Your location:

GDP is a long-run indicator - policy should not change after every preliminary estimate

    Today’s preliminary GDP growth figures for Q3 2011 (an increase of 0.5% on the previous quarter) imply that the economy continues to struggle back towards its position prior to the recession. Unemployment is rising, and business confidence is low. In view of this, the most common questions heard are ‘where will growth come from?’ and ‘what is the government doing to generate jobs?’

    The truth is that government cannot create jobs. As Fraser Nelson explained yesterday, it can only displace them: from one sector to another, or across time. It can certainly destroy them. And that is what makes advocates of knee-jerk policies to ‘stimulate’ the economy so dangerous. In the hope of generating a bit more consumer spending and employment now, there is little recognition for the long-term damaging effects that these policies will have.

    The causes of the current low growth are multiple: the Eurozone crisis, high levels of public, consumer and business debt, an uncompetitive tax and regulatory environment, high inflation, and yes, reductions in Government spending in some areas.

    But the latter is not cause in itself to reverse the Government’s spending decisions, as Labour party members would have us believe. IMF analysis has shown that there are absolutely no multiplier effects for open economies with high levels of public debt and flexible exchange rates. Likewise, a temporary cut to VAT, as suggested by Ed Balls, might divert some resources for a while - but any confidence effects are more than likely to be offset by a realisation that higher debt means higher taxes in the future.

    Most conservatives have long been advocates of natural readjustment. So it is surprising that the Government is now engaging in state aid programmes to industries – allocating £1 billion of public funds to numerous companies. They seem to be engaged in what Jon Moulton has described as Pain Aversion – an unwillingness to confront the problems head on, but rather a policy to ease the pain where possible.

    And make no mistake, the most serious problem is extraordinarily high debt levels, for government, businesses and households. Actions that governments have taken since the crisis have been quite successful in avoiding the pain of these high debt levels, with low interest rates and the initial stimulus spending of the Labour government inevitably meaning that unemployment was lower than it otherwise would have been. We have also had low corporate failure rates.  However, you cannot outstrip economic forces forever. Now, businesses and individuals, despite lending being cheap, are choosing to deleverage or sit on cash reserves – and this is being labelled as a ‘confidence crisis’.

    The response to this which says we need to stimulate these people into action essentially calls for a growth model based on more consumption or more debt, presumably so our growth figures in the next quarter are higher than expected. But what would this really achieve? If we want long-run, sustainable growth, we need resources to shift from consumption to saving and investment, towards the productive industries of the future.

    Businesses will start investing again when they think the time is right - when debts have been paid down and when resources are freed up. Capitalism works on the productive instincts of individuals, of entrepreneurs identifying opportunities which arise as much through the process of failure in difficult times than anything else.

    Government action, whether it be through tax, spending or regulation, distorts these economic signals which drive this entrepreneurial activity. On rare occasions, this is desirable. More often than not, it isn’t. The government should therefore seek to allow adjustment by doing less – by reducing taxes and easing regulatory burdens so that resources can be more quickly diverted to productive use.

    Some of these cuts to taxation and red tape will have dynamic revenue-enhancing effects in themselves. Others will need to be funded by reducing government spending elsewhere (not subsidising inefficient methods of energy generation should be a place to start). Either way, the UK’s competitiveness and the business environment must be improved to enable the natural process of business success and business failure to be played out –this will grant us the best chance to achieve long-run prosperity with high employment levels.

    Whilst the short-termism generated by the quarterly GDP figures certainly makes great drama, the government must largely ignore these quarter-to-quarter figures. Instead, it should recognise that creating the conditions for growth, rather than deferring pain by intervention, is the key to economic success.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

    Be the first to make a comment

    Centre for Policy Studies will not publish your email address or share it with anyone.

    Please note, for security reasons we read all comments before publishing.