tag:theconversation.com,2011:/uk/topics/gdp-growth-11140/articlesGDP growth – The Conversation2022-03-10T20:10:15Ztag:theconversation.com,2011:article/1790362022-03-10T20:10:15Z2022-03-10T20:10:15ZWhy stagflation is an economic nightmare – and may already be here<figure><img src="https://images.theconversation.com/files/523617/original/file-20230501-22-zod71e.jpg?ixlib=rb-1.1.0&rect=104%2C52%2C3777%2C2531&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Stagflation is scary.</span> <span class="attribution"><span class="source">dundanim/iStock via Getty Images</span></span></figcaption></figure><p><em>The <a href="https://theconversation.com/the-federal-reserve-and-the-art-of-navigating-a-soft-landing-when-economic-data-sends-mixed-signals-204707">economy is cooling</a> while <a href="https://www.pbs.org/newshour/economy/u-s-inflation-eases-but-stays-high-putting-the-federal-reserve-in-a-tough-spot">inflation remains elevated</a>. And that is <a href="https://fortune.com/2023/04/27/gdp-data-stagflation-recession-economy-outlook/">raising alarm bells</a> among economists who worry it means “<a href="https://www.bloomberg.com/news/newsletters/2023-04-28/stagflation-risks-rise-as-growth-ebbs-and-inflation-sticks-around?sref=Hjm5biAW">stagflation” is on the way</a>.</em> </p>
<p><em>But what is stagflation exactly? We asked <a href="https://scholar.google.com/citations?user=GyTN5PYAAAAJ&hl=en&oi=ao">Veronika Dolar</a>, an economist at SUNY Old Westbury and a visiting professor at Stony Brook University, to explain what it is, what causes it and why economists and policymakers hate the phenomenon.</em></p>
<h2>What is stagflation?</h2>
<p>Economists typically focus on the three big macroeconomic variables: <a href="https://www.investopedia.com/terms/g/gdp.asp">gross domestic product</a>, <a href="https://www.investopedia.com/terms/u/unemployment.asp">unemployment</a> and <a href="https://www.investopedia.com/terms/i/inflation.asp">inflation</a>. </p>
<p>Each measure tells its own important story about how the economy is doing. GDP – or the total output of all goods and services produced – shows us what the broader economy is doing, unemployment tells us about the job situation and inflation measures the movement of prices. </p>
<p>But their stories also overlap. And unfortunately, they usually don’t all tell us good news at the same time.</p>
<p>Under normal circumstances, there are trade-offs. You usually can’t have a strong pace of GDP growth and low unemployment without suffering the pains of higher inflation. And if you’re able to keep inflation low, that usually comes at the expense of subdued GDP growth and possibly more people unemployed. </p>
<p>So, normally there is some good news and some bad news. But with stagflation, there is no good news. </p>
<p><a href="https://www.investopedia.com/terms/s/stagflation.asp">Stagflation happens</a> when the economy is experiencing both economic stagnation – stalling or falling output – and high inflation. Additionally, a struggling economy will drive up unemployment. </p>
<p>In other words, all three macroeconomic indicators are going in the wrong direction. </p>
<h2>Has the US experienced it before?</h2>
<p>The last time this happened in the U.S. was in the 1970s, a <a href="https://www.bloomberg.com/news/articles/2022-03-10/world-economy-can-avoid-1970s-rerun-but-not-without-some-hurt">period when energy prices were skyrocketing</a>. </p>
<p>As a result of an embargo <a href="https://www.britannica.com/topic/OPEC">led by OPEC</a>, a cartel of oil-producing countries, the <a href="https://www.federalreservehistory.org/essays/oil-shock-of-1973-74">price of crude doubled</a> from 1973 to 1975. </p>
<p>Countries like the U.S. that imported a lot of oil experienced both high inflation and recession. The consumer price index <a href="https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator/consumer-price-index-1913-">exceeded 10% for the first time since the 1940s</a>, the unemployment rate <a href="https://fred.stlouisfed.org/series/UNRATE">jumped from 4.6% in 1973 to 9%</a> in 1975, and <a href="https://fred.stlouisfed.org/series/A191RL1Q225SBEA">GDP plunged</a>.</p>
<p>The same events – OPEC pushing up prices, inflation soaring, economies sinking into recession – <a href="https://www.federalreservehistory.org/essays/oil-shock-of-1978-79">repeated just a few years later</a>. Over this period, rising unemployment and reduced business activity meant everyone had less money, yet surging inflation meant every dollar was worth a little bit less every day. </p>
<p>Moreover, this experience with stagflation <a href="https://www.history.com/this-day-in-history/nixon-signs-national-speed-limit-into-law">fundamentally altered Americans’ way of life</a> and ushered in an era of fuel conservation and rationing not seen since World War II. </p>
<h2>What causes stagflation?</h2>
<p>The <a href="https://seekingalpha.com/article/4462851-stagflation">causes of stagflation</a> are still hotly debated by economists. Before the 1970s, they generally didn’t believe it was possible to have both high inflation and high unemployment in a stagnating economy. Economists had thought that <a href="https://www.stlouisfed.org/open-vault/2020/january/what-is-phillips-curve-why-flattened">unemployment and inflation were inversely related</a>.</p>
<p>There are a <a href="https://www.economicshelp.org/blog/glossary/stagflation/">few different theories</a> on how both high inflation and a stagnating economy can coexist, however. </p>
<p>The <a href="https://www.nber.org/system/files/chapters/c9160/revisions/c9160.rev2.pdf">most common</a> is that stagflation happens when there is a so-called negative supply shock. That is, when something that is crucial to an entire economy, such as energy or labor, is suddenly in short supply or becomes more expensive. One obvious example is crude oil. </p>
<p>Oil is a key input into the production of many goods and services. When some event, like the Russian invasion of Ukraine, reduces the supply, the price of oil rises. Businesses in the U.S. and elsewhere that produce gasoline, tires and many other products requiring petroleum experience rising transportation costs, which makes it less profitable to sell stuff to consumers or other companies no matter the price.</p>
<p>As a result, a great number of producers decrease their production, which decreases aggregate supply. This decrease leads to falling national output and an increased unemployment rate together with higher overall prices.</p>
<h2>Can the US do anything about it?</h2>
<p>For policymakers, there’s almost nothing worse than the specter of stagflation.</p>
<p>The problem is that the ways to fight either one of those two problems – high inflation, low growth – usually end up making the other one even worse. </p>
<p>The Federal Reserve, for example, could keep raising interest rates, as <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm">it’s been doing since March 2022</a>. But inflation <a href="https://www.bls.gov/news.release/cpi.nr0.htm">remains high, at about 5%</a>, well over double the Fed’s target of 2%. But that also hurts economic activity and overall growth, because it puts the brakes on borrowing and investment. </p>
<p>Policymakers could try to spur more economic growth – whether through government stimulus or lowering interest rates – but that would likely end up fueling more inflation. </p>
<p>Put another way, you’re damned if you do, damned if you don’t. And that means solving the problem may simply depend on circumstances out of U.S. policymakers’ control, such as an end to the crisis in Ukraine or finding ways to immediately increase oil supply – <a href="https://www.marketplace.org/2022/03/09/domestic-oil-could-increase-supply-but-it-wont-be-cheap-or-quick/">which is tricky</a>.</p>
<p>In other words, stagflation is a nightmare you never want to live through. </p>
<p><em>This article is an updated version of a story originally published on March 10, 2022.</em></p><img src="https://counter.theconversation.com/content/179036/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Veronika Dolar does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The US economy is cooling, yet inflation remains elevated, a combo that suggests stagflation might be right around the corner.Veronika Dolar, Assistant Professor of Economics, SUNY Old WestburyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1337352020-04-28T10:12:03Z2020-04-28T10:12:03ZHow to boost UK productivity after coronavirus<figure><img src="https://images.theconversation.com/files/320595/original/file-20200315-50551-wfnla7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">'Now, have I got the skills to fix this?'</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/male-model-red-overalls-fixes-pile-315655658">Shutterstock</a></span></figcaption></figure><p>The UK faces a highly uncertain economic future – with its recent withdrawal from the EU and the ongoing <a href="https://theconversation.com/uk-budget-2020-experts-react-133455">COVID-19</a> outbreak casting much into disarray. But one thing is clear: as part of its recovery, the UK economy will need to address some serious long-term issues around productivity. </p>
<p>Productivity is the output produced given the inputs employed, such as hired labour, capital and materials. It describes how efficiently a producer or service provider combines these inputs to deliver products or services. Crucially, productivity can turbo-charge economic growth – and ensure the survival and expansion of firms.</p>
<p>But while a productivity slowdown has put the brakes on many developed economies since the 2008 financial crisis, the UK has been particularly hard hit. This will almost certainly be exacerbated by the COVID-19 pandemic.</p>
<p><a href="https://www.theguardian.com/business/2020/feb/03/uk-productivity-slowdown-worst-since-industrial-revolution-study">UK productivity growth</a> has lagged behind that of other comparable economies since the 1970s and the country has suffered virtually zero growth in labour productivity since 2008, the latter known as the UK <a href="https://www.lbpresearch.ac.uk/wp-content/uploads/2019/10/UK-Productivity-Skills-Full-Article.pdf">“productivity puzzle”</a>. By 2016, the output per hour worked in the UK was <a href="https://www.ons.gov.uk/economy/economicoutputandproductivity/productivitymeasures/bulletins/internationalcomparisonsofproductivityfinalestimates/2016">16.3% below</a> the average of the rest of the G7 countries – although this has improved following adjustments to how labour input is measured.</p>
<p>But why? And what can be done about it in these uncertain times? Aston Business School explored this in a <a href="https://www.lbpresearch.ac.uk/wp-content/uploads/2019/10/UK-Productivity-Skills-Full-Article.pdf">recent white paper</a>.</p>
<p>In the short term, tumbling global and local demand and a slow economic recovery following the financial crisis arguably have played a part, as have other factors such as falling real wages and low business dynamism. Low real wages and low productivity usually go hand in hand – there’s less incentive to be productive when you’re undervalued – while low business dynamism reduces the likelihood of innovative ideas boosting productivity. </p>
<p>As part of the UK government’s austerity programme, around half a million jobs were slashed from the UK public sector, while the private sector added 1.7 million jobs between 2012 and 2015. But <a href="https://www.niesr.ac.uk/sites/default/files/publications/The%20UK%20Productivity%20Puzzle%20NIESR%20DP%20448_0.pdf">evidence</a> suggests that many of these new private sector, self-employed roles were low-productivity, part-time and based on zero hours contracts. On average, these mean low pay, low skills utilitisation and few opportunities for skills development. </p>
<p>Meanwhile, the acute decline in demand has also made firms less willing to invest in innovation and new ideas that might improve productivity. Again, COVID-19 could present even greater challenges, as firms are likely to invest less in research and development (R&D) than usual due to uncertainties and financial pressure. </p>
<p>So where does that leave us? We argue that technology, innovation and skills are central to the conundrum.</p>
<h2>Skills crisis</h2>
<p>There is some hope for the UK economy. In recent years, skills have improved at every skill level and are expected to continue to do so. High skills are already relatively abundant – <a href="https://books.google.co.uk/books?id=Tk7UDwAAQBAJ&pg=PA35&lpg=PA35&dq=uk+46%25+25-64+tertiary+education&source=bl&ots=YsQ5Bk16jA&sig=ACfU3U1dVf9flbzfalNJ3J7rC27zkkZTSw&hl=en&sa=X&ved=2ahUKEwiPte6WvIjpAhVlSxUIHT71BWcQ6AEwAHoECAkQAQ#v=onepage&q=uk%2046%25%2025-64%20tertiary%20education&f=false">46% of adults aged 25-64</a> have some form of tertiary education, compared to an Organisation for Economic Cooperation and Development (OECD) average of 37%. Meanwhile, in 2015, 13% of UK university students were enrolled in science, technology, engineering and maths (STEM) subjects, compared to an OECD average of 6%.</p>
<p>But the situation is gloomier when it comes to low and medium skills. In fact, while the UK is predicted to be ranked <a href="https://www.oecd.org/skills/piaac/Skills_Matter_Further_Results_from_the_Survey_of_Adult_Skills.pdf">seventh</a> among OECD countries in 2020 for high (tertiary level education) skills, it is projected to be 22nd for low (below upper secondary) skills and an even lowlier 28th for intermediate (upper secondary) skills.</p>
<p>The UK also lags behind its competitors in vocational education and training – and many adults remain hampered by poor literacy and, particularly, numeracy. Ranked 13th out of 18 countries by the benchmark <a href="https://www.oecd.org/skills/piaac/Skills%20volume%201%20(eng)--full%20v12--eBook%20(04%2011%202013).pdf">Surveys of Adult Skills</a>, a staggering quarter of UK adults scored at Level 1 or below (out of five) for numeracy skills (the OECD average is 19%). Worryingly for the future, the UK is the only country where older people (aged 55-64) outperformed younger people (16-24) in both literary and numeracy.</p>
<p>Productivity is driven by technology, but it demands the right level of skills, deployed when and where needed to be effective. And in the UK, growth in this new environment continues to be held back by workplace skills shortages, gaps and mismatches.</p>
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<img alt="" src="https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=419&fit=crop&dpr=1 600w, https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=419&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=419&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=526&fit=crop&dpr=1 754w, https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=526&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/320597/original/file-20200315-50538-1kiu2gy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=526&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">It’s a brave new technological world.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/uk-stock-graphic-background-on-financial-1064025851">Shutterstock</a></span>
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<p>New technologies and their adoption require varied skills. Nowadays, innovation in manufacturing means that customer service and embedding algorithms in customers’ software systems are as important as bashing metals. These changes must be adapted to if firms are to become more productive.</p>
<p>As technology advances, it’s no surprise that there are skills shortages and mismatches. But they must be addressed by policy, corporate practices and innovative thinking – especially in the current climate. Skills gaps may lead to reduced short-term R&D expenditure and long-term fixed capital investment, slowing productivity further. At a regional level, skills gaps sharpen competition for skills and talents between companies, <a href="https://www.enterpriseresearch.ac.uk/wp-content/uploads/2019/01/ERC-ResPap73-DuVanino-Final-1.pdf">favouring fast-growth firms</a> while impairing others.</p>
<p>There is a long way to go before a healthy balance is maintained. The UK Commission for Employment and Skills’ (UKCES) <a href="https://www.gov.uk/government/publications/ukces-employer-skills-survey-2015-uk-report">2015 Employee Skills Survey (ESS)</a> found that one in seven employers identified workers who were not sufficiently proficient in their positions, amounting to an estimated 1.4 million employees.</p>
<p>Meanwhile, three in ten employers are estimated to experience “over-skilling”, whereby employees are over-qualified and under-utilised. This is a clear waste of resources and a missed opportunity for productivity growth.</p>
<p>But while skills gaps are a central part of the productivity problem, current efforts to assess their scale tend to fall short. This is because skill levels are often measured via formal educational attainment. While most people finish their education by their early twenties, they can, and should in fact, continue to acquire skills throughout life – particularly if their workplace offers training. Indeed, <a href="https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/571675/ER5_The_UK_s_Skills_Mix_Current_Trends_and_Future_Needs.pdf">existing statistics</a> suggest the UK should encourage lifelong learning and better use of skills if it wants to boost growth, productivity and earnings.</p>
<p>Future research should reflect this – by focusing on levels of training and skills rather than education among the workforce.</p>
<h2>The future</h2>
<p>But the UK is also letting itself down on R&D, which helps drive firms’ innovations and productivity. The good news is that the UK has a world-leading fundamental science base and is ranked fourth among economies producing the largest volume of top-cited <a href="https://static.rasset.ie/documents/news/2017/09/oecd.pdf">scientific publications</a>. Despite this, however, it spends less on R&D, relative to GDP, especially by its corporate sector, than many other major world economies. In 2016, the UK ranked just 11th in the EU. </p>
<p>In this new economic environment, information and communication technologies (ICTs) will play a key role, accounting for <a href="https://static.rasset.ie/documents/news/2017/09/oecd.pdf">70% of global patents</a>. The UK, however, doesn’t feature among the top countries patenting emerging ICT technologies. And while it is on a par with France and Germany when it comes to artificial intelligence (AI) related patents, it is a long way behind Japan, Korea, the US, China and Taiwan. It also lags behind many other countries in robotics. These are issues the UK should consider as it seeks to thrive in this technological new world.</p>
<p>Productivity slowdown is not unique to the UK – it is a global issue that now faces a whole array of added challenges. Skills and technology are key components of the solution, but the two must be correctly balanced. Skills must meet the demands of evolving technologies, for they not only lead to new technological innovations, but also drive and facilitate their adoption and diffusion.</p>
<p>There is no easy fix. But forward-looking, bold policies, inspired and informed by solid research and a global perspective, are key to lifting the UK out of the productivity doldrums and providing a lasting recovery post-COVID-19.</p><img src="https://counter.theconversation.com/content/133735/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In these troubled economic times, skills and technology are key to lifting the UK out of the productivity doldrums.Jun Du, Professor of Economics, Aston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1254332019-10-17T11:12:00Z2019-10-17T11:12:00ZGrattan on Friday: Storm clouds avoid the bush, darken over the economy<figure><img src="https://images.theconversation.com/files/297447/original/file-20191017-98661-1db2wjx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">National Farmers' Federation president Fiona Simson says she doesn't think the government has a drought policy.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/dust-storm-australia-on-farm-rural-561255424?src=wgUAyJF4bTnE1DX3efisow-1-43">Shutterstock</a></span></figcaption></figure><p>Government sources insist shock jock Alan Jones didn’t drive Thursday’s announcement of a cash payment to drought-stricken farmers about to be turfed off their household support because they’d reached the four year time limit.</p>
<p>They say the measure – giving up to $13,000 to a couple and $7500 to individuals at a cost of $12.8 million this financial year - had been in cabinet’s expenditure review committee process for some time.</p>
<p>But the National Farmers Federation says it wasn’t given any notice, which seems odd since drought minister David Littleproud is constantly referencing the NFF.</p>
<p>Regardless of the sequencing, Jones’ extraordinarily angry and emotional performance on Tuesday, haranguing Morrison on radio, breaking down on TV, and warning of dire political consequences if the government didn’t do something, certainly concentrated the prime minister’s mind.</p>
<p>As one official puts it, Morrison is “attuned to the zeitgeist”. Described more prosaically, the PM is highly sensitive to public opinion, and he judges that in metropolitan areas as well as the regions, people want more action - and then more still - to help those brought to their knees.</p>
<p>As for Jones, whatever impact his outbursts had on the government, the fact the announcement followed so soon will be used to burnish his much honed image of having political influence.</p>
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Read more:
<a href="https://theconversation.com/view-from-the-hill-alan-jones-v-scott-morrison-on-the-question-of-how-you-feed-a-cow-125303">View from The Hill: Alan Jones v Scott Morrison on the question of how you feed a cow</a>
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<p>When he became PM, Morrison was immediately anxious to own the issue of the drought. He referred to it in his news conference the day he was elected leader, saying it was “the first thing I need to turn attention to”, and was quickly off to a drought-affected area.</p>
<p>Now he is feeling the full cost – political as well as financial – of that ownership, as he’s confronted with pressure on all sides. </p>
<p>NFF president Fiona Simson continues to say she doesn’t think the government has a drought policy.</p>
<p>The Coalition’s handling looks ad hoc and reactive. The responses of federal and state governments need to be better linked. For example, is there a case for federal help for moving breeding stock to agistment? Oh, the feds say, that’s in the state arena (rather than looking at augmenting state assistance). Drought policy is bedevilled by the old federal-state blame game, as shown by the wrangling over dam building.</p>
<p>Also, the government has no credible reason for keeping under wraps the report it commissioned from Stephen Day, who was its drought-coordinator, which would provide some useful overview.</p>
<p>Thursday’s announcement of the cash payment was messy: Morrison trumpeted it on radio at the same time as the Nationals unveiled it at a press conference.</p>
<p>(Morrison chose John Laws’ program, which he rarely goes on. Laws asked pointedly, “Why do you permit yourself to be harangued in the way that Alan Jones harangues you …[a lot of people] rather felt that it was a sign of weakness that you let Alan get away with what he got away with.”)</p>
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Read more:
<a href="https://theconversation.com/a-national-drought-policy-should-be-an-easy-bipartisan-fix-so-why-has-it-taken-so-long-to-enact-a-new-one-124775">A national drought policy should be an easy, bipartisan fix. So why has it taken so long to enact a new one?</a>
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<p>Some Nationals were unhappy at Morrison seemingly one-upping their leader Michael McCormack and his colleagues, especially as the PM went out of his way to tell listeners “that’s new news today on the John Laws programme”. </p>
<p>Nationals, under the pump in their seats, see it as symptomatic of a wider issue about Morrison’s approach. One senior National says: “Morrison is going to have to learn to build a deeper and more respectful relationship with the Nationals – find space for McCormack to be seen to be delivering for regional Australia.”</p>
<p>The Nationals’ problems go further. Outsiders observe the rivalry between the party’s deputy leader Bridget McKenzie and Littleproud, both of whom have stakes in drought policy. Littleproud was particularly upset at losing the agriculture portfolio to McKenzie after the election.</p>
<p>From the Coalition’s vantage point the drought debate – and the prime minister making himself so central in it - has raised unrealistic expectations of what government can do.</p>
<p>In prolonged drought, the harsh reality is some farmers will go under, just as in a recession, some city businesses will fail. There is only so much protection a government can or should provide. The difficulty for many farmers is deciding whether hanging on is worth the gamble, because there is no knowing how long it will be before the rains come.</p>
<p>On two fronts now Morrison, who likes to be in control, is at the mercy of events he can’t control. Apart from the drought, the International Monetary Fund’s downgrading this week of the growth outlook for the world and for Australia has reinforced the message that the government’s economic policy is on a knife edge.</p>
<p>The IMF’s latest downgrade of 0.4 of a percentage point takes the projection for Australia’s growth in 2019 to 1.7% - a year ago the IMF set it at 2.8%.</p>
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Read more:
<a href="https://theconversation.com/the-dirty-secret-at-the-heart-of-the-projected-budget-surplus-much-higher-tax-bills-124273">The dirty secret at the heart of the projected budget surplus: much higher tax bills</a>
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<p>The situation poses a judgement call for the government – inject some stimulus quickly or hope that it can get through on its present fiscal setting, keeping its projected surplus (its top priority) intact.</p>
<p>Three reductions in interest rates in quick time haven’t had much effect in boosting the economy (and there is speculation about another). On the evidence to date, neither have the income tax cuts achieved what was hoped. People are not spending enough; many businesses are uncertain.</p>
<p>So far, the government has held out in face of exhortations from Reserve Bank Governor Philip Lowe to help on the fiscal side. (Lowe’s style might be at the opposite end of the advocacy spectrum to that of Jones, but he can pack a punch.)</p>
<p>Morrison and Treasurer Josh Frydenberg (who is in the US for the IMF and other meetings) this week defended their position on the surplus as a giving a buttress against bad times.</p>
<p>“A surplus is not an end in itself”, Morrison told parliament - “a surplus … is a means to an end,” the end being that “Australians can have confidence that we can meet the uncertainties that are ahead.” </p>
<p>He describes Labor’s calls for government action as reflecting its “penchant … for panic and crisis.”</p>
<p>As it stands by its unwillingness to inject immediate stimulus, the government is harking back to the Labor’s action in the global financial crisis and what it condemns as overreach. Probably it was, but going hard and going early also made sure Australia had a gold-plated insurance policy.</p>
<p>The period ahead will tell whether the government’s present refusal to stimulate the economy does indeed show the “cool and clear heads” that Morrison boasts. Or whether it will turn out to be an unfortunate manifestation of pig headedness, with policy having to be modified subsequently. If the latter, let’s hope it won’t be a case of too little too late.</p><img src="https://counter.theconversation.com/content/125433/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michelle Grattan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>On two fronts now Morrison, who likes to be in control, is at the mercy of events he can’t control: the drought, and the IMF’s downgrading of Australia’s growth outlook.Michelle Grattan, Professorial Fellow, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1184662019-06-13T12:51:46Z2019-06-13T12:51:46ZRamaphosa’s critical choices to get South Africa back on track<figure><img src="https://images.theconversation.com/files/278903/original/file-20190611-32327-ae03gz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa has seen a steady rise in the number of protests </span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>South Africa’s economy is in dire straits. Unemployment has reached a 15-year high of <a href="https://www.fin24.com/Economy/just-in-unemployment-rate-rises-to-276-in-first-quarter-of-2019-20190514">27.6%</a>. And in the first quarter of this year GDP growth dropped by 3.2%. That’s the <a href="https://www.fin24.com/Economy/breaking-sa-gdp-falls-by-32-biggest-drop-in-10-years-20190604">biggest quarterly drop</a> in a decade. </p>
<p>Considered in conjunction with the country’s dismal education outcomes, which the IMF found are perpetuating inequality and contributing to the country’s <a href="https://www.imf.org/en/Publications/WP/Issues/2019/03/01/Struggling-to-Make-the-Grade-A-Review-of-the-Causes-and-Consequences-of-the-Weak-Outcomes-of-46644">low economic growth</a>, and the possibility of a ratings downgrade, the outlook isn’t auspicious.</p>
<p>Academics and political leaders have long warned that a combination of high youth unemployment, poor educational outcomes, and high inequality levels will eventually explode into large-scale <a href="http://news.bbc.co.uk/2/hi/africa/4035809.stm">social disorder</a>. There has indeed been a steady rise in the number of <a href="http://www.scielo.org.za/scielo.php?script=sci_arttext&pid=S1991-38772018000100004">protests</a>. The country is now classified as a <a href="https://www.corruptionwatch.org.za/fragile-states-index-2019-sa-in-the-warning-zone">fragile state</a> by Corruption Watch. </p>
<p>However, the recent elections provide two interesting pointers. The first was the extremely <a href="https://theconversation.com/south-africas-voter-turnout-a-mathematician-runs-the-numbers-117199">low voter turnout</a> of just 49%. The second was a near doubling of the Economic Freedom Fighters’ (EFF) share of the vote, from 6.4% in the 2014 poll to 10.8% in 2019. Taken together, these factors suggest that South Africa’s vulnerable citizens are frustrated with the established political parties. However, they are not as yet widely attracted to the potential re-distributive policies of <a href="https://www.economist.com/middle-east-and-africa/2019/05/18/south-africas-election-results-reflect-widespread-disillusion">populists</a>. </p>
<p>This raises a question. If South Africa’s political and socioeconomic stability are so fractured, how has the country managed to defuse the ‘ticking time-bomb’ for so long?</p>
<h2>Balancing act</h2>
<p>According to economists <a href="https://economics.mit.edu/faculty/acemoglu">Daron Acemoglu</a> and <a href="https://harris.uchicago.edu/directory/james-robinson">James Robinson</a>, the democratic system attempts to <a href="https://www.cambridge.org/gb/academic/subjects/economics/public-economics-and-public-policy/economic-origins-dictatorship-and-democracy?format=HB&isbn=9780521855266">balance</a> two forces. The revolutionary redistributive pressure of the citizens on the one side, against the repressive power of the elites on the other. But high levels of inequality interfere with democratic consolidation and make revolutionary change more attractive. For self-preservation reasons, elites must stomach high tax rates, or land and capital redistribution.</p>
<p>In the first decade of democracy in South Africa, the country followed a path of financial and trade liberalisation as it re-engaged with the global economy. The relatively strong economic performance then enabled government to placate the formerly disenfranchised through redistributive policies. The key ones were black economic <a href="http://www.dti.gov.za/economic_empowerment/bee.jsp">empowerment</a> and <a href="https://www.groundup.org.za/article/everything-you-need-know-about-social-grants_820/">social grants</a>. This was underpinned by an effective tax system. </p>
<h2>Under pressure</h2>
<p>Unfortunately, the ability to balance the insider-outsider economy with social support was then significantly rocked by two major disruptions. The first was the global financial crisis. The second was the <a href="https://www.news24.com/SouthAfrica/News/trevor-manuel-why-did-we-tolerate-zumas-misrule-for-so-long-20180518">misrule</a> of <a href="http://www.thepresidency.gov.za/profiles/president-jacob-zuma-0">President Jacob Zuma</a>. </p>
<p>Over the next decade, <a href="https://www.sastatecapture.org.za/">state capture</a> and crony capitalism, coupled with economic decline, weakened the middle class and entrenched meritocracy. In turn this raised pressure for greater re-distributive policies, both among factions of the ANC and eventually with the emergence of the EFF. The dire state of private sector investment and <a href="https://hsf.org.za/publications/focus/focus-82-the-economy/4-viegi-and-dadam.pdf">growth</a> meant that the increased redistributive pressure was initially alleviated by public sector employment creation. This grew from 2.2 million in 2008 to 2.7 million by the end of <a href="https://businesstech.co.za/news/government/113488/everything-you-need-to-know-about-sasgovernment-workers/">2014</a>. </p>
<p>But in recent years, as the corrosive effects of corruption took hold, economic decay has become entrenched. This has resulted in declining <a href="http://www.treasury.gov.za/documents/national%20budget/2018/review/Chapter%204.pdf">tax revenues</a> and spiralling <a href="https://www.iol.co.za/business-report/economy/moodys-warns-sa-of-indebtedness-that-may-reach-70-ofgdp-21470149">state owned enterprise debt</a>. Political factionalism and policy paralysis have also increased. </p>
<p>Consequently, government no longer has the financial wherewithal to fund the dysfunctional and indebted state-owned enterprises. These enterprises have been associated with the failed developmental state ideology. Weakened government finances have also made it difficult to provide social support via <a href="http://www.treasury.gov.za/documents/mtbps/2018/mtbps/Annexure%20B.pdf">public sector employment</a>. </p>
<p>As a result, the African National Congress (ANC) has increasingly turned to desperate policy debates such as expropriation of land without compensation, <a href="https://www.oldmutual.co.za/corporate/mindspace/article-detail/prescribed-assets-should-you-be-concerned">prescribed assets</a>, <a href="https://www.moneyweb.co.za/mymoney/moneyweb-tax/implications-of-the-change-to-tax-on-foreign-earnings/">off-shore income taxes</a>, and changing the mandate of the South African Reserve Bank to <a href="https://www.businessinsider.co.za/what-is-quantitative-easing-2019-6">print more money</a>. </p>
<p>To make matters worse, the global economy is experiencing the instability associated with <a href="https://blogs.uoregon.edu/timduyfedwatch/2019/05/31/trade-wars-heats-up-with-new-assault-on-mexico/">trade wars</a> and <a href="https://www.imf.org/en/Publications/WEO/Issues/2019/03/28/world-economic-outlook-april-2019">populism</a>. South Africa’s economy will therefore likely continue to perform worse than the slowing global economy. </p>
<h2>Tough choice ahead</h2>
<p>If the country is to survive its current crisis, government will need to undertake two difficult tasks simultaneously. It will need to:</p>
<ul>
<li>refocus on resuscitating inclusive growth by supporting the informal economy and removing red tape for small, medium and micro-sized enterprises,</li>
</ul>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/employed-but-still-poor-the-state-of-low-wage-working-poverty-in-south-africa-118018">Employed but still poor: the state of low-wage working poverty in South Africa</a>
</strong>
</em>
</p>
<hr>
<ul>
<li><p>provide policy <a href="https://www.fin24.com/Economy/ramaphosa-calls-for-anc-policy-certainty-says-ndp-is-our-lodestar-20190609">certainty</a>, </p></li>
<li><p>allow the private sector <a href="https://www.gov.za/speeches/minister-nhlanhla-nene-debate-addressing-governance-challenges-state-owned-enterprises-ncop">to invest</a> in state-owned enterprises, and </p></li>
<li><p>facilitate the move away from a fossil-fuel based mining economy. </p></li>
</ul>
<p>At the same time, government will also have to free up budgetary resources by <a href="http://www.dpsa.gov.za/dpsa2g/documents/cos/2019/Circular%20and%20Guideline%20on%20Managing%20Early%20Retirement%20without%20penalisation%20of%20pension%20benefits%20in%20terms%20of%20section%2016(6)%20of%20the%20Public%20Service%20Act%201994.pdf">reducing the size</a> of the bloated public sector and withstanding trade union <a href="https://www.fin24.com/Opinion/imf-ratings-agencies-point-to-need-for-tough-choices-20190604">wage demands</a>. </p>
<p>If the inclusion of left-leaning ministers in the <a href="https://www.businesslive.co.za/bd/opinion/columnists/2019-06-07-anthony-butler-leftists-in-cabinet-likely-to-dabble-in-state-centred-experiments/">new cabinet</a> and the recent contradictory policy statements from <a href="https://www.dailymaverick.co.za/opinionista/2019-06-06-anc-speaks-with-forked-tongue-its-time-for-ramaphosa-to-stamp-his-authority-on-the-country/">ANC leaders</a> are a precursor to continued fractional government paralysis, then the country can expect even more economic instability and policy stagnation ahead. </p>
<p>Eventually, this will lead to significant socio-political stress as the private sector disengages and disinvests. The public sector will collapse under its own weight, and disenfranchised citizens will clutch at populist straw men.</p>
<p>Given the dysfunctional state of the <a href="https://mg.co.za/article/2017-12-16-zuma-conference-must-decide-the-tripartite-alliances-future">ANC alliance</a> and the over-arching quest for ‘unity’, it is apparent that President Cyril Ramaphosa must make a choice between saving the ANC alliance or saving the country. He can’t save both. Let’s hope he chooses wisely.</p><img src="https://counter.theconversation.com/content/118466/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sean Gossel receives funding from UCT and the National Research Foundation.</span></em></p>If the country is to survive its current crisis, government will need to undertake two difficult tasks simultaneously.Sean Gossel, Associate professor, University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1012532018-08-09T20:09:58Z2018-08-09T20:09:58ZVital Signs: is the economy getting stronger? The RBA says ‘time will tell’<p><em>Vital Signs is a regular economic wrap from UNSW economics professor Richard Holden (@profholden). Vital Signs aims to contextualise weekly economic events and cut through the noise of the data affecting global economies.</em></p>
<hr>
<p>Together with the <a href="https://www.rba.gov.au/speeches/2018/pdf/sp-gov-2018-08-08.pdf">speech to the Anika Foundation about demographics and monetary policy</a> by RBA governor Philip Lowe, the latest <a href="https://www.rba.gov.au/media-releases/2018/mr-18-17.html">monetary policy statement</a> give some useful clues about how Lowe and the institution he leads are thinking about the state of the Australian economy and the future path of monetary policy.</p>
<p>The headline after Tuesday’s meeting of the Reserve Bank of Australia was, of course, that it <a href="https://www.rba.gov.au/media-releases/2018/mr-18-17.html">left the cash rate at 1.50%</a>. Again.</p>
<p>The RBA’s <a href="https://www.rba.gov.au/media-releases/2018/mr-18-17.html">monetary policy statement</a> was striking for how much most of it resembled the <a href="https://www.rba.gov.au/media-releases/2018/mr-18-16.html">last such statement</a>, and the <a href="https://www.rba.gov.au/media-releases/2018/mr-18-14.html">one before that</a>, and the <a href="https://www.rba.gov.au/media-releases/2018/mr-18-11.html">one before that</a>, and … I honestly thought I might have been looking at a cached version <a href="https://www.rba.gov.au/media-releases/2016/">from 2016</a> when I read it. </p>
<p>But after hitting refresh on my browser a few times and triple-checking the date I realised that, sadly, it was the current statement.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/when-monetary-policy-reaches-its-limits-what-of-fiscal-policy-43392">When monetary policy reaches its limits, what of fiscal policy?</a>
</strong>
</em>
</p>
<hr>
<p>It’s easy to summarise. Variable (insert your macroeconomic indicator of choice: unemployment, GDP growth, wage growth, inflation, etc.) is at a level we don’t like too much, but we forecast it will get better soon. For example:</p>
<blockquote>
<p>The Bank’s central forecast for the Australian economy remains unchanged. GDP growth is expected to average a bit above 3 per cent in 2018 and 2019.</p>
<p>… The outlook for the labour market remains positive. The vacancy rate is high and other forward-looking indicators continue to point to solid growth in employment. </p>
<p>… A further gradual decline in the unemployment rate is expected over the next couple of years to around 5 per cent. Wages growth remains low. This is likely to continue for a while yet, although the improvement in the economy should see some lift in wages growth over time.</p>
<p>… Household income has been growing slowly and debt levels are high.</p>
</blockquote>
<p>The problem is, of course, that the RBA has been <a href="https://theconversation.com/vital-signs-rba-rates-decision-stuck-between-jobs-growth-and-household-debt-82580/">saying all this for some time now</a>.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/vital-signs-rba-rates-decision-stuck-between-jobs-growth-and-household-debt-82580">Vital Signs: RBA rates decision stuck between jobs growth and household debt</a>
</strong>
</em>
</p>
<hr>
<p>Lowe switched gears in <a href="https://www.rba.gov.au/speeches/2018/pdf/sp-gov-2018-08-08.pdf">his speech on Wednesday</a> to talk about the long-run issue of Australia’s demography and how it connects to the short-run issue of monetary policy.</p>
<p>He began by noting a fact that has been largely overlooked – Australia’s population has been growing at an annual rate of about 1.5% for many years, significantly faster than almost all other advanced economies, as the following chart shows. It shows 2014 growth rates, but the same story has played out for the last decade.</p>
<iframe src="https://data.oecd.org/chart/5fSC" width="100%" height="645" style="border: 0" mozallowfullscreen="true" webkitallowfullscreen="true" allowfullscreen="true"><a href="https://data.oecd.org/chart/5fSC" target="_blank">OECD Chart: Population, Total, Annual growth rate (%), Annual, 2014</a></iframe>
<p>Lowe noted that the lion’s share of this has been driven by immigration, and that: “People living in Australia who were born overseas are more likely than the average Australian to have a post-secondary school qualification.”</p>
<p>Not only do immigrants tend to be more educated, they tend to be relatively young. The median age of Australians is 37, and in 2002 it was forecast by the ABS to be 45+ in 2040. The latest ABS estimate for the 2040 median age is now 40. That’s a big change, and it is due to immigration.</p>
<p>Lowe then went into some detail about how labour force participation of those over 55 has grown rapidly over the past 20 years. In the 1990s about 10% of the labour force was over 55. That now stands at about 20%. </p>
<p>Putting all of these factors together with life expectancy implies that while many other advanced economies are suffering from fiscally crippling dependency ratios – with simply too few workers paying taxes to properly fund retirees – Australia is in a much stronger position. </p>
<p>As macroeconomics goes, this is fascinating stuff.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/does-the-economy-need-some-quantitative-doping-15847">Does the economy need some “quantitative doping”?</a>
</strong>
</em>
</p>
<hr>
<p>Then Lowe pivoted to the implications for monetary policy. And just like a prisoner in a foreign country holding up a copy of today’s newspaper and professing in staccato that his captors were treating him well, Lowe trotted out all the greatest hits from the monetary policy statement of the day before. </p>
<p>For example:</p>
<blockquote>
<p>In terms of inflation, the latest data were in line with our expectations. Over the year to June, headline inflation was 2.1 per cent and, in underlying terms, inflation was close to 2 per cent … Over the forecast period, we expect inflation to increase further to be close to 2 1⁄2 per cent in 2020. In the short term, though, we would not be surprised if headline inflation dipped a little… </p>
</blockquote>
<p>and</p>
<blockquote>
<p>The labour market is gradually tightening and it is reasonable to expect that this will lead to a lift in both wages growth and inflation … Over time, we expect that this will become a more general story, although this is going to take some time.</p>
</blockquote>
<p>He even said: “Time will tell.”</p>
<p>Will the Australian economy actually start growing at a robust rate per capita? Will stagnant wages finally start growing in real terms? Will we avoid a deflationary trap? Will there be enough monetary and fiscal ammunition to respond to another recession or crisis? Will Governor Lowe get away with repeatedly saying things will get better but just not right now?</p>
<p>Time will tell.</p><img src="https://counter.theconversation.com/content/101253/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The new RBA monetary statement is just like the old one.Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/804572017-07-06T20:18:15Z2017-07-06T20:18:15ZVital Signs: the RBA was right to keep rates on hold<p><em>Vital Signs is a weekly economic wrap from UNSW economics professor and Harvard PhD Richard Holden (@profholden). Vital Signs aims to contextualise weekly economic events and cut through the noise of the data affecting global economies.</em></p>
<p><em>This week: Why the RBA was right not to raise rates this time.</em></p>
<hr>
<iframe src="https://datawrapper.dwcdn.net/qcDsJ/1/" scrolling="no" frameborder="0" allowtransparency="true" allowfullscreen="allowfullscreen" webkitallowfullscreen="webkitallowfullscreen" mozallowfullscreen="mozallowfullscreen" oallowfullscreen="oallowfullscreen" msallowfullscreen="msallowfullscreen" width="100%" height="296"></iframe>
<p>The Reserve Bank of Australia once again left official interest rates on hold this week - leaving the cash rate at an historically low 1.5%.</p>
<p>That certainly wasn’t a surprise, but the language used in governor Philip Lowe’s <a href="https://www.rba.gov.au/media-releases/2017/mr-17-13.html">official statement on the decision</a> was definitely interesting.</p>
<p>Gone were the predictions of 3% plus GDP growth, with the statement striking a much more cautionary note. Lowe noted slower growth in the March quarter, lower levels of mining investment but improved business conditions and investment when not related to mining. He said:</p>
<blockquote>
<p>At the same time, consumption growth remains subdued, reflecting slow growth in real wages and high levels of household debt.</p>
</blockquote>
<p>Former RBA board member, John Edwards, made a splash by suggesting that there would be eight interest rate increases, in fairly short order, because the cash rate was “way below where it will need to be in years to come”.</p>
<p>I don’t know if Dr Edwards was just setting his hair on fire to get an audience (if so, well played), but let’s assume he was being serious when he said:</p>
<blockquote>
<p>If inflation does indeed return to 2.5%, as the bank now expects, if growth does indeed return to 3% ‘within a few years’, as the minutes of the June board meeting predict, if the world economy is indeed picking up, then a policy rate of 1.5% is too low.</p>
</blockquote>
<p>That’s a lot of “ifs”, and it’s fair to say that the June RBA board minutes suggesting 3% growth were rather surprising. Even if that were to be the growth rate, population growth in Australia is quite high by medium-term (and also international advanced economy) standards, as the following chart shows.</p>
<p><strong>Australian population growth, annual (%)</strong></p>
<iframe src="https://d3fy651gv2fhd3.cloudfront.net/embed/?s=aus.sp.pop.grow%3aworldbank&lbl=0&v=201707310000v&d1=20070101&d2=20171231&h=300&w=600" height="300" width="100%" frameborder="0" scrolling="no"></iframe>
<p><br>source: <a href="https://tradingeconomics.com/australia/population-growth-annual-percent-wb-data.html">tradingeconomics.com</a></p>
<p>Surely it’s real GDP per capita that we should care about instead.</p>
<p>In any case, it seems that Dr Edwards is reflecting back on the macroeconomic recoveries of the past. Perhaps he’s right, but I don’t think so. </p>
<p>It’s quite likely that Australia, like other advanced economies, <a href="https://theconversation.com/vital-signs-australia-is-facing-an-interest-rates-dilemma-79340">is suffering from “secular stagnation”</a>. This view, most recently argued by former US Treasury Secretary Larry Summers, holds that the speed limit of advanced economies has been permanently lowered because of a fire hose of global savings chasing too few productive investment opportunities.</p>
<p>In a world where a laptop and a good idea can create a company more valuable than Australia’s Big Four banks combined (Facebook), people just don’t need the same volume of investment capital as in past eras. This drives down what economists call the “equilibrium real interest rate” - and ultimately limits potential GDP growth.</p>
<p>This has probably been the case for many years, but was masked in the US by a massive real estate bubble which burst a decade ago, and in Australia by the commodities boom.</p>
<p>So Dr Edwards prediction of a return to old normal in terms of growth, and hence interest rates, seems more aspirational than likely to me.</p>
<p>Importantly, the RBA statement also pointed again to the financial stability risks in the Australian housing market, saying:</p>
<blockquote>
<p>Growth in housing debt has outpaced the slow growth in household incomes. The recent supervisory measures should help address the risks associated with high and rising levels of household indebtedness. Lenders have also announced increases in mortgage rates for investor and interest-only loans.</p>
</blockquote>
<p>Let’s hope that those supervisory measures, which have provided some of the impetus for banks raising rates on interest-only loans, do the trick.</p>
<p>Yet as the RBA itself has pointed out, one-third of Australian mortgage holders do not have a month’s buffer. Stopping questionable new borrowing is one thing, but with slow wages growth it is hard for household to “delever” themselves.</p>
<p>And it’s for that reason that wages growth and the labour market are such a central part of the problem - and a big reason for the RBA not to raise rates any time soon.</p>
<p>Perhaps that also explains the <a href="https://theconversation.com/vital-signs-it-will-take-more-than-asking-for-a-pay-rise-to-fix-australias-wages-problem-79748">unusual remarks governor Lowe made</a> at the ANU recently, where he basically wished for higher wages growth.</p>
<p>In any case, I wouldn’t bet on eight rapid-fire rate hikes any time soon.</p><img src="https://counter.theconversation.com/content/80457/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden is an ARC Future Fellow.</span></em></p>The amount of Australians in mortgage stress is the reason why wages growth and the labour market are such a problem - and a big reason for the RBA not to raise rates any time soon.Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/795982017-06-22T09:53:13Z2017-06-22T09:53:13ZSix graphs showing the state of the UK economy a year after Brexit referendum<figure><img src="https://images.theconversation.com/files/174924/original/file-20170621-4662-1uzsrcw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">What's happened a year on?</span> <span class="attribution"><span class="source">via shutterstock.com</span></span></figcaption></figure><p>It has been a year since British voters went to the polls and <a href="https://theconversation.com/brexit-is-on-britain-votes-to-leave-the-eu-experts-respond-61576?sr=1">voted</a> by a narrow margin to leave the European Union. The Brexit referendum triggered a heated debate about the potential economic effects of Brexit. But what has actually happened to the UK economy in the year since the Brexit vote? These six graphs help explain. </p>
<h2>GDP growth</h2>
<p>Overall, the UK economy performed relatively well in terms of GDP growth during the second half of 2016 following the referendum. However, more recently there have been <a href="http://www.oecd.org/economy/g20-gdp-growth-first-quarter-2017-oecd.htm">indications</a> of a slowdown in economic activity in the UK.</p>
<p><iframe id="dD8WS" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/dD8WS/2/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<h2>The pound</h2>
<p>The British currency was one of the economic variables that was <a href="https://theconversation.com/brexit-shock-has-caused-a-sterling-crash-of-historic-proportions-heres-just-how-bad-it-is-for-the-pound-62191?sr=1">most affected</a> by the decision of the British electorate to leave the EU. Sterling has depreciated by a significant amount, around 15%, since last year as international markets reacted to the announcement of Brexit. A standard explanation is that markets expect lower volumes for future UK-EU international trade and also that longer term projections for future UK growth could be revised downwards.</p>
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<h2>Inflation</h2>
<p>The depreciation of the pound has contributed to a significant rise in the price of imports into the UK. British consumers are now having to pay a much higher price for foreign products. As a result, inflation increased from 0.5% in June 2016 to 1% in September and 2.9% in May 2017, the highest in four years. This is likely to affect both businesses that import products, and consumers. </p>
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<p>The rise in inflation also raises challenging questions for members of the Bank of England’s Monetary Policy Committee (MPC), which sets UK interest rates, and has a <a href="http://www.bankofengland.co.uk/monetarypolicy/Pages/framework/framework.aspx">target</a> to keep inflation below 2%. The MPC could tighten monetary policy by raising interest rates in order to reduce inflation, but this will probably hurt households and potentially GDP growth. Alternatively, it could decide to ignore inflation for the moment and lower interest rates even further. Or do nothing. In June 2017, members of the MPC remained <a href="http://www.bbc.co.uk/news/business-40354879">divided</a> over whether it is the right time to raise interest rates. </p>
<h2>Average earnings</h2>
<p>In the labour market, the most notable change has been a drop in real weekly earnings since the end of 2016. Average weekly wages (excluding bonuses) fell from £461 in June 2016 to £459 in December 2016 and £458 in April 2017. This is the result of weak nominal wage growth (closely related to the UK’s <a href="http://www.bankofengland.co.uk/publications/Documents/speeches/2017/speech968.pdf">productivity puzzle</a>), combined with the steady rise of inflation. Real wages have fallen in the UK and people are beginning to feel the pinch.</p>
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<h2>Household savings</h2>
<p>The drop in average earnings could have serious consequences for future UK GDP growth. This is both because household savings have steadily depleted in recent years, and recent UK GDP growth was <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/secondestimateofgdp/quarter1jantomar2017">driven by consumer spending</a>. If consumers have less in their pay packet each month, the economy could slow further. </p>
<p>The households savings ratio attempts to present a picture of how much money households save as part of their income. When the savings ratio is very small, it implies that households have fewer savings relative to their disposable income. In 2016, the ratio was at 5.2%, its lowest level since records began in 1963.</p>
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<h2>Trade balance</h2>
<p>One potential positive effect of the pound’s devaluation could have been an improvement in the UK’s trade balance – but that has not yet materialised. Standard <a href="http://www.economicsonline.co.uk/Global_economics/Marshall_Lerner.html">economic theory</a> predicts that currency devaluation will reduce a country’s imports (which become relatively more expensive), increase exports (relatively cheaper) and so improve the trade balance. </p>
<p>The UK’s trade deficit <a href="https://www.uktradeinfo.com/Statistics/BuildYourOwnTables/Pages/Table.aspx">was around</a> £30 billion at the time of the referendum in June 2016. Since then, although exports have risen by 12%, imports have risen at the slightly faster pace of 12.7%. As a result, the UK’s <a href="http://budgetresponsibility.org.uk/docs/dlm_uploads/Final_Model_Documentation.pdf">trade deficit</a> had worsened to £35 billion by the end of March 2017. </p>
<p>A trade deficit is not a problem per se, but a devaluation could have brought a sizeable increase in the export sector and helped to boost employment and wages. There are a number of reasons for why this did not happen, with one being that UK exporters <a href="https://marktomarket.org/2017/01/30/uktradeinflation/">have not</a> reduced the prices of goods sold abroad in foreign currency, and so just increased their profits per unit sold. </p>
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<p>The UK economy performed relatively well until the end of 2016, but there are signs that 2017 is going to be a challenging year. There is some <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/secondestimateofgdp/quarter1jantomar2017">evidence</a> – although early – that the economy is slowing down. Bloomberg’s Brexit Barometer, an <a href="https://www.bloomberg.com/graphics/2017-brexit-barometer/">index tracking</a> the impact of Brexit on the economy, has fallen in recent months, but does not put the economy in a “worse state” than before the referendum. </p>
<p>Of particular interest is going to be how households will react to the rise of inflation and the erosion of their real income given that their savings are at historically low levels. And don’t forget the increasing <a href="https://theconversation.com/brexit-why-uncertainty-is-bad-for-economies-64334?sr=1">uncertainty</a> that Brexit negotiations and tactics will bring to the economies of both the UK and EU. </p>
<hr>
<p><em>Correction: The graph regarding trade balance has been updated with corrected figures. The accompanying text originally stated that the UK trade deficit was around £175 billion at the time of the referendum, and had worsened to £197 billion at the end of March 2017. This has been corrected to £30 billion and £35 billion respectively.</em></p><img src="https://counter.theconversation.com/content/79598/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Agelos Delis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It was going pretty well until 2017 began.Agelos Delis, Lecturer in Economics, Aston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/719962017-03-12T19:16:25Z2017-03-12T19:16:25ZThe decoupling delusion: rethinking growth and sustainability<figure><img src="https://images.theconversation.com/files/160263/original/image-20170310-3703-1y89iac.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">No matter how hard we dig, the Earth's resources are ultimately finite. </span> <span class="attribution"><span class="source">Mining image from www.shutterstock.com</span></span></figcaption></figure><p>Our economy and society ultimately depend on natural resources: land, water, material (such as metals) and energy. But some scientists have recognised that <a href="http://www.nature.com/nature/journal/v461/n7263/full/461472a.html">there are hard limits to the amount of these resources we can use</a>. It is our consumption of these resources that is behind environmental problems such as extinction, pollution and climate change.</p>
<p>Even supposedly “green” technologies such as renewable energy require materials, land and solar exposure, and cannot grow indefinitely on this (or any) planet.</p>
<p>Most economic policy around the world is driven by the goal of maximising economic growth (or increase in gross domestic product – GDP). Economic growth usually means using more resources. So if we can’t keep using more and more resources, what does this mean for growth?</p>
<p>Most conventional economists and policymakers now endorse the idea that <a href="http://www.nature.com/nature/journal/v527/n7576/full/nature16065.html">growth can be “decoupled” from environmental impacts</a> – that the economy can grow, without using more resources and exacerbating environmental problems. </p>
<p>Even the then US president, Barack Obama, in a recent piece in <a href="http://science.sciencemag.org/content/early/2017/01/06/science.aam6284.full">Science</a> argued that the US economy could continue growing without increasing carbon emissions thanks to the rollout of renewable energy.</p>
<p>But there are many problems with this idea. In a recent conference of the Australia-New Zealand Society for Ecological Economics (<a href="https://anzsee.org/">ANZSEE</a>), we looked at why decoupling may be a delusion.</p>
<h2>The decoupling delusion</h2>
<p>Given that there are hard limits to the amount of resources we can use, genuine decoupling would be the only thing that could allow GDP to grow indefinitely.</p>
<p>Drawing on evidence from the 600-page <a href="http://www.presidency.ucsb.edu/economic_reports/2017.pdf">Economic Report to the President</a>, Obama referred to trends during the course of his presidency showing that the economy grew by more than 10% despite a 9.5% fall in carbon dioxide emissions from the energy sector. In his words: </p>
<blockquote>
<p>…this “decoupling” of energy sector emissions and economic growth should put to rest the argument that combating climate change requires accepting lower growth or a lower standard of living.</p>
</blockquote>
<p>Others have pointed out similar trends, including the International Energy Agency which last year – albeit on the basis of just two years of data – argued that <a href="https://www.iea.org/newsroom/news/2016/march/decoupling-of-global-emissions-and-economic-growth-confirmed.html">global carbon emissions have decoupled from economic growth</a>.</p>
<p>But we would argue that what people are observing (and labelling) as decoupling is only partly due to genuine efficiency gains. The rest is a combination of three illusory effects: substitution, financialisation and cost-shifting.</p>
<h2>Substituting the problem</h2>
<p>Here’s an example of substitution of energy resources. In the past, the world evidently decoupled GDP growth from buildup of horse manure in city streets, by substituting other forms of transport for horses. We’ve also decoupled our economy from whale oil, by substituting it with fossil fuels. And we can substitute fossil fuels with renewable energy.</p>
<p>These changes result in “partial” decoupling – that is, decoupling from specific environmental impacts (manure, whales, carbon emissions). But substituting carbon-intensive energy with cleaner, or even carbon-neutral, energy does not free our economies of their dependence on finite resources. </p>
<p>Let’s get something straight: Obama’s efforts to support clean energy are commendable. We can – and must – envisage a future powered by 100% renewable energy, which may help break the link between economic activity and climate change. This is especially important now that President Donald Trump threatens to undo even some of these partial successes.</p>
<p>But if you think we have limitless solar energy to fuel limitless clean, green growth, think again. For GDP to keep growing we would need ever-increasing numbers of wind turbines, solar farms, geothermal wells, bioenergy plantations and so on – all requiring ever-increasing amounts of material and land.</p>
<p>Nor is efficiency (getting more economic activity out of each unit of energy and materials) the answer to endless growth. <a href="http://journals.plos.org/plosone/article?id=10.1371/journal.pone.0164733">As some of us pointed out in a recent paper</a>, efficiency gains could prolong economic growth and may even look like decoupling (for a while), but we will inevitably reach limits.</p>
<h2>Moving money</h2>
<p>The economy can also appear to grow without using more resources, through growth in financial activities such as currency trading, credit default swaps and mortgage-backed securities. Such activities don’t consume much in the way of resources, but make up an increasing fraction of GDP. </p>
<p>So if GDP is growing, but <a href="https://www.bloomberg.com/view/articles/2016-04-20/how-finance-came-to-dominate-the-u-s-economy">this growth is increasingly driven by a ballooning finance sector</a>, that would give the appearance of decoupling. </p>
<p>Meanwhile most people aren’t actually getting any more bang for their buck, as most of the wealth remains in the hands of the few. It’s ephemeral growth at best: ready to burst at the next crisis.</p>
<h2>Shifting the cost onto poorer nations</h2>
<p>The third way to create the illusion of decoupling is to move resource-intensive modes of production away from the point of consumption. For instance, many goods consumed in Western nations are made in developing nations. </p>
<p>Consuming those goods boosts GDP in the consuming country, but the environmental impact takes place elsewhere (often in a developing economy where it may not even be measured).</p>
<p><a href="http://www.pnas.org/content/112/20/6271.full">In their 2012 paper</a>, Thomas Wiedmann and co-authors comprehensively analysed domestic and imported materials for 186 countries. They showed that rich nations have appeared to decouple their GDP from domestic raw material consumption, but as soon as imported materials are included they observe “no improvements in resource productivity at all”. None at all.</p>
<h2>From treating symptoms to finding a cure</h2>
<p>One reason why decoupling GDP and its growth from environmental degradation may be harder than conventionally thought is that <a href="https://www.zedbooks.net/shop/book/gross-domestic-problem/">this development model (growth of GDP) associates value with systematic exploitation</a> of natural systems and also society. As an example, felling and selling old-growth forests increases GDP far more than protecting or replanting them.</p>
<p>Defensive consumption – that is, buying goods and services (such as bottled water, security fences, or private insurance) to protect oneself against environmental degradation and social conflict – is also a <a href="http://www.sciencedirect.com/science/article/pii/S0921800913001584">crucial contributor to GDP</a>. </p>
<p>Rather than fighting and exploiting the environment, we need to recognise alternative measures of progress. In reality, there is no conflict between human progress and environmental sustainability; <a href="http://www.sciencedirect.com/science/article/pii/S1877343512000140">well-being is directly and positively connected with a healthy environment</a>.</p>
<p>Many other factors that are not captured by GDP affect well-being. These include the distribution of wealth and income, the health of the global and regional ecosystems (including the climate), the quality of trust and social interactions at multiple scales, the value of parenting, household work and volunteer work. We therefore need to measure human progress <a href="https://theconversation.com/beyond-gdp-are-there-better-ways-to-measure-well-being-33414">by indicators other than just GDP</a> and its growth rate.</p>
<p>The decoupling delusion simply props up GDP growth as an outdated measure of well-being. Instead, we need to recouple the goals of human progress and a healthy environment for a sustainable future.</p><img src="https://counter.theconversation.com/content/71996/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Ward works for the University of South Australia.
He is also privately affiliated with Sustainable Population Australia.</span></em></p><p class="fine-print"><em><span>Keri Chiveralls works for Central Queensland University. </span></em></p><p class="fine-print"><em><span>Lorenzo Fioramonti, Paul Sutton, and Robert Costanza do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Even supposedly “green” technologies such as renewable energy require materials, land and solar exposure and cannot grow indefinitely on this planet.James Ward, Lecturer in Water & Environmental Engineering, University of South AustraliaKeri Chiveralls, Discipine Leader Permaculture Design and Sustainability, CQUniversity AustraliaLorenzo Fioramonti, Full Professor of Political Economy, University of PretoriaPaul Sutton, Professor Department of Geography and the Environment, University of DenverRobert Costanza, Professor and Chair in Public Policy at Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/742202017-03-08T14:02:09Z2017-03-08T14:02:09ZUK budget 2017: why upcoming Brexit uncertainty will put bright economic outlook to the test<p>Philip Hammond has <a href="https://www.gov.uk/government/publications/spring-budget-2017-documents/spring-budget-2017">delivered his first budget</a> since taking over the role of chancellor of the exchequer after the UK’s Brexit vote <a href="https://theconversation.com/the-challenges-ahead-for-britains-new-chancellor-philip-hammond-62516">put paid to his predecessor</a>, George Osborne. He has unveiled a brighter outlook for economic growth, with an upgraded forecast for growth in 2017 <a href="http://cdn.budgetresponsibility.org.uk/March2017EFO-231.pdf">from the Office for Budget Responsibility</a>. He spoke of job creation and wage growth. And, with public finances in better shape than expected, he was also able to report lower borrowing forecasts than in his Autumn Statement.</p>
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<p>But recent history shows us why we should not be so confident about all these healthy forecasts. A look at the recent history of economic forecasting makes the upgraded expectations of 2% growth in 2017 questionable. Then there’s the fact that Brexit hasn’t happened yet. With Article 50 soon to be triggered, the uncertainty that harms economies the most will only get worse in the months to come. </p>
<h2>The problem with forecasts</h2>
<p>Deriving forecasts about the state of the UK economy and public finances is a huge challenge – in general – but especially now that we do not know how the UK’s relationship with Europe will shape up following Brexit. Indeed, the ancient Greek scientist <a href="http://www.philosophers.co.uk/thales-of-miletus.html">Thales of Miletus</a> was one of the first experts to (implicitly) recognise the challenges of forecasting by noting that “the past is certain, the future obscure”. </p>
<p>Reflecting the state of economic forecasting, the Bank of England’s interest rate setter Jan Vlieghe <a href="https://www.theguardian.com/business/2017/feb/21/we-will-miss-the-next-financial-crisis-predicts-bank-of-england">recently informed MPs</a>: “We are probably not going to forecast the next financial crisis, nor the next recession. Models are just not that good.” </p>
<p>As astonishing as this statement might sound, Vlieghe knows exactly what he is talking about. Figure 1 shows the inability of policymakers (the Bank of England’s in this case) to forecast GDP growth two years into the future. </p>
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<p>As the graph shows, policymakers’ ability to predict UK GDP growth has been rather poor. This can be seen in the way the forecast moves in the opposite direction to the actual outcome.</p>
<p>Figure 1 makes two further worrying readings. First, UK policymakers have been overconfident in their predictions. The Bank of England has, on average, over-predicted annual GDP growth by a massive 1.52% over the past nine years. Second – and perhaps much more worryingly – the Bank’s officials (and many other economists) completely missed the 2008-09 recession.</p>
<p>So what this tells us is that models are not good – at all – when they are needed the most. If this is indeed the case, what is the purpose of going through the somewhat futile exercise of presenting budget forecasts three to five (or even more) years into the future? Was this train of thought going through Phillip Hammond’s mind <a href="https://www.gov.uk/government/news/spring-budget-2017-date-confirmed">when he announced</a> that there will only be one, rather than two major budget statements a year?</p>
<h2>Revising the estimates</h2>
<p>Irrespective of what Hammond’s thinking might have been, the health of the UK public finances critically depends on the country’s economic performance. This is hard to pin down. Indeed, provisional (or real-time) published GDP data are often revised quite dramatically down the line. This is more the case in periods of increasing uncertainty – such as the recent financial crisis and (arguably) the present volatile economic climate following the recent Brexit vote. </p>
<p>Figure 2 plots together provisional and revised estimates of annual GDP growth in the UK. The revised estimates reflect the latest belief of how the economy has performed based on the most recent information. </p>
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<p>Although the correlation between provisional and revised GDP growth is quite high, a closer look at the data reveals the following:</p>
<p>1) During the 2008-2009 financial crisis, GDP fell earlier and more sharply than policymakers thought at the time. </p>
<p>2) Since 2015, provisional GDP growth data seems to be sending the rather misleading signal that the economy is doing better than it actually is.</p>
<p>This all has important implications for the UK’s public finances. Policymakers use data available in real time to produce forecasts about GDP growth and public finances. These forecasts should always be taken with a pinch of salt because real-time data (which are subject to potentially large revisions) are used as inputs in any forecasting model. To make things worse, forecasts critically depend on the underlying forecasting model, which is unlikely to adequately capture all the time-varying, evolving features of what we want to forecast. </p>
<h2>The challenge of uncertainty</h2>
<p>Even if we were to naively assume that provisional data remain unrevised and that we have an accurate forecasting model, economic uncertainty itself will challenge the economy. As Figure 3 shows, economic uncertainty takes its toll on annual investment growth, which in turn limits economic growth.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=339&fit=crop&dpr=1 600w, https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=339&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=339&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=426&fit=crop&dpr=1 754w, https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=426&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/159960/original/image-20170308-24192-g9xm5t.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=426&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The inverse relationship between UK economic uncertainty and investment growth, 1950-2016.</span>
<span class="attribution"><span class="source">Estimates of the authors using ONS data. Economic uncertainty is measured by the 10-year rolling volatility of UK's long-term interest rate</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>To keep buying UK debt, international investors will require a higher yield on UK bonds. This yield will also experience further ups and some downs as the UK goes through a potentially messy Brexit divorce. With economic uncertainty on the rise, UK investment will slow down. This will bring with it job losses and a reduction in public finances because of lower tax receipts and rising unemployment benefits.</p>
<p>The chancellor will no doubt be hoping that his plans to lower the UK’s corporate tax rate to 19% in 2017 and 17% in 2020 will keep businesses happy. But the UK’s existing corporate tax rate of 20% was already much lower than the <a href="https://stats.oecd.org/index.aspx?DataSetCode=Table_II1">24% average for 34 OECD countries</a>. It might be helpful for existing businesses and may even attract additional ones. But it will not be enough to counteract Brexit uncertainty. Business would definitely prefer assurances about a smooth divorce today rather than lower taxes in the future.</p><img src="https://counter.theconversation.com/content/74220/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>In 2012, Costas Milas was the principal recipient of a Bank of England Research Donations Committee Grant (bid for £5,604). Title of the project: “Liquidity and output growth in the UK”. Duration of the project: 5 months.</span></em></p><p class="fine-print"><em><span>From October 2013 to October 2016, I received an Economic and Social Research Council (ESRC) doctoral scholarship award.</span></em></p>Recent history shows us why we should take the latest healthy forecasts with a pinch of salt.Costas Milas, Professor of Finance, University of LiverpoolMike Ellington, Research Associate in Finance, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/724052017-02-07T03:33:49Z2017-02-07T03:33:49ZA vastly changed world means consumers won’t react the same to higher interest rates<figure><img src="https://images.theconversation.com/files/155774/original/image-20170206-27179-1oma700.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Consumers are faced with more economic uncertainty than the bottoming out of interest rates would otherwise suggest.</span> <span class="attribution"><span class="source">AAP/Sam Mooy</span></span></figcaption></figure><p>The Reserve Bank today <a href="http://www.rba.gov.au/media-releases/2017/mr-17-02.html">kept interest rates</a> at a record low of 1.5%. Such low rates create economic uncertainty – and if Australia’s historical GDP growth is anything to go by, consumers face more uncertainty than the bottoming out of interest rates would usually suggest. </p>
<p>This is because high house prices lead home-owners to feel wealthy, yet the economy as a whole does not convey a message of wealth to all consumers.</p>
<p>Boom and bust come and go, and sometimes you can be forgiven for feeling economic déjà vu. But how might Australians react to record low rates this time around? Business moves in cycles over time, so economists sometimes look to history as a guide to what might happen next.</p>
<p>A flattening out of interest rates can mean many possibilities for consumers and businesses. Historical GDP growth rates would indicate that the business cycle is at the same stage as in 2011. But what this means for consumers depends on how the other economic “stars” align. The indicators from 2011 are able to provide a model of how consumers may react over the coming years. </p>
<h2>Does 2011 provide a model?</h2>
<p>The relationship between interest rates and unemployment has been of interest since target interest rates were introduced in 1990. </p>
<p>The rise in unemployment from 4% to 6% between July 2008 and May 2009 occurred at the same time as the Reserve Bank rapidly slashed the target interest rates. </p>
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<p>However, with the Reserve Bank now unlikely to reduce interest rates any further, the impact on unemployment and other pointers for consumer behaviour may be different this time compared to 2011.</p>
<p>To predict consumer behaviour in the current uncertain conditions, the most appropriate method would be to consider past situations where GDP has gone up, and reflect on changes to key consumer indicators. </p>
<p>Based on Australia’s current GDP growth rates, and those of the last few decades, we are most likely at the “February 2011” stage of the business cycle – when growth was at 1.9%.</p>
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<p>Based on the <a href="https://melbourneinstitute.com/downloads/media_release/2017/CSI/PressReleaseCSI20170118.pdf">business cycle method</a> of anticipating future consumer indicators, we would expect the trend to continue. Consumers would save the same or less of their income. And consumer sentiment would remain flat. </p>
<p>However, with property prices <a href="http://propertyupdate.com.au/october-saw-capital-city-dwelling-values-reach-new-record-highs/">at all-time highs</a> in capital cities, it is possible this will counteract rising interest rates when it comes to consumer expectations because there are conflicting messages. On the one hand, consumers feel wealthy because of property prices. However, they are expecting their mortgage repayments to increase when interest rates start to tick up.</p>
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<p>In this environment it is expected that unemployment remains steady, as it has since 2009, with the sharemarket remaining flat. It is expected that as the sharemarket remains flat (or modestly increases) across developed countries, the price of gold continues to rise.</p>
<p>We can make these sorts of predictions, if 2011 is a guide to what will happen in the coming years.</p>
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<a href="https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=465&fit=crop&dpr=1 600w, https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=465&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=465&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=584&fit=crop&dpr=1 754w, https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=584&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/155767/original/image-20170206-27176-gaspl8.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=584&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><span class="source">ASX</span></span>
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<p>But using 2011 as a benchmark to help predict future trends relies on the basic academic assumption that the points of reference (2011 and 2017) are identical. The world of 2011 was vastly different from the world today – it was almost naively uncomplicated.</p>
<h2>Further dampening effects?</h2>
<p>The differences between 2011 and 2017 will likely result in further dampening effects on the economic recovery. One of the major potential dampeners is Australia’s relatively high level of government debt. </p>
<p>The reduction in government debt in 2007 occurred almost simultaneously with the global financial crisis, higher consumer saving rates and a steady decline in GDP growth each quarter. </p>
<p>Hence, core economic fundamentals (such as how cutting government spending when the economy is already shaky will likely result in a greater negative GDP impact than when the economy is strong) deem that if the current government takes steps to reduce debt, this could have further dampening effects on the economy. This is despite a bottoming out of interest rates, which indicates the economy is projected to be on the way up. </p>
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<p>Today’s world poses many challenges to forecasting how consumers will behave. One of the primary issues is high levels of debt (both for consumption and for property), which means a rise in interest rates will directly impact Australians. However, high property markets give consumers a feeling of wealth, despite the extreme lack of diversification across asset classes, and property that is hard to sell. </p>
<p>These competing forces mean consumers are likely to view formal government announcements with more scrutiny. As statements are made about improving economic prospects, individual consumers are feeling financial strain.</p>
<p>Combine these forces with increasing market complexity, product advances, geopolitical issues and climate change, and a certain level of unease is weighing on Australian minds, which goes over and above the likely increase in mortgage repayments.</p>
<h2>A lot has changed since 2011</h2>
<p>Technology disruptions are likely to further reduce trust in institutions, particularly banks, but may ultimately give consumers a greater feeling of empowerment and control.</p>
<p>In 2011, technological financial disruption was just a sparkle in Bitcoin’s eye. Now, technological disruption covers every sector imaginable. Many consider the future economy will be the <a href="http://www.sciencedirect.com/science/article/pii/S1094996813000376">collaborative economy</a>.</p>
<p>The collaborative economy is one in which consumers and businesses share their resources (for a fee). This increases efficiency and saves cost to the end consumer. </p>
<p>For example, AirBnB (the largest accommodation provider in the world, which owns no accommodation) connects people who have extra space with travellers who are seeking an authentic, low-cost experience while travelling.</p>
<p>If the shift toward the collaborative economy continues, large institutions – particularly banks – will find it more difficult to make the significant profits they are used to.</p>
<p>Since 2011, consumers across the world have shifted to more community-based banking systems and have lent directly to others to achieve higher interest rates than bank deposits – particularly in a low-interest-rate environment. This trend is likely to continue.</p>
<p>Coupled with <a href="http://www.ey.com/gl/en/industries/.../banking.../ey-global-consumer-banking-survey-2016">decreasing trust in institutions</a>, it makes it unlikely that the predicted trends will be identical to those in 2011.</p><img src="https://counter.theconversation.com/content/72405/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Katherine Hunt works for Griffith University and GlobalSisters, an NGO which empowers vulnerable women through microenterprise, and has previously worked as a financial planner with Aspire Financial Planning. </span></em></p>If the stars align, consumers will benefit from increased economic activity in the short term. And if they don’t, then the economic recovery will have consumers saving more in uncertain times.Katherine Hunt, Lecturer in Accounting, Finance and Economics, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/710562017-01-24T14:04:44Z2017-01-24T14:04:44ZHow to be an economist in 2017<figure><img src="https://images.theconversation.com/files/153621/original/image-20170120-5221-10c3h27.jpg?ixlib=rb-1.1.0&rect=128%2C221%2C2425%2C1412&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/fairtomiddling/4388010872/in/photolist-7FKGKS-4dTchT-4dXbJG-4dTcex-ngcnDG-wEXhf-5aQQ1b-bjA1qz-5eXXH-bjA1jF-4dXbFL-7JiyY-bjA1h2-4KD6HV-awz6oL-dzHdMu-bjA1bX-7DmLiG-9ejWzz-FpToUL-5aUurf-8Y2j5w-bjA1NT-6dv6AX-r7UTFe-5EE5Vq-4KHoMb-bjA1Kk-bjA1Ac-76XGrf-dBJ8aG-6nHWMJ-gfpgyE-gaRYfQ-bjzWWD-biA8jg-bjA1EH-bjzX1H-aD3rwb-f8Yoae-bmuksW-f4YjAD-bjsCSZ-ZVT5-bmua3G-5MyNaK-5p52Pu-5oZJw4-5oZHRn-jaraB">Sean McGee Hicks/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span></figcaption></figure><p>It has been a rough 12 months for economists. We have been <a href="https://theconversation.com/why-is-the-academic-consensus-on-the-cost-of-brexit-being-ignored-59540">ignored by voters</a>, <a href="http://www.huffingtonpost.co.uk/entry/michael-gove-experts-economists-andrew-marr-obr-ifs-nigel-farage_uk_583abe45e4b0207d19184080">ridiculed by politicians</a> and been told that <a href="http://www.bbc.co.uk/news/uk-politics-38525924">our discipline is in crisis</a>. </p>
<p>At its heart, the so-called “crisis” in economics is simply a result of the flaws in our species. Simply put, the variables used by economists are inherently problematic as they are attempts to model human decision making. What this should tell us is that the value in economics <a href="https://theconversation.com/economics-is-fundamentally-flawed-far-worse-than-the-bank-of-england-realises-71051">is not in some magical ability</a> to divine the future.</p>
<p>The trouble is, forecasting models are very attractive. They help investors assess risk, help central banks decide policy and allow politicians to justify ideological flights of fancy. And it’s in this last group that the caveats, warnings and limitations of these models are so often ignored. </p>
<h2>Being human</h2>
<p>Let’s look at those inherent problems in human decision making a little more closely. Let us say that an economy has grown by 3% every year for the past 20 years. A forecasting model, based on historical growth will rightly forecast future growth with a high probability of about 3%. Does this mean this is guaranteed? Of course not. </p>
<p>The model does not take into account that GDP is a product of human decision making. Just because we have constantly performed one action over and over again, are we destined to in perpetuity? <a href="http://www.investopedia.com/articles/investing/051415/how-calculate-gdp-country.asp">GDP is an observation</a> of our confidence, our tastes, our decisions to spend or save and so much more. These factors are in turn affected by countless others, the isolation of which is impossible due to their constantly changing nature.</p>
<p>I have something at stake in the debate. Right now, I am in the process of devising a model of the UK economy which incorporates relevant psychological drivers of decision making. In my model, I use proxies for people’s confidence and try to build in measures for this confidence to disappear very quickly – for instance how a major news story about people <a href="https://www.theguardian.com/money/negative-equity">falling into negative equity</a> might dent house buying confidence.</p>
<p>I also try to build in herd-like behaviour. And there are a host of other psychological effects to consider too. Did you know that people normally browse a holiday on a mobile phone or tablet but prefer to book it on a home computer? This is the same for most large purchases and the cumulative effects on the economy can be considerable. </p>
<p>It’s those pesky humans again, making everything complicated. You are less likely to impulse buy online if you have to enter your card details. Again this has a noticeable effect on the economy as new financial technology – <a href="https://www.theguardian.com/money/contactless-payments">such as contactless payments</a> – makes unnecessary purchases more likely. </p>
<h2>Doctoring the models</h2>
<p>Now, this model performs very well in tests designed to assess the robustness of forecasting. It identifies a general slowdown in confidence throughout 2017 culminating in a large downturn in general economic indicators at the end of the year. It seems plausible. However, I show this model to my students as an example of overconfidence in forecasting.</p>
<p>You see, it might produce statistically robust forecasts, but it cannot present the full picture and so its use as a means of prediction is limited. The <a href="https://theconversation.com/uk/eu-referendum-2016">unknown conditions of Brexit</a> may play a part, the weather may do as well. Without knowing these outcomes, and people’s response to them, my model is incomplete.</p>
<p>So, do I throw up my hands and curse economics as a futile endeavour? Just what is the value of the academic discipline to which I have (so far) devoted my career? Well, the analogy of a medical doctor is useful here.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/153622/original/image-20170120-5238-1ivtdux.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Taking the economy’s temperature.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/doctor-stethoscope-reading-temperature-measured-by-552441727?src=iwVLsE82ePrbAJcGkHlRpA-1-9">Yanawut Suntornkij/Shutterstock</a></span>
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</figure>
<p>Designing this model gives a better understanding of the economy even if it can’t guide it down a path of unblemished progress. In the same way, a doctor cannot definitely prevent illness, but can offer advice on prevention and hopefully offer a cure if you do get ill. This is the same for the work economists do. </p>
<p>Economists can offer advice on preventing crises or slowdowns but cannot definitively prevent them from happening. Economists can also offer robust advice on restoring growth, although when the advice is that the economy has grown too fast and should slow, it is often <a href="http://www.telegraph.co.uk/finance/2907805/Greenspan-should-have-removed-the-punch-bowl.html">not welcomed by policy makers</a>. This advice is built on a strong evidence base, however just like a doctor prescribing a cure, it is foolhardy to say exactly when the cure will definitely work, or if it will adapt to changing conditions. </p>
<h2>Odds on</h2>
<p>Perhaps the hard part is getting people to acknowledge these realities. There remains a prevailing view that an economics model makes a definitive forecast for the future – some economists themselves are guilty of maintaining an ideological belief in a method regardless of empirical observation. In fact, economics models simply suggest a version of the future, and incorporate the likelihood of that future occurring.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/153623/original/image-20170120-5238-jqe2bo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Leave it to the experts …</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/jeneeze/5500659718/in/photolist-9o5juE-nEjs4h-HTR73E-pvcHKf-98A1MS-b2XAzP-d3w8cj-6mbTpL-nGn64H-7c3L6x-qAB6fx-62zcy7-qKK1B-7D5FSD-a6881v-9hKVJA-57MWEV-7cTBUS-4Yxfzo-5KUVZ6-zB3C1i-v9UbKg-v9KtpN-B3cbxL-Kq8q1o-q9sXa7-7MrjHv-q9AEsa-hCLEcy-q9sWbo-qQrGzX-pufSPt-qoJBiy-bVZzE5-uEUUJ-7cKWtK-dNmz2f-ej9DCb-6viApT-qoJBdJ-7Mvief-qoJCwW-r5B8Ts-q9s6gC-q9AEAr-hqyuyx-bwU7dg-6DPVN1-6DPU1J-q9zcye">Jen Williams/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>My model meets a strenuous robustness check, but I still query the use of it as a forecasting tool. I can see, however, why these forecasts are extremely attractive to policy makers.</p>
<p>There is comfort in statistics, and our processing of probabilities is flawed. Someone making a bet with an 80% likelihood of success will be disproportionately disappointed if they lose. This is because we tend to overweight such high probabilities as a certainty and already expect the winnings before the outcome, whereas in reality there is a one in five chance of a loss. The opposite is true too. The very small chance of all the factors responsible for an economic crisis converging together at a particular time reassures people that it will never happen. </p>
<p>Policy makers are as susceptible to this as anyone, and should appreciate that the true value of the economist lies not in mystical fortune telling, but in achieving a better understanding of the nature of the economies in which we live and work.</p><img src="https://counter.theconversation.com/content/71056/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>This is developed from Richard Whittle's previous ESRC funded research.</span></em></p>Ridiculed and ignored in 2016, what can the ‘dismal science’ offer us now?Richard Whittle, Research Fellow in Economics, Manchester Metropolitan UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/702142016-12-14T19:07:49Z2016-12-14T19:07:49Z‘Big government’ hurts growth? It’s not as simple as that<figure><img src="https://images.theconversation.com/files/150011/original/image-20161213-18879-xb6uxj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">How harmful are big governments?</span> <span class="attribution"><span class="source">shutterstock</span></span></figcaption></figure><p>Since the late 1970s it has largely been <a href="http://www.heritage.org/research/reports/2005/03/the-impact-of-government-spending-on-economic-growth">the consensus</a> that “big government” is detrimental to growth. This manifested after the financial crisis when countries, including previously fiscally-comfortable countries like <a href="http://www.spiegel.de/international/germany/radical-cutbacks-german-government-agrees-on-historic-austerity-program-a-699229.html">Germany</a> and the <a href="https://www.theguardian.com/uk/2010/jun/22/budget-2010-vat-austerity-plan">UK</a>, adopted austerity programs, ostensibly to spur growth by cutting government expenditure.</p>
<p>But our research shows the story is not so simple. We found that studies tend to reflect selection bias. Findings that indicate a negative association between government size and growth are more likely to be published than those that show either a positive or no association. </p>
<p>Our research also found that the affect of the size of government is different between developed and developing countries and that there is a lot we don’t know about the optimal size of government, and whether some parts of government should be smaller than others. </p>
<h2>The existing research is inconclusive</h2>
<p>The existing research on the effect of the size of government on economic growth is actually contradictory, with <a href="https://www.jstor.org/stable/1804136?seq=1#page_scan_tab_contents">some researchers</a> asserting that a bigger government enhances growth, and <a href="https://www.jstor.org/stable/1058716?seq=1#page_scan_tab_contents">others</a> arguing that it hurts growth. </p>
<p>The arguments for a positive impact of a big government rely on examples like the potential of infrastructure development to <a href="http://www.abc.net.au/news/2016-12-12/treasurer-to-spend-state-budget-windfall-on-jobs/8113764">create jobs</a>, or intervening when there is a market failure (e.g. <a href="http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/3532604/RBS-now-58pc-owned-by-UK-government.html">taking over banks</a> during the GFC). Some of the <a href="http://www.heritage.org/research/reports/2005/03/the-impact-of-government-spending-on-economic-growth">negative affects</a> of a large government are thought to be felt through the excess burden of distortionary taxes, and government inefficiency.</p>
<p>But the research is ambiguous and inconclusive. A <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6419.2011.00697.x/abstract">survey</a> of the academic literature suggests the conflicting results could be a result of the decisions researchers make. About what measurement of government size is used, for instance, or the type of countries studied – developed or less-developed, rich or poor.</p>
<h2>Our research</h2>
<p><a href="http://onlinelibrary.wiley.com/doi/10.1111/1475-4932.12307/full">Our research</a> considered these distinctions, and so we sought to account for these variations when examining the relationship between government size and growth. </p>
<p>We did this through <a href="https://himmelfarb.gwu.edu/tutorials/studydesign101/metaanalyses.html">meta-analysis</a> - statistically analysing 799 estimates reported in 87 existing studies, looking at the relationship between government size and economic growth. We looked at the different measures of government size (e.g. total government expenditures and government consumption) and different levels of development (developed and less developed countries). </p>
<p>We found only partial support for the idea that the size of government has an effect on economic growth. Specifically, our research suggests that the effect of government size on economic growth is negative in developed countries but insignificant in less developed countries (LDCs). </p>
<p>Put differently, while we find evidence of a negative effect of government size on economic growth in developed countries, we find no effect in the case of LDCs. This is the case irrespective of whether government size is measured as the share of total expenditure or consumption expenditure in GDP. It also suggests that big government is usually bad for growth in developed countries but not in LDCs. </p>
<h2>What this means</h2>
<p>There are a couple of things to take away from our research.</p>
<p>For starters, as <a href="http://link.springer.com/article/10.1007/s11127-009-9527-7">has been hypothesised previously</a>, a small government can enhance economic growth by providing the minimum for investment and growth - the rule of law and protection of property rights etc. But when an economy becomes richer, the size of the government tends to grow beyond its efficient level, so a further rise in government size would reduce economic growth. </p>
<p>This is explained by <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0475.2010.00517.x/abstract">Wagner’s Law</a>, which suggests that when a country becomes industrialised and richer, it will be accompanied by an increased share of public expenditure. But while there are certain forms of government spending which are necessary to sustain a functioning economy, spending beyond a specific level can bring more costs than benefits. </p>
<p>But the existing literature does not explain much about the optimum government size. Theoretically, there is a point beyond which increases in government size lead to a decline in economic performance. But empirical work is limited and inconclusive in this area, and thus it is not clear what this point is. </p>
<p>The distinction between developed and LDCs is also very important. Caution needs to be taken when generalising the effects of government size on growth. </p>
<p>There’s a lot that we don’t know in this space. Further research is needed on the relationship between the size of particular parts of the government, and economic growth. Such studies are more likely to produce policy-relevant findings compared to studies that focus on total measures of government size. </p>
<p>This would help policymakers determine how big governments should be and which components of government to cut in the context of tight government budget constraints and excessive government expenditures.</p><img src="https://counter.theconversation.com/content/70214/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sefa Awaworyi Churchill is affiliated with Monash University. </span></em></p><p class="fine-print"><em><span>Mehmet Ugur, University of Greenwich, receives funding from ESRC and DfID</span></em></p><p class="fine-print"><em><span>Siew Ling Yew does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>That “big government” hurts growth has become received wisdom, leading many countries to austerity policies. New research shows it is a lot more complicated than that.Sefa Awaworyi Churchill, Casual Academic, RMIT UniversityMehmet Ugur, Professor of Economics and Institutions, University of GreenwichSiew Ling Yew, Lecturer, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/688682016-11-15T15:29:53Z2016-11-15T15:29:53ZGreece economy rallies while Germany stutters but restraint still required<figure><img src="https://images.theconversation.com/files/146072/original/image-20161115-31153-11zyfkj.jpg?ixlib=rb-1.1.0&rect=157%2C0%2C842%2C486&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-273465113/stock-photo-flags-of-germany-and-greece-painted-on-cracked-wall.html?src=SJVs2YpUeOy5rU7c_bE-nA-1-49">danielo/Shutterstock</a></span></figcaption></figure><p>Finally, some good news from Greece. It appears that the long-running contraction of the country’s economy <a href="https://www.theguardian.com/world/2016/nov/15/greece-edges-out-of-recession-with-two-quarters-of-growth">has finally halted</a> and there is some hope it has begun to enjoy modest growth. There is no reason for too much elation just yet as the Greek public finances remain problematic. Even after three bailouts the Greek state labours under a heavy debt burden that will remain well over 170% of GDP for the foreseeable future. </p>
<p>Yields on Greek ten-year bonds – a measure of the market’s enthusiasm for the Greek economy – have not dropped below 7%, and remember, this is the interest rate in euros, not a particularly inflation-prone currency. The good news has so far had no appreciable effect. By comparison, though the German economy has stuttered this quarter, German yields have been well below 0.5% – the difference is the quite elevated risk of Greek default anywhere between now and 2026.</p>
<p>The Greek <a href="http://www.reuters.com/article/eurozone-greece-gdp-idUSL8N1DF2ZC">statistics service data</a> showed an estimate for economic growth in the third quarter of 0.5%. In the second quarter, the rise in gross domestic product was revised up to 0.3%. In Germany, meanwhile, the <a href="http://www.bbc.co.uk/news/business-37984719">Federal Statistics Office reported</a> a halving of GDP growth, to 0.2% in the third quarter from 0.4% in the second as weaker exports weighed on the numbers.</p>
<h2>Reshuffle</h2>
<p>The growth in Greece is in some ways inevitable. An economy can only fall so far when it can rely on some measure of debt relief. Greek Prime Minister Alexis Tsipras understands that implementing the reforms he has promised to obtain support will become progressively more difficult. He <a href="https://www.theguardian.com/world/2016/nov/06/greek-prime-minister-tsipras-reshuffles-cabinet-to-boost-bailout-reforms">recently reshuffled his cabinet</a> to retain the goodwill he still needs from the International Monetary Fund, the European Central Bank (ECB) and his EU partners. </p>
<p>Perhaps his mind was focused by the way Portugal nearly lost access to the ECB’s quantitative easing programme last month after the last of four ratings agencies threatened to downgrade its debt below investment grade. That followed the introduction of a raft of populist policies by its socialist government this year, <a href="http://www.dbrs.com/industry/10036">reversing the downward trend</a> in its debt burden. This could still happen even though the country just chalked up its <a href="http://www.cnbc.com/2016/11/15/euro-zones-economy-grows-03-percent-in-third-quarter-up-16-percent-on-last-year.html">fastest growth since 2013 last quarter</a>.</p>
<p>Even if all goes according to plan, this Greek saga will last well past the middle of the century. In 2054 the Greek state will pay the European Financial Stability Facility €6.3 billion and over €1 billion a year to the European Stability Mechanism in each of the five years that follow. Again, that is if everything goes to plan, and that is over a very long and uncertain planning horizon. And so despite the relatively good news coming out of Greece today, the markets remain rightly very cautious about the future of its finances. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=458&fit=crop&dpr=1 600w, https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=458&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=458&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=576&fit=crop&dpr=1 754w, https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=576&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/146074/original/image-20161115-31129-9fg5d4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=576&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Caution remains high in debt markets.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-279555938/stock-photo-stock-exchange-chart-graph-finance-business-background-abstract-stock-market-diagram-candle-bars-trade.html?src=aHt0a2TufjOii11Jv3yXuQ-1-14">autsawin uttisin/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Spending patterns</h2>
<p>There is a lesson here for others. Conventional wisdom <a href="http://www.nytimes.com/2015/08/21/opinion/paul-krugman-debt-is-good-for-the-economy.html?_r=0">these days holds</a> that Western countries can safely remove the shackles of austerity and borrow to invest (proponents of government spending always use the word “invest” never “spend”). The rationale goes that this is because interest rates are so low that the borrowing amounts to “free money”. </p>
<p>It is wise to remember that not only do the interest payments need to be paid but the principal will need to be either repaid or (more likely) one day refinanced when interest rates are not so low. With its low debt burden, Germany can suffer even a severe recession and still not face a debt crisis, but if Greece experiences even a mild downturn it will need further bailouts.</p>
<p>Some projects may have the effect of growing the economy by enough to justify this extra burden, but this is not “free money”. Because that’s the thing about money, it is never really free. One thing that unites the politicians of the right and the left, Donald Trump, Hillary Clinton, Theresa May, François Hollande and Jeremy Corbyn, is the belief that tomorrow, or indeed the year 2059 will never come. At least it will only come long after they are gone.</p><img src="https://counter.theconversation.com/content/68868/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael Ben-Gad does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Athens can celebrate two consecutive quarters of growth. Berlin must stomach some weakness. Everyone should remember cheap money isn’t free money.Michael Ben-Gad, Professor of Economics, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/602422016-06-01T02:22:14Z2016-06-01T02:22:14ZElection FactCheck Q&A: has Australia had 25 years of continuous economic growth?<figure><img src="https://images.theconversation.com/files/124720/original/image-20160601-25573-oohdou.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Was Steven Ciobo right about Australia's economic growth?</span> <span class="attribution"><span class="source">Q&A</span></span></figcaption></figure><p><strong>The Conversation is fact-checking claims made on Q&A, broadcast Mondays on the ABC at 9:35pm. Thank you to everyone who sent us quotes for checking via <a href="http://www.twitter.com/conversationEDU">Twitter</a> using hashtags #FactCheck and #QandA, on <a href="http://www.facebook.com/conversationEDU">Facebook</a> or by <a href="mailto:checkit@theconversation.edu.au">email</a>.</strong></p>
<hr>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/5Y21t1oRXsY?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">Excerpt from Q&A, May 30, 2016.</span></figcaption>
</figure>
<blockquote>
<p>We’ve had 25 years of continuous economic growth, the only country in the world with a period of growth that long. – Trade minister Steven Ciobo, <a href="http://www.abc.net.au/tv/qanda/txt/s4449977.htm">speaking</a> on Q&A, May 31, 2016.</p>
</blockquote>
<p>Economic management is shaping up as a key election battleground, and the Coalition has been especially keen to keep the focus on the economy. </p>
<p>Trade minister Steven Ciobo told Q&A viewers that Australia has had 25 years of continuous economic growth, and is the only country in the world with a period of growth that long.</p>
<p>Is that right?</p>
<h2>Checking the source</h2>
<p>A spokesman for Steven Ciobo told The Conversation that Ciobo misspoke on Q&A. The spokesman said by email that:</p>
<blockquote>
<p>Mr Ciobo omitted the world developed, he meant to say “developed country”. </p>
</blockquote>
<p>That clarification does improve the accuracy of his statement quite considerably. Let’s test his two statements separately. </p>
<h2>25 years of continuous economic growth?</h2>
<p>Australia entered a period of low and sometimes negative economic growth in 1989. The last period where growth was negative was June 1991 (for the quarter-over-quarter growth), and December 1991 (for the year-over-year growth). </p>
<p>I would argue that the weak growth through 1991 means that you can’t say that the economy recovered and was growing until 1992. </p>
<p>So on that definition, we have had about 24.5 continuous growth – which is close enough to the Ciobo’s figure of 25 years.</p>
<p>It is true we are <em>in</em> our 25th year of consecutive economic growth. That’s how it was phrased in Austrade’s 2016 <a href="https://www.austrade.gov.au/International/Invest/Why-Australia/Growth">Why Australia Benchmark Report</a>, which noted that:</p>
<blockquote>
<p>Australia is not only entering its 25th year of consecutive growth, the country is expected to realise annual real GDP growth of 2.9% between 2016 and 2020 – the fastest of any major advanced economy in the world.</p>
</blockquote>
<h2>The only country in the world?</h2>
<p>As the minister’s spokesman said, Ciobo accidentally omitted the word “developed” from his statement. </p>
<p>It is true that all of the other 33 <a href="http://www.oecd.org/about/membersandpartners/#d.en.194378">member countries</a> in the Organisation for Economic Co-operation and Development (<a href="http://www.oecd.org/">OECD</a>) have had a period of negative GDP growth since 1991, with most going into recession during the Global Financial Crisis.</p>
<p>It is notable that the dip in growth during the GFC was smaller for the Group of 20 (<a href="http://dfat.gov.au/international-relations/international-organisations/g20/pages/the-g20.aspx">G20</a>) major economies than for the OECD, and the reason for this is that many emerging markets did not go into recession. </p>
<p>It is not true to say, as the minister accidentally did, that Australia is the only country in the world with a period of growth that long. The chart below shows Australia’s growth next to the G20, OECD, India and China. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=326&fit=crop&dpr=1 600w, https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=326&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=326&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=410&fit=crop&dpr=1 754w, https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=410&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/124535/original/image-20160531-13810-hgnto5.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=410&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Author provided. Source: OECD Main Economic Indicators and Emerging Markets database in DX database.</span></span>
</figcaption>
</figure>
<p>The chart shows that China and India, the two most important emerging economies, also have had positive growth in GDP in the past 25 years. It is now more than 25 years since both countries began their economic reform programs, and both countries have enjoyed very strong economic growth over this period.</p>
<h2>Verdict</h2>
<p>The statement that Australia has had 25 years of continuous economic growth is mostly correct.</p>
<p>The statement that Australia is the only country <em>in the world</em> to have had such a period of unbroken growth is incorrect. But it’s true Australia is the only one out of 34 OECD member countries to have had positive economic growth since 1991. <strong>– Mark Crosby</strong></p>
<hr>
<h2>Review</h2>
<p>The FactCheck takes the right approach of first confirming the Australian data, which show that there was effectively 25 years of uninterrupted positive growth in real GDP on a quarter-to-quarter basis.</p>
<p>Then it takes the right approach of looking at obvious counter-examples to the statement about Australia being the “only country in the world” with such a long period of uninterrupted positive growth. China immediately came to my mind too.</p>
<p>China is an important counter-example because it addresses the potential caveat that developed economies account for most of world’s economic activity and, therefore, “in the world” might somehow be approximately correct. China may be an emerging economy, but its GDP is now almost two-thirds the size of US GDP. So ignoring it would be a mistake.</p>
<p>It is also worth noting that positive real GDP growth is not the be-all and end-all when evaluating the state of the economy. We might well care more about growth in real GDP per person: on that measure, Australia has had a number of quarters of negative growth during the last 25 years. Also, the Australian unemployment rate increased dramatically by almost two percentage points during the GFC. So a strict focus on quarterly real GDP growth is probably too narrow when thinking about how the overall economy did over the past 25 years.</p>
<p>All in all, I agree with the verdict. <strong>– James Morley</strong></p>
<hr>
<p><div class="callout"> Have you ever seen a “fact” worth checking? The Conversation’s FactCheck asks academic experts to test claims and see how true they are. We then ask a second academic to review an anonymous copy of the article. You can request a check at checkit@theconversation.edu.au. Please include the statement you would like us to check, the date it was made, and a link if possible.</div></p><img src="https://counter.theconversation.com/content/60242/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Morley receives funding from the Australian Research Council. </span></em></p><p class="fine-print"><em><span>Mark Crosby does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Trade Minister Steven Ciobo told Q&A viewers that Australia has had 25 years of continuous economic growth, and is the only country in the world with a period of growth that long. Is that true?Mark Crosby, Associate Professor of Economics, Melbourne Business SchoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/539412016-02-04T11:08:53Z2016-02-04T11:08:53ZHow do we know if we’re in a global recession?<figure><img src="https://images.theconversation.com/files/110215/original/image-20160203-5826-y8dnii.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Recessions affect us all.</span> <span class="attribution"><span class="source">Unemployed line via www.shutterstock.com</span></span></figcaption></figure><p>Since the start of this year, stock markets around the world have fallen as panicked investors have begun believing that the world is slipping into <a href="http://www.wsj.com/articles/a-global-recession-may-be-brewing-in-china-1439764500">economic malaise</a>. </p>
<p>This <a href="http://www.marketwatch.com/story/another-great-recession-threatens-world-financial-markets-2016-01-12">fear</a> has also driven down prices of commodities like oil and copper and impelled <a href="http://www.wsj.com/articles/central-banks-go-to-new-lengths-to-boost-economies-1454098658">some central banks</a>, like Japan’s, to make dramatic efforts to boost growth. The concerns are being magnified by memories of the <a href="http://www.cnbc.com/2016/01/15/a-recession-worse-than-2008-is-coming-commentary.html">worldwide recession of 2008 and 2009</a>, when many countries experienced widespread joblessness, business bankruptcies and homelessness.</p>
<p>While national and international leaders cannot prevent worldwide economic downturns, a coordinated response among them can mitigate some of the impact. But it’s hard to rally government resources to this cause without the ability to determine whether we are actually in a recession or not. </p>
<p>So how do we know when the world is in a <a href="http://www.barrons.com/articles/the-global-recession-of-2016-1450511060">recession</a> and such a response is needed?</p>
<h2>What <em>is</em> a recession?</h2>
<p>To answer this question, first we need to understand what it means to actually be in a recession. </p>
<p>The generally accepted – and rather broad – <a href="http://businessmacroeconomics.com/">definition of recession</a> is a period of time when economic activity declines. While most people agree with this, there is controversy over how to translate it into practice. </p>
<p>Currently, three methods are used to determine when the world is in a recession.</p>
<p><strong>1) Threshold definition</strong></p>
<p>One way of defining a recession is when world output falls below a certain benchmark or threshold. For example, if global gross domestic product grows <a href="http://news.sky.com/story/1564804/world-is-on-brink-of-new-recession-imf-warns">less than 2.5 percent or 3 percent</a> a year, that means the world is in a recession. </p>
<p>It’s a yardstick the <a href="http://www.imf.org/external/np/tr/2001/tr010924.htm">International Monetary Fund</a> has used in the past and some in the media still employ. </p>
<p>Why 2.5 percent or 3 percent? Doesn’t a recession suggest an actual <em>decline</em> in GDP? The thinking is that since the world’s population is growing rapidly, each person’s slice of the global economic pie shrinks unless the overall pie expands by the same pace. If the <a href="http://esa.un.org/unpd/wpp/Graphs/Probabilistic/POP/TOT/">world’s population</a> is growing at 2 percent a year, as it was during the 1990s, world GDP has to increase at least 2 percent to keep up.</p>
<p>Many people, including current economists at the IMF (see box 1.1 <a href="https://www.imf.org/external/pubs/ft/weo/2002/01/pdf/chapter1.pdf">here</a>), feel the threshold definition is problematic because if the world is growing at 3 percent then total production doubles roughly every quarter-century. Doubling output in such a short period of time, even if population increases, does not match the general definition’s spirit of declining economic activity.</p>
<p>Nevertheless, the world is currently nowhere close to being in a recession by this definition, since the <a href="https://www.imf.org/external/pubs/ft/weo/2016/update/01/index.htm">IMF estimates</a> that world GDP will grow by 3.4 percent in 2016 and 3.6 percent in 2017, compared with <a href="http://www.worldometers.info/world-population/">population growth</a> of barely more than 1 percent.</p>
<p><strong>2) GDP definition</strong></p>
<p>A second definition of recession is when GDP falls two quarters in a row. This definition is <a href="http://www.investopedia.com/terms/r/recession.asp">widely known</a>, often quoted in the press and more closely matches the idea of declining activity since GDP is currently the best measure of what countries and the world produce.</p>
<p>The best way to calculate the world’s actual GDP is to simply add together the quarterly GDP figures provided by every country. Unfortunately, this simple method has a number of problems. </p>
<p>First, some countries provide only yearly data, like the <a href="http://www.cbsi.com.sb/">Solomon Islands</a>, while others in the midst of civil war or strife, such as <a href="https://www.chathamhouse.org/sites/files/chathamhouse/field/field_document/20150623SyriaEconomyButter.pdf">Syria</a>, Yemen and <a href="http://www.cbl.gov.ly/ar/images/stories/bohot/bulletinQ2.pdf">Libya</a>, cannot provide any information. </p>
<p>None of these countries is a major economic power, of course, so their data woudn’t make a huge difference to the end result. But if the world is on the knife edge of being or not being in a recession, knowing what is happening economically in small countries or in war-torn areas could be the determining factor in deciding if the world overall is expanding or contracting.</p>
<p>Second, some very large countries like the U.S. and India revise their GDP figures very frequently. U.S. GDP figures are <a href="https://www.bea.gov/papers/pdf/fixler_gdp_revise.pdf">revised a minimum of three times</a> and then are periodically revised roughly every five years as better data become available. It is hard to determine if the world is in a recession if a key country’s data are constantly being modified.</p>
<p>It is doubtful the world is currently in a recession based on the two consecutive quarters of negative GDP growth definition. While the U.S.‘ most recent figure of <a href="http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm">0.7 percent</a> growth in the fourth quarter of 2015 was lower than expected, it was not negative. OECD tables that <a href="https://stats.oecd.org/index.aspx?queryid=350">track quarterly growth</a> among the largest countries show a few negative numbers in places like Brazil and Greece, but the vast majority of the world’s economies have positive values.</p>
<p><strong>3) Committee of experts</strong></p>
<p>The third method of determining if the world is in a recession is to ask a nonpartisan panel of wise men and women. Both Europe and the U.S. use this method to determine – officially – if either is in a recession.</p>
<p>In Europe, <a href="http://cepr.org/content/euro-area-business-cycle-dating-committee">nine people</a> associated with the Centre for Economic Policy Research, or CEPR, make the determination. In the U.S., an <a href="http://www.nber.org/cycles/members.html">eight-person</a> committee at the National Bureau of Economic Research, or NBER, carries out the same task.</p>
<p>Both committees comprise academics who look at a wide <a href="http://www.nber.org/cycles/general_statement.html">variety of economic data</a>. When the committee concludes (by consensus) that the economy is declining, it declares a recession; when it decides the economy has resumed expanding, it declares the end of the recession.</p>
<p>The primary problem with wise advisers is that by design there is no consistent methodology. Each recession is treated as a unique experience that is assessed using a wide variety of data.</p>
<p>The other problem is that the process is historical. Until the committee makes its declaration – usually not until long after a recession has begun – no one is really sure of the state of the world. Finally, it is much harder to do this for the world than for a country because there is a wider variety of data to consider.</p>
<p>Is the world in a recession based on the opinion of the experts? This is impossible to know since neither CEPR or the NBER makes statements ahead of any pronouncement.</p>
<h2>A new alternative definition</h2>
<p>I believe it is time for a new definition to be added to the list: a recession is when the growth of GDP per capita is negative for at least half a year. </p>
<p>This is a modification of the threshold and GDP definitions and simply means that a recession is whenever the average person’s piece of the world’s economic pie shrinks for a sustained period of time. </p>
<p>Currently, <a href="http://databank.worldbank.org/data/reports.aspx?Code=NY.GDP.PCAP.CD&id=af3ce82b&report_name=Popular_indicators&populartype=series&ispopular=y">GDP per capita</a> has been growing about 1 percent per year, after shrinking a dramatic 6 percent during the 2008-09 economic downturn.</p>
<p>I prefer this new definition because it is useful not only when population is rising but also useful in places like Japan and Eastern Europe where <a href="http://esa.un.org/unpd/wpp/Publications/Files/World_Population_2015_Wallchart.pdf">population is or will be falling</a>. </p>
<p>While not all GDP and population data can be <a href="http://blogs.wsj.com/chinarealtime/2016/01/27/china-gdp-growth-could-be-as-low-as-4-3-chinese-professor-says/">trusted completely</a>, it is important to handle both rising and falling populations. Classifying a country that experiences a 1 percent decline in GDP when population falls by 3 percent as “in a recession” does not make sense for the reasons explained above. </p>
<h2>What can be done?</h2>
<p>There are numerous international treaties and organizations designed to coordinate <a href="https://www.wto.org/">world trade</a>, <a href="http://www.nato.int/">defense</a> and <a href="http://www.who.int/en/">global health</a>. </p>
<p>However, presently there is no organization that has the mandate to define, determine or coordinate a response to an international recession. The lack of a responsible organization is a huge problem since global recessions affect all of us. </p>
<p>Whatever definition is chosen, it needs to be simple enough to be widely understood, be easy to make accurate forecasts and handle countries that have declining populations as well as rising ones.</p>
<p>I don’t believe the world is presently in a recession, based on my preferred method. Nevertheless, sooner or later the world will experience another economic downturn. When this happens we cannot hope that an individual country changing its economic policies will cure a global problem. </p>
<p>Instead, today we need an international organization to define and declare global recessions and marshal a global response to return the world to prosperity.</p><img src="https://counter.theconversation.com/content/53941/count.gif" alt="The Conversation" width="1" height="1" />
Stock markets have been falling all year on concern the world risks slipping into a recession, which begs the question: how would we know if we were in one?Jay L. Zagorsky, Economist and Research Scientist, The Ohio State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/535672016-01-28T02:23:16Z2016-01-28T02:23:16ZChina’s greatest challenge will be escaping the middle income trap<p>China’s <a href="https://theconversation.com/chinas-6-9-gdp-growth-rate-is-not-the-hard-landing-feared-and-australia-can-benefit-53370">slower growth figures</a> have caused jitters in world financial markets. Nevertheless its growth remains at miracle levels. At this pace, China would appear to remain on track to become the richest and most powerful country in the world, bar none. </p>
<p>In a scenario where Chinese “miracle” growth continues around 5-6% for three decades and gradually slows to the average world growth rate, the average Chinese citizen would be as wealthy as the average American. </p>
<p>But ongoing Chinese growth miracle seems an unlikely outcome, when compared to the history of emerging economies. Instead, it is likely China will have to grapple with what is called the “middle income trap”. This is because China’s income level is currently at a level where many countries seem to stagnate.</p>
<h2>The middle income trap</h2>
<p>An example of this can be seen in the figure which charts per capita income for China, Turkey and Brazil as a percentage of the United States. It shows that, despite its remarkable growth, China’s income gap with the US has only reached the level that Brazil and Turkey had already achieved by the 1970s. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=436&fit=crop&dpr=1 600w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=436&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=436&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=548&fit=crop&dpr=1 754w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=548&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=548&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>Moreover it can be seen that, since the 1970s, Brazil and Turkey made practically no further ground in closing the gap with the US. </p>
<p>According to a 2012 <a href="http://documents.worldbank.org/curated/en/2013/03/17494829/china-2030-building-modern-harmonious-creative-society">World Bank</a> report, this slow growth pattern is typical of middle income countries. Specifically, of 101 countries that were “middle income” in 1960, only 13 broke through the middle income band to become rich countries. </p>
<p>Thus, based on history there is a reasonable concern that China’s growth will slow to an extent that it stops catching up with the West. China would then begin to look like like Brazil or Turkey in the sense that per capita income remains well below Western levels and there is a constant threat of political and economic instability. </p>
<h2>Causes of the middle income trap</h2>
<p>Unfortunately we don’t know very much at all about why there appears to be a middle income trap.</p>
<p>The authors of the <a href="http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICEXT/0,,contentMDK:21056110%7EpagePK:146736%7EpiPK:146830%7EtheSitePK:226301,00.html">World Bank study</a> who coined the term suggested it was due to rising wage costs that make exports less competitive. </p>
<p>It is true that wage increases can hurt some export sectors, but market forces prevent this happening for the economy as a whole. Thus wage growth cannot reduce an economy’s overall competitiveness. </p>
<p>Other explanations suggest the middle income trap results from too much investment in physical infrastructure at the expense of education and skills. Alternatively it could be a result of political failure.</p>
<p>But these are only descriptions of the symptoms – they don’t tell why so many countries have political failures or why so many countries over-invest in physical capital. </p>
<p>So while there are many descriptions of the middle income trap, there is no clear theory and hence there are no testable propositions. It remains an elusive statistical fact.</p>
<h2>Traps versus bad luck and bad policy</h2>
<p>The lack of a clear view about the causes of a middle income trap makes it difficult to know whether it is a pattern likely to continue in the future. In a recent <a href="https://www.researchgate.net/profile/Peter_Robertson3/publication/256050484_On_the_Existence_of_a_Middle_Income_Trap/links/55de944e08ae45e825d3a173.pdf">study</a>, therefore, we tried to get a better sense of the predictability of a middle income trap from a purely statistical viewpoint. </p>
<p>For example if, for any reason, a country was unable to change its growth rate, the growth rate would exhibit persistence over time. That is, if things got better by chance one year, there would be some market or political force that brings things back to trend. </p>
<p>Alternatively if some countries simply had a run of bad luck, or made some big policy mistakes, there may be little persistence in the data. The growth rate might display some randomness from one year to the next. </p>
<p>We therefore tested to see whether we could reject the hypothesis that the path of per capita income had followed a random trend for 47 middle income countries.</p>
<p>Thus in the previous figure one can see that there is apparently very little difference in the trend path of Brazil and Turkey – they have similar growth rates and growth variance. But, in fact, the statistical tests show that Turkey’s growth rate has persistence, but Brazil’s growth rate is random.</p>
<p>So despite the visual similarity, Brazil and Turkey have very different statistical properties.</p>
<p>We found that only seven countries show evidence of a persistent trend toward staying stuck in the middle like Turkey. </p>
<p>Of the rest of the countries, half had a trend that was random like Brazil. For most countries there was no evidence of a persistent trend toward the middle income band. </p>
<p>So only very few countries’ per capita income time paths are consistent with the pattern that we would expect to see if they were constrained to their current relative income level.</p>
<p>Although these results are descriptive, they could be taken as evidence against a structural reason for a middle income trap. That is, perhaps what appears to be a pattern of behaviour across many countries, is just the way things panned out. </p>
<p>So despite the bleak historical record, maybe good statesmanship, market friendly policies and bit of luck are all that is needed to sustain growth.</p>
<p>For China therefore, as a middle income country, the historical odds are against replicating the Japanese or South Korean economic miracle. Thankfully, however, the past need not be a good predictor of the future.</p><img src="https://counter.theconversation.com/content/53567/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Robertson receives funding from The Australian Research Council. </span></em></p><p class="fine-print"><em><span>Longfeng Ye does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The history of middle incomes countries shows China’s “miracle growth” probably won’t continue.Peter Robertson, Professor, The University of Western AustraliaLongfeng Ye, Assistant researcher, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/472552015-09-11T03:39:13Z2015-09-11T03:39:13ZData indicates the recession is effectively here; it’s what policy makers do next that counts<p>The latest economic figures released by the Australian Bureau of Statistics (<a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/5206.0/">ABS</a>) have fuelled the debate on the future of the Australian economy and prompted many to ask: “Will Australia go into a recession?” </p>
<p>This question is legitimate, but off the mark. In fact, the data tells us that we should not be worried about going into recession. </p>
<p>What we should worry about instead is how to get out of the recession. Because, like it or not, the recession is already here and the sooner we acknowledge the problem, the sooner we can start the recovery.</p>
<h2>So, what does the data say?</h2>
<p>According to ABS, trend Gross Domestic Product (GDP) growth in Australia in the second quarter of 2015 was 0.5%. This was only marginally below the rate observed in the first quarter of the year (0.6%). The implied annual growth rate of GDP is therefore around 2%.</p>
<p>While considerably below the long-term average of 3.25% a year, trend growth is still positive, which means that Australia is not technically in a recession.</p>
<p>Economists technically define a recession as a period of at least two consecutive quarters of negative GDP growth. This occurs rarely in an advanced economy like Australia.</p>
<p>The last time Australia was technically in recession was 24 years ago, when trend growth turned negative in the third quarter of 1990 and did not go back to positive until quarter four of 1991.</p>
<p>Before then, trend growth was negative for five quarters between 1982 and 1983, for two quarters in the middle of 1974, and for four quarters between 1960 and 1961. </p>
<p>However, while not being technically in a recession, Australia today shows most of the symptoms of recession.</p>
<h2>Reload: what does the data say?</h2>
<p>First of all, trend GDP is by construction smoothed. However, recessions (and expansions) are cyclical phenomena that are better represented by seasonally adjusted GDP.</p>
<p>In the second quarter of 2015, seasonally adjusted GDP in Australia grew by a mere 0.2%, sharply down from the first quarter when it grew by 0.9%. That is, seasonally adjusted data suggests that the country is much closer to the beginning of a technical recession.</p>
<p>Second, seasonally adjusted Gross Domestic Income (GDI) showed negative growth of -0.4%. This is particularly worrying because GDI is statistically <a href="https://theconversation.com/the-true-state-of-queenslands-economy-without-the-spin-35959">more reliable</a> than GDP as a predictor of the cyclical fluctuations of the economy. </p>
<p>Third, and probably even more importantly, indicators of an individual’s welfare are taking a turn for the worse. The second quarter of the year saw negative growth in GDP per capita (-0.2%) and net national disposable income per capita (-1.2%). </p>
<p>These negative income dynamics add to persistently weak labour market performance. </p>
<p>The <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/6202.0Main+Features1Aug%202015?OpenDocument">ABS labour force survey</a> shows that seasonally adjusted unemployment reached 795,500 units in July 2015. This is the highest level since November 1994 and approximately 125,000 units higher than at the peak of the global financial crisis (June 2009). The corresponding unemployment rate was 6.3%.</p>
<p>In the same month of July 2015, youth unemployment increased to 13.8%. This was the first monthly increase since the beginning of the year. </p>
<p>Perhaps this is not technically a recession, but certainly it looks, smells and feels a lot like one. </p>
<h2>Intervention needed</h2>
<p>The government, however, seems to be in denial. </p>
<p>Finance Minister Mathias Cormann is <a href="http://www.news.com.au/finance/economy/australias-economy-has-slowed-to-a-crawl-prompting-fears-we-may-be-slipping-into-a-recession/story-fnu2pwk8-1227511065914">reportedly</a> “very optimistic about the outlook moving forward”. Treasurer Joe Hockey <a href="http://www.news.com.au/finance/economy/australias-economy-has-slowed-to-a-crawl-prompting-fears-we-may-be-slipping-into-a-recession/story-fnu2pwk8-1227511065914">recently said</a> that “the Australian economy is showing a deep resilience that people in Canada and elsewhere would die for.”</p>
<p>Unfortunately, the fact that Canada is in a technical recession and other resource-intensive countries are suffering from falls in commodity prices does not make the situation of Australia any better.</p>
<p>Conversely, the business sector seems to have understood the reality of the situation. This is evident, for instance, in the declining levels of business confidence and conditions reported by the <a href="http://business.nab.com.au/nab-monthly-business-survey-july-2015-12396/">NAB Monthly Business Survey of July 2015</a>. </p>
<p>The good thing about recessions is that, generally, they end. The bad thing, instead, is that their effects are felt proportionally more by households at the bottom end of income distribution. </p>
<p>Another bad thing is that the consequences of a recession (in terms of unemployment and reduced welfare, for instance) tend to outlive the recession itself. </p>
<p>For all these reasons, some form of intervention would be desirable; but how?</p>
<p>In Australia’s case, the <a href="http://www.sciencedirect.com/science/article/pii/S0313592615300242">empirical evidence</a> clearly indicates that fiscal stimulus works: for each dollar spent by the government, GDP increases by more than one dollar. </p>
<p>In fact, already now, what has prevented the country from recording negative GDP growth is good old Keynesian spending. </p>
<p>Government final consumption grew by 2.2% in the second quarter of the year and 4% since the beginning of the year. Public gross fixed capital formation increased by 4% in the second quarter. </p>
<p>Without this extra public spending Australia would probably have experienced its first quarter of negative growth.</p>
<p>Certainly, Australia also has structural problems that condition its longer-term performance and that a fiscal stimulus will not solve. But the stimulus will improve the short-term outlook, restore confidence and create favourable socioeconomic conditions to undertake structural reforms.</p>
<p>To get there, however, an initial step is required: the government must get past its denial of the problem. Let’s hope that this happens sooner rather than later.</p><img src="https://counter.theconversation.com/content/47255/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Fabrizio Carmignani receives funding from the Australian Research Council for a project on the estimation of the piecewise linear continuous model and its applications in macroeconomics.</span></em></p>Technically, Australia isn’t in recession; but data shows we are effectively in a situation of negative growth.Fabrizio Carmignani, Professor, Griffith Business School , Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/470362015-09-03T20:06:31Z2015-09-03T20:06:31ZAustralia’s economy is slowing: what you need to know<p>Australia’s economy grew by just 0.2% in the June quarter, below expectations of 0.4%, largely as a result of reduced mining and construction activity and a decline in exports of 3% during the quarter. </p>
<p>Nominal Gross Domestic Product grew by 1.8% during the year, which the <a href="http://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/5206.0Main%20Features2Jun%202015">Australian Bureau of Statistics said</a> was “the weakest growth in nominal GDP since 1961-62”. Despite this, Australia has now recorded 24 straight years of growth. </p>
<p>The news has some analysts and economists spooked, and politicians blaming each other for the slowdown.</p>
<p>Treasurer Joe Hockey said:</p>
<blockquote>
<p>At a time when other commodity based economies like Canada and Brazil are in recession, the Australian economy is continuing to grow at a rate that meets and sometimes beats our most recent budget forecasts.</p>
</blockquote>
<p>He also said it was “factually wrong” to say it was the weakest growth since 1961.</p>
<blockquote>
<p>The fact is that the economic growth we had in the last quarter was in line with expectations. Of course it bounces around from quarter to quarter, but it was in line with our overarching expectation to have two and a half per cent growth in the last financial year.</p>
</blockquote>
<p>Shadow Treasurer Chris Bowen said:</p>
<blockquote>
<p>Growth has flat-lined since the Abbott government’s first damaging budget last year and cost of living pressures are continuing to increase. This is the biggest quarterly decline in living standards since the global financial crisis.</p>
<p>This is a very weak set of figures and for the government to cast around for international comparisons to try and make it sound better is a pretty pathetic excuse.</p>
</blockquote>
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<p><strong>The Treasurer says Australia is still doing better than Canada, Brazil, the US and New Zealand. How should people view these numbers in a global context? To what extent is the slowing rate of growth due to global economic headwinds, and to what extent is it due to domestic factors?</strong></p>
<p><em>Griffith Business School Professor Fabrizio Carmignani answers:</em></p>
<p>In the past, the Australian economy has proved to be quite resilient to global economic shocks. Today we are facing what could be potentially a perfect storm. </p>
<p>For one thing, international commodities prices are very volatile and have resulted in a sharp contraction of Australian’s terms of trade. For another, China is going through a complicated economic phase and it is not, at this moment, the same solid anchor for the Australian economy as it might have been previously. So, it is not surprising to see that on a seasonally adjusted basis, quarterly growth in Australia has been oscillating between 0.2% and 0.3% for the last five quarters. </p>
<p>We owe it to some good old Keynesian stimulus on the demand side (read: government consumption and to a lesser extent public gross fixed capital formation) if we are not entering a technical recession.</p>
<p>The comparison with Canada, on surface, is favourable to Australia. Canada has officially entered a recession after recording two consecutive quarters of negative GDP growth in the first half of 2015. This is essentially due to low oil prices. However, according to media reports, Canada is still committed to achieving a target of annual growth of 2.5% this year, which is exactly what the Treasurer has stated for Australia. So, it seems to me that the difference between Australia and Canada here is thinner that what might appear at first sight. A fraction of a percentage point below or above the zero growth line is not really indicative of substantially different structural positions. </p>
<p>Both Australia and Canada are facing similar challenges in terms of diversification. The current “crisis” to me shows that these challenges are still far from being fully addressed in both countries. </p>
<p><strong>Australia has had 24 years of consistent growth. How much of this can we attribute to the mining boom? And given the cyclical nature of the economy, can we expect a downturn?</strong></p>
<p><em>Griffith University Professor Tony Makin answers:</em></p>
<p>Australia has performed relatively well compared to other OECD economies over recent decades, though did actually experience a recession during the GFC according to income and production measures of GDP. </p>
<p>Taking population growth into account, Australia’s economic performance since the global financial crisis has been worse than the raw GDP numbers show. On a per capita basis, national income has grown on average below one per cent per annum, less than half the almost two and a half per cent per head per annum average rate in the decade before the GFC.</p>
<p>The extraordinary boost to the terms of trade from the world commodity price hike, especially between 2005 and 2011, substantially raised Australia’s international purchasing power. However, GDP growth during the mining boom was actually less than during the economic reform era from the mid-1980s through to the end of the 1990s when commodity prices were fairly flat. </p>
<p>The main culprit for Australia’s sub-normal economic growth in recent years has not been falling commodity prices, which have undoubtedly played a role, but Australia’s underlying competitiveness problem, combined with a productivity slowdown that began from the turn of the century. </p>
<p>While the recent depreciation of the dollar will go some way to restoring Australia’s competitiveness and help stave off recession, genuine productivity-enhancing reform focusing on the economy’s supply side remains as important as ever for returning GDP and income per head growth to long-term average rates. </p>
<p><strong>One journalist at Wednesday’s press conference said the new data showed “the weakest growth since 1961”, but the Treasurer said that was factually wrong. Who is right?</strong></p>
<p><em>UNSW Australia Professor Richard Holden answers:</em></p>
<p>The statement that it is the slowest growth since 1961 seems, to me, to be false. We have had recessions in the 1990s and 1980s, which is two successive quarters of negative growth. And yesterday we had positive growth, so it was a slowdown but not the worst we have seen since 1961. I think the journalist’s statement doesn’t seem correct to me, on the face of it. I think the Treasurer is right.</p>
<p>It is possible the journalist was referring to the Australian Bureau of Statistics comment yesterday that:</p>
<blockquote>
<p>GDP growth for 2014-15 was 2.4%. Nominal GDP growth was 1.8% for the 2014-15 financial year. This is the weakest growth in nominal GDP since 1961-62.</p>
</blockquote>
<p>Nominal growth and growth are not quite the same thing. <a href="http://www.businessinsider.com.au/australias-economy-just-posted-its-worst-nominal-growth-since-1962-2015-9">Nominal growth</a> means GDP growth that is not adjusted for inflation.</p>
<p>But yes, yesterday’s numbers are still below projected growth. It is below market expectations. I think the Treasurer saying we have projected 2.5% annual growth this year and this is basically on target is a bit disingenuous. This is slow growth, it’s actually very troubling.</p>
<p>I understand the Treasurer can’t talk down the economy so his comments are understandable and he is in a difficult position. But the low rate of growth is genuine cause for concern. </p>
<p>I have <a href="https://theconversation.com/forget-about-a-currency-war-well-have-bigger-worries-off-a-weaker-yuan-46072">written before</a> about the concept of secular stagnation, which is the idea that growth of advanced economies looks like it has slowed down dramatically. The figures yesterday are further evidence of that theory.</p>
<p><em>Victoria University Senior Research Fellow Janine Dixon answers:</em></p>
<p>While it is factually correct that real GDP – the volume of production in the economy – has grown, the low growth in nominal GDP points to an underlying weakness in the economy. This is our exposure to the very large fall in commodity prices. When we translate real GDP into real income, we take into account that fact that the prices of the things we produce for export have fallen relative to the prices of the things we consume, some of which are imported. This has been a very important determinant of real incomes in the last few years.</p>
<p>Real net national disposable income is a better measure of our living standards than GDP. As well as adjusting for prices, we take into account the fact that some of the income generated domestically actually accrues to the rest of the world if the factors of production are foreign owned. We also deduct the value of capital that is “used up” or depreciated during the year. </p>
<p>Real net national disposable income per person has now failed to grow for 14 quarters in a row. This represents the most sustained fall in standards of living in the last 50 years.</p>
<p>What’s especially interesting about this period is that falling incomes have not been associated with falling output or particularly high unemployment. In the 1990-91 recession (the one we had to have) or the early 1980’s, incomes fell, but the solution to the problem was fairly clear. More than 10% of the workforce was unemployed. Fixing unemployment would boost production, incomes and living standards.</p>
<p>This time around, incomes are falling because commodity prices are falling. Commodity prices, set on world markets, are largely out of our hands. The labour market is much more flexible these days, and unemployment is 6%, not 10%. We are left with just one way to turn things around. In the words of Nobel laureate Paul Krugman, “Productivity isn’t everything, but in the long run it is almost everything”.</p>
<p><strong>Is GDP really in line with expectations, both of the government and the market?</strong></p>
<p><em>Griffith University Professor Ross Guest answers:</em></p>
<p>These GDP expectations are continuously being revised down as new information comes to hand.</p>
<p>The projected growth is lower than nearly everybody expected and everybody is having to revise downward their expectation. </p>
<p><strong>What will the slowing annual growth mean for the federal budget, which had forecast growth for 2015-16 of 2.75%?</strong></p>
<p><em>Ross Guest answers:</em></p>
<p>If growth were to remain at its current level of 2%, the budget deficit would be A$15 billion larger, in ball park terms, than the government projected. To put that in perspective, the total amount we spend on unemployment benefits is A$10 billion.</p>
<p>Australia living standards and the Australian government budget are being hit by a perfect storm of lower commodity prices and lower productivity growth.</p>
<p><em>Victoria University Senior Research Fellow Janine Dixon answers:</em></p>
<p>The GDP growth forecast for 2015-16 is fairly subdued at 2.75% and the budget not overly ambitious – a deficit of 2% of GDP. The trouble lies in 2016/17 and beyond, when annual GDP growth is forecast to be above 3%.</p>
<p>Over the next five years a couple of downside risks exist that will make it unlikely that GDP will grow this strongly, and consequently the budget’s return to surplus will be more difficult to achieve.</p>
<p>If the terms of trade fall further than allowed for in the budget forecasts, and if productivity growth remains weak, as it has been in recent years, real national income could be 3% lower than forecast by 2020. Roughly, this means the tax base for the government will be 3% smaller than expected. Rather than having a balanced budget by 2020, we would still be running a deficit, of around 0.75% of GDP or $12 billion in today’s terms.</p><img src="https://counter.theconversation.com/content/47036/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden is an ARC Future Fellow. </span></em></p><p class="fine-print"><em><span>Fabrizio Carmignani receives funding from the Australian Research Council for a project on the estimation of the multivariate piecewise linear continuous model and its applications in macroeconomics.</span></em></p><p class="fine-print"><em><span>Ross Guest has received ARC funding in the past.</span></em></p><p class="fine-print"><em><span>Tony Makin is affiliated with the Centre for Independent Studies and has previously consulted for the Minerals Council of Australia.</span></em></p><p class="fine-print"><em><span>Janine Dixon does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Australia has had 24 years of consistent growth. Is it all about to come to a crashing end?Richard Holden, Professor of Economics, UNSW SydneyFabrizio Carmignani, Professor, Griffith Business School , Griffith UniversityJanine Dixon, Senior research fellow, Victoria UniversityRoss Guest, Professor of Economics and National Senior Teaching Fellow, Griffith UniversityTony Makin, Professor of Economics, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/443112015-07-09T05:24:06Z2015-07-09T05:24:06ZBudget 2015: will Osborne’s medicine be a driver for productivity and growth?<figure><img src="https://images.theconversation.com/files/87828/original/image-20150708-31563-1sgng9q.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Did Osborne provide a spark for productivity?</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/usairforce/4484170039/in/photolist-gwFPHH-4RUZRt-bDivUp-adoExP-6pvit1-7cisH-kzyuFM-km5jxp-9ZpbQk-hYcuBE-ippaMv-4Z6SVT-77YefF-dBnie2-dBniXe-iyb4sD-diGHcx-e3PyEe-e3Vm1s-7Qfxwx-9et5oZ-4Zb8ij-tmTefU-tn4woR-uiUwst-u2snjk-uj6b1a-uiUw5e-tn48rD-tmSK9o-ugyNqd-uj5GD6-tmSNPj-uiv657-uj5Gui-uj5KNn-uiU1kK-u2rWP8-u2iHnU-uj5F8R-uiuZZC">US Air Force</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>The most eye-catching announcement in today’s budget was the <a href="https://theconversation.com/budget-2015-living-wage-offers-rabbit-out-the-hat-but-magic-will-be-needed-later-44372">National Living Wage</a>. Now, this might be nothing more than a big hike in the minimum wage, but such increases <a href="http://cep.lse.ac.uk/pubs/download/cp290.pdf">can be beneficial</a>. There remains though a justified fear that this 11% increase decided by political fiat rather than careful independent consideration <a href="http://www.ft.com/cms/s/0/2e70ee20-255a-11e5-bd83-71cb60e8f08c.html#axzz3fCI0XMRQ">will result in job losses</a> – and is not the ideal way to address the fundamental issue at hand. </p>
<p>Productivity growth (the increase in GDP per hour) is a necessary condition for sustainable wage growth. Britain’s number one economic problem is that productivity levels are still about 15% below what we would have expected based on long-run trends <a href="http://cep.lse.ac.uk/pubs/download/ea021.pdf">prior to the global financial crisis</a> and real wages are <a href="http://cep.lse.ac.uk/pubs/download/ea024.pdf">some 20% lower than trend</a>. In the most recent data, GDP per hour is around 30% lower than France, Germany and the US.</p>
<p>Back in <a href="https://theconversation.com/budget-2015-experts-respond-38997">the March budget</a>, this poor productivity performance strangely slipped the chancellor’s mind, but since the election he has emphasised the need to act. The Treasury will publish a productivity plan on Friday and today’s speech gave us some hints of its key features. </p>
<h2>Skills, infrastructure, decentralisation</h2>
<p>Human capital is the <a href="http://cep.lse.ac.uk/textonly/people/vanreenen/papers/sianesi_published.pdf">driver par excellence of productivity growth</a> and the UK has a well-known weakness in intermediate skills compared to many continental European countries. One unexpected announcement is that there will be a further expansion of apprenticeships funded by a levy on larger firms. This move should be used to engage employers more in the system and channel resources into higher-quality placements for young people.</p>
<p>The expansion of higher education over the past 30 years has been successful and helped productivity. When student fees tripled there was <a href="http://cep.lse.ac.uk/pubs/download/ea026.pdf">no fall in the participation of low-income students</a>. So the replacement of maintenance grants for low-income students with loans is worrying on grounds of equity and efficiency.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/87831/original/image-20150708-31567-n8arpn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Bricks and mortar boards.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/nottinghamtrentuni/3327846297/in/photolist-6555Li-fcmApa-gsfnC-55aD2j-aJiawv-fcmB36-fcAVGd-fcATpW-9FwFow-6FQLCH-fcAWjE-gsh3A-6FUSvo-gsc4C-gsbMo-gscnk-gsbtK-gsbeR-gsfLK-gsfUA-9YfPLc-gsgUa-6M54Zo-p9JLpg-7V6gT7-aJ98Dg-6GjzXP-2Y7w5-9hCokd-fcAS3W-bSyypB-787QzZ-fcASKd-4mpNYX-6GhWbx-bnNnCa-kf85Er-71hgpD-oSwsup-6Gn1a5-6hSMS-8mvLCq-em88Mj-6269sC-5AZiu-dqNkR-7aFDx3-5nK1fg-9G8Euu-9G8EeW">Nottingham Trent University</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>On infrastructure, there is to be more of a commitment to roads, but no mention of <a href="http://www.bbc.co.uk/news/business-33270586">other forms of transport such as rail</a> – the delaying of many highly important projects including electrification of the Trans-Pennine Express is worrying – or indeed other types of infrastructure such as energy and communications, all of which require investment to match the standards of our international peers. And let’s not even mention <a href="https://www.gov.uk/government/organisations/airports-commission">Heathrow</a>.</p>
<h2>Investment obstacle</h2>
<p>Escalating house prices mean that investing in property is often far more appealing than investing in business capital. The chancellor has sought to slightly dampen buy-to-let incentives with less generous tax relief on interest payments. But this will have little effect given the panoply of voter-friendly policies which drive up demand. The announcements on more generous inheritance tax rules simply add to these problems. What we need are policies to drive up supply and <a href="http://cep.lse.ac.uk/pubs/download/ea033.pdf">tackle the affordability crisis</a>.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=484&fit=crop&dpr=1 600w, https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=484&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=484&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=608&fit=crop&dpr=1 754w, https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=608&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/87833/original/image-20150708-31577-1hhgx72.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=608&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">A plague on none of your houses.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/antsmith/8062499088/in/photolist-dhsq5Y-8F4BYW-bSXPg-eHLaeW-6LoW5g-6LLxQA-eFXMG7-dmvt4z-eFas9s-eFasr5-bvAgxH-9Rk8yV-nLYvMR-68gv1A-68cgBF-6Q1xAg-bvAfC2-b6HZ6p-dx7QvS-7o68AF-vqNKh-qTsrwn-GNWes-eiVi36-eiVdGB-ej215h-eiVemK-eiVcPt-eFRDoK-jGtGkg-qscmH4-eHE9vt-eHL7gC-eHE7fn-eHE5d8-eHE4ST-eHL9Dj-eHE6c2-eHE5RD-7rVCuS-AF8CB-eHE9cv-eHE6TV-eHL9jj-eHL8fd-aJH5Y8-aZHA7r-nPf96-ek87Jr-ek87Av">Ant Smith</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>The chancellor plans to devolve more decision making to city regions. Potentially this could unblock local opposition to development by giving local politicians more incentives to overcome “nimbyism”. The issue is whether the “Northern Powerhouse” can move beyond a slogan and beyond Greater Manchester. With my fellow <a href="http://www.citygrowthcommission.com/wp-content/uploads/2014/10/City-Growth-Commission-Final-Report.pdf">City Growth Commissioner</a>, Jim O’Neill, now a Treasury minister there is some cause for cautious optimism.</p>
<h2>Further austerity</h2>
<p>The chancellor has delayed the date for reaching a budget surplus by one year (to 2019-20). This will smooth the “roller-coaster” ride of public finances rightly <a href="http://cep.lse.ac.uk/pubs/download/ea034_executive_summary.pdf">criticised by the Office of Budget Responsibility</a>. Premature fiscal consolidation – especially in 2010-12 – was an important drag on growth and productivity, so the tweak to the timeline is to be welcomed. </p>
<p>Large cuts to in-work benefits are the big-ticket item as the chancellor looks for his £12 billion of welfare cuts. The hope that this will raise wages is forlorn – the evidence is rather that tax credits are an effective way to reduce poverty and unemployment. </p>
<p>The vision of the government is to bring down public spending to lower levels than we have seen for most of the post-war period, with the belief that shrinking state’s size will boost growth. Unfortunately, there is no clear evidence that differences in the amount of public spending as a fraction of GDP (in the range that we see normally see in OECD countries) has a <a href="http://www.lse.ac.uk/researchAndExpertise/units/growthCommission/documents/pdf/LSEGC-Report.pdf">robust relationship with growth</a>. </p>
<p>The main issue is what form the public spending takes (in terms of investment vs consumption) rather than its absolute level. The implied caps on public investment implied by legislating for surpluses during “normal times” are more likely to depress than stimulate growth.</p>
<p>Osborne is right to want to raise wages, but the best way to do this while maintaining employment is through concrete plans to raise productivity. It is ironic that his dirigiste plan is to push up wages by regulation. This will give political cover for the withdrawal of in-work tax credits, but it might come at the expense of low-paid jobs. We do not want to artificially increase productivity by forcing the less skilled out of jobs, so only the more productive are counted in the statistics.</p><img src="https://counter.theconversation.com/content/44311/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Van Reenen receives funding from Economic and Social Research Council</span></em></p>A living wage grabs the headlines, but sluggish productivity is a harder nut to crack than that.John Van Reenen, Director, Centre for Economic Performance, London School of Economics and Political ScienceLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/372202015-02-05T19:36:51Z2015-02-05T19:36:51ZHow to multiply the rate cut impact and unshackle the economy<p>This week’s Reserve Bank interest rate move surprised virtually everyone, bringing the cash rate to 2.25%, yet another historic low.</p>
<p>Despite Australian Treasurer Joe Hockey suggesting the rate cut means “the shackles are off the Australian economy,” the cut is unlikely on its own to kick Australia’s GDP growth rate back to trend level. But with a little help from friends offshore and a light touch from APRA, the rate cut just might work.</p>
<p>Let us review for a moment how a lower cash rate can boost the economy – the so-called “transmission channels” for monetary policy. There are three. First, rate cuts change asset prices, including foreign exchange rates. Second, rate cuts should reduce the cost of capital, all else being equal. Third, rate cuts should increase the availability of credit from banks’ balance sheets. All three elements are important considerations in yesterday’s move.</p>
<p>Asset prices moved according to expectations, with the ASX rallying 1.4% on the news. The main game, however, was the exchange rate.</p>
<h2>Pushing the dollar down</h2>
<p>Many commentators have focused their attention on the AUD-USD exchange rate, which fell by 1.5 cents immediately after the rate cut. Was this the RBA’s main target? The AUD had already depreciated significantly against the US dollar, with the AUD-USD as of 2 February already 15% below its average over the first half of 2014. At AUD/USD0.7769 as of 2 February, the benchmark rate of exchange was very near the level that RBA Governor Glenn Stevens had indicated was desirable.</p>
<p>What had not moved perhaps as much as the RBA might have liked was the trade-weighted index, which measures the AUD against a basket of the exchange rates of our major trading partners. The TWI had declined only 10% relative to its average rate across the first half of 2014, making the AUD the unwilling strong man in a world of “currency wars” depreciation. The ECB’s decision in late January to engage in its own version of quantitative easing - which sent the AUD back up above the AUD-EUR0.70 level, may have been one of the straws that broke the camel’s back and contributed to this early rate decision.</p>
<p>As of Tuesday, the TWI had dropped to below 63 for the first time since July 2009. This is welcome relief. But it can only last so long as other major central banks outside the US co-operate by avoiding further easing of their own.</p>
<p>What is likely to prove more important - and more durable - is a lower cost of capital and the potential to spur investment through greater availability of banking credit to the economy. Here, too, the RBA needs help – from the Abbott government and APRA.</p>
<h2>Getting credit flowing to business</h2>
<p>There is not a great deal of evidence to date that a lower cost of capital – with a historically low 2.5% cash rate already in place for a year – has induced an increase in investment in the Australian economy outside the property sector. Capital expenditure by firms has been largely limited to the resources sector, and is now petering out. </p>
<p>The household savings rate remains high, while the debt-to-asset ratio has fallen. This suggests households are electing to increase their equity in current investments rather than using leverage to expand their investment portfolios.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=553&fit=crop&dpr=1 600w, https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=553&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=553&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=695&fit=crop&dpr=1 754w, https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=695&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/71164/original/image-20150205-28601-3e6u3t.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=695&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<p>Within the property sector, credit continues to grow at a relatively rapid pace, with <a href="https://theconversation.com/infographic-how-exposed-are-australian-banks-30272">credit growth</a> for investment properties far outpacing the expansion of credit for other purposes - whether household or business. In 2014, credit to purchase investment properties appears to have accounted for about 35% of all new credit creation in the economy. No wonder critics worry that the RBA’s rate cut has the potential to stoke excessive leverage in the property market.</p>
<p>The question becomes whether there are other triggers that can be pulled to encourage more credit to flow into other types of investment in the Australian economy. Ideally, that would be a renewed expansion of business credit to support increased capital expenditure, and eventually business activity and employment.</p>
<figure class="align-left zoomable">
<a href="https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=523&fit=crop&dpr=1 600w, https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=523&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=523&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=658&fit=crop&dpr=1 754w, https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=658&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/71165/original/image-20150205-28578-egik59.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=658&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<p>The RBA cannot dictate that looser monetary policy be directed toward the business sector. But the Abbott government and APRA have in hand the tool to provide a not-so-gentle nudge.</p>
<h2>Will the government act on Murray’s advice?</h2>
<p>We are merely weeks away from the deadline for final feedback to the <a href="http://fsi.gov.au/">Financial System Inquiry</a>, led by David Murray. A key recommendation of the inquiry was to raise banks’ average internal ratings-based risk weights on mortgages to narrow the difference between the mortgage risk weights used by authorised deposit-taking institutions and the “standard” risk weights used by other institutions.</p>
<p>In shorthand, this recommendation would force the Big 4 banks to hold more capital against their mortgage books, making the mortgage-writing business relatively more expensive (and less attractive) from a capital perspective.</p>
<p>This recommendation makes sense. The post-2008 boom in investment property has been driven in part by investor demand – but also in part by the Big 4 banks being willing underwriters of residential real estate. This willingness has in turn been driven, at least in part, by the regulatory setting that makes mortgages one of the least capital-intensive – and therefore cheapest to produce – lending products in the Australian market.</p>
<p>Reducing this regulatory incentive to lend into the property market holds the potential to increase the appetite among the Big 4 for other types of lending, including business credit. It is a reform that the Abbott government and APRA can hang their hat on in 2015.</p><img src="https://counter.theconversation.com/content/37220/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Amy Auster does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>This week’s Reserve Bank interest rate move surprised virtually everyone, bringing the cash rate to 2.25%, yet another historic low. Despite Australian Treasurer Joe Hockey suggesting the rate cut means…Amy Auster, Deputy Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/343312014-11-18T13:44:23Z2014-11-18T13:44:23ZHard Evidence: are we facing another financial crisis?<figure><img src="https://images.theconversation.com/files/64832/original/xw6bv3zr-1416308033.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Cutting a dash. A 1957 Chevrolet</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/myoldpostcards/4229266345/in/photolist-7Vhu43-7rJ6xg-7oZyCT-7855oW-8aDW6P-8evM1p-6LG1iY-8C1iSM-8C1iwr-6R6LMt-7ZBPC9-7cDmCU-89PC1C-6Sppae-8chVUR-8aYtFE-781aPe-8zTK5V-8zTJHZ-6avAoG-8bhPeb-74PjY2-89PCwY-7mGhx8-6MtJBm-74Td3s-68MXMJ-7ewvrm-7VMDW1-8cmhbU-7jNiWi-7jSbuJ-8cNZ3k-7jgLrv-7jgMhx-7mGhpM-7a7NZf-7rJ7TF-7rJ7ev-6MpwhX-8imURZ-7X2AbR-6R6MD4-7cdJhY-8ez4BE-8iqaHG-65ifch-7c9SZ6-7NK5xi-4DtdMp">Randy von Liski</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>Taken at face value, David Cameron’s <a href="http://www.theguardian.com/commentisfree/2014/nov/16/red-lights-global-economy-david-cameron">warning this week</a> about risks in the global economy sounds like it might be wonderfully prescient. Here’s the country’s economic chauffeur, carefully checking his instrument gauges, and sure enough, sees the same signs today that should have given us warning of the crisis of 2007-08. Time to apply the brakes.</p>
<p>There’s only one problem: the economic dashboard that Cameron relies upon <em>did not</em> warn of the crisis before it happened. Instead, that dashboard advised Cameron and other leaders around the world that everything was looking rosy, and that going full throttle was entirely safe. </p>
<p>The OECD’s Economic Outlook, published in May 2007, stated that its “central forecast remains indeed quite benign” as it predicted <a href="http://www.euractiv.com/euro/oecd-raises-growth-forecast-europe/article-164004">“a strong and sustained recovery in Europe”</a>. Some dashboard that turned out to be.</p>
<h2>Motor skills</h2>
<p>Politicians are fond of car analogies when talking about the economy, because they’ve actually driven cars, and they know how they work. Press the accelerator, you go faster; hit the brake, you slow down; the tachometer tells you whether the engine is flat out or idle; the fuel gauge tells you whether you need to call into a petrol station. Car controls work because they are designed by engineers who actually built the car in question, and the dashboard tells you all you need to know, with no serious omissions and no distracting false signals.</p>
<p>But the economic dashboard that Cameron relies upon today was horribly wrong in 2007: the signals it focused upon – mainly the rate of unemployment (low and falling), the rate of inflation (low), the government deficit (heading towards a surplus), and the rate of interest (low but rising to cool the economy down) – gave absolutely no warning of the biggest economic crisis in a century.</p>
<p>This mainstream dashboard gave no warning of the crisis because it was built by economists whose theories have more in common with Alice in Wonderland than with engineering. And one Mad Hatter assumption their dashboard makes is that the level of private debt can be ignored.</p>
<h2>Debt wish</h2>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/64833/original/d3fvwx9c-1416308892.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Questions for Bernanke.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/fordschool/8384644018/in/photolist-dLVuxU-dLPWoT-dLVv7u-dLPWHz-dLPVBX-dLPWrv-dLVwZL-dLVtFJ-dLVwv3-dLPXFB-dLPZgz-dLPYBr-------------dLVtwd-dLPXCi-dLPWLk-dLPXXF-dLVwnw-dLVv4b-dLQ1JF-dLPXj6-dLVxbj-dLVupQ-dLPYZ4-a5Tpoq-akrKqb-5sNWLd-5qaUiF-aE1CZp-dLKUBV-dLKUCZ-dLKUD8-dLKUzX-aG9mYB-feXDGC-7vqUDD-ddAgRS-aq2PTp-4dmrw5">Gerald R. Ford School of Public Policy, University of Michigan</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>If that sounds crazy to you, that’s because it is. Some influential economists argue that private debt has “no significant macroeconomic effects”, <a href="http://books.google.co.uk/books?id=Uo_OyKsfjxoC&pg=PA42&lpg=PA42&dq=bernanke+%22no+significant+macroeconomic+effects%22&source=bl&ots=Y6yJpgalYW&sig=GHixQiKDfPsHxEUK7PETBRFavmI&hl=en&sa=X&ei=fRxrVIWEAoXlaq7dgKgH&ved=0CC4Q6AEwAg#v=onepage&q=bernanke%20%22no%20significant%20macroeconomic%20effects%22&f=false">to quote Ben Bernanke</a>. Only mavericks who follow the then-ignored but now famous American economist Hyman Minsky disagree, and regard the level and growth of private debt as vital economic indicators.</p>
<p>I am one of those mavericks, and the signs I saw back in 2005 led me to be one of the handful of economists who <a href="http://www.voxeu.org/article/no-one-saw-coming-or-did-they">did warn of the crisis before it happened</a>.</p>
<p>Since then, the American philanthropist Richard Vague – who made his fortune in banking – has <a href="http://debt-economics.org/">examined all major economic crises</a> since 1850, and concluded that the two key signs of an imminent crisis are private debt exceeding 1.5 times GDP and that ratio rising by 17 percentage points or more over five years. Both those signals were clearly “flashing red” in 2007.</p>
<h2>Signals, noise</h2>
<p><a href="http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS">Private debt in Britain</a> rose from 135% of GDP in 2000 to 180% when the crisis began in August 2007 – a 45% rise in less than eight years. In the US, it rose from 125% to 160% – a 35% rise. Both these levels and the rates of change were unsustainable: the growth in private debt had to stop, and when it did, I expected that the biggest economic crisis since the Great Depression would follow – which is what actually happened.</p>
<p>So what are those reliable but neglected indicators telling us today? <a href="http://www.theatlantic.com/business/archive/2014/09/government-debt-isnt-the-problemprivate-debt-is/379865/">In the US</a>, private debt fell from 1.7 times GDP in 2010 to 1.45 times in 2014. It’s been rising since 2012 and was now growing at 5% of GDP per year in mid-2014, which is <a href="http://www.telegraph.co.uk/finance/financialcrisis/10817959/Household-debt-is-Britains-hidden-timebomb.html">spurring economic growth</a> – but the headroom for continued credit-driven growth is limited because the aggregate level is still so high. We are nudging back closer to Vague’s danger zone.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=463&fit=crop&dpr=1 600w, https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=463&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=463&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=582&fit=crop&dpr=1 754w, https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=582&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/64835/original/xgn58v92-1416309496.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=582&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">US Private Debt Level & rate of change.</span>
<span class="attribution"><span class="source">Federal Reserve Flow of Funds</span></span>
</figcaption>
</figure>
<p>In the UK, private debt peaked at more than twice GDP in 2010. It has fallen to 170% today, but between 2012 and 2014 it rose – stimulating economic growth. Now it is falling again – by as much as 5% of GDP a year. That implies that a credit contraction – however welcome it might be in stopping at least one warning light flashing – is likely to reduce British economic growth in the near future.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=486&fit=crop&dpr=1 600w, https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=486&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=486&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=611&fit=crop&dpr=1 754w, https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=611&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/64830/original/nhn4kd3m-1416307721.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=611&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>So Cameron is right to worry, but he’s worrying about the wrong thing: panicking about a rising level of government debt, when at 91% of GDP, it’s 80 percentage points below the level of private debt. If Cameron thinks reducing government spending when private credit is contracting is good economic policy, then he’s ignoring the biggest car crash in economic history – the European Union, where government austerity turned the crisis into <a href="http://news.bbc.co.uk/1/hi/business/8242825.stm">a second Great Depression</a>.</p>
<p>The key indicator I use to anticipate where the economy is headed is the acceleration of private debt. Just as the rate of change of private debt indicates what’s going to happen to the level of economic activity, the acceleration of debt indicates whether activity is likely to rise or fall. That indicator, which was trending up from mid-2010 until mid-2012, has been headed down ever since. <a href="http://www.debtdeflation.com/blogs/2011/08/28/updated-credit-accelerators/">Debt acceleration</a> was strongly negative as of mid-2014, running at minus 10% of GDP.</p>
<p>That, combined with Richard Vague’s indicator that crises occur when private debt exceeds 150% of GDP (tick at 170% in mid-2014) and has grown by 20 percentage points or more over five years (in fact it’s shrunk by 30 percentage points since 2010), points to stagnation rather than crisis being the likely outcome for the UK economy. </p>
<p>In this scenario, an attempt to pare government spending back could make the stagnation worse – just as it has done across the Channel.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=524&fit=crop&dpr=1 600w, https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=524&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=524&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=658&fit=crop&dpr=1 754w, https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=658&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/64831/original/kzxsvhwm-1416307840.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=658&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>All in all, I would recommend Cameron gets his economic dashboard fixed, or he risks steering the UK in the direction of Europe. </p>
<hr>
<p><em><a href="https://theconversation.com/uk/topics/hard-evidence">Hard Evidence</a> is a series of articles in which academics use research evidence to tackle the trickiest public policy questions.</em></p><img src="https://counter.theconversation.com/content/34331/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Keen has received research funding from the Institute for New Economic Thinking (<a href="http://www.ineteconomics.org">www.ineteconomics.org</a>) and has consulted to the Governor's Woods Foundation (<a href="http://www.govwoods.org">www.govwoods.org</a>). He is affiliated with IDEA Economics (<a href="http://www.ideaeconomics.org">www.ideaeconomics.org</a>).</span></em></p>Taken at face value, David Cameron’s warning this week about risks in the global economy sounds like it might be wonderfully prescient. Here’s the country’s economic chauffeur, carefully checking his instrument…Steve Keen, Head of the School of Economics, History & Politics, Kingston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/283532014-06-23T16:08:34Z2014-06-23T16:08:34ZThere hasn’t been any austerity in the UK – and that might explain the upturn<figure><img src="https://images.theconversation.com/files/51943/original/h6fzpsw2-1403528309.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Sorry, spending has exceeded tax revenue.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/aspexdesign/8108673684/in/photolist-9Y54aX-f6eSjR-dwChML-dvWFJ9-dvR7Vv-dohTvG-dvWtwf-dvWtpu-dmx5bG-dtfgoK-dtfrKA-dtft9J-dtfg5i-dtfsmU-dtffKV-dtffBV-dtffrt-dtfrCm-dmtbvr-dmtbs4-dmtbon-dmtbj4-dmtbe4-dmCAkX-bjqHn4-dmCGnN-dmteWU-dmCDqB-f6eYbD-ceDa9q-dmCDvT-dD3M1L-dvR2Vx-dwChWJ-bvVMAN-dvQRzR-dvWpZw-dvWpTy-c2i3ZS-dvWDCS-9vgFZw-dmtgeE-dvRjXR-4a7uBA-duoWsb-4wBciA-4wBcbY-dmCwpx-dmCDX1-dmCDRb">Dean Thorpe</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>After all those years of flat-line economic performance in the UK economy and declining real incomes, we’ve seen quite a turn around. The growth rate is now <a href="http://www.cityam.com/blog/1400759313/uk-knocked-top-spot-germany-now-europes-fastest-growing-economy">one of the best</a> in Europe, <a href="http://example.com/">house prices are rising</a> and there are <a href="http://www.theguardian.com/business/blog/2014/jun/11/uk-unemployment-real-wages-uk-world-bank-live?view=desktop#block-539815f5e4b06713cee83f31">signs of wages starting to recover</a>. </p>
<p>Conclusion: the austerity programme may have hurt, but it worked. The gain was worth the pain. The siren voices calling for Keynesian borrowing and spending during the tough years have been proved wrong. We have been saved from a spending spree that would have saddled us with long-term debt. </p>
<p>This is the prevailing narrative from the right. If the recovery can be sustained in the run-up to the next election, it will be hugely helpful to the Tories. It reinforces the claim that they have a degree of economic credibility that Labour has lost. In the context of all the <a href="http://www.telegraph.co.uk/news/politics/labour/10854486/Voters-say-Ed-Miliband-is-a-problem-shadow-minister-warns.html">recent Labour anxiety</a> that Ed Miliband does not look like a winner, the fact that he is <a href="http://www.theguardian.com/politics/2014/jun/20/labour-party-leader-ed-miliband-challenge-how-win-over-voters-neil-kinnock">less trusted on the economy</a> than David Cameron underlines the damage that this narrative has done. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=361&fit=crop&dpr=1 600w, https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=361&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=361&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=454&fit=crop&dpr=1 754w, https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=454&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/51942/original/fmst3v38-1403528111.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=454&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
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</figure>
<h2>Grotesque caricature</h2>
<p>You’d expect this story to be attractive to Cameron and George Osborne. But in a way, it’s also a convenient story for the left. It suits their grotesque caricature of a hard and uncaring regime that doesn’t understand the pain felt by the many; a useful counterpoint by which to make a comparison. “We would have done it differently,” they say. “Cut a bit less hard, prioritised spending on the vulnerable, and recovered faster.”</p>
<p>But has there really been a period of austerity? And is it the reason for the economic recovery? We were told that the point of the austerity measures was to reduce the national debt. If we could live within our means by spending no more than we receive in tax revenue and running a so-called balanced budget, we wouldn’t add to the nation’s debt. And if we could run a budget surplus – spend less than we receive in taxes – then we could even start to pay off that debt. </p>
<p>It is worth remembering that none of this has been achieved. In every year of the coalition government, spending has exceeded tax revenue. It is true that the <a href="http://www.telegraph.co.uk/finance/budget/10708494/Budget-2014-UK-growth-forecasts-upgraded-by-biggest-margin-in-25-years.html">deficit is getting smaller</a>, down from its peak of £171bn in 2009/10 to a forecast £95bn in 2014/15. But the coalition pledged that it would be zero by the 2015 election and is now saying that it will not even have half-accomplished this task by that time. And each year’s budget deficit has added further to the national debt. Of course, there have been cuts and very tight spending rounds across departments, but these have been from a very high base in the pre-crisis period.</p>
<h2>The income picture</h2>
<p>But what does this mean for the individual? After all, our happiness today doesn’t depend on the size of the national debt. What matters for our well-being is our income: how much we have to work, and what we can spend it on. </p>
<p>UK real income per head today is roughly equivalent to its <a href="http://www.tradingeconomics.com/united-kingdom/gdp-per-capita">level in early 2007</a>. So the purchasing power of our income is equivalent to that in the latter days of Tony Blair’s premiership. Of course, had the economy continued to grow at the same rate as it did pre-crisis, income per head would undoubtedly have been higher today. Some consequently argue that during the recession the economy “lost” income. But just because we could have been richer doesn’t negate the 2007 comparison. Were we that destitute in those heady days just before the financial crash? </p>
<p>To answer this in any meaningful way, you also have to consider whether income distribution has changed over this period. Has austerity hit the poor more than the rich? Again data reveals that, though income inequality rose sharply through the 1980s and then more gradually for most of the following two decades, <a href="http://www.theguardian.com/uk-news/2013/jul/10/income-gap-narrowest-margin-25-years">it has actually fallen during the recession</a>. </p>
<p>This may be because real wages have been eroded <a href="http://www.bbc.co.uk/news/business-27047966">during a period where</a> the rate of inflation has outstripped the rate of wage increases, whereas benefits are protected by a degree of index-linking. Of course, as wage settlements start to exceed inflation and the effect of benefit cuts start to bite, this reduction in inequality may not endure.</p>
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<a href="https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=361&fit=crop&dpr=1 600w, https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=361&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=361&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=454&fit=crop&dpr=1 754w, https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=454&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/51941/original/z5n62zy3-1403527191.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=454&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<h2>Why the upturn?</h2>
<p>Our second question is whether the recent economic upturn is due to the austerity measures we’ve endured. Or is it a happy coincidence of falling energy prices, cheap loans and stimulants to the housing market? </p>
<p>Are we repeating the mistakes of the past – a recovery led by the housing market, generated by supply constraints, fuelled by cheap borrowing, and aided and abetted by the Help to Buy scheme? How vulnerable is this to rises in interest rates – quite possibly and for some, unhelpfully, before the next election? </p>
<p>It’s often thought to be a no-brainer that cutting the government deficit reduces the national debt. This is the logic espoused by the coalition. But even if you could achieve this, the logic doesn’t hold. </p>
<p>Cutting spending reduces demand, particularly by the poor, who tend to spend a larger proportion of their income. This adversely affects GDP and employment. This in turn reduces tax revenues, worsening the deficit. If spending is cut further to try and control the deficit, then a downward spiral results. </p>
<p>In fact, there is an inverse relationship between government deficit and the national debt. Cutting the deficit will increase the national debt in years to come. This is <a href="http://www.primeeconomics.org/?page_id=51">borne out</a> in the data over the past 130 years or so for the UK and many other countries. The conclusion is that government investment has a key role in stimulating demand and hence reducing the national debt. </p>
<p>This may explain why, despite the tough talk, the UK government has still run the deficit throughout the post-recession period. Perhaps Nick Clegg was partly to thank for this closet Keynesianism, perhaps reining back the natural tendencies of a Tory administration to cut further and faster, and narrowing the distance to Ed Balls’ calls to cut less and slower.</p>
<p>The bottom line is that there has been a lot less austerity than we might have been led to believe, and austerity is unlikely to have been responsible for the first signs of recovery we see now. Arguably the fact that government spending was not cut as aggressively as some would have liked has actually allowed the recovery to begin. </p>
<p>All the same, it is still too weak and unimpressive to be worth shouting about; and possibly fuelled by unsustainable stimulus to the housing market. With benefit cuts and interest rate rises likely to have an impact down the line, then even this recovery may be in jeopardy before long. Whether it is in time to help Labour at next year’s election is in the lap of the gods. </p><img src="https://counter.theconversation.com/content/28353/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>W David McCausland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>After all those years of flat-line economic performance in the UK economy and declining real incomes, we’ve seen quite a turn around. The growth rate is now one of the best in Europe, house prices are…W David McCausland, Senior Lecturer in Economics, University of AberdeenLicensed as Creative Commons – attribution, no derivatives.