We need a govt stimulus to escape the long slump in modern history


4:04 pm - July 12th 2012

by Duncan Weldon    


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We are in a slump, the longest slump in modern economic history. GDP is still 4% below its pre-crisis level, we have over 2.6m people out of work and another 2m under-employed.

Real wages have are falling and we’re experiencing the biggest crisis in living standards in generations.

The government has no plan to deal with this. Austerity is failing even on its own terms. Households are over-indebted and are experiencing falling income, export prospects look bleak and firms, understandably, are reluctant to invest.

To end this slump will take a fiscal stimulus, the one thing the government has set its face against.

Of course the slump won’t last forever, eventually we’ll experience some sort of weak growth. But we are now in the situation of Japan in the 1990s.

Jonathan Portes thinks the government have started to recognise this via recent plans to guarantee private investment.

I’m less hopeful – we’ve heard this sort of talk before, for example this speech from Nick Clegg in September last year.

The Bank of England, clearly concerned about the outlook, has restarted its quantitative easing programme. But that is not an effective substitute.

And the longer this slump continues – the more long-term damage that will be done the economy and to people’s prospects.

Yesterday, Martin Wolf wrote that when the private sector is trying to reduce debt and increasing its savings, the public sector has to spend.

This isn’t some fancy economic theory, it’s a simple accounting identity. German, US, Japanese and UK government bond yields (the interest rate on government debt) are at, or very near, historical lows.

A fiscal stimulus wouldn’t be the end of our economic problems, we can’t just go back to the business as usual world of pre-2008, for the reasons Frances O’Grady argued yesterday – we need to build a ‘new economy’.

But the first priority of policy makers right now should be ending the slump. Monetary policy will play a part in that – but without fiscal stimulus this slump will be much longer than it has to be, and it’s ordinary people who will pay the price.


A longer version is on the Touchstone blog

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About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
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Reader comments


I don’t need any stimulus.

Real wages are falling because

a) we’ve got inflation induced by Mervyn King’s printing press.

b) because mass immigration (five million non-EU, 2.3m EU – and those are the recorded figures) means it’s a buyers market for labour, so nominal wages are static at best.

http://www.telegraph.co.uk/news/uknews/immigration/9394130/Five-million-non-EU-immigrants-living-in-UK.html

In Mr Marx’s immortal words:

“The main purpose of the bourgeois in relation to the worker is, of course, to have the commodity labour as cheaply as possible, which is only possible when the supply of this commodity is as large as possible in relation to the demand for it”

3. Shinsei1967

Falling real incomes has been the main reason for the flat-lining economy over the last 18 months. The IMF and OBR couldn’t be more vocal about this (read either of their last reports on the UK economy). It isn’t austerity and it hasn’t been a weak Eurozone (well, not yet anyway).

And the primary reason for weak real incomes has been high inflation.

Fortunately oil and energy prices have begun to fall and the impact of a weak sterling has begun to reverse. Thus inflation is falling rapidly.

Fortunately employment growth is actually positive and nominal wages are rising slowly but they are rising.

There is every reason to think that real incomes will turn positive this year. With consumption being 70% of GDP this is an important boost to economic growth.

The last thing we need now is for a reckless fiscal stimulus that places the currency at risk and thus any short term stimulus is offset by an increase in inflation and thus falling real incomes.

And when one is already running a 7-8% of GDP stimulus there is not that much room for increased borrowing without upsetting financial markets.

Which government, one made it, the other is prolonging it

Duncan:

In the 1930s, 1970s, 1980s and 1990s, UK governments have combined fiscal consolidation (ie cutting the deficit) with (a) a loose monetary policy and (b) a devaluation of the pound – and every time it has worked. For instance, as I recall, from 1932-34, public spending was cut and taxes increased; yet GDP grew from 1933-37 by nearly 20%. This is not theory, but what actually happened.

Borrowers, like yourself, argue that we should borrow to stimulate the economy. But there is no historical precedent for that in the UK of which I’m aware. Which is not to say that you borrowers are obviously wrong; but it does place the onus on borrowers to explain why things are different this time – as, indeed, they may be.

6. Charlieman

That OP didn’t work for me. The longer version at http://touchstoneblog.org.uk/2012/07/we-need-a-fiscal-stimulus-to-end-this-slump/ is worth a read, however.

The original includes a few Keynes references that suggest what form of economic stimuli might work; bringing forward government capital projects that boost civil engineering, for the most part, to boost everything related. It is consistent with fiscal responsibility that is not masochistic

7. inyourhouse

No, we need fiscal contraction and monetary expansion. There are good social arguments for the government to tackle unemployment, though. My preferred policies would be:

1) a general marginal employment subsidy set at a level such that the (hours-adjusted) number of vacancies is equal to the number of (hours-adjusted) unemployed and underemployed. Given the historical vacancy/unemployment ratio in the UK, that would bring the unemployment rate down to 4-5%.

2) replacing JSA with a system whereby the unemployed are “auctioned” to various businesses. Firms would submit the amount they would require in subsidy to employ that individual and the firm with the lowest submission would “win” the right to employ the worker. The government could set a price ceiling on the highest amount it would be willing to pay so there wouldn’t be any ridiculously high subsidies. If no firm is willing to employ an unemployed person at a subsidy lower than the ceiling then the person would just receive JSA and be auctioned again the next week, and so on. I expect this would bring the unemployment rate down to 2-3% (Japanese-esque levels)

3) giving tax cuts to workers who move from high unemployment areas to low unemployment ones. Even in the current environment there are many areas that have an excess of vacancies over the local unemployed population, so encouraging labour mobility could fill that void and bring aggregate unemployment down. Maybe we could get the national unemployment rate as low as 1%. In the New Forest, where I live, many areas have unemployment rates even lower than 1% (just 0.5% in Bramshaw, for example), so it is quite possibly achievable.

However, these policies should be financed entirely through spending cuts in other areas (most obviously on the programmes they would make redundant) and/or new taxes. Leave aggregate demand management to the Bank of England, and if they’re not doing a good job (which they aren’t) then change their mandate (preferably to an NGDP target) and link MPC member pay to their performance in hitting that target.

inyourhouse – Japanese employment levels need a Japanese immigration policy.

Let’s assume that your prescription could create, say, two million net new jobs. That would suck in even more people from Eastern Europe and probably Spain as well.

After all, 2.9 million net jobs were created between 1997 and 2009. But nearly two million of those were filled by foreign workers, and as a result there were fewer British-born workers employed in the first quarter of 2009 than Q1 of 1997.

http://ukcommentators.blogspot.co.uk/2009/06/british-jobs-for-foreign-workers.html

Why such employer preference for foreign workers? I’d imagine that it’s not-so-bright Brits who are losing out to brighter Eastern Europeans. In which case, what are the employment prospects for Dave from Doncaster, IQ 85, when there’s always another Ladislas from Lublin, IQ 105, in the job queue?

9. inyourhouse

@Laban Tail

“Let’s assume that your prescription could create, say, two million net new jobs. That would suck in even more people from Eastern Europe and probably Spain as well.”

Quite probably, yes, but that doesn’t matter. The marginal employment subsidy would be set (changing periodically – every quarter, say) such that the government’s forecast for hours-adjusted vacancies (ie. the quantity of labour demanded) would always equal its forecast for hours-adjusted unemployment (ie. the quantity of labour supplied). In other words, there would always be sufficient aggregate labour demand, regardless of how many immigrants came over here.

Note that this would obviously not mean that unemployment would be eliminated because the unemployed may not have the right skills for the jobs on offer.

“Why such employer preference for foreign workers? I’d imagine that it’s not-so-bright Brits who are losing out to brighter Eastern Europeans. In which case, what are the employment prospects for Dave from Doncaster, IQ 85, when there’s always another Ladislas from Lublin, IQ 105, in the job queue?”

Tackling that problem is the point of the second policy I listed. It creates jobs for people who are unlikely to be hired unless businesses are incentivized to do so with a subsidy. It’s surely better for the government to spend money so as to ensure these people are in work, as opposed to the current policy of paying them merely to look for work.

It’s also worth noting that more high-skilled immigrants has the nice side effect of increasing the demand for low-skill labour (e.g. more people living here is going to require more dustbin men).

Duncan

I suppose fiscal stimulus in your eyes means more government spending on the public sector?

if you are going to once again increase the deficit, with all the negative for the long term that follow, why do you always seem to overlook tax cuts for individuals and business?

11. MarkAustin

@10. Tyler

Duncan

I suppose fiscal stimulus in your eyes means more government spending on the public sector?

if you are going to once again increase the deficit, with all the negative for the long term that follow, why do you always seem to overlook tax cuts for individuals and business?

Because that will not work. The problem is that we are in a liquidity trap: no-one wants to invest or spend—despite neo-classical economics saying this is the rational thing to do—because they are afraid of the future, so want cash in the bank.

In those circumstances there is only one actor who can turn things round: the Government.

I would agree that the situation is not helped by debt run up by that economic incompetent Gordon Brown.

@ Mark Austin

What if the growth effect of any new government spending/investment is less than the negative effect of the drag on growth created by more government debt and the interest payments on it? (take a look at Rogoff and Reinhardt for a good explanation).

I understand that people are paying down debt at the moment, but tax cuts allow people to do that faster and thus return to private spending/investment faster. So whilst tax cuts aren’t an immediate solution, they do remove one of the significant problems in the economy (too muh private debt) and allow it to move on.

More government spending on “investment” might give a temporary uplift in GDP, but can also take time to come on stream, and there is no guarantee it is going to be well targetted or exectuted – which means the money might simply be wasted. It’s not like governments the world over don’t have a history of building over-budget white elephants.

Ultimately though more government spending on “investment” doesn’t solve the true problem – too much debt in both private and public hands systems – and indeed increases the problem. At least tax cuts allow the private sector to deleverage at the cost of increasing public sector debt.

As you say though, Gordon Brown left the UK in a terrible position by simply spending too much pro-cyclically.

I agree we need stimulus, but what I don’t agree with is how we get it.

It is utterly bonkers not to understand the problems with a government stimulus at this point though. We are way beyond a government stimulus fixing this problem. Very much a case of old horse for new course. Govt. stimulus will only ever work in the short term. It is not a long term solution, it never has been, it never will be. The govt. cannot simply print money, and force ill thought-out demand side policy on the country.

If we introduce govt. stimulus that has to be paid for. It increases govt. debt, at a time when it is already too high. The argument goes that we are borrowing at very low rates, but the only reason that rate is low is because we are borrowing comparitively small amounts in ratio to the countries ability to absorb the debt long term.

Opening up the flood gates to more govt. stimulus is simply not going to work when we realise that there still is no demand in the country and now all of a sudden we have more debt to pay for. The problems are far more structural than any of this article suggests. The only we for the country to actually dig its self out of trouble is for the people who live in it to be able to earn and produce. Less taxation and more supply side orientated policy is therefore necessary. That will mean the underlying economy will grow, not simply dump money into the economy, which increases burden on debt that the same country has to pay back.

The old addage that you cannot cure debt by creating more debt still holds true. It doesn’t matter how low the borrowing costs are. It is simple to see.

14. Planeshift

“giving tax cuts to workers who move from high unemployment areas to low unemployment ones.”

But the problem here is that low paid workers generally also get housing benefit. So what we simply end up doing is moving somebody from jsa in area A to a low paid job in area B where the rents and council tax are far higher, and hence the treasury makes no net gain.

A more logical approach is to try and diversify the economy so that we extend the areas where there is low unemployment, improve transport links between these and the areas of high unemployment (both to improve employment rates and attract new investment to areas of high unemployment), and reform local government finance to create incentives for local authorities to promote investment locally.

“I suppose fiscal stimulus in your eyes means more government spending on the public sector?”

There is a running joke in Wales that the recent floods in west wales will provide an economic stimulus for the area. Insurance payouts and the obvious demand created for home improvements will generate local employment and stimulate the economy. So by this logic what the UK needs to do is pull off a giant insurance job….

@11. MarkAustin

“Because that will not work. The problem is that we are in a liquidity trap: no-one wants to invest or spend—despite neo-classical economics saying this is the rational thing to do—because they are afraid of the future, so want cash in the bank.”

But why do they not want to invest and spend. It is because there is no reason to do so. If the govt. introduces measures to make the country more attractive, like lowing taxation and making it easy to invest, the money will flow out of the bank accounts and into the economy. Importantly as well money will flow back into the country.

inyourhouse : “In other words, there would always be sufficient aggregate labour demand, regardless of how many immigrants came over here.”

Hmm. I look forward to the successful implementation of “Globalisation In One Country”, your future Britain of 150 million-plus souls, and I welcome the jobs that will be created as we concrete over the whole of England.

Incidentally, the Ernst & Young Item Club, which uses the Treasury model, recently compared growth under coalition plans with Labour’s plan for slower deficit reduction. The results are interesting.

In 2010, the economy grew by 2.1%, 0.7% in 2011 and is projected to grow by 0.4% this year. Under Labour’s plans, assuming nothing else changed, growth would have been marginally higher in 2011 at 0.8% and the same in 2012 – but at the cost of an additional £24bn of debt.

EYIC then assumed that gilt yields would have been 0.5% higher under Labour’s plans. Putting this into the model, growth under Labour in 2011 would have been 0.7% in 2011 – the same as under the Coalition – and 0.7% in 2012 – only 0.3% higher than under the Coalition. And the additional debt would be £37.5bn…

Labour, I’m afraid, does not have a different but workable solution to the UK’s economic difficulties.

And once debt exceeds 90% of GDP, annual growth can be 1% lower for up to 23 years (see: Rogoff and Reinhardt, as mentioned @12). The ONS says UK public sector net debt is 65% of GDP, excluding banking liabilities – 148% with them. Eurostat put UK psnd at 87%. Either way, taking on more debt for such a small growth dividend is hardly prudent.

18. Richard W

Duncan,

Every analyst always wants to know where the economy is in the economic cycle and where it is in relation to the past. Your chart of months from pre-recession peak is slightly misleading and leads you into believing that things are worse than the reality for most people. If you only look at the economy in GDP terms then the slump months from the peak is a worse performance vis-a-vis previous recessions. However, if one looks at GDP ex NS oil and gas output the recovery was following the path of the 1979-81 experience.
http://moneymovesmarkets.com/journal/2012/6/28/uk-2008-09-gdp-decline-revised-down.html

Rising NS output was a supply boost for the UK economy and current falling output reduces GDP growth without having a significant impact on employment for most people. A fiscal stimulus to raise demand is not going to do much if the poor RGDP performance is related to falling NS output. Targeted tax cuts to raise NS output and bring on stream marginal fields would be helpful. However, I have a hard time imagining oil companies as the recipients when the left speaks about fiscal stimulus. Go on prove me wrong.

As can be seen from the chart provided there has been a divergence from the 1979-81 path over the last six months. I think most of that divergence can be attributed to EZ problems that cannot easily be fixed with a UK fiscal stimulus. I have no problem with fiscal stimulus that takes the form of increased cap ex, cuts in employers NI contributions and a permanent cut in VAT. However, it should be neutral for total managed expenditure which would require cuts to be made elsewhere to maintain neutrality.

Engage in a below the water stimulus. (At least largely) match boosts to economically productive investment and employment support schemes with cuts to economically unproductive spending. Dramatically boost the economic impact of (already) sky-high government spending without risking a loss of confidence in deficit reduction. It’s a hard choice, but possibly the only one that can save the economy and thus protect public services into the long term.

20. MarkAustin

@12. Tyler, @15. Freeman

A, the usual nostrums. Lower taxes andencourage investment (this is generally code for cutting government spending radically, but sounds better).

This won’t work. We’re in a liquidity crisis. Far too many people want to get out of loans and investments. Cut taxes and all that’ll happen is that loans will get paid of and the money leaks out of the system.

Look at Quantitative Easing. Billions of pounds thrown at the banks, and the only economically useful bits are what leaked out in bank bonuses: and a goodle portion of that ended up, not spent, but, to coin a phrase, “under the mattress”.

All QE is doing is keeping interest rates a little lower than they should be, which doesn’t help as few want to borrow, and keeping inflation a bit lower than it should be, which is actually bad, as it’s keeping debt up.

Liquidity crisis’ are caused, almost exclusively, by failures of confidence—created by some real shock–when everyone rushes into the most liquid and/or safest haven they can find. Why are people buying UK/US/German Government Bonds—at current interest and inflation rates they are losibng value? It’s because they are percieved as safe—no-one expects a default, unlike in some of the other EU member states.

In this case only the Government can act as lender/investor of last resort. It can guarantee loans—and I welcome the recent decision to do just that. It can invest in infrastructure (not big vanity projects like the railway investment which cannot start for two years) but, for example, small scale housing (via Housing Associatioons) projects and grants/loans to invest in hopse improvement/insulation. Projects that have an immediate effect.


Reactions: Twitter, blogs
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  2. BevR

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  3. Clive Burgess

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  8. Breffni M O'Connor

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  9. Linda Burnip

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  10. Mahmoona Shah

    Duncan Weldon / We need a stimulus, or we will become Japan http://t.co/6eOQMmRO @duncanweldon





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