Ben Chu: Is the UK economy turning Japanese?


Is there ever going to be a recovery? The question is pertinent because last week the Bank of England downgraded its growth forecasts for the umpteenth time.

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Last year the experts of Threadneedle Street were expecting the economy to grow by 2 per cent in 2012. But now the Bank thinks there will be no expansion in output at all this year. It also said that the economy has been stagnant since the middle of 2010. The Bank did say that moderate growth would return next year. But it has been saying the same thing for five years and it hasn't materialised.

At the Bank's press conference, the Governor, Sir Mervyn King, was asked if the public could be forgiven for concluding that the promised recovery is destined to remain forever out of reach. He dismissed the idea of perpetual stagnation. "There is no historical precedent for an event of this kind leading permanently to the end of economic growth and I don't think it will here either," he said. "We will get back to the same growth rates that we experienced before the crisis, but it will take some time."

But, actually, there is a precedent for unending stagnation: Japan. It experienced a debt-fuelled asset bubble in the 1980s and has experienced weak growth since it burst in the early 1990s. In the two decades before the crash, Japan's growth averaged 3.8 per cent a year. In the two decades since, annual growth has averaged just 0.75 per cent, albeit with some sharp ups and downs.

And as Richard Koo, an economist at Tokyo's Nomura Institute, has noted, there are parallels between the Japanese economy in the years after the bubble burst there and the UK economy since the 2008 financial crisis. In Japan there was a significant expansion of the central bank's balance sheet as it sought to contain the destructive forces of deflation through quantitative easing. But this monetary activism failed to increase the money supply or boost bank lending, as the first chart shows. With private credit so meagre, it is no surprise growth has been so feeble.

Here in Britain, the Bank of England has also been activist, pumping more than £300bn into the economy in its own QE programme. But, this too has failed to translate into a boost in the money supply or an increase in bank lending as the second chart shows. This is one of the reasons the Bank and the Treasury have reached for the unorthodox £80bn "Funding for Lending" scheme in order to force more credit into the real economy.

Other indicators have also moved in parallel. Japanese 10-year yields slid in the years after the crash and have been bouncing around below 2 per cent as investors have squirrelled their money into risk-free government bonds. In the UK, 10-year gilt yields are now at historic lows of 1.5 per cent and showing no signs of rising for the very same reasons.

Koo argues that both Japan in the 1990s and the UK now are in what he terms a "balance sheet recession". This is different from the normal kind of slump brought on by central banks raising interest rates to tackle inflation. A balance sheet recession means individuals and businesses, which accumulated debts in the boom years, find themselves with assets that are worth less than their liabilities. They become fixated on paying down borrowings, despite rock-bottom policy interest rates and unprecedented actions from central banks to encourage the private sector to invest. With everyone desperately saving, growth never takes off. And with growth weak, businesses hold back from investment and consumers do not spend, locking in economic stagnation.

So if we are suffering from the same economic sickness as Japan, as Koo argues, what is the cure? Koo says that Japanese policymakers eased stimulus too early. Their central bank raised interest rates, mistakenly thinking that the worst was over, which hammered confidence. He also argues that the government got fiscal policy wrong, putting up the rate of VAT in 1997 and snuffing out incipient recovery.

Koo says the Japanese government should have borrowed more to counteract the private-sector deleveraging and that its failure to do so was turned into a false economy, resulting in a weaker economy and higher deficits further down the line.

If this analysis is correct, it implies the Bank of England should do still more on the monetary policy front, enacting further QE and also perhaps buying up private-sector bonds as well as gilts. It also implies that George Osborne should scrap his deficit reduction strategy and hold off from fiscal consolidation until the private sector has finished deleveraging.

It is possible to pick holes in the Japan/UK analogy. Some argue that the economies have important structural differences. Critics point out that though British consumers have high levels of debt in historic terms, the same is not true of the UK corporate sector, undermining the idea that business deleveraging is behind the weak UK output. It is also noted that the demographics of our two countries are different. Japan has an older age profile than the UK, which has been posited as an explanation for its population's relentless saving, rather than household deleveraging. Also Japanese domestic savers fund almost all of the Japanese government's borrowings. In the UK, by contrast, foreign capital is needed to soak up a third of the national debt, leaving us more vulnerable to a potential loss of confidence from overseas investors if fiscal policy were looser. Some of these points have force, others less so.

Yet the proof of the pudding is ultimately in the consumption (or, in this case, the lack of it). Koo's economic forecast of high saving and weak growth in the UK has performed better than the optimists' predictions, including the Bank of England. And the longer our economy flatlines the stronger grows the argument that the UK is, after all, turning Japanese.

Diminishing medal returns, but surely it's quality that counts

Pierre De Coubertin, the founder of the modern Olympics, said it was the taking part that really mattered. If he was around today old Pierre would surely be sent for re-education, because the 2012 Games, it seems, are all about winning. Or to be more precise: it is the medals table that matters.

British national pride is swelling like the thighs of Chris Hoy, right, over our lofty position in these international rankings, behind sporting superpowers the US and China. And we are told that, unless public funding for elite sports is protected, our national hoard of precious metal will be diminished when the next Games come round.

But if we're going to adopt this crude view of success, why not go the whole hog and scrutinise those public outlays? According to figures from UK Sport, in the run-up to the 2004 Athens Olympics we spent £70m on our athletes and they brought back 30 medals. In Beijing we spent £235m and Team GB returned with 47 medals. And in London 2012 we've spent £264m and look on course to emerge with around 60 medals.

What this means is that in Athens £1m in public funding delivered 0.42 medals. In Beijing, 0.2 medals. Here in London £1m has acquired roughly the same. In other words, public funding for elite sports seems to be delivering diminishing medal returns.

This is not to argue that funding for our top athletes ought to be scrapped, but to observe that to argue on the basis of an accumulation of metal discs could prove unwise. And a bit weird. Surely in the Olympics, as in most of life, quality is preferable to quantity.

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