I posted this thread on Twitter this morning:
In a week when politics is not meant to be happening the government has let it be known that it might hold a mini-budget next week and that growth is its sole economic goal. That aim makes no sense in the context of their own behaviour. A thread……
The growth Kwasi Kwarteng says he wants is in the gross domestic product, or GDP, of our country. GDP is said by economists to be our national income. Growth is the increase in that income.
There is a formula that explains how this is made up. It is:
GDP = C + G + I + (X - M)
C is basically household consumption. G is government spending excluding payments like pensions and benefits, which deliver consumption instead. I is investment in real new items for long-term benefit. X is exports and M is imports. So X-M is the net balance of trade.
The government's policy of delivering 2.5% growth does require that overall these aspects of UK economic behaviour trend upwards. But how likely is that?
Let me deal with the easy ones. Whilst Brexit stress remains, and with a trade war with Europe likely over the Northern Ireland protocol, the chance that exports are going to grow whilst imports will fall is remote. Politely, to suggest that might happen is absurd.
Investment growth is also easy to dismiss. First, there is no academic evidence that tax cuts stimulate investment. And in a period of economic crisis, which is what we have, there is massive evidence that investment falls because no one knows whether doing it will pay.
In that case, the idea that investment is going to increase over the next couple of years is another thing that only economic fantasists might believe in.
Then there is government spending. The government says it believes in the small state and wants to cut this. In that case, let's assume that it will stick to its word. That means government spending will fall.
So, three out of the four elements that can deliver growth over the next year or two have greater likelihood of falling than increasing. I suspect few economists would disagree.
That means Kwasi Kwarteng must be pinning all his hopes for growth on a massive increase in consumer spending right now. Nothing else can, simply because of the mathematics of this, deliver the growth he wants.
So is that growth in consumption likely? We know that a great many households will be stretched to their limits and beyond (meaning they will plunder whatever savings they have) over the next year or two by the cost of living crisis.
I estimate 60% of households will be hit very hard by the energy crisis and other inflation over the next couple of years. They will spend all they get. They might even borrow to spend a but more. So it looks like they will consume a lot.
But let me also add that they already do this. That is why those same households have remarkably few savings. They already spend all they get. All that will happen over the next year or two is that they will get no choice on what they spend their money on. It will just be basics.
GDP data does not care about this. That people will change what they spend their income on doesn't matter to the GDP calculation. However, there is still a reason why these 60% or so of lower-income households will contribute less to growth.
This reason is obvious and is that because they won't get the pay or benefit rises that they need to keep up with inflation, because the government is adamant that they should not, then in real terms their consumption will fall.
These households will spend all they have, but they will in real terms have less to spend because of real cuts in their income after inflation are taken into account. No amount of borrowing is going to make good for that. So, in real terms these people will cut their consumption.
That means all Kwarteng's hopes for growth will now hang on the top 30% to 40% of households, who will need to go on the most spectacular spending bonanza to give him the growth he wants.
And they are not going to do that. In economic downturns, which is what we have, people who have a choice don't spend, even when the falling value of money makes it rational to do so in the eyes of an economist.
Instead, these people save, because their mindset moves into a defensive mode. They are less likely to change job. And they put off spending on big-ticket items because they want to be sure that they will still have some money left when the crisis is over.
And saving, whilst rational for those doing it, does not create growth. Instead it withdraws money from use in the economy. And since investment is almost never funded by funds provided by savers in the UK, it does not increase investment either. It's just dead money.
Of course, there will be exceptions to all these comments. But generalities matter here. We are after all talking about the behaviour of populations and not individuals when looking at this issue.
When looking at these generalisations it is very hard to see where Kwarteng is going to find the growth he wants.
And that matters. His whole economic policy is based on growth. He assumes he can pay for tax cuts and new spending from growth. There is nothing else in his plan that could do so. And there's not a hope that the growth he wants will happen.
So what happens then? First, the government looks stupid. I can live with that.
Second, he runs a massive deficit. But that will then be used as an excuse for austerity, and because what austerity represents is a cut in government spending we'll just keep spiralling downwards into deeper recession.
In that case Kwarteng is not just mistaken in his assumptions about growth: he is also deeply dangerous because he is basing policy on those obviously false assumptions.
We are heading for deep trouble because economic ideologues are in charge of the country. Brace yourself for the impact. It's not going to be an easy ride.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
“First, there is no academic evidence that tax cuts stimulate investment”
well there is..
https://academic.oup.com/qje/article-abstract/133/4/1803/4880451?redirectedFrom=fulltext
https://research.stlouisfed.org/publications/economic-synopses/2019/08/30/tax-cuts-venture-capital-and-long-term-growth
https://taxfoundation.org/corporate-tax-cut-economic-growth/
https://scholarship.richmond.edu/cgi/viewcontent.cgi?referer=&httpsredir=1&article=1056&context=spcs-faculty-publications
why are you so disingenuous in what you do?
I’m not
I think all that work has been discredited
And just look at the data: see what happened when Sunak cut the rate and increased allowances
Control the rest for tax avoidance activity and the claims are nonsense
I would say why are the author’s of the papers Philip posts so disingenuous in what they do?
An obsession with GDP and growth piles folly on stupidity.
GDP is a useless measure in the first place – as Robert Kennedy said in March 1968, “it measures everything in short, except that which makes life worthwhile”.
And then Goodhart’s Law tells us that, “when a measure becomes a target, it ceases to be a good measure.”
Does it make any more sense to use a bad measure as a target?
Just a though experiment: one way to boost GDP would be to financialise the home and domestic relationships. Babies would have to pay parents for care (and would need to take out loans to fund it). Elderly parents would have to pay their children to visit. Partners would have to pay each other for cooking or doing the washing or other more personal services. Every action would require a payment Simple – nothing would change, but there would be measurable “growth” in the economy. And awful.
Wholly agreed
As I always told students, the easiest way to increase GDP is to have a climate disaster (an oil tanker hitting a coast) or to get everyone to divorce – the fees would be staggering, and the misery enormous, but GDP would rise
I like your analogy of the tanker hitting the coast…I think the government are on a similar course.
Wholly agree with Andrew’s comment about GDP being a useless measure. Similar to the (absurd) fixation with the FTSE, etc., indices. GDP fixation has been – and is seemingly continuing to be – used to justify extreme inequalities of income and wealth, austerity politics and, arguably, directly contributes to political decisions that lead to harming the planet.
Kwarteng is just the next in line of idealogues who adopt the mainstream economic view that there must be endless growth and adopt the Mont Pelerin society (neoliberal) approach to economics (and society). This was proven to be disastrously wrong with the financial meltdown that (if my memory serves me well) was marked this very day by the failure of Lehmans. Endless growth (reflected in GDP) is simply not a credible or viable goal. Indeed I would argue that it is a nonsensical goal particularly if we actually care about humankind in general and the planet that we live on. A more balanced approach must be adopted if we are to avoid this continued obsession with GDP growth, small government, austerity politics, etc., and the inevitable same outcomes! Madness has been sometimes described as continuing to do the same thing and expect a different outcome. They clearly haven’t learned – ironically on this very day that Lehmans failed – that neoliberal, monetarist policies do not work, never have worked and never will work and even propose removing or increasing the cap on banker’s bonuses!!!???
Putting aside the fact that it has been drafted by politicians, I would suggest reading the Scottish Government’s National Strategy for Economic Transformation. Whilst I would reserve judgement on certain elements, I do believe it is a step in the right direction for how the UK as a whole should be governed and would congratulate the Scottish Government for trying to convey a vision that isn’t simply about GDP. As a hugely summarised take on it I would highlight some key elements: 1. the deliberate use of the word citizen (as opposed to consumer that is all too often the basis of economic theory and thinking); 2. the emphasis on creating a “wellbeing economy”; 3. tackling structural inequalities; 4. driving a green economic recovery to meet climate and nature targets and a just transition; and, 5. a Fair Pay First approach. Interestingly, it emphasises the ‘Team Scotland’ approach, i.e., drawing on the strengths of people and organisations from all sectors of the economy and, in particular, the need for the government to continue to play a direct role in the economy. In short, Kwarteng (and others of his ilk) would do well to read it and implement a more balanced approach to the economic wellbeing of the country as opposed to their utterly futile proclamations about GDP growth, small government and raising the cap on banker’s bonuses. Their current approach will NOT address the cost of living crisis, increasing levels of poverty, avert the undoubted increase in deaths over the winter, etc. It is clearly not intended to address the increasing wealth gap and indeed is tailored to benefit the very wealthy and the wealth extractors. Sadly, with the right-wing control of most media, it is unlikely that an understanding of balanced economic policy is going to be absorbed by the general public and, should GDP increase, they will proudly declare themselves to be a successful government, masters of economic management and policy and the party of business and they will trot out their usual rubbish about tax, fiscal prudence, government debt, etc….all to the detriment of the vast majority of people in the country.
Thanks
Wow – you are on the ball today Richard!
I think that what Kwarteng is actually going to do is to try to move GDP around the economy thinking that he is actually going to increase it! I think that he thinks that by reducing yet more regulations and under-funding the public sector he will achieve this magical growth. He neglects the spending link between the public and private sector like all Tories do, whether black, white, whatever.
My public sector firm is losing people left, right and centre at the moment to higher paid wages in both sectors. I have lost two staff this month that way having spent 3 years developing them.
One of the worst things I’ve seen about Kwarteng was an article in the Guardian challenging Labour to have more front bench BAME shadow ministers.
It was typical identity politics because it was concentrating on the wrong problem.
It does not matter what colour, gender or ‘whatever’ your chancellor of the exchequer or shadow chancellor is; what matters is that they know what they are bloody doing and are not led by ideology.
Kwarteng clearly is led by ideology. His ethnic background is superfluous. It’s the former that will cause the damage as you point out.
So much for identity politics.
And, not to put too fine a point on it, more than half the Labour MPs elected in 2019 were women but less than a quarter of the Conservatives; and there are 22 Conservative MPs elected in 2019 from an ethnic minority background (out of 365) and 41 Labour MPs (out of 202). As a whole, the UK population is about half women (doh) and 87% white, so there should be about one in eight from minority backgrounds. So the Conservatives need to double both their proportion of women MPs, and their proportion of MPs from an ethnic minority background
And that is without thinking about the socio-economic or educational background of the MPs. How does about 6% of children attending private schools translate into more than half of the cabinet? How can they have any idea about the lives of ordinary people?
So we might congratulate Truss and Kwarteng in beating the odds within their own party – which seems to discriminate as an institution against people educated at state schools and against women and against non-white candidates – while also encouraging Labour to promote more people from their already quite diverse pool of representatives to high office.
Kwarteng went to Eton
It is intersectional.
Truss is a woman and attended a state school then Oxford (PPE). But she is also white and as I understand it she comes from a relatively privileged middle class background (father an academic, and mother a nurse and teacher).
Similarly, as I understand it, Kwarteng also comes from a middle class professional background (his father is an economist, and his mother is a lawyer). He attended Eton and Cambridge (History). And he is male. So he is already privileged in a number of respects. But no doubt he has faced his share of racism.
I suspect, like most Conservatives, both would claim they have risen to high office through their own innate talents, and not thanks to privilege and luck.
My main point is that the Conservatives presenting themselves as a paragon of social mobility because they have had three women prime ministers, or have several non-white faces on the front bench, does not match the reality that these are the exceptions. Most demographics (other than old white men, with private educations) are underrepresented on their benches.
Agreed
In his book “Chums” about the current generation of Tory leaders Simon Kuper explains that at the time that Johnson applied to Oxford there were on average 15 applicants for every place, unless like Johnson you applied to do Classics in which case the acceptance rate was four places for every five people that applied.
An anomaly that arose because only a very small number of schools, mainly private, taught Greek and Latin at A-level.
Anybody who has had any involvement in Higher Education knows where this situation leads in terms of student quality.
Kwarteng applied for and did the same course.
I did raise my eyebrows when I read about it this morning. Trouble is, most people have wages falling behind inflation. We have recently seen massive increases in energy bills, petrol, food, and raw materials. The idea that consumer spending is going to increase is simply delusional. Even with the price cap, all working people have taken a big hit recently , even it was presented as having saved us from disaster. Our energy bills have still doubled in the last 12 months.
When the maths laid out before us, I am at a loss to explain how the treasury can justify the logic behind the thinking. Then we realise the dangerous dogmatism at work here.
The Treasury couldn’t justify the logic behind the thinking – which is why Tom Scholar was immediately turfed out as Permanent Secretary. They’ll be looking for a new candidate to become Permanent Secretary who, I suspect, will find it within himself (or herself) to be able to find a way to justify the thinking.
Whether or not Scholar was much good at his job, I don’t know (notable that Lord Agnew had a suspiciously well-timed attack piece published in the friendly media shortly after he was fired), but you’d assume he’s not enough of a blithering idiot to back Kwarteng’s nonsense.
Agreed
Fantasy it is indeed. It beggars belief that this passes for policy.
Your thread captures the key points about the arithmetic of growth as well as the likely behaviour of individuals (as consumers, as investment decision makers etc.)
If I have a quibble it is only a minor one. I fear that net trade might actually contribute to growth… but not in a good way. Could imports collapse as people are simply unable to pay for stuff?
Tracking savings behaviour will be interesting but it really does need breaking down not just by sector (corporate/government/individual) but also amongst individuals by income/wealth; aggregate data may conceal a lot.
I suspect that the overall savings rate for individuals might not rise that sharply; lower income people will not save more – on the contrary, they will “dis-save” (borrow) in order to stay alive (and storing up further problems that will slow any eventual recovery)… and this group might well me quite large and have access to substantial borrowing via re-mortgaging etc.. When looking at aggregate data this dis-saving may well obscure a sharp rise in savings amongst those that do have “spare income” over life’s necessities. In some sense, it is the second quartile of earners that should be the bellwether for where discretionary consumption is going… and it won’t be great.
Thanks
Fair point re trade, but essentials will keep it high, as will exchange rates
Fantastic treatise by you as always Richard.
Yes we are being lead by the dogma of dangerous ideogues of rapacious neoliberalism.
Both parties Tory and Labour are trumpeting the faux argument for growth as the solution to our economic woes when the elephant in the room is Redistribution.
This is whats holding back growth. For an economy to function you need everyone to be players in it not just a few. If the UK continues with these policies it’ll be just the 0.2% left to take part whilst the rest of us have gone to economic gomorrah.
Great thread laying the madness bear for people to see, unfortunately many including the Chancellor et al will not see this. Also what gets me is when people say it’ll be so much better when the rate of inflation drops back to (say) 2%. They forget conveniently that the previous high rate of inflation has simply baked in the increased costs into the prices being charged for goods and services. Only deflation would reduce actual prices and that’s not great for anyone.
“the madness bear” – nice one!
At risk of being accused of nit-picking, can I put in a plea to avoid the confusing use of term ‘rate of inflation’ when referring to inflation (which is by definition a rate of change)? In mathematical terms, the ‘rate of inflation’ would be a second derivative (and thankfully nowhere near 9%!).
Noted 🙂
Probably a silly question. If prices increase so people buy less but spend the same amount, has growth reduced or remained the same?
GDP is measured in money, so that would be constant
Nominal GDP would remain the same…. but real GDP would decline…. and when people talk of GDP growth they are nearly always referring to REAL GDP growth.
Maybe….
I got the impression from other sources that they are relying, at least in part, on financial services (aka the City) to come to their rescue. Current contribution to GDP is about 8%, half in London – and arguably little of this is of any use to the man on the Clapham (or indeed the Mile End Road) omnibus. Rather it will increase the wealth of those who don’t need it, and whose spending does little for the real economy.
Financial services also contribute a trade surplus, so they presumably want to export even more – a clear case of using scarce resources to benefit the foreign sector and not the public good.
https://commonslibrary.parliament.uk/research-briefings/sn06193/
Thanks
Indeed! Every time there is a major earthquake in Japan, its GDP increases.
https://diem25.org/yanis-varoufakis-picks-apart-the-corrupt-european-energy-system/
An excellent youtube about energy. Even Kwarteng and Truss should be able to understand it.Not that they want to.
https://youtu.be/NicE0-N9ux0
Interest explanation from Yanis Varoufakis about the interrelationships he sees between the wholesale energy markets, where often the sellers and buyers are related, the energy cap and the enabling role of Governments across Europe in a broken energy market. How broken? The UKs top energy generators are estimated to make more than £170 billion in excess profits over the next two years whilst it’s estimated that the recently announced ‘energy price support package’ will require borrowing £150 billion.
Here in the UK there has been scarcely a peep out of the Competition and Markets Authority about the energy market in recent years. And the ‘non-ministerial government department and an independent National Regulatory Authority’ that is Ofgen is a minnow between powerful politicians and well resourced industry lobbying. Not a favourable environment for Ofgen’s to execute its principal duty of protecting customers
I was fascinated to discover that Kwarteng is the son of a professional economist and himself achieved a PhD in economic history. He ought to know those basics!
(Though I wondered how many economists make enough money to send their children to Eton, maybe his mothers legal work was highly remunerated).
He got a free scholarship
Maybe he understands the impact of the FX rate on the value of exports, unlike plenty on here it would seem?
So we follow the mistakes of other countries to preserve the exchange rate and still wreck the economy? Madness
Richard wrote in a comment “the easiest way to increase GDP is to have a climate disaster (an oil tanker hitting a coast) or to get everyone to divorce – the fees would be staggering, and the misery enormous, but GDP would rise”.
Apart from that, there is no mention of climate in Richard’s post or in any of the comments.
I am perplexed. Do all of you want growth?
I believe that, first, climate change is mainly caused because the proportion of CO2 in the atmosphere is one third higher than it was 150 years ago.
Second, the concentration is increasing by 0.7 per cent per year – relentlessly year after year.
Third, world-wide economic growth causes higher emissions of CO2.
Fourth, today there is a massive wild-fire in France (‘France 24’ reports other matters than the changes of the British Monarchy). Also, rising sea-levels, caused by our economic activities, threaten all nations with a coast. (British) Isles are especially vulnerable.
Fifth, COMING GENERATIONS WILL BE HUGELY AFFECTED – BUT LESS SO IF WE CUT CO2 EMISSIONS.
Sixth, surely we can contrive ways for our nations to have satisfactory lives – WHILE EMITTING MUCH LESS CO2.
WHICH OF THE ABOVE DO YOU *NOT* BELIEVE?
I have addressed this lint many times
Does “household consumption” include buying electricity and gas? Does that mean that hugely increased prices help to increase GDP?
Yes
This shows how absurd GDP is as a measure of economic well being.
There will be those who dig into their saving or stop saving so much in order to pay their energy bills. This will cause an increase in GDP.
There will be those who will pay their energy bills spending less elsewhere. The effect of this will, overall, be neutral.
And finally there will be those who will not be able to pay at all, causing a decrease in GDP.
However, if, as I suspect, the overall effect will be to increase GDP to some extent, this increase does not correspond to an increase in well being for any of these three groups.
“I suspect, like most Conservatives, both would claim they have risen to high office through their own innate talents, and not thanks to privilege and luck.”
I’m sure they would say that, but Samuel Kasumu would say prioritising candidates had something to do with Liz Truss’s rise at least: https://www.theguardian.com/politics/2022/sep/14/former-race-advisor-to-boris-johnson-defends-diversity-schemes-samuel-kasumu
Useful summary on the evidence in the article below re whether cutting taxes will help to generate growth.
https://theconversation.com/cost-of-living-crisis-the-uk-needs-to-raise-taxes-not-cut-them-heres-why-188938?fbclid=IwAR11oLBg3ozrmfe8Z_DvZCMuWjUHHSiqE6WBiSnHrIWPEYb6Q9qHtNFwBW0
Tax cuts for the wealthy? No ceiling for banker bonuses? Penury for the rest of us? Kwarteng seeks to create an oligarchy. We’re seeing a declaration of class war here.
Regarding the calculation of consumption (C) there is a rather disturbing factor to add, if the report below on opendemocracy is to be believed. The world price of food is currently being inflated by speculation on the commodities markets by the investment banks. This speculation is to be made easier by the UK Financial Services and Markets Bill which will remove controls over excessive speculation introduced in 2008 by the EU following a food price crisis.
So if his aim is growth perhaps this refers to the increase in turnover in the financial markets as well as the knock-on effect on household consumption (higher prices)?
Link to article: https://www.opendemocracy.net/en/oureconomy/financial-services-markets-bill-investment-banks-profit-food-oil-prices-inflation-hunger/
I think this is likely to be right
This shows a massive lack of understanding of commodity markets and investment bank practices.