Business investment falls sharply

Business investment fell heavily in the final three months of last year as the financial crisis restricted banks from lending to companies.Business investment by manufacturing and non- manufacturing companies in the three months to December was estimated to have fallen by 3.9 per cent from the previous quarter and was 7.7 per cent down on the same period in 2007, the Office for National Statistics said. “Businesses are increasingly and substantially scaling back their investment in the face of sharply weakening demand, rising levels of spare capacity, worsening cash flows and very tight credit conditions, deteriorating profitability, and serious concerns and uncertainties about the potential length and depth of the recession,” said Howard Archer, economist at IHS Global Insight. “On top of this, the marked downturns in the commercial property sector and the housing market are substantially depressing construction investment.“

While business investment data are frequently subject to revision, the figures underscore a key feature of the current recession – it is investment-led, with the drop in business spending having knock-on effects that are now filtering through the economy and pushing up the number of unemployed.

Link

How significant is the contribution of investment to aggregate demand? Explain how the fall in investment is affecting employment.

No V-shaped recession

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According to Ashley Seager in The Guardian 'it was always fanciful to expect we might be in what is known as a "V-shaped" recession, where we tumble quickly in and then bounce back out.' The latest eonomic perfomance figures from around the world make grim reading; 'Japan - the world's second largest economy - reported last week that its gross domestic product had shrunk by 3.3% in the fourth quarter of 2008. That is the equivalent of 13% over a 12-month period... The eurozone's biggest economy, Germany, is suffering the same problem as Japan and China in that it cannot export anything to a world economy in which demand has collapsed. The credit crunch is giving way to a manufacturing crunch - and it's deepening. There was also grim news from the United States with figures showing industrial production down 10% year-on-year in January. Car production in the world's largest economy is now a staggering 50% lower than a year ago. And housing starts there have fallen to a new low, suggesting the three-year-old housing downturn is far from over.'

Link to article

The UK recession is “not yet clearly worse” than other postwar downturns, although there is still a “strong case” for a further easing of monetary policy, according to a member of the Bank of England’s rate setting committee. Andrew Sentance, a member of the Monetary Policy Committee, said “the global financial crisis and synchronised global downturn” were “producing a recession which is relatively severe compared to past precedents – but not yet clearly worse than the mid-1970s and early 1980s downturns in output”. But Mr Sentance also admitted that monetary policy was unable to prevent recessions.“If there is a general lesson for monetary policymakers from this financial crisis and the resulting recession, it is a sense of humility,” he said. “Like the bankers, we are not the masters of the universe either.”

Link to FT article

Does Royal Mail need to be privatised in order to survive?

The government want to sell a stake of about 30% in Royal Mail to the private sector to help pay for the modernisation of the service. It is argued that the injection of private capital is necessary to fund the modernisation the company needed. Many European postal firms have automated a lot of their services which saved them money and made them more efficient. Union leaders and MPs are worried about the threat to jobs and the impact of private sector involvement on the Royal Mail's "universal service" obligation to deliver mail to every UK home. There are fears that selling off 30% will open the door to full privatisation in the future compromise this obligation. Ministers say they are committed to the universal service but argue that Royal Mail is less competitive than its European counterparts and needs to improve its performance in order to safeguard its long-term survival.

UK inflation rate declines to 3%

Consumer Prices Index (CPI) inflation fell slightly in January to 3%, from 3.1% in December, figures have shown. CPI inflation has now fallen for four months in a row from a high of 5.2% in September, driven down by falls in energy costs and fuel prices. Retail Prices Index (RPI) inflation, which includes mortgage costs and is often used in pay negotiations, fell to 0.1% from December's 0.9%. The drop in RPI may lead to pressure on employers to limit pay rises. The headline RPI rate of 0.1% is the lowest rate it has been since 1960. In addition to falling energy prices, the reduction in VAT from 17.5% to 15%, announced in the pre-Budget report in November, also had an effect.

Link to BBC News

According to The Guardian, sterling, not inflation, is the real worry. Whilst there is some concern that inflation has not fallen as much as expected...'what little inflation remains in the system is a symptom of the falls in sterling that have already happened; not a cause of anything more worrying in itself. It is further uncontrolled falls in sterling we should be concerned about, rather than outdated battles about monetary policy.'

Link

Economists under fire

As to be expected in the wake of the deteriorating economic situation, economists (and economics!) are at the forefront of criticism. Ilanna Bet-El reireated her view in the The Guardian (Economists should get smarter) that 'economics may be less than a science, quoting Jane Jacobs, author of Cities and the Wealth of Nations. "Never has a science, or supposed science, been so generously indulged. And never have experiments left in their wakes more wreckage, unpleasant surprises, blasted hopes and confusion, to the point that the question seriously arises whether the wreckage is reparable."'

'The massive stimulus bill just passed in the US is apparently an attempt to repair the current wreckage. However, since it is mostly based upon economic theory, there is room to doubt its future success: this may be yet another vastly expensive experiment based on a model, which is the tool of the economist. And given simulated models of securitised mortgages are what brought about the crisis to start with, what is now needed is a severe dose of harsh reality, combined with some common sense.'

She challenges the assumption that the answer to our economics woes is to get consumers back into the shops. Many consumers just don't have the money, credit has dried up and most of us in developed countries have sufficient consumer goods and don't actually really need anything. 'There is no obvious solution to the financial crises, but it should be clear that they cannot be resolved by economic theory or by depending on mass consumerism: that is a way back to the bad past.'

Instead economists should use 'a full range of tools as appropriate to a specific situation rather than sticking to a specific model or theory. In other words, rather than just veering between tax cuts and stimulus, between funding banks and buying up their bad debt, there should be room for examining each case in the round of a given economy and society – and seeking to balance both, not just the books.'
We should 'start thinking about "smart consumerism": a mode in which need and quality would be at the heart of production and consumerism rather than cheap credit and greed. More money would be exchanged per item, but less frequently: both sides would therefore stand to gain, and the environment would be filled with fewer cast-off items. '

Link to article

The mechanistic approach to economics has failed. We need to embrace creativity

Very thought-provoking piece by larry Elliott in today's Guardian. He considers whether we are on the brink of a 'depression', concludes that we just don't know and points the finger at economist who have come to rely on mechanistic models with flawed assumptions. 'One reason we are in this mess is that we assumed far greater foresight than actually existed. All the fancy models purporting to show only a minuscule risk of financial blow-out were flawed. They assumed the complexity could be captured by mathematics and pseudo-science. One silver lining to the storm cloud over the global economy is that there will now be an overdue revolution in how we do economics. Already, the cutting edge of the profession is looking to other disciplines - biology and psychology in particular - to explain why models that work in theory come a cropper in practice.' He draws on a new book by Richard Bronk to support his view. 'As Richard Bronk notes in his fascinating new book (The Romantic Economist): "Standard economics assumes that economic agents are perfectly rational; that is the basis of its predictive equilibrium-based models. Modern versions generally allow for certain types of information problem and market failure, and recognise that institutions and even history play a role; but they still assume that these factors do not call into question the underlying model of agents as rational utility maximisers within those constraints... There have been many economists down the years who have expressed scepticism about reducing their discipline to a mechanistic subject. Malthus told Ricardo to be wary of becoming too attached to abstract hypotheses; Schumpeter talked of creative destruction; Hayek saw the market as a voyage of discovery; Keynes stressed the importance of "animal spirits".

The models rely on past behaviour for their predictive ability and 'What we now know is that even the very recent past is an unreliable guide to the future; that risks are not distributed in a linear and predictable way; that human beings do not always act rationally even when they think they are; and that shocks are much more likely than economic orthodoxy would suggest. All of which explains why it is virtually impossible to say where the global economy goes from here. '

Read the article (Link) and consider reading the book!

How does it make you think about the models we use in economics?

Is the higher price of petrol justified?

BBC News reports that the price of petrol has been creeping up steadily since the beginning of 2009 despite the fact that the price of crude oil hase been falling. The average price of a litre of petrol is now 90.48p and diesel 100.74p, analysts Experian Catalist said. This compares to a recent low on 6 January of 85.89p for petrol and 98.06p for diesel. However, the price of crude oil is now 40% lower than the last time petrol cost 90p a litre, back in March 2007, according to the AA. Oil prices have tumbled by more than $110 since July last year. US light, sweet crude is currently trading at about $34 a barrel. Link

What factors, other than the price of crude oil, do you think influence the price of petrol? Do any of these justify the increase in the price of petrol?

UK now 'in deep recession' - economy will shrink by 4% this year

Further confirmation (if any was needed) of the worsening of the UK's economic position. The governor of the Bank of England, Mervyn King, has warned that the UK is "in a deep recession" in 2009 and said rate cuts may no longer work and hinted thta 'unconventional' measure may have to be used. In its latest forecast for economic growth and inflation, the Bank says that the UK economy will decline sharply in the first half of the year. And it says that there is a significant risk that the recession will be even longer and deeper than expected. The Bank forecasts the economy will shrink by 4% from mid-2008 to mid-2009.

Link to BBC News

What do you think Mervyn King meant by 'unconventional' measures?

Unemployment up to 1.97million

UK unemployment rose to 1.97 million between October and December, the highest level since 1997, figures show. The jobless number climbed 146,000 for the three-month period, data from the Office for National Statistics showed. For January, the number of those getting jobseeker's allowance added 73,800 to reach 1.23 million. The unemployment rate hit 6.3%, the highest since 1998, and comes as The Bank of England recently warned of a "deep recession" for 2009. Link to BBC News

The FT has a short video outlining the likely longer term prospects for the job market - and it isn't encouraging! Link

Graduates... take lower skilled jobs!

Students are being urged to take lower-skilled jobs or do voluntary work when they graduate this summer, after a poll of employers revealed widespread cuts in graduate recruitment. Vacancies for graduates in the City alone nose-dived 28% in the past year, the survey found. Leading companies from the banking, accountancy, construction and IT industries announced cuts to their graduate training positions for 2008, while across the board graduate pay has been frozen, the survey reported. In the worst hit industries starting salaries have been cut in an attempt to prevent further job losses.

Link to article

What impact do you think this information might have on those considering applying to university in the coming year?

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Obama's fiscal package

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Following our discussion in the Year 12 lesson today about Obama's fiscal stimulus, I saw this graphic in The Guardian which shows how $838bn will be distributed across the economy. $637bn will be in the form of a variety of spending projects and the remaining $182bn in tax cuts. According to The Guardian ... 'Obama's spending bill, which will be funded entirely by the taxpayer, aims to create or save millons of jobs by beginning work on thousands of New Deal-style projects to renew the country's crumbling infrastructure. It also provides aid for the unemployed, help for schoolchildren and students, and various energy measures.' The aim is to get the US out of recession as soon as possible. Billions of dollars will be spent on bridges, roads, waterworks and sewage disposal. Another big area of expenditure is education. The congressional budget office estimates the bill would create between 1.3m and 3.9m jobs by the end of 2009. US unemployment is 7.6%, about 11million people.

How will this spending 'be funded entirely by the taxpayer? Can you explain how increases in spending by the government and tax cuts will create jobs?

The end of monetary policy as we know it?

Three former members of the Bank of England's rate-setting committee have urged the central bank to rethink its monetary policy. Dr Deanne Julius, Sushil Wadhwani and Willem Buiter are all part of a new monetary policy forum, set up by Fathom Financial Consulting. The forum is designed to scrutinise the Bank's Monetary Policy Committee (MPC). The former MPC members are now urging the Bank to consider the use of quantitative easing - creating money to buy assets - as a tool for ensuring economic stability. Dr DeAnne Julius told the BBC: "We are clearly at the end of monetary policy as we know it." Link to BBC News

For explanation of Quantitative Easing see earlier blog.

Fall in UK's trade gap

The UK's deficit on trade in goods with the rest of the world fell to an 18-month low in December. Britain's goods trade gap fell to £7.367bn from a record £8.114bn in November, the Office for National Statistics (ONS) said. That was the lowest the gap - the difference between imports and exports - has been since June 2007 and was well below analysts' forecasts of £8.1bn. The narrowing gap was driven by a 2.5% fall in imports rather than an improvement in exports. The ONS provisionally estimated the trade deficit for 2008 as a whole at £93.2bn, compared with £89.3bn in 2007.

Link to BBC News

Link to The Guardian

Do you think there is a strong link between the weakening of the pound and the fall in demand for imports?

What is Quantitative Easing?

If you have heard the term 'Quantitative Easing' but are unsure what it means then the graphic in today's FT should help. As interest rates reach their lower limit with doubt about the effectiveness of rate cuts, the Bank of England is looking for other measures to stimulate spending in the economy; 'Quantitative Easing' is such a measure. Link

As predicted ... interest rate cut to 'historic 1%

The Bank of England has reduced interest rates to a record low of 1% from 1.5% in an attempt to boost the shrinking economy. This marks the fifth interest rate cut since October, as the Bank seeks to encourage more lending. However, there are concerns that savers will be hurt by lower interest rates. And business groups argue that this rate reduction will not be enough to ease the economic crisis, and will not encourage banks to lend. (See the concerns of the NIESR in yesterday's blog). Link to BBC News

Geoff Riley provides a good summary of the decision and a comprehensive chart-based student handout. Link

End of rate cuts?

As the Monetary Policy Committee begins its monthly meeting, an influential think-tank has said there was "not very much point" to the last cut. Martin Weale of the National Institute of Economic and Social Research said that other measures such as the Bank buying corporate bonds would be better. It is not the cost of credit that is deterring borrowers but that credit is not available. The think tank warned that the contraction of credit meant that rate cuts by the Bank of England were now ineffective in stemming the downturn. The NIESR predicted the UK economy would shrink by 2.7% in 2009, its worst performance for 60 years. Link to BBC News

With regard to the lack of available credit, see the video posted on the tutor2u blog. It concerns Leyland Daf trucks, explaining that whilst demand for vehicles is high, many smaller companies cannot get loans in order to puchase trucks whose price is around £100,000. It shows how this affects company production and employment, and its knock-on effects to suppliers and the local/national economy. Link

As the Monetary Policy Committee meets, the Bank of England announced that it has lent £185bn to financial institutions since April under its special liquidity scheme (SLS), set up to allow banks to temporarily swap assets that were difficult to trade, such as mortgage-backed debt, for UK Treasury Bills. It was designed to help encourage banks to resume normal lending practices by reducing the uncertainty that having illiquid assets on balance sheets was creating. Link to BBC News

Digital Britain - the consumer knows best?

Following the interim report on 'Digital Britain' by the communications minister, Lord Carter, which emphasies a key role for public sector support to secure Britain's place at the forefront of the global digital revolution, an interesting response in the FT. The chief executive of BSkyB, Jeremy Darroch, argues the case for leaving consumers and the market to determine the direction and nature of developments. He argues that in broadcasting ...'The consumer’s experience has been transformed. That is to be celebrated. But one feature has not changed much at all. The interim report on Digital Britain by Lord Carter, communications minister, reminds us that the traditional distrust of the market’s role in the provision of high-quality content is as strong as ever. Digital Britain proposes to support the creation of digital content and offset the decline in advertising revenues through alternative funding mechanisms.' He believes that a positive climate for commercial investment should be created. 'Consumers could make an informed choice about products and services they wish to consume and pay for. The revenues could drive profitable returns and reinvestment in further high-quality content.' Regulation will be replaced by effective consumer choice that will ensure quality. Link to FT article

Would leaving developments in digital technology to the private market result in efficient allocation of resources or market failure? Is broadband (and other such products) a 'merit good'?

British tourism bucks the trend!

The Independent on Sunday reports that 'grounded by the diminishing value of the pound and fears about the recession, record numbers of Britons will choose to holiday at home this summer. New figures suggest that 2009 could be a bumper year for British tourism.' After years of chichi mini-breaks in boutique hotels, the humble self-catering holiday is coming back, with Hoseasons, Butlins and the Youth Hostels Association (YHA) all reporting increased business. "Bookings for 2009 are up 20 per cent on last year," said Peter Joyner of Hoseasons. "Because we are the biggest self-catering firm in the UK we are a good barometer of what is going on in the rest of the industry." "UK holidays are usually cheaper than going abroad. If you go to a cottage in Britain you can just pack the car up and take all your own food. You've got greater control. When you go abroad you've got unknown elements," said Mr Joyner. Butlins also reported that bookings for the school summer holiday are up 15 per cent on last year. The YHA said January bookings were up on 2008.

Link to article

Are self-catering holidays in the UK and the other holidays referred to in the article examples of inferior goods? Think about the income elasticity of demand for such holidays.

Cameron calls for 'capitalism with a conscience'

David Cameron, leader of the Conservative Party, today called for “capitalism with a conscience” and said it was time for wealth to be distributed “more equally”. The Tory leader said that while he would stand up for business, he would also “stand up to business when the things that people value are at risk”. Speaking in front of world leaders, financiers and corporate directors at the World Economic Forum at Davos, Mr Cameron said: “…it is time to place the market within a moral framework - even if that means standing up to companies who make life harder for parents and families. It is time to help create vibrant, local economies - even if that means standing in the way of the global corporate juggernauts. And it’s time to decentralise economic power, to spread opportunity and wealth and ownership more equally through society, and that will mean recapitalising the poor rather than just the banks.” Mr Cameron spoke to the audience of the halcyon days of the 1950s where “there was a sense that everyone could have a slice of the pie”.

Link to Times Online

There is an interesting 'email' debate between Will Hutton and David Cameron in today's Observer where Cameron is challenged to explain how he would bring about 'capitalism with a conscience'. In one exchange he is aksed whether he embraces Keynesianism to which he responds ..."As a Conservative, I'm naturally sceptical of embracing anyone's theory or ideology, although I agree that Keynes had many good ideas, in particular his emphasis on the dangers of the contraction of credit. Here in Davos you see this clearly right now: for example, a representative from the African Development Bank told me how the lack of credit is holding up the construction of roads, bridges and other infrastructure. So I think our plan for a National Loan Guarantee Scheme would actually achieve many of the long-term outcomes people associate with "Keynesianism". But if by Keynesianism you mean a big fiscal stimulus regardless of the level of government borrowing, I don't agree. The reason is simple: because the government is already planning to borrow so much, if we borrowed a lot more now we'd actually make the recession worse. Why? Because we'd have to show how the extra borrowing was going to be paid back through tax rises. That would damage business and consumer confidence, which is in the end what will get the recovery going.

Link to Observer article