US stimulus measures pull economy out of recession ahead of UK

Saturday, November 21, 2009 9:47 PM

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By Juvenne Yee

Wednesday, November 04, 2009

The global economic environment has much improved since last September.

Now, with record low interest rates and billions of dollars pumped into stimulus packages across the globe, many of the world's leading economies seem to have regained their footing. Most notably, three G7 countries - Germany, France and Japan - were able to shake off the recession from as early as the second quarter of 2009, leaving their counterparts, the US and UK behind. For both of these recession-stricken economies, analysts and economic data overwhelmingly forecasted and suggested positive economic growth in the third quarter.

However, when the US and the UK released their official third-quarter Gross Domestic Product (GDP) figures, the US resumed economic expansion, while the UK continued to sing the blues for the sixth consecutive quarter. Nonetheless, the performance of the US and the UK creates undeniable contrast as both countries implemented starkly different stimulus programmes, despite having similar fundamental problems.

In the US, the government passed a US$787-billion stimulus package last winter which sought to directly spur consumer spending. This was most notably done through its US$3 billion "Cash for Clunkers" programme, which gave buyers as much as US$4,500 to trade in older cars for new, more fuel-efficient vehicles. Likewise, the US$8,000 federal tax credit programme for first-time home buyers was aimed at increasing housing sales.

On the other side of the spectrum, the UK's stimulus efforts have been more indirectly geared towards inciting consumer demand. The UK's most significant policy focused on reducing its Value Added Tax (VAT) or consumption tax by 2.5 percentage points to 15 per cent from 17.5 per cent, for a 13-month period which began last December. The lower tax rate was expected to reduce prices thereby propelling demand. This move cost the UK Treasury £12.5 billion (US$20.49 billion), while the average earner should save approximately £170 per year. However, it should be noted that the UK also had its own "Cash for Clunkers" programme which was executed on a much smaller scale, amounting to only £400 million (US$655 million).

Turning to the third-quarter GDP reports, it is quite evident that the US' stimulus strategies were far more effective than those crafted by the UK government. The world's largest economy exited the recession after four consecutive quarterly contractions, expanding at an annual rate of 3.5 per cent in the three-month period ended September. This performance was stronger than economists' expectations for 3.3 per cent growth. The biggest driver of growth was consumption, which made a 180 degree turnaround, increasing 3.4 per cent in the quarter and contributing 2.4 percentage points to GDP. This was led by an impressive 22 per cent rise in durable goods such as cars.

Therefore, if one were to zoom in on the numbers, it is undeniable that the "Cash for Clunkers" programme can be deemed a success, as motor vehicle production to meet the demand of new fuel-efficient cars contributed 1.7 percentage points to growth, nearly half of the total GDP increase. The housing tax-credit programme's impact on GDP growth was also positive, although the figures were not nearly as stunning. Residential investments added 0.5 percentage points to growth as investments in housing dramatically grew at an annual rate of 23.4 per cent, the most in 23 years.

In the UK, GDP contracted 0.4 per cent between July and September, completely missing the average estimate of a 0.2 per cent rise. Year-over-year economic growth declined 5.2 per cent. This is the first time the UK economy has declined for six consecutive quarters since records began in 1955, making it the country's worst recession in over half a century. The UK has now contracted 5.9 per cent from its peak before the recession began and is now one of the few major developed countries still experiencing a downturn.

The UK's economy, like the US', is highly dependent on the services industry, which unexpectedly declined in the quarter thus preventing growth. The UK's services industry, which account for approximately 76 per cent of GDP, fell 0.2 per cent on the quarter, led by distribution, hotels and catering which shrank one per cent. By contrast, the US' spending on services grew 1.2 per cent in the period.

While the GDP figures show that the US has exited the recession, one should bear in mind that the fundamental problems which plague both the US and UK are similar. For example, unlike its counterparts, both countries were amongst the hardest hit during the global financial crisis due to their heavy reliance on the financial sectors. Furthermore, both are burdened with higher levels of consumer debt as well as a collapsed real estate bubble, making it difficult to recover at the same pace. However, while the US has managed to muster growth in the third quarter, the question of sustainability surfaces as the country's aggressive economic stimulus measures dwindles due to budgetary constraints and inflationary concerns.

The US' stimulus efforts were not enough to stop the monthly increases in unemployment, suggesting that such levels of growth may be unsustainable. Therefore, learning from the UK's experience, producing positive growth without directly inciting consumer spending may prove challenging in the fourth quarter. However, looking forward, with the global economic environment improving and the US' and the UK's main trading partners continue to achieve growth both countries are now better positioned to foster sustainable growth.

Juvenne Yee is a Research Analyst at Stocks & Securities Ltd. You can contact her at jyee@sslinvest.com

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