Archived entries for GDP

Middle East Delegation Travellog – The Economy, Stupid

As part of our Middle East delegation 2011 travellog, Joel Mullan discusses nationa-building in Palestine.

The two-state solution is one of the shibboleths of the Arab-Israeli conflict, accepted as the end-game (at official level at least) by the Israeli government, by the PLO and by the vast majority of the international community.

Acres of newsprint are expended each week on physical conflict – confrontations between the various sides and analysis of the latest tit-for-tat. Yet very little is reported on one of the great strategic challenges for the region: a two-state solution requires action to be taken to allow for the birth of a viable Palestinian state. This is an obvious, yet oft forgotten or overlooked, truth.

The economic challenges are formidable. Palestinian GDP is equivalent to just 3% of the Israeli economy. A significant wage differential exists between the two countries which provides incentives for people to leave Palestinian territory and attempt to find work illegally in Israel, rather than complete the education that the Palestinian people will need if they are to compete in the new global economy.

Action is needed on the ground to break down the barriers to trade. In Hebron, we saw first-hand row upon row of closed stores. Closed, we were informed, either as the result of military order or in frustration with the conditions.

More broadly, progress needs to be made on improving arrangements for access to the Israeli and foreign markets, as well as movement of goods and services within the West Bank – a view shared by both the Office of the Quartet Representative and by the Palestinian leadership.

This situation is complex, and even the solutions to economic issues often require political answers. The economic success or otherwise of a future Palestinian state has deep repercussions for other dimensions of the conflict. For example, if economic failure results in delays to the pay of Palestinian civil employees, we could see security personnel abandon their posts. Similarly economic problems which worsen civilian conditions run the risk of strengthening more radical elements of the Palestinian political spectrum.

However, there is recognisable optimism. Senior figures in the Palestinian leadership called for the Palestinian diaspora to provide the expertise needed for nation-building and shared with us a vision for a Palestine capable of harnessing new technology to provide services which can compete with the likes of both India and, even, Germany. The Quartet is working hard with the Palestinians in their efforts and the Israeli Government is clear that “we don’t want a failed state.”

An opportunity for the world’s press arises in the next few weeks – on September 20th the UN General Assembly will assess Palestine’s application for membership of the United Nations. The economic situation is ripe for consideration.

Joel Mullan is a member of the Young Fabians and a delegate on the Young Fabian Middle East Trip 2011.

The case for smart industrial policy

In this member post, Will Lord puts forward a case for a smarter industrial policy in the UK.

Perhaps the greatest economic challenge for policy-makers over the next few years will be creating a new and more sustainable model of growth for the economy. The dire GDP figures from the last quarter of 2010 shows this is not just an issue for the long-term; it needs to be found urgently.

Much has been made of promoting the growth of hi-technology industries as a fresh source of wealth for the UK. Hi-tech industries have great economic value and could become key export industries. Furthermore, such industries tend to cluster close to quality universities – something London has no monopoly on. Promoting hi-tech growth could therefore contribute to balanced regional growth that benefits all areas of the UK (the growing video games industry in Leeds and internet businesses in Manchester are useful examples).

Britain is well placed to expand its technology sector and government has a crucial role in ensuring this. Successful clusters of technology firms have emerged in the UK, such as the famous “Silicon Fen” in Cambridge. But such examples are limited and small in scale – the UK will need to capitalise and expand on these successes if it is to compete.

Proponents of smaller government might argue that the best way to promote such growth is by letting innovative new companies flourish on their own with minimum interference. To do so would be misguided as some of the most important hi-tech institutions – for example, Silicon Valley and Israel’s technology sector – emerged with government links and assistance.

It would be foolish not to utilise public funds and help the growth of advanced industries when governments across the world are bolstering their hi-tech sectors and investing record amounts of money in new technologies.

But any government support must be carefully and intelligently designed and implemented.

Arbitrarily handing out loans and grants to individual companies can be wasteful – companies might fail, or survive only with government support, preventing dynamic new companies from entering the market. In some instances, there may be a strong case for lending to companies if the impact is near-assuredly good, such as the now cancelled loan to Sheffield Forgemasters, but making a comprehensive strategy out of it may not work.

It is fashionable to look to the USA for inspiration for hi-tech growth, but a better example lies eastward in Israel. Israel began the 1990s with a stagnant economy and very little in the way of high-tech industries. The Israeli government’s response to this was to create the “Yozma” (Initiative) Programme in 1992 in an effort to direct venture capital towards Israeli high-tech companies and promote their growth. Some $100 million of public money (around 0.15% of GDP) was put aside to pay for large shares of investments made by venture capital firms; tax breaks were also offered for firms investing in Israeli technology. Money offered by private firms was matched by the government and large companies with substantial research and development operations in Israel were given a corporation tax break of 10%.

By 2000 Israel had one of the world’s most vibrant technology sectors.

Israel has more start-ups per head than any other nation and the country receives around twice as much venture capital investment as the United States. There are more Israeli companies listed on the NASDAQ than European, Indian and Chinese firms combined. The “Silicon Wadi” on Israel’s coast now easily ranks alongside California’s Silicon Valley.

Britain can learn lessons from this eastern example, perhaps by creating its own Initiative Program. One key reason why the UK’s technology sector struggles is the lack of venture capital provided to small tech firms. Ever since the Dotcom bubble burst in 2001, venture capital firms have been cautious in offering money to hi-tech start ups. Britain’s large pension funds have also been shy of investing in new firms.

If the government were to alter incentives and direct investment towards our small and medium-sized technology firms, the UK would really have a chance to see its hi-tech sector flourish. Britain might even have the potential to create national champions on the level of Google or Verizon, something Israel with its smaller finance sector has been unable to do.

With a little change in policy from government, Britain would be well on its way to achieving a more sustainable model of growth and could see its financial sector properly working for the real economy.

Recessionary paradoxes

The global recession has highlighted two paradoxes at the heart of government policy (old and new) – I’ve been reminded of this by two articles I’ve read this week.

Firstly, why are we so concerned about retaining the parts of the financial services sector whose reckless practices resulted in one of the worst contractions in UK economic output in history?

On the one hand bankers are vilified for their part in the recession and the attendant increases in unemployment and reductions in tax revenues; on the other we are reticent to do much about them for fear of losing jobs and tax revenues.

Secondly, why are politicians of all colours at pains to ensure that interest rates remain low primarily to ensure that houses (by which, strictly speaking, they mean mortgage debt) remain affordable when overleveraging of households both contributed to and compounded the effects of the financial crisis?*

On the one hand we are concerned by over-indebtedness of households; on the other we want household debt to be affordable.

I suppose you could argue these are consistent positions to hold by appealing to practical issues of addressing the issues in the short term.

While parts of the financial services sector contributed to the global financial crisis, it is difficult for the UK to wean itself of them in the short term – how would you replace foregone tax revenues? If this isn’t possible, would it result in steeper and faster fiscal contraction? Would this make recessionary pressures worse?

As for household debt, it’s reasonable to have a short-term concern about the potential impact of rapid household de-leveraging: the potential for a vicious downward spiral of consumer expenditure. (See The Economist this week on the related issue of interest rates).

And yet. And yet.

Arguments about the forgone taxes bank relocations would cause seem overblown to me. A Reuters special report argues that it would be harder for banks to relocate than they would have you believe.

And I sense politicians – like most of the country – have an irrational love of home-ownership; affordable mortgages are at least as desirable as a means of allowing first-time buyers onto the housing market, or existing home-owners to trade up, as they are of reducing recessionary pressures.

If we prioritise short term imperatives over longer term considerations, then we are unlikely to find much reason to change at all.

Alex Baker is Secretary of the Young Fabians.

* A related issue is supply of new homes – other things equal, home ownership would be more affordable if the government built more houses. If that’s the policy goal, then you’ve got to ask why successive governments have shied away from building more homes.

Why “too far, too fast” isn’t enough

In this member post, Stuart Clark argues that Labour needs to improve its strategy for opposing the Coalition’s economic policy.

The details of yesterday’s Budget are still being dissected, but the economic and political arguments are well under way. On the face of it the Chancellor’s measures seemed to offer help to the British public: increases in personal tax allowances and duty rate cuts amongst the most heavily publicised. Yet these measures pale into insignificance given the context of this budget – the weakness in the British economy and last autumn’s Comprehensive Spending Review.

Osborne’s “Budget for Growth” saw UK growth figures for current and future years revised downward. This is where the opposition should – and has – primarily focused: Ed Miliband’s response to the budget was barely three minutes old before we were hearing, yet again, how government cuts were risking the fragile recovery and were going “too far, too fast”.

But this sound-bite is inadequate in contesting the ideological basis of the government’s economic policy.

Ideology was all too apparent in yesterday’s Budget; the country’s economic problems were tackled in a market-orientated fashion by a government determined not to use the state to its full potential to help people.

Labour failed and is still failing to communicate effectively that the size of Britain’s deficit is not the result of overzealous public spending but a calculated economic decision taken to protect Britain’s economy from the loss of private sector demand and investment caused by a global financial crises and severe recession which followed.

Labour made a moral decision to use the power and resources of the state to shield the ordinary people of this country from the worst effects of the recession and in so doing accepted the need to run a deficit. As the private sector recovered, tax receipts would have risen and public spending could have been withdrawn – this was a viable strategy focused at preventing excessive unemployment.

The Chancellor’s rhetoric may be about growth, but if he really cared about it he would spare the country the cuts in public spending and increases in VAT, which will reduce demand and therefore harm our economy’s prospects.

Criticising deficit reduction as “too far, too fast” concedes the argument in favour of some sort of mandatory deficit reduction, something which Labour’s plan to halve the deficit in four years is also guilty of.

Reductions in public spending should be wholly conditional on growth.

Labour, by failing to articulate the success of the stimulus and the continued viability of UK borrowing in the short term, has made it far too easy for the Coalition to argue that cuts are necessary immediately.

And this makes it harder to expose the coalition policy as one of ideology rather than one of economics.

A ‘maxed out credit card’?

Ahead of the Chancellor’s Budget announcement this week, Young Fabian Member Mark Anderson takes the coalition government to task over its positioning of its austerity measures.

One argument given by the UK government for its vast programme of public sector cuts is that the UK has ‘maxed out its credit card’.  Such a crude and misleading analogy bears no resemblance to the reality of Britain’s financial situation, yet it goes largely uncontested in public debate and serves to legitimise the devastation that is being wreaked on public services, the welfare state and public and private sector jobs and working conditions.

Far from the UK being no longer able to borrow money on the international financial markets, the interest that the UK pays on its debt is currently at a historically low level, as is the UK’s debt-to-GDP ratio. UK ten year bond yields are marginally higher than those for the US and far healthier than those for Australia and New Zealand, for example. In the run up to last year’s General Election, amid scaremongering about a potential debt crisis and the dangers of a hung parliament, yields on government bonds remained stable.

In a September 2010 article entitled ‘Can bond yields fall even further from these historic lows?’, Ross Watson, portfolio manager with Securities and Trust of Scotland told the financial journal Investment Week that:

“For the taxpayer, it is excellent news that the Government can fund its deficit at such low returns.”

Such sentiment presumes against a country close to bankruptcy.

Another argument the coalition government gives for frontloading public sector cuts is that it is unfair to saddle future generations with a mountain of debt. This argument is a perversion of the realities of private sector-induced deficits on several counts.

Firstly, it fails to take account of the fact that over 70 per cent of interest payments on government debt remains within the UK, going into savings and pension schemes – yours and mine.

Secondly, it bypasses the fact that you can’t cut your way out of a private sector-created budget deficit. Trying to do so simply condemns an economy to years of low growth – as seen in Japan over the last decade (when the Japanese government cut its stimulus too soon after recession, before Japan’s private sector had had a chance to recover) or in the UK in the 1930s (the last time that a post-recession public sector cuts programme was implemented in the UK on such a scale). Economic slowdowns make it harder to address structural deficits and repay government debt.

Thirdly, taking demand out of the economy when the private sector has not fully recovered risks a double dip recession which would increase government debt, not decrease it. Despite the Coalition’s best efforts to mislead the public, the UK’s structural deficit is a product not of Labour overspending, but of the collapse in output of the private sector following the collapse of Lehman Brothers in 2008.

Fourthly, at a time when the economy is already on its knees, it leaves the economy ill-equipped to compete against its healthier, better educated and better connected, more meritocratic international competitors.

Ending the previous Labour government’s fiscal stimulus, public sector cuts, a contraction in UK GDP at the end of 2010 and increases in unemployment and associated welfare payments, combined with the damage that the prospect of deeper cuts to come has done to business confidence and investment, have exposed the continued weakness of the UK’s private sector and led to a rise in government bond yields, thus further increasing the amount that the UK has to pay to service its debt.

Austerity is doing the opposite of what we are told it is aimed at achieving, and all this before the cuts have really started to bite.

A version of this post has previously appeared on Left Foot Forward.

Osborne’s apparent lack of understanding of the National Accounts

Perversely, today’s surprise GDP figures have provided meat to all sides. Labour claims it was their action while in government that helped grow the economy 1.1% in the second quarter compared to the first. The Coalition claim the figures validate their approach of expedited deficit reduction, pointing to the fact that the majority of the 1.1% growth (around 1 percentage point of it) came from the private sector.

AFP reports Osborne as saying:

“Today’s figures show the private sector contributing all but 0.1 percent of the growth in the second quarter, and put beyond doubt that it was right to begin acting on the deficit now.

“While I am cautiously optimistic about the path for the economy, the job is not yet done.

“The priority now is to implement the budget policies which support rebalancing and help ensure … sustained growth.”

This is, of course, a bit misleading. GDP is calculated on a value-add basis – the difference between the value of a produced good or service, and the value of the materials used to create it.

What this means in practice is that the stated government contribution to GDP doesn’t accurately reflect government expenditure. For example, the government could buy £1bn of baked beans and fill the House of Parliament with them, and it would add very little to the government share of GDP. The value add would end up elsewhere – in consumer expenditure or exports/imports, for example.

So quite a lot of Government expenditure doesn’t show up in the government consumption share of GDP – this is the difference between what the Government produces on a value-add basis, and the total income it derives from taxation and borrowing (a lot of government expenditure is just a transfer from one group to another).

This is quite an important point in the context of savage cuts to government department budgets. When the government scales back expenditure, the feed-back effects are more broadly felt – we can expect wider consumption and capital investment to fall because some business and consumers rely on government transferring tax revenues to them (for which they may or may not provide services).

And if you scale back government expenditure by enough, you can start having material effects on non-Government components of GDP because of the way the national accounts are assembled. This may mean lower or negative GDP growth.

Osborne’s analysis of these results therefore seems a little naïve, or deliberately misleading.

Copyright © 2004–2009. All rights reserved.

RSS Feed. This blog is proudly powered by Wordpress and is derived from Modern Clix, a theme by Rodrigo Galindez.