Hamish McRae: Are we following in the footsteps of Japan and heading for a lost decade?

Economic Life: Household debt has shot up. We must pay the excesses of the last boom - excesses by us as individuals as well as by the Government on our behalf

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The Independent Online

A lost decade? It is a nasty prospect but one that you hear repeated a great deal in recent days on both sides of the Atlantic... the idea that we in the developed world are in some way condemned to a longish period of relative economic failure. It was implicit in the tone of the World Economic Outlook published earlier this week by the IMF and on a domestic level by the suggestions here that UK spare capacity might be much smaller than previously estimated and that our long-term growth prospects might also be lower too. Not good.

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It is serious concern because hanging over the experience of all of us is what happened to Japan after its great credit binge of the 1980s. There are obvious parallels and uncomfortable ones. Japan seemed to run out of policy options, with zero interest rates and a huge fiscal deficit both failing to boost the economy, rather as seems to be happening in much of the developed world now. The lack-lustre response to the latest effort by the Federal Reserve to nudge down long-term interest rates there is pretty ominous and I don't think there are many people in the world who believe that there is any room for indebted countries such as the UK or US to try to borrow yet more.

Indeed, these recent suggestions that the UK might have a £5bn boost from the Government makes the basic point. In an economy of some £1.5 trillion, that is a rounding error. The idea that it could make any difference either way is absurd. There may be a bit of nipping and tucking but Western nations have pretty much run out of policy options.

These concerns, it should be noted, would exist irrespective of the turmoil across the Channel. The rigidities imposed by the existence of the euro do make adjustment harder but the problems of slow growth and debt would exist anyway. The "blame it all on Greece" line makes no sense. So what can be done?

Well, the first point to make is that despite everything there is the prospect of global growth, rapid growth in the case of the emerging world and slower growth for the rest of us, as the first graph, taken from the new WEO shows. The divergence of performance existed before the downturn and will continue after it. The issue is how might developed countries share a little more in the growth that is around.

The second point is private consumption for the developed world, taken as a whole, is still positive, as the next graph shows, though it may well taper off next year. Here in Britain consumption is just about square year on year and it would be positive if we had been a bit better at controlling inflation. Our consumers are spending nearly 5 per cent more in cash terms than they did a year ago. Problem is that prices have gone up by that and more. There is no shortage of a desire to consume, something that does not seem to apply to Japan.

And third, remember that adjustments are being made. Household debt has shot up in both the US and to an astounding extent in the UK, so that both have higher levels now than even Japan. But as you can see from the third graph, families in both countries have started to plug away at cutting debt. There is, of course, a long way to go.

All this says is that the growth phase of this cycle will be characterised by the need to pay off the excesses of the last boom – excesses by us as individuals as well as by the Government on our behalf. What it does not say is that productive capacity has suddenly dipped too. That is a separate debate, though obviously if productive capacity is lower the scope for recovery is lower too, and therefore the slog of getting debts to an acceptable level is correspondingly tougher.

So what is the long-term growth rate that the UK is capable of sustaining? The general perception, and the numbers used by the Treasury, used to be that it was around 2.25 per cent a year. You may recall that Gordon Brown, when chancellor, suggested that it might be higher, something closer to 2.75 per cent, and he was not alone. With hindsight that does look to be wrong, as quite a lot of the capacity that we thought was there does not seem to have been capacity that was real, or at least really needed. Most obviously, our banking capacity could not be sustained and may not have even existed.

So we may have simply miscounted the underlying size of our GDP. We are finding it harder and longer to get back to the previous peak in output because that peak was artificially inflated. If that is right, and I am sure there is something in it, we were never quite as rich as we thought we were. That is the bad news. The good news is that our capacity to grow, albeit from a lower base, may not be so seriously damaged as it first appears – assuming, that is, that we do not damage that capacity by ill-designed policies.

That leads to the comparison with Japan, which failed to grow for the best part of a decade and a half not only because it was carrying a huge load of debt but because it failed to reform its domestic structure. It retained all sorts of restrictive practices, controls over hours in which shops could be open, what type of buildings might be built and so on, and these held back the recovery. The UK by contrast had already swept away many of these in the 1980s reforms – remember how shops were not allowed to open on Sundays? – and though some controls have been reintroduced we retain a reasonably flexible economy.

There are other ways in which the UK and indeed the US remain reasonably flexible relative to Japan. We do not have the strict immigration controls and, combined with higher birth rates, as a result have a rising population.

In terms of income per head that may not be so relevant, but if you have a pile of debt to pay off, it helps to have more people of working age to help do so.

But this also leads to a real debate as to how much more we might do: what might a growth strategy really be?

If you cannot do anything on the fiscal side and not much on the monetary side, what remains? The missing bit is structural policies – policies that improve the underlying productive capacity of the country.

This is not the place to do more than sketch what these might be, but they would include regulations that are unnecessary, road blocks (literally) in infrastructure, inefficient public services and so on.

Do these and we may well find that the growth capacity of the economy might still be above 2 per cent a year – not brilliant, but not a recipe for a lost decade.

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