The curious case of recoveries in UK and US post recession

     Another article from The Economist that I found interesting was published under the section Free Exchange: "The price of getting back to work" (issue of February 1st 2014). 

     Post 2008-09 there was a slump in GDP of both the economies. The American GDP bounced back relatively quickly but the employment in contrast suffered a more a dramatic decline. In case of Britain it was completely opposite; the GDP declined quickly without much downturn in employment as compared to US. The picture below taken from that very own article will help in visualizing the scenario. 

    

     Here I would like to quote what Paul Bowles has written in his book Capitalism - a short history of a big idea. He mentions business cycles under Capitalism and Crisis. 

     "In the boom period of the cycle the profit expectations are high and investment is high. The demand for labor is high and as a result unemployment falls and wages start to bid up. However, after a while, the rise in wages eats into the capitalists profits and creates a 'crisis'; the crisis of profitability. This is solved by capitalists reducing their investment levels, with the result that growth falls and unemployment increases until workers are disciplined to accept lower wages; at this point profit expectations pick up and the whole cycle is repeated".

     Though this maybe the central idea of a business cycle many aspects about the paragraph above can be debated. If this general idea is applied to the situation seen in the graph, the puzzling thing is, the divergence in the unemployment-GDP relation in the Britain and US economies.

    According to the The Economist article the US had a normal recession whereas Britain didn't and it can be explained by what they call 'productivity puzzle'. In US the weak demand, which accounts for output loss led to shortfall of jobs. In contrast in Britain falling demand has been accompanied by strange decline in workers' productivity. Falling productivity cushioned the economy against large jobs losses, since more workers were needed to do the same amount of work. As it reflected the loss of productive capacity, it led to higher inflation. The annual inflation in Britain has been double that of US since late 2007. 

   

This is where the even more interesting part comes in. Bill Martin and Robert Rowthorn, of the University of Cambridge, argue that this productivity puzzle has an opposite causation effect: 'wages did not fall in response to declining productivity; declining productivity was instead a consequence of falling real wages'. Putting it simply; as the nominal wage rise in Britain was 1.6% and inflation was more than 3% the real wages fell by 7.8% making the labor cheaper than the prices of goods and services. Hence the moderately high inflation was the difference between a jobless recovery and a job-filled one.

   

China's Economy

As mentioned in my introduction I am going to share what I read and experience. Well most of my reading nowadays is from some interesting books I have collected related to economics and my subscription to "The Economist".

I read an article in 'The Economist' ( issue of January 25th 2014, pg 59), under the Finance and Economics section. The title of the article is "China's economy - In three parts". The author of the article says that to understand China's economy, it would be helpful to think in threes. Three forms of growth: in supply, demand and credit.

The part that interested me the most was the one about how credit is spent. According to Richard Werner of Southampton University, credit spending can be divided into three categories.

1. Credit can be spent fruitfully on new capital and infrastructure which increases the economy's productive capacity. Lending of this kind adds to both demand and supply which results in higher economic growth without higher inflation.

2. Credit can also be spent wastefully, either on consumption or on misconceived projects such as coal mines without markets. These loans add nothing to the economy's productive capacity, but they do add to the demand. They make a claim on the economy's goods and services, without adding to its ability to provide them. Credit of this kind results in higher inflation, increasing nominal GDP but not real GDP.

3. The third kind of credit is speculative kind. It is spent on existing assets, real or financial, in the hope that these will rise in value. Because these assets exist, they can be purchased (and repurchased) without adding directly to GDP or straining the economy's capacity to produce new goods and services. Credit and asset prices then chase each other, even as consumer prices remain flat.

The author states that the lack of inflation suggests that growth in credit should be of the third kind (Speculative). The article considers the data as of 2013. Then if the author has eliminated the first kind of credit spending, then it means that China has failed to add much in terms of productive capacity. We ( Indians ) have not been known to spend credit the way China has. This leaves me the question: What kind of credit expenditure are our financial authorities doing? With inflation rising and growth slowing are we spending credit wastefully?

Also, credit expenditure expands the banks balance-sheets. The author mentions that Chinese financial authorities have accepted that the bank (especially mid-tier banks) balance-sheets are overstretched and they will carry out the necessary measures to encourage the flow of credit to 'real economy'.

Other than the above part there are certain statistics that have been mentioned about China that I find fascinating.

1. The working age population of China shrank by 2.44m in 2013, having already fallen by several million the year before. This is a demographic turning-point dubbed 'peak toil' ( interesting use of words ).

2. Last year China's output of services contributed 46% of GDP, finally overtaking the output of its industry which stood at 44%. In China Services are known as tertiary sector whereas agriculture and industry are considered primary and secondary respectively.