Tutor HuntResources Accounting Resources

Why Has The Uk Growth Lagged Us Growth Since The Gfc?

Date : 25/06/2013

Author Information

Rushil

Uploaded by : Rushil
Uploaded on : 25/06/2013
Subject : Accounting

Abstract: After the major impact of the global financial crisis (GFC) in 2008, countries are now more reliant and pressured on producing a plan of action to route themselves towards an economic recovery. Both the UK and US have approached the crisis in a different manner, though economic theory would not predict this, this in turn has meant that there are differences of growth within the US contrast to the UK. This paper investigates reasons behind the lack of growth rate within the UK comparative to the US. Results from this paper indicate that the GDP between both countries prior to the crisis was seemingly similar; though GDP in the running before the crisis was higher in the US. This paper examines circumstances prior the crisis and determines that conditions such as the overreliance on wholesale-funding, lending and shadow banking has attributed towards the lack of future growth within the UK comparative to the US. Policies and actions implemented after the crisis have also been examined and this paper seeks to believe that lack of growth comparative to the US can be ascribed to TARP and Fiscal austerity. Several other factors such as lack of oil access, decrease in net exports, lack of educational and infrastructural investment, have also been analysed and identified as contributing to the lack of growth within the UK. This paper concludes with various reasons as to why UK growth lags US at present and thus concludes with suggestions as to how the UK can overcome this.

1. Introduction:

This paper will analyse and concentrate on the circumstances of the United Kingdom (UK) compared to the United States Of America (US) before and after the global financial crisis (GFC) which occurred in 2008. This in turn will demonstrate reasons as to why UK growth has lagged US growth since the GFC. This paper will address the circumstances which affect one country more than the other (UK vs. US) Which actions specifically taken up by both countries have proved to be more successful in the process of a recovery and which actions provide less significant routes towards growth. This will be achieved by comparing and contrasting the differences in the conditions before the crisis. In addition to this, the paper will take account of the reaction and state of affairs after the crisis- which in turn will demonstrate reasons as to why UK growth has lagged US growth after the GFC. The findings will be concluded with brief thoughts as to how the UK can overcome its issues with growth.

1.1 Defining a Crisis Countries and the economies attached to these countries are prone to a 'financial crisis (FC)'. There is no particular definition of a 'financial crisis' however, Goldsmith (1982) has defined it as:

'A sharp, brief, ultra-cyclical deterioration of all or most of a group of financial indicators - short-term interest rates, asset (stock, real estate, land) prices, commercial insolvencies and failures of financial institutions' (P.7).

Further to this explanation, Kindleberger (2005) characterises a FC as:

'Successions of several phases: exogenous shocks, speculative manias (with euphoria, overtrading and excessive gearing), financial distress and finally disastrous meltdown of the economy' (P.7).

It appears that a FC is formed due to a combination of misleading information and financial panic spreading across a country by which individuals and companies sell off their assets or withdraw money from savings, with the anticipation that the value of those assets will drop if they remain at a financial institution (Stearns, 2013). These are factors which contribute to the definition of a FC, however what does a country do after it is hit with such a 'calamity'?

If a country faces a FC, the John Hopkins University book on 'Financial crises' states that:

'the feedbacks among different parts of the financial system make them dangerous and difficult to stop' (P. 537).

Despite this, countries are required to act accordingly; they need to formulate a 'plan of action' in order to begin the process of a recovery - for their economies. This particular plan of action generally holds opposing views due to the differences of governments and the differentiation in how each country is run; including distinctions in economic and political constraints. In spite of this, it is this fastidious action taken by the countries which has recently proved to be important in analysing the differences of recovery rates between different countries (UK vs. US).

Figure 1.1 illustrates a diagram typifying the causes of a FC and provides a good picture as to what could occur in the lead up to a crisis.

[Insert Figure 1.1]

It is significant to note that no two financial crises are exactly alike (Murphy, 2010) and thus a full contrast cannot be made (UK vs. US); comparative to this, the mere difference in the size of the economies between the US and the UK suggests that certain comparisons cannot be made to full effect. However, the traits leading to a FC are uncannily similar, such as the fall in asset price, insolvencies, liquidity crises and the increasing in lending and spending. It is these characteristics which make evaluating the conditions prior the FC between the UK and US and the reaction to these problems feasible and somewhat easier to compare.

Reinhart & Rogoff (2008) proclaim that a FC may lead to:

'Major declines in economic performance for an extended period' (P.5).

Which could provide reason as to why growth within the UK and US has somewhat been more lethargic than anticipated. Roubini (2009) conveys that the current recovery is unusually sluggish and this reflects the severity of the financial crisis- examples of major FC have been identified and stated as the 'Big Five' by Mullineux (1990) Kaminsky and Reinhart (1999), and Caprio et. Al (2005) as:

'Spain (1977), Norway (1987), Finland (1991), Sweden (1991) and Japan (1992).'

Before identifying what the UK and US executed after the crisis, it is important to take note of the differences in circumstances between the UK and US before the FC, and whether or not this had any impression on the discrepancies in recovery rates today.

2. GDP - Pre crisis

GDP is currently (2013) superior in the US compared to the UK, which prioritises the need for this paper to assess the conditions prior the FC.

The use of GDP (Growth Domestic Product) is a key measure of a country's economic activity (Lanefeld, 2010). Thus, Table 2.1 provides a view of the disparities of GDP between the UK and US pre-crisis (1997-2007). The US boasted a higher GDP; however a lower GDP per capita compared to the UK. Valero et.al (2011) mentions that the GDP for the UK (per capita) was in fact better than in any of the other G6 countries between 1997 and 2010. This presents ground for this paper to conduct further research into why the UK growth has lagged US growth. The differences of GDP per capita between the G6 can be identified from Table 2.2 and Figure 2.2.1.

Table 2.1-Average GDP between the UK and US from 1997-2007. GDP GDP per person GDP per adult UK 2.89 2.42 2.20 US 2.98 1.95 1.63

Table 2.2 - Average GDP per capita between the G6 countries from 1997-2010. G6 UK GERMANY US FRANCE JAPAN ITALY GDP PER CAPITA % 1.42 1.26 1.22 1.04 0.52 0.22 Figure 2.2.1 -GDP per capita between the G6. Further to this, by analysing Figures 2.1 in relation to figure 2.2 (which plots the US and UK GDP growth rate annually), it can be distinguished that in the decade before the crisis, the average US trend growth was lower than the UK's (average GDP growth annually was approximately 2.5% GDP compared to 2.85% GDP respectively) - does this indicate that the UK ought to be in a stronger position compared to the US after the GFC (in terms of growth)?

Figure 2.1 -US GDP from January 1997 to January 2007.

It would seem that with further comparisons this is not the case. An imperative note to consider when comparing Figures 2.1 and 2.2 is that the US had a higher GDP in the running before the GFC compared to the UK, which could present reason as to why the US GDP reads higher in 2013.

Figure 2.2 -UK GDP from January 1997 to January 2007.

In addition to the measure of GDP, Stiglitz et al (2009) states that net domestic product (NDP) should be used as a determinant of comparison- as it offers an improved picture of welfare changes. Pessoa & Reenen (2012) further suggests the use of NDP as a form of comparison as:

'if the deprecation rate in a given country is large it means that a significant amount of GDP is set aside to replace capital, which diminishes significantly what the society can potentially consume' (P.22).

Thus, Table 2.3 provides an illustration of the NDP, NDP per person and per adult from 1997-2007. It can be recognised that the US retained a lower NDP then the UK pre crisis, however in contrast with the GDP of both countries (Table 2.1) it can be identified that GDP figures are similar to the NDP figures which indicates that both countries conditions of capital stock were fairly stable.

Table 2.3- Average NDP, per person, per adult (UK vs. US) from 1997-2007. NDP NDP per person NDP per adult UK 2.95 2.48 2.26 US 2.84 1.81 1.49

Examining the GDP and NDP -pre crisis, it can be observed that there are not many significant differences between the UK and US which could facilitate reasons as to why UK growth has lagged US after the GFC, despite this, a point to consider after conducting this analysis is the underlining fact that the US had a higher GDP in the running towards the GFC which could imply reason as to why GDP may be higher in the US today.

Though this assessment provides a revealing fact - a problem linked with using GDP as a form of measurement is the distribution income of each country may prove to be extremely different. In relation to this - differences in hours worked also suggests reason as to whether the use of comparing GDP is effective. If for example - the workers in the US were on average to work longer hours compared to those in the UK, this could misleadingly inflate GDP figures in the US in comparison to the UK. Thus to overcome this issue Figure 4.3 provides a view of the differences in GDP per hour worked and displays relatively little movement against each other.

Figure 4.3 - GDP per hour worked UK vs. US In addition to the comparison of GDP and NDP, it is important to understand and compare the circumstances of each country before the FC and the features attached to this which could potentially affect the variations in recovery rates that we see today.

3. Pre crisis factors affecting future growth

The US had expected to enjoy a good form of steady growth for many decades, thanks to a combination of a flexible economy and the innovation of the tech boom (Reinhart & Rogoff 2008). In accordance to this, the corporate balance sheets were generally strong going into this episode given the major restructuring efforts that followed the 2001-02 dot-com bubble collapse (Collyns 2008). The US was seemingly in a strong position to take a recession head on, though, considering the impact of these factors - should the country be in a highly-favoured position in terms of a better recovery rate than the UK? Looking at what sustained the growth of the UK between 1997-2008 it proposes that this is not the case, since it had become apparent that UK in fact held similarities to the US, as it was fuelled by the importance of skills and new technology' (LSE 2011).Therefore which conditions prior the FC could have affected current growth trends?

3.1 Housing prices One condition prior to the FC which could alter the impact of growth between both countries is 'housing prices'- Borodo (2008) states:

'The crisis occurred following two years of rising policy interest rates. Its causes include: major changes in regulation, lax regulatory oversight, a relaxation of normal standards of prudent lending and a period of abnormally low interest rates' (P.3).

Many in fact believe that the housing policy stimulated the sub-prime bubble with the increase in distribution of loans and the effect that the financial sector had on the US markets and environment which led to the housing bubble becoming seemingly evident. Colombo (2009) stresses: 'Consumers were urged to apply for credit no matter their financial history, By 2000 the US were known for no-and-low document loans, mortgage dealers, astoundingly large executive bonuses, and sub-prime lending' (P.34 ).

Richardson et. al (2009) in relation to Colombo's point states:

'By September 2008, investment-banking operations that had loaded up on AAA tranches of subprime mortgages had effectively brought down UBS, Bear Stearns, and Lehman Brothers.' (P.9).

Shiller's (2008) book about the recent FC deems the main reason which diminished the growth of the US after the crisis was the consequence of the US real-estate bubble, he further stated that hardly anyone was able to recognise that' bubble as a bubble' when it happened. It is focal to note that the housing bubble did not just affect the US but also the UK, though, factors such as the housing bubble impacted both the UK and US - it is the severity of these factors and how these influence the two countries which are key to take note off, and the housing bubble had seemingly shaped the US a lot more. Collyns (2008) expresses in the period before the FC:

'Household balance sheets do not look nearly so solid, particularly in the United States' (P.7)

Further to this by comparing figures 3.1 (US) and 3.1.1 (UK) it can be viewed that the housing bubble was in fact worse in the US in comparison to the UK due to the significant change in house prices in the US from $225,000 pre crisis falling to roughly $175,000 (-$50,000) after crisis as opposed to the UK £180,000 approximately falling to £150,000 (-£30,000) respectively.

Figure 3.1 and 3.1.1- Illustrating house price change in the US and UK

Shularick and Taylor (2008) further state that as the credit bubble in the US was more excessive than that of the UK - the recession/recovery path for GDP should have been lower in the US - which is not the case - this paper will consider why.

3.2 Banking In addition to this analysis of 'house price changes', Hardie et al (2009) states that the US had moved away from the 'ideal' and moved more towards 'market-based banking' whereas the UK moved more towards a 'bank-based model'. Bank lending in the UK non-financial companies had experienced some dramatic growth, whilst the opposite was said about the equity financing of the UK - which has been fairly negative. Further to this was a prominent change in the UK financial system in the decade before the financial collapse; financial institutions that were primarily traditional-banking focused became increasingly market-based, whereas the main change within the US was the 'increasing dominance of parallel banks' (Maxfiled, 2009). It was also apparent that the growth of the parallel banks in the US was much higher than that of the UK. Other distinctions between the UK and US that has been identified pre crisis was that:

1. The US banks were more reliant on 'selling loans' in order to facilitate ongoing lending - US had adopted this approach to a greater extent than the UK. (Maxfield et al 2009).

2. 'Shadow banking' was another aspect which underlined a difference between the UK and US - as it had come apparent that the US were seen to be removing assets from the balance sheet, whereas UK assets generally remained on them (Basel Committee on Banking Supervision, 2009).

3. The UK pre crisis increasingly relied on 'wholesale funding', whereby loans to deposit ratios rose' (Hardie, 2009). It has further been established from figures established by IMF that the proportion of the UKs borrowing in terms of overall funding was 52% an increase of 26% over the US, which an outstanding difference is considering the diverse economies.

Identifying the issues pre crisis it could be perceived that the US was in fact less reliant on bank lending than the UK. The Bank of England (2008) stated that for banks in the UK since 2001 - lending to customers grew at a rapid rate 'than their holdings of securities'. Miles (2009) also points out that the assets of the UK banks had increased approximately five times in relation to the size of the UK economy. Comparative to this is the UKs productivity growth and growth potential probably inflated before crisis as a lot of it relied on the continuing success of the much larger in UK (relative to US economy) banking sector. This overreliance on bank lending for the UK in relation to the points mentioned above provides a reason as to why the growth in the UK has lagged that of the US after the GFC.

3.3 Other sources of growth Figure 3.3.3-Sources of growth for the UK and US pre crisis.

The differences between sources of growth pre crisis between the UK and US can be summed up from the figure 3.3.3. An important note to consider is that the growth for the UK pre crisis was not purely based on the finance sector (Corry et al 2011).

3.4 Pre crisis conclusions: From conducting research on the differences between the UK and US pre-crisis, reasons as to why UK growth has lagged US growth after GFC can be summed as:

1. The US obtaining a higher GDP in the running before the GFC. 2. UKs overreliance on bank lending in comparison to the US - factors also includes the UKs increase in selling loans and wholesale banking. 3. Shadow banking within the US. However, it is important to stress that issues such as the 'housing bubble' had seemingly affected the US more which advocates reason that the US should in fact have a slower recovery than the UK after the GFC - however this is not the case. This provides this paper rationale to assess actions implemented by both countries after the GFC.

4. GDP - After the Crisis This paper will now address and compare the differences in GDP after the GFC of both countries from January 2007 to March 2013. This can be seen by analysing Figures 4.1 and 4.2.

Figure 4.1 -GDP Annual growth rate in the UK from January 2007 - March 2013

Figure 4.2 -GDP Annual growth rate in the US from January 2007 - March 2013 The average GDP movement in the UK from 2007 to March 2013 is 0.22% between 24 quarters in comparison to 0.82% of the US, which shows a difference of 0.60% GDP between the countries. The UKs GDP dropped to -6.1% around mid-2009 and many would suggest that this figure is more of an outlier. Therefore excluding any outliers (-6.1 GDP in the first qu

This resource was uploaded by: Rushil