Is the economy healing?
The Chancellor has long been keen to tell us that “the economy is healing” and, according to the latest Bank of England forecasts, he might finally have some justification in saying this. At his press conference last week the Sir Mervyn King was able to revise up growth forecasts for the first time since the financial crisis hit.
The Bank now expects growth in 2013 to come in around the 1.2% mark, an upward revision from the 1.0% it expected in February and twice as high as the OBR’s own estimate of 0.6%.
Presented with this information, one response is to hail ‘Good news Britain’ and point out that the Bank now expects a recovery twice as fast as the OBR. Another and I would argue more correct response, is to note that whilst growth of 1.2% is obviously preferable to growth of 0.6% it is nothing to shout about.
Indeed the OBR expected growth of 1.2% in 2013 as recently as last December. Last week’s upward revisions from the BOE simply take us back to where we were 6 months ago. The initial OBR forecast for 2013, on which the Government’s fiscal plans were based, was for growth of 2.9%. No one now thinks 2.9% growth in 2013 is remotely plausible.
The economy might be healing in as much as it is showing some tentative signs of growth but whether compared to the original forecasts, to international experience or to the UK’s own history this is an appallingly weak recovery.
As I noted a few weeks ago, on the IMF’s forecasts (as good as any) the UK is set to experience a lost decade of GDP per capita growth. This is not what a ‘healing economy’ looks like.
And for most people this recovery does not feel like a recovery in any meaningful sense of the word.
Today we learned that inflation dropped a touch in April, but it remains well above the pace of earnings growth. Real wages in the UK have been falling for three years. The chart below shows average weekly earnings (total pay including bonuses) in real terms (March 2013 prices using RPI).
As can been seen real wages have fallen by a huge 8.5% over the past three years.
Even leaving aside inflation, nominal earnings have been falling since last summer. And, as James Plunkett notes on twitter, the level of people in employment has dropped since the end of 2012.
It is an odd recovery indeed that is accompanied by falling employment and falling incomes and it is even odder that anyone can look at the UK data and see much to celebrate.
So, if the labour market is stagnant and real incomes are squeezed, where is this modest recovery coming from? One answer can be found in the housing market where prices are once again rising. As I wrote after the Budget:
in the June 2010 Budget, the Chancellor expected 57% of all growth to come from his preferred (and ‘sustainable’) sources of business investment and net trade. By this time last year, that contribution had fallen to around 52%, lower but still more than half of all growth.
Yesterday’s forecasts have business investment and net trade contributing only 31% of all growth to 2017…
Three years ago George Osborne argued that “that we cannot go back to the last decade’s debt-fueled model of growth”. As I listened to his housing market announcements yesterday, I thought “it sounds like he is going to try”.
The early indications are that the Chancellor’s interventions in the housing market are starting to bear fruit, prices are heading north and activity is picking up.
So I foresee three possible scenarios for the UK economy in the next three or four years (in the absence of rapid rebalancing towards a net trade or investment led recovery and in the absence of a change in fiscal or monetary policy):
- First, and most preferable but most unlikely, we get strong growth in real incomes as inflation falls back towards 2% and wage growth increases. If that happens consumption growth will be stronger and the economy will grow at a decent pace.
- Second, and what I think is the most likely outcome – my central ‘forecast’ if you will – household income growth will be weak and the savings ratio will not drop by much. The result will be weak consumption growth and an economy that is growing, but growing slowly – in the order of 1-1.5% a year. In historical terms of recovery from recession this is pretty much a disaster.
- Third, it is possible that we still get weak income growth but that the savings ratio drops rapidly. In this scenario we’d see faster consumption growth and hence faster overall growth. This however would be accompanied by a big increase in household debt. It might give us 3 – 4 years of decent growth, but at the risk of increasing the financial imbalances that got us into trouble in the first place.
I hope for the first outcome, expect the second and worry about the third.
Strong income growth seems increasingly unlikely, we are likely to get either my second or third scenario – the real worry now is that the Government’s housing interventions (that push up prices not building) will mean we get the third. Some will no doubt argue that a few years of faster growth are a better out turn than stagnation. Whilst this is true we shouldn’t kid ourselves that an asset price, consumer debt led recovery is a good, or sustainable, outcome.
…spending on infrastructure (assuming some positive external effects and that the economy is depressed – neither of which are heroic assumptions) could easily result in a lower debt/GDP ratio, not a higher one. We get the boost to growth, we get lower unemployment, we get the additional infrastructure and it ultimately pays for itself.
This is a close to a “free lunch” as macroeconomic policy makers will ever get. In the context of an economy ambling through a lost decade it would be madness not to seize this chance.
My pessimistic scenarios were crucially based on there being no change in monetary or fiscal policy. Since I wrote that post the case for a change in fiscal policy has become much stronger.