Think today about two countries, both in Europe but not in the euro. They should, in theory, be facing very similar circumstances.
But one country, having performed strongly since the worst of the global financial crisis, surprised the markets a few days ago with a 1.4% jump in gross domestic product in the second quarter.
The other, having struggled since the crisis, shocked markets with a 0.7% second quarter GDP fall. In July, one country’s purchasing managers’ index for its manufacturing sector rose from 48.4 to 50.6, while the other’s slumped from 48.4 to 45.4, its lowest for more than three years.
To end the suspense, the first country is Sweden and the second, as you may have guessed, Britain. For Sweden, to quote Abba, it is a case of The Winner Takes It All.
Though Sweden’s latest GDP figures were a surprise, and have resulted in a hurried upward revision of 2012 growth forecasts, they were no flash in the pan.
After slumping 5% in 2009, Sweden’s economy surged 5.8% in 2010 and 4% last year. Britain shrunk a little less in 2009, 4%, but grew only 1.8% in 2010 and 0.8% last year. Leaving aside the vagaries of the data, the maths suggest any growth this year will be difficult. Sweden’s economy is well above pre-crisis levels of GDP, while Britain’s is more than 4% below it.
What is Sweden’s secret? It helps to have had a banking crisis in the past. The Swedish crisis of the early 1990s was used as a template in the wider crisis of 2008-9.
Bust banks were nationalised and assets sold off. Taxpayer funds were injected at considerable cost. The banks were later privatized and, on some measures, at no overall cost to government of the rescue.
The episode did not make Sweden immune to the crisis in 2008-9, as the GDP figures show. But, unlike in Britain, there has been no prolonged banking hangover.
Some Swedish lessons are water under the bridge. In Britain, the Bank of England and Treasury were happy to condone a sharp fall in sterling, around 25%, as the mechanism for rebalancing the economy in favour of exports and manufacturing.
Maybe the policy needs more time to work but you would have to say the evidence so far is discouraging. Britain’s manufacturers are struggling and export success has been balanced by rising imports.
In Sweden, in contrast, the currency has stayed strong but exporters have done well and conrtinue to do so. Ben May, who follows the Swedish economy for Capital Economics, notes that its exports of high-technology capital equipment, which is in demand all over the world, do not appear to need a devaluation boost. Britain has a current accountb deficit of 2%-3% of GDP, while Sweden has a 6%-7% surplus.
The fall in the exchange rate has, of course, had other negative effects on Britain’s economy, pushing up inflation via higher import prices. Officail figures last week showed that real incomes per head in the first quarter dropped to their lowest level since 2005, with high inflation the main culprit.
Some people think consumers are not spending in B ritain because of high levels of household debt. There is, however, no evidence of that. Sweden has similar levels of household debt as a percentage of GDP and income as Britain. It also had a similar pre-crisis rise in house prices.
Yet consumer spending has recovered much more strongly – up 3.6% in 2010 and 2.1% in 2011 – the absence of an inflation squeeze on real incomes being a big factor.
The final factor is fiscal policy. David Cameron used to talk about fixing the roof while the sun was shining. Sweden, having had awful public finances in the 1990s, went into the crisis with healthy ones, a budget surplus of 3.6% of GDP in 2007. Britain, in contrast, had deficits of similar size on comparable figures from the Organisation for Economic Co-operation and Development.
The result of what the OECD describes as “steadfast fiscal discipline in the past” is that Sweden has not needed the tax hikes and spending cuts Labour and the coalition were forced to introduce in Britain. With a budget close to balance, Sweden has room for a fiscal stimulus, if needed.
What can we learn from the Swedish experience? The most fundamental lesson is that, logical though it seemed, devaluation is no short cut to export success.
The route is a longer and more arduous one, having enough firms with the right products that other countries – particularly emerging economies – want. Britain has some – and is the world’s third biggest exporter of services – but not enough.
Second, inflation matters. Falling inflation is the main hope for a sustained recovery in consumer spending, as the growth in real incomes is restored. The Bank lost control of inflation – it would argue because of factors outside its control – and the ecnomy has suffered in consequence. At the very time low inflation was needed, it was not achieved. We have to hope things will be different from now on.
What about fiscal policy? Going into the crisis with a budget deficit was an error. Is trying to fix too quickly the bigger deficit that resulted from the crisis also an error?
The National Institute of Economic and Social Research examines this in its quarterly review. Nitika Bagaria, Dawn Holland and John Van Reenen, sensibly acknowledge that fiscal consolidation – deficit-cutting – “is essential for debt sustainability”.
Research in America by Bradford DeLong and Larry Summers suggests deficit-cutting when the economy is depressed – and monetary policy has little further room to respond by cutting interest rates – is more damaging. So the National Institute authors examine the case for delaying further deficit cuts until after 2014.
The effects, unsurprisingly, are that economy would grow more. What surprised me was that these effects are quite small. So next year the National Institute expects Britain to grow by 1.3% with deficit cuts but only 2% without them. In 2014, the numbers are 2.4% and 2.6% respectively, while in 2015 2.7% and 2.9%. After that, growth is weaker under the “delayed tightening” scenario than under existing plans.
So is it worth delaying? Even the International Monetary Fund has suggested next year’s fiscal tightening might have to be postponed, so it is a reasonable question.
More growth now is the economists’ equivalent of a bird in the hand worth two in the bush. Unemployment would be lower now – ameliorating some corrosive effects of long-term unemployment, particularly for the young – but higher later.
The big question is whether the government could get away with fiscal delay, in the markets and with ratings agencies. If the short-term growth benefits were more striking, ministers would no doubt be more willing to risk it. As it is, I suspect they will stretch “Plan A” as far as they can but stick with it. They must envy the Swedes.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.