Economics: On the road to recovery in hair-shirts

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The Independent Online
THERE can no longer be much doubt, after last week's figures for manufacturing output, that the great recovery has begun. But is the recession yet over? This is not a clever paradox. It is merely to point out that national output can rebound, but the rise can be too slow to reduce unemployment.

This phenomenon - growth below about 2.25-2.5 per cent a year - is what is called a growth recession in the United States. Indeed, it used to be called a recession here in the years before the first oil price shock of 1973.

Between 1948 and 1973, there were only two years in which national output declined. But there were 12 in which unemployment rose.

Perhaps we should be thankful for small mercies. The stagnation since the beginning of last year - what the Bank of England dubbed bumping along the bottom - appears to have ended. The most telling indicator is the 2.5 per cent real rise in manufacturing output between December and February.

Those who thought that the January rise might be a freak that would be unwound in February were confounded. Not only did February's manufacturing output rise strongly again, but the increase in January was revised upwards. There are plenty of other real signs - not just buoyant business and consumer confidence surveys - that the upturn is at last upon us.

Retail sales volumes have been on a gradually rising trend since the trough in the second quarter of 1991, and this increase is no longer just due to people switching spending to high-street basics such as food and clothing from items such as restaurant meals that are counted only in the wider measure of consumers' spending. As the second graph shows, total real consumers' spending has been edging up since the second quarter of last year.

The sharp growth of the narrow money supply - the M0 measure of notes, coin and bankers' cash at the Bank of England - is probably in part due to the fall in interest rates. There is no longer such a large incentive to put money into interest- bearing deposits. But the growth in M0 is so frisky - up 1.1 per cent in March alone and now way above the Government's 4 per cent ceiling - that it must be telling us something about spending.

The pick-up in house sales will also boost consumers' spending as people furnish and decorate their new homes. The 1 per cent rise in prices reported in March may spark a lot of demand among people who understandably preferred to stay out of the market while prices continued to fall. It will also do something to repair battered consumer confidence. People may be less keen to repay debt if the value of their main asset looks as if it is rising again.

Indeed, both consumer confidence and spending could revive nicely if the fall in unemployment in February is a harbinger of a flattening jobless trend. People repeatedly cite fear for their jobs as one of the reasons for not buying a house or spending more. The recovery in output and the diminishing threat of redundancies will help to establish a virtuous circle.

On the current state of the data, it is almost certain that there will be a rise of at least 0.5 per cent in national output in the first quarter. Even if output then stagnates for the rest of the year, the average level of GDP in 1993 will probably be nearly 1 per cent higher than the average in 1992.

As the third graph shows, the CSO estimates that third-quarter GDP was 0.3 per cent higher than it previously thought and that the whole economy has been gently edging up since the second quarter of last year (although this was entirely due to oil and gas; the onshore economy stagnated through the year).

So the consensus forecast of 1.2 per cent growth this year is not ambitious. My guess, though, is that there will be periods when many people question whether even a sluggish recovery is happening at all.

This is precisely what we have now seen four times in the US: only two months ago, US economists were congratulating themselves over a 4 per cent annualised growth rate in the fourth quarter. They are now worrying about the recovery fizzling out.

For Britain, there are two key factors still depressing the outlook. The first is my time-worn theme about the high debts of both consumers and businesses, and their resulting preference for paying off debt rather than spending. But the other is the truly horrifying state of our principal continental markets.

Last week's numbers from Germany, now our largest export market, showed a 4.2 per cent real fall in retail spending over the year to March. By comparison, the worst year-on-year fall in UK retail spending in this recession was a little more than 2 per cent. Germany's industrial production has fallen 11.2 per cent over the year to February, whereas the total peak-to-trough decline in UK manufacturing was 7.6 per cent.

Confidence in Germany is clearly collapsing, and the Bundesbank is being remarkably insensitive in failing to recognise the gravity of the recession with sharper interest rate cuts. The threatened rise in taxes, combined with the prospect of slower wage growth in the east, is undermining spending power sharply.

Apart from the direct threat of collapsing markets, continental developments could pose a challenge for policymakers. If the Bundesbank panics and slashes German interest rates, the mark (and other ERM currencies) could sag against the pound. Sterling's recent rally could then be merely a foretaste of a run up to DM2.60 or even DM2.70 and above. Such a sharp rise would imperil the competitiveness of our manufacturers. The balance of payments would in time become a problem, forcing a tightening of policy and a slowdown of growth.

There is an alternative threat. If the revival in British home spending is too rapid at a time when our export markets are in decline, there could be a sharp worsening in the balance of payments, a panic in the foreign exchange markets and a sell- off of sterling. If the Government then raised interest rates, the recovery could come to a grinding halt.

Britain's recovery will only be sustainable if it occurs through exporting more and capturing more of our home market from foreign imports. Imports must remain subdued, and exports must grow. In other words, much of the increase in national output will have to go overseas merely to justify our present taste for imports.

There are some policymakers who would court a rise in sterling because of the beneficial effects on import prices and inflation. A rise could, in time, also be attractive to politicians because it raises real incomes and spending in the short run. But it would be a strategic error.

The price of living beyond our means during the Thatcher-Lawson boom of the 1980s is that we must live well within them during the puritanical 1990s. We can have our recovery. More of us can work. We can work harder and longer. But we cannot have sharply higher incomes and spending. The fruits of growth must be sent overseas while we wear hair- shirts at home.

(Graphs omitted)

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