Tuesday, 30 May 2017

Simon Wren-Lewis says more spending will lead to more GDP.

Wren-Lewis is an Oxford economics prof, and he is normally very clued up. That’s why I follow his blog. But the following passage from his latest blog article (in green italics) is very questionable. (Title of article: “Growth will be lower if the Conservatives win”)

“Both the Labour and LibDem manifestos amount to an increase in public investment, and an increase in public spending financed by higher taxes, compared to current government plans. Standard macroeconomics implies that both higher investment and spending will lead to an increase in GDP, unless the Bank of England raises interest rates to exactly offset this effect. With interest rates currently stuck at their lower bound, and with public investment helping aggregate supply, that last possibility is extremely unlikely. The conclusion therefore has to be that GDP over the next few years would be higher under a Labour or LibDem government than under the Conservatives.

This is why, according to Larry Elliott, Oxford Economics estimate that “the economy would be 1.9% bigger under the Lib Dem plans and 1% bigger under Labour’s plans than under Conservative plans.”

Well now it’s certainly true that “higher investment and spending will lead to an increase in GDP” all else equal and assuming there is room for that extra spending: i.e. assuming the effect is not just extra inflation rather than extra real GDP.

And it’s also true that that extra GDP is dependent on the BoE not raising interest rates. But it’s clear that the BoE ACTUALLY IS CONCERNED about rising inflation!!! Indeed, UK inflation has been above the 2% target for the last three months or so. Plus the governor of the BoE has warned that rising rates are coming soon.

Thus Wren-Lewis’s assumption that rates WILL NOT RISE is questionable to put it mildly. Hence his claim that increased spending, including investment spending, will lead to a quick rise in GDP is equally questionable.

Living standards.

Shortly after the above quote, W-L then says, “This is not the only reason why living standards would be significantly higher under a Labour/Lib Dem government.”

Now hang on. Increased GDP resulting from more investment spending DOES NOT lead to a quick rise in living standards. Investment spending (certainly investment spending on infrastructure or education) does not pay off for five, ten or even thirty years later. That’s not to criticise such spending. But the pay-back in terms of increased standards of living certainly does not come quickly.

BTW, I normally answer W-L’s articles in the comments after his articles, but he doesn’t seem to have had time to moderate many comments recently (for which I do not blame him). So I’ve answered on this, my own blog, today.

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