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29 Aug 2014

Enjoy the UK recovery while it lasts

Stephen King

by Stephen King

HSBC Group Chief Economist

Enjoy the UK recovery while it lasts

The UK recovery would be more encouraging if there was clear evidence of a sustained pickup in productivity

There’s been much excitement about Britain’s return to the top of the international growth league. Its economy was 3.2 per cent bigger in the second quarter of 2014 than it had been a year earlier. Over the same period, Germany was up 1.3 per cent, France a measly 0.1 per cent and Italy down 0.3 per cent. Even the supposedly dynamic US economy was unable to keep up with the UK, posting a 2.4 per cent gain. Japan was totally stagnant.

From Britain’s point of view, this all sounds rather wonderful. An economy that had been on the ropes for many years is coming out fighting, stronger than all the other leading industrialised nations but not, it should be noted, the strongest in Europe: both Latvia and Hungary are doing better.

Many a sin, however, can be disguised through the misleading use of statistics. Yes, Britain is doing better than it was. Yes, it is growing more quickly than some of its key competitors. Yet the UK economy today is only a tiny bit bigger than it was in 2008, just before it was engulfed in its bespoke version of the global financial crisis. The American and German economies, in contrast, are now much larger than they were then. Even if the present league position is encouraging, people up and down the country will be wondering why their wage packets are still shrinking, at least when allowance is made for inflation.

Perhaps, in time, these problems will go away – after all, continued economic expansion at current rates would make most people better off – but growing this quickly when other countries are struggling to expand will be no easy task. The problem is peculiarly British. It’s called the balance of payments. It’s not impossible for a country to grow more quickly than others without eventually sucking in imports at a ferocious rate.

Rapid productivity growth – more outputs from given inputs, the alchemy of economic progress – will do the trick. Countries lucky enough to experience rapid productivity gains may not only be able to raise living standards at home but also, via strong, technology-led export gains, living standards abroad. In the 1960s and 1970s, both Japan and Germany pulled off this trick. More recently, China has managed much the same. In all three cases, rapid gains in living standards were associated more often than not with balance of payments surpluses.

Even if the present league position is encouraging, people up and down the country will be wondering why their wage packets are still shrinking

Post-war Britain has not been quite so lucky. All too often its position at the top of the growth league has been fleeting, not so much because the economy eventually has drowned in a sea of inflation but, instead, because rapid expansion has been associated with an equally rapid deterioration in the UK’s balance of payments position. We may be approaching one of those unfortunate moments now. The recovery so far has been associated with a hopeless productivity performance, while the deficit on the balance of payments is already running at a disturbingly large GBP20 billion per quarter, or thereabouts. Relative to the size of the British economy, it’s not far off the biggest on record.

Some argue that none of this needs matter. Ben Broadbent, deputy governor of the Bank of England, suggested in a speech at Chatham House last month that the balance of payments deficit didn’t pose any kind of “independent, existential threat to UK growth”. His view is based on the observation that the payments we have to make to our foreign creditors typically are lower than the receipts we receive on our own investments overseas. Put another way, the UK is acting like a giant version of a successful hedge fund: it raises funds cheaply from its creditors and re-invests some of that money in much higher returning assets elsewhere. The remainder can be spent on imports. On this basis, apparently we can live beyond our means forever.

It’s hardly a novel argument. Many American economists made similar claims about their economy before the onset of the sub-prime crisis. Yet the argument has its flaws. If growth elsewhere in the world is persistently lower than in Britain, it’s difficult to believe that those foreign assets will continue to deliver superior returns. It’s equally difficult to believe that foreign creditors will continue to pour their money into the UK if we are unable ultimately to turn that money into productive investments that will lead to higher exports. Without the support of foreign creditors, we simply won’t be able to support our addiction to cheap imports.

At this point, it’s worth thinking about Britain’s export performance compared with its nearest competitors. It doesn’t make for happy reading. Despite a huge fall in sterling in 2008, British exports have struggled to make headway. One oft-quoted explanation is our dependence on exports to the eurozone. That, however, hardly explains why our export performance has been so miserable. Germany and France have done better, even though they, too, are intimately tied to the eurozone. And as for our ambitions in the emerging world, they have hardly been met: since the beginning of the 1990s, our exports to the most dynamic parts of the world have made a lot less headway than those of our leading European competitors.

The UK’s recovery would be a lot more encouraging if, first, there was clear evidence of a sustained pickup in productivity and, second, if our exports were even close to matching those of our peers. In reality, we are neither productive nor, it seems, particularly export-focused.

Enjoy the recovery while it lasts. There’s a good chance that, like previous periods of economic outperformance, eventually we’ll find ourselves succumbing to a balance of payments crisis. It’s one British tradition that we seem unable to shake off.

The article originally appeared in The Times on 27 August 2014.
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