Posts Tagged ‘Government spending’

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It is kind of assumed that savings are good, debt is bad. If that is so, then there has been good news from the EU and bad news from the UK. In the EU savings ratios are rising, according to recent data, while in the UK they are falling. So that is EU good, UK bad. It is just that the real story is quite different, because there is something missing, and that missing ingredient is called investment.

Across the global economy savings equal investment. They have to; it is a matter of definition. GDP equals consumption plus exports, minus imports, government spending and investment. But across the global economy exports must equal imports. Drill down and look at government spending and actually it is one of two things: consumption or investment. So GDP really equals consumption plus investment.

But what are savings? By definition they are income that is earned but not spent on consumption. So by definition, savings equal investment.

But supposing we all decide we want to save more, and we all park more of our earnings in our savings account. Supposing there is no corresponding rise in investment. If this were to happen, given the equation that GDP equals consumption and investment, then either as we save more, other people borrow more, or the money we save is lost forever.

To put it another way, across the economy there is no point in saving unless this is matched by investment.

Now take the EU. According to data yesterday (30 July) in the EU27, the household saving rate was 11.0 per cent, compared with 10.7 per cent in the previous quarter. In contrast the household investment rate was 7.9 per cent in the first quarter of 2013, compared with 8.1 per cent in the fourth quarter of 2012.

Now take the euro area. In the first quarter of 2013, the household saving rate was 13.1 per cent, compared with 12.4 per cent in the fourth quarter of 2012. The household investment rate was 8.4 per cent, compared with 8.7 per cent in the previous quarter.

In short, savings ratios are rising, but investment ratios are not. This is not merely a negative development, it borders on being disastrous.

In contrast, the household savings ratio in the UK was 4.2 per cent in Q1 2013, the weakest since Q1 2009 when it was 3.4 per cent. The UK savings ratio is too low, but what really matters is not savings, it is investment.

In the UK investment remains way too low, but here is some rare good news. 2013 looks to be on course for seeing the highest levels of investment in the UK since before the crisis of 2008.

© Investment & Business News 2013

Here are two technical terms, before we get underway: fiscal multiplier and blinkered. A fiscal multiplier simply describes the relationship between government spending and GDP. Blinkered, which was a theory developed by Professor Obvious from the school of common sense, may apply George Osborne.

Here is some simple maths. Let’s say that for every pound the government spends on welfare and department spending, the economy grows by 60p. Let’s say that for every pound spent on infrastructure, the economy expands by one pound. Professor Obvious might suggest the following: spend less on welfare and departmental spending, and use the money saved to boost spending on infrastructure.

If you want to take a view from the ‘School of the Not Quite so Bleeding Obvious’ (SNQBO), then things change. What is true now may not be true tomorrow, next week or in, say, ten years’ time.

It does, however, feel as though the equations described above are roughly right at the moment.

Yesterday the IMF said: “The United Kingdom could boost growth by bringing forward measures already included in its fiscal plan, such as spending on infrastructure and job skills.”

Capital Economics reckons that if the government was to spend £10 billion in this way, it could cancel out the GDP dampening effect of its planned £6 billion cut on welfare and department spending for 2013.

The other benefit of investment into infrastructure, and indeed job skills, is that it can lead to improved productivity, precisely the area where the UK is so weak.

Furthermore, by taking money scheduled for expenditure at a later date, Mr Osborne could implement the IMF recommendations without worsening the UK’s public debt in the long run.

So why not do it?

One reason might be, and excuse the introduction of another technical term, the slippery slope. Osborne may fear that short term one-off initiatives have a habit of becoming entrenched. That is to say that theory might suggest we just need to take the money from planned future expenditure, but when we get to that future date, the government may find that it is still under pressure to spend that money.

The other reason is that Mr Osborne, to use the jargon, is blinkered.

© Investment & Business News 2013

It is one of those Victor Meldrew theories. In other words, it is easy to say: “I don’t believe it.”

Economic theory, at least some of it, says government spending does not lead to more growth in an economy. The theory says that households spot that the government is spending more, and say to themselves, “aye aye, tax will rise,” and start spending less as a result, which cancels out the effect of the government stimulus.

At least that is what the “Lucas Critique” developed by Robert Lucas, for which he won a Nobel Prize in 1995, says. Some go further and say Barack Obama caused the global financial meltdown. They say even though the US recession began before Obama was President, the US electorate anticipated his victory, and thus cut back on their expenditure.

So there you have it. The Multiplier from a fiscal stimulus is zero. It is odd, because the IMF recently said that right now the multiplier is between 0.9 and 1.7.

The Lucas Critique is famous for its elegant maths. But just because something is elegant it does not mean it is right. And if it is the case that as the government spends more, we spend less, explain this: Gillian Tett pointed out in the ‘FT’ that US consumers seem to be varying their monthly spend around pay day far more often these days.

She quoted the boss of one of the US’s largest food and drinks companies as saying: “Since 2007, spending patterns have become extremely volatile. More and more consumers appear to be living hand-to-mouth, buying goods only when their pay checks, food stamps or benefit money arrive. And this change has not simply occurred in the poorest areas: even middle-class districts are prone to these swings. Hence the need to study local pay and benefit cycles.” See: The cost of hand-to-mouth living

So if that is so, how can they at the same time be so willing to save more if governments start spending more?

© Investment & Business News 2013