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British economy faces years of pain

Allister Heath
“THE UK is a must to avoid. Its gilts are resting on a bed of nitroglycerine.” So says Pimco’s Bill Gross – and given yesterday’s pathetic 0.1 per cent fourth quarter growth, he is clearly right.

It is good news that we are out of recession at last. But the last year and a half has been grim. Our recession lasted longer than our main competitors: six quarters, against four. The scale of our collapse – we shrunk by 6 per cent – was much greater than in America (down 3.8 per cent) or France (down 3.5 per cent) but not as bad as Germany (down 6.7 per cent) or Japan (down 8.6 per cent). The UK was the only G7 country to stay in recession in the third quarter of last year and lagged the US, Euro area and Japan in the fourth quarter. We got the least bang for our buck when it comes to spending taxpayers’ money, monetary activism and currency depreciation.

Construction output was flat in the fourth quarter while industrial production (thanks entirely to the car scrappage scheme, now defunct) and services grew by just 0.1 per cent. I must add one caveat, however: surveys tend to be more accurate than early versions of the official stats – so GDP could easily be revised up again, just as it was in the third quarter (it has already gone up from -0.4 to -0.2 per cent). But even if the last few months turn out to have been slightly less bad than feared, it won’t reverse our relative underperformance and it won’t affect our bleak outlook.

In the first year after the last three major downturns – 1976, 1982 and 1993 – the UK grew by 2.6 per cent, 2.1 per cent and 2.2 per cent respectively. Don’t count on such buoyancy this time; my bet is on 1-1.5 per cent. This recession was accompanied by unprecedented monetary reflation and an extreme budget deficit. Both of these need to be reversed, starting now. Debt definitely needs to come down: according to McKinsey, total household, corporate and government debt is now 466 per cent of GDP in the UK, similar to Japan’s 471 per cent and much higher than America’s 300 per cent and Germany’s 285 per cent.

Cutting public spending would actually boost growth by making the markets more confident that the UK won’t face a sterling crisis and by reassuring corporate Britain that the public finances are back under control. Once a country’s public debt exceeds 90 per cent of GDP, its growth rate slows by 1 percentage point; we must avoid this. But terminating quantitative easing, while necessary, will send gilt yields – and hence the cost of borrowing across the economy – soaring and will spook the global markets.

Meanwhile, Vat, which has just gone back up to 17.5 per cent, is bound to rise again. Mortgage rates will shoot up with Bank rates; credit will become permanently dearer as a result of the reforms to the banking system. The savings rate will have to rise further as households continue to pay off debt. House prices will slump again.

It gets worse. The 50p rate, high marginal tax rates, the war on the City and crippling red tape mean that the UK is now a deeply uncompetitive nation which penalises work and rewards leisure. Together with our poor infrastructure and weak skills, we are now positively unattractive. Large governments always act as a drag on growth – and public spending will reach 53 per cent of GDP this year.
So it’s going to be bad: at best, years of sluggish growth; at worst, a wholesale sterling, sovereign and inflationary crisis. I wouldn’t want to be the next Chancellor of the Exchequer.

allister.heath@cityam.com