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If the UK Chancellor George Osborne announced that he had retained a Druid to perform growth-enhancing ceremonies each morning in Parliament Square, would the media report this as a credible recession avoiding measure? I assume that it would, since radio, television and the newspapers, even the business pages of The Guardian, treat seriously Osborne's prediction that growth of private employment will compensate for his pubic sector redundancies.
For months media commentators have mulled over the possibility that the US, the UK and the euro zone countries might suffer from a "double dip", a "return" to recession. The ink, airwaves and cyberspace spent on this non-issue give new meaning to "idle speculation".
Let me draw attention to the obvious:
There was one Great Dip, we are in it, and Mr Osborne's policies made a strong contribution to it.
To grant the Chancellor the benefit of the doubt is to humour a madman. The proposed rescue of the UK economy by the private sector is more than unlikely, it is so improbable that it approaches the impossible. Even business recognizes this:
"I think [the Bank of England] are right to review their forecast and to expect a slower recovery based on the new Government’s decisions regarding public sector spend, and the surely obvious resulting fall-out of these." [Managing director of the COS Group, James Emery, quoted at www.walesonline.co.uk, 13 August 2010]
As my fellow Americans would say, "HELLO"! Or, "no kidding?"
A few simple calculations demonstrate the absurdity of Mr Osborne's fairy tale. For the economy not to decline, the net fall in government spending (expenditure reductions plus tax increases) must be matched by an equal increase in net private spending. The increase in net private spending must come from increases in household consumption, exports, business investment, or a decrease in imports. The first and second can be ruled out. Consumption is primarily a function of household income which will be determined by the other components of demand. Exports will not rise because the UK's largest trading partner, the EU, is also in recession. Imports may well decline, but it will be the result of falling household incomes, not a source of recovery.
Mr Osborne's hopes rest on a burst of business enthusiasm for new investment. Increased investment does not occur when falling domestic demand generates excess capacity. And there other several obvious and equally insurmountable problems. Public expenditure is at least three times the size private investment (depending on one's exact definition). Therefore, to prevent the economy from declining a given cut in public sector demand must be matched by a private sector increase three times as large in percentage terms. If Mr Osborne were successful in achieving a five percent reduction in public expenditure, the compensating increase for private investment would be fifteen percent. Should he seek a very modest one percent rate of growth for 2011, an increase in private investment of twenty percent would be required, and an increase of over a third for two percent growth. All three of these improbable increases would bring the investment share in GDP to its highest level in decade. In a recession? Not very likely.
Why would private investment increase without expectations of increased sales? The question itself is absurd. But right wing ideologues such as Mr Osborne and his colleagues in the Calamity Coalition (Cal-Co for short) are fond of arguing that less public spending will lead to a fall in the commercial interest rate which would induce investment (see previous comment, "Growth and Deficits"). Cal-Co ideologues may not have noticed that the Bank of England base rate is at a historic low (one-half of one percent). And on 11 August the head of the Bank of England warned of an increase in commercial lending rates as banks "look to their balance sheets".
Mulling over multiple dips can end. Forget recovery. There will be no growth in 2011 for the UK. Considerably more probable is that the economy will decline. The most likely outcomes are:
Scenarios Growth outcome
1. The Calamity Coalition achieves
part of its cuts but not all positive, but less than 1%
2. Expenditure cuts & tax
measures fully adopted negative growth near zero
3. Proposed measures depress
private expectations, investment falls negative, minus 1 or lower
4. Number 3, plus fall in exports due
to EU fiscal cuts& no US recovery minus 4 or lower (as in 2009)
Were I a betting man, I would inquire at Ladbroke's about odds being offered for UK growth being negative in 2011. Because the pros at Ladbroke's are more rational (and may know more economics) than Mr Osborne, the odds they will offer are not likely to be very favourable.
A year ago I was extremely optimistic that the US fiscal stimulus combined with Gordon Brown's modest one, plus the policies then in place on the continent would make the recession short and "shallow". Mr Brown is gone, Angela Merkel has become a expenditure reducer (despite a small public deficit and a trade surplus), and the Cal-Co team makes Jack the Ripper seem benign. Plan on depression.
[Sources: Bluebook 2010 for expenditure shares in GDP. For a study of UK investment shares 1979-1990, http://www.ifs.org.uk/bns/bn18.pdf. Anyone wishing details on my estimation of the "scenarios", please email me.]
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