Economic growth – a cautionary tale of risky comparisons

Yesterday, the initial estimate of economic growth in the UK for quarter one was announced – the economy grew 0.5%. This is a very interesting statistic because there is clearly something for everyone concerned depending on your political persuasion.

The coalition government can claim that the economy is back on its feet and is starting to generate the growth that was claimed. They can say how the private sector is being encouraged and that their cutbacks have and will continue to aid the (foreign) investment.

For any opposition, the official line is to concretely doubt the capability of the government to generate anything resembling growth and this is even without the cuts having started. They will state how the government has taken a huge risk with increasing VAT, slashing public spending and increasing unemployment.

Now don’t get me wrong; I completely understand that this is politics and the game that we all play is to try and convince the public that your argument is more believable than the next.

However, as an economist, some claims relating to the economy rile me mercilessly. The first comparison is to look at the growth rate after Osborne’s spending review: 2010Q4 was -0.5%; 2011Q1 is 0.5%. This indicates that the economy is ‘flatlining’, ‘stagnant’, ‘plateau-ing’ or not growing over 6 months (actually it is slightly negative growth as the economy shrinks and then grows by the same rate but from a lower base). The desire is to then compare it to the 6 months preceding the spending review: 1.8% of positive growth.

Now these points are factually correct but I must highlight how much caution we should take. Such simple graphs indicating the two growth rates are dangerous because it does not take into account the virtually infinite number of variables that an economy is affected by. All it assumes is that the economy will continue on in precisely the same way, ceteris paribus, until Osborne announces the CSR. This is clearly the wrong way to look at this – so many variables that are all interlinked and correlated that a longer time period is needed to see if the CSR was the key turning point – what if the media has sensationalised things to reduce confidence, for example.

And time period is another key point here. To look at economic growth over two volatile, post-recession 6 month periods (and during key economic and political changes) should be carefully analysed before unhelpful, simplified graphs are churned out and spewed across the media.

The next gem of false economic comparison is that of comparing the ‘poorly performing UK to the fast growing US’. The problem is that the UK’s quarter one growth rate was compared to the annualised growth rate of the US. Today, it was announced that annual economic growth in the US has shrunk from 3.1% to 1.8%. First of all there were too many comparisons of 1.8% and 0.5% which is incorrect. The actual quarter one growth rate in the US was 0.4%; not dissimilar to the UK.

The attention then turns to the six month period post-CSR in the UK (~0% growth) with the same 6 month period in the US (1.2% growth). This is a completely unfair and erroneous comparison. Due to the political lags, the US has only just agreed the budget after the Democrats and Republicans managed to hammer out a compromise within days of not being able to pay public sector workers. This has meant that the government spending has continued and therefore of course the growth should be higher.

But this is no reason to advocate large government spending per se. The credit rating outlook for the US has been downgraded to negative because they have yet to agree a credible plan to reduce the level of debt in the economy – unlike the UK, Germany and France. As a result, the austerity measures will be brought in – if they convince the markets then the outlook will positively change and the phasing in of cuts will work; if they don’t then they will be downgraded which will increase borrowing costs and make it more expensive to service debt.

But we are also forgetting a key component that is not being considered. As the dollar is the world’s reserve currency, the US can use quantitative easing (printing money) without as large inflationary fear – this means proportionally more money can be pumped into the economy, the government can continue to spend and the economy will be propped up. Clearly this is not the case for the UK and yet the initial argument on further government spending is often used but is based on this principle.

This article does not profess to know which economic policy is correct, nor does it begrudge the lobbying factions. What I hope it does is to expose the fundamental differences in the economies and their set-ups in an attempt to highlight how complex this topic is.

The simplified partisan ‘analysis’ that has been churned out is unhelpful and does not give the public credit. I certainly would be expected to produce more rigorous analysis than this and the public should expect the same.

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