What would a good economic recovery look like – and is this one?
The employers’ organisation, the CBI, certainly thinks that the economy recovery which started some twelve months is a good one. In a press release put out last month, its Director General, John Cridland, was reported as saying:
“We are starting to see signs of the right kind of growth.
“In our view this is not a debt-fuelled, housing bubble-led recovery - our forecast shows encouraging signs that business investment and net trade are starting to play their part.
“More businesses are feeling inclined to invest in new technology and advertising. We can also expect to see more companies coming to market to raise finance and an uptick in merger and acquisitions activity as animal spirits return.”
A couple of weeks later, the CBI added to the sense of optimism by reporting that its growth indicator had risen at its fastest rate ever in the three months to February.
Is this just the CBI being the CBI? Well, although more measured, the Deputy Governor of the Bank of England, Charles Bean, in a speech last week to northern business leaders, was saying some very similar things. As reported in the FT, Bean said there were “unmistakable signs that a robust recovery is under way”, but warned that business investment must pick up, productivity must improve and net exports must expand for growth to be “both sustained and sustainable”
The Deputy Governor also expressed concerns over the poor performance of service sector exports in particular and the recent increase in the value of the pound which “would not be particularly helpful in terms of facilitating a rebalancing towards net exports”.
So what the Deputy Governor and the Director General want (although more strongly in the case of the latter) is a shift to economic growth that is led by investment and net exports (that is, exports minus imports).
Investment and net export are two of the four components that go to make up the economy as a whole as measured by GDP. The graph below shows the size of each of the components (with net exports split into exports and imports). It also shows the share that each of these sectors contributed to net growth in the last twelve months. As can be seen, household consumption accounts for almost two thirds of total spending in the economy. Over the last year, it accounted for the vast majority of all growth, with net exports (due to a rise in imports) reducing growth rather than adding to it.
Three things are striking here. The first is this. If a recovery is to be sustained, growth in investment and net export alone will not be enough. For one thing, arithmetic alone is against it. Exports and investment together are only half the size of household and government consumption.
But it is not just the arithmetic that is wrong: so too is the politics. Exports and investment in themselves do nothing for living standards today. In the short term, a recovery based on investment and net exports is actually a recipe for growth with continued austerity. Politicians wanting to win an election in 2015 should be aiming for a balanced recovery, in which spending by all sectors of the economy plays a part, including spending by households and spending by government on health, education, transport, defence and so on.
The third thing that is striking is that neither the ‘right kind of growth’ (the CBI) nor ‘sustaining the recovery’ (the Bank) includes any mention of the thing that has dominated the political debate about the economy since 2010, namely, the excessive public sector deficit. This isn’t because the problem has been solved. On numbers consistent with those in the graph, the deficit is still close to £100bn a year, about 6% of GDP, an unthinkable sum before 2008. The Chancellor is certainly going to be talking about it in the Budget speech on Wednesday.
So what’s going on here? In a way, although neither the CBI nor the Bank mention this deficit explicitly, they both place a lot of weight in their arguments on the financial balances – net lending (surplus) or net borrowing (deficit) – of the other sectors of the economy.
An improvement in net exports would represent a reduction in net lending by the rest of the world to the UK economy. The hoped-for rise in investment is (all else equal) would represent a reduction in net lending by the corporate sector. If these two sectors which have been net lenders for more than decade were to reduce their surpluses, and if, too, the household sector were to remain where it is, then the public sector deficit would fall too, of its own accord. So in actual fact, the economists are talking about the public sector deficit after all, but only implicitly.
In assuming – as all leading political parties now do – that the public sector deficit is a problem both above all others and unto itself, politicians are making a terrible mistake. Behind the careful pronouncements of both the CBI and the Bank, lurks a more subtle analysis which can correct it.