Category Archives: Growth

Bill Phillips and the working MONIAC

When Bill Phillips is mentioned most people think of the Phillips Curve. However, while a student at the LSE, Phillips used his training as an engineer to develop MONIAC, an analogue computer which used hydraulics to model the workings of the British economy, inspiring the term hydraulic macroeconomics. A live demonstration of the only working MONIAC in the Southern Hemisphere. This is located in the Reserve Bank Museum & Education Centre, Wellington, New Zealand. The video below is very informative.

A2 Revision – Costs and Benefits of Growth – Mindmap

With the June exams approaching I thought it appropriate to share some mindmaps. Below shows the definition, policies, costs and benefits of Economic Growth. The costs and benefits of Economic Growth is a common essay question at A2 Level.

A country’s gross domestic product (GDP) is a measure of economic activity during a set period of time, normally reported on a quarterly and an annual basis. It is the sum of money values of all final goods and services produced in an economy over a set period. The primary indicator used for tracking economic performance over time is known as real gross domestic product, or real GDP. Real GDP is gross domestic product adjusted for changes in prices.

UK Economy – Goldilocks and the output gap

Chris Giles of The FT wrote a very good article explaining the output gap using Goldilocks and the three bears. As you may know in the story Goldilocks found the first bowl of porridge too hot, the second bowl too cold but the third bowl just right. We can use this analogy with regard to the economy:

  • running too hot – a positive output gap – the economy is overheating and higher interest rates and less government spending is needed to slow the economy down.
  • running too cold – a negative output gap – the economy has a lot of spare capacity and needs to be stimulated by dropping interest rates and increasing government spending.
  • running just right – no gap – there is neither a requirement for an expansionary monetary and fiscal policy nor a contractionary monetary and fiscal policy.

Just as Messrs Friedman and Phelps had predicted, the level of inflation associated with a given level of unemployment rose through the 1970s, and policymakers had to abandon the Phillips curve. Today there is a broad consensus that monetary policy should focus on holding down inflation. But this does not mean, as is often claimed, that central banks are “inflation nutters”, cruelly indifferent towards unemployment.

If there is no long-term trade-off, low inflation does not permanently choke growth. Moreover, by keeping inflation low and stable, a central bank, in effect, stabilises output and jobs. In the graph below the straight line represents the growth in output that the economy can sustain over the long run; the wavy line represents actual output. When the economy is producing below potential (ie, unemployment is above the NAIRU), at point A, inflation will fall until the “output gap” is eliminated. When output is above potential, at point B, inflation will rise for as long as demand is above capacity. If inflation is falling (point A), then a central bank will cut interest rates, helping to boost growth in output and jobs; when inflation is rising (point B), it will raise interest rates, dampening down growth. Thus if monetary policy focuses on keeping inflation low and stable, it will automatically help to stabilise employment and growth.

Gapology

 

However policymakers rely on estimates of the output gap – which compares actual GDP with a country’s full capacity when all resources are fully employed. The concern that the Bank of England have is that official data shows that the UK economy is showing sluggish growth rates with a tight labour market.

Almost all employment indicators suggest the economy close to overheating – recruitment difficulties and industry facing capacity constraints. This is in contrast to economic growth which suggest that there is room for expansion. Add to this the uncertainty about Brexit, the reliability of the output gap even more dubious. Current techniques might correctly measure the output gap but what about the contribution of potential capital projects which are underway?

Some economists have suggested that output gaps are inherently political and chosen to rationalise existing policies, rather than to set the correct prescriptions. However for economists is there an alternative to taking the temperature of an economy.

NZ Government Spending by Political Parties

The GDP of a country is made up of four things: C+I+G+(X-M).

C = Private Consumption
I = Business Investment
G = Government Demand
(X-M) = Net Exports

With government spending being very liberal and effective in creating growth there is a need for the other components of GDP to do their part – Private Consumption, Business Investment and Net Exports.

It is interesting to look at government spending as a % of GDP in New Zealand over the last 30 years. It follows a familiar pattern that relates to the Government of the day. As with most economies a government that is more left wing tends to spend more and a government that is right wing tends to spend less. However the graph can be a bit misleading as although spending went down under a National Government as a percentage of GDP, it could mean that spending could have been increasing but overall GDP going up at a much higher rate.

Source: Westpac

A major factor that will support GDP growth over the coming years is the large increase in fiscal spending including:

  • Approx $1.5bn of spending per annum on transfers to low and middle-income households as part of the Families Package.
  • Approx $8.5bn of spending over the coming four years in areas like health, education and infrastructure.

These increases in fiscal expenditure will see Government consumption spending growing by around 4% per annum through 2019 and the early 2020s. That’s roughly double the pace seen over the previous decade, and will see the Government’s share of economic activity rising from around 18% at present to over 20% in the early 2020s. The impact of this spending will be seen across the economy and will help to support employment growth.

Source: Westpac Overview February 2019

China and the Easterlin Paradox

I have blogged before on the Easterlin Paradox and was interested to read about the relationship between economic growth and happiness. In the mid 1970s Richard Easterlin drew attention to studies that showed that, although successive generations are usually more affluent that their parents or grandparents, people seemed to be no happier with their lives. It is an interesting paradox to study when you are writing about measuring economic welfare and the standard of living.

What is the Easterlin Paradox?

  1. Within a society, rich people tend to be much happier than poor people.
  2. But, rich societies tend not to be happier than poor societies (or not by much).
  3. As countries get richer, they do not get happier. Easterlin argued that life satisfaction does rise with average incomes but only up to a point. One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

GDP growth is generally held as the most reliable predictor of a country’s level of happiness but in China GDP has increased 5 fold over the last 20 years but the level of well-being is less that in 1990. The levels of well-being bottomed out in the period of 2000-2005 and although have recovered they are not a level to that of 1990 – levels of happiness were high for then a poor country. This was similar to Russia before its transition where high levels of subjective well-being were reported.

Growth not a reliable indicator of happiness in China

Chinese level of happiness was highest in the 1990’s In the days of the “iron rice bowl system” – Chinese term used to refer to an occupation with guaranteed job security, as well as steady income and benefits. So it transpires that GDP growth in China was highest when happiness levels were falling. In fact, none of the six predictors used in the World Happiness Reports prove to be reliable predictors in China as there was little or no correlation between happiness and the six predictors- see below:

  1. GDP per capita,
  2. healthy years of life expectancy,
  3. social support (defined as having somebody to rely on in times of trouble),
  4. trust (defined as perceived absence of corruption in government and business),
  5. perceived freedom to make life deci-sions,
  6. generosity (defined as giving to charity)

The two main factors explaining China’s trajectory in happiness levels are unemployment and the social safety net. Unemployment rose sharply after 1990, reaching its peak in 2000–2005—the trough of China’s happiness—and has since declined moderately, as happiness levels have risen moderately. The level of unemployment is mirrored by the relative coverage of the social safety net over the same time period.

It seems that the restructuring of state-owned enterprises (SOE) has had the most profound effect on the happiness of Chinese people. This mirrors developments in Eastern European countries. In addition to unemployment rates and the social safety net, education and age are also important factors in determining Chinese people’s happiness over the period. Levels of education and of happiness are indeed linked; not only does a college education provide access to better job opportunities, but it also makes one more adaptable to changing circumstances.

Source:
Chinese Discourses on Happiness (2018) Edited by Gerda Wielander and Derek Hird

China’s ghost cities – there needs to be another plan

Below is a very good report from 60 Minutes Australia that gives you an update on China’s ghost cities. Roughly 22 percent of China’s urban housing stock is unoccupied, according to Professor Gan Li, who runs the main nationwide study. That adds up to more than 50 million empty homes, he said. One solution that the government could use is property or vacancy taxes to try to counter the issue, but neither appears imminent and some researchers, including Gan, say what actually counts as vacant could be tricky to determine.

For so long China has relied on major infrastructure projects including building cities to drive growth figures in their economy. Historically China’s economic model was based on export-led growth, massive government injections into the economy and access to cheap money. This is not sustainable and although you can keep blowing up bridges and build cities that nobody lives in at some point it becomes unsustainable. Furthermore since the global financial crisis economies have increased protectionist policies to look after their own economy and this has been followed with by the potential trade war with the USA. Therefore the Chinese government need to refocus the growth of the economy on domestic consumption rather than building things – Gross Fixed Capital Formation. So much more C than I in the GDP Expenditure equation. EG:

GDP = C↑+ I↓+ G + (X-M)

Economic Developments for 2019

This is a good summary of economic developments to watch in 2019 – from Al Jazeera. Some of the key points are:

  1. Protectionist policies will remain and any truce between the US and China will be short-lived.
  2. The US is in an unsustainable boom – the fiscal stimulus will fade and this will be followed by two larger deficits – budget and external. The US is consuming far more that it is producing and it mirrors the 1980’s – Reaganomics.
  3. China is slowing down – as well as the protectionist issues as a result of the US trade policy there are tensions between the economic system of capitalism and the political system of communism. This combination is referred to as ‘Market Socialism’. The problems are associated with: economic growth v environmental problems, rural areas v urban areas, rich v poor. China’s movement away from oil to gas which benefits Qatar but to the detriment of the Saudi economy.
  4. The Gulf economies are taking a hit from the fall in oil prices and government budgets may have to be cut. Diversification from the dependence on oil is necessary to avoid the resource curse and with a growing youth population job creating is needed. Movement to a more knowledge-based economy and large infrastructure projects are becoming focus areas as a necessity.

Aussie kick the resource curse

I have mentioned the ‘resource curse’ in many postings since starting this blog. It affects economies like in sub-Sahara Africa and Australia which have a lot of natural resources – energy and minerals. The curse comes in two forms:

  • With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly.
  • This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.

The Australian economy did well at the height of the commodity boom in 2013 with iron ore, copper etc earning companies and the economy significant amounts of money. Investment in this area amounted to 9% of GDP in the same year with new mines, gas fields and infrastructure to cope with the increasing demand. But the collapse in commodity prices didn’t have the effect that suggest the resource curse. Countries like Venezuela – oil, Chile – copper, Nigeria – oil etc. have gone through turbulent times as commodity prices fall. Australia though has come through this period quite well for the following reasons:

  • falling investment in the mining sector has allowed the central bank to lower interest rates allowing other sectors, previously shut out, cheaper access to investment funds
  • the falling exchange rate – AUS$ lost 40% in value against US$ between 2011 – 2015 – made other elastic exports more competitive and this was particularly apparent in the tourism, education and construction sectors.
  • Tourism – spending by tourists increased by 43% from 2012 and amounted to AUS$21bn in the year ending March 2018.
  • Education – overseas student numbers increased from 300,000 in 2013 to 540,000 in 2018. Each year they contribute AUS$40bn.
  • Construction – firms have completed projects worth AUS$29bn in the 4th quarter of 2017 which compares with AUS$20bn in the 1st quarter of 2012. The Foreign Investment Board approved AUS$72bn worth of residential-property purchases in 2016, up from AUS$20bn in 2011.

Australia GDP Annual Growth Rate – 2010-2018

Source: Trading Economics

So despite the end of the resources boom the Australian economy’s GDP per annum hasn’t fallen below 2.4% – see GDP graph. Furthermore, Australia ranks as the 14th largest economy on the globe but ranks 7th regarding the volume of foreign investment and this ranking has risen despite the end of the resources boom. Prudent fiscal measures and a sound monetary policy have also played their part in a resilient Aussie economy.

Top 20 Country GDP (PPP) Ranking History (1980-2023) – Dynamic Graphic

HT to colleague Paul Chapman for this graphic from ‘Dynamic Graphics’. The Dynamic Graph (Data Visualization) Shows the Top 20 Countries with the Highest GDP PPP from 1980 to 2023. The Ranking includes superpowers, such as United States, China, Japan, India, and Germany. It also compares the total GDP (PPP) of different continents from the Top 20 countries, mostly North America, Europe, and Asia. Interesting to see the rise of China and the changes in top continent by GDP (PPP).