Sunday, October 21, 2012
With a fair wind, lasting recovery starts here
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Even before gross domestic product figures for the third quarter are published at 9.30 on Thursday, the arguments are well-rehearsed.

Pessimists and the government’s critics will say any pick-up is a mere statistical blip, which does not change the picture of a flatlining economy prone to falls in gross domestic product (GDP). On this view, the double-dip will be followed by triple, quadruple and even more exotic dips.

The other is that the third quarter will mark the start of a sustained recovery. The upturn had a temporary setback, exaggerated by special factors and what the Office for National Statistics (ONS) concedes are more revision-prone data in recent years. But the economy’s firmer tone, reflected in strong employment growth, will persist.

You can, of course, never rule out new shocks. The eurozone crisis is still smouldering and America’s mad fiscal cliff of emergency tax hikes and spending cuts looms (though surely it will be avoided). But, on this view, this week should mark the beginning of better times.

Which will it be? There is a danger of counting chickens before they are hatched. Official forecasters were surprised when the ONS pronounced the double-dip in April, after the data in the early part of the year looked strong. There is always a risk the statisticians will bowl a googly again.

It would, however, be quite a surprise. Economists expect third quarter growth of between 0.4% and 0.8%, some of it merely reflecting a statistical bounce from the jubilee-depressed second quarter.

If it is near the top of the range, there will have been underlying growth since spring. A figure at the lower end, merely making up the second quarter fall, would maintain the picture of a flat economy.

What will happen after the third quarter? There is a great temptation, which the government’s critics fall for, of blaming every woe on George Osborne. I can understand it. He plays the role of pantomime villain well; not everybody could get booed at the Paralympics. He is no great communicator and, after an error-strewn budget, has work to do to inspire confidence. He gets into scrapes in first-class train carriages.

But it is nonsense to suggest that the economy has not grown because of his fiscal tightening, or that it cannot grow as long as austerity persists.

Two reports published in the past few days offered useful insights. One was from the Office for Budget Responsibility (OBR), the independent fiscal watchdog, which proved you can learn as much more from your mistakes as your successes.

After a brief interlude in which a crude exercise from the International Monetary Fund was leapt on as proof that the coalition’s fiscal tightening was solely responsible for disappointing growth, the OBR provided a more rounded picture.

It addressed the question of why, while the budget deficit in the coalition’s first two years came down in line with its June 2010 forecast, growth has fallen well short. Compared with a prediction that GDP would rise by 5.7% between mid-2010 and mid-2012, it only increased by 0.9%.

Where did the growth go? The biggest reason identified by the OBR is one frequently noted here. High inflation has eaten into real, or inflation-adjusted, consumer spending. Interestingly, consumers have been spending; the OBR’s forecast of a cash spending rise of 9.3% over two years was spot on. But it was eaten up by higher prices, leaving no room for “real” growth.

The other weak components of GDP were business investment, which the OBR attributes mainly to eurozone uncertainty and lack of credit, and exports, or net trade, similarly affected by eurozone woes.

Did it not allow enough for the impact of the fiscal tightening? Possibly, though any such effect is balanced by the fact that government spending so far has been significantly stronger than it expected.

The other useful report was from the ONS. To coincide with a seminar it held in Westminster on the great productivity conundrum - why has employment been so strong when GDP has been so weak? - it published a paper by Peter Patterson, its deputy chief economist.

Productivity is not the same as growth, though it is a key driver of it. It measures output per worker or output per hour. According to the latter, productivity was growing 2.4% a year in the decade or so before the crisis but has barely grown - a mere 0.2% a year - since mid-2009. An economy that does not generate productivity growth is in trouble.

Though most sectors of the economy are suffering from weaker productivity growth, two stand out. One is North Sea oil and gas, where output per hour has dropped more than 40% in five years.

The other is financial services, where productivity was growing by more than 4% a year, but in the past three years has been falling nearly 3% annually, as its output has plunged. Just these two sectors provide much of the explanation for the very weak productivity numbers.

So what do these reports tell us? In the case of the OBR’s assessment, it is possible the unhelpful factors that have depressed growth over the past two years will persist.

Some of them, however, are subsiding. The fall in inflation is easing the squeeze on real incomes and should support stronger consumer spending. The eurozone crisis has not been solved but has been contained. There is tentative evidence the global economy, after slowing, reached its low point in the third quarter. Any recovery will be good for exports.

As for the ONS exercise, there are signs that the plunge in output in the North Sea and in the financial services sector - which accounts for a tenth of GDP - is coming to an end. Even stable output would mean both being less of a drag on future growth.

Can we start to believe in a sustained recovery? With a fair wind, yes, and that is also the view of most economists. Consensus Economics, a consultancy, polls economists regularly. In its latest exercise, it asked for medium-term predictions.

For Britain, the forecast was for 1.2% growth next year, 1.9% in 2014 and 2.2% in 2015, election year, before settling at 2% over the medium-term. In the past that would have been regarded as so-so but it is not that much below America, which settles at 2.5%, the eurozone, which is seen as growing by 1.5% in the medium-term and Japan, which struggles to hit 1%. Britain is even seen as outpacing Germany, which grows in line with the eurozone average.

In the long-run, as Keynes noted, we’re dead. In the medium-term we can hope for better growth.