We are fixing the roof while the sun is shining.
It’s a soundbite that has served George Osborne well down the years and he’s still using it as the rationale for the government’s deficit reduction plan. The chancellor says he is taking advantage of the good times, putting the public finances in the sort of shape that would make the UK more resilient to recession than it was back in 2008.
This proved to be a powerful message during the election campaign because Labour’s lack of economic credibility with voters stemmed from the idea that Gordon Brown spent and borrowed too much, leaving the economy vulnerable when the financial crisis broke.
The reality is that Britain would have suffered a stonking downturn in 2008 whatever the state of the public finances. The sheer size of the City in relation to the rest of the economy meant Britain was going to feel the full effects of the financial meltdown. A more valid criticism of the last Labour government was that at the end of a long upturn that started under the previous Major administration the economy was so unbalanced and heavily reliant on an unsustainable build up of private debt.
It is worth recalling that when Osborne became chancellor five and a half years ago that he had two big objectives. The first was to repair the hole in the public finances, which is still very much a work in progress. The other was to shift the centre of gravity of the economy back towards making things for export. This remains a pipedream.
Hang on a bit, Osborne and his supporters would say – the economy is growing. Britain makes more cars than it ever did, and the plants making them are some of the most productive in the world. Business investment is growing. Exports are bound to take time to pick up given the travails of the eurozone.
All the above is true, but provides only a partial picture. The latest growth figures showed that the economy expanded by 0.5% in the third quarter, but both manufacturing and construction contracted. Net trade – imports growing faster than exports – subtracted a record 1.5 percentage points from growth between July and September.
Despite the welcome pickup in business investment, the main driver of growth has been consumer spending, which has been boosted by low interest rates, the fall in inflation caused by lower oil prices, and a modest acceleration in earnings. The consultancy Capital Economics notes that this is “not the ideal shape for the recovery” and it can say that again. The current recovery looks like all the previous recoveries.
Again, the chancellor would have an answer. Household debt is lower than it was back in 2008 and shows no sign of getting out of control. The Bank of England has been given new powers to monitor the financial system to make sure bubbles don’t appear. The independent Office for Budget Responsibility is forecasting steady non-inflationary growth until the end of the decade. Concerns about the shape of the recovery simply reflect the gloomy disposition of economists and economic commentators.
The history of the past 40 years suggests that the Cassandras of the dismal science have been right to issue their warnings. What have often looked like solid and sustainable periods of growth have, with startling rapidity, turned into raging booms. That was true of the mid-1980s and the mid-2000s when the line from first Nigel Lawson and then Gordon Brown was that everything was under control.
There is, of course, always the chance it will be different this time. It is possible, if not entirely plausible, that a new golden age of manufacturing is about to dawn and that the UK’s current account is about to go into the black after 33 consecutive years in the red. But it would be unwise to bank on it.
Indeed, as a fascinating new paper from the Centre for Business Research in Cambridge shows, it would only require relatively minor deviations from the OBR forecasts for the UK economy to be in serious trouble early in the next decade.
The argument goes as follows. Recent rapid jobs growth will come to an end due to a combination of rising wages, higher interest rates and public sector cuts. Real government spending will be reduced by higher than expected inflation. Businesses will be put off investing due to a lack of effective demand. Trade will continue to be a drag on growth.
All this has three consequences. The first is that growth is lower than the OBR is forecasting, making it impossible for the chancellor to complete his repair job on the public finances. Instead of a small surplus by the end of the parliament, there is a deficit of 2% of GDP.
The second is that there is a growing gap between the UK’s actual level of output and the level that would have been achieved had the pre-recession trend continued. The third is that the only thing that prevents the economy from diving back into recession in 2018 and 2019 is the high level of household borrowing.
As per usual, in other words, there will be a choice between extremely low growth and debt-fuelled growth. In the Lawson boom of the 1980s, the ratio of house prices to disposable income per head peaked at 12; in the Brown boom it peaked at 14. The CBR forecasts it hitting 17 by 2020, a third above where it was before the crisis and double its level in 1996, when house prices troughed at the end of the property crash that followed the Lawson boom.
The paper argues that two alternatives would be reflation at either the global or the domestic level, with governments borrowing for investment. Neither option looks likely since they would require governments to tolerate higher levels of debt and inflation. There has been no real global economic cooperation since 2010 and the prospect of the UK “going it alone” is remote in the extreme.
“There is a dilemma for UK macroeconomic policy,” the CBR paper notes. “Fast-rising household debt is needed to maintain a reasonable rate of growth in consumers’ spending and GDP in a world of government debt reduction and in a context of slow growth in world trade, itself caused by debt-reduction policies especially within the eurozone. The problem is that financial ratios and house prices eventually become stretched well beyond historic experience and probably beyond sustainability.”
No “probably” about it. If the economy pans out in accordance with the CBR forecasts, there will be a colossal housing crash that will rip through the banks and threaten a repeat of 2008. John McDonnell, the shadow chancellor, says he is sick of hearing Osborne say the roof is being fixed while the sun is shining. There is an obvious riposte. Know any other good gags, chancellor?
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