Governor of the Bank of England, Mark Carney
Britain’s economy is in recovery mode. But will this be another false dawn as in 2009-10 or a prolonged upswing that boosts prosperity and improves household and public finances?
Does the expansion merely represent the flickering flames of another property inferno on the back of rampant debt and consumption growth? Or is the consumer-led recovery the inevitable first step in an orderly rebalancing? And how does this square with Mark Carney’s vision for growth led by financial services, outlined by the Bank of England governor last week?
These are the broader questions that will shape Britain’s move from stagnation to growth; they will provide both the consequence of policy decisions and the trigger for action. As they are resolved over the next few years, there is very little consensus as to the most likely scenarios.
For all George Osborne’s protestations that “growth is balanced across all sectors of the economy”, so far the chancellor has seen little rebalancing from services to manufacturing, from London to the regions, from consumption to investment and exports.
There has been a shift in income away from the rich and towards the poor, but this reflects the effect of the great recession and initial tax increases and poorer families are now being hit by deep benefit cuts. There has been no fundamental change in economic structure.
Most worrying is the breakdown of total expenditure. After a 25 per cent depreciation of sterling, Britain’s current account deficit has barely improved, a situation Charlie Bean, Bank of England deputy governor, called “distinctly disappointing”. British exporters have performed far worse than their counterparts in Ireland, Spain and Portugal. Falls in investment have been detracting from economic growth since 2010 with private consumption again becoming the main driver of expansion.
When gross domestic product is analysed by the strength of industrial sectors, a similar story is evident. Construction and production, including manufacturing, remains more than 10 per cent below the 2008 peak, while the service sector surpassed the peak in the third quarter of 2013.
Judging by house prices and incomes, the traditional North/South divide is operating again – recovery is strongest in London and weakest in the most peripheral English regions.
The picture remains business as usual for the UK economy, although households are still saving more than they were and the growth of credit is far below the levels of the 1990s and 2000s. With such a lack of rebalancing, it would be natural for Mr Osborne to shy away from talk of balanced growth and cringe when reminded of his “march of the makers” 2011 Budget speech. But he is having none of it, and praises schemes such as Help to Buy as easing “lack of mortgage availability at higher loan-to-value ratios [which] has itself been one of the biggest factors holding back the supply of new housing”.
The chancellor’s approach is similar to that of Lord King, the former Bank of England governor, who regularly talked of a “paradox of policy” in which it was necessary to stimulate consumption with loose monetary policy in the short term with the hope that rapid initial unbalanced growth would soon give way to higher business investment, more exports and domestic substitutes for imports.
The Bank of England’s task is to ensure the UK can host a large and expanding financial sector in a way that promotes financial stability. Only then can it be both a global good and a national asset . . . [But] we’re not cheerleading for the City
– Mark Carney
The current governor favours a different approach. In his groundbreaking speech last week, Mr Carney moved away from Lord King’s disdain for growth led by financial services and the City of London and instead embraced the idea, within a strong regulatory framework.
“If organised properly, a vibrant financial sector brings substantial benefits,” he said, envisioning a world in 2050 where banking assets grew from four times national income to nine times. “The Bank of England’s task is to ensure that the UK can host a large and expanding financial sector in a way that promotes financial stability. Only then can it be both a global good and a national asset,” he added, while insisting later: “We’re not cheerleading for the City”.
The benign scenario
This is the outcome policy makers expect. As consultancy Capital Economics sums up: “What starts as the ‘wrong’ sort of growth [is] the trigger for a shift into the ‘right’ sort.”
Businesses, reassured by the rise in household spending, finally start to invest their huge cash piles. Companies are also confident enough to borrow money again, and banks are confident enough to lend to the ones with viable prospects. Fresh demand and investment helps to improve productivity after years in the doldrums.
For economists who have been sceptical of the recovery’s sustainability, this is important. “The one world in which everything could be OK is if productivity starts to turn around,” says Andrew Brigden from Fathom, an economic consultancy.
Because productivity is on the rise, unemployment comes down slowly and inflation stays in check. This means the Bank of England is not under pressure to raise interest rates.
As workers become more productive, their employers start to pay them more, and real incomes grow again. This allows households to spend more without cutting the rate at which they are saving. House prices rise gradually, which encourages more housebuilding.
Manufacturing is never going to be a big part of the UK economy, but it does grow in importance as more sectors follow the success of the car industry. The trade deficit improves after the eurozone emerges from recession, helped by growing financial services exports from a strong and stable City of London.
The boom-bust scenario
As animal spirits return, Britain proves once and for all it is addicted to financial services and property speculation. The Help to Buy scheme persuades another generation to borrow to the hilt to buy assets that are already overvalued.
Housebuilding, hamstrung by restrictive planning laws, cannot keep up with demand, and prices continue to rise.
The buoyant property market encourages homeowners to spend more in the shops, even though their wages are still falling. They cut the rate at which they are saving. Banks funnel loans to consumers and housebuyers, not to businesses.
Meanwhile, productivity does not recover as the Bank of England had expected. Instead, companies have to hire more workers to cope with higher demand. Unemployment falls quickly. Inflation picks up. The BoE comes under pressure to raise interest rates, or cancel Help to Buy, or both.
As George Buckley, an economist at Deutsche Bank, points out, up until this point the economy has enjoyed a lot of outside help. “You’ve got rates at a 300-year low, you’ve got QE worth almost 25 per cent of GDP, you have the Funding for Lending Scheme . . . [and] the Help to Buy schemes one and two. All of that is a lot of support, and you think to yourself, is that sustainable? Well, it depends how long they keep those policies in there for.”
The withdrawal of some of this stimulus – or even the threat of withdrawal – pushes up borrowing rates. The most leveraged households cannot cope. Repossessions rise. House prices fall. Sterling tumbles as foreign investors head for the exit.