Adapt Or Die

Answer: The type practised by the UK’s new Chancellor of the Exchequer, George Osborne.

Only in the weird and wonderful world of government finances can a 12% increase be described as a 25% cut. The Daily Mail, for example, seemed a little uncomfortable admitting in the body of its article that spending is due to rise over the next five years, despite its “slash and burn” headline.

One can quibble that the 25% reductions only apply to certain government departments, while other areas – health, overseas aid, for example – are protected. But the real difference between the two figures, and the reason why the Chancellor can announce cuts in spending while signing ever-bigger cheques, lies of course in the economic growth forecasts his government is using.

In particular, the UK government is expecting growth of 1.2% this year and 2.3% in 2011, then 2.8% in 2012, 2.9% in 2013 and 2.7% in both 2014 and in 2015.

Compound those hoped-for annual growth rates and you end up with a total of nearly 15% expansion over five years, against which a 12% rise in public spending could perhaps be described as a cut…just.

But what if the growth doesn’t materialise? For a start, the UK chancellor is also predicting average inflation at around its 2% target over the five years, giving us forecast nominal GDP growth of around 5% a year.

If you look at what happened in Japan, however, following its late eighties bubble and subsequent real estate and equity market crash, it was nominal GDP that stopped growing.

Nominal GDP in Japan, Germany, UK, US (1990=100)

 

Japan has managed some economic growth since 1990, but it’s been a case of a percent or two of real growth here and there, often combined with a negative percent or two on price indices (leaving nominal GDP growth close to zero).

In the words of economist Al Breach, from whose Thomson Reuters blog the above chart is taken, “The biggest lesson [for Western countries from Japan’s experience] is that it is hard to generate nominal growth in an economy where debt is not growing because people are deleveraging — even if you chuck vast amounts of money at it.”

If Japan is where we’re heading – and the similarities between many Western economies now and the land of the rising sun 20 years ago are too close for comfort – then, according to Breach, we face “low or no inflation, slow nominal growth and flat or declining asset prices.” And, returning to George Osborne’s budget, we can forget about a projected rise in spending from £637 billion to £711 billion representing a cut. Osborne – and his successors – will be lucky to get away with much of a cash spending increase, if any at all. An axe will have to be taken to the thorny problem of public sector pension promises, and most of us will be facing wage freezes, at best.

Growth will depend on productivity increases, not rises in demand, so for those companies that can develop and realise efficiencies, the outlook won’t necessarily be all that bad. But for those sectors that have lived off the borrowing boom of the last 20 years, it will be adapt or die.

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