Britain has begun the wrong sort of recovery
Front-loaded austerity puts economy back to where it was five years ago
Why all the excitement about the UK economy? Recent data have, it is true, been modestly encouraging and a rebound is certainly under way. Yet thanks to chancellor’s of the exchequer George Osborne front-loaded austerity the economy is still not back to where it was five years ago. In the first quarter of this year the Office for National Statistics estimated that gross domestic product was 3.9 per cent lower than in the first quarter of 2008 before the financial whirlwind struck. Equally dispiriting is that the UK has once again embarked on the wrong kind of recovery.
After the credit-fuelled boom and bust in property there was a clear need to rebalance the economy away from consumption towards exports and investment. Little rebalancing has happened. Instead consumption is driving the recovery financed in part by reduced household savings. In the first quarter the household savings ratio was at its weakest since early 2009. Giving the rebound a notable push are the government’s Funding for Lending and Help to Buy schemes. That push will be increased when the quixotic second phase of Help to Buy is extended to existing properties.
The logical way to help first-time buyers is to reduce house prices to more affordable levels. Unfortunately that cannot be done without threatening the solvency of a still shaky banking system. So instead we have the prospect of another house price inflation along with continuing trade deficits, underinvestment in industry and a “solution” to an overhang of debt that requires households to take on more debt.
The trouble with this very British property obsession is that it damages the structure of the economy. As house prices rise, the wealth effect encourages homeowners to spend more, which inflates the size of the non-tradeable sector. Workers are sucked out of the tradeable sector as the demand for labour in the non-tradeable sector increases. The difficulty is that innovation and technological growth are lower in that area than in the tradeable sector. So, in effect, housing bubbles encourage deindustrialisation and reduce the growth potential of the economy.
What makes this worse is that the property obsession is rife in the banking sector too. UK banks rely more heavily on property collateral than those elsewhere. So if bankers are not confident about the housing market, they extend less credit to finance an upturn. Since banks require entrepreneurs to back their borrowings with housing collateral the small business sector also needs a rising housing market to prosper and generate jobs.
Rebalancing the economy is made more difficult by the Anglo-Saxon capital market culture. When UK manufacturers are given the benefit of a devaluation they tend to respond to increased export demand by raising prices rather than reaching for market share. This boosts the short-term profits on which executives’ incentive pay is based and cheers up those fund managers who take a narrow, short-term view of corporate performance. But there is a long-term cost.
There is a strong sense of déjà vu in all this. I recall in the recession of the early 1970s a top Treasury official responding to complaints about underinvestment in the UK by asking how else a recovery was going to start if not through increased consumption. That point can be made with equal validity today. The public sector is contracting. The external environment is dismal, with the euro zone struggling and emerging markets slowing down sharply. The manufacturing sector accounts for a mere 11 per cent of GDP, so there are limits to what it could do even if export prospects were rosy. At this stage of the upturn companies are too uncertain about potential demand for their products to increase investment significantly.
It is tempting for the British, at this point, to cast an envious glance at Germany, which has rebounded more strongly from the recession and where exports have been the chief motor of economic growth. Not only is home ownership much lower in Germany but house prices there fell in real terms over the first decade of the new millennium.
Yet the German export obsession is arguably as damaging as the British property obsession. Adam Posen, president of the Petersen Institute for International Economics, rightly pointed out last week that dependence on external demand has deprived German workers of what they have earned, and should be able to save and spend. The export obsession has also distracted policy makers from recapitalising the banks, deregulating the service sector and incentivising the reallocation of capital from old industries.
The Brits like their houses, the Germans their exports. To each his poison.
The writer is an FT columnist
– Copyright The Financial Times Limited 2013