Tuesday, 2 November 2010

Crowded house: the Welsh economy

The Welsh Economy
The Economist this week reports on two very interesting academic studies on the effects of increased government spending which could have a profound impact on our understanding of the Welsh economy.

The first study, by Harvard Business School academics, investigates whether higher government spending can "crowd out" private consumption and investment -- i.e. the phenomenon were government uses up financial and other resources (including personnel) that would otherwise be used by private enterprise. As an 'economy' is basically an aggregate of the actions of literally hundreds of millions of different people and organisations making diverse informed decisions on how to spend their money, the biggest problem faced by economists is to isolate just the factors they want to study -- in this case what influence increased government spending has on the private sector -- however the Harvard Business School academics hit on a very ingenious solution:

"When American politicians become chairmen of congressional committees, they are able to direct federal spending to their home states. To take one example, Richard Shelby, a Republican from Alabama, became chairman of the Senate intelligence committee in 1997. Before that Alabama averaged $6m less in annual federal earmarks, or specific funding, than other states. After his appointment the state received $90m more than the average.
Chairmanships are based on seniority. They require another senator or congressman to lose their seat. Appointments have little relationship with economic activity in the state concerned, and extra spending will occur at all stages of the [business] cycle. It is a truly independent variable.
The academics examined 232 appointments across 42 years. They found the average state receives a 40-50% boost in earmarks in the year following a chairman’s appointment, an increase that persisted for the rest of his tenure. Private firms reacted by reducing capital expenditure (by 8-15%) and research and development (by 7-12%); employment and sales growth also suffered. This test appears fairly robust, as it covered a wide variety of states and was also reversed when the chairman stood down."

Furthermore the second study highlighted by The Economist and conducted by academics associated with the OECD discovered through statistical analysis of a panel of 145 countries between 1960 to 2007, that a 1% rise in government consumption as a share of GDP eventually reduced private-sector consumption by 1.9%.

If these findings are correct, what does this tell us about the Welsh economy were public spending as a share of GDP has, according to the latest figures, reached 69.1% -- second only in its reliance on the public sector to Northern Ireland?

Public spending as a share of GDP (source: CEBR)

I have previously written how, despite the Welsh Assembly spending more per capita than any other UK region on economic development, Wales still remains at or near the bottom of most indicators of economic health such as GVA, unemployment and business failures. The Institute of Welsh Affairs, which commissioned the research (and which counts the sainted Gerry Holtham on its management board), opined that the causes for this underperformance were general cack-handedness and a lack of accountability and transparency. However, bearing in mind the results of the above studies, is it not more likely that the growth of the Welsh private sector is in fact being artificially stunted due to the crowding-out effects of an overlarge public sector? It surely cannot be healthy for Wales that the government spends £7 out of every £10 spent in this country.

Furthermore, in the past both Rhodri Morgan and Ieuan Wyn Jones have given speeches saying that the problem is not that the Welsh public sector is too large, but that the private sector is too small. But surely this is putting the cart before the horse -- under normal circumstances a country can only afford a public sector which can be sustainably paid for by its private sector. If the findings of the above studies are correct then they will have profound implications on our understanding of why the Welsh private sector is so stunted.

(Finally, before I am accused of hypocrisy for having called for Welsh Assembly support for the port of Holyhead just days ago, please note there is a big difference between targeted and limited government support and a structurally over-large public sector.)

9 comments:

Anonymous said...

I totally agree; Wales cannot compete to attract multinationals when they can go to a cheaper "elsewhere" with a "can do" attitude. The private sector is the way forward to secure prosperity.
IWJ is handed clean-tech manufacturing on the plate for 250 jobs in Holyhead but fails to secure the deal. This is a secret sutuation that will be revealed at a future time.

As is always said here "What has IWJ done for Anglesey?" ....see the above answer.

TGC said...

Another very interesting and challenging topic. I even agree (despite my reservations about capitalism!)

I wonder whether geographical influences are allowed for in this debate, however? I mean, if we were to reduce the tap on public finance into Anglesey today, would we really see private business start to move in? I'm not so sure; the evidence seems to point to business preferring consistently to stick closer to markets and other businesses - St. Asaph Business Park almost seems like an investment boundary, the land beyond simply being too distant from anything.

The Druid of Anglesey said...

"I wonder whether geographical influences are allowed for in this debate, however?"

I would agree that in general the location of Anglesey on the periphery of the UK has been a disadvantage. But as per our recent discussion on windfarms, in some cases geography is actually in our favour. You could also argue that our proximity to Ireland has also been a boon to us and to the port of Holyhead.

"I mean, if we were to reduce the tap on public finance into Anglesey today, would we really see private business start to move in?"

You may find our most able people making different career choices -- not opting for a safe and well paid council job, for example, but setting up and running their own business maybe. This would not necessarily adress the issue of outward migration, but successful businesses eventually beget more businesses.

"I'm not so sure; the evidence seems to point to business preferring consistently to stick closer to markets and other businesses - St. Asaph Business Park almost seems like an investment boundary, the land beyond simply being too distant from anything."

Undoubtedly. This is why Anglesey needs to work on its natural advantages - those which which other areas cannot compete with, i.e.:
- the largest agricultural sector in North Wales, with a nascent cottage industry of home-made jams, cheeses, chocolates, etc.
- An under-developed tourism industry considering our resources in terms of coastline and watersports possibilites, historical remains, proximity to Snowdonia, etc.
- A large port and status as gateway to Ireland
- Geography conducive to all forms of energy, nuclear, wind, sea turbines, etc.

TGC said...

I agree entirely. It was only this morning that I was looking at what Wirral Council is presenting on its website for the benefit of smaller businesses. It puts Anglesey's total lack of effort in the same direction to shame (wait for the 'Economic Recovery Plan' screen to appear on first visiting):

http://www.wirral.gov.uk/

The Red Flag said...

Anonymous said...Wales cannot compete to attract multinationals when they can go to a cheaper "elsewhere"

I must contest that statement if by "elsewhere" you mean within the UK. Wages levels on Anglesey are catastrophically low (I use catastrophically deliberately. Low wages is low spending is low growth). It is cheaper to set up here than most of the rest of the UK.

The Druid hits the nail on the head - I would agree that in general the location of Anglesey on the periphery of the UK has been a disadvantage. Business ideally needs to be close to it's target market. We are not going to attract business here unless there is a specific advantage in being here and the only advantage we offer is low wage levels and that is proving to be of no interest to outside business.

Anonymous said...

NOTICE: See Rand Paul speech on Sky news .....exactly what we need in Wales....."We have come to take Government back because Government has failed"

Welsh Ramblings said...

Anon 01:12- you might have slept through it, but the most recent recession was caused by market failure. What almost collapsed was the engine room that the entire private sector, globally, depends upon. Financial services.

At most, you could say the government was too small and didn't regulate enough. Which I presume is NOT the point you are trying to make!

Some people have short memories.

Anonymous said...

There is no Economic Recovery in Wales, we are all skint....

Anonymous said...

bring back our own money

http://cgi.ebay.co.uk/1794-ANGLESEY-MINERS-HALFPENNY-TOKEN-NICE-GRADE-/320612626986?pt=UK_Coins_Tokens_RL&hash=item4aa600722a