Stirring the UK Stimulus Debate

The UK got a pleasant surprise on Thursday, when the Office for National Statistics (ONS) announced retail sales rose 0.3% m/m in July—and revised June’s sales growth from 0.1% m/m to 0.8% m/m. With Q2 construction and industrial production also revised up (from -5.2% m/m to -3.9% m/m and -0.7% m/m to -0.5% m/m, respectively), perhaps we’re seeing the upshot of the ONS’s admitted trouble tabulating June data.

May and June were rather tricky months for UK economic data. The Queen’s Diamond Jubilee shifted a bank holiday from May to June, and torrential rain pounded the nation—keeping many shoppers at home. The ONS devoted an entire page of its Preliminary Estimate of Q2 GDP to explaining the resulting difficulty making seasonal adjustments, ultimately saying Q2’s data “may be subject to greater uncertainty than usual and therefore increase the chance that the GDP estimate will be revised”—making it possible the contraction would prove milder than the estimated -0.7% q/q.

Granted, these upward revisions don’t mean Q2 headline GDP will jump from contraction to growth when the second estimate is released August 24. But they do suggest the UK economy is perhaps a bit firmer than most assume—providing an interesting counterpoint to growing calls for more fiscal stimulus and less “austerity.”

The chorus includes nearly half of the 20 economists who co-signed a letter to the Sunday Times in February 2010 urging then-Chancellor Alistair Darling to cut spending and borrowing. Responding to a magazine’s recent survey on their current views, nine said Chancellor George Osborne should abandon his deficit reduction program, borrow more and spend more on infrastructure and other projects. Now, this might seem rational if government spending were falling and if it were the optimal source of economic growth. Except, neither is true—UK public expenditure hasn’t fallen once since 1985, and the private sector has long been the UK economy’s primary engine. This seems consistent with Osborne’s overall deficit reduction plans, which target the rate of spending growth rather than actual spending cuts—and it means the current pullback is concentrated in the private sector. The revised data points suggest this pullback may be starting to ease a bit without government help.

Which raises a question: Setting aside quibbles over whether the government has made cuts, would higher spending on infrastructure projects really help from here? Looking at the Q2 GDP estimate, it’s easy to see why some assume it might. Of all GDP’s components, Construction has contributed most to the contraction. And it seems fair to say more investment in construction projects would help accelerate its recovery (if the revised Q2 print indeed proves to be the start of an uptrend).

But the government isn’t necessarily the best source of that investment. When governments pick projects, they generally use different criteria than private firms might—unlike a firm motivated by profit, the government may not pick the most productive or efficient projects. The money thus may need to be re-spent a few times before it finds its most productive use, which can delay its positive impact on the economy. A better tack, in our view, would be making it easier for private firms to invest directly in construction projects—increasing the chances the money’s spent well and flows quickly to the broader economy. Coincidentally, that’s exactly what the UK government is doing with UK Guarantees, through which the Treasury will back bank loans to private construction firms. It puts the government’s strong balance sheet to work but keeps the private sector in the driver’s seat.

Don’t get us wrong—fiscal stimulus does have its time and place. But we’d argue that time and place isn’t the UK in 2012. Even if next week’s GDP data don’t show substantial private sector improvement, there’s anecdotal evidence firms are finding their own ways to compete and grow—as they tend to do in free economies. Policies making it easier for firms to continue doing this—whether by reducing red tape, freeing trade or using the Treasury’s balance sheet to support private lending—seem the most sensible solutions.