Action to promote growth! Why didn’t we think of that?

Greetings from New York.

I have been busy on this side of the Atlantic for the past couple of weeks, hence the lack of blog posts, but have been prompted to write by a sequence of developments.

First there were reports that the government is considering plans to stimulate housebuilding. These were followed by an open letter from Alastair Darling the former Chancellor in which he urged the government to change course and take ‘urgent action to promote growth’ including building more houses and other infrastructure projects. Then this was followed by the grim figures for the public finances just in. July is usually a good month for the taxman, such that government finances were in surplus (by £2.8 billion) this time last year. The latest figures, however, reveal a sharp (£3.4 billion) deterioration, to a deficit of £0.6 billion.

These figures come as no great surprise to me or my colleague Dr Tim Morgan who publishes research for Tullett Prebon. We have both been warning that there are in effect no spending cuts despite the propaganda to the contrary and that the growth on which the government was relying to correct the deficit would not arrive. Now it is proving to be so.

I suppose I also shouldn’t be surprised that both the government and Alastair Darling put forward housebuilding as one of the solutions to this problem of a lack of growth. Neither seems to have considered the following factors:

1. An obsession with home 'ownership' (with a 100%+ interest only mortgage-hence the inverted commas) was part of the cause of the financial crisis;

2. In the most successful economy in Europe-Germany-less than half the population own their home; and

3. No one has ever managed to export a house.

By the way, the government is talking about promoting 'affordable housing'. For those of you familiar with Hutber’s Law, if there is such a thing as 'affordable housing' what does that make the remainder?

So I am not surprised that the UK’s public finances are deteriorating rather than improving, or that the government and at least one member of the Opposition think that promoting more housebuilding is part of the solution rather than the problem, but I must admit I am surprised by Alastair Darling’s intervention because I had him in the sensible camp. It’s particularly disappointing that he points to the current low interest rates as evidence that the government could borrow to undertake a programme of building infrastructure projects and houses. He seems to have missed the fact that such rates exist: a) because of the contrast between the UK’s statements on correcting its deficit and the train wreck which is taking place in the Eurozone. Of course, at any moment, the bond markets may just spot that this is all baloney. The July public finance figures are just the sort of catalyst for this; and b) the government owns over a third of its own bonds through the Quantitative Easing programme. It is unlikely that the government will set the same rate at which it will buy its own bonds as an external investor would.

At some point someone like Ed Balls or Alastair Darling may get to a position of power again and launch a policy of increasing borrowing even more than it is growing already (bear in mind that the public debt is still rising-they are trying to reduce the deficit, there is no likelihood of a surplus) in order to pursue this attempt to borrow and spend their way out of debt crisis.If they do, it will be amusing to watch the outcome, from a safe distance.

Comments

[Alcuin]

Danny Gabay writes: "Between 1992 and 2008 Japan enacted no fewer than 15 separate fiscal stimulus packages, worth in total more than 200pc of its GDP, according to the International Monetary Fund. They tried everything from permanent tax cuts in both personal and corporate taxes and massive infrastructure spending to handing out spending vouchers, as well as all sorts of lending schemes. And all of it pretty much for nought."
http://www.telegraph.co.uk/finance/comment/9491129/Building-bridges-and-airports-wont-solve-the-UKs-key-problem-of-household-debt.html

I had not heard the Japanese story in such detail before, though Gabay does go on to suggest a US style "stimulus", which I see as little better than anything the Japanese have tried. And as I commented on his article, he left out the dramatic fall in US gas prices, and the fact that any fool can create short term growth by resort to the Ponzi scheme.

The only real solution is some form of default, by whatever euphemism you choose to call it.

[David K]

Terry, most of the time you are correct, however your last post misses a couple of points I believe.

Firstly, there is a shortage of houses, particularly in the South East. This pushes up prices and means that people spend a greater proportion of their income on housing (be it mortgage related or rental costs). Restrictive planning laws and lender forbearance make it hard for prices to find equilibrium or for more houses to be built. We just need more and a freely functioning market will determine prices. Something must be done to arrest the artificial seemingly never ending increase in house prices.

Secondly, there are significant industries around flat pack houses with Germany leading the way in exporting houses many of which are highly energy efficient, of outstanding build quality and a good 20-35% cheaper than brick & mortar built houses. Huff Haus is an example.

[Shiv Malik]

Do you live in a house?

[Terry Daly]

We need democratism, not capitalism, liberalism, socialism, conservatism or any other 'ism'.

[David Starkie]

Excellent piece. I sit in disbelief watching the news that the PSBR is likely to exceed expectations and this brings forth calls for a change of tack, in terms of borrowing still more!!
David Starkie
PS The Brits have never exported a house but the Germans have! Must be a lesson in that somewhere

[Frank Throssell]

Ref youritem 3 above ,China is exporting prefabricated housing to Barrow Is off the NW coast of West Australia for long term workers accomodation Called Dongas, they are self cotained motel style units 2or 3 to a block & similar in size to a container & transportable

[Grumpy Oldman]

3. No one has ever managed to export a house.

I thought lots of London was being bought by rich Russians and oil sheikhs?

[Stephen Britt]

Terry,
Your post raises a few points;
1. Is there, or is there not, a shortage of homes in the UK (or certain parts of it)?
2. Surely, if we built lots more, the prices would naturally fall (supply & demand)?
3. If housing stock prices fall then rents will fall, encouraging more people to rent?
4. We may not be able to expot houses, but surely we can 'import' some foreign currency in rent from visitors, businesspeople etc?
On another point, good to see market forces working with University places & fees!

[Terry Smith]

A general reply to all the responses on my post Action to promote growth:

The main point I was seeking to make was that borrowing and spending more as a response to being too heavily indebted will not work, and I am grateful to Alcuin for pointing to the recent material on the Japanese example.

However, most of the responses were about the housing market plans. Yes, I was aware that there are a number of flat pack housing companies and that some of them export. One British company exported such houses to Iran before the revolution there. And in the US there is a “manufactured housing” sector and the infamous trailer parks. And as a Londoner I am acutely aware that significant numbers of central London properties have been sold to foreign buyers. I used the phrase “No one ever exported a house” to make a point. What we surely need to promote are export industries , and housing is not likely to become a serious export industry despite some examples of flat pack manufacturers and foreign buyers. Housing by its nature is best manufactured locally-there was once a portion of the motor industry in flat pack exports-but these have naturally been replaced by regional plants. And I doubt we will “export” significant numbers of houses to wealthy foreign buyers outside the London W and SW postcodes.

I am aware that there is a shortage of houses in the south east of England. Like a number of other shortages which may exist, such as adequate pension or healthcare provision, we may just have to live with those shortages if we can’t afford to supply them. In any event, I find the idea that government intervention is going to promote free market activity rather counter intuitive. I also find the idea that the government would like to see subsidised affordable housing as a means of bringing down the price of houses unlikely-in my experience politicians from both the government and the Opposition are more concerned with losing votes from home owners/mortgagees than they are with breaking the British obsession with rising house prices.

[David K]

Terry, a couple of points.
First is it not government that is inhibiting a free market through highly restrictive planning regulations?
Secondly, surely if there were more houses, the prices of which were fairly stable, then the get rich quick by owning a house mentality held dear by so many would wane. Of course not over night, but in time, and for sure there are no quick fixes to the malaise we are now in.

[Andrew]

"Of course, at any moment, the bond markets may just spot that this is all baloney."

I suppose eventually interest rates are going to have to rise again...but I've been hearing this kind of "baloney" for three years and yet interest rates remain stubbornly low.

I don't suppose it might be worth considering an alternative reason for that?
No, probably not because then the whole "prosperity through austerity" argument falls apart doesn't it.

Perhaps the Bond Vigilantes are just taking a nap...a very long nap. Yup, I'm sure that's it.

[Nick]

Indeed. Politicians will do what they think will get them elected so they are not going to engineer a fall in house prices. They, with the help of the BoE, are trying to do the opposite (or at least stop them falling). Even so, Mr Market will put things right one way or the other, even if we have to wait.

I hear on the radio this morning an economist telling us that cutting a pound of government spending in a recession will cut more than a pound out of the economy. As such it is a bad time to cut. Better to cut in a boom when the loss of one pound of government spending will have less than a pounds worth of impact.

Nothing new there as I thought Keynes proposed that 80 odd years ago. Only problem is that when the good times come the politicians forget to cut spending to hold back the boom. There is then no reserve to help us through the bust. Thus we are where we are.

[BobBeveridge1]

Have you come across this report on the correlation between government size and growth?
http://journalistsresource.org/wp-content/uploads/2011/08/Govt-Size-and-Growth.pdf
It shows a clear inverse correlation between the size of government and growth. This really just confirms common sense, as government only takes from private production to fund its spending. And while some government spending is productive, much of government spending is not. So there is an inevitable cost to an economy of increasing the size of government.

[Terry Smith]

Thank you for this although I had seen mention of the research in an excellent note by Peter Bennett from Walker Crips Stockbrokers, but it was good of you to post the hyperlink so that I can read it in full. You are right, this is common sense but sadly common sense is an inappropriately named attribute as it’s not at all common.

[Andrew]

I particularly enjoyed the last paragraph of the paper's conclusion [Emphasis mine]:

Finally, while there is close to a consensus on the sign of the correlation, THERE IS ALSO CONSENSUS ON THE FACT THAT CAUSALITY IS VERY HARD TO ESTABLISH with certainty using the method of instrumental variable
estimation—or any other method currently available. In fact, IT IS CLOSE TO CONCEPTUALLY MEANINGLESS TO DISCUSS A CAUSAL EFFECT FROM AN AGGREGATE SUCH AS GOVERNMENT SIZE ON ECONOMIC GROWTH. Thus, several
scholars in our view have rightly concluded it is more fruitful to analyze separately the mechanisms
through which different taxes and expenditure affect growth. NOT ALL TAXES ARE EQUALLY HARMFUL, AND SOME STUDIES IDENTIFY PUBLIC SPENDING ON EDUCATION AND PUBLIC INVESTMENT TO BE POSITIVELY RELATED TO GROWTH.

[RussH]

I would like to see more attention paid to the part of the Bergh and Henrekson report that makes the link between levels of trust and economic growth. Almost no politician, or poster for that matter, says "we really must sort out corruption". There is a tolerance of what is basically spiv capitalim in the U.K which is just as damaging as wasted Government investment.

I agree that the obsession with home ownership is highly damaging but that was a private sector mess, the Banks that lent the money that caused the trouble we are in, were not state owned at the time.

I am not convinced that large scale cutting of the state will lead to the economic sunny uplands, both state and private sector need to learn how to produce a return on investment. At the moment it looks like neither of them are particularly good at it.

[Terry Smith]

Andrew: That’s not taken from the paper’s conclusion but from section 3.7 the final sub section of “3. What do EXISTING studies show?” [Emphasis added] The actual Concluding remarks are in section 5, which is snappily named “Concluding remarks” to give you a clue, and it says ‘most recent studies published in scientific journals tend to find a negative relationship between government size and economic growth in rich countries.’ And ‘the debate regarding the existence of a correlation between growth and aggregate government size now seems more or less settled.’ I agree that causality is an important issue which needs to be settled before a correlation is used as a basis for action, but it’s still interesting to see this correlation which has been denied apparently confirmed. The study goes on to say that ‘our results do not imply that government must shrink for growth to increase’ but I note that it does not even comment on the suggestion that increases in government spending from current levels will increase economic growth, which many observers, commentators and politicians assert.

RussH: Yes it would be interesting, although I imagine that trust is a difficult concept to define and measure. From my perspective, we probably need to change behaviour of a number of parties to establish it. For example, the consumers who borrowed from the bankers surely share some culpability, or even governments which have encouraged or even mandated mortgage lending, sometimes to groups which clearly could not service the debt.

[RussH]

Whilst its true that that caveat emptor applies to getting a mortgage, I would expect a greater sense of responsibility should apply to the people giving out mortgages as its something they do all the time and they ought to be good at managing the risks. Getting a mortgage is something people do only rarely, so you can hardly expect people with no experience to be any good at a subject.

You would not expect to go to a Hospital and to plan and understand your own treatment regime, its something you would pay for but you would expect the Hospital to assume the risk if the service went wrong.

The finance industry is supposed to be run by professionals, its well paid and if it goes wrong you accept responsibility and don't try and pass the buck!

[Terry Smith]

RussH: You don’t have to be a finance professional to work out that you can’t service or repay a mortgage. I am not aware of anyone who was coerced into taking out a mortgage. Blaming bankers for granting mortgages is on a par with those who blame fast food restaurants or processed food manufacturers for obesity. People need to take some responsibility for their own lives, their decisions and the outcome of their actions. I would suggest that should include questioning medical professionals about treatment for which of course the vast majority of people make no direct payment. And you have omitted to comment on the role of government: In the United States government mandated lending to groups in society who clearly could not afford to service mortgages, and in the UK government so both sides of the political spectrum have encouraged and are still seeking to encourage home ownership.

[RussH]

Whilst I have no problem with teaching people responsibility, the ability to ask the right questions requires considerable knowledge and when obtaining a mortgage that knowledge, as far as I am aware, was never mentioned. People may not have had a gun put to their heads to get a mortgage but people respond to herd behavior and peer pressure and both of those were highly in evidence in the build up to the crash. As to comparing medical treatments to mortgages, its very easy to ask the right questions to a Doctor who has no financial interest in treating you, all you have to say is "If you/your child had this condition would you have the treatment on offer". Someone who gets paid according to how many mortgages they sell is hardly going to have your interests at heart, they only want to sell mortgages.

Now asking a Doctor, who has just been told by his Hospital that the CAT scanner is under utilized and needs to generate more revenue, whether you need a CAT scan is not something I would like to do but that is another subject.

As regards to home ownership I am sure we can agree the the Government response is poor, the U.K. needs more properties. The Government response of thinking of guaranteeing mortgages is so insane I have to pinch myself to find out if I am dreaming. I do not see why a large house building program cannot help the situation we are in, it helped in the thirties. More rented properties would have the added benefit of a more flexible labour market because of the much lower costs in relocating when renting as opposed to owning.

[Terry Smith]

RussH: We’ll have to agree to differ to some extent. I can agree with you to the extent that some mortgages were clearly mis-sold, but if an adult can’t work out whether or not they have enough money to make the payments I would suggest that they shouldn’t be allowed to drive or operate heavy machinery let alone buy a house. On the housing market I have a simpler suggestion: just let house prices decline as they clearly should to bring them back into line or even below the long run ratio of prices to income and then more people will be able to afford to buy or rent them.

[RussH]

I think we will have to agree to differ, my view is that when determining mortgage affordability you have to plan over a period of twenty five years, a not inconsiderable task.

As regards to house prices declining they will only decline if the availability increases, not necessarily because mortgages are rarer as you have to factor in the distorting influence of the Bank of Mum and Dad and the increasing population.

[Terry Smith]

RussH: I am fairly sure that raising interest rates would send house prices down.

[Andrew]

Sorry, I haven't been following this thread for a while so I'm a bit late to the party.

A few points:
1. "I agree that causality is an important issue which needs to be settled before a correlation is used as a basis for action." We may still disagree on a number of issues but I think this is a step in the right direction. Thank you for saying so.

2. "In the United States government mandated lending to groups in society who clearly could not afford to service mortgages." I'm afraid this statement is false. It derives from a misunderstanding of the Community Reinvestment Act. In your defence, you're probably just regurgitating something you've read somewhere rather than having researched it in any detail yourself.

3. I'd like to turn one of your sentences around and see if it makes as much sense: " if an adult can’t work out whether or not [a borrower has] enough money to make the payments I would suggest that they shouldn’t be allowed to drive or operate heavy machinery let alone [work for a bank]."

As RussH has alluded to, an assumption that the borrower (or the patient) "ought to know better" ignores both the information asymmetry and the adverse incentives involved in that decision process.

That said, I like your obesity analogy. After all, McDonalds never has to pay the costs of treating people who have become obese: they get society to pick up the tab for that.

[Davey]

Terry, probably a silly question, but who owns the houses that more than half the German population don’t own?