(UK) Economic luck that cannot last
By Martin Wolf
Published: October 30 2003 21:37 | Last Updated: October 30 2003 21:37
Mervyn King, the new governor of the Bank of England, calls it "nice". What he was describing, in a speech earlier this month, is the UK's "non-inflationary consistently expansionary" economic performance since sterling's eviction from the exchange rate mechanism of the European Monetary System in September 1992. The event that destroyed the Conservatives' reputation for competence has proved a turning point in the country's economic history. Can these good times last? Up to a point, is the answer.
UK economic performance over the past 11 years has been remarkable: between the second quarters of 1992 and this year, gross domestic product expanded at a compound annual rate of 2.8 per cent; output rose in every quarter, a performance unmatched by all other members of the Group of Seven leading economies; inflation averaged 2.5 per cent, while never deviating more than a percentage point from that figure; and unemployment fell from almost 10 per cent to around 3 per cent, on the claimant count.
Mr King notes that the US has also improved its economic performance. But the change is broader than this. Think of it as the return of the "Anglo-Saxons". Between the second quarters of 1992 and 2003, Australia's economy grew by 50 per cent, Canada's by 44 per cent, that of the US by 41 per cent and the UK's by 36 per cent. Over the same period, the French economy grew by just 22 per cent, the eurozone's by 21 per cent, Italy's by 17 per cent, Japan's by 15 per cent and Germany's by 14 per cent.
The governor emphasises four underlying causes of the improvement in UK performance: a monetary framework that evolved from inflation-targeting, in 1992, to the Bank's operational independence, in 1997; fiscal consolidation; 20 years of supply-side reforms; and a series of shocks that averaged out over time, rather than cumulated "in either an upward or downward spiral".
Yet, as Mr King notes, one beneficent shock did cumulate: to the terms of trade (the ratio of export to import prices), which improved by about 10 per cent after 1996. This generated a substantial increase in real take-home pay without adding to employers' costs. That, in turn, permitted household spending to grow at well above trend real rates, without putting pressure on inflation. Thus, at constant prices, the share of household consumption in GDP rose from 63 per cent in in the last quarter of 1995 to 68 per cent in the second quarter of this year. In current prices, however, it rose only from 64 to 66 per cent.
Can the "nice" performance last? Two distinct classes of threat can be distinguished: those to trend growth; and those to stability.
Any serious threats to trend growth would come from productivity or labour market performance. Recent revisions to the data indicate that labour productivity has been growing at close to its long-term trend of 2 per cent a year. There is no good reason to expect either a marked improvement or a marked deterioration. The same is true for the labour market. While there are some threats to the UK's deregulated markets, they are not severe. Overall, trend economic growth of around 2.5 per cent is plausible.
Stability is in greater danger, however, even though the underlying macroeconomic policy framework is vastly superior to anything that preceded it. This is so for four reasons.
First, global economic expansion depends heavily on a US economy that is running huge current account and fiscal deficits. Second, the chancellor of the exchequer will almost certainly need to raise taxes in the years ahead. Third, strong household borrowing, driven in large part by an unsustainable increase in house prices, lies partly behind buoyant domestic demand. Finally, the improvement in the terms of trade is far more likely to reverse than to continue. Though none of this spells disaster, it will be difficult to maintain stability.
Consider, for example, a fall in the terms of trade that coincided with a big increase in the tax burden. If workers tried to maintain past growth in their real disposable incomes, either profits would be squeezed or inflation would rise. Either way, the Bank would confront a worsening short-run trade-off between inflation and real activity. Alternatively, a reduction in the rate of growth of real disposable incomes combined with a slowdown in, or reversal of, the rise in house prices could lead to an unpredictably rapid jump in the rate of household savings and weakening in domestic demand.
The combination of sustained growth with macroeconomic stability of the past 11 years has been a matter of luck, as well as judgment. However adequate the supply-side and policy regimes, only the foolish would expect the luck, and so the astounding stability, to last for ever.
martin.wolf@ft.com |
