In recent posts I have drawn attention to the new fiscal-economic approach that the Conservatives seem to have settled on: that they/we can afford to cut the deficit on day one because, economic theory tells us that easier money and a cheaper exchange rate will fill the gap – with higher investment and a contribution from net exports. Here is his speech giving this view. The CEBR have backed this up – without giving us any of that ‘valuable intellectual property’ that might be their workings . . .

So I spent a day or so just looking into how likely this might be.  Has the UK ever done it?

Weeellll, not exactly.  This graph shows how much net exports and capital investment have added to growth in the past.


You can see that there were some bumper years for Capex, like 1973 or 1988, the Great Overheating: but often net exports pulled the other way.  Even the legendary export-led recovery from 1992 did not amount to much – the exchange rate recovered from 1996.

The blue bars dominate.  That’s household consumption.  If that is weak – perhaps as it might be if a government goes hell-for-leather after a fiscal consolidation – then growth is very hard to find.

The following two graphs suggest that Japan, the exporter-par-excellence, also had a similar experience.  Despite exporting to growth for the last 5 years before the Crash, they never got much from business investment:


Again, growth in capital investment and growth in net exports (exports minus imports) tended to go in opposite directions.

The same goes for Germany, the other great Growth through Austerity example that Conservatives are no doubt poring over.  Look at these figures:

Germany Household consumption Government consumption Capital Investment Exports Imports GDP Growth
1996 1.56% 2.08% -3.57% 6.05% 3.53% 0.99%
1997 0.81% 0.50% 1.28% 11.71% 8.22% 1.80%
1998 1.37% 1.80% 5.32% 7.96% 9.45% 2.03%
1999 2.91% 1.15% 3.26% 5.94% 8.55% 2.01%
2000 2.33% 1.37% 2.26% 13.53% 10.17% 3.21%
2001 1.96% 0.53% -7.84% 6.44% 1.23% 1.24%
2002 -0.84% 1.47% -9.14% 4.29% -1.44% 0.00%
2003 0.10% 0.38% 2.44% 2.46% 5.36% -0.22%
2004 0.08% -0.71% -0.31% 10.25% 7.28% 1.21%
2005 0.24% 0.41% -0.99% 7.67% 6.53% 0.77%
2006 1.10% 0.62% 7.50% 12.69% 11.85% 2.96%
2007 -0.40% 2.19% 5.01% 7.47% 5.03% 2.46%
Averages 0.93% 0.98% 0.43% 8.04% 6.31% 1.54%

Encouraging? Even though exports grew way faster than imports, capex just didn’t grow.  Because household and government investment were anaemic, so too was overall GDP growth.  Fiscal hawks may envy Germany: the consumers had it rough.

Given similar scepticism about QE (mysteriously missing from the CEBR), I am becoming a bigger fan of Duncan’s idea of a National Investment Corporation.  Investment is a good way of leading growth: but how do you make it happen in Depression circumstances?  This is one way – similar to Vince Cable’s earlier idea at conference.

What I am certain of is that prioritising the debt at all costs can be a very damaging mistake.


4 thoughts on “Warning to Osborne: this ain’t ever happened before . . .

  1. Investment is only good if it yields a return that exceeds the (risk adjusted) cost of capital. To say that investment is a good way out of recession does not make sense – if you invest in things with a low return you are spending 20 pounds to buy 19 – not a good idea. Look at Japan since 1980 – incredibly high rates of investment, and low growth. Building lightly used infrastructure is not a sensible thing to do, for example. You might as well have a really big bonfire party, and burn the money directly!

  2. Well put. But don’t your figures just confirm basic common sense? I mean two things:
    1. For the UK, the import-intensity of capital goods is quite high. So higher investment is associated with lower net exports.
    2. The current account deficit – which is hugely correlated with net exports – is, by arithmetic, equal to the excess of domestic saving over investment. So if investment rises, ceteris paribus, the current account deficit rises, and net exports fall.
    Of course, cutting the government deficit means savings rise. But this gives us two possibilities. Either investment rises more than savings – we get extreme crowding in – in which case S-I falls and net exports fall. Or investment rises less that savings, in which case net exports do rise, but only because the deficit cuts do weaken the economy.
    However we look at it, Osborne is just talking gibber.

  3. Thanks for both of these. Chris, that is really valuable – I can look a bit naive asserting what appears to be an empirically discovered identity when it actually has some logic behind it.

    tim, I think we are talking across one another, with me in the Keynes position and you in the Treasury position against him. Capital investments only push out the productivity frontier if they are clever, yes: but if an economy is deeply beneath its potential, don’t any investments actually increase GDP? that is the point of the Keynes burying-bottles-filled-with-money example, which he clearly gave for comic exaggeration effect but no doubt has a grain of truth to it.

    After all – increasing your debt by paying people to do something useless is fairly similar to giving, say, the low-taxed/non-working a tax-rebate – they get more money, there is more demand, government Debt goes up. Both are reckoned to increase GDP in a slump: Bush tries the second, Obama the first.

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