Home > General Politics > 0.8% growth Q3 still needs to be viewed with caution

0.8% growth Q3 still needs to be viewed with caution

Unfortunately, today’s growth figures act as a Rorschach test; the coalition government and its supporters see growth at 0.8% in the third quarter of 2010, and growth for the last six months at 2%. What the opposition will see is a drop of 0.4% when between April and June growth was positioned at 1.2%.

Since growth was forecasted far lower than expected, many – such as Vince Cable, who was said to have a big smile on his face this morning, possibly after finding out the data – are probably just pleased to see a higher figure, not because it is necessarily a good sign for the economy, but simply because it will make for easy smoke and mirrors. Look we can cut and grow, it’s easy.

Others may note that the worst of the cuts have not been factored into the figures yet. It’s important to note that cuts will have been factored in already; the squeeze for many councils started a while ago, redundancies are a reality now, and small and medium businesses (SMEs) are already checking their books with a grimace.

Construction was the real winner with contributions of 4% (p. 3), compared with an increase of 9.5% in the previous quarter, and 11% since Q3 2009 and Q3 2010.

Read in a certain way, today’s figures will prove politically opportune for the Tory/Lib Dem government, which may set back Labour’s current lead in the polls. But it is not mere politicking to point out that the severity of the cuts, spelt out in the CSR last week, have not been entirely factored in, and that growth really needs to be sustained and sustainable.

There is even tension within the government about the road to growth. Vince Cable has recently slammed David Cameron’s optimism, saying that the “sunlit uplands” strategy will not necessarily be the case. If he has any sense about him, Cable’s supposed smile this morning will be matched by caution.

In Cameron’s “new economic dynaims” vision, he wants to “make sure we have a banking sector that is really focused on small business lending … rather than the banks thinking how [they] can become bigger and bigger investment banks.”

Cameron hopes to get those banks which the government has a stakeholder share of, to start lending again and fuelling a private sector revolution.

According to a recent NEF report entitled Where did our money go? the 2009 budget noted that RBS needed to lend an additional £25bn (£9bn – mortgage / £16bn – business); Lloyds an additional £14bn (£3bn – mortgage / £11bn – business); Northern Rock an additional £5bn in 2009 / £3-9bn from 2010 onwards.

After the bailout, there was disappointment that the banks were increasing the bonus pot without actually kickstarting small businesses with money. In an ongoing discussion I had with an acquaintance, I was reminded that the bailout was paid in order to cover liabilities at the time, but the reason behind doing so, and not allowing them to fail, was so they could start lending again – for this is the reason why those banks are too big to fail.

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  1. Lethe
    October 26, 2010 at 12:06 pm

    The NEF report also argues that banks are facing a funding cliff and may need a public bailout again. This doesn’t seem overly consistent with pushing for them to increase lending.

    Reinhart and Rogoff find that recessions stemming from financial crises tend to haev long, slow and painful recoveries. It may well be that an extended period of low growth is inevitable in the UK. The economy needs to re-balance, an important part of which is the de-leveraging of banks and households. A rough and ready illustration of the latter half of that proposition is the graph in this link: http://news.bbc.co.uk/1/hi/uk/8608935.stm, which shows how low the houselhold savings ratio has gone.

    It is difficult to see how this process can be married with a rapid recovery. I remember one of the worries that my office had as this was all kicking off was where growth would come from after the dust had settled. I particularly remember Joe Stiglitz arguing that the US and UK economies had been driven by consumer debt and houseprices and there was nothing there to pick up the slack.

    As a sidenote, the NEF report does, inadvertantly I’m sure, put the lie to the myth that a reduction in bankers’ bonuses would make a significant difference to the health of the banking sector. According to the NEF figures banks currently have to borrow £12bn a month to sustain their current level of activity. This equates to £144bn for the year. The bonus pool for this year for the City, which includes non-banking financial institutions, is around £7bn. Making an extremely optimistic assumption that this could be halved without harming the industry we get £3.5bn, which is roughly 2.4% of the annual funding requirements.

    Reinhart and Rogoff find that recessions stemming from financial crises

  2. Agog
    October 26, 2010 at 12:42 pm

    Lethe,

    A counterfactual: suppose that the bonus pool were £3.5bn, how optimistic would it be then to assume that the pool could be doubled without ‘harming the industry?’ as you put it? Via misaligned incentives, short-termism and so on? And how about harming the wider economy?

  3. Lethe
    October 26, 2010 at 1:37 pm

    Oh, of course there are problems with misaligned incentives and short-termism. Though even here it is not so clear-cut. The fact that much of the bonuses were already given out in shares, and that many senior bankers lost millions is something which is often conveniently ignored.

    What I really wanted to drive at is that bonuses are probably the issue one hears most about in the media and blog debate. This is of course understandable given the large figures and the degree of injustice they reflect. Yet in reality, the nature and size of bonuses, whilst important, is by no means the most important problem in banking. Ther were and are far deeper issues, and it seems absurd to me that these slip under the radar whilst so much time is spent on bonuses.

  4. Agog
    October 26, 2010 at 2:16 pm

    I think the one problem that dominates all the others is the sheer proportion of our economy taken up by financial services. Economists, and commentators, from across the political spectrum noted during and after the GFC that UK suffered deeply and rapidly because of this (like Iceland, like Ireland; the ‘UK as giant hedge fund’ idea). So most people agree that it needs to be shrunk to some extent (as a proportion). And surely a squeeze on renumeration would be one way to encourage that. Clearly, given the size of the sector, one wouldn’t want to make a sharp, drastic effort to reduce that part of the economy, because of the risk to the wider economy caused by that reduction in activity (nudge, wink – there’s an analogy there somewhere…), but perhaps by slowly but surely affecting a number of individuals at the margin each year, they would take the hint and move elsewhere. Dubai, Mumbai, Shanghai – you know the routine.

    The result is that we would de-risk somewhat. And as they say, cutting one portion of expenditure (‘unproductive’ financial services) one can sometimes stimulate some more-welcome activity in other parts of the economy…

  5. Lethe
    October 26, 2010 at 3:01 pm

    I know what you are saying here, but it strikes me as quite a negative way of solving the problem. The argument flows something like this:

    1) We do financial services really well;
    2) But so well that it is too big a part of our GDP;
    3) So if the industry suffers then GDP goes down a long way;
    4) Therefore, we should shrink the contribution of banking to our GDP.

    I reckon the most obvious answer is to expand the contribution of other sectors. There is no problem with banking spewing out £x billion quid if other sectors produce just as much. Rather than spend energy ruining one of the few industries where we are a (the?) world leader, surely we should be harnessing that energy to improev other areas.

    Of course, it probably is the case that bankers are too highly paid and that areduction in their pay would see people going to other industries where they would be more productive and contribute more to the economy. This change could well entail a shrinking of the banking sector. But the rationale behind the change is different. The emphasis is on cutting banking to promote growth, rather than cutting banking because the rest of the economy is too anaemic to cope in the same playground. The two strands are obviously related but I think that conceptualising it in terms of efficiency is more likely to generate policies that lead to growth and policies that see banking as a threat are more likely to lead to stagnation.

  6. Sir Oswald the Slasher
    October 26, 2010 at 4:41 pm

    “What the opposition will see is a drop of 0.4% when between April and June growth was positioned at 1.2%.”

    Please bear in mind that the growth of 1.2% was artificially high, due the bad weather pushing much of the construction work back. You’ll recall that construction showed a boom them. 0.4% was probably too pessimistic, and comparing with 1.2% is a little misleading.

    • October 26, 2010 at 5:05 pm

      I was comparing 0.8% (actual growth) with 1.2% (Q2 figures) – 0.4% was probably pessimistic, but why would comparing it to the last quarter be misleading?

  7. October 26, 2010 at 4:58 pm

    Interesting debate.

    If I could address the bonus; though they make a relatively small dent to the overall borrowings, it is an insult that a sector so close to the government (some would even have you believe banks are too close to the state) remunerates large sums when the second part of the bailout deal is slow. Sure, as you mention a recovery will be slow on the uptake, but where is the risk reduction initiatives either by the government or the banking sector? Where are the minimum standards of lending, lined at a point which will help offset SMEs and other areas where growth is likely – look at construction as an example; it seems obvious given today’s figures, but this sector is obviously one politicians are keen on developing further (Philip Hammond was waxing lyrical about Korean construction in Middlesborough on Question Time last week).

    As for the subject of how we are going to curb the amount of influence the financial sector wields upon the UK GDP, though I’m not altogether scared by the capital flight arguments, it wouldn’t be good to be seen squeezing on remuneration without good reason. I don’t think I’d be too controversial in saying first things first the government should take steps trying to cut down short-termism and excessive hedge fund transactions by whacking a 1% tax on all transactions. Dominique Strauss-Kahn should be consulted on this, as he has a sympathetic opposition to the Tobin Tax, where he said it is slightly olde, and it would not be too challenging to avode such a tax. Unfortunately I haven’t caught quite how he qualifies that statement, but it seems to me that he wouldn’t say it if he didn’t know what he was talking – though I may get my fingers slapped for relying too much on his wisdom.

    Obviously if we reduce the financial sector’s influence on GDP that gap will need filling. This is a double-edged sword; to increase productivity elsewhere to fill the gap we need the banks lending again (all the more reason for a lending minimum as part of the exchange for a bailout, and, perhaps, that second bailout noted by the NEF). Something in me thinks that the government cannot ask the banks to fund their own suicide, but the government can insist banks manage, and are liable, for their own risk, slap taxes where possible, remunerate where necessary, punish excessive and counter-productive risk.

    Goodness, I’m not altogether skeptical; the coalition government could be the most socialist we’ve ever had.

  8. Lethe
    October 26, 2010 at 6:01 pm

    1) “Sure, as you mention a recovery will be slow on the uptake, but where is the risk reduction initiatives either by the government or the banking sector?” I’m afraid I just don’t understand this sentence. As to the latter point about lending guarantees, they never seemed to make much sense to me for reasons that I and others have been stated before: i) banks end up lending to firms they shouldn’t be; ii) guarantees as to mortgage lending seem ridiculous in the wake of the housing bubble; iii) we want banks to be rebuilding their balance sheets; iv) the NFC sector is a massive net saver.

    2) On the Tobin tax, I’m afraid I simply don’t know much about it. The simple 1% for each transaction seems like it could have lots of unintended consequences by decreasing liquidity – but I can’t pretend I’ve read the literature.

    3) I think increasing productivity in the NFC sector is a long-term structural problem. God knows how we solve it. We may end up waiting for Third World labour costs to rise to make UK labour competitive again… either that or spend billions on technical education and expertise and try and compete with Japan and Germany in building solar panels and wind power…

  9. Agog
    October 26, 2010 at 8:36 pm

    Lethe (#5) – so you favour a Ballsite program relying on growth alone (expanding “the contribution of other sectors”) instead of my Darlingite policy of measured cuts… I take my hat off to you, sir.

  10. Lethe
    October 27, 2010 at 12:09 am

    Yes, other than the fact I’d replace “government spending” with “GDP” I am in complete agreement with Ed Balls.

  11. October 27, 2010 at 3:26 pm

    Lethe;

    I fully accept all of your points re lending guarantees, but the sector needs to show that bailouts have done more than just cover liabilities and bonus pots. A minimum could be correlated to what’s needed to offset SMEs, but regulation would manage loans going crazy – the cause of the housing bubble. No more 100+% mortgages, but lending to small enterprises. Slightly off point, if small and medium enterprises signed themselves up to social enterprise bonds – and of course the government promoted these better – then central government could measure how effective those businesses are to local communities – which would thus become an idicator of how worthy they are of loans.

    On your point about the transaction tax; the notion of liquidity is what’s levelled by more informed critics of the tax – and I tried to address informed criticisms by mentioned Strauss-Kahn – but I cannot think of anything else, from the top of my head, that would stunt excessive transactions by hedge funds. Whatever that is, it will be a variant of the Tobin Tax.

    Your third point, can you not foresee the US calling for something like (in true soundbite fashion) “global solutions to global problems” where they kindly ask China to stop exporting anything at all so the rest of us can catch up?

    Agog;

    I wonder if you saw the article in today’s Guardian by US NY Mayoral candidate Jimmy McMillan [http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/27/jimmy-mcmillan-the-rent-is-too-damn-high]. He said this:

    “Cut the average top banker salary from $20m a year to $45,000 a year. Bankers do not deserve big money. The free market has spoken: their businesses collapsed.”

    I thought that resonated with what you said yesterday.

    Furthermore, he said:

    “If they [bankers] say they [banks] are “too big to fail”, and hate the free market when it applies to them, then make them a government organisation”.

    I wondered if this appealed to you?

  12. Agog
    October 27, 2010 at 4:59 pm

    Carl – hadn’t seen it, thanks. There are good points there, especially free-market hypocrisy. A nice laissez-faire approach that ought to please these economic liberals would be to prevent organisations that have ‘casino-style’ banking operations benefiting from limited liability. Then see how much risk they take…

  13. Agog
    October 27, 2010 at 5:03 pm

    (Btw I first heard that suggested from one of these radicals at the BoE – Andrew Haldane. I think the same point was made earlier by Steve Waldman at Interfluidity. Most of the big US investment banks were run as partnerships, not PLCs, until the 90s, I think.)

  14. Agog
  15. Lethe
    October 27, 2010 at 8:16 pm

    Agog: I guess from the reference to casino-style banking you are advocating a split of retail and investment banking.

    Splitting banking is another one of those areas where people seem to ignore the evidence. To wit: Northern Rock, HBOS and a score of building societies managed to go bankrupt through bad lending and funding decisions, not through playing the markets. RBS went bankrupt through the terrible proprietary trading at ABN, but Barclays were greatly helped by their investment banking arms.

    A true laissez faire approach would be to stop any bank from enjoying the state guarantee, retail or investment.

  16. Agog
    October 28, 2010 at 12:18 pm

    I don’t think abandoning deposit guarantees would be sensible, which seems to be implied in your purist approach. So ‘utility’ banks need protection. This is pragmatism. Denying protection to highly levered entities is also the pragmatic way to go it seems to me. Thus you are led to the idea of a split of some kind. The details are clearly debatable. Glass-Steagall is not the only option.

  17. Lethe
    October 29, 2010 at 4:00 pm

    Carl:

    1) I think we are getting into “re-designing of paradigm” land there.

    2) Will see what happens with the transactions tax; I imagine a long fight.

    3) The US will pursue global initiatives only where it suits them. Though I’m not sure they are asking China to stop exporting, simply to let there exchange rate appreciate to reflect their exports.

    Agog: sorry, I didn’t mean to imply abandoning deposit guarantees. What I meant was that we should aim for a system where banks like Northern Rock and HBOS can just be allowed to collapse without all the King’s horses rushing to save them. Depositors should be kept safe (apart from the very richest who have the facilities to know better) but shareholders and creditors should be allowed to be wiped out.

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