Hamish McRae: We can survive a eurozone slowdown, but only if the Chancellor gets radical
Sunday 05 February 2012
Here's a puzzle: can the UK manage to continue its, albeit scruffy, recovery this year if the eurozone slips back into recession? It is a question that the Bank of England's monetary committee will have to contemplate this week as it decides whether to approve the next bout of quantitative easing. But of course it is a much bigger issue, in that to goes to the heart of the long-term strategic issue for Britain as to what extent it should seek to decouple its economy from Europe.
The question was pushed to the forefront last week with some encouraging data on the UK economy, recognised by rising share prices. The purchasing managers' index for the all-important services sector came out stronger than anyone had expected. These PMI indicators are the most important forward-looking sets of data that people look at. They are derived by asking companies whether they expect activity (or prices or whatever) to expand or contract in the months ahead. If more than half the companies expect expansion, the score is above 50; if more than half expect contraction, the score is below. The score for British services is now 56, a clear majority, and the highest level since last spring. The score for manufacturing has also improved and while construction has slipped a little, the overall outlook is quite positive.
You can take the scores for the different bits of the economy over the past few years and relate that to changes in overall output. They are not a perfect lead indicator – no such thing exists – but this new clutch would suggest growth up about 0.7 per cent in the first quarter, which would be equivalent to an annual rate of growth of nearly 3 per cent. You can see the calculation on this, done by Capital Economics, in the main chart. Now, it is true that we have just had a bad quarter, with the official figures showing the economy shrinking, and growth this year as a whole is not likely to be anything like that. But if you listen to the chatter from the various economy-watchers, you hear more and more the possibility of the economy doing better than expected.
The equivalent PMI numbers from Europe have also picked up a bit over the past month, though not by as much: the equivalent indicator is just above 50. Most notably, there is a huge divergence between north and south: Germany and Scandinavia doing pretty well, the Mediterranean countries pretty badly, and France somewhere in between. The geographic element of European economic performance is, if you think about it, quite remarkable. Aside from the north/south element, there is in the Mediterranean an east/centre/west one: the further to the left or right the worse things are, with Greece on one side and Portugal on the other doing worst of all.
If, however, you take the eurozone as a whole and look at what is happening to consumption, the picture has deteriorated in recent weeks. The Royal Bank of Canada's capital markets unit calculates a consumption indicator based on the more timely retail sales and other data, and it reckons that consumption shrank in the final quarter of last year and may well fall further this quarter.
If that were to happen it would mean that consumption in the eurozone had been falling for 18 months, an exceptionally weak performance, and are back to the level of 2005 (see small graph). Even in Germany, despite the decent overall growth and falling unemployment, retail sales are no higher than they were four years ago.
You can have two reactions to this. One is to observe that if it is not a bundle of fun in Britain at the moment, it is probably worse for most people across the Channel. The other is to recognise that exports to the eurozone will be weak for the foreseeable future, maybe very weak. So, if we are to grow much this year, the additional demand will have to come from the home market and from exports to the rest of the world.
On the first, the key will be inflation. What has happened is that people have been spending the money but have not been getting much back in return. The very latest data coming through has not been too bad, but I think we will have to wait until the second half of the year before there will be any rise in living standards, with wages rising as fast as prices.
On the second, the problem is that while the outlook for exports to the US looks positive and the US remains our largest single market, exports to the emerging world are still small in the totality of our overseas interests. They are growing fast and there are lots of little snippets of positive news coming through – expansion of Jaguar Land Rover sales to China, for example – but the base is small, much smaller than for Germany.
So what do we do? Well, there is of course no magic wand but the usual principles of good economic management do apply. The first is to do no harm. That applies at a macro-economic level and gets one into the whole debate about whether the Chancellor should ease up a bit on the deficit-cutting path. I don't think there is much point in adding to the industrial quantities of advice that he is getting, except perhaps to note that the numbers being urged on him by the "do something" brigade are small in relation to the economy as a whole. Where there might be a case for radical fiscal action would be if the eurozone moves from crisis to catastrophe but they are not there yet.
The same principle applies to monetary policy. The case for more QE would be all the greater were there to be a crisis of liquidity in the eurozone banking system – indeed the case for more this week is greatly increased by the squeeze on European banks. Insofar as they have business in Britain, the more they have to pull back, the more our own banks have to step in.
That leads to a final thought. We do not know what will happen in Europe, but the only prudent thing to do is to plan for the worst. And that is the answer to the puzzle at the beginning. We can continue our recovery in the face of a eurozone slowdown, but we might need more radical policies to do so.
Bonus row could herald a rise in entrepreneurs
A footnote on the bonus row. One of the things that has become quite evident in recent weeks is that we are in the early stages of a big social shift on executive pay.
This shift is most evident in banking, but will increasing apply to other industries and there will be several consequences. One will be that basic salaries will tend to rise and bonuses fall. People will no longer be paid something extra just for doing their job. They may get extra payments in the case of insecure jobs, but those in more bureaucratic lines will not. The idea that civil servants should get bonuses will seem quite wrong.
Some performance-related payments will however remain. They will include commissions for salespeople and other activities where performance can be measured precisely. It is the artificial performance targets that will go.
Two other things are likely to happen. One is that fast-growing companies will use share option schemes to lure employees – but there will be much more emphasis on these schemes applying to all or most of them, not the favoured few. Profits from these carry no opprobrium. Look at the way the Facebook millionaires have been celebrated.
And the other is that energetic entrepreneurial people will look to create their own businesses rather than go down the corporate route. Make your fortune by building a business is still a respected way to wealth.
If Western societies get more new businesses out of this social shift that may be no bad thing at all.
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