In today’s column.  Above all, the theme: Growth is what is needed to fix the finances.

Then he adds his voice to those arguing against the myth of the spending splurge:

the explanation for the sudden explosions in the share of public spending in GDP and the fiscal deficit is not that spending is out of control. It is, instead, that nominal GDP and tax revenue have fallen far below what was expected just two years ago. According to the 2010 Budget, public spending will be just 2.2 per cent higher this financial year than was expected two years earlier, despite the recession. But nominal GDP will be 9.3 per cent lower and tax revenues 18.1 per cent lower.

As I argued at tortuous length in my village anecdote.  You will note that MW has updated his approach since following Policy Exchange’s line last year, when he wrote:

How did this fiscal debacle occur? The answer lies far more in spending, forecast to jump by an astounding 8.4 per cent of GDP between 2007 and 2010

His mention of PX is in this piece. My irritation at people taking such a simple ratio take on spending is one of about 100 reasons that I wrote A Balancing Act.  I have always known that Martin Wolf understood this perfectly, and was mystified at him taking the PX line – and today’s column is proof that I was right.  So I am rather chuffed with this.

Wolf has other good advice today about how to boost investment, including from a much-praised PX paper by ex-FT writer John Willman. It is a good paper.   His column ends with this commentary on the NI controversy:

Finally, we have the question of how to tighten the fiscal position. I would have no problem with Conservative opposition to higher employers’ national insurance contributions, if they had not suggested that greater efficiency alone might replace it. With a need to tighten fiscal policy by at least £100bn (7 per cent of GDP), the UK must implement all the efficiency savings it can imagine, plus real-terms cuts to public sector pay bills and services, plus tax increases. The parties are determined not to discuss these realities. If politicians treat voters like children, the voters will throw tantrums when cuts come.

This is not just criticism of the Conservative position; it must count as criticism of any party who has found something nice to do and a way to fund it.  In a crisis, the bond market might just take the latter, and deny the leeway to carry out the former.  The same might apply to the Lib Dem raising of tax thresholds.  No matter that they are costed, the real world result might be: get rid of pensions reliefs soon, introduce a mansion tax now, and so on – and we will phase in your tax threshold increase as we think it can be afforded.

UPDATE: In a rush, I forgot to mention other nails he hammered:

The second qualification is that the country is not living beyond its means, to any significant degree; the government is. Not only is the current account deficit modest, but the UK’s net liabilities were only 13 per cent of GDP at the end of 2009. On a consolidated basis, the chief creditor of the UK public sector is the UK private sector, not foreigners

I pointed this out a few weeks back, criticising none other than Wolf’s FT colleage Chris Giles for saying Britain is borrowing too much.  As argued on the Long View, Britain is in debt to itself.  This is important, you know …

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18 thoughts on “Martin Wolf hits several nails on the head

  1. Of course he is right that growth is the necessary & sufficient condition to get out of recession & bankruptcy..

    Nor is there any dispute that it can be done fairly easily.

    Nor that it cannot be done while government, being overwhelmingly parasitic, takes up 53%(or as he says 52%) of the economy.

    Glad you have finally started seeing the direction of daylight.

  2. I agree also that growth is necessary to resolve this crisis, but it can’t ersolve it on it’s own. To cover a 12% budget deficit would need compound growth of about 30% (remembering that tax revenues are ~ 1/3 of GDP, and it is TAX that pays for spending, not GDP).

    Part of the problem is that the UK was overspending qiute heavily since 2001, though this was masked by good growth and PFI. Keynesian stimulus is all well and good, but he wrote his theories in days of lower taxes, lower debt and lower deficits. There was simply more room for it.

    As it is, the UK has little extra room to raise taxes without damaging competativeness, and already the state is dominating spending. Cuts are going to have to happen, and they will be large – I would expect the whole of the structural deficit of about 9%.

    If they don’t happen, the UK will eventually go the way of Greece, Iceland, Hungary, Latvia, Lithuania and Ireland….not to mention many outside Europe….and have a painful devaluation, be it internal through massive pay and spending cuts, or external through higher inflatio, higher rates and a much weaker currency.

    As a final point, regarding the NI increase; it will cost jobs, predominantly in the private sector, where cutting waste (or spending) will mostly cut jobs in the public sector. Given the overweening size of the state now, even if the tax cut is not deficit reducing short term, it is still in the right direction for the economy and the bond market.

  3. 30% growth compounded is what China will achieve in under 3 years & we could too. In any case with that sort of growth unemployment would drop & thus government payments would to. In any case nobody is proposing zero cuts along with growth. In any case 10% growth would mean that any borrowing of less than 10% of current national debt (say 7% of GNP) would still mean that the debt was a reducing portion of GNP. In any case that sort of growth allows non-inflationary increases in non-interest bearing bonds (coloquially – money).

  4. Hi neil

    Thanks for that. Could you point me from Angus Madison’s data to any 3 year period in UK history during which GDP growth (per head or not; I’m presuming you’re not advocating importing the population of Hungary in the UK) was more than 5% pa

    Victorian growth was just 1-2% per cap. by the way Check out this wonderful post by a promising blogger
    http://freethinkingeconomist.com/2010/01/08/does-high-debt-consign-us-to-neverending-low-growth/

  5. I’m sure you know there has been no such period. Nor was there any period in Victoria’s time when Chinese growth exceeded 5%. However over the last 30 years China has consistently managed 10%, over the last 20 Ireland has managed 7% & over the last decade the world has averaged 5% (& that includes a lot of below average countries).

    If something is being done then one would need some fairly spectacular evidence that it is impossible to do it or that British people are so much more inherently incompetent that we can’t. I await your evidence with interest.

    1. China is catching up. It is having to invent little because it is a long way from the frontier. Ireland was also catching up, and is as small a city state. My evidence is a sampling of 15 advanced nations over 150 years of their growth at the frontier or near it. The evidence does not need to be any more spectacular than ‘loads of data points, none of them above 8%’.

      Look up catching up, development economics, the Solow Growth model, all useful stuff. Marginal returns on capital, curves that slope down, blah blah. Economics.

  6. Neil;

    Just to add to what Giles has said above;

    The UK has never grown that fast, and I would bet against it doing so. 1% – 2.5% would be standard growth path. To be honest, dealing with China economic data in the job I do, I don’t entirely believe all the data that is coming out of there either (though that bubble is a topic for another day I feel).

    There is a continuing fallacy about Debt/GDP levels, as if there is some point at which debt no longer beocmes affordable. As long as you can pay your interest, you can go on indefinately, as Japan has shown. As you say, if GDP grows by 10% but the deficit is 7% (of GDP), you actually reduce the debt/GDP ratio.

    However, you have to pay for the debt from tax reciepts, which run between 30-40% of GDP for any given country. Not sure where UK is now, but around 40% as a rough estimate won’t be too far off. So, for our (rough) calculation above, only 4% of GDP growth is actually taxed, and your real terms debt increase is 3% of GDP. You have actually got more debt than less.

    To reiterate: the important ratio to look at is the ratio of debt/tax reciepts.

    This is effectively the first stage of the debt trap – you can’t grow fast enough to cover the increase in your interest payments. Running massive deficits over the top of that will only compound the problem. Japan has been doing the above for 20 years now, helped by super low interest rates. In that time, they’ve had very little growth, still run large deficits and have a looming problem regarding the scale of their interest payments compared to their tax income.

  7. Having seen all the data points you will have noticed that historically the fastest rate of growth has normally been among the most developed economies (that is why the disparity between us & Senegal is greater than in the 19thC). The automatic “catch up” argument, while reassuring to rulers of wealthy declining countries, has no historical basis. As regards the no historic growth ratesd below 8% – the point is that because technological change is happening faster (eg Moore’s law) EVETYBODY is growing faster than a century ago & indeed they are mostly growing faster than 2 centuries ago, & so to 3 centurues ago & so on back for at least 10,000 years.

    I suggest you check out whether the Solow curve is actually valid –

    “Since the 1950s, the opposite empirical result has been observed on average. If the average growth rate of countries since, say, 1960 is plotted against initial GDP per capita (i.e. GDP per capita in 1960), one observes a positive relationship. In other words, the developed world appears to have grown at a faster rate than the developing world, the opposite of what is expected ”
    http://en.wikipedia.org/wiki/Exogenous_growth_model#Empirical_evidence

    Being evidence based is what makes economics, or at least some elements of it, scientific..

    If, as a country we refuse to adopt modern technology then we will obviously not grow but there is no necessity that we refuse.

    Tyler when the world can manage to AVERAGE 5% the suggestion that we cannot manage more than 20%-50% of the average needs more than guessing. While you are right about the state’s share of GNP being much less than 100% that is irrelevent to the conventional comparison of debt as a ppn of GNP because tax receipts have always been a minority part of GNP. If anything, with the stare spending rising from the roughly 6% of GNP in the late 19thC to 53% today one would expect the tax receipts/debt ratio to now be a more favourable ratio than it used to be.

    1. Neil

      What nonsense. The fastest rates of growth that I know of were East Asian and Japanese in 60s and 70s, post war Europe, in earlier eras Germany when catching up with the UK – and of course China now. In all cases they were behind the leading nation, in some cases by a long way, and the presumption that distance from the frontier increases the ability to grow fast, as would common sense as well; adoption is much easier than continuous invention.

      I like humouring you Neil, and some of your right wing stuff may have some good arguments behind it – just very seldom yours …

  8. Neil:

    debt/tax reciept ratio is a measure of affordability. The most acute ratio of that form form would be:

    debt interest + maturity/rate of tax reciept increase.

    If the number is >1 then you are in trouble in the long term. You either need to be able to increase taxes (which we can’t without affecting competativeness, because our marginal tax rates are so high) or reduce debt. Which means cuts.

    Greece is going to have to cut spending by a huge amount, but are actually lucky in so far as tax avoidance there is a national sport, so there is real scope to reclaim more tax without changing headline tax rates.

    Regardless, it’s a lovely idea to think that the UK can grow upwards of 5% a year. It won’t though – even the 3% the Treasury are coming up with looks overly optimistic, and as debt piles up, it will act as a drag on growth. A little realism, please.

  9. BTW, recent IMF paper on Japan notes:

    “… Since the early 1990s, JGB yields and fiscal variables, such as public debt and the deficits do not appear to be linked. During the 1990s the 10-year Japanese Government Bond (JGB) yields declined steadily from 7 percent to below 2 percent, while net public rose from 20 percent of GDP to 60 percent of GDP. Since 2000, net public debt has further climbed to 90 percent of GDP, while long term yields have remained fairly stable at below 2 percent …”

    LOL!

    http://www.imf.org/external/pubs/ft/wp/2010/wp1019.pdf

    Also, have to recommend “The “Burden of the Debt” and the National Income” by Evsey Domar, member of the Fed’s board of governors during WWII for some modedlling of interest payments on the national debt given various assumptions. Domar shows that given moderate growth even substantial & continuous long term deficits are sustainable.

    http://www.jstor.org/stable/1807397

  10. If I didn’t make the previous response sufficiently clear the a debt to GNP ratio of about 75% in a society where the tax glass ceiling is 37% (Frank Field’s estimate) has ALWAYS been 2.8 if you meaure it that way. Changing the measurement mid-stream is comparing apples & oranges. If anything the glass ceiling, back when the state was 6% of GNP must have been much lower so if you want to use that measure things have improved.

    I agree with you that the Treasury’s 3% estimate is very optimistic but only because they have no intention of doing the things (mainly government stopping preventing things) which would allow higher growth. Check http://a-place-to-stand.blogspot.com/2008/11/getting-out-of-crunch.html . If any politician or journalist or indeed economist thinks they know any reason why such growth is impossible they have been remarkably reticent in saying so. It may be realistic to say the politicians, at least of the semi-official parties. won’t allow the economy to grow but it is unrealistic to say they don’t know how to.

  11. Didn’t Smith have something to say about this? (He may be out of date, but on this one I suspect not.) From my memory, which is disturbingly hazy given I only finished Wealth of Nations earlier this year, there’s an effect of diminishing marginal returns to capital. So you get lower growth if you’re more developed. We’re more developed than China. The rest is an exercise for the reader.

  12. As pointed out Britain has grown faster than Senegal since publication of Wealth of Nations. Thus we have information he didn’t & had never heard of Moor’s law. Actually Smith thought the loss of the American colonies would reduce Britain to the status of a 2nd class power so he was not infalible. Looking at the current facts rather than relying on centuries old authority might be a useful exercise.

    1. I must have missed that boat. I thought the loss of the American colonies had reduced us to a second-class power. Or is it your contention that we are a third-class one? 😉

      I’m quite relaxed about the idea that Smith can be out of date, but are you going to deal with the idea of diminishing marginal returns to capital, or do you prefer to cling to your single data point?

  13. If growth is the answer then time to dust off one of Patrick Minford’s ideas.

    Leaving the EU and moving to unilateral free trade would give us a one off boost of 3% of GDP (erm, one off but sustained if you see what I mean, not another 3% each and every year but not just 3% in one year).

    So, let’s leave the EU (and stop paying them £14 billion a year which is handy) and have free trade.

    That both Professor Minford and I would recommend both leaving the EU and having free trade in all and any conceivable circumstances has nothing at all to do with my advocacy of these measures as a way to boost the growth we all agree we need. Nope, not one tiny little bit I tell you.

  14. By East Asian & Japanese in the 60s & 70s you mena Japan in biooth & singa[pore, Hong Kong, Taiwan & S Korea basically in the 70s managing up to 10%. By comparison we nopw have China managing 10% for 3 decades, India doing 10% & 35 countries today managing 7.9% & above. http://www.geographyiq.com/ranking/ranking_GDP_real_growth_rate_dall.htm
    Your argument depends on claiming that the 60s & 70s regularly had a higher rate & is therefore clearly rubbish. Statistically of course the “leading country” would onlt be the fastest growing 1 year in 200 so your leading country claim is clearly irrelevent. Looking at the countries listed they run the gamut from Singapore (one of the world’s wealthiest) to Mozambique (not). What they have in common, apart from a couple of oil regimes, is that they are trying to grow using more classic liberal free marketism (sometimes from a very illiberal base). Perhaps Venezuella but no others are trying to increase state parasitism, put the lights out or criminalise technological progress as Britain’s “LibDems” are.

    Just being patronising is not a substitute for facts or ratiocination.

    Philip I do not think that Britain could be considered a 2nd class power during the Napoloenic wars or Victorian era. We have certainly declined since then but I would need some evidence that there had been no other factors since in the 2 centuries since the Americans were revolting. 😉 The correct answer to the marginal returns theory is that the facts don’t bear it out, as I have already pointed out. That can be explained as theory by pointing out that technological progress keeps moving the goalposts – the marginal return on investment in 18thC sailing ships does not now repay investment but that on 747s still does, in a way impossible 2 centuries ago.

  15. Tim I assume you are talking about the one off advantage of coming out from under the EU tariff restrictions. There is also the advantage that, according to EU “Enterprise” Commissioner Verheugen, 5.5% of GNP of the EU countries is consumed in satisfying their regulations. If that were free to be put into investment it would mean a little short of 1% extra growth each year. There is, of course, the possibility the EU Commissioner is underestimating the damage the EU Commission does & indeed we do see growth in EU countries averaging about 1.5% less than the world average.

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