We must urgently improve the quality of our economic growth
BARRING an astonishing shock, today’s second quarter UK GDP figures will be good. But while economic activity is now clearly increasing again, I’m deeply worried about the quality of the growth and its sustainability when monetary policy is eventually tightened.
Ever since the Keynesian revolution, the City and government have been far too obsessed with aggregate, macroeconomic figures, as well as by consumer spending and retail sales, the final purpose of economic output, and have paid too little attention to the economy’s capital structure. We care too much about the total value of goods and services produced by the economy, and insufficiently about why these goods and services are being produced. Are they being financed by excessive infusions of credit, by government hand-outs, or printed money – bad growth – or are they being sold to solvent consumers or firms in the UK or exported abroad in competitive markets – good growth? If today’s GDP expansion turns out to have been caused by the first set of reasons, we are in trouble; if it is the latter, then we will genuinely be adding to our national wealth.
GDP has its uses, of course, but it doesn’t distinguish between debt-financed bridges to nowhere and genuinely sustainable output from viable entrepreneurial firms, exporters or productivity-enhancing innovators. During the bubble, strong GDP figures camouflaged very bad things that were happening to the capital structure, a massive misallocation of resources and the build-up of unviable industries. While establishment economists were patting themselves on the back, and Gordon Brown was claiming to have eradicated boom and bust, several percentage points of the economy were being misallocated. When the music stopped, much of this had to be liquidated – with more still to come, sadly, as the purging process has been delayed by easy money.
So what is good growth – and what is bad growth? Good growth is sustainable in the strict sense of the world: it is the kind of activity that would continue in the absence of subsidies and if the cost of money rose again to properly reflect the supply and demand of funds, long-term output expansion, expected inflation and other risks. Good growth can be financed with debt, of course: there is nothing wrong with credit, as long as it is priced correctly and there isn’t too much of it. A sustainable activity adds more to the economy than it subtracts – in other words, the value of the output is greater than the cost of its inputs, under realistic market conditions and without artificial distortions introduced by the government or the monetary authorities.
Ordinarily, prices act as a signal to firms and investors, telling them how much to produce, when to build a new factory or open a new office. But this process of economic calculation can be destroyed if the cost of money or interest rates are distorted, or if risk is nationalised. When that happens, companies and investors take vast amounts of incorrect decisions. This cluster of errors eventually causes a recession when reality reasserts itself. Our easy money policies, combined with endless interventions to prop up house prices, are bound to cause yet more corporate and individual errors.
A great case study of how good GDP can emerge from bad is UK car manufacturing. Output peaked in 1972 at 1.92m units, yet the industry was inefficient and loss-making and collapsed. Output recovered by 2003, which saw the highest production in recent years, totalling 1.65m units. Again, however, too much of the production was low value added. But today’s industry – owned by Indian, German and Japanese firms – is the most efficient ever, with a great mix of cars. Output rose to 1.47m units last year; exports hit a record at over 1.2m units, up eight per cent on 2011. We need to grow – but in the right way this time.
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