Stable Financial Output of the UK - Essay Example

UK experiencing stable output Introduction One of the common plights of countries affected by the global financial crisis was volatility in the levelof output. There have been extensive debates in academic literature regarding short-term volatility of output on long-term economic growth. A considerable part of these arguments show that volatility in output is detrimental for the economy as this can lead to lower investments, causing the level of capital accumulation to fall (Gaskarth, 2013). In case of U.K., which was severely affected by global financial crisis, it has been found that though the level of output has experienced quite high fluctuations on a quarterly basis, yet overall level of output has been quite stable. The recovery of UK from the recent global crisis has been considerably slower compared to its previous recoveries (Pitlik, 2012). The purpose of this paper is to analyze the pattern of output growth and the level of inflation of U.K. and its implications in the long run. Recent impact on output Ever since the global financial crisis has weakened the output growth of the economy, the trajectory of output growth has been quite weak. Since 2010, output growth of U.K. has been a meagre 1.1%. The reason that can be attributed for low growth in output relates to shortfall in three sectors of the economy, namely manufacturing, oil and gas extraction and construction sector (Goodwin, 2013). However, this fall in the level of output has been compensated to some extent by rise in the level of production in the service sector and its output has nearly touched the pre-crisis mark. Though these figures indicate a positive recovery, yet economic outlook of a nation can be comprehended with the help of output gap of an economy. Output gap of a nation relates to the difference between actual levels of output and the potential output of a nation, which in turn should be consistent with overall inflationary pressure on the economy. The year 2012 was particularly harsh on the U.K. economy because of weak recovery of the trade sector. Nonetheless, the domestic economy had shown improvement through increase in level of consumption spending and level of investment (Economic Secretary, 2013). The following graph shows the level of GDP growth over the last seven years. Figure 1: GDP growth (Source: Trading Economics, 2014) The damage done to the economy Due to the global financial crisis, following are the permanent damage encountered by the U.K. economy (Pybus, 2011). Capital Stock: The research conducted by various government organizations and independent researchers suggest that fall in the capital stock due to perverse business environment has been one of the permanent damages that has been inflicted upon the economy. According to the research of IFS, 2013, investment in the nation had fallen by 24%. Labour supply: Research conducted by IFS has concluded that labour participation rate in the economy has not been greatly altered due to the crisis. This is because short-term unemployment has been compensated by long-term structural shifts. In short, it can be inferred that though the level of unemployment is high, yet it has failed to rise proportionately with fall in the level of GDP. Total Factor Productivity: Research conducted by a large number of eminent scholars has shown that U.K. always had poorer labour factor productivity compared to other countries of the European Union. A large number of reasons had been attributed for this fall; one of them being that expenditure for research and development has been quite flat showing a marginal increase of 0.3% from 2008 to 2011. Balakrishnan, et al., (2009) had shown in his research that countries with higher financial development had recorded maximum fall in the level of productivity. Potential output and output gap Positive output gap of a nation indicates the level of aggregate demand in its economy to be very high, which causes the level of actual output to rise higher than that of potential output. If the economy is experiencing a positive output gap, then economic theory suggests that the prevailing level of inflation will rise due to increased cost of labour and production (Gaskarth, 2013). Figure 2: Positive output gap and high aggregate demand (Source: Economics Online, 2014) On the contrary, a negative output gap in an economy indicates that the level of output is below the potential level and this happens when aggregate demand in the economy is low (Gaskarth, 2013). Figure 3: Negative output Gap and Low Demand (Source: Economics Online, 2014) In case of U.K., it has been observed that the level of GDP had fallen below the potential level of output during the period of recession; this implies that the country had experienced negative output gap when the recession had begun. Conventional economic wisdom suggests that during initial phase of recovery, a nation undertakes policies that produce higher growth in the short run. GDP growth figure of the country suggests that the economy had shown positive growth when recovery after the recession had begun. However, it is extremely difficult to predict whether the economy will be able to return to its long-run potential GDP growth path (Bank of England, 2013a). Since the process of recovery has begun for the U.K. economy, there have been a number of researches trying to determine level of output gap of the economy. It has been already stated that level of inflation is an important determinant for understanding the concept of output gap. The study that has been conducted by Bank of England has shown that Consumer Price Inflation of the country has been around 2.7% in the last quarter of 2013 and also confirmed that level of inflation will remain above the 2% mark in the next two years. This implies that rate of inflation is marginally higher compared to the ideal 2% benchmark that has been set by the central authority. The section on permanent damages has revealed that there has been a significant impact on the potential output of U.K. economy due to recession (Bank of England, 2013b). It is almost impossible to accurately determine the level of output gap and different agencies have estimated separate values for the potential output and the output gap of U.K. Different research organizations have dissimilar views regarding potential output and GDP because in order to study the output gap, researchers uses different proxy for output gap. A study conducted by Labour Market has revealed that spare capacity of U.K. labour market is very high and the level of growth in earnings of the workers is very low. The phenomenon of hysteresis has been blamed for this purpose as the persistent level of high output gap has reduced productivity of workers. This report indicates that; as capital and labour in the economy has remained inactive for a long time, productivity has fallen. On the other hand, reports published by most business surveys do not support this hypothesis (Goodwin, 2013). According to estimates of the reports of Oxford Economics, level of output gap of U.K. was 4.5% of the potential GDP in 2012. The prediction made by the research of IFS claims the output gap to be at 5% of GDP. The following graph shows the level of output gap of U.K. as has been predicted by various research works (Pybus, 2011). Figure 4: Comparative output gap predicted by researches (Source: Economic Secretary, 2013) Implications on the future Weak recovery of the economy since the global financial crisis and the level of current and predicted inflation suggest that future output gap of the economy is likely to aggravate. It can be seen that all of these organizations have predicted the output gap to be negative in future. Only intensity of the value is different. From this analysis, certain future implications can be drawn. Most of the researches conducted have also reached another similar conclusion; level of damage that has been caused particularly by this financial crisis is higher than previous crisis damages (Bank of England, 2013a). This paper concentrates on impacts of future GDP growth and the corresponding output gap on household consumption as well as corporate and external sectors (Goodwin, 2013). Consumption: The current figures have indicated that presently, level of consumer spending in U.K. is quite high. Though the positive growth is weak, yet it has instilled confidence of people in the economy and they are raising the level of their spending on durable consumer goods. This is a good sign as rise in the level of consumer spending implies that aggregate demand will increase; this in turn will raise level of GDP growth of the economy. Yet, this growth is not likely to sustain, if level of real income of customers does not rise in the future (Economic Secretary, 2013). Labour Market: It has been estimated that level of real earnings of the population is not likely to rise strongly in the future. It is expected that level of unemployment in future will fall compared to the present level; but, earnings per worker is unlikely to show much alterations. Currently, spare capacity of the economy is high and researchers assume that unemployment levels in the economy will decline as labourers fill up the vacancies. The low level of productivity is one of the biggest weaknesses of U.K. and future growth in productivity is a major determinant in sustaining the rise in output in the future (Economic Secretary, 2013). Corporate Sector: Corporate sector impacts the expenditure component of GDP through business investments and also contributes to income of the economy through profits. Needless to say, there has been difference in opinion regarding rise in level of investments in the economy after the recession. The report that has been published by Bank of England suggests that level of investment will slowly rise post-2012; yet, this level will remain lower compared to the pre-crisis level. Even so, the report published by CBI Industrial Trends Survey reflects that the level of investment is unlikely to increase. On an average, most of the researchers conclude that falling level of uncertainty regarding demands and growing level of productivity stimulates business investments. As far as corporate profits are concerned, profits of the financial sector are expected to rise at a slower rate than that of profits of non-financial sectors (Economic Secretary, 2013). External Sector: The export markets are likely to remain grim in the future as most studies suggest that the level of exports will remain weaker in the future due to perverse conditions in external trade markets. The weakness is likely to be dominant in the financial markets. Statistics show that level of market share of U.K. exports is likely to fall in the subsequent years. The forecasts about imports tend to point out that its level will grow in future. The net trade balance is unlikely to make any considerable contribution to the economic growth. This is due to weak growth of exports. Conclusion This paper has studied consequences of stable output growth of the U.K. economy since the financial crisis. It can be concluded from the study that U.K. economy is slowly recovering from the crisis. The output gap of the economy is expected to remain negative in the subsequent years. This is because permanent damage has been done to the economy due to the current crisis as has been discussed through TFP, capital stock and labour market. The results from multiple studies conducted by independent organizations suggest that present rise in consumption spending is likely to fade if real earnings growth does not accelerate. Productivity in the labour market is also expected to improve marginally in the future. The business investments are likely to rise in future as investors are gaining confidence in the economy. The trade sector is not expected to contribute to future growth as export sector will remain weak. Reference List Bank of England, 2013a. Annual Report. [pdf] Bank of England. Available at: [Accessed 1 April 2014]. Bank of England, 2013b. Inflation report. [pdf] The Monetary Policy Committee. Available at: Economic Secretary, 2013. Economic and fiscal outlook. [pdf] Crown Copyright. Available at: [Accessed 1 April 2014]. Gaskarth, J., 2013. British foreign policy: crises, conflicts and future challenges. New Jersey: John Wiley & Sons. Goodwin, A., 2013. The UK economic outlook. [pdf] Oxford Economics. Available at: [Accessed 1 April 2014]. Pitlik, S., 2012. Output volatility, growth and the role of economic freedom. [pdf] Austrian Institute of Economic Research. Available at: [Accessed 1 April 2014]. Pybus, T., 2011. Estimating the UK’s historical output gap. [pdf] Crown Copyright. Available at: [Accessed 1 April 2014]. Trading Economics, 2014. UK GDP. [online]. Available at: [Accessed 1 April 2014]. Economics Online, 2014. Equilibrium. [online]. Available at: [Accessed 1 April 2014]. Read More