<<<	articles
The argument about the Brown miracle Samuel Brittan: Financial Times 23/05/03 More years ago than I like to think, I witnessed an entertaining dispute in the Cambridge Economic Faculty. On the one side there was Sir Austin Robinson, a disciple of Keynes and very much a numbers man, and on the other Prof Milton Friedman, then on a sabbatical. Robinson regaled those students who are good at note taking with a thorough statistical analysis of the British balance of payments. The prognosis needless to say was sombre and pointed to the need for - you will never guess - structural reform. Friedman refused to lose any sleep over the problem, saying that anyone could create a structural payments deficit or surplus by pegging the exchange rate. Robinson for his part maintained that Friedman was concentrating on getting the price signals right without looking at required physical changes. Interestingly enough, the structuralists emphasised fiscal policy, while the market economists emphasised exchange rates and monetary policy - a division which persists to this day. By present day standards the debate was almost excessively polite, conducted in different lecture rooms and with no face to face confrontation. I must admit that my sympathies were divided. My libertarian instincts were with Friedman. But as I thoroughly dislike much of the foreign, home and educational policies of the Conservative governments of the period I wanted to find something adverse to say about their economic policy - which then as now was wrongly regarded as the main political battlefield. All these years later, the dust has not settled. Market inclined economists would still agree with Friedman, while the structuralists would echo Robinson. The most glaring case of apparent structural disequilibrium is the US. But I prefer to take the UK as a test case, not merely because I am more familiar with the data, but because the US has the complication of having its debts denominated in dollars, which might or might not postpone nemesis. These memories came to the fore during a recent meeting of a discussion club devoted to Brown's record. The structuralist flag is now been flown by Wynne Godley at Cambridge. The most interesting change since the earlier debates is that a Labour chancellor, Gordon Brown is now to be counted among those who, at least by implication, give emphasis to the price and monetary incentives. The Brown supporters pointed to the record since 1997 of reasonably stable growth, compared with other countries, and moderate inflation averaging around the target 2½ per cent per annum. The structuralists argued that the UK had experienced a consumption boom and that an awful awakening was in store. The discussion happily cut across the normal political and partisan line. Faced with these embedded temperamental differences I did something which both Friedman and Robinson would have approved; I looked at the figures covering the whole quinquenium 1997-2002. The 1997 starting point was not only the year Labour came to office, but also the last year the Treasury believed that UK growth was on trend. The Treasury reckons that the last cycle lasted until 2001. But to obtain a reasonable period I have gone up to 2002. The results are easier to comprehend if we look at cumulative growth over the period rather than the usually cited annual averages which I fear send non-specialists to sleep. At first sight the results (see above) seem dramatically to confirm structuralist fears. Real growth cumulated to nearly 13 per cent, but household consumption grew by over 23 per cent. One does not have to get involved in any arguments about the normality or otherwise of consumer debt ratios. There is no way by which consumption, which accounts for slightly over half of GDP can grow indefinitely nearly twice as fast as GDP itself without a nasty shock somewhere along the line. Yet these numbers repay a second glance. For they are expressed as usual at constant market prices. I therefore looked at another series in which they were expressed in nominal terms, that is the actual cash payments which you and I make across the counter. A radically different picture then emerges. The cumulative growth of consumption then comes to just under 32 per cent compared with total GDP growth of just under 29 per cent. Slightly uncomfortable but hardly a source of disaster. Incidentally the average annual growth of GDP itself in nominal terms came to 5.2 per cent - an achievement which must gladden the heart of any advocate of nominal GDP targeting. I doubt if British economic managers could have done as well if they had deliberately aimed for a nominal GDP objective. The reason for the discrepancy is clear enough. Prices of consumer goods rose only half as fast as the GDP deflator. They rose as third as fast the price index for government consumption which is the next largest component of domestic spending. This is clearly linked both to the high sterling exchange rate which obtained for most of the period and the extremely competitive conditions, in for instance, the retail trade which made it difficult to pass on cost increases. There are puzzles in the data. A disproportionate part of the increase in consumption was provided by imports. Yet the British current balance of payments deficit remained at around 2 per cent of GDP, much less than it reached in the late 1980s or than the US is experiencing today. Godley attributes this to an anomaly in the way that overseas investment earnings are estimated by official statisticians. (Financial Times, Jan.28). There is another interesting finding. This is that while the domestic price level rose by a moderate amount in line with the offical target, prices of British exports actually fell by a cumulative 3 per cent over the five year period. This reflects the pressure of a high exchange rate which forced British exporters to cut sterling prices to remain competitive. Import prices however fell even more than export prices, which gave another boost to real incomes. The recent fall in sterling makes it likely that the terms of trade boost to real income will go into reverse. After all a devaluation works by making exports more attractive and imports more expensive. Despite the consumer boom household spending has been growing slightly more slowly than household income in the past few years; and the investment firm of Goldman Sachs has produced plausible arguments to suggest that much of so-called mortgage equity withdrawal, resulting from older people trading down in the housing market, is being saved rather than spent. My own guess is that the official forecasts showing a much smaller rise in consumer spending than we have had in the last five years from 2003 onwards will be vindicated. Real consumer incomes are being squeezed from many sides: higher local taxes and national insurance contributions as well as a likely reversal in the terms of trade. But this benign outlook depends on a good many provisos. The obvious one is that there is no collapse in a world economy, even if the euro area continues to stagnate. Another proviso is that if the underlying growth of either output or of revenue turns out to be less than the Treasury now forecasts then the chancellor should either curb his spending enthusiasms -- or more likely -- raise taxes. Yet another is that we do not have too many "doves" on the Monetary Policy Committee whose beaks itch to dribble more money into the economy whenever real growth shows the slightest hesitation and who takes far too seriously official estimates that the economy is working below capacity. These estimates are based largely on projecting trend lines, which is always hazardous. With sterling crumbling and inflation at the upper end of the target targets, both in the here and now and in the Bank of England projections, it would be irresponsible to stimulate demand further. There is a danger of forgetting why it is that governments of all political persuasions had after the mid-1970's to abandon the direct targeting of output and employment. Harold Macmillan, who was no fan of sound money, once remarked that it would be folly for the UK to be an island of inflation in a world of deflation. The word "deflation" should not taken too literary even in the present state of world economy, but the general thrust of the former prime minister's remarks were right however much he disliked saying them.
<<<	articles
Site designed and managed by Andrew Heavens - aheavens@ftnetwork.com