Osborne’s Omens: private boom or double dip?
Authors: Andrew Sissons
18 October 2010
After a week of mixed news on the state of the economy, the government is set to announce the results of the Spending Review on Wednesday. While much of the detail will be about where the cuts will fall, the most important question remains about the effect they will have on the UK’s economic recovery. The Government is banking on a private sector boom to fill the void left by the spending cuts, but the recovery remains both nascent and fragile, and it is vital that cuts in public spending keep pace growth in the private sector. Cut too fast, and you risk plunging the economy back into recession. Cut too slowly, and you may stifle the private sector – or worse, precipitate a debt and currency crisis. Chris Huhne has already hinted that the government’s deficit reduction plan needs to be responsive to changes in the economic climate. So how do the omens look for the UK economy ahead of Wednesday’s big announcement?
Firstly, some of the latest forecasts suggest that economic growth has slowed down somewhat over the last three or four months. The latest GDP estimates from the National Institute of Economic and Social Research suggest that the economy grew by 0.5% over the three months to September, which is less than half the growth rate for the previous three months. While this slowdown in growth suggests the recovery is not proceeding as rapidly as we might have hoped, it follows exceptional growth of 1.1% from April to June, while 0.5% is not far off the estimates given for Q3 by the Office for Budget Responsibility in June. However, the OECD’s Composite Leading Indicators have been falling for four months now, which suggests a possible downturn in the UK’s business cycle in the next few months.
In terms of domestic demand, last week contained two bouts of bad news. Nationwide reported a sharp fall in its Consumer Confidence Index last month, while there are signs of downward pressures on house prices (which matter to the UK economy more than most).
Business confidence also appears to have taken a hit last month, with a Business Trends optimism index falling slightly in September. Meanwhile, the latest information from the labour market suggested that, while we are still creating jobs, unemployment has barely fallen at all over the last few months.
Most worrying, however, is the UK’s position within the global export market. Although our trade deficit improved slightly in August to £4.7 billion, the deficit remains a significant problem, while total exports fell by 2.1%. The weak pound was expected to allow exports to grow, but we are still importing far more than we export. To compound this situation, the IMF has warned of a global “currency war”, with countries competing to devalue their currencies to keep their exports competitive.
The IMF still expects the world economy to grow over the next two years, although it is striking that growth forecasts are lower for 2011 than 2010. Further, most of this growth is driven by emerging economies, with prospects for the USA and Eurozone (our main trade partners) looking more sluggish. Given this evidence, a double-dip recession looks unlikely, but we can hardly expect growth to surge ahead either. Besides this, talk of double-dips need not be as alarming as is made out by much of the media; it is worth remembering that most of the UK’s recessions of the 20th Century have featured a small blip in their recovery (as the chart below documents):
Andrew Sentance offered a more positive view of the UK’s economic outlook on Wednesday. He correctly points out that we have lost far fewer jobs over the course of this recession than during previous downturns – in theory, this should mean that consumer demand is stronger, as more people have pay cheques to spend. Even better, he points out that the manufacturing sector has bounced back strongly from a serious contraction during the recession, a sign that the UK economy is starting to rebalance itself. So it definitely isn’t all bad news.
All of this brings us to the question of public spending cuts, and how well the private sector is equipped to deal with them. In June, we suggested that, based on data from previous recessions, that the UK can absorb a “magic number” of around 750,000 jobs losses from cuts in public spending. Exceed this figure, and the private sector will not be able to create enough jobs to make the recovery happen over five years. Analysis by PwC on 15 October suggested that current plans for cutting public spending will lead to one million jobs losses, half in the public sector, half in the private sector. When this result is taken alongside the mixed signals for economic recovery, it looks likely that we may be facing a difficult economic climate for some time to come.
This leaves George Osborne to perform a delicate balancing act. If the manufacturing sector and the rest of the knowledge economy can grow faster than the public sector shrinks, then the UK should have a more balanced and resilient economy by 2015, laying a platform for further economic growth. However, if the pace of the cuts overwhelms the private sector recovery, we could be facing several more years of economic instability, and leave many people facing the prospect of sustained unemployment.
All blog posts for this author