FOR once, yesterday’s GDP figures are telling a story consistent with other economic indicators. The economy grew by 0.3 per cent in the first quarter of this year – equivalent to an annual growth rate of 1.2 per cent. That is roughly in line with the average 1.3 per cent growth we have seen since the recovery started in the second half of 2009 – once we strip out the impact of falling North Sea oil production.
But it is not the recovery we expected when it first started. Then, there was an expectation that growth would bounce back to the 2 to 3 per cent rate seen before the financial crisis. There was also a view that the UK would need to rebalance away from services towards manufacturing. On both counts, the reality has been very different.
First of all, we are in a “new normal” economic world, where the underlying growth rate appears to be around half the trend seen before the financial crisis. This is not just affecting the UK. Neither the Eurozone or the US has bounced back to the growth trends we saw before the crisis.
In the 1990s and 2000s, economic growth in the UK and western economies was supported by three powerful tailwinds. We were in a world of easy money, set in train by financial deregulation, globalisation and the willingness of central banks to support growth in a low inflation environment.
The second tailwind was cheap imports – driven by the “China effect”. As China and other low-cost producers integrated into the world economy, falling prices of manufactured goods benefited western consumers, and firms moved activities offshore to make larger profits.
The third factor supporting growth was confidence in the private sector and financial markets that central banks and governments could sustain steady growth with low inflation. This, in turn, encouraged consumers, businesses and financial markets to believe that we were in a new world of stability – providing additional momentum to consumption and investment.
All these three tailwinds have now been undermined by global economic developments. The era of cheap imports has been eroded by the surges of energy and commodity price inflation we have seen since the mid-2000s. Now, western consumers find themselves paying a lot more for energy and manufactured goods – and wage increases in “low-cost” economies like China are adding to these pressures.
Easy money has clearly gone by the board in the aftermath of the financial crisis. And the pressure on banks from regulators to rebuild capital reserves is adding to the pressure to restrain lending. Meanwhile, the confidence that central banks and governments could put the economic show back on the road after big global shocks has been eroded by the experience of the crisis. Consumers, companies and financial markets lack confidence as a result.
So it is not surprising that we are in a low growth and volatile economic environment. And I would expect this to continue through the mid-2010s, while western economies continue to adjust to a post-crisis world affected by the emergence of China, India, Indonesia and other large emerging economies.
In this “brave new world”, the more successful western economies are likely to be those which tap into new sources of growth – strong demand in Asia and other emerging markets, as well as changing patterns of demand driven by technology and new consumer trends. But these growth opportunities are not unique to the manufacturing industry. And the UK is not as well-placed to benefit from a manufacturing resurgence as stronger industrial economies like Germany, the US and Sweden – despite the big fall in the pound since 2007.
What we do have are some very successful service sector activities – which contribute three-quarters of the output of our economy, and more than 80 per cent of employment. Some of these are also very successful export sectors. Business, professional and financial services, the creative industries, education, and tourism driven by our culture and heritage, attract spending from the rest of the world – contributing a healthy trade balance in services. It is not surprising, therefore, that the services sectors are leading the recovery.
Policymakers should support our service industries and recognise the contribution they can make to our future prosperity. Rebalancing the economy should be about creating a business-friendly culture and climate where the most dynamic and innovative businesses in all sectors can succeed – in services as well as manufacturing.
Andrew Sentance is senior economic adviser to PwC, and a former member of the Bank of England’s Monetary Policy Committee.