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This double-dip looks like a trade problem

Britain is importing more and exporting less, and that's where the recession stems from.

Cranes help build the Bishopsgate Tower in London
Cranes help build the Bishopsgate Tower in London, but construction has fallen flat nationwide. Photograph: Getty Images

A lot of people – myself included  – were surprised by the economic contraction announced today. There had been lots of positive noises from the various surveys and data releases since the New Year, and the expectation was for positive (if meagre) growth. Retail spending has increased strongly in the new year, employment has picked up slightly, and the various surveys of businesses all suggested that the economy was growing slightly.

But there was one big problem: trade. It was export growth that propped up the UK economy during 2011 – without exports, the economy would have shrunk by 0.8 per cent over the year. However, UK exports slipped back at the start of 2012, and this may have been enough to tip the economy into recession.

Exports are key to the UK’s economic recovery, because conditions in the domestic economy are so strained. Consumer spending, which underpinned economic growth during the goods years, is being suppressed by falling incomes and stifling household debts. Add in the cuts in public spending, and the banks’ failure to lend money to the real economy, and it’s clear that the domestic economy is unlikely to lead us into recovery. Business investment, another potential route out of the crisis, is being crippled by a lack of confidence and weak demand. The UK economy is caught in a demand trap, and the only easy way out of it is to look overseas.

This export-led approach is at the heart of the government’s economic strategy. The government’s fiscal plan has enabled the Bank of England to keep interest rates low, and pump more money in through quantitative easing. These low interest rates have not been enough to boost consumer spending or investment, but they do have one very helpful side effect – they keep the pound weak, which boosts exports. In principle, this is a decent strategy, but the latest figures suggest it may be unravelling.

The latest ONS trade stats show that the UK’s trade deficit worsened dramatically in January and February, after having improved through 2011. Rather than helping to prop up the economy, trade has started to act as a drag this year, as imports grow and exports shrink. As a result, some of the contraction in the economy came mostly from the production sector, which tends to export more. And perhaps this trade problem shouldn’t come as a surprise, because the pound has been steadily appreciating over recent months. This makes exports more expensive, and imports cheaper – and suggests that the government’s efforts to keep the pound weak are no longer working.

This trade problem may also help to explain how the economy could shrink if retail sales grew. As it turns out, an awful lot of what we buy in the shops is imported, whether its clothes from East Asia or cars from Germany. If the increase in retail spending has helped fuel a rise in imports (or if the imports, such as petrol, have become more expensive), this will not help the economy grow. That isn’t just bad in the short term – it suggests our economy is heading in the wrong direction altogether, and certainly not re-balancing. We will have to hope that this trade problem turns itself around, or it will be even harder to get out of the economic slump.

There is one more point to address: the biggest factor in the GDP contraction was construction. But this should surprise no-one – we already knew that domestic spending was going to be weak, that the government is cutting back investment, and that there are questions over how reliable construction figures are anyway. The problem is that, up until now, these domestic weaknesses have been compensated for by export growth. If that stops being the case, the economy could be in even more trouble, and there will be even more onus on the government to come up with another economic strategy.