Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 28 July 2017

The UK slowdown is a result of Brexit and austerity

In the contest between economists and Brexiteers, which I last visited here, the score was 5:0 and Brexit supporters were already leaving the ground. But in that total I had not counted the 2017 Q1 GDP figure, because it could have been a statistical blip. We now have the first estimate of Q2 growth. I’m afraid the economists have scored again.

You may remember that Brexiteers made an awful lot of fuss when growth in the second half of 2016 was mediocre [1] rather than plain bad. We now know why that was: consumers were borrowing and running down savings. That is not a source of sustainable growth. Growth in the first half of 2017 (2017 H1) has been virtually non-existent. As this chart shows, we have not seen such slow growth since before the 2013 ‘recovery’ period.

What is more, what little growth there was in 2017 H1 seems to be coming from consumption due to more borrowing, which is worrying for the future. (We will know more when the expenditure breakdown is released with the second estimate.) Those who argued that Brexit would bring a short term slowdown have been proved right: they just got their timing slightly wrong. Have all those who earlier lambasted forecasts of a short term Brexit slowdown offered their apologies? Pigs will fly.

Yet in his press release when the figures were announced, Labour’s Chancellor in waiting John McDonnell mentioned the government’s austerity policy but not Brexit. This is surprising, but how do we know whether austerity is to blame for this slowdown or Brexit?

The answer is both are to blame. After a pause, fiscal policy (to judge from the OECD’s estimate of the underlying primary balance) started taking demand out of the economy in 2015 and particularly 2016. That will have been an important factor behind the slow growth in both years. However the additional slowdown in the first half of 2017 is likely to be a Brexit phenomenon.

For those who say Brexit has not happened yet, the mechanism is clear. The Brexit depreciation immediately after the vote has led to a fall in real incomes, meaning less consumption. It has not led to any compensating increase in exports because firms are not going to expand markets that might soon disappear because of leaving the Single Market or customs union. The Brexit depreciation has brought forward some of the negative impacts of Brexit on living standards.

Yet austerity is still to blame in the following respect. The Brexit slowdown in 2017 H1 is a slowdown in demand, not supply. Monetary policy did what it could after the Brexit vote, but with interest rates at their lower bound it can do no more. (I trust there are some very embarrassed faces on the MPC right now among those suggesting a rate rise.) Fiscal policy should have helped monetary policy out by filling the demand gap, but those running the Treasury refuse to acknowledge this role for fiscal policy.

So McDonnell is correct to blame austerity, but his failure to also blame Brexit I’m afraid reflects darker political motives. The silence on Brexit as a cause of the current stagnation is because Labour, like the government, supports Brexit. No one wants to say that the Brexit vote is already causing considerable damage. Just like courtiers to a monarch, no one dares tell the king (the 52%) the bad news that their decision have brought harm in case the king takes his anger out on the messenger (the political parties). 

[1] Growth in Q4 was just below historic trends, but growth in Q3 was way below. Hence mediocre.

5 comments:

  1. I agree with everything you say here; I was never one who thought that Brexit would be painless, even in the short term; furthermore, we have not seen the end of this and I would suspect further difficulties along the road.

    The problem I have with your view is that you persist in seeing this through short term vision only when it is quite obvious that it is a decision for the long term (forty years); the jury will be out in effect for a very long time on this one.

    The second thing is that you see it in exclusively economic terms when it is not so.The economic arguments may be correct (I agree with most of what you say on this subject) but they are not decisive; they may be a necessary but are certainly not a sufficient condition for judging this matter.

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    1. Exactly. A good quote from David Goodhart's book: "When a worker from Sunderland votes for Brexit, he is stupid, when a high rate taxpayer votes for higher taxes, he is noble". Economists need to stop thinking that everything is about economics. We are moral beings.

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  2. Theoretical sovereignty vs power in practice. Who would choose the former at the cost of economic hardship? The UK effectively led the EU with France and Germany and had more than enough sovereignty. Now we have theoretical sovereignty (only theoretical in comparison) but hugely diminished power to shape Europe. So even if we disregard the economic, what do we really gain from Brexit?

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  3. Borrowing to spend has surely been an issue for a decade now, bearing in mind in real terms the average UK wage is down 10.4%. Brexit might be considered the final straw, but you would hardly blame the final straw for a camel keeling over, would you?

    The UK voted to leave the EU for various reasons, some of which have nothing to do with the economy. The actual success or otherwise of leaving the EU will take decades to understand, one six month period of slow growth is irrelevant to the bigger picture.

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  4. I really don't understand how serious commentators can talk about Europe in such glowing terms, Germany the economic engine of Europe has been bouncing along over the last 5 years at around O.4% growth and is currently selling off it's motorways just like the Tories are dismantling our state here.

    https://tradingeconomics.com/germany/gdp-growth

    We are constantly told of just what a basket case for an economy Zimbabwe is, but just look at their growth rates over the same period, now standing at just over 16%, not O.16% but 16%.

    In my view although I am a great believer in European unity I really can't see how anyone can claim leaving Europe is the disaster they say it will be.

    https://tradingeconomics.com/zimbabwe/gdp


    Britain has dismantled it's manufacturing base, is finalising the finishing touches to dismantling the state, and so all the talk of competing in Europe is laughable, just as it is with the rest of the world.

    Neo-Liberalism is the problem both here and in Europe, of course there will be problems leaving the EU, but in reality there are also similar problems if we stay in.



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