New Economist

UK recession roundup: the magnificent seven

A lot of interesting newspaper articles and blog posts on the Q1 UK GDP results have been published since my post earlier today. Here are links to seven of the best, along with an excerpt from each:

1. NYT columnist and uber econoblogger Paul Krugman (@NYTimeskrugman) lambasts the UK Government's austerity plans: Cameron’s Remarkable Achievement

Now Britain is officially in double-dip recession, and has achieved the remarkable feat of doing worse this time around than it did in the 1930s. Britain is also unique in having chosen the Big Wrong freely, facing neither pressure from bond markets nor conditions imposed by Berlin and Frankfurt.

Now, the defense I hear from Cameron apologists is that the austerity mostly hasn’t even hit yet. But that’s really not much of a defense. Remember, the austerity was supposed to work by inspiring confidence; where’s the confidence? Basically, the expansionary aspect should already have kicked in; it’s all contraction from here.

Needless to say, Cameron and Osborne insist that they will not change course, which means that Britain will continue on a death spiral of self-defeating austerity.

2. NIESR director Jonathan Portes (@jdportes on Twitter) manages to quote both Keynes and Popper in his blog post, also critical of the government: On GDP figures today, credibility, and Popperian falsifiability..

Is there a credible alternative? Of course there is. You don't have to be Keynes to think so. And you don't have to take my word for it. Ask the IMF. Or Martin Wolf at the FT. Or Ian Mulheirn at the Social Market Foundation. Or John Van Reenen at the LSE. As I said over a year ago, the real hit to credibility comes from sticking to unsustainable policies in the face of the facts.

George Osborne says that we are all "at the outer fringes of the international debate." That's clearly false as far as serious economists go. But if he's right in terms of UK government policy, the main losers won't be us: it will be the unemployed, especially the young.

3. BBC economics editor Stephanie Flanders (@BBCStephanie) provides a good account of the numbers, including the impact of the Q1 construction decline, in her post: No recovery for UK: No let up for ONS

Are the official numbers wrong? An impressive number of independent experts, with access to a lot less information than the ONS, are today convinced that they are.  ...I don't know which is more striking, the doubts about the ONS numbers - or the supreme confidence of their critics.

4. Guardian economics editor Larry Elliott (@BusinessDesk) believes the double-dip recession affords George Osborne no escape from this reality

The coalition's fear is that the government would be punished by the markets if it went soft on austerity – and there is no obvious magic bullet for Osborne to fire. Since the recession began, the Treasury has borrowed £500bn, the pound has depreciated by 20%, interest rates have been pegged at 0.5% for more than three years, and the Bank of England has plonked £325bn of newly created money into the banking system. The result has been the weakest recovery of the past 100 years.

There are ideas knocking about. ...[but] Osborne has no Plan B and shows no sign of wanting one. He has made reduction of the budget deficit the judge and jury of Britain's performance, talking tough in the hope that the financial markets will spare Britain the harsh treatment they have meted out to the weaker members of the euro. Until now they have, but slow growth has meant progress in getting the deficit down has been much slower than the chancellor planned, and the credit rating agencies are getting jittery. Two of them have put the UK's prized AAA rating on negative watch.

A second recession hard on the heels of the first gives the (accurate) impression that the economy is a disaster area and makes a downgrade more likely.

5. Investment Chronicle writer and prolific econoblogger Chris Dillow (@CJFDillow) explains why there is such scepticism about the GDP estimate: What recession?

Today’s figures conflict with at least five other findings:

- Purchasing managers surveys found a “marked expansion” in construction activity, and the strongest growth in services activity since Q2 2010.

- Official figures show that retail sales volumes rose 0.8 per cent in the quarter. Would consumers really have gone on such a spending spree of the economy was shrinking?

-The ONS reported last week that in the three months ending February, total hours worked rose by 1.4 per cent. This can only be reconciled with falling GDP either if hours fell sharply in March or if productivity has slumped.

- The NIESR estimates that GDP grew by 0.1 per cent in Q1.

- The latest British Chambers of Commerce survey found a “welcome improvement” in the economy.

6. Telegraph assistant editor Jeremy Warner (@jeremywarnerUK) argues that the Chancellor must ignore this double-dip recession

Personally, I wouldn't try to deny that fiscal consolidation is damaging growth; the more important question is whether the Government has any choice in the matter. In my view it does not. We'll never know what would have happened to interest rates had Labour won the last election and pursued a different policy, but the evidence of sharply rising spreads around the political negotiations that led up to the formation of the Coalition is that like the eurozone periphery, they might well have run out of control.

For a highly indebted economy such as the UK's, with an overgrown banking sector, this was not a risk any sensible government could have afforded to run. The banking sector, not to mention many households and businesses, would have been tipped over the edge by any significant rise in short and long term interest rates.

Stagnation in the UK economy is not the result of government policy as such, but is part of the adjustment process to the financial crisis. The idea that you should counter a crisis caused by too much debt by taking on more of it runs counter to common sense.

7. Finally, housing writer/blogger Jules Birch (@jules_birch) argues that housebuilding "will deliver the quickest boost to the economy and generate the most jobs": If you’re in a hole, start digging

Judging from his speech at the Home Builders Federation (HBF) this week Grant Shapps seems to think that all he has to do is sit back and wait for all his initiatives, from FirstBuy to NewBuy, from cutting red tape to boosting self-build, from the New Homes Bonus to extending the right to buy, to pay off. ...Yet for all the rhetoric and all the new wheezes, housebuilding remains stuck at around half the level needed to meet demand and nowhere near his ‘gold standard’ of building more homes than Labour.

Relying on big housebuilders that care more about rebuilding their balance sheets than building homes will not work. A serious programme of investment in building new homes and refurbishing empty ones could be channeled through smaller firms, housing associations and local authorities and combined with reform of the housebuilding industry. That would start to generate the jobs and deliver the boost for the economy we need at the same time as tackling the housing shortage. Borrow to invest, change the borrowing rules or try something new like quantitative easing for housing. We are in a hole. It’s time to start digging.

Economist job of the week: Director of Economic Analysis, Competition Commission

I have a number of economist friends and former colleagues who are looking for work, so I thought it might be helpful to post a 'job of the week'. They will mostly be senior, and mostly based in London - so apologies to my overseas readers and to more junior economist reading this post. I also plan to offer some advice on looking for jobs.

My first job of the week is a senior role at the UK's Competition Commission:

The Competition Commission is an independent public body which helps to ensure healthy competition between companies in the UK for the ultimate benefit of consumers and the economy. It conducts in-depth investigations into mergers and markets and also has certain functions with regard to the major regulated industries.

The vacancy is for their Director of Economic Analysis, a senior civil servant post paying £65-£80k base salary, plus benefits.They are looking for a"a first-rate economist" who is "practical in designing and implementing projects", is "an effective leader" and "an excellent communicator". Of course, it helps if you know something aboput competition and regulatory economics! The role also involves being Deputy Chief Economist at the Commission.

Closing date: Monday 23 April 2012

Growth diagnostics: the dangers of agnosticism

Why does income grow faster in some countries than others? A common empirical approach in recent growth analysis has been to adopt an 'agnostic' approach and let the data do the talking (i.e. weak priors). But a new paper by Antonio Ciccone from Barcelona's ICREA-Universitat Pompeu Fabra, and ECB economist Marek Jarocinski, question this approach. In their new ECB working paper no. 852, Determinants of economic growth: will data tell? (PDF), they show that small differences in the comparative income data can have a substantial effect on the outcomes:

As many potential explanatory variables have been suggested, these agnostic empirical approaches inevitably need to start out with a long list of variables. We show that, as a result, the growth determinants emerging from these approaches turn out to be sensitive to seemingly minor variations in international income estimates across datasets. This is because strong conclusions are drawn from small differences in the R2 of different growth regressions. Small changes in the relative fit of different models—due to Penn World Table income data revisions or methodological differences between the PWT and the World Bank income data for example—can therefore lead to substantial changes regarding growth determinants.

Their analysis clearly shows that agnostic growth regressions can be sensitive even to small data revisions. They suggest that "the available income data may be too imperfect for agnostic empirical analysis". So what to do? Stronger (and fewer) priors:

At the same time, we find that the sensitivity of growth determinants to income differences across data revisions and datasets falls considerably when priors regarding potential growth determinants become stronger. That is, the data appears good enough to differentiate among a limited number of hypotheses. Empirical models of the typical size in the literature, for example, tend to point to the same growth determinants using different versions of the PWT or the World Bank income data.

Researchers who want to continue giving equal a priori weight to all potential growth determinants in the literature, should consider shrinkage priors, explicitly incorporating priors about measurement error in the income data, or implementing Zellner’s (2002) adjustment for data quality.

Growth theory: Solow or Lucas?

I've just come across a new OECD economic working paper on growth theory: Solow or Lucas? Testing growth models using panel data from OECD countries. Authors Jens Arnold, Andrea Bassanini and Stefano Scarpetta test whether the growth experience of a sample of OECD countries over the past three decades is more consistent with the human-capital augmented Solow model of exogenous growth, or with an endogenous growth model à la Uzawa-Lucas with constant returns to scale to “broad” (human and physical) capital. Here's their methodology:

We exploit the different non-linear restrictions implied by these two models to discriminate between them. Using pooled cross-country time-series data, we specify our growth regression by imposing cross-country homogeneity restrictions only on  long-run  coefficients, while  letting  the  speed  of  convergence  and  short  term  dynamics  to  vary  across  countries.

Their conclusions?

The results suggest a strong effect of human capital accumulation: the estimated long-run effect on output of one additional year of education (about 6-9%) is also within the range of the estimates obtained in microeconomic analyses of the private returns  to  schooling. Our estimated speed of convergence is too fast to be compatible with the augmented Solow model, while is consistent with the Uzawa-Lucas model with constant returns to scale. This main finding is robust to several robustness tests. 

US recession risk revisited

My previous posts, Is the US heading into a recession? seems to have a caused a flurry of comments. I remain of the view that the US economy will just scrape through 2008 without one. Admittedly, the run of data since that post has hardly been encouraging, with a plunge in the ISM (signalling a likely manufacturing recession) and some very weak non-farm payroll numbers.

Richard Berner & David Greenlaw from Morgan Stanley put the case for the prosecution in their recent piece: Is Recession Now in the Price?

Incoming data suggest that tighter credit has pushed the US economy to the brink, and we reiterate our call for a mild US recession in the first half of 2008. Weak employment data and slowing in export orders reported by purchasing managers undermine the case that a healthy consumer and strong global growth would forestall a downturn. Moreover, the ongoing housing recession is deepening, declines in capital goods bookings hint that business equipment spending will contract, and inventory liquidation seems likely. ...Most of the weakness is concentrated in the first half of the year; we project the economy will contract by about ¾% annualized in the first half of 2008, compared with 0.3% last month.

I agree the weakness will be in the first half, as I argued in my post 2008: No US recession. We might even see one negative quarter; but I'd be surprised if we see two consecutive declines. And that is the standard definition of a recession. My views are closer to those of Stefan Schneider at Deutsche Bank. In today's talking point he puts forward the DB baseline:

The US economy staggers for a few quarters, but does not actually collapse. The USD recovers in line with the US economy and the pricing process on the oil market returns to “more reasonable” ranges. In this environment the emerging markets grow somewhat less than last year but still quite strongly, at roughly 6½%.

Like Deutsche, I agree most of the risk are to the downside, and I could well be proved wrong. But don't underestimate the Fed. Today's dovish comments by Ben Bernanke show a preparedness to take whatever steps are deemed necessary:

...we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks.

Meanwhile, the Economist today published its's latest R-word index. While it is certainly spiking upwards, we are not in 2001-territory just yet.

The Economist's informal R-word index is also sounding alarms. Our gauge counts how many stories in the Washington Post and the New York Times use the word “recession” in a quarter. This simple formula pinpointed the start of recession in 1981 and 1990 and 2001. In the past few years the R-word index has been extremely low. It began to rise in the second half of 2007 and, measured at a quarterly rate, has soared in early 2008 (see chart). Although the number of stories is still lower than before previous recessions, the recent jump—if sustained for a quarter—is similar to that which preceded the 2001 downturn

Other pointers include the Economic Cycle Research Institute weekly index. According to an Investor's Business Daily report, we're not there yet:

"A lot of things are teetering on the edge of tipping toward a recession," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.

...The ECRI's leading U.S. index ticked higher in the latest week. But the annualized growth rate fell to -6.2%, the weakest since Nov. 16, 2001, at the end of the last recession. The index's components include housing activity, job growth, interest rates, investor confidence, money supply growth, corporate profits and productivity.

"If these downward trends in the leading indicators continue for much longer, we will end up with a recession," Achuthan said. F

Finally, what about the prediction markets? Intrade have a US recession 08 contract, where you can bet on the likelihood that there are "two successive quarters of negative real GDP growth" this year. The contracts were hovering around the 50% mark until last week. Since then they have shot up to the 60-65% mark (click on chart). Given my assessment, I should probably short the contract.

How useful is Okun's Law?

Edward S. Knotek asks an interesting question in the latest Kansas City Fed's Economic Review: How Useful is Okun's Law? (PDF)

From the beginning of 2003 through the first quarter of 2006, real gross domestic product in the United States grew at an average annual rate of 3.4 percent. As expected, unemployment during the period fell. Over the course of the next year, average growth slowed to less than half its earlier rate--but unemployment continued to drift downward. This situation presented a puzzle for policymakers and economists, who expected the unemployment rate to increase as the economy slowed.

Typically, growth slowdowns coincide with rising unemployment. This negative correlation between GDP growth and unemployment has been named “Okun’s law.” Part of the enduring appeal of Okun’s law is its simplicity, since it involves two important macroeconomic variables. Additionally, the relationship appears to enjoy empirical support. In reality, though, Okun’s law is a statistical relationship rather than a structural feature of the economy. As with any statistical relationship, it may be subject to revisions in an ever-changing macro economy.

Knotek considers the usefulness of Okun’s law for policymakers and economists. The evidence suggests that Okun’s relationship between changes in the unemployment rate and output growth has varied considerably over time and over the business cycle. Nevertheless, Okun’s relationship can still be useful as a forecasting tool--provided that one takes its instability into account.

Productivity vs employment growth: a zero-sum game?

All economists know productivity matters. But they also know it isn't easy to measure, nor to explain the often large and persistent productivity gaps between nations. A new paper by Harvard's Ian Dew-Becker and Northwestern University's Robert J. Gordon makes a provocative contribution to the productivity debate. Presented at a meeting of the NBER Program on Technological Progress and Productivity Measurement in Boston last week, the authors argue there is a "strong negative tradeoff between productivity and employment growth". The abstract from their paper, The Role of Labour‐Market Changes In the Slowdown of European Productivity Growth (PDF), continues:

We document this tradeoff in the raw data, in regressions that control for the two‐way causation between productivity and employment growth, and we show that there is a robust negative correlation between productivity and employment growth across countries and time. We simplify the task of explaining intra‐EU differences in the performance by reducing the dimensionality of the issue from the 15 EU countries to four EU country groups, chosen by geography.

We provide a comprehensive analysis of the role of policy and institutional variables in causing changes in productivity and employment per capita growth across these country groups. Using both a calibrated theoretical model and several reduced‐form regressions, we document the strong effects of European policies that raised labour costs, such as the tax wedge, employment and product market regulation, unemployment compensation, and union density, in causing employment to fall and productivity to rise before 1995, and for this process to be reversed after 1995.

The policy implications of their research are stark:

The strong evidence that we find for a productivity‐employment growth tradeoff changes the questions that European policymakers should be asking. They should no longer ask how they should boost productivity growth or raise employment growth. Most policies will push productivity and employment in opposite directions, and we have shown that these offsetting effects make the effects of policies on growth in output per capita ambiguous. Our new policy framework suggests that policy changes be assessed as much on their effects on government budgets as on productivity or employment, since the productivityemployment tradeoff causes some policy changes to have a negligible effect on growth in output per capita.

I'm not sure I'd necessarily agree with the authors 'zero sum' conclusions. There are for example some economies which perform better on both productivity and employment growth than others; so it's not always such a direct trade-off. One implication - that higher employment rates or higher productivity in large part reflect different national preferences - has certainly been argued before. But if their general 'zero-sum' argument proves to be more the rule than the exception, it has profound implications for policy makers throughout the OECD - especially in Europe.

OECD Economic Outlook: "not that bad in view of the recent shocks"

The OECD released its latest Economic Outlook today. Though some fear that falling house prices and the global credit crunch might drive the US into a recession, that view is not shared in Paris. Their US forecast expects weakness in the US housing sector to drag down growth in the near term but it "is unlikely to trigger a recession". GDP growth is forecast to 2.0% in 2008. Private consumption will be weak - but public and non-residential investment should remain quite perky, and the cheap US dollar will see net exports add to growth next year just as it they have this year. Here's their summmary of the US outlook:

Healthy gains in private consumption have helped to keep GDP growth above trend thus far this year. However, the correction in residential construction is likely to accelerate over the near term, and housing wealth could decline which, together with weaker labour market conditions, could lead to lower consumption growth over time. GDP should therefore slow to a pace below potential in 2008 and then recover in 2009, although there are considerable downside risks.

This assessment is broadly in line with recent Federal Reserve and private sector forecasts. An outside risk of recession, to be sure - but not considered that likely. (For another recent official US economic overview, see yesterday's Congressional testimony by CBO Director Peter R. Orszag).

But what about the overall economic outlook? You can watch a webcast of the news conference by OECD's acting Chief Economist Jorgen Elmeskov here. Or just read his 18 page handout (PDF), which contained this precis:

Several shocks have hit OECD economies recently: financial turmoil, cooling housing markets, and higher prices of energy and other commodities. Fortunately, they have occurred at a time when growth was being supported by high employment that boosts income and consumption; by high profits and strong balance sheets that underpin investment and resilience in the face of financial losses and tighter credit; and by still buoyant world trade driven by robust growth in emerging economies. Hence, although near-term growth has been revised down virtually everywhere in the OECD area, the baseline scenario depicted in this Economic Outlook is actually not that bad in view of the recent shocks.

Of course, as the accompanying chartset makes very clear, there are still plenty of reasons to be concerned. Energy and commodity prices have surged, headline inflation has picked up, credit conditions are tight, house prices are decelerating, consumer confidence is softening, and job creation is slowing. Against that, fiscal positions have improved and world trade is buoyant.

It's not the end of the world, but it's not exactly time to crack open the champers either. Or as Elmeskov put it at the news conference: “It’s not a recession but obviously it’s not going to feel all that great either.”

Who's on top?

Lists and rankings fascinate many, from Letterman's top ten to People magazine's best and worst dressed. Even economies have their own such lists. This week the Economist Intelligence Unit published its business environment rankings, with the United States the 9th most attractive place for business out of 82 countries, "the lowest the country has placed since the launch of the business environment rankings in 1997". Angola came last, while Denmark was ranked first, followed by Finland and Singapore. Canada came fourth, followed by Switzerland and Hong Kong.

The World Economic Forum's Global Competitiveness Report 2007-08 was also published this week. They rank the United States first for their Global Competitiveness Index, followed by Switzerland and Denmark.

The IMD's World Competitiveness Yearbook 2007 also ranked the US first, closely followed by Singapore and Hong Kong. Luxembourg was fourth, followed by Denmark and Switzerland.

Finally, the World Bank's Doing Business 2008 (sic) report ranks Singapore first in its Ease of Doing Business Index - followed by New Zealand and the United States. Hong Kong was fourth, followed by Denmark and the United Kingdom.

One can of course argue with the components and weighting of the various indices, which are by their nature somewhat arbitrary. Nonetheless, despite very different methodologies, the same handful of countries crop up time and time again. The general conclusion, as a previous post on this topic argued, is that three groups typically do well:

* the Nordic economies, particularly the smaller economies of Denmark and Finland;

* the Anglo-saxon economies - the US, UK, Canada, Australia and New Zealand;

* the Asian city-states of Singapore and Hong Kong.

So too does Switzerland.

These are clearly very different economic models, showing that in the path to economic prosperity 'one size fits all' just isn't true. Second, most of these countries have relatively 'free' markets and light regulatory regimes. Third, the relative success of the Nordic economies show that low tax rates are not a necessary pre-requisite. Fourth, in Europe smaller countries seem to do better than the larger ones.

Growth: the central questions

Daron Acemoglu's new textbook on economic growth concludes at Chapter 24 with a discussion of 'what we have learned', some answers to what he dubs 'the central questions', and a quick overview of 'some of the many remaining questions' faced by researchers. On page 1068 (sic) he writes:

The central questions are these:
(1) Why did the world economy not experience sustained growth before 1800?
(2) Why did economic takeoff start in 1800 and inWestern Europe?
(3) Why did some societies manage to benefit from the new technologies and organizational forms that emerged starting in 1800, while others steadfastly refused or failed to do so?

I will now offer a narrative that provides some tentative answers to these three questions.

And so he does. It's the best summary of the economic growth literature I have read - but alas, too long to include in this blog. To tempt readers, here is a small sample, from pages 1077f:

Why did some societies manage to benefit from the new technologies while others failed?

The economic takeoff started in Western Europe, but quickly spread to certain other parts of the world. The chief importer of economic institutions and economic growth was the United States. The United States already had participatory political institutions, founded by settler colonists, who had just defeated the British crown to gain their independence and set up a smallholder society. This was a society built by the people who would live in it, and they were particularly keen on creating checks and balances to prevent a strong political or economic elite. This environment turned out to be a perfect conduit for modern economic growth.

The lack of a strong political and economic elite meant that a broad cross-section of society could take part in economic activity, import technologies from Western Europe and then build their own technologies to quickly become the major industrial power in the world (Galenson, 1996, Engerman and Sokoloff, 1997, Keyssar, 2000, Acemoglu, Johnson and Robinson, 2002). In the context of this example, the importance of technology adoption from the world technology frontier is in line with the emphasis in Chapter 18, while the growth-promoting effects of a lack of elite creating entry barriers is consistent with the approach in Section 23.3 in Chapter 23.

Similar processes took place in other West European offshoots, for example, in Canada. Yet in other parts of the world, adoption of new technologies and the process of economic growth came as part of a movement towards defensive modernization. Japan started its economic and political modernization with the Meiji restoration (or perhaps even before) and a central element of this modernization effort was the importation of new technologies.