Wednesday, 18 May 2011

The economic outlook

The Magna Carta institute at Brunel University run by Justin Fisher held an interesting event on 'The Coalition - one year on' at the British Academy earlier this week. I plan to talk about some of the other presentations later, but here is a summary of what I had to say (my statistics generally come from the National Institute for Economic and Social Research).

The 'privatised Keynesianism' model identified by Colin Crouch in which the economy is driven by consumer debt linked to the housing market is no longer viable in the medium term, if at all. Consumer spending is forecast to fall by 0.6 per cent in 2011 (it still accounts for two-thirds of aggregate demand).

Consumers are being squeezed by inflation at 4.5 per cent with real disposable incomes falling. Indeed, I think that the Bank of England has de facto abandoned the inflation target. That may not be a bad thing, but they won't admit it is what they have done. Given fiscal consolidation, the economy needs a monetary stimulus and inflation also erodes the debt burden.

Real house prices are forecast to fall by 4.5 per cent in 2011, although the London market is still relatively buoyant, especially at the higher end where it is driven by foreign buyers. There is a fear of unemployment, particularly in the public sector. The Government's austerity rhetoric may have dented consumer confidence.

Export led manufacturing growth is forecast to be 6.9 per cent this year and 4.3 per cent in 2012. This is mainly driven by the weakness of the pound. All three political parties support rebalancing the economy and this is one of Nick Clegg's little known strategic objectives. However, much of manufacuturing is now essentially assembly operations and much of the value chain in industry has been wiped out. It should be noted that past government industrial policy interventions have not been conspicuoulsy successful.

The OBR's growth forecast for 2011 is now seen as rather optimistic and many commentators anticipate 1 to 1.5 per cent. It is unlikely that the economy will grow faster than the trend rate of 2.1 per cent until 2013. The higher growth rates recorded recently have little to do with government policy but reflect the fact that they have been hit less hard by the banking crisis (so far, but they are exposed to a Greek default). The German economy also has strength in high quality, high valued added manufacturing.

The output gap is probably larger than we thought whuich means that the sustainable output of the economy is lower than thought. Productivity growth is likely to be low and the economy will not grow as fast as it did without generating inflation.

It should be noted that the Coalition Government does not aim to eliminate the cyclical deficit (the cyclically-adjusted current budget) so in fact Conservative and Labour positions on the budget are less far apart than the rhetoric would suggest. There will be public spending increases in real terms over the Parliament, although as a share of GDP public expenditure will fall back to 40-41 per cent.

Given that the weakness of the recovery will depress tax revenue, even if (a big if) spending targets are met, net borrowing will fall to 3.6 per cent of GDP in 2015-16 rather than the projected 1.5 per cent. The current budget will run a deficit of 2.2 per cent of GDP compared with the 0.2 per cent forecast.

The Government has been criticised for the lack of a growth strategy, but there are limits to what governments can do to stimulate growth. The most useful measures such as skill formation only bear fruit in the medium term.

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