Osborne’s woes

George Osborne may be trying to put a brave face on today’s 0.5% 2011Q1 growth figure for the UK, but he knows things are bad. One-half of one percent was at the lower end of the range of what most economists were forecasting. Critically, though, it means that over the past two quarters (6 months) the UK has had zero growth—or marginally negative growth depending on whether you think end-of-year quarterly growth in 2010 (2010Q4) was -0.5% or -0.6% (the latter was the Office of National Statistics’ revised forecast).

Writing in the Financial Times yesterday (26 April), Chris Giles said: ‘There are [various] reasons why it will be difficult to claim that the recovery is self-sustaining unless Wed­nesday’s number is at least 1.2 per cent and possibly as high as 1.7 per cent.’^[1] The negative 0.5% figure for 2010Q4, attributed to heavy snow before Christmas, means that a basic bounce-back of 0.5% in 2011Q1 could be expected even if the underlying trend growth rate was zero. Moreover, the ONS thinks that delays in production and deliveries add another 0.2%, bringing the bounce-back to 0.7%. Arguably, we should add a further 0.5-1% growth for the quarter if underlying growth is in line with the OBS forecast, so making Osborne’s true bounce-back figure for 2011Q1 between 1.2% and 1.7%.  In short, George Osborne has fallen far short of his target.

Duncan Weldon has summed up the situation admirably: GDP is about 1.1% lower today than the OBR thought it would be 10 months ago, 0.8% lower than was assumed back in November and about 0.2% lower than the forecast from last month. The question now is whether the full year 2011 forecast will be revised down for the fourth time?^[2]

Don’t forget that the full effect of the cuts, which began in April 2011, will only be felt in the remaining three quarters, so we can expect lower growth in 2011Q2-Q4. How much lower? My most optimistic guesstimate—and it’s only guesswork—-is 0.3, 0.2 and 0.2 percentage points for the remaining quarters respectively, which results in a growth figure for the year of 1.2%. But this figure will only be realised if household borrowing continues to rise to enable consumers to keep on shopping despite their shrinking pay packets.

There are some important qualifiers which justify thinking that we may just fall back into recession in the course of this year. First, the retail sales figures for March were the worst on record.^[3] Such sales account for about 40% of aggregate demand. Secondly, so far there’s no sign of the export boom forecast by the OBR—-and our main market, the EU, is going to suffer further debt crises this year.

Thirdly, there’s no sign of an investment boom either. The share of investment in GDP is currently running at around 13%, a very low figure. Osborne has always argued that public investment crowds out private investment. But with public spending falling and with a weak outlook for private spending, why should entrepreneurs invest? In truth, the ‘crowding out’ argument has never been remotely convincing.

Most important, the IMF estimates that if other countries are cutting at the same time, if interest rates cannot fall and if the currency does not depreciate, then spending cuts of 1% of GDP subtract 2% from growth. Osborne’s spending cuts (6.2% of GDP in total) subtract about 1.5% per annum from GDP between now and 2014. To quote their recent Economic Outlook:

When countries cannot rely on the exchange rate channel to stimulate net exports, as in the case of the global consolidation, and cannot ease monetary policy to stimulate domestic demand, due to the zero interest rate floor, the output costs of fiscal consolidation are much larger. (WEO Oct 2010, p110) ^[4]

Other countries are cutting at the same time (the latest is the US); UK interest rates are more likely to rise than fall, and the currency shows no sign of depreciating past its low of £1 = €1.05 in December 2008. If the underlying growth rate of the economy is 2-2.5% as the OBR currently thinks; if a 1% cut subtracts 2% from growth as the IMF says, and if Osborne’s cuts are 1.5% a year…. I leave the reader to draw the obvious conclusion.

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[1] http://www.ft.com/cms/s/0/44e38282-6f6d-11e0-952c-00144feabdc0.html#axzz1KcXCDKAU

[2] http://duncanseconomicblog.wordpress.com/

[3] http://online.wsj.com/article/SB10001424052748704662604576256860011335054.html

[4] http://www.imf.org/external/pubs/ft/weo/2010/02/pdf/c3.pdf

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