The dismal experience of the past few years has obscured the UK’s very real economic strengths. Now we need to deal with its weaknesses
Does the return of the UK economy to growth vindicate the government’s economic strategy? To argue that it does, you don’t just have to move the goalposts – you have to claim that you were playing cricket not football all along. When the government announced its fiscal consolidation plan in June 2010, it predicted that, by now, the economy would be about 8% larger, driven by a sharp rise in business investment and an improvement in the current account balance. As a result of this strong, sustained and balanced recovery, the deficit would have been reduced by two-thirds.
In fact, even after today’s figures, GDP has only grown at about half that rate; as a consequence, the deficit is still twice as large as predicted. Meanwhile, business investment has fallen and the current account deficit has worsened. As for wages – well, if things had turned out as planned, average earnings would be almost £2,000 higher.
Now this is by no means all the government’s fault. Growth was derailed by a combination of bad luck and bad macroeconomic policy, not just here but in the eurozone. Spending was cut too quickly; in particular, the very large cuts in public sector investment are now universally recognised as a mistake. Moreover, while policy was supposed to boost confidence, and spur private sector investment to fill the gap, business was understandably reluctant to invest in a climate of uncertainty about demand. Fortunately, the UK’s flexible labour market – the result of three decades of largely successful reforms – has meant that unemployment rose far less than was feared, and has come down much more quickly than many dared hope.
And the government did get one big call right. As the Office for Budget Responsibility has pointed out, deficit reduction stalled in 2012. The government was faced with a choice: when in a hole, should it, as its original fiscal plan suggested, keep digging? To its credit, the answer was no; the timetable for debt and deficit reduction was allowed to stretch.
So why recovery now? As Adam Smith said, “there is a great deal of ruin in a nation”. Poor policy delayed, but didn’t kill, the economy’s capacity to grow. Most of the factors described above have now turned positive: the OBR calculates that we’ve now worked through the negative impact of fiscal consolidation on growth, while the eurozone and global environment is much more benign. Aggressive monetary policy, while slow to work through, has also helped; and has been combined with increasingly aggressive, some would say reckless, action to pump up the housing market.
Looking forward, how much should we worry about the unbalanced nature of the recovery, reliant as it has been so far on consumer spending and the housing market? In the short term, any recovery is welcome at this point, and we are a long way from “bubble” territory. Paradoxically, the underperformance of the recent past means that, in the short term, the potential for rapid expansion exists. Unemployment and underemployment are still very high. If sustained, growing confidence among business and consumers, combined with a strengthening global economy, should yield some recovery in business investment and our trade balance.
Looking forward, the dismal experience of the past few years has obscured the UK’s very real economic strengths: as well as our flexible labour market, we have successful industries ranging from cars to higher education. But equally, none of our underlying problems – a dysfunctional housing market, systematic underinvestment, both public and private, and a failure to provide all of our young people with the skills they need for today’s labour market – have gone away. And over the longer term, we still need to work out how to finance high quality public services for an ageing population. The focus of the economic debate should be on these challenges.
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