A fragile recovery – but the Tory economic plans remain folly

The Duncan Weldon Economics Matters Column

Last week saw the release of the second estimate of third quarter GDP. I thought I’d use this column to go through the release in greater detail than my quick initial response on Left Foot Forward.

The second estimate provides more detail than the preliminary release and looking through it gives a good picture of the State of the UK economy and some clues for policy makers. The headline quarterly figure was revised up from -0.4% (quarter on quarter) to -0.3%. What is more interesting is the breakdown.

The chart below shows the contributions of the various components of GDP to growth since the beginning of the current recession.

The first thing to note is that Household Consumption stopped contracting in Q3 2009 – the first time it has not subtracted from growth since the beginning of the recession. It remains 3.7% below its Q1 2008 peak. What is interesting to note is that the ONS release says that this was driven by ‘a strong increase in expenditure on motor vehicles’. This would appear to indicate that the Government’s ‘cash for clunkers’ programme was a major factor in preventing consumption falling again. In the absence of such support it is highly likely that consumption would still be dragging GDP down.

Government Consumption (current government spending) remained a source of growth. It is now up 1.9% in the past year. The chart above demonstrates that government spending has been one of the few sources of growth over the past 18 months; if the Government had cut spending and tried to balance the budget (the policy pursued in Ireland and welcomed by many Tories), the falls in GDP would have been even more severe.

Gross Capital Formation (investment – a vital component discussed on LabourList last week) continued to fall – although by less than previous quarters. As I argued last week, the fall in investment, rather than the increase in government debt, is the real threat to future growth. The chart above demonstrates that it has also been the major driver of the current recession. The ONS release demonstrates the government action is helping, noting that “there was a significant increase in government investment”.

A separate ONS release, on Wednesday, reported that ‘business investment’ has fallen 21.7% year on year. With the prop of increased government investment, gross fixed capital formation is ‘only’ 14.2% lower than one year ago.

Worryingly, despite the large falls in investment, the Conservatives now plan to abolish the £50k investment allowance, reduce general plant and machinery allowances by 12.5% and long life plant and machinery allowances by 6%. It is not hard to imagine the effect this will have on business investment.

Finally, Net Trade subtracted from growth for the first time since the beginning of the recession as the UK trade balance widened. This is a worrying development and one that demonstrates the problems inherent on relying on ‘export led growth’ as the Tories currently appear to.

The overall picture that emerges from the release is one of fragile recovery. Government support for the economy (in the form of ‘cash for clunkers’, or increased current spending and increased capital spending) is gaining traction and stopping the falls from being as bad as they could be. In the absence of government support, the quarterly fall could easily have been more like -0.6% than -0.3%.

The report also demonstrates the folly of Conservative plans. Not only have they argued against the current stimulus and in favour of cutting back spending but they seem to be pinning their hopes on ‘export led growth’.

Cutting back on government spending and investment whilst abolishing tax reliefs on investment would lead to an economic disaster. Imagine what the chart above would look like:

Consumption: In the absence of schemes such as ‘cash for clunkers’ and with reduced personal income (from benefits) this would again start to contract.

Government Spending: Under Mr Osborne’s plans for an ‘austerity budget’ this would stop adding to GDP and start subtracting.

Gross Capital Formation: If government capital spending is cut and private sector investment inducements removed, this could go back into freefall – not only reducing GDP in the short run but also harming our long run growth potential.

Net Trade: This is the great hope of the Conservative Party. But to drive GDP forward (in the face of falling domestic demand), the UK would have to sustain an export boom with net trade adding at least 0.5/0.6% each quarter. Given the world economic outlook and given that many countries are pinning their hopes on similar strategies, this seems highly unlikely.