Thursday, December 20, 2012

What's Wrong With the UK Economy?

Last week, I looked at the UK economy's problems.  Here are some more great observations:

    The UK government debt has low interest rates now because growth is low and demand for safe assets is high. British interest rates decline in response to bad news on growth, and market measures of the riskiness of gilts increase when interest rates and growth drop.  The opposite should hold – rates and market risk should rise together – if indebtedness were markets’ concern.  They don’t and it isn’t.

    Private UK businesses have kept adding workers in recent years (albeit some part-time or temporary) because they view future prospects as unchanged or better.  Employers only increase staff in a flexible decentralized labour market like Britain’s when they think wage costs are competitive.  The opposite should hold – declining growth and wages should lead to permanent cuts in employment – if UK potential growth was down for most businesses.  They didn’t and it isn’t.

    The spreads between the interest rates that small businesses and first time mortgage borrowers must pay for loans versus established large borrowers, and the fees that those new borrowers are charged have gone up and stayed up.  If there were lack of demand for investment, the interest rates and fees that banks could charge for loans would be declining – they are rising instead.

    Sterling has been stable in value since its 2008 depreciation, and foreign direct investment continues to pile in to such industries as auto manufacturing and fancy foods as well as business services.  If the lack of investment were due to doubts about government solvency or business competitiveness, capital would be flowing out of the UK and the pound would be declining.  The opposite is the case.

    Cuts in government spending and increases in taxation have had large effects per pound on consumption and growth overall (far larger than the Government, the MPC, and the OBR projected).  That occurs when confidence is being beaten down rather than raised up by fiscal consolidation.  If lack of confidence in government finances were a major weight on British households and businesses, the direct drag from fiscal contraction would be offset (if not reversed) by a rise in investment.  Again, the opposite is the case, and no such confidence effects have been seen.