The growth figures

April 27, 2011 3:55 PM

There is no doubt that the growth figures this morning are, in a word, lame.  Half a per cent up this quarter after a half a per cent down last quarter equals nothing much for six months.  The question has to be: why isn't the economy growing much?  This morning many people are saying that this shows the result of the fiscal consolidation, that the economy is slowing down as spending cuts start to bite.  Looking at the numbers though, that doesn't seem very clear at all.

The critical thing is the different contributions to growth.  The Office for National Statistics release (summarised in the graph to the right) shows that services rebounded after a dismal winter.  Manufacturing continued to grow though its contribution to overall economic growth is limited as the sector isn't that large these days.

Government and other services grew.  The release says that: "Health and recreation made the largest contributions to the increase."  That is a little hard to reconcile with the idea that cuts in spending are the source of our present economic malaise.  Cuts haven't really shown up in the data yet.

What has fallen sharply is construction.  It's down again and offsets the services and manufacturing growth to produce the stagnation we've seen.  In the earlier quarters of 2010 where growth was stronger, so was construction.   Another graph from the report shows how sharply construction output has fallen, and how strongly it was growing earlier in 2010.

If we want to understand why growth has been lame in the past couple of quarters, we need to look at why construction output has been falling.  There are a few potential explanations:

While spending cuts haven't got going yet, people know they are coming so economic confidence is low. It could be that other sectors are being weakened and construction particularly hit by the expectation of cuts even if they hadn't really got going even in 2011 Q1.  The problem with that argument is that once you start talking about people's confidence in the future why stop there?  If the economy is contracting because of a future contractionary fiscal policy - expected cuts - then why wouldn't more borrowing now - more expected cuts further down the line - have a similar effect?

Economists have asked this question before, Robert Barro formulated it as "Are Government Bonds Net Wealth?" and I looked at the evidence in an earlier post.

Construction is in particular trouble because of sharp cuts in government investment spending. Ironically this is the least contentious aspect of the Government's fiscal policy, and represented a bipartisan consensus going into the last election.  Lots of capital spending had been brought forward and Alistair Darling planned for it to halve from £44 billion in 2009-10 to £22 billion by 2013-14.   That was why, in our report on how to cut spending by £50 billion with the Institute of Directors, we focused on consumption expenditure.  This is important to note because it means that if we wanted to row back, we would be reversing not just this Government's plans but those of the previous administration.  That would undermine the credibility of British fiscal policy and likely make the eventual adjustment a lot harder.

Construction is just pretty volatile. Jeremy Warner, Associate Editor at the Daily Telegraph, made a very good point on Twitter.

[blackbirdpie url="http://twitter.com/#!/jeremywarnerUK/status/63186333421678592"]

That final possibility is important.  The Institute of Directors always predicted an "L of a recovery" and their judgement appears to have been pretty sound.  After a financial crisis and with the finances in such a poor state the recovery was always likely to be weak and fluctuations in construction spending that could mean very little at all could blow it off course.  At this stage we are still in a pretty average position by eurozone standards.  Neither collapsing like the periphery or going from strength to strength like Germany.

Instead of panicking on the basis of one quarter or another's data we should be focussing on building a long term strategy for growth by reducing avoidable burdens imposed on families and businesses.  That's where there is a more credible criticism of Government policy and where I made some recommendations last time the growth figures came out.There is no doubt that the growth figures this morning are, in a word, lame.  Half a per cent up this quarter after a half a per cent down last quarter equals nothing much for six months.  The question has to be: why isn't the economy growing much?  This morning many people are saying that this shows the result of the fiscal consolidation, that the economy is slowing down as spending cuts start to bite.  Looking at the numbers though, that doesn't seem very clear at all.

The critical thing is the different contributions to growth.  The Office for National Statistics release (summarised in the graph to the right) shows that services rebounded after a dismal winter.  Manufacturing continued to grow though its contribution to overall economic growth is limited as the sector isn't that large these days.

Government and other services grew.  The release says that: "Health and recreation made the largest contributions to the increase."  That is a little hard to reconcile with the idea that cuts in spending are the source of our present economic malaise.  Cuts haven't really shown up in the data yet.

What has fallen sharply is construction.  It's down again and offsets the services and manufacturing growth to produce the stagnation we've seen.  In the earlier quarters of 2010 where growth was stronger, so was construction.   Another graph from the report shows how sharply construction output has fallen, and how strongly it was growing earlier in 2010.

If we want to understand why growth has been lame in the past couple of quarters, we need to look at why construction output has been falling.  There are a few potential explanations:

While spending cuts haven't got going yet, people know they are coming so economic confidence is low. It could be that other sectors are being weakened and construction particularly hit by the expectation of cuts even if they hadn't really got going even in 2011 Q1.  The problem with that argument is that once you start talking about people's confidence in the future why stop there?  If the economy is contracting because of a future contractionary fiscal policy - expected cuts - then why wouldn't more borrowing now - more expected cuts further down the line - have a similar effect?

Economists have asked this question before, Robert Barro formulated it as "Are Government Bonds Net Wealth?" and I looked at the evidence in an earlier post.

Construction is in particular trouble because of sharp cuts in government investment spending. Ironically this is the least contentious aspect of the Government's fiscal policy, and represented a bipartisan consensus going into the last election.  Lots of capital spending had been brought forward and Alistair Darling planned for it to halve from £44 billion in 2009-10 to £22 billion by 2013-14.   That was why, in our report on how to cut spending by £50 billion with the Institute of Directors, we focused on consumption expenditure.  This is important to note because it means that if we wanted to row back, we would be reversing not just this Government's plans but those of the previous administration.  That would undermine the credibility of British fiscal policy and likely make the eventual adjustment a lot harder.

Construction is just pretty volatile. Jeremy Warner, Associate Editor at the Daily Telegraph, made a very good point on Twitter.

[blackbirdpie url="http://twitter.com/#!/jeremywarnerUK/status/63186333421678592"]

That final possibility is important.  The Institute of Directors always predicted an "L of a recovery" and their judgement appears to have been pretty sound.  After a financial crisis and with the finances in such a poor state the recovery was always likely to be weak and fluctuations in construction spending that could mean very little at all could blow it off course.  At this stage we are still in a pretty average position by eurozone standards.  Neither collapsing like the periphery or going from strength to strength like Germany.

Instead of panicking on the basis of one quarter or another's data we should be focussing on building a long term strategy for growth by reducing avoidable burdens imposed on families and businesses.  That's where there is a more credible criticism of Government policy and where I made some recommendations last time the growth figures came out.

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