This isn’t the recovery we expected but we shouldn’t write it off entirely

GIVEN that we are celebrating a royal birth, it seems appropriate to say “Happy birthday!” to the UK’s economic recovery, which is four years old this quarter. To celebrate, the Office for National Statistics has presented us with one of the better GDP figures we have had in recent times. The output of the UK economy is estimated to have grown by 0.6 per cent in the three months May to June. All the main sectors of the economy contributed to growth in the past quarter – manufacturing, services and construction.

But to paraphrase Mr Spock of Star Trek: “It’s a recovery, Jim, but not as we know it”. A number of aspects of the recovery have been disappointing. I would highlight four in particular – one for each year of the recovery’s short life.

First of all, growth has been slow. Even if we take out the depressing impact of North Sea oil and gas, the average annual growth rate over the past four years has been just 1.3 per cent. That compares with growth of 3.3 per cent in the decade before the financial crisis, and a longer-term trend growth rate of around 2.5 per cent. Second, we haven’t seen the much anticipated rebalancing of the economy towards manufacturing. Manufacturing output is still over 10 per cent below its 2008 peak, whereas the services sector has more-or-less recovered all of the ground lost in the recession.

A third area for disappointment is productivity growth. Output per worker has barely increased over the course of the recovery to date. And we are a long way from recouping the drop in productivity during the recession. Finally, this has been a high inflation recovery – despite the fear four years ago that the economy was going to lapse into deflation. Consumer price index inflation has averaged 3.2 per cent since June 2009, requiring many explanatory letters from the former governor of the Bank of England to the chancellor.

But before we write off our fledgling recovery as a total disappointment, there are some positives. The flip side of the disappointing productivity performance of the UK economy is that employment has held up well. Despite worries that unemployment could rise above 3m, as it had done in the 1980s and 1990s, it has stabilised at around 2.5m and is currently falling. A million new private sector jobs have been created in the past two years, even though the public sector has been cutting back.

Second, the lack of rebalancing towards manufacturing does not mean that the UK lacks success in overseas markets. We are one of the biggest exporters of services in the world. Data on services exports takes a while to catch up with reality. But the strong growth in some areas of the services sector – like professional and business services – must surely reflect success in winning new business overseas.

Third, despite the slow progress in reducing the budget deficit, the UK government has maintained the confidence of the bond markets. Our longer-term interest rates remain low, and we have not suffered from the lack of confidence affecting the troubled economies of southern Europe. But that can only be sustained if we stick to the course of public spending restraint and deficit reduction.

Where is this recovery heading? In the short term, I am moderately optimistic. The GDP figures suggest we can achieve 1 per cent growth this year or perhaps a bit better. And 2 per cent growth or more is likely next year, which would be the best growth year for the recovery so far.

But we should not get carried away with this short-term improvement. The UK – along with other western economies – has lost the tailwinds of easy money, cheap imports and confidence, which supported our economy from the 1980s until 2007. And we should not be trying to recreate these conditions artificially. A stronger sustained period of growth will only emerge when our economy has adapted more fully to the “new global economy” in which the Asia-Pacific region, led by China, is the dominant force.

Until then, the “new normal” for the UK will be economic growth of 1.5 to 2 per cent, not the 3 per cent plus we became accustomed to before the financial crisis. It will be the services sector – which employs over 80 per cent of the UK workforce – that will continue to lead this recovery. We should expect the economy to continue to improve and unemployment to come down gradually. But it will be slow progress – though hopefully more sustainable as a result.

Andrew Sentance is senior economic adviser at PwC, and a former member of the Bank of England’s Monetary Policy Committee.

Share

In Other News

April 17, 2014, 1:02pm
April 17, 2014, 1:41am
April 16, 2014, 7:50am