You hear it a lot. Britain has a recovery that is fragile and unbalanced. It is reliant almost exclusively on consumers spending money they do not have – or running down savings – and the government’s short-term boost to housing.
But it is wrong.
For those who never expected a recovery as long as George Osborne was chancellor, hopping onto its supposedly unbalanced and unsustainble nature has been highly convenient.
But this kind of thinking, oddly enough, is not confined to the government’s critics. Mark Carney, in presenting the Bank of England’s inflation report last month, talked of “a few quarters of above-trend growth driven by household spending”, which he said were “a good start but they aren’t sufficient for sustained momentum”.
Even the chancellor himself caught the bug during his recent stopover in Hong Kong. “I’m the first to say that the recovery is not yet secure and our economy is still too unbalanced.” he said. “We cannot rely on consumers alone for our economic growth, as we did in previous decades.”
There has been, it is true, some blurring of this interpretation since the release of revised fourth quarter gross domestic product (GDP) figures a few days ago. But this was mostly “one swallow doesn’t make a summer”. A quarter of better-balanced growth, in other words, changed nothing.
Let me be clear about one thing. It is possible to have an economic recovery without a rise in consumer spending but that recovery is likely to be very weak.
Consumer spending accounts for nearly two-thirds of gross domestic product, 62%. Expecting all growth to come from the remaining 38% is asking too much.
By the same token, to say that this recovery relies on consumers alone flies in the face of the facts.
Let us look at the evidence. In the year to the final quarter of 2013, GDP rose by 2.7%. Consumer spending rose by a reasonable 2.4% over that period – slower than overall GDP – and its rise was dwarfed by the increase in overall investment, 8.7%, and business investment, which rose by 8.5%.
Consumers played their part in the recovery. Of the 2.7% rise in GDP, 1.5 percentage points came from consumer spending. Their contribution to growth, just over half, was however smaller than their long-run 62% share of GDP.
Investment, meanwhile, accounted for a percentage point of the GDP rise, and there were also contributions from net trade (exports minus imports) and government spending. If there was a glitch it was that net trade only contributed 0.1 points to the 2.7% growth rate. Much of that, however, reflected an unusually bad third quarter of 2013, when for no obvious reason Britain’s trade lurched into much bigger deficit.
The story of a better-balanced recovery is also in the GDP breakdown by sector. All three of the main sectors of the economy grew over the past year; industrial production by 2.3%, services by 2.7% and construction by 4.3%.
What about the argument that, even if consumers are not driving the recov
ery, their spending should not be going up at all given the continued squeeze on real wages? Again, this is wrong.
In the year to the final quarter of last year the official figures for “compensation of employees” contained in the GDP data,showed a rise of 3.9%, faster than any measure of inflation.
Though employees’ compensation includes employer pension contributions they tend to rise in line with wages and salaries. Helped by rising employment, there has been a significant real increase in the amount of money being received by the household sector as a whole, and thus available to spend.
Does not the drop in the saving ratio, from 7.9% of disposable income in early 2012, to 5.4% in the latest reading (for the third quarter of last year), not tell us households are only able to spend because they are eating into savings?
No. The saving ratio fall mainly reflects the fact that some households are now able to borrow whereas previously they were not. Most of this borrowing is in the form of mortgages to finance house purchase, not current spending. The pre-crisis norm, using housing equity for holidays, cars and kitchens, went into reverse in 2008 and is still in reverse now.
That’s enough on the numbers. The pattern of recovery will evolve in coming months and years – very many years – to the point where the upturn we think we have now will look very different.
But I also think the recovery can get better. The investment shoe has dropped but the contribution of exports – net trade – can improve, and should. Sterling has risen but remains competitive.
The bigger picture is that the worries about this recovery being neither balanced nor sustainable are misplaced. No recovery is perfect but this one has been unfairly castigated.
When does the recovery become sustainable enough for a rise in interest rates? Some, such as former monetary policy committee member Andrew Sentance, think it has been for some time.
The MPC has, however, reached a compromise in which it can talk about eventual rate rises – committee member Martin Weale has been most explicit about the prospect of higher rates in about a year’s time, while maintaining the formula that there is no immediate need to act.
David Miles, another MPC member, thinks that when rates do rise, the neutral or equilibrium level of Bank rate will be at or below 3% for some time to come. That may be for his successors. He is due to leave the Bank after a six-year MPC term on May 31 next year, and may do so without ever having voted for a rate hike (the last was in July 2007).
That is all for the future. In the meantime, let us enjoy the recovery. It is healthier than you think.
This piece is cross-posted from EconomicsUK with permission.