We are expanding again – but the journey has barely begun

Allister Heath

FOR ONCE, economists managed to predict exactly yesterday’s second quarter GDP growth figures of 0.6 per cent. Such statistics should be treated extremely carefully: they are inevitably revised, sometimes dramatically. Yet it has been clear for months now that activity is thankfully returning, as is confidence, though the UK faces immense structural challenges.

The economy was 1.4 per cent larger at the end of the second quarter than it was 12 months previously, which in today’s unambitious New Normal is something to celebrate. All parts of the economy grew in the second quarter, including construction, which edged up by 0.9 per cent. The crisis has been a catastrophe for the sector: its output had collapsed to its lowest since 2001 in the first quarter of this year so it is great that the decline now appears to be over. The City is also growing again, albeit still weakly: the output of business services and finance increased by 0.5 per cent in the second quarter, following a decrease of 0.1 per cent in the previous quarter. One must hope that this growth will continue even when monetary policy is eventually tightened.

However, one figure in particular worried me: the government sector is still expanding, for all of the belt-tightening that is supposed to be going on. The output of government and other services increased by 0.1 per cent in the second quarter, following an increase of 0.4 per cent in the previous three months. Over the past year, which is always the best time-frame by which to assess these trends, the output of government services increased by 1.6 per cent, slightly more than the 1.5 per cent rise recorded for business and financial services and more than the 1.4 per cent registered for the economy as a whole. In other words, the public sector’s share of output and GDP has gone up, not down, over the past 12 months. That is not what I call rebalancing.

There is a positive take, however: if public spending on government departments other than the NHS and schools is being cut (and I don’t mean total spending, which also includes gilt payments and benefits) then these figures imply that the public sector’s productivity is increasing. If so, that would be excellent news and would confirm that the gross inefficiency and waste in the state sector are even larger than previously understood and that much greater reductions in spending ought to be possible without affecting output. The Cabinet Office is doing a great and little-noticed job at saving taxpayers’ money.

Some are bemoaning the fact that there was no manufacturing versus services rebalancing. But there is good rebalancing – and then there is irrelevant or bad rebalancing. We need to shift over time towards an economy with more savings, less credit fuelled consumption, more production of goods and services, greater amounts of investment (including in construction) and more exports. We also need to shift from public to private, shrinking the state.

Yes, it would be highly desirable for manufacturing output to grow – but there is no reason to favour manufacturing over tradable services, such as business or financial services. It is as valuable to the UK economy to produce more cars as it is to export more architectural services and M&A advice, assuming that the degree of value added is the same. Ideally, we would be getting both. A more intriguing problem with yesterday’s figures was that the fastest growing sector was distribution, hotels and restaurants, which increased its output by four per cent over the past year. It is great that the sector is expanding, and increased efficiency in retail is vital for productivity growth, but it does feel suspiciously like this is once again a case of too many consumers still spending too much. So yes, it’s excellent news that we are growing – but I’m not yet ready to uncork the bubbly.

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