Sunday, July 30, 2017
Britain's big challenge is getting out of the slow lane
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.

So it has come to pass that Britain’s economy has experienced its weakest first half for five years, having undergone what the Office for National Statistics describes as a ~notable~ slowdown in growth this year.

Notable, and predictable. Slower growth has been staring us in the face since sterling’s referendum plunge guaranteed a squeeze on household real incomes and a cloud of renewed uncertainty descended on business.

Gross domestic product growth of 0.2% in the first quarter and 0.3% in the second represents a halving of the post-crisis trend, and averages barely a third of what was being achieved in the years leading up the crisis. GDP per head, which showed no growth in the first quarter and 0.1% in the second, is now stagnating.

The economy defied gravity for a while, thanks to the willingness of consumers to borrow and to run down their savings. There are still elements of that unsustainability even in the slower growth that Britain is now experiencing; the economy’s weak growth was bolstered by a rebound in retail sales in the second quarter.

Consumer confidence is falling. The latest closely-watched GfK consumer confidence barometer shows a further fall for this month to -12, taking it back to levels last seen in the immediate aftermath of last year’s referendum. Households are gloomy about the economic outlook. The brightest spot for consumers remains the strength of employment.

Despite this, the appetite for consumer credit remains very strong, according to the latest financial activity barometer from John Gilbert Financial Research, which will worry the Bank of England. This barometer, based on additional questions in the GfK survey, suggests falling savings and increased borrowings have become the norms for British households. The CBI’s distributive trades survey, suggesting warm weather kept sales strong into the first half of this month, also suggested that consumers are not quite dead yet.

But, by definition, something that is unsustainable cannot continue for long. Oxford Economics’ spending power index points to a “very subdued” outlook for consumer spending this year and next. Colin Ellis of Moody’s Investors Service predicts a “prolonged moderation” of consumer spending.

We come back to some basic questions for Britain’s economy. Where will the growth come from? And can we avoid getting stuck in the slow lane?

Before coming on to those, let me deal with a couple of puzzles. The first is the contrast between upbeat surveys of manufacturing and downbeat official data, which showed a 0.5% drop in the second quarter. The CBI’s industrial trends survey said that output in the three months to July grew at its fastest pace since 1995 and that order books, while slightly down, remained robust.

It is a challenge translating survey data into hard numbers. When firms say they are producing more than in the previous three months, in surveys they usually do not say by how much. In numerical terms, the idea that we are currently seeing the strongest output in more than 20 years, admittedly from a smaller manufacturing sector, does not stack up.

The hard evidence we have, from one of the bright spots of British manufacturing, leans towards the official data. Car manufacturing dropped sharply in June, by nearly 14% on a year earlier, and in the first half of the year was down by 2.9% on a year earlier.

The other puzzle is that something that does not normally happen, weaker growth in Britain at a time of stronger global growth, is indeed occurring. The International Monetary Fund, in its latest update, maintained its global upturn forecast of 3.5% growth this year and 3.6% next, despite downgrading both Britain and America. Stronger growth in the EU and in emerging economies has been the compensating factor.

The downgrade for Britain mainly reflected the growth disappointment so far this year. The downgrade for America reflected the fact that the much-trumpeted Trump stimulus - $1 trillion of infrastructure spending and big personal and corporate tax cuts – has not been forthcoming, and may not be.

The strengthening global economy is one of the ways in which Britain can avoid staying in the economic slow lane indefinitely. The record of sterling devaluations in delivering sustained, export-led growth is, it should be said, very poor.

What matters for growth, of course, is the difference between exports and imports. If indeed we are to see subdued growth in consumer spending, which seems highly likely, then that should be associated with a slowdown in the growth of imports.

Exports do not, in other words, have to race away to contribute to economic growth at a time when import growth is subsiding. A bigger contribution to growth from net exports is one of the factors that has been driving the hawks on the Bank of England’s monetary policy committee (MPC) to push for a hike in interest rates, the other factor being that they expect business investment to hold up better than feared.

I don’t expect the hawks, who were three in number last time the MPC voted on rates, to swing the argument for a rate hike this week. One of them has left the committee and weak second quarter growth should have persuaded other MPC members to stay their hands, though it promises to be an interesting meeting. Soon the Treasury’s chief economic adviser Sir Dave Ramsden will be joining the MPC as one of the Bank’s deputy governors, though not in time for this week’s meeting.

The hawks’ argument, that we are seeing a forced rebalancing of the economy thanks to the lower pound and the squeeze on consumers, is perhaps the best hope for the economy.

It is also, however, asking rather a lot. Periods of strong export and investment-led growth are rare in Britain. When the consumer is subdued so, in general, is the economy. A stronger global economy will help keep Britain to keep growing, but that growth may not be very strong. Maybe the best hope, unsustainable though it would be, would be for consumers to continue to binge on credit.

The certainty that business is crying out for, meanwhile, is not there. Even Philip Hammond says he cannot promise transitional arrangements for leaving the EU. Nor can he, for they are not within his gift, though they are plainly now the government’s preference.

When businesses hear the international trade secretary say a trade deal with the EU will be the easiest in history, they do not know whether to laugh or cry. What matters is not just the starting point but future arrangements and how regulatory divergence is managed and policed, as useful research from the Institute for Government points out.

The very public debate in cabinet, on everything from chlorinated chickens to immigration and the desired length of time for transitional arrangements, is also doing nothing for confidence.

So, getting out of and staying out of the slow lane is a challenge, particularly in the current environment. We have examples of economies that get stuck in the slow lane, such as Japan in recent decades. And, as we have seen with Britain’s productivity figures, weakness can become the norm.