Fiddling while Rome burns

Civitas, 26 July 2011

Today the ONS released the latest quarterly GDP figures, indicating that the British economy had grown by 0.2 per cent in the second quarter of 2011. The ONS estimated that growth could have been approximately 0.5 per cent higher if it wasn’t for the ‘special events’ of the royal wedding, Japanese earthquake, Olympic ticket sales and the unusually hot weather in April.  It is highly questionable that all of these events had a significant, or any impact upon growth. Furthermore, focusing on the quarterly growth figure diverts attention away from long-term economic problems, evident in the underlying statistics.

Growth can be effected by ‘special events’ or exogenous shocks, that is events outside of the usual workings of the economy, in three ways: it can can be destroyed, displaced or redistributed. The majority of growth is usually displaced or redistributed rather than destroyed.

The difference between displaced and destroyed economic activity is illustrated by the case of the royal wedding and accompanying bank holidays. Like the cold weather in the fourth quarter of 2010, a bank holiday or a day off work because of poor weather means that some economic activity is destroyed. If workers do not go to work it is likely that some service industries, coffee sellers, food retailers, etc will see their profits dip. This dip is not made up on subsequent days: no-one buys two cups of coffee the following day. While this destruction accounts for some economic activity, other economic activity is displaced. An investment banker in the process of cementing a merger does not work over the bank holiday, but the merger is completed at a later date, economic activity is displaced, put forward into the future, not destroyed. Similarly someone who plans to buy a new widescreen TV but who doesn’t leave the house this weekend on account of the weather will, in all likelihood, buy the TV next weekend. Once again economic activity is displaced not destroyed.

The difference between destroyed and redistributed economic activity is illustrated by the case of the unusually hot weather in April. Hot weather does not destroy growth, it affects the profits of energy suppliers. In all likelihood hot weather could have redistributed growth, consumers spent less on heating and more on other forms of consumption (perhaps they purchased an extra couple of Olympic tickets and so will add to growth in the third quarter of 2012 when tickets will be recorded in household final consumption expenditure and add to GDP).

With these distinctions in mind it is clear that some of the growth inhibited by these ‘special events’ will simply show up later, perhaps in the next quarter. If they displaced a significant amount of economic activity this quarter, growth will show up in a subsequent quarter or quarters. However I think it is unlikely that these events, aside from the Japanese earthquake, had a significant and destructive effect on growth. Nevertheless it should still be borne in mind that the ONS states that the ‘special events’ only reduced growth by 0.1 per cent in the productive sector (as opposed to the services sector).

The real problem is that focusing too much on the recent growth figure, and haggling over the size of the effect that ‘special events’ had, ignores the long-term weaknesses in the economy – something illustrated in the annual figures published alongside today’s figure. Perhaps most revealing is the fact that current production in the production industries is 88.6 where production is indexed at 100 for 2006. Production today is lower than it was in 2006. In contrast all services, aside from construction, have witnessed growth over the same period, with current production standing at 103.1. This underlines one of the significant weaknesses of the British economy – its overreliance on services and problems in the manufacturing sector.  The Government has not addressed this issue, and a Civitas publication released today, argues that the Government needs a strategy to revive manufacturing, close the trade in goods deficit, and promote economic growth.

Ignore the arguments that growth is suffering as a result of ‘special events’ the real story in today’s growth figures is how little is being done to solve the deeper economic malaise affecting Britain.