Economics for policy makers -- talk at Grow Further event 2013 -- Tera Allas

Economic growth as a policy objective: reflections and

implications for policy makers9 September 2013

Tera AllasStrategic Advisor

Department for Business, Innovation and Skills

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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

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100

102

104

106

Q0 Q4 Q8 Q12 Q16 Q20 Q24 Q28

GD

P In

dex

(100

=Qua

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2008 OBR forecast (Mar 2013)1990 19801973 1930s

2013Q2

2015Q2

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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

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R, B

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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

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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

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% 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

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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

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Compared to others, the UK does reasonably well on most growth drivers

Structural reform “heat map” for selected countries

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But our labour productivity lags behind other leading countries

Index of GDP per hour worked100=UK level

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And business investment has been consistently lower than other countries

Business investment as a share of GDP% of GDP

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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:

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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

[ ]

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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

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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

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The government’s industrial strategy is largely motivated by economic analysis

EXAMPLE

Expenditure Contributions to Growth

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-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

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re c

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to

GD

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Importance of trade and investment to GPD growthOffice for Budget Responsibility (OBR) forecast March 2013

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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

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It is impossible to say in the abstract what type of transport projects are best

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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*

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The optimal electricity mix depends critically on oil prices which are volatile

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Cost of electricity under different scenarios* £/MWh

Historical oil prices$/bbl in 2012 dollars

EXAMPLE

http://www.economywatch.com/



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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

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Generally accepted Based on cost-benefitanalysis

15-20%

8-12%

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EXAMPLE

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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

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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

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Economics is a key input into robust evidence-based policy making

Sou

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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

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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

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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.)

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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

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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

http://www.dh.gov.uk/en/index.htm

http://www.hm-treasury.gov.uk/home.htm

Thank you for listening!

Questions/comments?

[email protected]

@TeraPauliina

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Economic growth as a policy objective: reflections and implications

Economics for policy makers -- talk at Grow Further event 2013 -- Tera Allas

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Transcript of Economics for policy makers -- talk at Grow Further event 2013 -- Tera Allas