Stephen King: America and Britain: united by debt but divided by economic performance - so far

Click to follow
The Independent Online

First of all, let us think about the similarities. Both countries enjoyed big gains in stock prices in the late 1990s. Both countries saw an investment boom. Both countries experienced large declines in equity prices in 2000 and 2001. Investment then lost its way. And policymakers responded by loosening monetary and fiscal policy. The net result, in both countries, was a housing boom, relatively rapid growth in consumer spending and expanding budget deficits.

Now think about the differences. The UK continued to expand after the stock market bubble burst whereas the US had a recession: that loss of US activity in 2001 may have created more room for a subsequent sustained expansion. The UK, despite all its investment, failed to see any significant improvement in productivity growth, whereas during good and bad times, US productivity growth has continued to expand at a rapid rate.

The UK's fiscal loosening came through as a result of higher public spending, whereas in the US, easier fiscal policy was associated mostly with tax cuts. Capital spending has stagnated in the UK, whereas it is still growing at a healthy rate in the US. The UK's trade with a stagnant continental Europe takes up a far bigger share of its GDP than does America's. Higher interest rates in the UK have led to a progressive slowdown in the housing market which, in turn, has led to softer consumer spending. There isn't even a hint of the same story in the US - at least, not yet.

At first sight, the productivity differences are puzzling. If you ask a Frenchman or a German about economic systems, there will certainly be some disdain expressed about the "Anglo-Saxon model". Yet, on productivity, there appears to be at least two variants of the Anglo-Saxon model: a successful one in the US, a less impressive one in the UK.

This divergence has been an ongoing feature for a number of years. Of the many factors behind it, I suspect differences in fiscal policy may have played an important role, at least recently. In the UK, a lot of additional demand has come from the public sector. Yet the relationship between public spending increases and productivity gains - at least in the near term - is notoriously weak. Moreover, by creating more jobs - as opposed to the higher post-tax profits and wages in the US - the UK's labour market may simply have been too tight to absorb flexibly the new technologies that have boosted US productivity in recent years.

None of this is to say that productivity gains will never come through in the UK. Spending money on education - if effective - should eventually lead to a rise in the quality of human capital and, hence, should eventually lead to better productivity performance, but it's unlikely to be coming through yet.

What about business investment? I suspect the differences in this area are relatively easy to explain. In the UK, there has barely been any recovery at all whereas, in the US, capital spending has put in a sprightly performance. The main difference may prove to be taxes: capital spending in the US has been helped along by a series of tax breaks, including the accelerated depreciation allowances after 11 September and, this year, the Job Creation Act (known in its formative days as the Homeland Investment Act). Other than tax, companies appear to be behaving in similar ways on both sides of the Atlantic: saving rather than spending, paying down debt, plugging holes in their pension funds and giving money back to their shareholders in the form of share buy-backs.

But the biggest difference, at least from a cyclical point of view, probably lies with housing and the consumer. From the Bank of England's point of view, the UK economy has delivered three major surprises over the past 18 months. The first surprise has been the slowdown in housing activity given that short-term interest rates rose only to 4.75 per cent last year, hardly a threatening level by previous standards.

Surprise No 2 has been the consumer's response: house prices are now roughly flat year-on-year, yet consumers have retrenched more rapidly than the Bank had expected. And the third surprise has been that, on the back of all these housing and consumer shenanigans, interest rates are on the verge of falling once again, suggesting that the neutral, or structural, level of interest rates is a lot lower than the Bank of England ever seriously contemplated.

To date, there is no evidence that the same effects are coming through in the US. The housing market continues to boom and, although consumer spending is not as strong as it once was, consumers seem happy to continue spending and borrowing even in the light of slowing real income growth. Although short-term interest rates in the US have risen quite a long way, they clearly have not had the same effect on housing behaviour that we have seen in the UK.

One reason for this lack of response lies with the ways in which Americans fund their house purchases. Unlike the British who, for the most part, are hooked on borrowing at short-term interest rates, Americans borrow at long-term interest rates and these have remained remarkably low over the past year or so.

This, however, is probably not a complete explanation. First, Americans have recently begun to borrow more at the short end: house prices are so high that many cannot afford to buy unless they borrow at lower,more volatile, short-term interest rates. Second, even if rates are low, the housing market can still weaken, as the UK has found to its cost over the past 18 months. What matters is the perceived intention of the central bank: if the Federal Reserve becomes more vocal about its house price worries, homebuyers may think that the Fed will continue to raise rates until house prices come off the boil. As with the UK, this may be sufficient for the housing market to cool even if interest rates, ultimately, never have to rise very far.

What is absolutely clear, however, is that policymakers on both sides of the Atlantic will be watching each other's experiences very closely indeed. Should the US economy reaccelerate, that can only be good news in the short term for UK exporters, providing an external safety net to mitigate any fallout from the domestic housing market. Should the UK economy suffer a prolonged slowdown or, even worse, eventually plunge into recession, that can only be bad news for the US economy. It would suggest that no amount of monetary and fiscal manipulation is enough to deal with the underlying issue of excessive, economy-wide, debt: after all, housing booms very rarely end in anything other than leveraged tears.

Stephen King is managing director of economics at HSBC