which began as Britain’s imperial influence declined, gathered pace under Margaret Thatcher’s insistence that all industries face the discipline of the “market”.
British manufacturing declined by around 25 per cent between 1971 and 1981, while the deregulated financial market environment led to the boom in financial services. The over-representation of financial services in the British economy now, which made the British economy more vulnerable thatn most to the collapse in 2007 and 2008 begain with Thatcher’s manic deregulation.
The March of the Makers came to an abrupt halt under Thatcher’s contractionary regime. The persistently high unemployment during the 1980s in Britain was mostly the result of the demise of manufacturing.
The economic growth that came in the late 1980s was largely the result of the growth in financial services.
The British ONS also released the – Quarterly National Accounts, Q4 2012 – yesterday, which confirmed that the British economy is not marching to the makers but, instead, marching into recession.
The major elements of the December-quarter performance were:
- Real GDP growth fell by 0.3 per cent in the December-quarter.
- The main reasons for the contraction were a slump in private investment (0.2 per cent) and the deterioration in the external accounts.
Here is another view of the “March of the Makers (Out)”. This graph is taken from Figure 3 of the latest ONS publication – Quarterly National Accounts, Q4 2012.
Since the current government took office, real Manufacturing output has steadily declined. As I noted above, fiscal austerity is to blame for that. Both the austerity in Europe and in the UK. We cannot blame the UK government exclusively for the decline.
The following graph (taken from Figure 2 of the ONS National Accounts publication) is interesting. It shows real annual GDP growth from 1948 to 2012.
The interesting thing for me was: (a) the depth of the current recession; and (b) the weakness and short-lived nature of the current recovery compared to the previous years after the troughs.
It is quite clear that in previous recoveries the economy recovered more quickly. In the current recovery, the 2010 response seemed to be consistent with previous bounce-backs, given the depth of the 2009 trough. But once the current government enacted its fiscal strategy the recovery evaporated and the economy has been heading south ever since.
You might wonder about the 1980s which was the period (1979-1990) that Margaret Thatcher was Prime Minister. The following graph uses data available from the HM Treasury – Public finances databank February 2013 – and shows the real GDP Output Gap (%) on the horizontal axis and the Budget Balance as a % of GDP on the vertical axis.
I split the sample from 1979-80 to 2011-12 into two sub-samples: (a) the Thatcher period; and (b) the Post-Thatcher period.
The Post-Thatcher period observations are consistent with normal outcomes driven by the automatic stablisers. As the output gaps increases, growth in tax revenue falls (or is negative) and welfare-based outlays rise. The budget deficit thus typically increases as it should to support aggregate demand.
On top of the cyclical effects (the automatic stabilisers), discretionary (counter-cyclical) shifts in public net spending also allow the budget deficit to rise when there is a slowdown or slump in non-government spending.
The Thatcher period violated this typical behaviour.
When she came to office there was a zero output gap (remember the Treasury estimates of the output gap are likely to be biased downwards). The budget was in slifht deficit (1.7 per cent of GDP).
Within two years the budget was in surplus of 2.9 per cent of GDP and the output gap had ballooned to 6.4 per cent and a massive downturn was underway.
Despite trying to run against the cyclical tide, the budget gradually moved towards and into deficit towards the mid-to-end 1980s and the output gap declined.
Part of that was a comeback of private industry, which was (as noted above) mostly related to investment in the financial services. I will analyse that period in another blog later this year as I am working on a book documenting the Monetarist era.
I get many E-mails asking me to explain the Thatcher period from an Modern Monetary Theory (MMT) perspective and when I get time I will decompose the data movements and explain what I thought was going on. I lived and studied in Britain during that period and have a first-hand experience of what was happening on the ground in industrial towns such as Manchester.
What is driving the contraction in British output? The following Table shows the contributions to real GDP growth by expenditure compoent since 2011Q1.
The interesting thing is that despite the austerity intent of the government the rising budget deficit (as a result of the cyclical decline) is still supporting growth (in the sense that it is attenuating the contraction arising from private investment and net exports.
This graph (Figure 4 in the ONS publication) shows real Manufacturing growth (quarterly) since the end of 2007. The March of the Makers (Out) is consistent (despite the September-quarter blip).
The British ONS also produces an Austerity versus Deficit-supporting-growth graph (although they don’t exactly call it that). They prefer the title “International GDP growth rates, annual CVM SA”. Here it is (Figure 15 from the ONS publication).
Not much argument to be had there!
I also updated my sectoral balances database for the UK today. You can get data from – Public finances databank February 2013 – from HM Treasury and the – Balance of Payments, Q4 2012 Dataset – compiled by the British Office of National Statistics.
The private domestic balance is computed as a residual balancing item given the other two balances – external and government – are fairly reliable.
The data is for financial years and the 2012-13 are estimates. I think the Budget Deficit will be larger than the Treasury estimate of 3.6 per cent of GDP. The external balance is heading to be around 4 per cent of GDP.
The brief statement of these balances is:
(S – I) = (G – T) + (X – M)
The three balances have to sum to zero as a matter of national accounting. The sectoral balances derived are:
- The private domestic balance (S – I) – positive if in surplus (overall private spending is less than income), negative if in deficit (overall private spending more than income).
- The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
- The Current Account balance (X – M) – positive if in surplus, negative if in deficit.
The private domestic and the current account balance sum to be equal to the non-government balance. The basic result that the government balance equals exactly $-for-$ (absolutely or as a per cent of GDP) the non-government balance (the sum of the private domestic and external balances).
As I noted last week when I analysed the British Budget the familiar pattern is evident. There is a reciprocal relationship between the budget deficit and the private sector balance. When the British government ran surpluses in the late 1980s and then later in the period 1997-2001, the private domestic sector moved sharply into deficit.
More recently, the larger deficits driven both by discretionary stimulus measures in 2008 and 2009 and the automatic stabilisers associated with the downturn in the cycle, allowed the private sector to achieve higher savings overall.
The highly indebted private sector is now being squeezed again by the attempted fiscal reduction. in the 2012 British Budget, the implicit strategy was that growth would come from an increase in private sector debt driving consumption and investment spending (refer back to the Table 1.1 above) and net exports.
The expectation is that by the end of the current financial year (2012-13), the Government’s strategy accompanied by the continued decline in the external situation, evident in yesterday’s data release, will drive the private sector into deficit overall.
This is at a time that business investment is also weak or contracting.
Given the indebtedness of British households (overall) this fiscal strategy is crazy.
Britain is declining in economic terms. The situation in Europe is not helping but given the deterioration across the Channel, there was a need for a major shift in fiscal strategy to allow expenditure to be switched to the domestic economy.
As a result of the ideological stubbornness of the British government the aggregate policy settings are exacerbating the external conditions and the British economy is contracting again.
They are lining up for a triple-dip recession and in a few months we will know whether that is the case. Notwithstanding what the data shows (that is which side of the zero growth line the economy ends up in the March-quarter) the current policy strategy has failed and should be reversed.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.