Hamish McRae: The world comes back from holiday to find it can't go on living beyond its means

If US consumers pull back, it will have a knock-on effect on Asia
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The Independent Online

In the world of economics and finance, at least, August has proved a less wicked month than many. There have been surprises, sure: that rise in UK interest rates, for example. But there have been no currency crises or other financial shocks. Further, the world beyond economics appears slightly more encouraging that it did a couple of weeks ago. The latest terrorist attack seems to have been averted and the news from the Middle East is a little less dire.

But people will return from holiday to a world where the economic outlook has shifted perceptibly. Both here in the UK and to some extent in the eurozone, growth has picked up. By contrast the US economy has started to struggle a bit. In a sense, that is welcome news, for it suggests that the rebalancing of growth within the developed world is proceeding in the right direction. That is one of the key issues of the autumn, of which more in a moment. First some thoughts about the new data.

Britain is interesting because there seems to have been a spontaneous burst of growth this spring and summer. The Treasury may well beat its growth target, something most of us thought unlikely. I suspect that the real reason behind the Bank of England's rise in interest rates was not so much the danger of higher inflation (the official line), as the evidence of a rebound in house prices with implications for faster growth in consumer spending.

The most interesting thing about the UK, though, is the growth of the workforce, the extent to which this has been absorbed, and what that tells us about future trends. Officially some 400,000 immigrants from new EU member states have registered to work since enlargement but the total may be double or more that figure. To that must be added the re-entry of older workers. It is the fastest growth in our labour force for 20 years. Yet the number of people in jobs has continued to rise; it is now nearly 29 million. Over the past year the workforce has grown by some 500,000. Unemployment is up by 250,000 and employment by the same amount. Meanwhile the number of people who are economically inactive has continued to fall.

But while the great job machine continues, there are strains. Some are political, the concern about a further influx of workers from Romania and Bulgaria being an obvious example. Others are practical: to what extent has migration increased pressure on house prices? If UK growth depends on having to import additional labour, at some stage that growth becomes hard to sustain.

The big surprise on the Continent has also been a pick-up of growth. The consensus forecast for eurozone growth this year, according to MJ Economics, is 2.3 per cent, up from 1.4 per cent in 2005. This faster growth gives the European Central Bank the chance to increase rates, which it has wanted to do for some time. It moved this month and is widely expected to do so again through the autumn.

But in the US there have been further signs of a slowdown. House prices have started to fall and sales and mortgage applications are down; this seems to be starting to undermine consumption growth, though the evidence is still foggy.

If the US consumer does pull back, that will have knock-on effects on Asia, for China and Japan depend on the US market as their ultimate source of demand. But they too need to rebalance because it is not sustainable for them to carry on lending the US the money to keep buying their goods: the US current account deficit cannot carry on rising for ever.

All this leads to a string of questions for the autumn. No one can answer these yet; they are just issues we need to be aware of - I would list half a dozen, the first three of which flow from the above analysis.

As far as the UK is concerned, the key remains the housing market. The Bank cannot allow another leg to the housing boom, so if the present rises continue and if mortgage borrowing continues to rise swiftly it will have to increase rates further. If that is the key question for the homebuyer, there is a subsidiary question for the taxpayer. Public borrowing continues to run at a higher level than last year (though the very latest figures show an improvement). So the question is what balance Gordon Brown will make between curbing the growth of public spending and increasing taxation and user charges - assuming he is still in the job.

For continental Europe there is really only one question: will growth at something over 2 per cent be sustained? If so, this should be very helpful to public finances in Germany and France, both struggling to get their deficits below 3 per cent. If not, then the long grind continues.

For the US there is also one question: what will the consumer do? Indeed I think that is the most important single question facing the world economy.

As for the other three questions, the most obvious is oil. Its price affects everything, from our household bills upwards. The supply/demand ratio will remain tight through the autumn and so we will remain vulnerable to any disruption in supply. But at the present price level there certainly ought to be increasing substitution: it ought to be high enough to be teaching us to use less of the stuff. The oil companies still seem to think the long-term balance is below $50 a barrel but the longer the price remains higher, the less credible that view seems. Still, a fall in the oil price to that level would give a strong boost to growth and the possibility should not be dismissed.

The next question is what will happen in China. The boom continues but the authorities are trying to contain demand, putting up interest rates last week. China supplies one-third or so of the incremental demand in the global economy, so whether growth races on at 10 per cent plus, or slows, matters hugely. What happens to China's growth is probably the most important single influence on world commodity prices. It should be watched.

And, the final question - where are the surprises? A dollar crash? Some other sort of financial market disruption? Surprises cannot be predicted, so the issue is how well the financial system can cope with them. There is quite a strong global liquidity squeeze taking place, but real interest rates are still low by historic standards. The world's financial institutions look pretty robust but there may be some stress-testing ahead.

So, an interesting autumn looms. Faster growth inevitably leads to higher interest rates. We should welcome the former but beware the latter. A lot of people and institutions all around the world are over-borrowed. Coping with that is the task ahead.

Adam Smith is the real star of the Edinburgh Festival

It is the greatest show on earth, as anyone who goes to the Edinburgh Festival will testify. It depends on how you do the numbers, but the clutch of artistic endeavours - in the main festival, the Fringe, the books, film, jazz and other parts - make it about three times as big as any other arts festival on the planet. If you have never been, go, and you will have an amazing time.

But it is not just an artistic tale; it is also an economic one. It is a triumph of the marketplace. What makes Edinburgh different from, say, Avignon, is that it is not just a top-down conventional arts festival organised by a committee of municipal big-wigs. From the very first time, when several troupes arrived uninvited and created the Fringe, it has been an example of using market signals to create enterprising opportunities, which in turn generate critical mass.

Take the Fringe. There is no quality control, no formal entry barriers, no subsidies from the taxpayer. The central mind is very small but it is hugely innovative in finding new performance spaces, in centralising seat bookings and helping applicants put on a show.

Because of the Fringe, with its million-plus seats on sale, there is a mass audience for the other parts, including the original festival. If you cannot get into the show you want, you go and meet your favourite author who just happens to be at the books festival that morning. Or you listen to some blues. Or you watch the impromptu street displays.

Many of the acts don't register at all, even with the Fringe: they just show up, do it and then they pass the hat.

As an economic enterprise this is a pure example of the market at work. The word gets round that something is good and people flock to see it. Somehow the good is sifted from the dross. The shows themselves are developed with the help of the audiences. Of course, some are beyond redemption but some get radically better and a few, a tiny few, go on to be the global mega-stars. But everyone has a chance. Adam Smith would have been thrilled at his "invisible hand" creating something so utterly special in the streets he knew so well.

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