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Investment and consumption performance demonstrates the frailty of the UK economy; the economic recovery is not yet secure
The government has facilitated, at long last, a return to strong growth. But they have done so by ramping up the economic growth model that served Labour so well until 2008 – a model George Osborne had promised to dismantle.
The pace of growth evident in the UK economy is impressive. Of course, the economy is still growing below the pre-crisis trend, and the pace seems to have declined slightly in recent months, but after several years of stagnation, almost 2 per cent growth in GDP in 2013 is not to be sniffed at.
We should be wary, of course, of confusing levels and rates. Generally speaking, weak growth from a higher base trumps strong growth from a low base. The UK economy has still not attained the level of output reached before the recession; by this stage of the recovery after the most recent recession in the UK, in 1990, output was already 13 percent above its pre-recession peak. Even after the Great Depression in the early 1930s output was 6 per cent above peak by this stage.
The headline output rate also marginalises concerns about GDP per capita; strong population growth since the recession means that GDP growth is not creating genuine improvements in living standards. We may eventually be producing more but there are more people around to claim a slice of the pie.
The performance of the labour market tells a particularly illuminating story. The economy has confounded conventional economic theory by exhibiting a relatively job-rich recession and recovery. Unemployment did not rise as much we might have expected after 2008, and fell more quickly than expected once growth returned (strong employment growth in fact preceded the increase in overall growth) – the former usually inhibits the latter.
The reason for this paradox is the continuing wages squeeze, a trend evident long before the recession. Employers were able to retain staff by paying them less, ceteris paribus (and, to some extent, reducing their hours) and recruit staff cheaply as the economy picked up. Of course, few individual employers will have adopted this strategy; rather, these are economy-wide trends which tell us about the type of jobs now being created, with the recession exacerbating the rebalancing of employment within the UK economy towards low-paying sectors. It is generally median-paying industries, such as those in the manufacturing and construction sectors, which have seen employment retract, rather than high-paying sectors such as finance.
This has resulted in increasing inequality which is not only socially malevolent but also economically devastating. The UK’s pre-crisis growth model depended heavily on household consumption. Low pay problematises this approach, but for a remarkably sustained period growing personal indebtedness and housing equity withdrawals enabled us to solve what Colin Crouch called ‘the great puzzle of the period’. There is little value in crying over spilt milk, but alarmingly, the current recovery has been led by a resurgence of household consumption – with personal indebtedness and a housing boom again compensating for pay stagnation.
It wasn’t supposed to be like this. Before and after forming a government, the coalition partners were adamant that the economy needed to be rebalanced. In a 2010 speech, before the general election, George Osborne posed himself a question: ‘Given that we cannot go back to the last decade’s debt-fuelled model of growth, the question I am asked most often at the moment, is “where is the growth going to come from?”’. His answer was refreshingly clear: ‘The economics profession is in broad agreement that the recovery will only be sustainable if it is accompanied by an internal and external rebalancing of our economy: in other words a higher savings rate, more business investment, and rising net exports.’
David Cameron and Nick Clegg’s foreword to the coalition agreement claimed that ‘we both want to build a new economy from the rubble of the old’. The main document explained that: we need to take urgent action to boost enterprise, support green growth and build a new and more responsible economic model. We want to create a fairer and more balanced economy, where we are not so dependent on a narrow range of economic sectors, and where new businesses and economic opportunities are more evenly shared between regions and industries’. This was followed by a speech from David Cameron, which stated: ‘our economy has become more and more unbalanced, with our fortunes hitched to a few industries in one corner of the country, while we let other sectors like manufacturing slide’.
‘Rebalancing’ is a useful analogy for the coalition, suggesting as it does profound economic problems that require only minor policy adjustments. Yet even this narrowly defined objective is not being achieved. Investment is stagnant, the trade deficit is remarkably stubborn despite sterling depreciation, and pay in financial services is outpacing manufacturing. Sound familiar? If this simply represented a post-recessionary reassertion of deep-lying tendencies within our national business model, perhaps we could let the coalition government off the hook. But they (and their appointees at the Bank of England) have undoubtedly sought to bolster these tendencies by boosting the housing market and asset price speculation through Help to Buy, Funding for Lending, incredibly low interest rates, and continuing Labour’s ‘regressively redistributive’ quantitative easing programme.
We know there will be another economic downturn. The question is neither ‘if’ nor ‘when’, but rather ‘what’. Will it be a typically cyclical downturn (the Bank of England tells us that the UK business cycle now lasts around six years)? Or will it be a more profound crisis along the lines of 2008/09? It seems unlikely the next crisis will be directly triggered by a financial crisis. These are similarly never very far away, but higher capital buffers for the banks and greater regulatory scrutiny of business practices will mitigate against this possibility in the short term.
But the ‘real economy’ seems more than capable of conjuring up its own crisis. If wages do not begin to grow strongly, household consumption cannot continue to prop up the economy. There are clearly limits to the strain that can be taken by consumer and mortgage borrowing if households’ underlying sources of income continue to stagnate. Higher productivity will be the key to higher wages, but will not happen without higher rates of long term investment. But the increasing dominance of low-skilled, labour-intense services sectors in the UK economy mean the incentives to invest in capital-intense industries are weakening rather than strengthening.
As Duncan Weldon warns, a purely cyclical downturn is all it might take to trigger crisis. The recovery is underway but monetary and fiscal policy are still in crisis-mode, which will constrain the government’s ability to respond to the next downturn, turning the business cycle into a downward spiral. None of this is to suggest that the growth we are seeing now is a bad thing: it is vital that the UK economy heads into the next downturn in as strong a position as possible. But the type of growth now evident is recreating many of the elements that turned the last downturn into the ongoing crisis.
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