As a keen cyclist, I went down to London last weekend to watch the Olympic road race. It was pretty exciting standing on the Fulham road watching the peleton go past. That part of London seemed pretty busy and nearby cafes were doing very well. However, in the centre of London, many shops and hotels have complained of lower than expected business – with many tourists and shoppers being put off by threats of traffic chaos.

Given forecasts of four hour traffic jams, it is unsurprising that so many stayed away. However, whilst some have sought to avoid London during the Olympics, there have also been a new wave of visitors, who will hopefully want to revisit a revitalised London in the future.

The economic legacy of London 2012 is going to be much more than the three week duration of the Olympics. However, given the last GDP statistics showing a shock 0.7% fall (partly blamed on Jubilee holiday) The government will be hoping that the Olympics gives the economy a boost – there are only so many times you can blame falling GDP statistics on bad weather and public holidays.

Feel Good Factor?

UK consumer confidence is near record low levels. After four years of recession, creating positive economic news has been difficult. It is possible a successful Olympics will help change consumer confidence and encourage economic activity. From a macro perspective, with a double dip recession the Olympics has come at a good time. The question is whether watching sporting success actually translates into consumer spending and investment. Despite the scale of the Olympics, there are still more important factors affecting economic confidence and growth.

However, I think that overall the Olympics will have a positive effect on economic spirits.

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Readers Question: Will Cutting Public spending bring economic growth?Do Countries with lower government spending as a % of GDP have higher economic growth rates?

After recent data on -0.7% growth in Q2 2012, several experts offered suggestions for restoring economic growth to the UK.

In the Guadian, Sheila Lawlor suggested (link):

The UK’s output figures, which show a quarterly drop of 0.7%, are not surprising. Economies with big public spending to GDP ratios have difficulty growing.

But there is a solution, to cut public spending and embark on structural reform, proven as the sure path to growth. The evidence from a variety of economies shows that cutting public spending and structural reforms brings growth: Brazil since 1990, Ireland in the 1990s, Sweden from the 1990s.

Basically, the argument is cut government spending and the private sector will have the freedom to take over inefficient government spending and then we can enjoy rapid economic growth. Whilst some blame austerity measures for pushing UK into double-dip – this analysis suggests we just haven’t done enough austerity.

Firstly, it is possible to cut government spending and still enjoy economic growth and an improvement in economic growth. Lawlor could have pointed to Canada in the 1990s, which also enjoyed rapid growth – despite cutting government spending. However, these periods of cutting government spending usually have other factors to stimulate growth.

• Countries have own exchange rate
• Countries can pursue a loosening of monetary policy
• Strong global growth, leading to higher demand for exports.

Cutting government spending in an economic boom can be absorbed. It is fine to cut spending – if the private sector have the opportunity to replace government demand.

Ireland’s cuts  in the 1990s were quite successful – helped by independent currency, strong export demand and loosening of monetary policy. But Irish austerity policies since 2008 have been a disaster for economic growth. The problem is that government spending cuts in the 2000s, have not led to the private sector taking the place of the government.

The idea that cutting government spending is the ‘sure’ path to economic growth hardly fits with the picture in Greece, Spain, Italy or Ireland in the past three years. I would have thought even the most optimistic austerian would see that cutting government spending doesn’t always lead to an economic miracle. (e.g. Spain crisis)

In the current climate, the private sector is unwilling to invest because it is uncertain there is the demand in the economy.

Therefore, cutting government spending in the current climate, is unlikely to cause ‘crowding in’ of the private sector.

It is not enough to just rely on supply side policies and strutural reforms, a key factor determining private sector investment is not just amounts of red tape – but is the demand there to buy the goods?

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Keynes was one of the great economists of the twentieth century. Even his critics would have to admit he had a certain turn of phrase and wit. These are some of his more memorable quotes

The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.

A Tract on Monetary Reform (1923) Ch. 3.

“In truth, the gold standard is already a barbarous relic.”

– Monetary Reform (1924), p. 172

“If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.”

– “The Future” Ch. 5, Essays in Persuasion (1931)

” There is no harm in being sometimes wrong — especially if one is promptly found out.”

– Essays in Biography (1933)

“The day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems — the problems of life and of human relations, of creation and behaviour and religion.”

– First Annual Report of the Arts Council (1945-1946)

“The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it beginning with page 45 [Hayek provided historical background up to page 45; after that came his theoretical model], and yet it remains a book of some interest, which is likely to leave its mark on the mind of the reader. It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in bedlam.”

– On Friedrich Hayek’s Prices and Production, in Collected Works, vol. XII, p. 252

” Education: the inculcation of the incomprehensible into the indifferent by the incompetent.”

As quoted in Infinite Riches: Gems from a Lifetime of Reading (1979) by Leo Calvin Rosten, p. 165

“When the facts change, I change my mind. What do you do, sir?”

– Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider’s History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220

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Readers Question: Whose is to blame for the continued UK recession?

With the banking crisis and economic recession, politics seems to be currently dominated by a ‘blame’ game – trying to work out whose fault it is. Unsurprisingly, the coalition have tried to shift blame on to Euro crisis and banks. Others have blamed the governments own spending cuts.

Possible Suspects for continued recession

1. Euro-crisis – uncertainty and recession in Eurozone affecting UK exports and investment levels in UK
2. Bank Lending – Banks reluctance to lend to firms is stifling investment and economic recovery.
3. Government spending cuts – Cuts in government spending have led to a fall in demand and also a subsequent fall in consumer spending.
4. Global downturn. The UK is being affected by global economic slowdown. (though other parts of the world are still posting positive economic growth)
5. Reduced real wages. Combination of real wage cuts and higher commodity inflation has squeezed disposable incomes in past few years.
6. Weakness of housing market
7. low levels of UK consumer spending
8. Government spending under Labour

Euro Crisis.

The chancellor, George Osborne has sought to put considerable blame on the Euro crisis for holding back UK recovery. Osborne recenlty said:

“Our recovery – already facing powerful headwinds from high oil prices and the debt burden left behind by the boom years – is being killed off by the crisis on our doorstep,” Eurozone crisis killing off recovery

Source: ONS

If we look at exports to the Eurzone, there is some evidence of a recent decline in 2012. Though there has always been an element of volatility in the past two years, there is no clear downward pattern. The economic slowdown is most pronounced in peripheral countries, such as Spain and Italy. Others like Germany and France have been able to post positive economic growth.

The Eurozone is definitely important for exports and wider UK economic confidence. However, looking at the trend in exports to Europe, there is no clear pattern that falling exports to our main trading partner is leading factor in causing a recession.

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