Sunday, November 28, 2010
Growing through the squeeze
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column in available to subscribers on www.thesundaytimes.co.uk - this is an excerpt.

There will be many moments of truth for the government in the coming years but one will come tomorrow, when the independent Office for Budget Responsibility (OBR) gives its verdict on last month’s comprehensive spending review.

The OBR will publish forecasts for growth, public borrowing, debt and a range of other variables. Robert Chote, its new chairman, was often a thorn in the government’s side when director of the Institute for Fiscal Studies. If he were to declare tomorrow that the government’s cuts will drive the economy back into recession, it would be a huge problem for the coalition.

I do not expect that to happen, though no economist says never on such matters. Chote and his team have to answer the question most people in business ask me: where will the growth come from? When we have the “squeezed middle”, in fact the squeezed everybody, where will the demand be? I shall come back to how the OBR may answer that in a moment.

One thing we need to know is the intensity of the squeeze and I am indebted to Lord Young of Graffham, until recently the government’s red tape adviser, for encouraging me to delve into corners of the Office for National Statistics’ (ONS) website that often go unexplored.

He, as you will remember, got into trouble for declaring that most people had never had it so good, despite the “so-called” recession, mainly because of ultra low tracker mortgage rates.

He and I go back a long way. In the 1980s, when he was employment secretary - before he became “enterprise” secretary - I remember him turning up to a briefing by statisticians on the unemployment figures to berate journalists for being too gloomy about the labour market.

Though it is not a good idea for politicians to go around saying “you’ve never had it so good” - Harold Macmillan used a variant of it in the 1950s when his government was under pressure - most of the time they can get away with it.

Lord Young could have got away with it, statistically if not politically, not so long ago. In the second quarter of 2009, near the end of the recession, real household disposable income hit a record high of £221.4 billion (in 2006 prices), an increase of 4.7% since the recession’s start in 2008.

Real incomes rose even as the economy endured its worst recession in the post-war era, because employment held up well, inflation for a while was low and Vat was cut. It was an odd combination.

Even odder is that real incomes have been falling as the economy been recovered. A year on from that 2009 high point, household incomes fell by 2.6%. High inflation has eaten into incomes as earnings growth has stayed low. The January restoration of Vat to 17.5% did not help.

So where do we go from here? ONS figures for real incomes go back to 1948, since when there have been only five years when they have fallen on an annual basis. The years were 1951, 1974, 1976, 1977 and 1981. The recession of the early 1990s came and went without an annual fall in real incomes. Though they fell away sharply after the second quarter peak, real incomes in 2009 showed a 1% rise over 2008.

So this year looks like being unusual. Independent economists surveyed by the Treasury expect real incomes for 2010 to be 0.5% down on 2009, followed by a smaller 0.2% fall in 2011. Some will ask whether next year’s fall may be bigger, given the January Vat hike, the April increase in employee National Insurance contributions and the impact of spending cuts.

The upshot, however, is that we are in the middle of a rare two-year fall in real incomes, not seen since Britain’s IMF crisis in 1976-77. Taking account of the modest rise in 2009, by the end of 2011 Britain will have had three years in which, overall, real incomes will have been stagnant. The effect of this can be seen in the numbers.

Though the CBI’s November survey was upbeat, official figures show that retail sales volumes in October were marginally down, by 0.1%, on a year earlier. Monthly mortgage approvals from the major banks are showing a 12-month fall of 27%. With the scrappage scheme no longer helping, private new car registrations last month were almost 36% down on a year earlier.

Though these falls may exaggerate it, the squeeze on incomes means the recovery will not be led by consumers, or realistically can be.

So where will the growth be? The Ernst & Young Item Club, which uses the Treasury’s model of the economy, has produced a useful preview of the OBR forecast, to be published tomorrow. One positive development it expects is a reduction in the number of public sector job cuts, from the 490,000 estimated after the June budget to around 400,000. This is because the spending trimmed average real spending cuts in non-ringfenced departments from 25% to 19%.

As for the rest, the numbers should be reasonably upbeat. This year the economy has grown faster than expected, so the OBR’s June forecast for 2010 growth of 1.2% will be revised up, perhaps to 1.7%. Item’s forecasts for 2011 and 2012, 2.2% and 2.9%, are similar to the OBR’s June forecasts of 2.3% and 2.8%. This is despite consumer spending growth of a feeble 0.8% next year.

How? This is where the great rebalancing kicks in - a recovery led by net exports (the difference between exports and imports) and investment. And, while I can sense scepticism, it is not necessary to look into the crystal ball to see this rebalancing beginning.

Figures last week confirmed that the economy grew by 0.8% in the third quarter. Half of that growth came from net exports, with export growth easily outstripping imports. Investment is growing at a good pace and should pick up further.

Exports and investment are starting to replace consumer spending and government as the drivers of growth. That is why the economy has grown by a strong 2.8% over the past year in spite of falling household incomes. It is also why the recovery can continue through the squeeze on incomes. As with a diet and exercise regime, it may not feel very comfortable. We should, however, emerge healthier and better balanced from it.