It’s growth and recovery all right. But how sustainable is it?
September 14, 2014
George Osborne will hope to continue a welcome habit of confounding his critics. Steady progress at deficit reduction and austerity measures in parts of the public sector have not prevented a return to economic growth. Unsurprisingly, Labour have been forced to shift their line of attack to the continuing squeeze on living standards as inflation continues to outpace wage rises. This is ironic, as by rights Labour should have little crow about on this front – after all, real wages have been static for the average Briton since 2004.
Furthermore, the Opposition’s ill-disguised hostility to business and wealth creation in reality leads them down an economic cul-de-sac: none of this is a sensible policy programme for a Party aspiring to government within eight months.
So will this economic recovery prove sustainable? It is a familiar question that lies at the very heart of the election battle ahead.
For all the talk of ‘our long term economic plan’ (the now famous OLTEP) the coalition in reality has two distinct economic strategies. Implicit in the OLTEP slogan is a recognition that the benefits of infrastructure investment, slashed in 2010 and restored last year, along with an aggressive programme of export-led growth in developing markets like China and India will not come this side of May 2015.
These admirable, long-term investment projects certainly live up to Osborne’s narrative, when in Opposition, of promoting a new model of growth that does not rely upon consumer debt. The only snag with this revitalisation of the UK economy is that it will only begin to bear fruit well into the latter part of the decade.
Meanwhile, the coalition has a distinctly short-term plan to get the UK economy through the next election, which I reckon the Treasury feels cannot come too soon.
The surging growth of the past 18 months owes much to the ongoing, massive monetary stimulus provided by five-and-a-half years of near zero interest rates and £375 billion of Quantitative Easing. Funding for Lending provided the banks with an incentive to lend to the mortgage market, and consumers were similarly encouraged by assurances that credit would remain cheap for the foreseeable future. Indeed, in spite of a recent reorientation of the Funding for Lending programme away from real estate lending, barely one-eighth of bank lending is used by companies for investment beyond property. Three-quarters of allbank credit is still being gobbled by domestic householders to service mortgages and fund related consumption.
For so long as the Bank of England’s attempts to calm the overheating London/South East property market do not damage confidence, the economy should continue to expand at a steady pace until the election is behind us. It is possible that despite (or perhaps, given its notoriously inaccurate predictions, because of) the IMF’s exuberance we may see some slowing-down in growth rates over these next three quarters. Manufacturing and construction data show clear signs of reduced activity although, perhaps thankfully, it is the UK’s services sector that accounts for over three-quarters of the national income.
So a fundamental rebalancing of the economy seems as far away as ever: paradoxically, the current strength of sterling continues to weaken our export performance and the UK’s balance of trade. This also suggests that the elusive gap between growth rates in wages and inflation may widen again in the months ahead.
None the less, the coalition’s short-term economic plan is clearly on course and, unlike most other finance ministers in the G20, our Chancellor has the confidence of the markets.
It is in the medium-term where the economic fundamentals do not look so smart. I suspect the period 2016-18 may be difficult whoever is in government. The budget deficit remains at an historical high of six per cent – double that of France and at a time when the German budget is almost balanced. Two thirds of the programme of public spending cuts have yet to kick in, and it may prove politically impossible to consider austerity at the level necessary to wipe out of the deficit by 2018-19.
Interest rates will eventually need to rise. Indeed, this may even be forced upon the next administration by action in the global bond markets. In all likelihood any prudent government will have to slam on the brakes by 2016, and bring to a halt this unprecedented era of cheap credit. The puzzle over the UK economy’s declining productivity of recent times will require resolution. All this will test just how strong an economic recovery the UK is living through.
Only once interest rates begin to rise to ‘normal’ levels will the impact of our accumulated public and private debt take its full toll. Worryingly, this may all come at a time of further Eurozone turmoil, with international strife leading to a slowdown in the global economy just as the current economic cycle turns down.
Yet there is one curious omission in the Labour party’s critique of current economic policy. The fact is that, for all the talk of austerity, the coalition will have borrowed around £190 billion more during the course of this parliament than predicted at the time of the June 2010 Emergency Budget. Ironically, Labour’s plans then to borrow a mere additional £50 billion over this period were derided by the coalition as irresponsible and potentially ruinous to the UK’s economic health.
There are two reasons Ed Balls makes so little of this fact. First, this level of additional spending undermines the ‘reckless austerity’ charge levelled against the government. Second, he knows that it has only been the credibility engendered by Osborne with the international capital markets that has allowed such overspending not to have impacted on interest rates. A Labour administration over these past few years would simply not have been allowed to overshoot its budget without a strongly adverse impact on the cost of borrowing.