Sunday, June 29, 2014
Global winds can blow us to a long-haul recovery
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.

Britain’s economy is expanding at a healthy rate. This month, for the first time, the average growth prediction for 2014 has hit 3% among the independent forecasters surveyed each month by the Treasury.

With half the year gone, you may say that this is not a particularly bold forecast. The numbers and the surveys are heading that way, with no sign yet of the feared slowdown in the second half of the year. If anything, growth is looking stronger.

It is, however, a milestone. This year see the strongest growth since 2007, the year when the crisis began to wreak havoc but before its economic impact was felt. This year’s growth is a powerful sign that the crisis’s deadly grip is weakening.

Not only that but I began to fear that growth numbers beginning with a “3”, normal in past recoveries, were going to be denied to us this time. Maybe those banking and fiscal hangovers had left us so groggy that the last thing we could do was run faster.

So this is good news. The question is whether this is the only 3% year we see, a bit of a flash the pan, or whether there can be more of them. In other words, is this stronger recovery sustainable?

The Office for Budget Responsibility is typically cautious. Though it thinks the upturn will last, its March forecast had not a single year of 3% growth, including this one, and a slowdown to 2.3% next year.

The Bank of England is much more upbeat, with a 3.4% growth forecast this year slowing only slightly (to 2.9% and 2.8%) in 2015 and 2016. Though it would be nice if that 2.9% was a tenth of a percentage point higher, nobody would complain too much if its prediction proves correct.

For some, however, the flash in the pan argument is a powerful one. Even the Bank of England governor says the economy is unbalanced and over-reliant on consumers whose incomes are squeezed. The balance of payments, though improving, is in a sorry state and productivity is becalmed at pre-crisis levels. So what hope is there for a sustained recovery?

For reassurance I turned to a perhaps surprising source. Capital Economics, the consultancy founded by Roger Bootle, is not known for an excessively sunny disposition. But its latest economics focus report seeks to answer the question: “Is the recovery sustainable?”

The answer it comes up with is a positive one. “Providing that interest rates rise only gradually over the years ahead, the UK economy looks set for a prolonged period of strong growth which mends rather than exacerbates its existing imbalances,” it says.

Capital points out, as I have here, that the recovery so far has often been unfairly labelled. The contribution of consumer spending over the past year or so, for example, has been low by historic standards and smaller than its share of the economy. Now investment has started to increase it is punching above it weight in the recovery.

Capital also notes that the recovery is broad-based by sector. Of the 20 main sectors of the economy, 16 are growing significantly, a similar proportion to the long upturn in the 1990s and 2000s.

How about those imbalances? Though they do not expect a return to the pre-crisis norm for average earnings growth of 4% to 5%, Capital’s economists see a gradual strengthening of real income growth alongside a recovery in productivity. They think the business investment upturn, now it has begun, is likely to continue.

Revised first quarter GDP figures, released on Friday, confirm the "better balanced" story. Business investment rose by 5% in the quarter, for an increase of more than 10% on a year earlier. Investment is much smaller as a proportion of GDP than consumer spending but over the past year it has made as big a contribution to growth.

Capital also believes that, while export performance has disappointed so far, it is likely to pick up. British exporters are diversifying, they say, and world trade weighted by Britain’s export markets should pick up “significantly” over the next couple of years.

What could derail the recovery? The Bank of England, with last week’s move to limit high (4.5-plus) loan-to-income mortgages, has taken modest action to head off what it sees as the main internal danger; housing boom turning to bust.

The biggest risk – and the biggest potential – comes from outside Britain. Whether or not exports grow is one big way in which the world economy affects Britain’s economy but it is far from the only one.

A research paper in the latest Bank of England quarterly bulletin - How have world shocks affected the UK economy? – concludes that Britain has been malignly affected by global influences in recent years.

In the long upturn that preceded the global financial crisis the world economy provided a leg-up to Britain. Not only did the China effect push down prices, lifting real incomes, but there were big growth benefits through trade, confidence and international capital flows. Policymakers in Britain took a lot of credit for riding helpful global waves.

Since then, according to the Bank’s research, global influences have worked the other way. Two-thirds of the weakness in Britain’s economy since 2007 can be attributed to them, both in the 2008-9 recession and the slow upturn in 2011-12. Part of that negative influence comes through trade but it is mainly via what the Bank describes as the financial and uncertainty channels.

Those who blame Britain’s austerity for the disappointing recovery usually fail to allow for these global factors. At most, home-grown austerity has been responsible for part – and probably not a large part – of a third of the economy’s weakness, in other words not much at all.

That is why, according to Capital, the economy can grow through the austerity that is yet to come. But it is also why, ultimately, the question of whether the recovery is sustainable will not be decided in the Treasury or Threadneedle Street.

Britain’s economy, as always, is buffeted by international events. If you were looking for trouble you might look in Iraq and the wider Middle East, or America’s weather-affected first-quarter slump (followed by a decent second-quarter bounce).

If you were looking for reassurance, it could be in the fact that international forecasters like the Organisation for Economic Co-operation and Development expect the global recovery to strengthen. What we should not do is ignore what is happening beyond these shores. As far as the economy is concerned, Britain is not an island.