Drop in the Baltic Dry signals trouble

All the economic indices are showing that there’s going to be a slowdown.

So, at long last, we have had a positive surprise on the economy after many months of negative surprises. With the first estimate of GDP for the second quarter of 2010 coming in at a weighty 1.1 per cent, the economy did better than people expected rather than worse (which recently seems to have been the mantra from the Office for National Statistics). Output of the service industries increased by 0.9 per cent, production industries increased by 1 per cent, government and other services increased by 0.9 per cent. Meanwhile, construction increased by a whopping 6.6 per cent, compared to a decrease of 1.6 per cent in the previous quarter.

The good news for the British economy is that this growth will start to raise tax revenues, which in turn will help to lower the deficit still further. These numbers are a major vindication of the former chancellor Alistair Darling's strategy of supporting the economy through the crisis. The combination of the big fiscal stimulus, historically low interest rates and unprecedented levels of quantitative easing (£200bn) appears to have been working. It's worth recalling that the Tories opposed stimulus and QE at every turn without offering any alternative.

Speaking to the New Statesman, Darling said the growth figures "expose the fallacy of the coalition government's claim that things were worse than they thought. They've made a political choice to cut more and are taking a real risk with the jobs and the recovery. To argue as [George] Osborne has that these figures justify his stance doesn't stand scrutiny. You can't decide to take a further £40bn out of the economy on the basis of one set of figures. The recovery is still fragile and it would be very easy to derail it. That's a risk that I wouldn't take." Me neither.

As good as it gets

Sadly, these numbers are likely to be as good as it gets for a while, because there looks to be some slowing on its way, especially in light of the tax increases and spending cuts and the weak net trade figures from the first quarter. The National Institute of Economic and Social Research (NIESR) has forecast that, in spite of the very strong growth in the second quarter, the economy will expand by just 1.3 per cent in 2010, implying negative growth in the second half of the year. The institute's forecast is for GDP growth to be 2.2 per cent in 2011 and 2012, well below the overly optimistic forecasts of 2.3 per cent and 2.8 per cent from the newly created Office for Budget Responsibility. The NIESR expects the coalition government's emergency Budget to lower the growth rate by 0.4 per cent in 2011, not least because "economic growth this year has so far been supported by government current and capital expenditure".

There is evidence, too, that the world economy, driven by developments in the United States and China, is starting to slow. Data from the Baltic Dry Index, shown in the chart below, is of particular concern. The index, which measures the shipping costs of dry goods such as iron ore and coal, fell precipitously in 2008, giving an early warning of the trouble to come later that year. Now, it has dropped 60 per cent since May this year. The question is whether this simply points to rising shipping supply or to something deeper.

blanchflower graph

As Melissa Kidd of Lombard Street Research noted on 23 July, there is now evidence of weakening trends in world steel production and car manufacturing that reinforce the picture of slowing import demand. The rapid rise in Chinese steel production increased world demand for iron ore in 2009 and early 2010. Chinese production rose 50 per cent between October 2008 and April 2010, but has fallen back 25 per cent since then. World car production has been weakening since September 2009. Big falls in the Baltic Dry are a worry.

July survey data from Markit and YouGov showed a further deepening in households' pessimism regarding their current and future financial situation. This finding is consistent with the Nationwide Consumer Confidence Index, which fell in June for the second month running. The Markit/YouGov figures showed that public-sector job security and pay expectations hit new record lows. Meanwhile, household spending was broadly unchanged since June, following four months of continuous growth. Almost 47 per cent of UK households said they expected a deterioration in their finances over the next 12 months, compared to just 21 per cent that forecast an improvement. As a result, the Future Finances Index dropped to 36.9 from 38.8 in June, signalling the highest degree of pessimism since March 2009.

The survey highlighted a continued erosion of job security, the latest deterioration the most marked since February 2009, when industrial production was in free fall and headlines were reporting that UK unemployment had hit a 12-year high of almost two million. Commenting on the results, Tim Moore, an economist at Markit, said: "Households' pessimism about their future finances has returned to levels not seen since the economy was in free fall towards the beginning of 2009."

Get ready for the slowdown

Earlier in July, the service sector's Purchasing Managers' Index of business confidence showed that business activity rose at its slowest rate since August 2009. In addition, the Economic Sentiment Index registered its largest monthly fall ever, because of fears over the impact of the government's spending cuts.

It has now fallen three times in the past four months since reaching a three-year peak in February, which suggests a slowdown in the growth performance of the sector heading into the second half of 2010.

Unfortunately, Chancellor Osborne's talking down of the British economy and his misguided Budget have hugely undermined confidence among businesses and consumers. Firms won't invest and consumers won't spend if they think incomes are going to fall and unemployment is about to rise, which is what is going to happen. Any observed weakness in the economy, from now on, should be blamed on No 11 Downing Street. We urgently need to restore confidence in our economy.

David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling