Economic growth as a policy objective: reflections and
implications for policy makers9 September 2013
Tera AllasStrategic Advisor
Department for Business, Innovation and Skills
2
Economic growth as a policy objective: outline of today’s discussion
• Economic growth is currently the government’s (and often any government’s) number one policy objective
• In theory, this would mean making policy and spending decisions solely based on optimising economic outcomes
• However, knowing what is “optimal” is rarely easy or even possible (given changing external circumstances)
• Moreover, in practice, the realities of political economy and human preferences need to be taken into account
• Nevertheless, policy makers need to understand growth, key economic concepts and where to go for advice
92
94
96
98
100
102
104
106
Q0 Q4 Q8 Q12 Q16 Q20 Q24 Q28
GD
P In
dex
(100
=Qua
rter
prio
r to
1st
qua
rter
of c
ontr
actio
n)
2008 OBR forecast (Mar 2013)1990 19801973 1930s
2013Q2
2015Q2
3
Despite recent acceleration, recovery has been slower than in previous recessions
Index of real GDP in previous recessions100=quarter before recession started (Q0)
Sou
rce:
ON
S, N
IES
R, B
IS a
naly
sis
4
In his address to the Top 200 Civil Servants recently, the Prime Minister said:
“I have two priorities at the moment: the economy, and everything else”
Economic growth is currently the government’s number one priority
5
Growth is needed to reduce the budget deficit and pay for public services
OBR forecasts of nominal government expenditure & receipts includes APF & Royal Mail Transfers
30
35
40
45
50
20
00
-01
20
01
-02
20
02
-03
20
03
-04
20
04
-05
20
05
-06
20
06
-07
20
07
-08
20
08
-09
20
09
-10
20
10
-11
20
11
-12
20
12
-13
20
13
-14
20
14
-15
20
15
-16
20
16
-17
20
17
-18
% o
f GD
P
Public sector current receipts Total Managed Expenditure
OBR forecast of government expenditure and receipts% of GDP
All other things equal,
economic growth will
reduce government expenditure and increase receipts as a
% of GDP
Sou
rce:
Bud
get 2
013
Sou
rce:
The
Hid
den
Wea
lth o
f Nat
ions
, Dav
id H
alpe
rn (
Gal
lup
data
; gra
ph fr
om A
ngus
Dea
ton,
Har
vard
)
Mea
n l
ife
sati
sfac
tio
n
International comparisons of GDP per capita and life satisfaction
GDP per capita in 2003, 2000 PPP
The size of the circles corresponds to population size
Longer term, economic performance is also correlated with overall well-being
7
Compared to others, the UK does reasonably well on most growth drivers
Structural reform “heat map” for selected countries
Sou
rce:
Eur
opea
n G
row
th: E
ven
Mor
e Im
port
ant,
Eve
n M
ore
Cha
lleng
ing,
Bru
egel
, Oct
ober
201
1
8
But our labour productivity lags behind other leading countries
Index of GDP per hour worked100=UK level
Sou
rce:
ON
S
9
And business investment has been consistently lower than other countries
Business investment as a share of GDP% of GDP
Sou
rce:
EEF
base
d o
n O
EC
D
10
Economic growth as a policy objective: outline of today’s discussion
• Economic growth is currently the government’s (and often any government’s) number one policy objective
• In theory, this would mean making policy and spending decisions solely based on optimising economic outcomes
• However, knowing what is “optimal” is rarely easy or even possible (given changing external circumstances)
• Moreover, in practice, the realities of political economy and human preferences need to be taken into account
• Nevertheless, policy makers need to understand growth, key economic concepts and where to go for advice
11
A theoretical model of policy decisions would focus on economic criteria
Identify theproblem
Outline allpossible
policy options
Analyse costsand benefitsof all options
Choose optionwith highestnet benefits
Implement
• Direct costs to all agents (gvt, business, citizens)
• Indirect costs to all agents• Positive and negative
externalities (e.g., environmental impacts, social impacts)
Costs and benefits would traditionally include:
• Labour participation • Productivity (of labour,
capital, raw materials)• Aggregate demand• Business investment• Net exports
But an even more “economically” minded analysis might focus on:
12
One would still of course check that the policy choice was deliverable in practice
The “Five Cases” for a Business Case:
1. Strategic: case for change2. Economic: optimise value for money3. Commercial: ensure viability4. Financial: ensure affordability5. Management: ensure deliverability
Additional criteria for economically rational decision makingExample of the HMG Five Case Model
[ ]
Sou
rce:
Pu
blic
Sect
or
Bu
sin
ess
Case
s u
sin
g t
he F
ive C
ase
Mod
el: a
Toolk
it,
HM
T
13
Some recent policy choices are indeed relatively consistent with this model
Departmental allocations of capital in the 2013 Spending Round% change between 2014/15 and 2015/16
Sou
rce:
HM
T d
ocum
ents
on
Spe
ndin
g R
evie
w 2
010
and
Spe
ndin
g R
ound
201
3, B
IS a
naly
sis
In the most recent Spending Round,
government increased overall capital investment
by £3bn for 2015/16, which
economists agree is a strong pro-growth measure
EXAMPLE
14
The government’s industrial strategy is largely motivated by economic analysis
EXAMPLE
Expenditure Contributions to Growth
-4
-3
-2
-1
0
1
2
3
4
1997-07 2008-09 2010-11 2012 2013 2014-15 2016-17
Ave
rage
ann
ual c
ontri
butio
n (
ppts
)
Govt consumption & investment Net tradeOther$ Business investmentHousehold consumption & NPISH#
3.3%
- 2.5% 1.4% 0.2%
2.7%
2.0%
0.6%
GDP growth
OBR forecasts
$ includes dwellings investment & changes in inventories
# non-profit institutions serving households (mainly charitable sector)
Expenditure Contributions to Growth
-4
-3
-2
-1
0
1
2
3
4
1997-07 2008-09 2010-11 2012 2013 2014-15 2016-17
Ave
rage
ann
ual c
ontri
butio
n (
ppts
)
Govt consumption & investment Net tradeOther$ Business investmentHousehold consumption & NPISH#
3.3%
- 2.5% 1.4% 0.2%
2.7%
2.0%
0.6%
GDP growth
OBR forecasts
$ includes dwellings investment & changes in inventories
# non-profit institutions serving households (mainly charitable sector)
Source: Office for Budget Responsibility Economic and Fiscal forecasts March 2013
Exp
end
itu
re c
on
trib
uti
on
to
GD
P g
row
th
Importance of trade and investment to GPD growthOffice for Budget Responsibility (OBR) forecast March 2013
15
Industrial Strategy complements the government’s overall growth strategy
Macro strategy Structural reforms Industrial Strategy
• Deficit reduction• Monetary activism
• Plan for Growth (Growth Reviews), e.g.
– Corporation tax rate reduction
– Planning reforms– Reduced red tape– Scale-up of
apprenticeships– Labour market
reforms
• Long-term partnership with business to provide confidence to invest:
– 11 sector strategies– 8 great technologies– Employer ownership
of skills investment– Business Bank
Key elements of the government’s growth strategyEXAMPLE
16
Economic growth as a policy objective: outline of today’s discussion
• Economic growth is currently the government’s (and often any government’s) number one policy objective
• In theory, this would mean making policy and spending decisions solely based on optimising economic outcomes
• However, knowing what is “optimal” is rarely easy or even possible (given changing external circumstances)
• Moreover, in practice, the realities of political economy and human preferences need to be taken into account
• Nevertheless, policy makers need to understand growth, key economic concepts and where to go for advice
17
It is impossible to say in the abstract what type of transport projects are best
Sou
rce:
The
Edd
ingt
on T
rans
port
Stu
dy, D
ecem
ber
2006
* S
mal
ler
proj
ects
can
hav
e ve
ry h
igh
BC
Rs,
but
eve
n w
ithin
thes
e, v
aria
tions
from
pro
ject
to p
roje
ct a
re la
rge
Benefit-to-cost ratios of different types of transport projects
EXAMPLE
Wide range of
benefit-cost-ratios across
all modes and
types of investment*
18
The optimal electricity mix depends critically on oil prices which are volatile
Sou
rce:
Blo
ombe
rg N
ew E
nerg
y F
inan
ce; h
ttp://
ww
w.e
cono
myw
atch
.com
/*
Mos
t of t
he d
iffer
ence
bet
wee
n th
e up
per
and
low
er r
ange
s fo
r co
al a
nd g
as fi
red
pow
er c
omes
fr
om d
iffer
ence
s in
foss
il fu
el p
rice
assu
mpt
ions
, whi
ch in
turn
are
hig
hly
corr
elat
ed w
ith o
il pr
ices
Cost of electricity under different scenarios* £/MWh
Historical oil prices$/bbl in 2012 dollars
EXAMPLE
19
Economic growth as a policy objective: outline of today’s discussion
• Economic growth is currently the government’s (and often any government’s) number one policy objective
• In theory, this would mean making policy and spending decisions solely based on optimising economic outcomes
• However, knowing what is “optimal” is rarely easy or even possible (given changing external circumstances)
• Moreover, in practice, the realities of political economy and human preferences need to be taken into account
• Nevertheless, policy makers need to understand growth, key economic concepts and where to go for advice
20
Optimisation by definition means that “more” is not always “better”
Illustrative shape of costs and benefits of any area of spendImaginary monetary units
Optimum is around here
Net benefits can be negative!
Scale or scope or sophistication of activity
Gro
ss c
ost
s an
d b
enef
its
Economically optimal levels of provision often feel too low to people and politiciansEstimates of desirable capacity margin (“spare” supply over peak demand) in the UK electricity system% of peak demand
0
5
10
15
20
25
Generally accepted Based on cost-benefitanalysis
15-20%
8-12%
Sou
rce:
DE
CC
ana
lysi
s 20
07; n
ote:
sin
ce th
en, t
he c
alcu
latio
n w
ould
hav
e ch
ange
d si
gnifi
cant
ly d
ue to
a
chan
ging
und
erly
ing
ener
gy m
ix w
ith m
ore
inte
rmitt
ent w
ind
pow
er
EXAMPLE
22
People’s preferences tend to differ from “economically perfect rationality”
Known preference patterns (“cognitive shortcuts”) that diverge from “perfect rationality”
Loss aversion Placing much more importance on avoiding losses than securing gains
Availability bias Being overly concerned about unlikely, but memorable or vivid, events
Anchoring Being heavily influenced by your starting point (e.g., sense of entitlement)
Short-termism Preferring small, immediate rewards to larger, more distant ones
Inertia Putting off decisions involving complexity, self-doubt or inconvenience
Sou
rce:
Ada
pted
from
MIN
DS
PA
CE
: Inf
luen
cing
beh
avio
ur th
roug
h pu
blic
pol
icy,
C
abin
et O
ffice
and
Inst
itute
for
Gov
ernm
ent
Political economy came to play in choosing the 2nd phase Growth Reviews
1 Infrastructure
2 Logistics
3 Open data
4 Mid-sized businesses
5 Rural economy
6 Education and skills
Phase 2 projects in the Growth ReviewsEXAMPLE
24
Economic growth as a policy objective: outline of today’s discussion
• Economic growth is currently the government’s (and often any government’s) number one policy objective
• In theory, this would mean making policy and spending decisions solely based on optimising economic outcomes
• However, knowing what is “optimal” is rarely easy or even possible (given changing external circumstances)
• Moreover, in practice, the realities of political economy and human preferences need to be taken into account
• Nevertheless, policy makers need to understand growth, key economic concepts and where to go for advice
25
Economics is a key input into robust evidence-based policy making
Sou
rce:
Man
agin
g P
ublic
Mon
ey, H
MT
, Jul
y 20
13
In a key report in 1918, Haldane concluded that “continuous acquisition of knowledge and the prosecution of research” were
needed “to furnish a proper basis for policy”
Extract from “Managing Public Money”, July 2013
26
In his address to the Top 200 Civil Servants recently, the Prime Minister said:
“I have two priorities at the moment: the economy, and everything else”
Economic growth is currently the government’s number one priority
27
Meeting the PM’s challenge requires policy makers to understand what drives growth
GDP per capita£ ‘000
Labour participationHours worked
per capita
Labour productivity£ GVA* perhour workedPopulation
m
GDP£ billion
x
x
First-order drivers**include:
• Aggregate demand• Incentives to work• Cost of labour• Labour market
efficiency• Skills• Competition• Trade• Enterprise• Innovation• Investment
* GVA=Gross Value Added; value of outputs (price times quantity) minus value of inputs; when aggregated up across sectors and adjusted for taxes and subsidies, adds up to total GDP [GDP = GVA + taxes on products/services – subsidies on products/services]** Many of the drivers are interconnected (e.g., enterprise drives innovation; trade drives competition) and are themselves driven by other factors (e.g., investment is driven by business environment, including interest rates, taxes, regulataory environment, planning system, etc.)
28
Policy makers should also know key economic concepts relevant to their work
Example list of key economic concepts everyone should know
• Marginal costs and benefits• Opportunity cost• Counterfactual• Net present value (NPV)• Market failure• Externalities• Incentives (rational choice)• Supply and demand dynamics• Creative destruction (competition)
Examples of ways in which economics and analysis add value
• Identifying market failures that may require rectifying
• Horizon scanning and analysis of emerging trends
• Quantifying impact of issues or problems on the economy
• Using tool-kit of potential interventions to identify options
• Connecting with citizens’ and businesses’ behaviour/incentives
• Identifying 2nd order consequences through systems thinking
• Modelling impacts and monetary costs/benefits of options
• Helping understand risk and uncertainty in decision making
• Defining meaningful performance indicators and monitoring them
• Communicating messages compellingly with supporting facts
• Monitoring and evaluating outcomes and reporting on them
29
Economists can help guide many parts of the good policy making process
Identifyingissues
Prioritisingissues
Developingoptions
Appraisingoptions
Decidingon policy
Implementingoptions
Evaluatingperformance
Mak
ing
a d
iffe
ren
ce t
o o
utc
om
es
Balanced growth
Physical infrastructure
Sustainable resources
Stable macro
economyBusiness environment
Innovation
Skills
Social infrastructure
People
All Departments and Government Agencies contribute to growth in the UK
Thank you for listening!
Questions/comments?
@TeraPauliina
31
Economic growth as a policy objective: reflections and implications