Why the UK has to get used to lower economic growth


8:32 am - August 8th 2011

by Chris Dillow    


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In the economic debate between left and right, there seems to be a shared presumption which I find questionable.

The presumption is that if only we can get the right policies – the right fiscal policy (whatever it is), banking reform, tax and regulatory policy, whatever – then the economy will grow as normal.

I doubt this, on several grounds:

1. Some of the growth since the 1980s came from a rise in households’ debt-income ratios as these adjusted upwards following the relaxation of credit constraints. Although I’m not as convinced as some that consumers are over-indebted, this process is now over.

2. History shows that recoveries from recessions and financial crises are often weak.

3. Gravity works against the UK. We export more to Spain and Italy than we do to all four BRICs.

4. In one important respect, the economy was running out of oomph even before the crisis. In the five years to the peak in 2007Q4, real business investment grew by 4.4% a year. In the previous 20 years – which encompassed a sharp recession, remember – it averaged 5.3% a year.

5. The factors behind this slowdown haven’t disappeared. These include: a realization (thanks to Nordhaus’s research) that investment in innovations is rarely profitable; the migration of low-wage projects to emerging markets; and a slowdown in the rate of monetizable innovations.

The thing is, I’m not sure that there’s much that policy can do about all this. It’s not good enough to “set the private sector free” because it doesn’t want to invest anyway. And it’s not enough to fix the banking system or set up a state bank, because the problem is a lack of demand for credit, not just supply.

And “confidence”  is a red herring; the problem is that there is a genuine dearth of investment opportunities, not that firms are unwilling to see them.

If I’m right, or even nearly so, there are implications here for both politics and the markets.
For politics, it suggests the task is not (just) to promote growth – which might not be greatly possible – but to adapt to an era of slower growth. For the markets, this suggests a fundamental reason for permanently(ish) lower equity valuations: that future growth will be lower. 

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About the author
Chris Dillow is a regular contributor and former City economist, now an economics writer. He is also the author of The End of Politics: New Labour and the Folly of Managerialism. Also at: Stumbling and Mumbling
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Reader comments


1. Paul Newman

Yes I agree with that and have been saying this for ages. I locate the problem however, chiefly in the long term migration of resources from competitive and productive activity into parasitic public sector employment and property related services to some exten . In the lack of Labour mobility and the drag of public housing, in the crowding out of enterprise in the Cuban regions where real economic activity in New business has almost stopped.
I do not agree that because there are low wage economies this is a bad thing for us neither do I see you emphasis on “exports” as reasonable in that 80% of trade is internal .There is much that can be done to get our own house in order starting with a recalibration of the rewards and expectations in the public sector as compared to the real economy where rewards for winners and survivors must , once again , dwarf those of the baby pool when all is safe and child friendly
This change, the reform of welfare the destruction of Union domination of education which the country cannot afford will take time as will the re-re-employmment of the idle.

I have long considered the damage New Labour did to the supply structural deficit but to safely adjust low growth is the least worst option ultra low interest rates also go some way to correcting the social injustice of the old saver parasitising the younger working population .

Ten years I `d say , it took about that to knacker the country .

On point 1 you make it sound like the population is a static lump. The UK population is constantly changing through immigration and young people joining the labour force.

Some analysts are saying that the future UK trend growth could have fallen to between 1-1.5%. If accurate that will have serious implications for reducing the deficit and for the size of the state that we can afford.

” The thing is, I’m not sure that there’s much that policy can do about all this. It’s not good enough to “set the private sector free” because it doesn’t want to invest anyway. And it’s not enough to fix the banking system or set up a state bank, because the problem is a lack of demand for credit, not just supply. ”

There is some truth in that because large firms and some not so large have got plenty of money on their balance sheets. Unfortunately, in a sign of risk aversion, they are not spending it and are foregoing profit maximisation in favour of debt reduction. Moreover, they are buying their own shares to boost their value rather than investing. A similar pattern is happening in the US where the corporate sector are sitting on $2 trillion in cash. Last Thursday on the NYSE, when the equity markets were in meltdown. The order flow ratio was 99 sellers to every 1 buyer. However, most of the bids were companies buying their stock because it was so cheap for them that day. These are not good signs when we want firms to invest and employ idle workers.

There are plenty of things that we could do on the supply side to encourage new start-up firms. Moreover, it is not beyond our capability to provide incentives for small and medium size firms to become larger. It is those type of firms who will generate growth and usually the only way that they can grow is to employ more workers. Large firms usually want to increase their profits through employing less people.

One growth enhancing thing we could do is to close down every local authority planning department in the country and brick up the entrance to keep them out permanently. Alternatively, tear random pages from all the planning regulations and consider them abolished. Absolutely no one would notice the difference. The planning departments exist only to stop people doing things and are responsible for every ugly monstrosity that has been built in the UK since WW2. Deport the NIMBY and BANANA brigade to the Falklands or somewhere equally cold and miserable. The Victorians managed without our regulations and they built nicer buildings than we do.

I disagree with you that the psychological effect of a lack of confidence is not a factor in risk aversion.

On equity valuations depends which valuations you mean. Share buybacks will distort your theory that they may be overvalued. Moreover, the FTSE 100 companies earn most of their revenue abroad often in the fast growing markets.

3. Mike Killingworth

Good piece, Chris. Pity you seem to bring out the Flat Earthers…

4. Leon Wolfson

There’s “weak” recovery, and then there’s the anemic non-recovery we’re showing.

Moreover, you’re telling the wrong people. You need to be talking to the Tories, they’re the ones who need to produce growth, and whose plans are based on high growth.

@1 – “starting with a recalibration of the rewards and expectations in the public sector ”

Cut, cut, slash, slash. The public sector has to bleed again, eh? Fewer good teachers, less people going to university, slashing nurses pay, less people collecting tax from the companies who hide their profits away. The same, monomaniac answer to everything.

Blind, absolutely blind – your type of policy has killed growth, how low do you want to go?

5. Limiting Factor

It has been clear for some time that you can have free-flowing global finance, or you can have democratic nations that are accountable to their electorates, but you cannot have both. To the the latter end, a few obvious steps are needed; a) reinstate money controls, regulate the flow of cash in and out of the country, b) import tarriffs, c) import substitution, yeah, thats right, lets get this country making things again, d) increase taxes on upper earners and corporations, e) properly man the division of HMRC that deals with tax evasion/fraud, and close the damn loopholes. Oh, and renegotiate the great sucking wounds known as PFI contracts. These are the things that are necessary to reestablish something like a democratically accountable nation. Of course, if all you’re interested in is a plundered country ruled by weak policiticans that are swapped around by the rich and the corporations like playing cards, then just carry on with Osborne’s Plan A. Yeah, let freedom ring!

I think this is why Labour and the Tories are cutting welfare if everyone is on lower benefits then the country can just about afford to trundle along at the bottom for longer. sadly the people of this country may not want to trundle along with Labour or the Tories.

But I suspect this will turn out to be the biggest down turn in living or non living memory.

I suspect the Government knew about this change a long time ago, seems even the CIA was warning the UK about welfare in the EU was going to cause a massive down tun way back in 2005, sadly Blair being a brilliant American decided to act.

Looks bleak

7. theophrastus

LF @ 5:

“a few obvious steps are needed; a) reinstate money controls, regulate the flow of cash in and out of the country, b) import tarriffs, c) import substitution, yeah, thats right, lets get this country making things again, d) increase taxes on upper earners and corporations, e) properly man the division of HMRC that deals with tax evasion/fraud, and close the damn loopholes. Oh, and renegotiate the great sucking wounds known as PFI contracts.”

These steps may be “obvious” to you, but they seem deeply flawed to me:-

a) There would be mass flight of capital and people at the first hint of such a policy. There would be no inward investment by foreign companies. The City would be crippled. Mass unemployment would probably follow.

b) Import tariffs make the poor poorer because they are forced to buy more expensive home-produced goods. Producers with captive markets become lazy, inefficient and don’t have to innovate, so UK consumers would end up having to buy inferior products. Ladas all round…

c) see b) above, and note planned economies don’t have a great track record of meeting consumer demand

d) Increasing taxes on higher earners and corporations will result in them moving elsewhere. Unemployment will increase as wealth creators depart.

e) Tax evasion and fraud are illegal, unlike tax avoidance which is legal. Parliament decides on the closing of legal “loopholes”, not the HMRC. Despite Richard Murphy’s fantasies, a more robust approach to tax evasion/fraud will not solve our budgetary problems…

As for renegotiating PFI contracts, that is certainly something that needs to be looked at, on a case by case basis.

8. DisgustedOfTunbridgeWells

Blind, absolutely blind – your type of policy has killed growth, how low do you want to go?

Why, it’s almost as if they’re crashing the economy on purpose.

9. Leon Wolfson

@5 – Fine. Oops, you now have massive trade tarriffs with a pissed-off EU (where we do most of our business), UK nationals thrown out of jobs abroad, China turned against us and finance fled to Germany.

Nice plan!

Yes, we need to throw cash at closing the tax gap, but we can do that without a trade war which would hurt us a LOT more than anyone else.

@7

These steps may be “obvious” to you, but they seem deeply flawed to me:-

a) There would be mass flight of capital and people at the first hint of such a policy. There would be no inward investment by foreign companies. The City would be crippled. Mass unemployment would probably follow.

Capital controls werre common until the 1970s under the Bretton Woods system with no apparent ill effects. Similar predictions of disaster were made in 1998 when Malaysia introduced capital controls during the east Asia financial crisis, yet Malaysia recovered more quickly than its neighbours. http://en.wikipedia.org/wiki/Capital_control

b) Import tariffs make the poor poorer because they are forced to buy more expensive home-produced goods. Producers with captive markets become lazy, inefficient and don’t have to innovate, so UK consumers would end up having to buy inferior products. Ladas all round…

c) see b) above, and note planned economies don’t have a great track record of meeting consumer demand

But then maybe the poor might have prospects of getting a job. Our current regime of outsourcing manufacturing to the far East has created the global trade imbalances which was one of the major causes of the present economic crisis. And is in the long run unsustainable.

d) Increasing taxes on higher earners and corporations will result in them moving elsewhere. Unemployment will increase as wealth creators depart.

So it is said. Yet Sweden et al has high taxes, and yet their economy seems to do quite well.

e) Tax evasion and fraud are illegal, unlike tax avoidance which is legal. Parliament decides on the closing of legal “loopholes”, not the HMRC. Despite Richard Murphy’s fantasies, a more robust approach to tax evasion/fraud will not solve our budgetary problems…

Any evidence for this?

Capital controls would breach the Treaty of Maastricht. There are provisions when an EU member can on an emergency basis introduce capital controls if that nations banking system is threatened with collapse. Not quite sure why people seem to think capital controls are a good idea. Moreover, one can have two from the impossible trinity, but not all three.

A fixed exchange rate.
Free capital movement (absence of capital controls).
An independent monetary policy.
http://en.wikipedia.org/wiki/Impossible_trinity

The UK is historically easily the number one European destination for foreign direct investment as a gateway to the EU. That would immediately disappear with CC. Import tariffs would breach numerous treaties and obligations that the UK has signed and others would respond in kind. The free trade battle of ideas was won in the 19th century, and it is kinda of funny to see some on the left adopting 19th century Tory arguments.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    Why the UK has to get used to lower economic growth http://bit.ly/nb8die

  2. MustBeRead

    On @LibCon: Why the UK has to get used to lower economic growth, by Marxist economist @CFJDillow http://t.co/mebUZx2

    by Chris Dillow

  3. Simon

    Why the UK has to get used to lower economic growth http://t.co/bMBEJZp

  4. Liam Joyce

    Why the UK has to get used to lower economic growth | Liberal Conspiracy http://t.co/F23qWEv via @libcon

  5. Richard Try

    On @LibCon: Why the UK has to get used to lower economic growth, by Marxist economist @CFJDillow http://t.co/mebUZx2

    by Chris Dillow

  6. London in flames, police cuts in doubt and the economics of no way out: round up of political blogs for 6 – 12 August | British Politics and Policy at LSE

    […] Dillow blogging at Liberal Conspiracy has 5 reasons why the UK should get used to having slower growth. Tony Dolphin at says that it is the lack of demand for credit, rather than the supply of it that […]





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