‘Going for Growth’ Wendy Carlin UCL & CEPR. UK’s economic predicament Growth is weak … no V-shaped recovery where growth is faster than trend to return.

‘Going for Growth’

Wendy CarlinUCL & CEPR

UK’s economic predicament

• Growth is weak … no V-shaped recovery where growth is faster than trend to return economy to previous growth path

• ‘Double-dip’ debate diverts attention from fact that growth rate is unlikely to be above trend

Bank of England Projection for the level of GDP

Source: BoE Inflation Report February 2011 Chart 5.11

Longer-run perspective: permanent loss of approx. 10% GDP for UK

90

100

110

120

130

140

150

160

170

180

1993 1996 1999 2002 2005 2008 2011

WorldUK

GDP: Forecast vs. pre-recession trend2008=100

Source : Oxford Economics/Haver Analytics

*dotted lines represent pre-recession trend Fcst

UK’s front-loaded fiscal consolidation

-2

-1

0

1

2

3

4

US Eurozone France Germany UK Japan China

2009 2010 2011

World: Fiscal policy% of GDP

Source : Oxford Economics

Planned discretionary fiscal policy changes. +ve represents stimulus

UK’s economic predicament

• Fiscal consolidation is necessary but current plan is too front-loaded– If fiscal consolidation was to be expansionary, we should

see front-loaded positive expectations effects on consumption & investment

– Preferable would be to back-load the consolidation by building in commitments (legislation) to lower entitlements (e.g. higher pension age, lower public sector pensions)

• these do not reduce aggregate demand now but secure the long-term commitment to a reasonable debt ratio

Implications for growth strategy

3 opportunities that should not be squandered1.The labour market has performed better than in previous recessions – danger of losing this advantage in next couple of years; focus on entrants to labour market2.Firms entered the crisis period with high profits – reflected in low bankruptcies in crisis BUT investment has been extremely low

Real interest rates are very low … in principle, favourable conditions for private & state investment

3.Large depreciation. How to capitalize on this to produce the re-balancing required?

Unemployment rates

Source: BoE Inflation Report February 2011

Participation rate

Source: BoE Inflation Report February 2011

Company liquidations in England and Wales and GDP

Source: Bank of England Inflation Report February 2011 .

UK Real interest rates

-6

-4

-2

0

2

4

6

8

10

1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013Source: Oxford Economics

%

UK: Real interest rates

Long rates

Short rates

Forecast

‘Rebalancing’

– Dealing with regulatory / competition issues in banking and introducing macro-prudential component into stabilization policy regime

– Shifting the balance in the contributions to the growth of demand: from consumption, housing & government expenditure to investment and net exports

– The longer term role of finance as a producer of tradeable services, i.e. as an export industry

‘Rebalancing’

• Clear that the balance in the pattern of growth has to change toward investment and net exports

• Less clear that this entails a major shift in the UK’s industrial specialization

• UK’s high value added tradeables sectors are in finance, business services, cultural industries, education, pharmaceuticals, biotech/medicine, selected high tech engineering, …

• Rely on excellent higher education system, international labour & capital mobility

Why do tradeables matter?

• In long run, welfare depends on productivity growth, which requires investment and innovation

• In an open economy, ability to compete in export markets is key to being able to pay for imports

• Depreciation provides a quick boost to competitiveness – but it reduces living standards

• Can only contribute to rebalancing & longer run productivity growth if the breathing space is taken advantage of by investment in tradeables– What is UK’s comparative advantage? Radical innovation industries

Government role

• Using public debt as a buffer in face of large shock is sensible • Growth is essential to reducing public debt ratio• Tight constraints on traditional current government

expenditure and tax cuts• Exploit relative price changes with complementary policies

that are light on the current deficit and target growth

Make use of

• Low interest rate environment to promote investment Note the weakness of global as well as UK investment prior to financial crisis in spite of high profitability … cannot rely on adequate rebound of private investment

• Complement behavioural changes induced by increase in oil price with policies to steer large-scale structural change to low-carbon economy

• Boost to tradeables from depreciation – use complementary not conflicting policies such as immigration controls that damage higher education & other high VA industries

There are economically sensible policies available to support growth consistent with debt stabilization – challenge is in sufficiently creative / imaginative politics

Chart 4.8 CPI inflation and the contribution of VAT, energy prices and import prices(a)

Sources: ONS and Bank calculations.

(a) The blue swathe sums the minimum and maximum of the individual estimated impacts of VAT, energy prices and import prices on CPI inflation. The VAT impacts are based on the 25% and 75% pass-through assumptions shown in Chart 4.2, adjusted for changes in petrol prices that are incorporated in the energy price impacts. The energy price impacts are the direct and total including indirect estimates shown in Chart 4.4. The import price effects are based on the estimates shown in Chart B in the box on page 34. The green swathe shows CPI inflation less the minimum and maximum of the blue swathe.