Economic growth stalls – and slump will carry on until 2013

The recovery is way behind where it should be after such a steep, deep recession and it may be time for 'Plan B'

Economics Editor,Sean O'Grady
Wednesday 27 July 2011 00:00 BST

The UK economy is still smaller than it was when it entered the recession and is unlikely to return to the peak output levels of 2008 before the year 2013, breaking all records in the past century for the length of a slump.

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Yesterday's economic growth figures were in line with expectations, with a rise of 0.2 per cent in the second quarter of 2011. But that is only because our expectations have been so depressed. Even if we factor in the various "special factors" – the royal wedding and so on – the growth rate for the quarter would still be only 0.7 per cent. That is way behind where it should be after a steep, deep recession. It leaves the UK at the bottom of the global growth league – not counting Japan, which has difficulties not of its own making.

This means the Office for Budget Responsibility (OBR) will again have to chop its growth forecast for this year when the Chancellor makes his Autumn Statement. The OBR forecast in June 2010 that this year's growth would be 2.6 per cent; by the time of Mr Osborne's Budget in March this year, the OBR reduced the forecast to 1.7 per cent. The latest consensus among economists is for an expansion of 1.3 per cent; some say it may come in closer to 1 per cent.

More importantly, it is bad news for public finances, for unemployment and for living standards, all of which will be worse than anticipated because of this slowdown. Tax revenues will run lower than hoped, spending on the jobless will rise, and the Chancellor is likely to allow the resulting expansion in borrowing to go ahead. That's because this aspect of higher borrowing can be attributed solely to the slowdown – the cyclical element – and should disappear if the economy returns to robust growth.

Mr Osborne had already pencilled in another £46bn in borrowing over the next few years for this very reason and this will go higher. Yet, provided he presses on with his plan to eliminate the structural deficit – the part that won't go away when the economy grows again – the markets should remain calm and UK borrowing costs will be kept low.

But how low can we go? Talk of another round of "quantitative easing" by the Bank of England has become louder recently. It is unlikely to happen at next week's meeting of the Monetary Policy Committee, but "QE2" could be launched by the year's end.

Time for a Plan B? Yes and no. Allowing borrowing to expand will support the economy – it's what the Chancellor has called "flexibility", and is actually a textbook Keynesian response (the alternative would be to cut and shrink the economy each time in a self-defeating vicious circle, the mistake of British governments in the 1930s). In the jargon, these "automatic stabilisers" should do just that, though they may not be enough. The Bank of England, as Vince Cable and Mr Osborne have made clear, can support the economy through maintaining ultra-low interest rates. At the margins, there may also be some wriggle room in existing plans that can be dressed up as a "Plan for Growth" – a few judicious tax cuts for business, say, or some spending on public infrastructure, moves that would do some good while not tainting the Government's reputation.

Broadly, though, the Chancellor does have a point. Britain is vulnerable to speculative attacks of the kind that hit Greece. It would be ironic if gilts and sterling were mauled because the Government's strategy has undermined growth so badly that investors lose faith in our ability to grow at all. Reports suggest precisely those kind of doubts are already growing in No 10.

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