TUMBLING unemployment, a sharp IMF forecast upgrade for the UK, a buoyant CBI survey on manufacturing and a notable improvement in the public finances: after this slew of truly positive news, what could upset this applecart of goodies? What are the threats to the recovery story and the possible nasty surprises that lurk in all this data?
A notable knock-on effect of the recovery has been the sharp improvement in the public finances, with government tax revenues up by 3 per cent year-on-year in December, an upsurge in housing-related stamp duty revenues to the fore. Over the first nine months of the financial year the underlying public sector net borrowing requirement is down almost 5 per cent on the previous corresponding period. This should bring the total for the financial year down to £109.4 billion, well down on the forecasts made back in April.
The strength of the recovery in jobs has surprised almost everyone. The sharp fall in unemployment to 7.1 per cent – and to just 6.4 per cent in Scotland, the lowest since 2009 – has caught out both the Office for Budget Responsibility and the Bank of England’s “forward guidance”. This sought to reassure markets that there would be no change in interest rates until unemployment fell to 7 per cent – an event not envisaged until 2015-16. Now Bank governor Mark Carney has had to put out a statement to calm market concerns over a rise in interest rates.
However, my concerns about potential threats to this recovery are less to do with interest rates (Carney notwithstanding, I believe they will start to rise before the end of the year) than with two intractable problems: the continuing no-show in business investment, and a burgeoning trade deficit with little sign of an export recovery. With the deficit on current account now at 5.1 per cent of GDP, close to a peacetime record, it heightens concerns about the “wrong sort” of recovery and has the capacity to knock sterling.
Some argue that this is a false and misleading recovery, heavily dependent on house price inflation and consumer spending. Keynesians in particular argue that it has come without that textbook increase in public infrastructure spending and a resort to deficit finance.
But the recovery now evident could be said to be a product of Keynesian finance – indeed, uber-Keynesianism. Though well down on crisis levels, we are still running a huge budget deficit, close to 7 per cent of GDP in 2013 (more than double the Maastricht Treaty ceiling). And public sector net debt is heading over £1.2 trillion. Combined with quantitative easing there has been massive official stimulus, any more of which would have impacted on our credit rating.
Now, at last, we are seeing an upswing; led, it is true, by domestic consumer spending despite the pressure on household incomes. There is room for argument as to whether the growth in average incomes has now caught up with or is overtaking inflation. But there is broad agreement on this: that it will take some time yet before households experience a significant upturn in their fortunes and that a return of the “feelgood factor” can be hailed with confidence.
And this I believe is one of the key factors behind the continuing sluggishness in business investment. Despite all the good news, there have been notable company profit warnings and earnings downgrades, particularly in the consumer sector: companies from Morrisons to Unilever at the forefront. Those impressive-looking higher turnover figures have been achieved at the cost of margins, with price discounting markedly in evidence over the peak Christmas period.
Many corporates last year were slow to be convinced that the recovery was strong enough or sustainable enough to justify heavy investment spending. And it is notable in the reports from the World Economic Forum at Davos last week that this reticence is shared internationally. It has also led to soul-searching about the growth in income inequality.
Here QE has been a mixed blessing. It has boosted the value of assets such as shares and property held by the affluent. But for millions of households without such assets it has done little. They have borne the brunt – evident in the continuing growth of discount retailers.
So the rise in numbers in work, encouraging though this is, has not been accompanied by a feeling of being better off, but instead has fed a concern about low wages and falling living standards. An economy driven by consumer spending cannot sustain a recovery on this basis. Even the Conservative Chancellor George Osborne now champions a rise in the minimum wage. But the adverse macro-economic impact of income inequality is going to require more bold and radical action than this.
Further proof of the danger we face can be seen in the trade figures. While most countries have narrowed deficits over the past five years, the UK is one of the few that have widened theirs. As HSBC economists note, the UK was expected to rebalance following the big sterling depreciation in 2008, but this failed to happen.
Large deficits, they point out, tend to adjust eventually, through some combination of slower growth and currency depreciation. But adjustments tend to be more disruptive if the deficit was fuelled by consumption rather than investment and if they are accompanied by large fiscal deficits. “Unfortunately, the UK ticks both these boxes.” We are not yet on the sunny uplands. «