June 1, 2013 by johnmillsjml
Exchange Rate Reform Group
BULLETIN – June 2013
Where does economic
growth come from?
If the UK economy is to start growing again, where can we reasonably expect the growth to come from? This Bulletin provides an answer to this question and reviews what we need to do to get our economy back on track.
Economic growth is achieved when the output of the economy goes up in relation to the inputs which go into it. This happens as a result of factors such as investment, technical progress and better management. When it materialises it is seen as increases in productivity or gross added value (GAV). Total GAV is one measure of the economy’s Gross Domestic Product (GDP). Increases in GAV year by year – or lack of them – determine the growth rate in GDP.
The UK’s Office for National Statistics has very large spreadsheets – not normally published because of their size and complexity – which those responsible for compiling the statistics which appear in ONS publications use to reconcile all the component elements of the UK economy. This enables them to present a coherent and internally consistent picture of the way the economy is operating. By abstracting figures from two of these spreadsheets – one showing GAV by Standard Industrial Classification (SIC) and the other the labour force by SIC – it is possible to determine with a reasonably high degree of precision where the growth which took place in the UK between 1997 and 2012 occurred. This is the whole of the period for which sufficiently detailed figures are currently available. The results are on page two of this Bulletin. Highlights are:
1.A Over the whole of the 15 years covered by the spreadsheet, GAV per head rose by just over 18% – 1.1% per annum. 18% was significantly less than the overall growth rate of the economy as the labour force increased over the period from 27.8m to 30.6m, an increase of just over 10% – reflecting the increase in the UK’s population over this period.
1.B The sectors of the economy where increase in GAV per head were highest were Information and Communications at 103%, Manufacturing at 62%, and Finance and Insurance at 49%.
1.C Because of their differing relative sizes, however, the contributions to economic growth from these three SICs were ranked in a different order. Of all the growth achieved over the period 1997-2012, 34% came from manufacturing, 23% from Information and Communications and 19% from Finance and Insurance. These three sectors, comprising over the period a total of no more than 26% of total output, therefore provided 76% of all the growth which was achieved.
1.D If to these three sectors are added Professional, Science and Technical Services at 8% and Motor Vehicle at 9%, 93% of all economic growth was provided by these five SICs, making up no more than 42% of total output. All the remainder of the economy taken together – 58% of total output – contributed no more than 5% of total growth.
1.E Turning now to the figures at the top right hand side of the spreadsheet table, these show what changes to the proportions of total output took place between the constituent SICs. While the proportion of economic output from Information and Communications rose from 3.3% to 6.3% of GDP – an increase of nearly double in ratio terms – and Finance and Insurance went from 8.1% to 9.4%, a ratio rise of about 16%, Manufacturing fell from 14.5% to 10.7%, a ratio fall of 26%.
The key policy conclusions to be drawn from these figures are as follows:
2.A The figures confirm that Manufacturing is still by far the single most important source of economic growth. It is evidently much easier to secure productivity increases in this sector of the economy than it is in services.
2.B The fall in Manufacturing as a percentage of GDP in the UK is therefore one of the main reasons why our growth rate has slowed up. By allowing Manufacturing to fall to a lower and lower percentage of GDP, we have cut ourselves off more and more from easily the largest and most prolific source of increases in productivity
2.C The decline in UK manufacturing is also the main reason for our longstanding inability to pay our way in the world. The last time we had a balance of payments surplus on manufactures was in 1982 and the most recent year in which we had an overall foreign payment surplus was 1983. Over 60% of our exports are goods, about three quarters of which are still manufactures. We have a massive foreign payments deficit – estimated to be about 4% of GDP or just over £60bn of GDP in the 2012 Autumn Statement – and it is clear that this gap will never be closed other than by increased exports of manufacturers and more production in the UK of goods to be consumed by the domestic economy.
2.D As long as our ability to expand the UK economy is heavily constrained by our weak foreign payments position, we will never be able safely to increase demand sufficiently to get the economy to grow at a reasonable speed. Unless this happens, both the UK economy as a whole and the government will continue to rack up debt much faster than the economy’s capacity to service or repay it. This is simply unsustainable.
We therefore very badly need some way of breaking out of this vicious spiral. Is there any way in which this could be done? There is – but the only way of doing so is to increase our exports of manufactured goods and to produce more of those we consume within the UK. The only way, in turn, to get this done is to make it more profitable to export them than it is at the moment and to make it more difficult to make money out of importing. This is entirely an exchange rate issue. We need a much lower external value for the pound – probably about one third less than it is at the moment – i.e. with £1.00 equals little more than $1.00 or about €0.80, to make a major difference to our balance of trade position. All the available measures on the responsiveness of world demand to export prices becoming more or less competitive shows that a policy along these lines would work, although there would be a difficult adjustment period lasting a couple of years before the new incentives kicked in to produce the results we need.
With a much more favourable balance of payments position, combined with rising corporate and consumer confidence, government borrowing would fall, Both the country and the government would then see their liabilities rising much more slowly than their capacity for servicing and repaying their debt. A sustainable future for the economy would then be at hand – with the growth rate rising probably to 3% or 4% per annum and unemployment falling to perhaps 3% over a fairly short number of years.
Does anyone else agree with this analysis? If the rumour mill is accurate, perhaps there are going to be some major changes made to our exchange rate policy in the near future. Pimco, a major US investment house, recently put out a bulletin saying that they had heard that Mark Carney, the new Governor of the Bank of England, wanted to get the pound down by 15%. Is this going to happen – and if it does, will this be enough? We shall have to see. No doubt a big change in policy of this sort is going to involve an enormously important battle of ideas between those wedded to austerity as the only solution to our current problems and those who believe that getting demand up is the only way ahead. We can only hope that demand wins and that austerity loses.
Published by the Exchange Rate Reform Group
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