So the immediate recovery is secure – we will have confirmation of that with the third-quarter GDP figures on Friday – but the longer-term prospects for the economy remain as clouded as ever.
This is a matter for us in the UK but it is also, more importantly, one for the entire developed world. We all need five years of solid growth both to pay the bills of the last recession and to get us into decent shape before the next recession strikes.
Using the growth phase of the economy to get into decent shape matters. Germany did so, with the result that living standards there are back to their previous peak. We didn’t, with the result that our living standards are still down by more than 5 per cent for all income groups. It is no consolation that the US and France have done no better, nor that Italy and Spain have done much worse.
Saying that we have to use the growth sensibly is one thing; knowing how long and how strong this phase will be is something else. What I think we can do is point to the pluses and the minuses that are becoming evident, and note the things to look for as growth evolves.
Start with the UK position now. What we are seeing is growth led by the service sector. It is strong growth, running at the moment at an annual rate of around 4 per cent. This is not yet showing through in the GDP figures but you can catch a feeling for it in the current activity indicator developed by Goldman Sachs, which gives a more timely feeling for what is happening to the economy. Intuitively it is also more accurate as it does not jump about as much as the official figures. The left-hand graph shows this indicator for the UK and the eurozone, together with the published GDP numbers. As you can see ,it suggests the 4 per cent number for the UK (the gold line) and around 1.1 per cent for the eurozone (the blue line).
The bad or at least baddish news is that our growth is fuelled largely by consumption, itself driven, in part at least, by the revival in the property market. That is not sustainable in the long term. The better news is that this growth is increasing employment, which is now well past its previous peak, rather than wage levels. We have an inflation problem but that is in large measure the result of government policy (the increases in university fees, the “green” levies on public utilities, planning and employment legislation and so on), rather than rising labour costs.
I do not expect growth to stay at 4 per cent, but it would be reasonable to expect it to run above its long-term trend growth rate of around 2.25 per cent for some years. There is a lot of slack to take up, but we don’t know whether we can continue to grow above trend for, say, two years or five. If only two, we are in trouble; if it is five, we will be all right.
The duration of the expansion will depend on the extent to which the various imbalances in our economy, and those of the rest of the world, have been corrected.
As far as we are concerned, a key factor will be the pace at which exports rise. We remain very dependent on Europe for our exports. As you can see in that graph, our own growth performance has been very close to that of the eurozone, with the UK only outpacing Europe materially since the beginning of 2012. Yes, we can grow faster than Europe, but not that much faster.
What will happen in Europe? There is undoubtedly a modest and welcome recovery taking place. Unfortunately it is an uneven one, with growth skewed to the north. One of the reasons for that is the difficulties faced by southern European companies in gaining access to bank funds. You can see one such difficulty in the right-hand graph. German companies typically pay 3.7 per cent on their loans, whereas Italian ones have to pay more than 5 per cent. It is a huge disadvantage, alongside all the others, for Italian industry. From our own point of view, these imbalances within Europe will remain a drag on our exports.
There are other imbalances affecting the world economy in addition to the eurozone one. Some of these were highlighted in a recent presentation by Stephen King, chief economist at HSBC. He described much of the correction of imbalances that has been taking place as “recessionary rebalancing”. For example, Spain was cutting its current account deficit less by increasing exports and more by cutting imports. China has made some progress in reducing its current account surplus, but this has been because growth in exports has fallen as much as imports increased. This form of rebalancing poses more threats than driven by export growth.
I think that warning is well made, and it is certainly true that the present balance of growth in the world is not at all ideal. But then, it never is. It is certainly not ideal for several large countries – including the US, Japan and UK – to be running large fiscal deficits. It is not ideal for Europe’s largest economy, Germany, to be running a huge current account surplus. It is not ideal to have China restricting manufactured imports.
But then the state of the world economy is never ideal. What I think you can say is that the imbalances evident now are no more serious than those in 2003, when the previous global expansion got going, and less serious than in 2006-07 when the boom was allowed to run out of control.
So intuitively, yes, we do get five years of decent growth. But my word, we need it.