When the government published its spending review in 2010, the promise was of an early return to healthy growth. The forecast then was that the UK would grow by about 3.5 per cent over 2011 and the first half of 2012. Since then, the economy has shrunk. The latest estimates from the Office for National Statistics show that the UK economy contracted by 0.7 per cent in the second quarter of 2012 – a third consecutive fall – while the year-on-year drop in GDP of 0.8 per cent was the steepest since the end of 2009.
This continued gloom fits a convenient narrative for analysts on all sides. It vindicates the arguments of those who, like me in these pages a year ago, argued that the government’s misguided macroeconomic policies would choke off recovery. But it also supplies ammunition to those who want yet more spending cuts beyond those already planned. They can continue to point to high deficits – higher than were forecast before the government’s plan was announced – as justification. There may be no economic logic to this position but rhetorically it is a powerful point. Despite the present gloom, we are not doomed to slow growth or indefinite fiscal austerity. There are three overlapping varieties of economic pessimism but there is little evidence to support any of them.
First, there are the “supply-side pessimists”, who think that, even in the short term, the economy isn’t capable of generating much growth. The Office for Budget Responsibility (OBR) claims that although output is about 4 per cent below its peak, we haven’t got much room to grow. It thinks that spare capacity in the economy is only about 2.5 per cent. Looking a little deeper, this is very difficult to believe. The OBR’s estimates imply that firms have no spare capacity at all, given the levels of employment. That is, that everyone in work is pretty much fully occupied. Even the International Monetary Fund finds this implausibly gloomy.
Second, there are the “permanent austerians”, who argue that the deficit is so large and the fiscal forecasts so dismal that we will have to keep on cutting, not just until 2015, as per the original plan, but until 2020, as the Prime Minister has suggested. Yet recent history suggests thata proper recovery would quickly render these forecasts obsolete. In 1993-94, the budget deficit was only slightly lower than it was last year. In sharp contrast to the current administration, the then government adopted the sensible policy of not trying to cut the deficit until recovery was established. The result was strong growth and rapidly falling deficits. In four years, the deficit had been almost eliminated and only three years after that we had the largest surplus in modern times.
Both these arguments are used by those who want to stick with current economic policy despite the dismal results; they argue that changing course wouldn’t make things much better. This is a self-fulfilling prophecy. If we set fiscal and monetary policy on the basis that we are doomed to low growth, that is exactly what we will get. Moreover, as the long-term unemployed drift away from the labour market and new firms find it difficult to start or expand, long-term growth really will be damaged. But the underlying health of the UK economy is much better than the OBR forecasts suggest. Over the past two decades – up to and including the recession – GDP per capita grew faster in the UK than in all our major comparator economies, as the chart below shows.
Nor was this an unsustainable boom. The chart shows GDP per capita, so the growth wasn’t driven by immigration pushing up the population and GDP without raising overall prosperity. There is no obvious bubble in 2006 and 2007 but consistent good performance throughout the period. While a small part of that reflects the growth of the financial sector, some (but not all) of it illusory, the vast majority was because of improvements in the UK labour market, a more skilled workforce and a more competitive economy. None of those has gone away. In the short term, “growth pessimism” is self-fulfilling; sensible macroeconomic policy, both here and in the eurozone, could make things much better quite quickly.
How the UK economy has grown
GDP per capita (1995=100)
Long-term government borrowing is as cheap as it has been in living memory. We have unemployed workers and plenty of spare capacity. The UK is suffering from creaking infrastructure and a chronic lack of housing supply. So there is ample scope for investment and growth. The third and more substantive argument is made by those who point out that there is a serious question as to the sustainability of present policies in the long term. The OBR’s long-run fiscal sustainability report points to a substantial gap between projected tax revenues and public spending. As the books have to balance in the long run, something must give; policy must change.
Reasons to be cheerful
As a matter of arithmetic, this is correct – but to translate this into “Britain is bust” is absurd. The truth is the opposite. Britain is rich and will get richer. The same OBR report says that income per head in 2060 will be substantially more than double what it is today. As countries grow richer, people want more and better health and education and spend less of their increased income on necessities such as food. That is both inevitable and desirable.
It so happens that the British want good-quality health and education, largely provided free at the point of use by the public sector; decent state pensions and social care, and for old people to be able to leave their houses to their children, not to have to sell them; and they don’t want to pay the taxes necessary to fund all this. This combination doesn’t add up and poses a significant political challenge; but that doesn’t make us any poorer, let alone bust. These are the problems of success in a rich, ageing, developed economy. There is plenty to worry about. We are still stuck in the longest period of stagnation in recorded economic history, thanks to damaging and unnecessary policy failures, both here and globally. But things could and should be better, if policymakers would only act. Over the longer term, there are – from a purely economic perspective, at least – reasons to be cheerful.