Sunday, May 15, 2022
The drivers of growth risk going into reverse
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. Not to be reproduced without permission.

The mood has darkened, even as the days are getting longer. The economy is not so much falling off a cliff as entering a kind of deep freeze, which unintentionally rhymes with one of the main causes, the cost-of-living squeeze. Recent surveys showing sharp falls in business and consumer confidence show that the wisdom of crowds works. People and businesses knew instinctively that something was up, and they were right. The pound’s weakness is becoming quite a thing too, so the foreign exchange markets are also on to the story.

At times like this, it is useful to go back to first principles, and what I describe in my book Free Lunch as “the most useful equation in economics”. This tells us that the economy, gross domestic product (GDP), consists of consumer spending, plus investment, plus government spending, and plus exports, though minus imports.

On the face of it, the figures we had a few days ago, for the first quarter of the year, were not that bad. GDP rose by 0.8 per cent on the quarter, which is better than it does in normal times. Over 12 months the economy grew by a hefty 8.7 per cent, reflecting the comparison with a very weak first quarter of last year, when the country was in lockdown. That 8.7 per cent figure means that, while we have undoubtedly seen the best of the year already, it would be statistically very difficult, if not impossible, for the economy to show an annual fall this year, in the sense of 2022’s GDP being lower than in 2021.

I hate using the expression “the devil is in the detail” but on this occasion it really is. One bit of detail which was widely reported is the slowdown in GDP during the quarter, from a rise of 0.7 per cent in January, to no growth at all in February and a fall of 0.1 per cent in March.

When the February figures were published, I was able to offer the reassurance that, without a sharp fall in NHS test and trace activity, there would have been decent growth on the month. No such reassurance is available for March, sad to say. The weakness was genuine and bodes badly for the second quarter, which we are now in the middle of, and which will suffer from the twin effects of the intensification of the cost-of-living squeeze and the extra bank holiday for the Queen’s Platinum jubilee. To remind you, the economy shrank slightly in the second quarter of 2012, when there was an extra bank holiday to mark the diamond jubilee.

Going back to my equation, the March GDP data, in combination with the first quarter figures, tell us something useful about consumer spending, the biggest component of GDP, accounting for just over 60 per cent of it in normal times.

Consumer spending rose by 0.6 per cent in the first quarter, which again was not bad, but even before the intense phase of the cost-of-living crisis was 0.5 per cent lower than in the pre-pandemic period in the final quarter of 2019. There was also, as the monthly figures show, a lot of the weakness as the quarter went on, particularly affecting spending on cars. So-called consumer-facing services are 6.8 per cent down on where they were in February 2020 before the pandemic struck.

Consumers are now under the cosh, thanks to the biggest squeeze on real incomes – after allowing for taxes and inflation – since records began in the mid-1950s. The questions is whether the other elements of GDP can come to the rescue.

I have focused quite a lot recently on business investment, not just because it is necessary to lift productivity but because it has become a focus for Rishi Sunak. A few days ago, the Treasury put out a consultation asking for ideas on the permanent reform of capital allowances. The chancellor has acknowledged that the UK spends significantly less on business investment relative to GDP than competitors. As well as wanting to reform the system because it needs reforming, he is keen to head off the feared slump in investment when corporation tax goes up from 19 to 25 per cent.

Before then it was expected that there would be a boom in business investment as firms took advantage of the 130 per cent corporation tax “super deduction” announced by the chancellor last year, which expires next April. I have to tell you that, even as we move into choppier waters for the economy – with the Bank of England predicting a small contraction in GDP next year and the National Institute of Economic and Social Research saying that we will meet the standard definition of recession this year, with two consecutive quarters of falling GDP – there is no sign yet of that boom.

Business investment fell by 0.5 per cent in the first quarter and is 9.1 per cent below pre-pandemic levels. Over the next few months we will find out whether businesses invest for tax reasons or because of other factors. Some increase may still occur to take advantage of the super-deduction but talk of a mini boom has gone away.

What about government, which came to the rescue during the pandemic, with spending on a scale never seen before? Day-to-day spending is now falling back, as exceptional pandemic spending, such as on NHS test and trace, is reduced. Government spending thus fell by 1.7 per cent in the first quarter, and will be an engine of growth no longer.

The other government element, investment, is still firing on all cylinders, rising by 23.6 per cent in the first three months of the year, reflecting additional outlays on “buildings and other structures”. There is more to go on this, reflecting one of the government’s priorities, as set out in an otherwise lacklustre Queen’s Speech. But you cannot grow an economy on infrastructure alone.

I have left the worst until last, and it is something of a horror story. Export-led growth is the holy grail, the golden ticket, for the economy. But it is not happening. Exports fell by 4.9 per cent in the first quarter and are 19.9 per cent down on pre-pandemic levels. Some of the recent weakness is because of change sin recording procedures. Most of it is genuine. Brexit is, of course, the main factor, along with some others.

Whatever you think of Brexit, and I have made clear over the years what I think of it, we should be able to agree that this was a terrible time to do it, let alone threaten a trade war now, to compound one of the great policy errors of our time.

Import volumes, by contrast, rose by 9.3 per cent in the first quarter and were 2.3 per cent above pre-pandemic levels. They, remember, subtract from growth. The trade deficit in goods and services in the first quarter was £32.5 billion, easily a record.

To sum up, consumers are squeezed, businesses are not yet investing, the government is spending on infrastructure but reining back pandemic outlays. The trade story is not for the fainthearted. Those are the drivers of growth and we are not going anywhere fast.