Friday, 1 June 2012

Economics 101 – A Recap On The Current UK Economic Situation

We are on the brink.  The UK is in recession again, tax rises and public spending cuts are biting, unemployment – especially amongst the young – seems intractable, for many living standards have fallen sharply and the outlook is for worse to come.

Why Is This Happening?

Has the economic growth prevalent for around 250 years since the industrial revolution come to a halt?  Actually no.  Overall the global economy is in fine shape, with annual growth around 3-4% a year (a rate that means the living standards of the 7 billion people on earth double roughly every 20 years).

So the world is moving on fine, shifting people out of dollar-a-day poverty at a record speed.  But Western Europe, Japan and some other developed countries are not growing.  Why is this?

Mainly because countries like China and India can undercut us.  Their labour is cheaper and so they can make things for less than we can in the UK.  Us consumers tend to like a bargain, and so we have bought imported goods and through those choices closed down much of the manufacturing (and increasingly service) base of the country.

In many ways this is a good thing.  If there is extra money to go around wouldn’t we, morally at least, prefer it to go to people earning a fraction of our income, rather than us?  Not that moral comfort gets the bills paid.

So the Western world’s share of global wealth is declining, and all we can hope for is that this happens in a way that isn’t too painful.  If it goes too fast our share will decline so rapidly that our living standards will fall; if we are lucky, then we’ll merely stagnate.  Cheery, eh!

Not much can be done about this trend, and there is plenty of it left.  It ain’t going away soon, as the following link to a TED video shows ( ).  And once India and China finally catch us there are plenty of others left to join them, including most of Africa, if it can get its act together. 

Meantime we’ve all been assuming that the growth trends of the last 50 years will continue, sort of expecting the typical post-war year on year improvements in our economy.  When this doesn’t happen there is a strong reaction as illustrated by the horror expressed that the UK economy has gone in to a double dip recession.  Politicians have heard this need of ours and gone out of their way to keep growth going for as long as possible, not least so that they have a good shout at getting re-elected.

Unfortunately this has had a side-effect that even when we can’t grow that fast the politicians have felt they have to keep boosting the economy.  To some extent we’ve all done it by living beyond our means.  Borrowing money is sometimes sensible, for example to take out a mortgage, but governments, businesses and individuals have taken on debt way beyond sensible levels over the years.

As you would if you went wild on the credit card, life was good while we enjoyed all this spending… and borrowing.  You can look like you are doing well, keep up with the Jones, boost GDP figures to unsustainable levels.

Until the bank manager called and asked how we’d pay it all off.  We wondered if we might borrow some more, have some more time to reduce the loan.  As we neared our credit limit the answers became more and more severe, and for those countries that finally lost the confidence of their debtors (such as Greece, or Leeds United) the consequences were catastrophic.

Worse still we’ve not only got record levels of debt, but we’ve made promises that we can’t keep in areas such as pensions, health care and looking after the old and disabled.  If these commitments were put on the country’s balance sheet overall levels of debt would double again.  It’s not surprising that politicians would rather not do so, really.

We've overspent (and in a way participated in a form of generational theft; our past high living standards will have to be paid for by our children in the future), and this will have to be dealt with through painful measures such as cutting back spending and raising taxes.  There can be some debate as to the speed of the cutbacks, but only at the margin.

This, of course, is not the first time we’ve dug ourselves a huge financial hole.    In fact you can see these little booms and busts as the slight wobbles in the growth trends of post was UK in the TED video link.  Look out for the ‘crashes’ of 1974, 1990 and 2000.

But, what is different this time is that the difficult remedies take place in the context of global competition, which means our trend rate of growth is close to zero (rather than 3%), and cuts mean a genuine reduction in living standards, not just a slowing in their growth.  People tend not to like that.

As the doctor might say, this is going to hurt.  A lot. 

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