Stephen King: UK still short of reaching economic nirvana

Avoiding the odd quarter of contraction is not a real test of economic health
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The Independent Online

"I can now report that Britain is enjoying its longest period of sustained economic growth for more than 200 years ... the longest period of sustained growth since the beginning of the industrial revolution." You can hardly blame the Chancellor for wanting to crow a bit about the UK economy's recent achievements. Of course, given the Office for National Statistics' ongoing difficulties in measuring GDP, this might turn out to be a rather feeble claim: it's difficult to believe, for example, that output could have been measured accurately during the reign of George III. Nevertheless, it's still an impressive statistic, and it got last week's Budget off to a good start.

Is this measure a good test, though, of our prosperity? Or is it no more than a clever soundbite, designed to impress without being particularly impressive? Unfortunately, I don't have the Chancellor's 200 years of data to hand but I do have enough data to suggest that the claim, although true, may not be all it's cracked up to be.

The left-hand chart shows a history of economic "sustainability" since the mid-1950s. I've chosen to measure sustainability in very simple terms, counting up how many successive quarters have gone by in each cycle before there's been an outright decline in activity. In the 1950s and Sixties, there were plenty of reversals. The reversals became less common in the 1980s, and even less frequent in the 1990s and beyond.

So, if our prosperity is dependent on sustainability, this looks like very good news indeed. The Chancellor is absolutely right: the "stop-go" cycles of the past seemingly have come to an end. No more do we have an economy of fits and starts, when you were never quite sure whether the good times were just beginning or whether they were drawing to a close all too soon. The good times seem to be with us all the time, with growth consistently firm, inflation consistently stable and unemployment consistently low.

Now take a look at the right-hand chart. Here, I've shown the average annual growth rate over seven-year periods since the early 1960s, moving along one quarter at a time. I've chosen seven years for an obvious reason - it was seven years ago that this government came to power, so this is a useful way of assessing how Gordon Brown has performed relative to his predecessors. I've also adopted this approach for another reason: it's a good way of smoothing out the ups and downs in economic data that may prove to be no more than a bit of "noise".

What do we find? On this seven-year comparison, the numbers still look good but the 200-year claim looks a bit less impressive. Throughout the Sixties and into the early 1970s, growth was, on average, consistently at or above current rates. The remainder of the 1970s and the early 1980s were decidedly unimpressive: a combination of two oil price shocks, poor industrial relations, high inflation, the aggressive tightening of policy from the Thatcher government at the beginning of the 1980s and, towards the end of this period, the onset of the Latin American debt crisis.

Then came the Lawson boom: heady days for the economy when, for a time, growth was even better than it has been recently and where, again, the government of the day was preening itself on the abolition of the economic cycle. Nigel Lawson, the then Chancellor, was able to boast on Budget Day in 1989 that "we have experienced the longest period of strong and steady growth since the war". The only real difference between this claim and that of the current Chancellor's is the war in question: Second World War or Napoleonic War.

The obvious issue at this stage is whether Gordon Brown's claims prove to have greater longevity than Nigel Lawson's. To be fair to the former Chancellor, growth did genuinely improve during the 1980s and, even after the early-1990s recession, it was still possible to boast that things were a lot better than they had been in the 1970s. It was the magnitude of the boast that proved to be the problem. Returning to the right-hand chart, what really matters now is the current Chancellor's ability to maintain growth at roughly current rates: if he can do that for a few more years, his reputation in history really will be assured; at least benchmarked against the performance of the UK economy over the last 30 years.

In truth, the fact that the UK economy has avoided the odd quarter of contraction here and there is not a real test of lasting economic health. There are a number of reasons why the economy has become a lot less volatile now, and a lot of them have very little to do with sensible macroeconomic management. With agriculture and manufacturing output shrinking as a share of total GDP, the inherent cyclicality of economic performance has declined. With capital flows around the world becoming a lot more liquid, it is much easier to keep growing without bumping into the balance of payments constraints that were so prevalent in the Sixties. With oil becoming a smaller part of the economy, the risks associated with a nasty oil shock should also be smaller.

Put another way, the Sixties experience suggests that volatility in itself need not be a major constraint on economic success. No one wants the economy to be going up and down but minimising the number of quarterly contractions says very little about longer-term economic health. The US is an obvious example: it's been a lot more volatile than the UK in recent years - strong growth followed by a mild recession - but on the most obvious measure of lasting economic health - productivity growth - it's a long way ahead of the UK. Avoiding declines in economic activity is a desirable consequence of macroeconomic policy and it is fortuitous that the loosening of fiscal policy that Gordon Brown instigated at the beginning of the new Millennium occurred when the world economy, against Treasury expectations, went into recession.

It seems to me that we're not yet in an economic nirvana, no matter what the Chancellor claimed in the Budget. If the world economy weakens again - and the most recent signs have been rather less encouraging - he no longer has quite the firepower that he once had to offset global weakness with domestic fiscal expansion. If macroeconomic policy needs to be tightened, it's still less than clear that fiscal policy would play its part: there is no established process or rule of thumb that encourages a healthy decision-making relationship between the Bank of England and the Treasury.

And the Chancellor is still vulnerable to supply-side problems. We may have enjoyed macroeconomic stability but productivity performance is still not terribly impressive. Indeed, the Chancellor himself may be contributing to the inefficient use of resources. When Labour came to power, the Budget report amounted to a little more than 100 pages. It's now up to almost 300. A cheap point, perhaps, but it shows that the Treasury finds it hard enough to ensure lasting efficiency in its own backyard - a relatively small challenge compared with the Chancellor's (commendable) ambition to transform the economic performance of the country as a whole.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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