Looking under the bonnet: is the UK economic engine firing on all cylinders?
On the face of it the economy looks to be into a good recovery phase – growth at its highest since 2006, record employment levels and the public sector deficit under half what it was at its peak in 2010.
But when you look beneath the bonnet you find an unbalanced economy where labour productivity growth has stalled and momentum is overly reliant on household spending. These are not the characteristics of an economy poised for sustained take-off as it was in 1995 when, interestingly, the public sector deficit stood in the same ratio to GDP as it does now.
Indeed, as a new paper - ‘Beneath the bonnet: how sound is Britain’s economic recovery?’ – that I have co-authored argues, the next Government needs to address the economic imbalances currently emerging if it is even to be an economy that can deliver some sort of sustained recovery.
The statistics looked at in the paper could hardly be clearer with respect to the four key ‘cylinders’ in the UK’s economic engine:
PRODUCTIVITY - Record employment has been accompanied by the virtual disappearance of growth in labour productivity. After each of the recessions in the 70s, 80s and 90s, labour productivity rebounded strongly. Its absence this time round spells danger: sustained real wage growth is impossible, the choices that governments have to make, far harder.
EMPLOYMENT - Although the total number in work and the employment rate are at record levels the data shows this is to a large degree due to the rise in self-employment, income from which has at the same time plunged. The scale of zero hours contracts also points to the weakness beneath the record. Secure, decently paid jobs are in less abundant supply than the headline figures might suggest.
HOUSEHOLD INCOME – Instead of rebounding sharply as it did after each of the last three recessions, real household disposable income has barely increased at all since 2009. This makes sustainable growth, let alone growth that feeds through to good living standards, far from assured
TRADE AND OTHER SECTOR BALANCES - The public sector deficit at 4.5% is the same now as it was 19 years ago during the recovery from the early 1990s recession. But at that time, the other sector balances, for trade with the rest of the world and for corporate investment, were set fair for sustained economic growth. The household sector was still saving like mad (+7.0% of GDP), the corporate sector was strongly borrowing to invest (-3.4%) and there was a small balance of payments deficit (+0.9%). So this was an economy where investment was driving growth and where the main policy challenge was to encourage households to spend more and drive growth improving living standards.
2014/15 looks quite different, as the graph below makes clear. Now, the household sector needs to save more not less – something unlikely to help growth in the medium run. The balance of payments deficit (+5.3%) is already well above its long term average (+1.8%). And while the corporate sector deficit (the first since 2002) is a relatively bright spot (at -1.5%) it is pulling the economy towards growth a lot less strongly than it was in 1995/96.
The current situation therefore looks much more like the end of a period of growth than the early stages of a strong, sustained recovery.
What this data shows is that growth at present, while still leaving us a long way to go to catch up with the output loss since the great recession, is also unbalanced. Yet current policies are not addressing the fundamental weaknesses. Unconventional monetary policy, in the shape of quantitative easing, came to the rescue after the global banking crisis led to the loss of a massive 15% of output. Other ‘unconventional’ economic policies are now urgently needed.
Deficit reduction is necessary but it is quite wrong for it to be the overwhelming, even sole, focus of government policy. A recovery in which growth was sustainable would be one with a bigger corporate deficit and a smaller balance of payments deficit than we have now. Government needs policies for these sector deficits every bit as much as it needs them for “the” public sector deficit.
This blog appeared initially on Pieria on 27 April 2015.