Heroin to a heroin addict

2008 has brought a wave of economic gloom but actually lower house prices and lower consumption woul

Newspapers report with alarm the property boom has ended when, in fact, a long period of house price stagnation would be desirable and, with prices as they are, modest falls are probably preferable to further sharp increases.

The trend rate of growth of the economy is probably about 2.5 per cent p.a., or possibly slightly higher depending on what assumption one makes about future rates of immigration.

In the nature of things it follows that periods of rapid growth will be followed by periods of slower growth. This is neither a disaster nor a surprise.

The growth rate I anticipate for this year, of 1.5 to 2 per cent will obviously be a shock to anyone who believed that last year’s figure, expected to be more than 3 per cent, was sustainable. The slower growth rate is similar to what we experienced in 2005 and that hardly felt like an economic catastrophe.

Consumer spending too is likely to grow more slowly in the future. Indeed the rate of saving is so low that it has to. The prospect of slow consumption growth may worry Marks and Spencer but it is less of a worry to economists who can see that high debt-financed consumption today means low consumption in the future.

High and rising house prices impose a burden on future generations in much the same way as government borrowing; they are not a miraculous source of wealth and are plainly not sustainable as a driver of the British economy.

The growth of house prices over the last twelve years, if continued, would inevitably lead to housing becoming unaffordable. And that's neither likely nor desirable. To argue interest rates should be cut to reflate the housing boom and induce people to spend, on the back of rising property prices or to ease debt-financed spending is much like treating a heroin addict with more heroin.

The economy eventually has to be steered back to a position in which consumption is relatively less important and saving is higher. Savings need to be invested. Home investment has risen recently; the capital stock has expanded because, the labour force, boosted by immigration, needs more capital to work with.

But,as Andrew Smithers of Smithers and Co has suggested, many of the incentives businesses provide for managers function much like profit sharing and this is known to depress investment. Thus, unless we find a better way to reward senior management, investment in the UK is likely to remain weaker than in its neighbours.

Fortunately the recent movement of the exchange rate offers more than a ray of hope on the horizon. We have seen a fall in the trade-weighted index of seven per cent since the summer months, largely because UK interest rates are now expected to be much lower than people had then anticipated.

Plenty of people are saying that further falls are likely, although past experience suggests that the best forecast of the exchange rate is its current value.

But even if we give these forecasts the attention they deserve, and assume that there will be no further change, this is a fairly sharp improvement in the country’s competitiveness.

It is bound to lead to higher exports and lower imports reducing, and possibly eventually removing the balance of payments deficit.

Even if we do not become a net exporter of savings, it is likely that the UK economy will become less reliant on foreign savings as a means of financing its investment. This exchange rate change provides a valuable means of moving the economy from consumption-led growth to export-led growth.

The recent wave of pessimism comes after a long period of unjustified belief in the superiority of British economic management and British economic performance.

People have confused a long housing and consumer boom with sustainable drivers of economic growth. Among the illusions shattered by the run on Northern Rock has been the idea that the United Kingdom outperforms its neighbours.

Martin Weale is Director of the National Institute of Economic and Social Research