GDP Falls!

Those of you keen eagles will have noticed that GDP figures for 2010Q4 were announced today by the ONS, and the figures contained quite a shock: GDP fell in the last quarter of 2010.

After three quarters of positive growth, analysts had expected a small positive number for GDP growth, but numbers plummeted. There have been many concerns since the Coalition implemented its austerity package that it might plunge the UK into a double dip, and hence those worriers appear to be feeling vindicated in voicing their concerns.

However, there are good arguments for why we might have seen such a contraction: We had lousy weather for most of December! Certainly George Osborne has leapt on this explanation to maintain that austerity remains the right path to take. Construction fell particularly strongly in the period, down 3.3%, supporting this view. It's a rather British response to blame the weather, isn't it?!

Yet December was just one month out of three in the quarter. What happened in the other two months? Growth clearly couldn't have been particularly strong in that period.

Do these figures mean we're definitely heading for a double dip? Of course not. The numbers will still be revised (this is the first estimate based on just a third of the available data), although it is unlikely they will be revised up substantially enough that growth would become positive. And it's just one quarter - the working definition for a recession is two quarters of negative growth.

But it ought to be a concern. We learnt last week about the role government spending plays in aggregate demand (how much we all demand of goods in the economy), and as such it ought not to be surprising that as the government reduces G significantly, aggregate demand falls and growth slows. The government is hoping for a strong longer-term impact rather than any short-term impetus with its austerity - it argues private sector behaviour has long been crowded out by high government spending. Later in term we'll assess in more detail crowding out and we'll be better placed to give an assessment of the likely success of the Coalition's economic strategy.

US Economists on the UK Austerity

As you may have noticed, last Wednesday George Osborne announced the Comprehensive Spending Review, to much fanfare.

There are a few things to say in addition to linking up a couple of comments from US economists (against is Paul Krugman, for is Stephen Williamson).

The most important is this: When you're doing economics, try as best you can to separate what politics from economics. All politicians have a rather distorted view of economics: Tory ministers blame anything and everything on Labour, Labour ministers blame anything and everything on the Conservatives. Of course, they both have their economists, but the point is: Soon you'll be able to understand which bits each set of economists is ignoring to come to its conclusions.

For example, according to the Tories Labour is entirely responsible for the recession we suffered, and the budget deficit that has resulted. They support this with some assertions (apparently lax regulation from the FSA, not "fixing the roof when the sun was shining" whatever that actually means!). But what you will learn this year is that recessions happen: They are part of the natural cycle of the economy, and no amount of government action will solve that (Tories are right to laugh at Gordon Brown's comment years ago about ending boom and bust it's fair to say).

Additionally, government finances are a product of the economic cycle: In recessions, people are out of work and hence they don't pay taxes and instead claim benefits. So the budget deficit will worsen in a recession, especially the worst one in 70 years.

You'll learn next term about why economists worry about these cuts in spending (regardless of their views about how large the state should be). It's something called Aggregate Demand, and the Multiplier principle. The practical upshot is found in warnings by KPMG that the public sector cuts have a direct impact elsewhere because many small businesses rely on the public sector (councils, etc) for contracts, and hence many may go out of business as a result.

Robert Skidelsky on Deficit Cutting

Robert Skidelsky is a very prominent economist, not least for his biographies of Keynes.  As you can imagine, he is more Keynesian in his leaning as an economist than some.  Right now, with the austerity of the Coalition and others the flavour of the moment, people are much less inclined towards Keynesian arguments.

The feel now is that we need to cut the deficit - this is the big problem, not the fact we're stuck in an anemic recovery from the recession of 2008-9.  Skidelsky has written this article in Project Syndicate on the issue, and I think the punchline has to be:

Events and common sense drove them to deficit finance in 2009-2010, but they have not abandoned the theory that depressions cannot happen, and that deficits are therefore always harmful (except in war!). So now they vie with each other in their haste to cut off the lifeline that they themselves extended.

Policy Uncertainty

One thing we'll talk about second term is the impact uncertainty can have on economic outcomes.  In other words, if people are uncertain, they do less: They don't take big decisions.  In particular, they don't make investment decisions.

A big thing in the US currently is the impact of uncertainty over government policy, and its impact on the economy.  Tyler Cowen at Marginal Revolution (a blog well worth subscribing to for both terms of your econ101 experience) has this post about it.  Some people suggest that uncertainty over policy is the reason why the US economy is not recovering strongly.  These people are generally Republicans responding to the fact they are out of power and trying to lay all the blame at the foot of the in-power Democrats.

As Cowen points out though, there's much more at stake - not least the restructuring that's going on in the US economy.

The main point I think is: Don't trust anyone who tries to tell you there's a single cause for why the economy is in the mess it's in, either this side of the Atlantic or the other.  There's many, many causes, and a huge number of alternative solutions out there that may or may not work.  The economy is a complicated beast, and far too complicated for single-cause explanations...

The Austrians

A fairly non-mainstream school of thought in economics is the Austrian School of Thought.  Austrians emphasise the price mechanism and its supremacy: Left unconstrained it leads to the best possible allocation of resources.  It may be that the market doesn't lead to be the optimal allocation, distortions are possible; but government intervention won't be helpful - the "dead hand" of government will always lead to a worse outcome.

As a result, an Austrian economist probably doesn't like very much the actual Austrian, or continental European, economic systems - social democracies with high taxes and heavy government intervention in markets.

Funny then that this Austrian economist, Don Boudreaux, seems to be gloating about strong growth in Germany vs the US.  Germany has just reported 2.2% GDP growth last quarter (which is impressive), while the US appears to be toiling towards a double dip recession.

Germany also has been embracing austerity recently, with significant spending cuts to address its large budget deficit, while the US, via Obama and the Democrats, is about the only major economy still attempting to pursue fiscal stimulus policies to encourage economic growth.

So the fact that the US, maintaining strong government intervention, is muddling towards a double dip recession, while Germany, cutting it back, has reported strong growth, is music to this Austrian's ears.

Of course, the story is so much more complicated than that.  Not least: You can't prove anything with one data point.  Then: How quickly do fiscal policies have any effect?  Finally, what is the impact of government intervention in the macroeconomy?  (the answer is it's quite slow with time lags, so the current numbers have nothing to do with recent decisions on austerity vs stimulus spending).

All these things you'll learn more about second term next year when we get to macroeconomics in the econ101 course.