Economic Growth – today, tomorrow and long into the future.

Economic growth is a key economic objective. Not only does it affect living standards, it affects productivity although there is discussion about whether productivity causes growth or vice versa. It is linked to the balance of payments with export-led growth being an ideal way of achieving two objectives yet  growth can worsen the balance of payments in both the short and long term; in the short term countries often have to purchase machines from overseas and build up raw materials and components and in the long run, particularly in the UK which has a high marginal propensity to import, higher incomes associated with growth cause significant increases in imports. It provides a fiscal dividend for the government, allows for a redistribution of income by channelling the rewards of growth towards low income earners and can allow the economy to expand in a non-inflationary manner by shifting the long run aggregate supply outwards although it is also associated with demand pull inflation when aggregate demand increases more than aggregate supply.

When analysing the causes of growth, economists differentiate between short run growth, usually associated with increases in demand, and long run growth which emphasises supply side policies. However recently there is a view among some economists that the developed world might be entering a period of prolonged stagnation. This was an idea first espoused in the 1940s but refuted by the post-war boom. Today the OECD are  predicting growth of below 3% among its members compared to 6% before the financial crisis and there is increased interest in the very long run.

Some suggest that today’s technological advances focus more on improving the quality of life and have a smaller impact on productivity than previous advances. However this is difficult to quantify since major developments, such as the internal combustion engine and electricity took over 50 years to work through the economy.

Another possible cause of the slowdown, if indeed we are entering a prolonged slowdown, is the fall in birth rates and increasingly ageing population which impact on the supply of workers and, possibly, on the development of new ideas. As well as the supply of labour being an issue, there are also concerns over increasing difficulties being faced in extracting raw materials as the world is having to use increasingly marginal sources. In the 1950s, one could extract the equivalent of 100 barrels of oil by expending 1 barrel while today the ratio is 20 to 1.

Some economists also suggest that not only are gains in long run aggregate supply increasingly difficult to achieve, old-fashioned reflationary policies are having a smaller impact than in previous years resulting in a weak recovery post 2008 throughout the developed world with the exception of the USA.

Does slow growth matter? Does faster growth and higher incomes bring greater happiness? Do the environmental advantages from a move to a lower growth path outweigh the benefits?

GDP – what does it measure and is it still useful?

Gross Domestic Product, which measures the total market value of goods and services produced in an economy in a period of time, is regarded by economists as the single best measure of economic activity. It provides a measure of how well a country is doing relative to other countries and, if adjusted for inflation, i.e. measured in constant prices or real terms, it shows progress over time. When converted into a common currency such as the US dollar, its size reflects a country’s economic power in the world while its PPP (purchasing power parity) value is used to compare living standards between countries. Equally importantly, it provides information which the government can use to manage the economy.

It is measured in three ways – output, income or expenditure in an economy – and, in theory, these should be the same since expenditure on a product determines its monetary value and also generates the incomes of the factors of production involved in its production. The output method involves looking directly at the value of the output of goods and services produced less the inputs used to produce them, plus indirect taxes minus subsidies. The income method considers the income earned by households and businesses in the production of goods and services and the expenditure approach measures spending by households, businesses (investment in capital and stocks of goods) and the government, plus net exports (exports less imports) of goods and services. Government services, such as healthcare or education, which are not paid for directly, are particularly difficult to measure. In the past, the Office for National Statistics has looked at the cost of providing these services; more recently it supplements this by looking directly at outputs such as the number of patients seen.

It is accepted that GDP does not measure the value of activities which are not traded, such as volunteering or services undertaken at home by parents such as childcare or cleaning; it does not directly measure  welfare, takes no account of inequality and most recently, concern has been expressed that it does not take into account the depletion of natural resources. Thus, if Brazil increases its logging in the Amazon, its GDP increases through the production of timber, without any corresponding reduction to take account of resources used up. Similarly, ironically, a disaster is good for GDP since it will require  re-building of houses, factories, roads, etc, which is counted, while the initial damage is not subtracted. GDP does not adequately take account of improvements in quality, particularly with electrical goods – computers are estimated to be 1,000 times more powerful than 30 years but in real terms are cheaper.  It also does not accurately reflect the hidden economy, although since 2014, UK GDP data has included an estimate of the value of  illegal drugs and prostitution (£10bn in 2014) in the GDP data.

There has been concern over the accuracy of GDP estimates, which are frequently revised following initial publication as more data becomes available. The UK is similar to other countries in this respect but where the problem becomes important is when the country might be entering a recession, with all the political and economic significance attached to it. The definition itself (two successive quarters of negative growth) is questionable since it suggests an economy shrinking by 0.1% in two successive quarters is in recession and therefore doing badly, while one growing by 0.1% in one quarter and then shrinking by 2% in the next quarter is okay.

15 years ago, only half the adult population had access to the internet. By 2015 only 10% of adults did not have internet access. Today two thirds of adults own a smartphone, a percentage which has more than doubled in nine years. This increase in on-line activities has been one factor behind the increasing discussion of the usefulness of GDP as an economic indicator and the government commissioned Professor Sir Charles Bean to produce a review of government statistics. He noted that, when an economy mainly produced tangible products, measuring GDP was relatively simple. As services became more significant, GDP calculations became more difficult and, in recent years, with the rise of on-line services, such as Spotify and Google, the validity of GDP statistics has become even more doubtful. Previously, for example, if I wanted to go on holiday to Paris, I might buy a map. Today, I will use google maps instead. Although the physical quantity of goods produced has dropped, I receive the same “product” in a different form, but it will not be recorded in GDP data. As Professor Bean writes, “Digital products delivered at a zero price ……  are entirely excluded from GDP. …….  The issue is analogous to that posed by public goods provided free of charge at the point of delivery. But, unlike that example, there is not even a protocol that dictates their value is related to the value of inputs used in their creation.”  (Page 76, Independent Review of UK Economic Statistics – Professor Sir Charles Bean)

He considers what has been omitted and also looks at the way the digital revolution has made us more productive saving time ( or less productive if you get bored reading this and go off and email friends or buy something on-line) and estimates that the digital economy currently adds approximately 0.5% p.a. to our GDP growth which we are not adequately measuring. Given the current low levels of UK GDP growth, this is a significant adjustment.

Globalisation, international trade and the coronavirus.

Last month Tesla finished the first Model 3 cars produced in its new Chinese factory in Shanghai and their production provides useful examples of economic theory in action.

International trade theory suggests that producers making complex products often make them initially close to home, e.g. the Tesla factories in Nevada and New York state, where there are the designers and engineers on hand to deal with production difficulties. Another example is Dyson shifting its manufacturing plant from the UK to Malaysia while maintaining its research and design facilities in the UK. Once the product is refined and the production process is running smoothly, it is possible to outsource production to areas of the world where costs are lower in order to take advantages of those areas’ comparative advantage.

The Tesla factory is the first wholly foreign-owned car plant in China and, from starting construction to producing the first finished cars took less than a year – significantly faster than such a product in the UK. However it is worth noting that the initial negotiations according to Elon Musk, took “years”.

The Chinese-made cars are cheaper than imported models ($50,000 compared to $63,000) and, as production increases and more local components are used, costs will fall further, possibly as much as 20%.

Apart from making it easier to tap the potential in the Chinese market, the ability to produce in China means that the factory’s output would avoid possible tariffs on US exports. In the future, cars might be exported from China to consumers in the UK who would benefit from lower prices.

The above example shows the benefits of international trade and globalisation. However news this week of the effects of the coronavirus shows the reverse situation highlighting the dangers of increased interdependence through global supply chains. Jaguar Land Rover has announced that it could run out of components from China within two weeks. Apple has similarly announced that its iPhone supplies are suffering because of the problems in China where Foxconn workers, the business which assembles phones, have been told to stay away from work because of the virus. In addition, as the Chinese economy has grown, and it now accounts for 16% of world GDP, as well as its role in world supply, its slowdown also impacts on demand elsewhere in the world.

Should economists be worried about the coronavirus?

The coronavirus has been in the news this weekend with the 35,000 people in different countries being affected. In addition, the business pages of many papers are expressing concern about the implications the coronavirus might have on Western economies – what economists refer to as an economic shock – with the Federal Reserve Bank talking of a risk to the global economy. This is because of the increasing importance of China in the world today. Not only is it the second largest economy, accounting for 19.7% of world GDP, it also demands a staggering 69% of world mineral production. 20% of world tourism spending is linked to China, both inward and outward, with the Japanese economy predicted to experience a £17.3bn cost from the virus. Cathay Pacific, a Hong Kong based airline, has asked 27,000 staff to take a three-week unpaid holiday while, in the UK last year 415,000 visitors from China spent £714 million in UK hotels, shops, restaurants, etc. One estimate in the newspapers suggests every 22 visitors from China to the UK creates an additional job.

China now accounts for 13% of world trade. Wuhan, the region where the outbreak started, is prominent in world car production. Honda, Toyota and General Motors have factories there and many of these are currently closed to prevent workers travelling to work and catching or spreading the disease. Similarly, many shops are closed and Chinese branches of Western stores, particularly luxury products, such as Burberry, Estee Lauder and Canadian Goose have talked of falling sales in China as Chinese citizens stop shopping for such luxuries and the number of foreign tourists to China drops significantly. Ralph Lauren has closed 55 of its 110 stores in China. China is the world’s largest oil importer, daily consuming as much as the UK,  France, Germany, Italy, Spain, Japan and South Korea, and, as China’s economy slows oil prices have dropped with analysts comparing it to the fall as a result of the financial crisis

Apart from direct effects, China factories have a major impact on world supply chains, assembling products and producing components from everything from cars to iPhones. Fiat Chrysler, the Italian-American carmaker, has said that it could shut one of its plants on the Continent if the disruption continues while Sony and Nintendo have both talked of unavoidable delays in the supply of some of their products.

As Chinese production slows and both its exports and imports decrease, world growth will fall. Whether this is a temporary blip or a permanent drop will depend on how serious the epidemic turns out to be. However there is an upside – in China demand for  contraceptives and  Netflix subscriptions are both booming.

Brexit – The Sequel

The UK has been on a long journey since voting to leave the EU three and a half years ago. According to some, we are in the departure lounge waiting to start an exciting voyage while, for others, we are standing on the cliff edge. So what is in store for the UK?

By Monday, our Members of the European Parliament will have lost their jobs and there will be a new 50p commemorative coin but little else will have changed since we will be in the transition period, currently scheduled to finish at the end of the year. This means that for eleven months we will be keeping to EU rules, following its treaties, and paying into and receiving grants from the EU budget. During this period, we will be negotiating with the EU to establish the trading arrangements which will come into effect in 2021.

The Government will have some difficult decisions to make – many leavers are looking forward to being free from the EU’s regulations while many areas of the country which switched from Labour to Tory in the recent election rely on industries being able to export to the EU and therefore need a deal which agrees an alignment between UK and EU standards. Parts of these areas are dependent on the motor industry which did not enjoy a good 2019. Car production in the UK fell last year by 14% down to 1.3 million, the lowest level for ten years and the third consecutive year of decline. The industry has put this down to a move away from diesel cars and falling demand in some of our major markets, such as China. Many plants are producing significantly below capacity, e.g.  the Vauxhall Astra plant in Ellesmere Port can produce almost 200,000 cars a year but, last year, produced only 61,000. The EU accounts for 55% of our motor exports and, last year, their demand fell 11%. A deal which limits our exports of cars to the EU will have significant consequences and a Government paper suggested that the North West, the North East and the West Midlands would see a fall in GDP of 16% if no deal is reached.

The motor industry is not the only one where the nature of the deal (if one is agreed) will be significant. The fishing industry, with annual exports to the EU of almost £1 billion, is pressing the Government to limit the access of EU boats to UK waters while the financial sector, which exports £26 billion to the EU annually, is keen to maintain its access to EU financial markets. There is comment in the newspapers about bankers being sacrificed for fishermen and it will be hard for the Government to satisfy both parties.

The service sector is becoming increasing concerned about talk of a Canada style agreement (CETA – Comprehensive Economic and Trade Agreement) because that agreement between the EU and Canada concentrated largely on goods, while services make up 80% of UK GDP. It is not clear that the EU will be wiling to offer the same agreement to the UK as to Canada. Because we are geographically much closer to the EU than Canada is, the EU is more concerned about the UK being used a backdoor into the EU by third parties. They are also keen to ensure that the UK observes the same regulatory standards as the EU so we are not able to undercut EU producers because, for example, of generous assistance provided by the UK Government or weaker environmental standards.

Finally, remember that took the EU and Canada seven years to agree CETA and we have eleven months.