The Coalition and the Economy

Professor Brian MorganUWIC

Lloyd George Society 19 February 2011

Which Coalition?

• I assume I was asked to talk about the London one!

• But I will have a few words to say about the Bunch in the Bay

• The presentation will focus on the economic situation facing the Coalition in 2011

The ‘NICE’ Decade

The Great Moderation

• January 2007 Gerard Baker, the US editor of the Times : • “we are living through one of the great transformations of

modern history; a period of unprecedented economic stability. Recessions were once as frequent as World Cups Now, they hardly happen. something historic has happened in the past quarter of a century.

• The business cycle has not been abolished, but in the US and the UK, it has been stretched, to improbably great lengths. Economists have coined a term for this remarkable period of stability …... they have called the current era the Great Moderation.”

The cause of this remarkable stability?

• “It is the liberation of markets ….... have had a damping effect on the fluctuations of the business cycle. ... The economies that took the most aggressive measures to free their markets reaped the biggest rewards…….

• Similarly in 2004, Ben Bernanke:• “the sources of the Great Moderation will continue to be

debated …….. I have argued today that improved monetary policy has likely made an important contribution. …. This conclusion makes me optimistic for the future, ………..”

• Then the credit crunch arrives, but UK already in trouble

1998 2000 2002 2004 2006 2008 2010 2012 2014 201530

32

34

36

38

40

42

44

46

48

50

G%T%Huge Budget Deficit

Government Expenditure and Tax Revenue as % of GDP

The Fiscal Deficit in the UK

Budget Surplus

Real UK Government Expenditure as % of GDP

Tipping Point

Public Spending

• The Green Budget (2010), the cuts in spending, "would reverse almost all of the increase in departmental expenditure . . . as a share of national income since Labour took office".

• Effectively by 2015 we will have, then, marched public spending up to the top of the hill and marched it down again.

• (see top left chart below)• Legacy for the expenditure splurge?

Five key factors affecting Growth1. Impact of Cuts• a 1% of GDP fiscal contraction reduces GDP by 1% p.a. in years 1,2 and 3

(if expenditure reduced in isolation), • GDP growth expected to be between 1% and 3% p.a. on the pessimistic /

optimistic scenarios (2011 – 15) .2. Consumer spending• - increased by 1% in 2010 after collapse of 3.2% in 2009. 1% increase

expected in 2011 • but slow rise in wages, house prices falling and credit in short supply, could

lead to negative 1% in C. 3. Industrial production• Been a huge fall in investment expenditure.• Investment has not been a key driver of the recovery in the last 4 recessions

Effective Sterling Exchange Rate

60

65

70

75

80

85

90

95

100

105

110

Jun

-88

Jun

-89

Jun

-90

Jun

-91

Jun

-92

Jun

-93

Jun

-94

Jun

-95

Jun

-96

Jun

-97

Jun

-98

Jun

-99

Jun

-00

Jun

-01

Jun

-02

Jun

-03

Jun

-04

Jun

-05

Jun

-06

Jun

-07

Jun

-08

Jun

-09

Source Bank of England

Source: ONS

Months Since Recession Started

Labour market: evidence of labour market flexibility

UK - Employment Level during recessions

90.0

92.0

94.0

96.0

98.0

100.0

102.0

Months

Ind

ex 1980s

1990s

Current

Problems of National Debt

• Interest Payments. The cost of paying interest on the government’s debt is very high.

• In 2008 Debt interest payments were £31 billion a year (est 2.5% of GDP).

• In 2009, they were £35 billion (similar to defence budget) - debt interest payments

• 4th highest spend after social security, health and education.• By 2015 they will be 9% of GDP• The National Debt will then be 90% of GDP• Inevitable ‘Crowding out’ of private sector investment /

spending

Public sector net borrowing, % of GDP, 1990s and 2010s

Source: Andrew Sentance

Current Scenarios

• A credible deficit reduction plan is needed to keep the rate of interest on government debt manageable

• But to do this G has to be reduced from 48% of GDP in 2009 to 39% of GDP in 2015 - this is a sharper fall in spending than any other country bar Ireland and Iceland.

• The burden will fall on HE, Environment Dept, and Housing; as well as LAs.

• NHS and Energy will see an increase

Fiscal assumptions of the Coalition

• Trend economic growth is permanently lower for next decade

• Government expenditure and taxes need to be brought back towards 40% of GDP

• The national debt to income ratio must be reduced steadily from 2015 - when it is likely to reach 90% of GDP.

• Fiscal contraction has to begin NOW – to prevent a meltdown in confidence

Economic Growth

• Without economic growth the national debt will be over 100% of GDP in 2015

• Where will growth come from?– Investment in IT industries – broadband etc.– Low carbon and renewable industries – green

investment bank needed– Investment in transport infrastructure –

infrastructure investment bank needed – Better, faster planning and investment in skills

And Wales?

• Implications for Wales• The Welsh economy is fragile and has the

lowest share of private sector employment• WAG has to eschew its perennial interest in

peripheral vote winning policies • Focus instead on implementing a robust

economic development strategy that is focused on private sector expansion

Wales

North East

Northern

Ireland

Yorkshire

and the H

umber

West

Midlands

North W

est

East M

idlands

South W

est

East of E

ngland

Scotla

nd

South East

London

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

GVA per Capita 2008 [£]

GVA per Capita 2008 [£]

WALES

Source: UK Competitiveness Index 2010, www.cforic.org

74% of UK average

Business Density - VAT registrations per 1000 inhabitants (2009)

London 44.5South East 40.3Northern Ireland 39.8South West 38.9East of England 38.0East Midlands 33.4West Midlands 32.7North West 30.8Wales 30.7Yorkshire and the Humber 29.2Scotland 28.2North East 22.3

Source: UK Competitiveness Index 2010, www.cforic.org

Business Start-up rate per 10,000 inhabitants (2007)

London 54.6South East 38.5East of England 34.8South West 32.9East Midlands 30.1North West 30.1West Midlands 29.2Scotland 28.4Yorkshire and the Humber 28.1Northern Ireland 25.1Wales 22.9

North East 22.6Source: UK Competitiveness Index 2010, www.cforic.org

% of employment in Knowledge Based Occupations (2008)London 28.4South East 20.8East of England 17.6South West 16.2North West 16.0Scotland 15.1West Midlands 14.8East Midlands 14.7Yorkshire and the Humber 14.5Wales 12.7North East 12.5

Source: UK Competitiveness Index 2010, www.cforic.org

Output per Hour Worked (Index)2006 RANK 2007 RANK

London 131.4 1 129.7 1South East 105.5 2 104.7 2East of England 98.8 3 100.6 3Scotland 96.5 4 95.6 4South West 94.6 5 94.2 5East Midlands 93.4 6 92.3 6North West 90.8 7 92.2 7North East 89.9 8 91.2 8West Midlands 88.1 10 89.6 9Yorkshire and the Humber 89.7 9 89.2 10Wales 84.3 11 84.6 11Northern Ireland 82.9 12 84.1 12

Source: UK Competitiveness Index 2010, www.cforic.org

Source: Office for National Statistics, Labour Force Survey, Labour Market Statistics

% of employment in Public and Financial sectors (2010)

Public Sector Employment Financial Sector Employment

Wales 25.3% 2.2%

North East 25.0% 2.5%

Scotland 24.5% 3.8%

Yorkshire and the Humber 22.5% 3.5%

North West 21.7% 3.0%

West Midlands 20.9% 3.2%

London 20.8% 9.3%

South West 20.4% 3.1%

East Midlands 18.2% 2.2%

South East 16.3% 3.0%

East of England 16.3% 2.6%

Weekly pay 2006 – Differential between top 10% public sector jobs and top 10% in the private sector

United Kingdom -7.60%

South East -19.20%

Scotland -5.80%

West Midlands -0.10%

South West 2.00%

North West 3.30%

North East 4.40%

Wales 9.30%

Source: Annual Survey of Hours and Earnings

Regional UK Competitiveness Index 2010(UK=100)(Robert Huggins UWIC)

Implications

Source: UK Competitiveness Index 2010, www.cforic.org

What’s needed:

• A short sharp action plan with imaginative steps in the direction of involving the private sector in delivery of business support

• Need to encourage WAG to stick to the knitting, to stop inventing new things on which to spend money

• And make growing the economy the overarching aim of its economic renewal programme.