Friday, 23 April 2010

Economic Growth: I don't agree with Gordon

A couple of figures released in the last couple of days show that the recovery from the recession is weak - despite, as I noted the other day, very low interest rates and a substantial amount of funds injected into the economy by the Bank of England (QE, or quantitative easing).

Unemployment was up to 2.5 million, and this does not include those of working age classed as "economically inactive", a record 8m.

GDP in the first Quarter was estimated to be up 0.2%. That is lower than expected.

And in addition, inflation (the RPI) rose to 4.4%. This will partly because of the fall in the value of sterling but supports those woried that the large QE programme and low interest rates will be fuelling inflation. This is good in that its one way of reducing the debt burden - but bad because interest rates may have to rise.

So does this mean that the Government is right to warn that the Conservative plan to "take £6bn out of the economy" risks damaging the stilted recovery? And that teh focus must be on protecting growth rather than cutting the deficit?

I think not:

The amount that the Tories are talking about in 2010/11 is small compared to the economy. Even if it were to have a negative effect on the economy it's too small to be material (even Vince Cable agreed with that, until he changed his mind). But it is an important start which sends a message that is critical to investors who fund our debt.

As I've noted before, reducing the amount the Government takes from the rest of us does not take it out of the economy. It leaves it with the rest of us; and we are capable of spending it much more efficiently than the Government.

And perhaps most importantly, the debate on this topic has ignored the interest rate burden from our massive public sector debt. The Bank of International Settlements (the nearest thing the world has to a central bank) published a report on the debt burden around the world, noting amongst other things that the UK has one of the biggest long term problems.

The interest paid on Government debt (about £30bn last year) is in the top 10 of things the Government spends money on, and is forecast to rise to the top 3 or 4 in the next five years (at over £70bn a year). That's in the same ball-park as the entire education budget.

And a lot of that payment really IS money out of the economy. Many countries with high debt - like Japan, Germany and Italy - are fairly secure because their debt is mostly owned by their own residents. The UK however cannot afford to buy all the debt we have. A lot (about a quarter) is held by overseas investors. So although some of the interest we pay is recycled in the UK economy as payments to savers, pension funds and so on, a lot goes to overseas investors. And leaves our economy.

Each % point rise in interest rates we have to pay on Government debt means about £3bn will leave the UK economy. And that figure will grow as the debt figure rises (currently the debt figure is rising at about £150bn a year).

That is why action has to be taken on the deficit quickly. If it isn't interest rates will have to rise to persuade people to buy our debt.

On reading this post I can understand why the Conservatives aren't making more of the point. It's a bit complicated, even boring.

But it's really important: the debt run up by Labour has become so big that the interest we pay - especially that we pay overseas - is becoming a massive drag on the economy. The other parties aren't really interested in this, but it runs to the heart of Conservative thinking for the past few years. If you don't cut the deficit, growth will be weak. Not the other way round.

1 comment:

Troy said...

It is obvious to you, it is obvious to me. Shame the rest of the country were not taught economics at Nottingham University.