Sunday, April 01, 2012
The British tortoise and the American hare
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

My natural instinct when confronted with unexpectedly weak growth figures is to question them.

Nobody doubts that this is a subdued recovery but the downward revision of gross domestic product in the fourth quarter of 2011 to show a fall of 0.3%, coupled with small, mainly negative changes for earlier quarters, had me asking questions again.

The GDP figures are out of line with surveys they usually track closely, notably the monthly purchasing managers’ index. Not only that but long experience has taught me it takes years to get the full picture.

The recession of 1990-92 was barely more than half as bad as first reported. I was wrongfooted in late 1998 and early 1999 when the statistics showed Britain flirting with technical recession, compared with the strong growth the numbers now show .

More recently, the economy’s apparent failure to recover in the second half of 2009, while Britain’s competitors were doing so, became a big issue for the last Labour government. Now we know the economy was recovering, thanks to data revisions.

The figures, however, are the figures, and they set the tone. It is on the basis of them that the OECD suggests Britain is in a mild double-dip recession. When they are revised, as they will be, few will notice.

Even so, as noted above, even data revisions will not turn this into a strong recovery. Britain’s emergence from the crisis and recession is hesitant and bleary-eyed. It is not as weak as the official statistics suggest but it is far from strong.

Britain, according to the OECD, is performing similarly to a weighted average of the three largest euroland economies; Germany, France and Italy (though Germany, in almost every respect, looks healthier).

Where there is much clearer divergence is in respect of America. While Britain will struggle to show any net growth in the first half of this year, the US economy will grow at an annual rate of nearly 3%.

This will maintain the post-crisis pattern. A US recovery that is disappointing by historic standards is much stronger than Britain’s. From its recession low-point in mid-2009, the trough, Britain has grown by 3.2%, an average growth rate of little more than 1%. America, in contrast, is more than 6% above its recession lows.

The US economy has surpassed its pre-crisis level while Britain is more than 4% smaller than before the crisis hit. Since the crisis originated in America, while exposing vulnerabilities elsewhere, some might consider that rough justice.

Why is this? I have dealt before with the crude “Keynesian stimulus versus coalition austerity” argument. The great experiment some wished for, of Obama pumping in spending and cutting taxes while Osborne was sucking the lifeblood out of Britain’s economy, was never there.

There were, however, important differences, and some of them relate to fiscal policy. By coincidence, even before the latest ONS numbers and the OECD, they had been addressed by Adam Posen, a member of the Bank of England’s monetary policy committee.

Posen, in a speech ‘Why is their recovery better than ours?’ (though confusingly he is American), listed several reasons why America has shown Britain a clean pair of heels. The two striking weaknesses in Britain are in business investment, which fell by 3.3% in the final quarter of 2011, and consumer spending.

Business investment rebounded much more in America, he said, because firms had a wider range of financing options. They were much less dependent on banks. If credit rationing has been a factor in Britain, and many small and medium-sized firms would say it has, this goes some way to explaining investment weakness.

The lending caution of British banks, meanwhile, has become entrenched because they are more exposed to eurozone risks than their US counterparts.

What about the weakness of consumer spending? The astonishing thing about this recovery is that the consumer has been a bystander. Though consumer spending perked up in the final quarter of 2011, rising by 0.4%, it was 1% down on a year earlier.

Consumer spending is less than 1% above its recessionary trough and 5% down on pre-crisis levels. Never before have we had a recovery in which spending has stayed so weak.

Posen, and this is where fiscal policy does come in, said part of the explanation is that there has been a bigger tightening in Britain than America, which is true.

Some of it is due to the nature of that tightening. George Osborne’s first big announcement, in June 2010, was a hike in Vat to 20% the following January. It was a conscious break with the stealth taxes of the Brown years, a big up-front tax hikes which showed that we were all in together.

But Vat, as the chancellor is discovering with pasties, is a bit too visible. People notice it. Retailers make sure they notice it, so price rises get blamed on the government. Three months after Vat went up, so did employees’ national insurance, a tax hike bequeathed by Labour. There was barely a squeak.

The biggest reason for weak consumer spending, and the fact that real incomes fell more last year than in any since 1977 (the year when the 1976 International Monetary Fund rescue hit home), was the unintended squeeze from high inflation.

Posen says the main reason British consumers fared worse than their US counterparts was that the rise in energy costs was amplified by the weakness of sterling; its 25% depreciation. An open economy blown around by international developments can be unhelpful.

There are other reasons why consumer spending is so weak. In 2007, when the crisis hit, the houssehold saving ratio was less than 3%. Now it is nearly 8%. Borrowing constraints and caution about employment have changed behaviour.

Will this change? Posen thinks the differences between America and Britain will subside. On consumer spending, the best hope remains a fall in inflation and a restoration of real income growth, with oil the biggest threat to that scenario.

As for business investment, a report from RBS notes the £754 billion corporate cash mountain but also warns that it could be next year before we see a decisive rise in investment. Jefferies, the investment bank, also cites the corporate sector as “the best hope for a stronger UK recovery”. Either way, whether corporates or consumers, there is some catching up with America to do.