|Economy needs to spend, lend and change to recover
|It is not the triple dip that we should focus on, but that the economy is suffering from a triple whammy of a lack of demand, a lack of lending and a lack of confidence, argues Gerard Lyons, chief economic advisor to Boris Johnson.
Is the UK in a triple dip recession or not? This is likely to be the hot topic of conversation about the economy this week, as first quarter growth - or Gross Domestic Product (GDP) - figures are released on Thursday.
The release of this weekís figures comes against a recent backdrop of disappointing economic news at home and overseas. As a result, the Chancellorís policies have come under renewed scrutiny, with the International Monetary Fundís chief economist last week being the latest to call for a shift in policy thinking.
It is now approaching five years since the financial crisis hit and the UK economy has remained in the doldrums. Whenever it has shown signs of recovery it has lacked momentum, or to use the words of the incoming Bank of England Governor, Mark Carney, it has not reached ďescape velocityĒ. As a result the economy has remained fragile and vulnerable to shocks.
Indeed, last autumn another shock from of the eurozone hit the economy hard and contributed to a 0.3pc fall in UK growth in the final quarter of last year. Hence the added attention to what happens to the growth figures this week. Two successive quarters of declining growth is regarded as a recession. As we have already seen this twice in the recent years, this would be the third time: hence triple dip.
The trouble with GDP figures is that they are not always the best guide at the time of their release as to what is actually happening in the economy. Usually they are only a snapshot, based on partial data, and over time they can sometimes be revised quite substantially.
It also means that the initial figure when released can also sometimes turn out to be very different to market expectations.
The consensus is for a tiny rise in GDP. In my view, the economy is probably not as weak as the GDP figures suggest, but clearly it is not as good as it should be. The UK is still below its pre-recession peak and has been the weakest performer of any major economy during the crisis.
In recent years I have been on the pessimistic side about the UK, but I think the economy is now starting to turn, albeit very slowly.
The trouble is, economic statistics are not telling the same story. Despite low interest rates, bank lending is still weak. Despite the weak pound, exports are not doing that well, even though they have picked up from a low level to economies such as China.
And despite the recession, the jobs data have defied expectations, although even they succumbed to weakness last week. Unemployment rose to 2.56m and youth unemployment remains stubbornly high at just under 1m. Admittedly the numbers in work are high, at 29.7m and new job creation has been strong.
What should we make of this? In my view, it is not the triple dip that we should focus on, but that the economy is suffering from a triple whammy of a lack of demand, a lack of lending and a lack of confidence.
Each is important and all three are inter-linked. What the economy needs for a stronger recovery is to spend, lend and change. There also needs to be more focus on how the UK will prosper in a changing and still growing global economy.
The UK cannot be seen in isolation from the world economy, and the news over the last week is unlikely to have helped confidence. As has become the norm at this time of year, the IMF revised down their growth forecast for the world economy.
Yet despite all this, we need to appreciate that the global economy is still growing at a steady pace, driven by the emerging economies.
Last week financial markets also over-reacted in a negative way to news that the Chinese economy grew only 7.7pc in the first quarter. Quite why this should have shocked the markets, I donít know. Practically every Chinese policymaker has hinted at this pace of growth for some time. But it was enough to hit commodity markets hard - with gold, copper and oil prices all falling sharply. This should allow UK petrol prices to fall, helping spending power here at home.
The legacy of high debt left the Chancellor with a no-win situation in how to get the deficit down. Policy has continued to evolve and now there is both a shock absorber for the economy and a shock amplifier. The trouble is the shock absorber is not really working that well, while the amplifier is making things harder.
Letís take the amplifier. The Government has wanted to get public spending under control. In essence there are three parts to such spending: departmental spending on areas such as health and overseas aid that is protected; annual managed expenditure which includes things such as debt interest and unemployment benefits which is hard to control because it is heavily linked to the economyís performance; and non-protected departmental spending which has become the shock-amplifier.
If the economy disappoints the public finances worsen. This adds to pressure for a further squeeze on spending. It is a pro-cyclical policy, or put another way, it is akin to being in a hole and deciding to dig deeper.
The shock absorber is monetary policy. But there is only so much monetary policy can do. Last week central bankers gathered in Washington expressed fears that low interest rates around the world may encourage bad behaviour again, yet showed few signs of wanting to tighten policy.
The UK is now locked into low interest rates. Five years ago I said that Sir Mervyn King would not raise rates again as Governor. He hasnít. What about Mark Carney? At some stage he needs to get the economy off the drug of low rates, but not just yet.
The economy needs more lending and the Bank of England thinks the best way to achieve this is for banks to recapitalise themselves.
There is little doubt the transmission mechanism of monetary policy is not working. But small and medium sized firms cite sluggish spending, rising business rates and tough lending conditions as to why they are not borrowing. In short, there is credit rationing, and thus I think the Bank of Englandís Funding for Lending Scheme is a good idea and should be expanded.
The economy also needs more demand. There is a strong case for more infrastructure spending.
Some people find it hard to accept that if the aim is to reduce the deficit then how can the Government borrow more to spend, albeit on infrastructure? The ideal situation is that governments should run fiscal surpluses in good times, so that in bad times, like now, they can spend.
Of course, the Chancellor did not have that luxury because of the fiscal mess he inherited. Yet two wrongs do not make a right. Just because it was wrong for previous governments to spend too much in good times, it would be wrong now to not take advantage of low borrowing rates to invest for the long-term. There is a huge difference between current consumption, which can be squeezed, and infrastructure spending which is necessary.
Personal disposable income has been held back by a combination of factors, including sluggish wage growth, the need to repay debt, stubborn inflation and too many tax increases.
Consumption did receive a windfall boost from compensation payments from banks for mis-selling and that will be less this year, but that will be offset by the welcome large increase in personal allowances that should help spending.
Confidence is the key to all of this. The challenge is getting firms and people who have the money available to spend to have the confidence to do so. It would, however, be wrong to think that the economy just needs a recovery in confidence.
Firms will feel more confident about investing if they expect demand to recover strongly, or because they have confidence in the longer-term outlook for the UK economy.
One group that is displaying confidence in the UK is international investors. They continue to pour money into many areas. The most apparent is central London property but the signs are promising in many areas.
Take the London Gateway project, on the north side of the Thames Estuary, which will open this autumn and has the potential to make London a port to rival Rotterdam. DP World has invested £1.5bn, and without any UK tax payer support. The importance of this project for the UK economy should not be under-estimated.
London can lead the UK recovery. It is now just under 22pc of the UK economy. Add in the South East and surrounding regions, which are heavily dependent upon the capital, and its influence is even higher. Empowering London, and other regions across the country, as was outlined by Lord Heseltineís review last October, makes sense.
There is a whole series of huge infrastructure and construction projects already underway across London in areas such as housing, transport and retail.
Rapid population growth will add to these in the future. Londonís population is 8.2m, the UKís 63.2m. Official projections point to these numbers reaching 9.1m and 65.4m by 2020 and still rising.
By 2060 the UKís population is expected to reach 81.5m, although the upper trajectory, which I think is more likely, is 94.8m.
Little wonder therefore that international firms based overseas, who see the growing global economy first hand, and who are confident about the UKís ability to rebound, are investing. It raises the question why more British firms are not investing, or indeed why is the Government not taking advantage of low interest rates to renew the UKís creaking infrastructure?
In the wake of the death of Baroness Thatcher there has been a renewed discussion on the need for supply-side reforms. In recent years the UK seems to have lost its way in this area.
Supply-side measures are hard to explain, but there was an election broadcast from before the 1979 General election that I always thought got the message across well.
It was shot at the old West London stadium, and showed a race where each runner represented a country. Britain was in the lead, and then the management started to place weights around the British runnerís neck.
These weights were labelled with words such as taxes and regulation. They slowed the runner down, so much so he was overtaken by other countries.
The answer, in that broadcast, was to change the management in order to remove the weights from around the British runnerís neck so that he would then be able to go faster, and overtake the field. He did.