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UK economy could continue to flag Samuel Brittan Financial Times 13/01/05 Despite unexpectedly good Christmas sales, there has been a marked slowdown in UK growth in the year just ended – to 1¾ per cent according to Treasury estimates, compared with a trend of 2½ per cent or more. This is far from being a disaster, but it does amount to what American economists call a growth recession. Official forecasters treat this as a temporary relapse, largely explained by world conditions such as the rise in oil prices. They expect a recovery of output growth this year to between 2 and 2½ per cent, or almost up to trend, and in the following two years a further rise to about 3 per cent or above. Many analysts regard this as too optimistic. But rather than nit-pick over year-to-year details, it is more helpful to look at the motors of economic growth over a period. Economist Christopher Smallwood’s contribution to Lombard Research’s latest Monthly Economic Review does just that. The main motor of economic growth since 1997 has been consumer spending and its faltering in 2005 was the main reason for the slowdown. A further contribution to demand growth has been made by a big swing into overall deficit in the government budget, which also cannot continue. The rise in consumer spending has been associated with an unparalleled expansion in consumer debt, itself taking place on the back of a boom in house prices. But this has also come to an end. The picture of consumer- led growth based on high borrowing, supported by booming house prices, is reminiscent of the US economy. So is the growth in both the balance of payments and the budget deficits. On paper, the US payments deficit seems much larger, but much of the difference may be due to accounting conventions. On the other hand, while the US has experienced a maintenance of the productivity spurt that started in the mid-1990s, in the UK the growth of output per hour has moved downwards. Moreover, the US, as the world’s largest economy and provider of its main currency, is in a better position to finance an overseas deficit than the UK, even though neither country can finance indefinite amounts indefinitely. What can fill the gap that a slower rise in UK consumer spending will create? The two obvious and virtuous candidates are investment and net exports. But despite recent good profits, business seems in no mood to step up capital spending – the need to repair deficiencies in corporate pension plans is likely to have priority. Nor are exports likely to grow much faster than imports. What, then, if anything, should be done? British productivity drives have been going on for aeons. In the late 1940s, the chancellor, Stafford Cripps, established Anglo-American productivity teams. Neither Labour nor Conservative governments seem to have had any effect on underlying productivity growth. In the 1960s and early 1970s, the instinctive governmental response to a growth slowdown would have been to relax fiscal policy; that is, cut taxes or increase government spending to the extent that this could be done without provoking a run on sterling. Today, Mr Smallwood suggests the opposite policy of cutting the government deficit by a greater amount than Gordon Brown, the chancellor, intends, by raising value added tax. His argument is that with lower government borrowing it will be safer to cut interest rates. This, he argues, would encourage investment; the lower pound produced by a looser monetary policy would encourage exports. The economy would be rebalanced as well as stimulated, despite the clampdown on consumption. I have always been suspicious of the view that tax increases are the answer to most economic problems. The policy of artificially stimulating investment is also too reminiscent of postwar conventional wisdom. The sterling depreciation side of the remedy is even more suspect. Previous government attempts to manipulate the pound have badly misfired. Either sterling has not responded or it has fallen much more than anyone had bargained for and has led to a crisis and policy U-turn. What is left? To avoid trying to fine-tune the economy and accept that the remarkably stable growth of the decade or so to 2004 was exceptional. The monetary policy committee has, of course, a duty to prevent a downward spiralling recession just as much as an inflationary take-off; but this does not mean that it has to offset every departure from someone’s estimate of trend. It is important to leave enough spare capacity in the economy to cope with any upsurge in exports or investment that arises naturally, whether or not accompanied by falling sterling. It is because of the need to maintain this capacity gap that I have instinctively been on the side of the hawks rather than the doves in the MPC debates. But please let us avoid too many official attempts to restructure or rebalance either the British or the American economies. Market correctives work imperfectly and jerkily, but are still a better bet than official intervention rationalised by the latest policy fad.
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