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

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  • PROTECT [IL2]
  • But economic growth is not just about closing the structural deficit and being able to finance public sector expenditure going forward. Economic growth also underpins citizens’ well-being and quality of life. International studies demonstrate that – on average – countries with higher levels of prosperity also display higher levels of life satisfaction.
  • The Plan for Growth: Overarching Ambitions To create the most competitive tax system in the G20 To make the UK one of the best places in Europe to start, finance and grow a business To encourage investment and exports as a route to a more balanced economy; and To create a more educated workforce that is the most flexible in Europe Strong, sustainable and balanced growth that is more evenly shared
  • Economics for policy makers -- talk at Grow Further event 2013 -- Tera Allas

    1. 1. Economic growth as a policy objective: reflections and implications for policy makers 9 September 2013 Tera Allas Strategic Advisor Department for Business, Innovation and Skills
    2. 2. 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
    3. 3. 92 94 96 98 100 102 104 106 Q0 Q4 Q8 Q12 Q16 Q20 Q24 Q28 GDPIndex(100=Quarterprior to1stquarterofcontraction) 2008 OBR forecast (Mar 2013) 1990 1980 1973 1930s 2013Q2 2015Q2 3 Despite recent acceleration, recovery has been slower than in previous recessions Index of real GDP in previous recessions 100=quarter before recession started (Q0) Source:ONS,NIESR,BISanalysis
    4. 4. 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. 5. 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 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 %ofGDP 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 Source:Budget2013
    6. 6. Source:TheHiddenWealthofNations,DavidHalpern(Gallupdata;graphfromAngusDeaton,Harvard) Meanlifesatisfaction 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. 7. 7 Compared to others, the UK does reasonably well on most growth drivers Structural reform “heat map” for selected countries Source:EuropeanGrowth:EvenMoreImportant,EvenMoreChallenging,Bruegel,October2011
    8. 8. 8 But our labour productivity lags behind other leading countries Index of GDP per hour worked 100=UK level Source:ONS
    9. 9. 9 And business investment has been consistently lower than other countries Business investment as a share of GDP % of GDP Source:EEFbasedonOECD
    10. 10. 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. 11. 11 A theoretical model of policy decisions would focus on economic criteria Identify the problem Outline all possible policy options Analyse costs and benefits of all options Choose option with highest net 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. 12. 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 change 2. Economic: optimise value for money 3. Commercial: ensure viability 4. Financial: ensure affordability 5. Management: ensure deliverability Additional criteria for economically rational decision making Example of the HMG Five Case Model [ ] Source:PublicSectorBusinessCasesusingtheFiveCaseModel:aToolkit,HMT
    13. 13. 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 Source:HMTdocumentsonSpendingReview2010andSpendingRound2013,BISanalysis 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. 14. 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 Averageannualcontribution(ppts) Govt consumption & investment Net trade Other$ Business investment Household 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 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 Averageannualcontribution(ppts) Govt consumption & investment Net trade Other$ Business investment Household 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 inventoriesSource: Office for Budget Responsibility Economic and Fiscal forecasts March 2013 ExpenditurecontributiontoGDPgrowth Importance of trade and investment to GPD growth Office for Budget Responsibility (OBR) forecast March 2013
    15. 15. 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 strategy EXAMPLE
    16. 16. 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. 17. 17 It is impossible to say in the abstract what type of transport projects are best Source:TheEddingtonTransportStudy,December2006 *SmallerprojectscanhaveveryhighBCRs,butevenwithinthese,variationsfromprojecttoprojectarelarge 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. 18. 18 The optimal electricity mix depends critically on oil prices which are volatile Source:BloombergNewEnergyFinance;http://www.economywatch.com/ *Mostofthedifferencebetweentheupperandlowerrangesforcoalandgasfiredpowercomes fromdifferencesinfossilfuelpriceassumptions,whichinturnarehighlycorrelatedwithoilprices Cost of electricity under different scenarios* £/MWh Historical oil prices $/bbl in 2012 dollars EXAMPLE
    19. 19. 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. 20. 20 Optimisation by definition means that “more” is not always “better” Illustrative shape of costs and benefits of any area of spend Imaginary monetary units Optimum is around here Net benefits can be negative! Scale or scope or sophistication of activity Grosscostsandbenefits
    21. 21. Economically optimal levels of provision often feel too low to people and politicians Estimates 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-benefit analysis 15-20% 8-12% Source:DECCanalysis2007;note:sincethen,thecalculationwouldhavechangedsignificantlydueto achangingunderlyingenergymixwithmoreintermittentwindpower EXAMPLE
    22. 22. 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 Source:AdaptedfromMINDSPACE:Influencingbehaviourthroughpublicpolicy, CabinetOfficeandInstituteforGovernment
    23. 23. 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 Reviews EXAMPLE
    24. 24. 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. 25. 25 Economics is a key input into robust evidence-based policy making Source:ManagingPublicMoney,HMT,July2013 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. 26. 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. 27. 27 Meeting the PM’s challenge requires policy makers to understand what drives growth GDP per capita £ ‘000 Labour participation Hours worked per capita Labour productivity £ GVA* per hour 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. 28. 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)
    29. 29. 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 Identifying issues Prioritising issues Developing options Appraising options Deciding on policy Implementing options Evaluating performance Makingadifferencetooutcomes
    30. 30. Balanced growth Physical infrastructure Sustainable resources Stable macro economy Business environment Innovation Skills Social infrastructure People All Departments and Government Agencies contribute to growth in the UK
    31. 31. Thank you for listening! Questions/comments? tera.allas@bis.gsi.gov.uk @TeraPauliina 31 Economic growth as a policy objective: reflections and implications

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