GDP estimates for the UK and US exposed

Alasdair Macleod – 23 November 2009

The UK’s pre-budget statement is scheduled for Wednesday 9th December, and given that a lot has happened since the last budget, it will be of consummate interest to the scribblers. What tends to be forgotten by them is that the Treasury uses the occasion to mislead.

The real economy is of course only the private sector. The total GDP numbers are manipulated by changes in public sector spending which are then presented as the real economy. An objective critic must therefore differentiate between public and private sectors to see what is actually happening. This distinction is illustrated in the chart below.

The chart shows real GDP growth for the whole economy together with the public and private sector components adjusted by the consumer price index, as well as government forecasts for fiscal 2010 and 2011 (these figures are taken and derived from ONS and the Treasury). The behaviour of these components in the crrent fiscal year is eye-catching with a forecast for GDP of -3.8% made up of a ramp in public spending concealing an 11.6% contraction in private sector GDP. A Keynesian would say this is an example of the benefits of public sector intervention; a free-market cynic would call it a cover-up.

A reading of the 2009 budget statement confirms that the Treasury is relying on the global economy recovering as least as much as on its own fiscal stimulus. In other words the economic outcome is somewhat beyond its control.

To get to the truth, it is worth recapping how the private sector has actually performed since Labour first took office in 1997 when Gordon Brown became Chancellor. New Labour adopted a policy dubbed “prudence”, but it can be seen that public spending actually rose in real terms the moment they took office. Labour’s second term was secured by promises of increased spending on health and education. This spending continued through to 2005 after which the growth rate in public spending dipped modestly.

This spending growth concealed the poor performance of the private sector, whose annual growth rate declined from 7.3% just before Labour was elected to -0.1% in 2004/05. During this period, the Treasury was always more optimistic in its GDP forecasts than private sector economists were, and the chart shows why: extra government spending would rescue the GDP headline numbers.

The brief recovery in the private sector during 2005/06 and 2006/07 was at the height of the credit bubble, when consumers were buying anything and everything through increased mortgages, but this hardly registered in the published GDP figures.

So through these ups and downs, what has been the private sector’s performance under Labour? Since 1997/98 the private sector has grown a total of 16.4%, which equates to an annual compound rate of about 1.25%, while public sector related GDP has grown by 71% representing an annual compound rate of about 5.75%. In the process the private sector has financed its consumption through the biggest credit bubble in its peacetime history, a bubble that according to monetarist theory should have been enough to stimulate the socks off the economy.

The benign outlook shown in the chart is comprised of Treasury forecasts. Given the Treasury has employed smoke and mirrors in the past to hide economic truths, it is tempting to think it can manage the outcome; but can it still do so?

In the last Budget, the Chancellor stated,

“In 2009, the world economy is forecast to contract for the first time in the post-war period, with UK GDP forecast to drop 3½ per cent. As support from macroeconomic policy takes hold and credit conditions ease, the world and UK economies are forecast to recover. Recovery in the UK is forecast to begin in late 2009, with growth picking up through 2010 and the economy is forecast to grow strongly in 2011.”

But the assumption was that global economic growth of 2.5% and 4.25% will underpin the UK in 2010 and 2011. It was also assumed that credit conditions would normalise and “the effects of significant macroeconomic policy stimulus and the depreciation of sterling take hold”.

Maybe, but there is no sign of credit conditions normalising, rather the reverse, and to the extent that other G10 nations have artificially boosted headline GDP numbers by excessive public spending rather than private sector growth, the Treasury’s own forecasts become a leap of faith. Furthermore, in practice forecasts that rely on the logic of a falling exchange rate are almost always wrong. If the Treasury is incorrect in these assumptions, the “economic stabilisers” of increased welfare payments will also reverse the forecast decline in public sector spending growth against a background of lower tax revenue, sucking yet more financial resources out of the private sector.

The United States

The same problem exists in the US, where the breakdown of GDP into its public and private sector components shows similarities to the UK position.

(Figures from http://www.usgovernmentspending.com and CBO)

The current spike in public spending is far greater than that of the UK and probably under-records the eventual outcome. For 2010 and 2011, Congressional Budget Office forecasts depend on significant economic recovery in the private sector to an extent difficult to foresee at present. With home repossessions and unemployment still high or increasing, how can the private sector rebound from last year’s sharp decline to growth of 9.1% in Fiscal 2010?

If there is a difference between the UK and the US, the UK is relying more on the American recovery than domestic influences, while America is relying more on domestic influences than global recovery. This is the obvious explanation for the differences in the relative degrees of stimulus and the assumed result.

Both outcomes smell like a desired result, with public spending being used as the swing factor. Fortunately, there has been some recovery from the extremes of early-2009, but a sharp contraction of 9.8% in the UK and 13.2% in the US private sectors can be expected to be followed by a consolidating recovery of some sort.

In the absence of a pick-up in bank lending on both sides of the Atlantic there is a high probability of a Japanese-style stagnation, or even a second leg to the slump following this mini-recovery. Before dismissing these possibilities as bearish ranting, account should be taken of the extraordinary profligacy of the Obama regime, which is pressing ahead with healthcare reform and green energy policies, both of which represent a substantial extra cost burden on an indebted and struggling private sector. This makes CBO forecasts for a decline in government and state spending in 2010 laughable, and a resumption of private sector growth less likely.

Meanwhile, in the UK we wait to hear the Chancellor deliver his pre-budget forecasts on 9th December as he juggles to find a plausible balance between public and private sector contributions to GDP. He will doubtless come up with some compromise that sadly won’t be properly questioned by economists and journalists who naturally find it easier to accept the party line.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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