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18 Nov 2013

Is the recovery built to last?

Stephen King

by Stephen King

HSBC Group Chief Economist

Is the recovery built to last? (Getty Images/Chris Sattlberger)

In Spain the overall decline in output from peak to trough was 7.5 per cent

Instead of a Germanic economy built on manufacturing, our recovery risks resembling Spain’s property boom. In Madrid this week I spoke to many Spanish investors about the state of the UK economy. Some, to use Mark Carney’s phrase earlier in the week, thought of the UK as a “glass half full” economy. Others, ignoring the upbeat views of the Bank of England’s charismatic Governor, could see only a glass half empty.

At first sight this disparity of views is surprising. For all its woes, the UK economy is now considerably outperforming its Spanish rival. In Spain the overall decline in output from peak to trough was a whopping 7.5 per cent. The UK’s performance was, initially, not much better, with output down 7.2 per cent; but while Spanish unemployment may now have peaked, it’s almost four times higher than the UK equivalent. And whereas the UK has posted considerable output gains this year, Spain is only now showing signs of life. Economic activity in the UK is 2.5 per cent below the previous peak: in Spain, activity is still at rock bottom.

The Spanish know, however, that periods of strong growth can all too easily be followed by periods of severe economic setback. Making sure that growth can be sustained, quarter after quarter, year after year, is a much bigger challenge. Spain failed. Will the UK do any better?

Ultimately, this is a question about the quality of growth, not its quantity. One of the telltale signs that Spain’s economy in the years before the financial crisis was not in the best of health was a persistent widening of the current account deficit in its balance of payments. Spain was a country living beyond its means, not so much because its government was borrowing too much — it wasn’t — but, instead, because huge inflows of capital from, among others, German savers, were being squandered in nutty property schemes and excessive wage growth.

For all its woes, the UK economy is now considerably outperforming its Spanish rival

The UK’s balance of payments position is nothing like as bad as Spain’s was before the onset of the financial crisis: the UK deficit averaged 4.3 per cent of GDP in the first half of 2013, compared with a much bigger 10 per cent of GDP in Spain back in 2007. Nevertheless, the UK’s balance of payments position is distinctly odd. The deficit is already large when Britain is supposed to be only at the beginning of its economic recovery.

At the start of the global financial crisis, Britain’s policymakers spoke incessantly about the need for economic “rebalancing”. It was time to say goodbye to housing booms and debt-fuelled consumer recoveries and hello to export and investment-led economic growth. We were going to be more “Germanic”, dependent less on financial froth and more on the nuts and bolts of cutting-edge British manufacturing. As a result, our balance of payments position was set to improve.

Yet it hasn’t. Weakness elsewhere in the world certainly hasn’t helped, but the nature of the British recovery is also playing a role. Households have, once again, started to dip into their savings, fuelling higher consumption without a corresponding increase in wages. The housing market is on the up, encouraging more leverage. If this continues, our current account deficit is in danger of rising rather too quickly, particularly if the eurozone — by far the UK’s most important trading partner — remains mostly comatose. International creditors could then turn tail, sending sterling lower, forcing interest rates higher and leaving the recovery in tatters.

A quality recovery has to be built on three pillars. The first is productivity. Output per hour has been lamentably weak through the financial crisis. As yet, there is little sign of any improvement.

Workers appear to be pricing themselves into lower-paid jobs, a process that helps to reduce unemployment but does nothing of note to raise living standards. Nor does it do much to raise competitiveness: producing less for lower pay is not a model of economic dynamism.

The second pillar is investment. It’s still a remarkable 25 per cent below its 2007 peak. Britain’s larger companies are still refusing to dip into their considerable piles of cash. Continued uncertainty over both the strength of global recovery — understandable in the light of this week’s disappointing growth numbers in the eurozone and Japan — has left companies both in the UK and elsewhere in the world happy to sit on the sidelines. Their inactivity, however, only serves to prevent a fully fledged recovery from materialising.

The third pillar is wage growth. British workers have really suffered in recent years, faced with a combination of remarkably low wage growth and uncomfortably high inflation. Should both productivity and investment now pick up, the case for higher wages would be much stronger, underpinning a more sustainable increase in consumer spending, a reflection of genuine economic gains and not mere financial froth.

If all three pillars could be built, Britain’s balance of payments position would improve and its recovery would become much less dependent on the continued administration of monetary drugs.

Those in Spain who remain ambivalent about the UK’s prospects know only too well that a period of growth built merely on low interest rates, a booming property sector and rising levels of debt is likely to hit a brick wall sooner or later. Let’s hope we can prove them wrong.

This article originally appeared in The Times on 16 November 2013.
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