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Good and Bad News – The message from this week’s GDP growth figures

The announcement on 11th November of a slowdown in the year-on-year growth of Britain’s real Gross Domestic Product (GDP) to a ‘mere’ one percent in the third quarter (2019 Q3) was quickly seized upon by the political opposition as a stick with which to beat the Conservative government. In fact, the detailed figures from the UK Office for National Statistics (ONS) contained some mildly encouraging news about the UK’s international trade position. However, the ONS statistics also revealed a near terrifying collapse in fiscal discipline, even before current election spending pledges have hit the fan. The government spending trajectory established in the first half of the current fiscal year is unlikely to prove sustainable for longer than a few years without generating a fiscal stabilisation crisis akin to Britain’s 1969 and 1976 International Monetary Fund (IMF) bailouts.

However, it is important to start with two important caveats. The first is that the annual growth pattern has been heavily distorted by huge swings in stock-building and imports caused by the constantly changing date of Brexit. Real imports, for example, jumped by 10.3 percent quarter-on-quarter in 2019 Q1, ahead of the aborted end-March Brexit deadline, but then collapsed by 13 percent in 2019 Q2 before rising by 0.8 percent in 2019 Q3, while stock-building and ‘valuation changes’ added three percent to GDP in 2019 Q1, had no significant impact in Q2, and reduced GDP by 1.2 percent in the third quarter. Such wild, Brexit-timing associated, swings meant that overall GDP rose by 0.6 percent in 2019 Q1, fell by 0.2 percent in Q2 and then rose by 0.3 percent in Q3. Arguably, the latter figure was uninspiring but not dreadful, given the political uncertainties and the evidence that the world economy as a whole slowed markedly around the late summer. Two causes were President Trump’s trade war with China and an earlier regulatory induced slowdown in monetary growth, which now seems to be unwinding.1

A second important caveat is that these GDP data are prone to substantial revision. Thus, it may be a year or more before the ONS data for the third quarter of this year achieve even a semi-solid state. The present GDP figures, which incorporate the annual ‘Blue Book’ revisions, have revised up cash GDP in 2019 Q2 by 2.2 percent compared to the pre-Blue Book figures and real GDP by 1.8 percent. Such revisions to the level of activity are important if one is concerned about concepts such as the ‘output gap’ that ostensibly measures the deviations of activity about its supply potential, and plays a crucial role in Central Bank forecasting models. Unfortunately, politicians and the media tend to approach the data as lawyers might, treating the numbers as rock solid and quibbling over miniscule and statistically insignificant movements, rather than as engineers who have a robust understanding of the margins of error attached to their calculations.

One piece of mildly encouraging news in the ONS release is that the volume of exports rose by 5.2 percent in the third quarters of this year, even if this followed a 6.6 percent quarterly decline in 2019 Q2, which was preceded by 1.6 percent increase in 2019 Q1. The resultant diminution in the real trade deficit boosted real GDP by 1.3 percent in the third quarter and provides a slight gleam of light. However, the export and import figures have been so badly distorted by business’s measures to defend their supply chains that it is premature to conclude that Britain’s entrenched trade deficit is finally starting to improve.

Now for the bad news! The ONS accounts reveal that the real general government consumption (i.e. central government and local authorities’ current expenditure), rose by four percent on the year in 2019 Q2 and 3.9 percent on the year in 2019 Q3. This is well above the growth of national productive potential, which many suspect is now only some 1.5 percent or so. Even more disturbing, the value of general government current expenditure rose by 6.4 percent in the year to 2019 Q2 and 7.1 percent in the four quarters to 2019 Q3, when money GDP rose by 3.7 percent and three percent, respectively. This implies that the cost of providing government services rose by 2.3 percent in the year to the second quarter and 3.1 percent in the year to 2019 Q3, at a time when the household consumption deflator went up by 1.4 percent and 1.2 percent, respectively. As a consequence, government current expenditure (which makes up some 48 percent of total general government spending) is chewing up a growing share of national output,2 even without the future spending fecklessness to which the political class have committed themselves.

Since the government has no resources of its own, all political spending commitments imply higher taxation,3 either immediately or in the future when the outstanding stock of government debt has to be rolled over, possibly at significantly higher rates than today’s. As far as bond holders are concerned, it would only take a relatively modest rise in the twenty-year gilt yield from its present 1.15 percent to, say, 2.5 percent to impose a capital loss of one third or more, after which the authorities might face major funding problems.

The stark conclusion is that a Conservative government would probably face a serious need for fiscal stabilisation within two or three years of taking office. For a Labour government with little market credibility, the time horizon could be a matter of months, weeks or even days. However, all good Marxists want to destroy the present system, not run it effectively, implying that this scenario might appear as an opportunity rather than as a threat. It is more surprising that Conservatives have chosen to travel so far the same way and are wallowing in Big Government fiscal irresponsibility.


1 For example, the annual growth in Britain’s M4ex broad money supply has accelerated from 1.8 percent in April 2019 to 3.9 percent in September.

2 Total UK General government spending was 44 percent of the author’s preferred factor cost measure of GDP in the four quarters to 2019 Q2 (the data are not seasonally adjusted so running annual totals are the best guide).

3 According to the official tax ready reckoner: a 1 percentage point hike in basic rate income tax would generate £4.9bn in fiscal 2020-21; an equivalent rise in VAT would raise £6.55bn, and a 1 percentage point hike in Corporation tax £2.9bn. However, these are purely static calculations that do not allow for adverse second round effects. These suggest that only around one third to one half of any ex ante tax hike is achieved ex post. Even a purely static calculation implies that the extra £38bn or so spending conceded by the Conservatives this year might imply a 25 percent VAT rate, a 22.8 percent rate of Employers’ NIC’s or a 28 percent standard rate of income tax, if just one of these were to be the sole chosen funding method.

David B. Smith

David B. Smith is a City economist who worked as a macroeconomic modeller and economic forecaster, predominantly in banks (including the Bank of England) and security houses (1968-2006). He maintains his own macroeconomic forecasting model at Beacon Economic Forecasting. His Politeia publications include Britain's Taxable Capacity: Has it Reached the Upper Limit? (2020), The Brexit Settlement and UK Taxes (2018) and Banking on Recovery: Towards an accountable, stable financial sector (as co-author, 2016).

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