Hamish McRae: We can survive a eurozone slowdown, but only if the Chancellor gets radical

Economic View

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.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Mortgage Advisor - OTE £95,000

£40000 - £95000 per annum: Recruitment Genius: This is an exciting opportunity...

SThree: Trainee Recruitment Consultant

competitive: SThree: Are you passionate about sales?Do you have a keen interes...

Recruitment Genius: Loan Adviser - OTE £30,000

£17000 - £30000 per annum: Recruitment Genius: This is an exciting opportunity...

Recruitment Genius: Sales Assistant / Buyer

£15000 - £17000 per annum: Recruitment Genius: This company offers a range of ...

Day In a Page

Greece debt crisis: EU 'family' needs to forgive rather than punish an impoverished state

EU 'family' needs to forgive rather than punish an impoverished state

An outbreak of malaria in Greece four years ago helps us understand the crisis, says Robert Fisk
Gaza, a year on from Operation Protective Edge: The traumatised kibbutz on Israel's front line, still recovering from last summer's war with Hamas

Gaza, a year on from Operation Protective Edge

The traumatised kibbutz on Israel's front line, still recovering from last summer's war with Hamas
How to survive electrical storms: What are the chances of being hit by lightning?

Heavy weather

What are the chances of being hit by lightning?
World Bodypainting Festival 2015: Bizarre and brilliant photos celebrate 'the body as art'

World Bodypainting Festival 2015

Bizarre and brilliant photos celebrate 'the body as art'
alt-j: A private jet, a Mercury Prize and Latitude headliners

Don't call us nerds

Craig Mclean meets alt-j - the math-folk act who are flying high
How to find gold: The Californian badlands, digging out crevasses and sifting sludge

How to find gold

Steve Boggan finds himself in the Californian badlands, digging out crevasses and sifting sludge
Singing accents: From Herman's Hermits and David Bowie to Alesha Dixon

Not born in the USA

Lay off Alesha Dixon: songs sound better in US accents, even our national anthem
10 best balsamic vinegars

10 best balsamic vinegars

Drizzle it over salad, enjoy it with ciabatta, marinate vegetables, or use it to add depth to a sauce - this versatile staple is a cook's best friend
Wimbledon 2015: Brief glimpses of the old Venus but Williams sisters' epic wars belong to history

Brief glimpses of the old Venus but Williams sisters' epic wars belong to history

Serena dispatched her elder sister 6-4, 6-3 in eight minutes more than an hour
Greece says 'No': A night of huge celebrations in Athens as voters decisively back Tsipras and his anti-austerity stance in historic referendum

Greece referendum

Greeks say 'No' to austerity and plunge Europe into crisis
Ten years after the 7/7 terror attacks, is Britain an altered state?

7/7 bombings anniversary

Ten years after the terror attacks, is Britain an altered state?
Beautiful evening dresses are some of the loveliest Donatella has created

Versace haute couture review

Beautiful evening dresses are some of the loveliest Donatella has ever created
No hope and no jobs, so Gaza's young risk their lives, climb the fence and run for it

No hope and no jobs in Gaza

So the young risk their lives and run for it
Fashion apps: Retailers roll together shopping and social networking for mobile customers

Fashion apps

Retailers roll together shopping and social networking for mobile customers
The Greek referendum exposes a gaping hole at the heart of the European Union – its distinct lack of any genuine popular legitimacy

Gaping hole at the heart of the European Union

Treatment of Greece has shown up a lack of genuine legitimacy