Britain's Economy Is a Disaster and Nobody Is Entirely Sure Why

[jimmy olsen]

Odd, Minsky what do you think?

http://www.theatlantic.com/business/archive/2013/01/britains-economy-is-a-disaster-and-nobody-is-entirely-sure-why/272556/'

Britain's Economy Is a Disaster and Nobody Is Entirely Sure Why
By Matthew O'Brien

inShare7 Jan 27 2013, 1:53 PM ET 87

Britain's GDP fell again in the fourth quarter of 2012, raising the specter of a triple-dip recession

PensiveCameron2.jpg.jpg
(Reuters)

Britain's economy is a riddle wrapped in a mystery inside an enigma, but this much is clear: it's a disaster. After its Olympics-fueled growth, such as it was, lifted it out of recession in the third quarter of 2012, Britain might be headed back after its economy fell 0.3 percent at the end of the year -- the fourth time in five quarters its GDP has contracted. Britain's now verging on a triple-dip recession, which is just another way of saying a depression.

But it's not so simple.

Britain is stuck in its worst GDP slump in a century, but not so for jobs. As you can see in the chart below from Jonathan Portes, the director of the National Institute of Economic and Social Research, Britain's stagnating economy has left it in worse shape at this point of its recovery than it was during the Great Depression. GDP is still more than 3 percent below its 2008 peak, and it hasn't done anything to catchup in years. At this pace, there will be no recovery in our time, or any other time.



It's no accident this era of zero growth has coincided with an era of austerity. Despite entering office with borrowing costs at 50-year lows, the Cameron coalition decided the government deficit, and not the growth deficit, was the chief threat to future prosperity. It raised taxes and cut the growth of spending, but did so with little regard for what constituted smart cuts and what did not. As Portes points out, public net investment -- things like roads and bridges and schools,  and everything else the economy needs to grow -- has fallen by half the past three years, and is set to fall even further the next two. It's the economic equivalent of shooting yourself in both feet, just in case shooting yourself in one doesn't completely cripple you. Austerity has driven down Britain's borrowing costs even further, but that's been due to investors losing faith in its recovery, rather than having more faith in its public finances. Indeed, weak growth has kept deficits from coming down all that much, despite the higher taxes and slower spending. In other words, it's economic pain for no fiscal gain.

But the story of Britain's flatlining growth isn't just one of ignoring Keynes' maxim that the boom, not the slump, is the time for austerity. It's more like an economic whodunit. The euro crisis -- yes, we're rounding up the usual suspects -- has kept Britain from exporting its way out of trouble, as its largest trading partner, the euro zone, has been too busy flirting with breakup and recession to buy as much stuff as it otherwise would. It hasn't helped that some of Britain's big productivity industries like oil and finance have gone into what might be the start of long-term declines; the North Sea oil and gas fields and the City of London have both shed output and jobs. But this downtrend in Britain's top industries doesn't nearly explain the real puzzle of its economy -- the collapse in productivity.

In other words, the disconnect between GDP and jobs. While the economy is, at best, stuck in neutral, Britain has been adding jobs at a better-than-decent clip the past year or so. Unemployment recently reached an 18-month low, and, in absolute terms, more people have a job today than in 2008 (though underemployment is a problem). This combination of zero GDP growth with positive job growth means Britain is working more to do less. Richard Davies of The Economist calculates Britain is 12 percent less productive today than it was at similar points in other recoveries -- and the decline of the North Sea fields and the City probably only explain 1-2 percentage points of this gap. That leaves a pair of, hardly mutually exclusive, possibilities: either Britain has some serious GDP mismeasurement problems or some serious economic problems, full stop. The former is usually the case any time there's an apparent disparity between GDP and jobs data, but the disparity is so large and so persistent in this case that it seems something else is going on. Davies hypothesizes zombie firms are starving new, more productive firms, for credit, which may well be true, but, again, doesn't seem to explain the full scope of the disaster.

The good news, if there is any, is Britain just poached Mark Carney, one of the top central bankers in the world, to run the Bank of England, and he seems determined to do more than his predecessor to get the country out of its economic rut. And that's it. There is no other good news. Thank goodness for stiff upper lips.

[Tamas]

if "deficit spend 'till our hair falls out"  was such a good recipe, Europe would be flourishing right now. Instead, it is... not. So I am getting tired of these "omg DO NOT stop the presses" articles

[The Minsky Moment]

The article hits all the usual explanations: the self-inflicted austerity wounds, the decline in North Sea oil production, the travails of the City.

Haven't seen a good clear explanation for the productivity mystery yet.  There probably are some measurement issues involved.  Another factor is that ultra-low interest rates are keeping weak and dying firms on life support.  That would explain productivity problems but it wouldn't explain why the UK is so impacted in particular (the US for example suffers from the same phenomenon).  There is some speculation about labor hoarding but that doesn't seem a very convincing explanation for a hit of this magnitude.

[mongers]

.....

I'm living The Dream Lie.

[mongers]

The article hits all the usual explanations: the self-inflicted austerity wounds, the decline in North Sea oil production, the travails of the City.

Haven't seen a good clear explanation for the productivity mystery yet.  There probably are some measurement issues involved.  Another factor is that ultra-low interest rates are keeping weak and dying firms on life support.  That would explain productivity problems but it wouldn't explain why the UK is so impacted in particular (the US for example suffers from the same phenomenon).  There is some speculation about labor hoarding but that doesn't seem a very convincing explanation for a hit of this magnitude.

I'm not sure what that one gets trotted out as it's been in decline for a decade or more, something that could be taken into account and planned for, so it really shouldn't be a surprise to anyone.

In other times maybe a government might even have invested some of the windfall in infrastructure/R&D/new industries to take up the slack when oil revenues declined ?

edit:
Apparently peaked in 1999 and current output is a bit under half that output. 
I guess the oil companies got lucky that the declining production was masked for some time by high oil prices until relatively recently.

[Sheilbh]

The BBC have had a few articles on it. I found this graph from one of them quite interesting. Maybe the Europe wide paradox of thrift helps explain it:


Edit: Also this speech by BofE committee member looks at the topic and is interesting:
http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech599.pdf

It reminds me of Adam Posen's (former American BofE dove) piece:
http://www.prospectmagazine.co.uk/economics/adam-posen-george-osborne/

What next?
by Adam Posen / DECEMBER 20, 2012 / 4 COMMENTS
Osborne needs a change of direction, says top former Bank of England official

While serving on the Monetary Policy Committee, the committee at the Bank of England that sets interest rates, I avoided addressing directly the current government's Plan A for economic recovery through austerity. I felt and feel that sitting central bankers should not publicly comment on fiscal policy beyond forecasting its short-term effects, or on structural matters. Silence, however, was not assent on my part. For two-and-a-half years, the coalition government's economic policies have focused on the wrong narrow goal, been self-defeating in pursuit of that goal, and in so doing have eaten away at British economic capabilities and confidence. It is past time for me, and far more importantly for the chancellor, to say so. Unfortunately, his Autumn Statement reiterated the same misguided priorities of deficit reduction and the same failed approach, with only minor variations.

The coalition government has failed to address the shortfall in productive British investment. As many have pointed out, British capital investment, public and private, has been well below the level of that of its international competitors like Germany, France, Japan, and the US. Addressing the shortfall requires structural, supply side measures, as well as a demand or stimulus agenda that fits with those measures, and is by definition business supporting. It requires confronting the real deficiencies of the British financial system with the same reformist zeal with which governments took on labour market liberalisation in the 1980s and 1990s. For at least 100 years, the City has far better served global finance than British domestic business, and that means the UK government needs to develop alternatives to the City for internal investment.

First, fiscal stimulus—or at least significant slowing of fiscal consolidation—should be adopted in the form of aggressive investment tax credits to non-financial business. Investment tax credits channel investment to directly where the shortfall lies, raising productive capacity and thus tax revenue over the longer term—certainly far more than consumption tax cuts. The UK government should go further, changing corporate governance rules to make it less attractive for businesses to sit on cash, e.g., by making large cash corporate holdings that are neither invested nor returned to shareholders as dividends over a two-year period automatically subject to a vote at the Annual General Meeting. It is understandable in the aftermath of the crisis that businesses want cash buffers and are risk averse. What is incomprehensible is the government playing with a long list of proposed tax adjustments from the Pasty Tax on up over the last two years, and never proposing a serious investment credit.

Second, the UK needs to create a credit market that lends to projects in the small and medium business sector that can't get credit. Right now, the British economy is lacking the diversity of lending sources that the US and Germany have, with no small or community banks, a very high minimum company size required to float corporate bonds, and tiny corporate paper and venture capital markets. Countries around the world are passing laws, issuing charters to specialised financial institutions, making markets to allow companies to borrow from the market by issuing bonds (in conjunction with the central bank), and encouraging new entrants to create just such infrastructures in their own economies. Both Latin American and South East Asian emerging markets have made huge strides in domestic credit and capital creation in recent years through such policy efforts. It is time the government learned from these initiatives, and benefitted from the handbooks that the IMF and World Bank have written for how to do so.

Third, the government needs to create more competition in domestic banking, as the Vickers Commission has bluntly and rightly advocated. The current British banking oligopoly creates distortions—for the world's eighth largest economy to have essentially only five domestic lenders (plus one very large mutual doing mortgage loans) is extraordinary and, as liberal economics would tell you, distortionary and inefficient. The government should sell off parts of the banks currently under its (meaning public) ownership control, just as it would break up any instance of excessive market concentration. As importantly, it should change the rules governing the entry of new banks into the system, and encourage the expansion of the banks tied to supermarkets and the like. Regulators should make banks more transparent, fees and application forms for loans should be standardised, and services should be mandated to assist microbusinesses and small or new firms with such applications.

Fourth, to further promote both domestic financial development and bank competition, the government should create a sizable specially chartered public bank for lending to small businesses, and accompany it with creation of a Fannie Mae-like company to bundle, securitise, and sell those British enterprise loans. Since I first advocated this approach in September 2011, many British officials and business leaders have taken up the call, including the British Chambers of Commerce, the Labour party leadership, and the current business secretary Vince Cable. The chancellor's autumn statement, however, omitted any commitment to creating such an institution, and it is clear that any efforts the current Treasury would make in this useful direction would be insufficiently ambitious. Again, most of the UK's major competitors, including Germany, France, and the US, have such banks—so state aid rules are not a real barrier—and provide better funding for small and medium-sized business. Concerns about reducing the franchise re-sale value of the semi-nationalised banks in UK government hands is about as classically penny-wise and pound-foolish, from a growth and investment perspective, as one can get. It is also moot, given that no one is going to be reselling those banks at a profit for years to come (another argument for selling off parts, as argued above).

Finally, the government should restore public investment levels, with an emphasis on large infrastructure projects. As Gavyn Davies, former chief economist at Goldman Sachs,  has pointed out, British public investment has fallen by a quarter since 2010. That is a huge reduction, and is self-defeating in terms of short-run revenues and long-run growth. Besides, some humility about criticising wasteful investment is called for after the throwing away of private investment funds in the bubbles and frauds of the 2000s. Figures as politically different as Gordon Brown and Michael Heseltine have pointed out that the UK can get ahead in public-private partnerships and even sell stakes in large infrastructure projects abroad.

The MPC and Bank of England can and should support this pro-investment agenda, once it is pursued by a government, as I have been arguing for some time, right up through my last two speeches as a member of the MPC last summer. The Bank of England can purchase assets other than UK government bonds, particularly loans and bonds for public-private investment funds, and loans from the newly created banking entities, thereby simultaneously providing more effective monetary stimulus and giving British businesses access to more credit. In its new financial supervisory role, the Bank of England can enable new entrants to increase competition, and increase transparency of fees and counter other oligopolistic behaviors in the current British banking system. And the MPC and its members should stop talking about the need for reductions in spending when forecasting British economic growth and inflation—as argued above, the economic argument goes against such scaremongering. Furthermore, statements to this end from the MPC officially feed the policy defeatism and austerity cycle that is currently doing so much harm to British economic policy and the British economy.

It is not enough for Messrs Cameron and Osborne to claim that they have done what they promised to do. Their policies have left the British economy malnourished, and indeed made parts of it quite ill. There are alternatives available, and the British government should switch to these now.

[Warspite]

The Economist also ran something on this:

http://www.economist.com/news/britain/21570692-dive-britains-productivity-puzzle-uncovers-serious-risk-economy-job-rich

BRITAIN'S economy has had an odd five years. In output terms, things have been terrible. The slump that started in 2008 is far worse than the 1930s depression; only the years after the first world war were harsher. Consumption has been dragged down by weak real wage growth, investment has been held back by tight credit and exporters have struggled with weak demand in the euro zone. The initial estimate of GDP growth in the fourth quarter of 2012, due shortly after The Economist went to press, was expected to contain more bad news.


Yet the job market is humming. Data released on January 23rd show that employment has topped previous peaks (see first chart). The combination of economic slowdown and plentiful jobs means output per worker has fallen 12% further than at the same stage in previous recessions. That is equivalent to the loss of the entire manufacturing sector. Britain is now startlingly unproductive compared with other rich countries. What is going on?

One answer is that the GDP data could be wrong. Since early estimates are based partly on models and surveys, they are often revised. The Office for National Statistics (ONS) tends to revise GDP up after a recession. This would realign GDP and employment. But although post-recession revisions can total as much as 3-4%, the average error across all periods is tiny. So a large markup is unlikely. Even if there is one, 10% of output could still be missing.

If GDP estimates are not much too low, over-egged employment figures could explain the disparity. Some point to Britain's growing army of part-timers, who account for a third of the 1.3m net new private-sector jobs created since 2010. Interns and other unpaid workers are classified as employed but may produce little output while learning their trades.

Still, neither answer solves the puzzle. Average hours worked have increased even as part-time jobs have become more common. And the 275,000 or so unpaid workers are a tiny fraction of Britain's 30m- strong workforce. Britons really are producing less per hour worked. It is not the data that are odd. It is the British economy.

One explanation is that British firms are hoarding labour. A 2012 survey of private-sector employers by the Chartered Institute of Personnel Development reported that close to a third had more staff than they needed to fulfil current orders. Most said they were anxious to retain their skills base. Indeed, it might make sense to let some workers stand idle if this cuts hiring and firing costs and avoids delays in training new workers when demand recovers.

But if labour hoarding is tempting today, it would have been more tempting in previous recessions, when stronger labour protections meant that laying off staff was more costly. Yet productivity during this slump is the outlier in recent history, not the norm (see second chart). And the longer the sluggish economy persists, the less labour-hoarding seems to make sense. British firms went into the crisis with cash buffers that could pay for surplus staff, but few bosses can justify excess headcount for half a decade. Nor does the hoarding theory fit with a deeper dig into the data, says Joe Grice, the ONS's chief economist. Plenty of people have lost their jobs, but even more jobs have been created.


Working hard in the wrong places

So most British workers are not sitting idle in firms shielding them from the sack. The productivity puzzle is genuine: Britons are working harder to produce less. There are lots of reasons for this, suggests Kevin Daly of Goldman Sachs, many of them temporary. Jobs that involve winning contracts are tough in a slump: estate agents and the like must hunt harder for clients. In such sectors more hours do not necessarily imply more output. In manufacturing firms, production techniques can be adjusted to reflect the fact that labour is cheap but investing in machines is costly. Companies might delay investment and work existing equipment harder by putting on night shifts. Such trends keep employment up and output down. They are fairly easy to reverse as the economy recovers.

But there is another, far less benign, explanation for the productivity puzzle. In a recent paper Ben Broadbent, a member of the Bank of England's Monetary Policy Committee, explains that it takes time for hard-hit sectors to shed labour and capital following a shock. It also takes time for new, fast-growing sectors to mop up these resources. During this period of flux, people and capital are concentrated in declining sectors, and economic output will be less than it could be. And the stickiness is not just between one sector and another. A recent analysis by the ONS of some 50,000 firms revealed huge productivity gaps between companies in the same industry. Reallocating resources to the most productive firms and sectors could give the economy a huge boost.

There are worrying signs that Britain's economy has become bad at performing this allocation. The fact that relatively few firms have failed does not mean British companies are thriving. More firms are making losses, but they are not being shut down. In part this reflects banks' willingness to cheapen or extend old customers' credit—keeping dying firms alive to avoid taking a loss themselves. At the same time, credit for new firms with better prospects remains tight.

The danger is that whereas workers are fairly mobile, capital is getting bunged up in inefficient firms while new businesses remain starved of credit. In short, people are working for firms that should not exist. This risks turning a temporary output drag into a long-term reduction in supply.

A lot now turns on "credit easing"—government attempts to lower banks' own cost of funds. With cheaper funding, banks can lower the rates they charge to new customers. They can also build capital buffers, allowing them to take losses and get bad loans off their books. It is too soon to know whether the latest round of credit easing, which started in August 2012, is working. At the first sight that it is not, policymakers will need to beef it up very quickly.

[Admiral Yi]

Any insights on explanations for the factors mentioned by Broadbent?

Why the aversion by failing British firms to lay off workers?

Why the preference by British banks to lend to failing firms?

[Sheilbh]

Any insights on explanations for the factors mentioned by Broadbent?

I think the fact that we've only got 5 lenders is probably a factor. And the regulation of new lenders is pretty extreme. As Posen mentions we've also got a less flexible corporate bond museum than in many other countries. So I think big companies and very small companies find it plausible to raise funds but the ones in between are shafted.

Why the aversion by failing British firms to lay off workers?

British workers have gone German. They take pay or hour cuts rather than lose their jobs. So flexible labour market and labour hoarding. If they're doing just enough to stay in business then they're probably more optimistic, similarly if they're just in work their employees are much the same.

Why the preference by British banks to lend to failing firms?

There's a huge amount of forebearance by the big banks at the minute, especially in commercial property - the FT had an article on this a while ago. Probably they'd rather do that than write down loans.

[Gups]

Hyperbole  to call the British economy a disaster. The Greek economy is a disaster. The Biritish economy is flatlining.

[Martinus]

Gups, how's the legal services market in the UK? Are you experiencing a slump or SNAFU?

[Gups]

Depends what sector you are in and where in the country. London is doing fine, rest of the country isn't. M&A is shit, litigation very good, property just about starting to recover. Crime doesn't pay.

Most firms have flat revenues.

[The Minsky Moment]

Why the preference by British banks to lend to failing firms?

Low interest rates. 
Why write down to zero just so you can collect some liquidated cash you can't lend out for a decent return anyway.  Better just to roll over and hope.

[KRonn]

Third, the government needs to create more competition in domestic banking, as the Vickers Commission has bluntly and rightly advocated. The current British banking oligopoly creates distortions—for the world's eighth largest economy to have essentially only five domestic lenders (plus one very large mutual doing mortgage loans) is extraordinary and, as liberal economics would tell you, distortionary and inefficient. 

This truly seems bizarre, to have so few lending institutions. How could things have gotten to that point?

[mongers]

Third, the government needs to create more competition in domestic banking, as the Vickers Commission has bluntly and rightly advocated. The current British banking oligopoly creates distortions—for the world's eighth largest economy to have essentially only five domestic lenders (plus one very large mutual doing mortgage loans) is extraordinary and, as liberal economics would tell you, distortionary and inefficient. 

This truly seems bizarre, to have so few lending institutions. How could things have gotten to that point?

http://en.wikipedia.org/wiki/Thatcherism