Sunday, February 27, 2005
If Britain is doing so well, how come it doesn't feel like it?
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

On March 16, when he presents his ninth budget, Gordon Brown will roll out an array of statistics to demonstrate how well the economy has been doing under his management, punching home Labour’s political advantage in this area.

On the face of it, his claims will be hard to dispute. I have on several occasions lauded the economy’s record run of 50 successive quarters of growth, combined with 11 years of low inflation and a low level of unemployment that is the envy of Europe.

But now the moment has come to face up to a question that has been troubling me for some time and is regularly raised by readers. If things are so marvellous, how come it does not feel like it?

Britain’s economic miracle might, one would have thought, have led to more obvious evidence of prosperity, the kind of easy confidence encountered in Germany or Japan in their most successful periods.

Instead, the years of success have not eradicated the country’s shabby feel, from the squalor of the majority of public buildings and the transport network, to the grimness of Britain’s high streets. Without wanting to be nostalgic for the 1980s, it was a decade in which British retailing was revitalised and raised its horizons. Now discount retailers dominate the scene and people fight over bargain sofas at Ikea. A country that has apparently never had it so good scrabbles around for cheap tat. Clothing and footwear prices have dropped 40% since 1996 and it shows.

Economic optimism, according to Mori, the pollster, is in the doldrums — a net 19% of people questioned expect the economy to get worse over the next year, roughly where optimism has been for the past several years.

There is, it should be said, a kind of curmudgeonly bias to this index, which is based on the question: “Do you expect the general economic condition of the country to get better or worse over the next year?” Asked about their own situation rather than that of the economy in general, people tend to be more cheerful. But the optimism index was pretty high in 1997-98 and has been low, and sometimes very low, since.

So why is this? Recent years have been good for the economy, but have they been exceptional? If we take the past 10 years, from the end of 1994 to the end of last year — a comparison that is helpful to Labour because it includes the period of strong growth at the end of the last Tory government — gross domestic product rose by 30.7%. That is pretty good, but not unusually so.

In the previous 10 years — the era of Tory “boom and bust” — GDP surprisingly rose 28.8%, only just adrift of the recent period in spite of including the longest recession since the war. Indeed, if we take the 10-year periods for which we have quarterly data, a GDP rise of about 30% is the norm. The 1954-64 figure was 34.3%, followed by 27.9% in 1964-74. The exception was the turbulent 1974-84 period, which straddled Tory and Labour governments, when GDP rose only 17.2%.

The statistics are even less flattering in respect of growth of real incomes. Again, a 10-year rise of about 30% is the norm for real per capita incomes and this was achieved in the 1994-2004 period with an increase of 31%. But in the previous 10 years there was a bigger increase in real incomes, 33.5%, even if it was a much bumpier ride.

We should, of course, look at the wider picture. Growth has in recent years been combined with low inflation, which is good. But as John Major pointed out to the Bow Group last week, defending his record, this has been a global environment of low inflation, and for Britain the recent run of stability began before Labour took office.

In terms of the “feel” of the economy, there are a few other reasons why this does not seem to most people to be a miracle period. The first is that economic progress in recent years has been incremental, the economy growing roughly in line with its trend rate. People only really notice a difference when there is a boom.

Second, while consumer spending has been strong, it has shifted towards the kind of things we do not get pleasure from. Since 1996 (the base year for the consumer price index), insurance premiums are up by 67%, car-repair costs by 63%, and education, on which some spending is through gritted teeth, by 62%. Council-tax bills have risen 70%.

Third, and related to this, one reason why real incomes have not grown that rapidly is that taxes have gone up. When Labour took office, voters were prepared to pay more for better public services. Eight years on, some services have improved, but they have not got better fast enough given the extra resources. In economic terms, transferring resources to the public sector means they are used less productively. The public is far from satisfied with the return on its taxes.

Fourth, and this is harder to prove, the job market has been healthy but the workplace has become tougher. Rising employment has been associated, in some surveys at least, with declining job satisfaction.

Finally, people will not feel warm about the economy if their quality of life is deteriorating. Whether or not it is the price of prosperity, many of Britain’s town centres have become no-go areas at night because of drunken yobs, while more general anti-social behaviour, such as graffiti, vandalism, burnt-out cars and casual violence, has soared.

On one day in 2003, as an experiment, the government recorded all the incidents of anti-social behaviour across the country and came up with 66,107, not far short of one a second. Labour claims it has the means in place to tackle anti-social behaviour but cannot claim success, because there isn’t any. And it is hard to claim a miracle economy alongside a dysfunctional society.

PS: Paul Tucker, who once told me he thought the “neutral” rate of interest for Britain was between 5% and 5.5%, has ensured we will all pay very close attention to the Bank of England’s deliberations in the coming months. He was the monetary policy committee (MPC) member who voted for a shock hike in the Bank’s repo rate (equivalent to base rate) from 4.75% to 5% this month. The other eight disagreed with him, although some, we don’t know how many, said it wouldn’t take much to persuade them.

For the aggressive rate-cutters among City pundits, who were looking for a downward move this spring, it was bad news. Even for me, expecting a long period of unchanged rates before a possible cut later in the year, last week’s February minutes and some hawkish noises from other MPC members were a challenge.

So how concerned should we be? Tucker was, after all, only being honest. The Bank’s new inflation forecast pointed to inflation eventually heading above the 2% target. Under such circumstances a hike in rates is the appropriate course. Mervyn King, the Bank governor, got round it the previous week by saying the risks were on the downside. My view is that if you have a central forecast, the upside and downside risks should be equal, but let that pass.

A rise in rates is more likely than it was but it is not inevitable. Inflation actually dropped last month on the old target measure and pay pressures, notwithstanding a rise in average earnings growth to 4.5%, look to be contained. A stagnant housing market (see this Friday’s Money Programme on BBC2 at 7pm) will take a slice out of consumer spending. I’m taking the Bank’s message as a warning shot, not a certain attack.

One plea. If the MPC is going to raise rates, let it have the guts to do it before the election.

From The Sunday Times, February 27 2005

Comments

Clearly, GDP growth - i.e. spending more money - doesn’t automatically generate a better quality of life or ‘happiness’. As well as the incremental progress there’s incremental decay – both moral and physical.

I trace the UK’s moral decay back to 1986, in the middle of the Thatcher reign, when Sir Robert Armstrong uttered the phrase “economical with the truth”. At that point a light bulb went on in the mind of the British middle class – deceit isn’t bad, it’s clever. Since then deceit has become ‘normal’ in every type of relationship and is even more common now that ‘we’re all middle class’. Unfortunately deceit inevitably leads to stress, breakdown and unhappiness.

At the root of the UK’s physical decay are the housing market and the government’s failure to control it. The rise in the cost of UK houses, simply because of the shortage, has led to all sorts of distortions. The money that’s wasted on this bubble has caused under-investment elsewhere in infrastructure and social problems, e.g. marriage break-ups.

So why don’t people recognise the problems and take corrective action? Partly it’s because the degradation is so slow – the frog in boiling water effect. Partly it’s because most people don’t analyse their situation, they just copy other people’s behaviour - hence the rise of celebrities, soap opera and reality shows. And partly it’s because the media mislead people.

The way the media have changed is a great example of evolution – survival of the most appropriate through random mutation. Mutation requires a large number of experiments, or ‘stories’ in this case, and the ones that survive are the ones that fit the environment best. What fits today’s social environment is entertainment, not information. Entertainment is emotional stimulation. The strongest emotions are conflict, fear and greed -hence the sensationalism of print and TV news. They don’t even bother to call them reports, just stories – often, historical fiction. (Present company excepted).

Still, it may be bad now but whether the next economic ice age is followed by religeous extremism or a new enlightenment I bet there’ll still be someone out there saying “I don’t believe it!”

Posted by: David Sandiford at February 27, 2005 11:53 AM

Interesting perspective and I think you’ve hit a nail here – although my dictionary tells me that the phrase “economical with the truth” dates from the 18th century, I agree that there has been a retreat from calling a lie a lie by the middle classes. And that widespread acceptance of the word “spin” is the best evidence of your thesis.

However while money doesn’t buy happiness it helps and it is therefore worth asking as well whether the real figures are overstated; the obvious reason why the GDP growth figures incomes are reflected on the ground is that they overstate GDP per capita because the population/labor force growth ahs been underestimated due to the under counting (or non counting) of immigration. Then we also have Len Cooks resignation over the number of errors and revisions in national statistics. In summary no one trusts either the denominator or the numerator in calculating GDP per capita.

But like you say this is perhaps symptomatic of pervasive economy with the truth in middle class professions – if the culture says could you revise this one, you smile and do1

Posted by: giles at February 27, 2005 07:35 PM

Ah, it’s good to point out the dark matter of the economic universe – the black economy (as well as the dodgy numbers). The black economy must be huge: illegal workers, smuggling, drugs, crime, tax evasion – especially VAT evasion, which is considered a moral duty in some parts of the Home Counties.

But at least the black economy is probably net positive for GDP (unless we count illegal immigrants as imports).

It’s just that GDP doesn’t seem a particularly useful number (and I refer here to page 62 of the paperback edition of Free Lunch).

It’s fine to have our national Gross Domestic Product as the sum of stuff that consumers buy, governments buy, businesses buy and foreigners buy – but then we subtract imports?

So Germany and Japan could get out of recession (defined by GDP) just by buying less imports from the US and UK – that doesn’t seem right.

In 2001 there was a near-recession in the US. But what really happened was that business investment fell. All the other components, including consumer spending, continued as before. Why use the ‘r’ word when business investment is the problem?

Well now the MPC has got its eye on spending by UK consumers. Maybe they should focus on the quality of what they buy rather than how much they spend.

Posted by: David Sandiford at February 28, 2005 11:07 AM

the mainstream economy have increased. In part this is due to change the increased complexity of the economy, but it may also be due to the weakened adherence to the truth that you outlined.

The imports measure isn’t a very good measure – if a country reduces its imports and holds its exports equal, then it has increased its external savings. So it’s a bit like getting a pay rise where you salary isn’t increased but your boss increases contributions to your pension fund. In the situation, like “Germany or Japan” I am not better off in terms of my current life style, but am in terms of my wealth. So it does make sense to classify this as an improvement via the GDP figures.

GDP is a good measure of well being, just not quoted in isolation –you also need to look at the accounts and see where the growth is coming from. In welfare terms 3% growth arising from export expansion is very different from 3% growth arising from import substitution is very different from 3% growth arising from government expenditure.

Posted by: Giles at February 28, 2005 04:13 PM

Add

"My point was not that the Black economy was mis measured but rather that the errors in measuring "

at the begining

Posted by: Giles at February 28, 2005 04:14 PM

The uncertainty in the figures does make it difficult for the MPC – hence the talk of needing to be both ‘pre-emptive’ and ‘careful’ from opposing sides on the interest rate debate.

Here in Australia the picture’s a lot clearer. The current account deficit has just been announced at 6.5% of GDP for 2004 Q4 – bigger than the US. Australians have been borrowing against their bubbling house values to suck in imports by the boatload.

Now you would think it was obvious that this has to stop and, in the face of political cowardice, the central bank has to raise interest rates. But the shout has gone up “don’t raise rates - the economy’s slowing down, GDP growth might be zero in the last quarter”. The effect of those imports will indeed be negative for GDP. But to say the economy is slowing or risking recession in these circumstances is ridiculous.

There’s a good assessment here:
http://www.theaustralian.news.com.au/common/story_page/0,5744,12401852%255E28737,00.html

Fortunately it looks as though Australian interest rates will rise tomorrow. I hope the MPC and Gordon Brown take note.

Posted by: David Sandiford at March 1, 2005 07:17 AM

the article is very interesting. However i do not think the comsumer confidence is as low as you say.The main reason is that the AD and growth in the economy is still strong even though it is growing a the normal rate.

Thanks!

Neelabja Nathabja

Posted by: neelabja nathabja at March 1, 2005 08:34 AM

"Now you would think it was obvious that this has to stop"

Not really - Australia's largest deficit was over 15% of GDP and its had deficits over 10% of GDP on a number of occasion over the last 150 years. In fact over its history the deficit in Australia has averaged about 4%. This is entirely sustainable as long as the economy grows at a comparable rate. In Australia’s case this was possible through continual immigration and a high fertility rate which helped its population grow by about 2-2.5% pa in the post war period. As long as productivity grew by 2-3% pa, a 5% deficit was entirely sustainable.

A boom in house prices in Australia increases construction and the housing stock (as it has more free land and less planning restrictions than say the UK). This increases its potential to absorb population increases through immigration and hence makes the current account more, not less, sustainable. It also pre commits the economy to population increases.

The housing boom is not nation wide – its only occurring in the places like Sydney where there is high demand while prices stagnate in Adelaide and Broken hill where demand is low. This is the normal operation of supply and demand and I don’t see why the RBA should raise rates to interfere in the efficient operation of any market other than the market for money. Rates are perhaps a points too low given the governments tardiness with supply side reform, but the housing market is not part of the equation.

Posted by: giles at March 1, 2005 03:01 PM

Well, the RBA did raise interest rates today by 0.25% to 5.5%.
RBA statement: http://www.rba.gov.au/MediaReleases/2005/mr_05_04.html

The GDP figures for 2004 Q4 were also released, showing growth of 0.1% for the quarter - high imports and a rundown of inventories cancelled out high business investment spending.
ABoS release (with graphs): http://www.abs.gov.au/AUSSTATS/abs%40.nsf/mf/5206.0?OpenDocument

Oddly, the Aussie dollar fell because of the low ‘growth’ rather than rising because of the higher interest rate.

To be fair Governor MacFarlane hasn’t blamed the imports, the borrowing or the housing bubble. And Treasurer Costello has criticised the move - in a way you couldn’t imagine Gordon talking about a Merv decision.

But there is already a big distortion in the Aussie tax system where the treatment of ‘negative gearing’ heavily favours investment in residential property over business investment. Also under-investment in infrastructure (because of misdirected tax money) has left Australia unable to shift exports fast enough.

So the situation wasn’t sustainable because the economy (the export part at least) wasn’t growing at a comparable rate – as you mentioned, Giles.

Nevertheless, Australia does have a lot of very nice new houses, thanks to the availability of land – which is more than can be said after the UK’s house price bubble. In the UK, house ‘improvements’ often destroy what little architectural merit the houses had in the first place.

But this all supports my view that GDP growth can be a misleading indicator and that it’s not a good idea to manage the entire economy through interest rates. I think taxation should occasionally be used to interfere in the market - to prevent bubbles and other distortions that are not in the national interest.

Posted by: David Sandiford at March 2, 2005 09:50 AM

As a large exporter of commodities terms of trade effects are very important in understanding Australia’s economy.
Australia’s recent boom has been driven to a large extent by a substantial improvement in its terms of trade since 2001. To a large extent this has been driven by China’s insatiable appetite for commodities and, as many think, this demand is a long term phenomenon then the terms of trade improvement will be expected to be permanent. The large deficit therefore represent a rational decision on the part of Australia to borrow against expected increased earnings – a bit like taking out a bigger mortgage once you’ve got a pay rise.
The fall in the dollar was not caused so much by the lower growth as the slow down/fall in the terms of trade over the last year. This reduces GDP by way of a direct accounting effect (lower price of exports) and also reduces expected future income (terms of trade improvement no longer expected to be permanent).
Interest rates are relatively irrelevant but as you say the key is tax. Australia has a tax system that seems to favor speculation over real business investment but I also wonder to what an extent this is simply the result of it being a small market – how many major business investments are viable in a 20 million person market?
Secondly I don’t think that infrastructure investments are the problem so much as restrictive labor practices followed by the workers operating that infrastructure.

Posted by: Giles at March 2, 2005 02:12 PM

That’s exactly right, Giles.

The interesting thing now is whether the Australian government, after gaining control of both houses of parliament, can deliver the goods on tax and industrial relations reform. (Tony Blair must be watching with interest).

Even so, Australia is extremely lucky in being able to make money by digging it out of the ground – even if it can’t fill the ships waiting at the ports fast enough.

Interestingly, the Eurozone’s GDP growth for 2004 was announced yesterday as 0.2% in Q4 and 1.8% for the whole year – beating Australia’s 0.1% and 1.5% on both counts. So things must be going even better over there, then. ;)

It just shows that a rise in GDP isn't really what most of us think of as ‘growth’.

Posted by: David Sandiford at March 3, 2005 05:25 AM

P.S. It would really have set the cat among the pigeons if the ECB had reduced EU interest rates today, but no such luck.

Posted by: David Sandiford at March 3, 2005 02:14 PM

The interesting thing now is whether the Australian government, after gaining control of both houses of parliament, can deliver the goods on tax and industrial relations reform.

Well it can, but it often seems that some of the steam has gone out of Howard on the domestic front.

Anyway good cartoon:-
http://www.nicholsoncartoons.com.au/

Posted by: giles at March 3, 2005 11:28 PM

Good one.

Posted by: David Sandiford at March 4, 2005 09:00 AM