UK: Economic Review - Second Quarter 2005 - The post-election landscape

Have we ever had it so good ?
Last Updated: 17 May 2005
Article by Roger Bootle, Economic Adviser, Deloitte

Most Read Contributor in UK, August 2017

Foreword

by John Connolly
Senior Partner & Chief Executive
Deloitte

Arguably, the new Labour administration won its historic third term in office on the back of a period of unbroken economic growth, low inflation and low unemployment. This record was achieved against a background of pretty volatile international conditions which in previous periods may have caused the UK economy to fall into recession. The era of stable economic conditions has been good for business. The key question is will this continue?

There are many challenges ahead that will need to be addressed with some urgency by the new government. In particular, Roger argues that there will be pressures from the housing market, and the external deficit and public sector finances will present difficulties for the Chancellor if he is to retain his economic record for prudence, keep taxation under control and keep borrowing within the limits required to meet his Golden Rule. More than this, Roger argues that the disappointing productivity performance has the potential to undermine the long term competitive performance of the economy and this has to be of concern to any business leader.

The road ahead is one which is likely to see some significant challenges for Labour to retain its record of unbroken economic growth. It is a balancing act that we will all be watching intently.

Once again, I do hope that this Review helps you in both your immediate and long-term business thinking.

Executive summary

  • In the recent election campaign, voters were bombarded with a baffling array of claims, counter-claims and statistics relating to the economy’s past performance and prospects. Now the election is over it is time to ask how well has the economy really performed in recent years?
  • What’s without doubt is that the economy has registered an impressively long period of uninterrupted expansion in pretty d i fficult global conditions. But the average growth rate has not been particularly strong compared to that seen in previous decades, even the supposedly disastrous 1970s.
  • Meanwhile, although the economy has performed well in comparison to many other countries, it is easy to overstate its relative strength. The UK has outpaced most members of the euro-zone and Japan, but lagged behind much of Australia, Canada and the US.
  • A key factor behind the economy’s recent performance has been the stability and low level of inflation. This has owed much to the establishment of the Bank of England’s Monetary Policy Committee, but this was a further step in an existing low-inflation policy rather than an abrupt break from the past.
  • In any case, the move to lower inflation has been a global trend. Similarly, while UK interest rates are very low by historical standards, they are just about the highest in the developed world.
  • What’s more, behind the strong growth numbers lurk a number of imbalances which could have adverse consequences on the economy’s future performance. Most obviously, the over-valuation of the housing market threatens an abrupt downward correction, with knock-on effects on household spending and overall activity.
  • Second, the trade position has steadily worsened as UK imports have grown rapidly and exports have been depressed by an overvalued currency. There is a danger of a sharp fall in the pound, which could threaten the stability of growth.
  • Third, the public finances have deteriorated dramatically and are set to act as a drag on the economy in the next few years, as the g o v e rnment takes action to bring borrowing under control.
  • Finally, a more fundamental black mark against the economy’s performance is the apparent lack of any acceleration in productivity growth. This could reflect mis-measurement, but it is too soon to conclude that any meaningful improvement is underway.
  • Overall, our assessment is that the economy’s recent track record has been good. But with the election now out of the way, there are major challenges still to be faced.

Have we ever had it so good?

Assessing the post-election landscape

During the general election campaign, claims and counter-claims relating both to the economy’s past performance and its future prospects were flying between the Government and the opposition parties in a baffling exchange of facts and figures. Pity the poor voters attempting to make sense of it all!

Now that the election is out of the way, the purpose of this piece is to cut through the statistics and the party politics and, as impartially as we can, take an objective look at the true performance of the UK economy in recent years. Has the economy really undergone an economic transformation? What are the major economic challenges ahead?

50 not out

Let’s start with the relatively uncontentious, which is that the economy has recorded a long period of uninterrupted growth in recent years. Indeed, the official figures show that real (i.e. after inflation) GDP has expanded continuously since the third quarter of 1992, that is, for a full 50 quarters. The Government has boasted that this has been the longest period of continuous economic expansion since modern records began at the beginning of the industrial revolution.

This is strictly true and the lack of even a single quarter of falling output is certainly testament to the impressive stability of the economy in recent years against global economic conditions, which have been far from stable.

However, this observation on its own arguably overstates the comparative strength of the economy in recent years. Throughout the 1950s and 1960s, the economy grew strongly and yet there were rather frequent quarterly falls in output of minor extent and short duration. The result is that if you focus on the quarterly data, two decades of great economic success are disqualified as a period of continuous growth. But if you look, instead, at the annual data, then the economy is shown to have expanded continuously from 1947 to 1973, and this period, not the years since 1992, counts as the longest period of continuous economic expansion.

Average growth not so impressive

Likewise, a look at average growth rates over different periods also paints the recent run of uninterrupted growth in a rather less favourable light. The average growth rate since 1997, for example, has been 2.8%. Over the long period since 1831, the average was 2%. But growth averaged 2.7% in the 1950s, 3.3% in the 1960s, and even 2.4% in the supposedly disastrous 1970s.

Admittedly, the performance since 1997 compares well with the average growth rate of 2.1% seen under the Conservatives from 1979 to 1997. The reason for this comparatively low figure can be used both to indict them and to excuse them. Their governments w e re marred by two very serious recessions, in 1980-81 and 1991-92. The indictment derives from the fact that policy probably contributed to these recessions. The excuse is that, at least in the case of 1980-81, the government was grappling with fundamental problems of the economy which had lain untouched for a long time, namely high inflation, excessive union power and bloated state enterprise.

And after the exit from the ERM, the Conservative record on macroeconomic policy dramatically improved. Until their defeat in 1997, the average growth rate was 2.9%, marginally higher than the rate achieved by Labour since.

So despite the greater stability of growth in recent years, the average growth rate has been little different from many previous periods. In any case, assessing economic performance is bedevilled by long time lags. The comparatively good economic performance under Labour has been partly the fruit of the Conservative reforms.

International comparisons

While the economy has performed fairly strongly by our own historical standards, it is now a widespread belief in the UK that we have also performed better than many other countries.

This is largely true, but it is easy to overstate the case. It is true that British growth has been high compared to most members of the euro- zone and Japan. But what a low standard to set yourself! Since 1997, the UK economy has grown more slowly than Australia, Canada, and the US.

However, this partly reflects the fact that the UK workforce has been expanding rather less quickly than those in some of these other areas. Not only has UK GDP growth been the most stable of all members of the G7, but real GDP growth per head has been higher than in the rest of the G7 except Canada.

Overall, then, while a closer look suggests that the economy has not performed quite as strongly as some have claimed, it has been more stable than many other countries and more stable than at many other points in our history. What’s more, this has occurred against a background of pretty difficult global economic conditions which may have caused the UK economy to fall into recession in some previous periods.

Low inflation the key

What has caused this improvement? One major contributor is a favourite Gordon Brown boast – inflation is "the lowest for a generation". So often in the past, inflation has got out of hand and the attempt to bring it down again has led to a recession. Inflation has been remarkably low and stable in recent years.

Again, however, the major change occurred not over the last few years but rather in the early 1990s. By May 1997, RPIX inflation was already at 2.5%, roughly the same as it is now.

The one unambiguous achievement of the last few years in combating inflation is the granting of operational independence to the Bank of England and the establishment of the Monetary Policy Committee (MPC) in 1997. This radical move has been credited with ensuring that inflation expectations have remained firmly anchored around the inflation target of 2% on the consumer price index (CPI) measure of inflation (2.5% on RPIX before December 2003). 

This in turn has helped to keep wage claims under control and ensure that, even when inflation has moved away from its target, it has returned to it pretty quickly, instead of triggering a wage/price spiral as it may have done in previous periods.

Of course, the system has yet to face a very rigorous test, given the relatively stable general economic conditions since its establishment. But the doubling of oil prices in the last 18 months has presented quite a challenge and, although it’s still early days, the initial signs have been encouraging. Although headline inflation has crept higher in response to higher petrol prices and associated items such as airfares and gas and electricity bills, core inflation has remained subdued.

Yet even the establishment of the MPC was less of an abrupt break from the past than a development of existing policy. The road to the MPC began with the institution of inflation targets and the publication of the Inflation Report after the exit from the Exchange Rate Mechanism in 1992, along with the introduction of monthly interest rate meetings between the Chancellor and the Governor of the Bank of England, which became known as the "the Ken and Eddie show". Handing over full control of monetary policy to the Bank of England (albeit with the inflation target still set by the Government) was arguably just the next logical step along the road.

In any case, low inflation is not a uniquely British phenomenon. The "death of inflation" has occurred globally in response not just to a new commitment to low inflation on the part of global policymakers, but to a series of major changes in the behaviour of the global economy. The dismantling of trade barriers, the rapid growth of low labour costs countries like China and India and the explosion of the internet are just some of the changes that have contributed to a reduction in price pressures right across the developed world. Note, though that the UK has enjoyed the greatest combined stability in both activity and inflation.

Similarly, although UK interest rates are low by historical standards, so are they more or less everywhere. Indeed, our interest rates are just about the highest in the developed world.

Trouble ahead?

So while the recent performance of the UK economy has without doubt been impressive, a closer examination reveals that at least some of the favourable developments apparent in recent years were either a legacy of changes put in place some time ago or have been part of a global trend.

What’s more, any assessment of the past performance of the economy has to include at least some reference to its possible future performance. In this respect, there are areas in which the legacy of the economy’s recent strength could have adverse consequences on its future behaviour.

Housing a danger

The first of these involves the most talked-about aspect of the economy, the housing market. While Mr Brown has spoken proudly of banishing "the bad old days of boom and bust" forever, one part of the economy has certainly been enjoying a good old-fashioned boom – housing. House prices have risen by a total of 150% since 1997.

Of course, the strength of the housing market has helped to contribute to the growth of the overall economy in recent years. With the corporate and external sectors weighed down by the weakness of global economic conditions, the Monetary Policy Committee has deliberately shored up the domestic economy with very low interest rates. The housing market has been a key part of the transmission mechanism through which low interest rates have propped up the economy.

But most commentators, including the policymakers themselves, appear now to recognise the danger that the housing market could act as a negative force on the economy in the coming years. We do not intend to say too much about the housing market here, but suffice it to say that most indicators suggest that housing has become fundamentally over-valued both against other assets and against earnings and is therefore vulnerable to a downward correction. The ratio of house prices to average earnings, for example, is not only well above its long run average but also well above the levels reached during the previous three housing market booms since 1970

Admittedly, the Monetary Policy Committee has played down this danger by observing that the link between the housing market and household spending has loosened significantly in recent years, the implication being that house prices could fall with very little negative effect on spending. But the Committee itself has recognised that the risks to this view are on the downside and the slowdown in the growth of retail sales seen in recent months suggests that households may already be tightening their belts.

Indeed, this is one area in which the inflation targeting policy regime may eventually be found wanting. If a narrow concentration on the targeted measure of inflation allows "bubbles" in asset markets such as housing to inflate (and remember that house prices are not even included in the targeted measure of inflation, the CPI) then this could ultimately increase the volatility of both inflation and output as these bubbles burst.

Trade worries

The second area of concern involves the external sector. As we have already mentioned, the recent strength of the domestic economy has helped to offset a deteriorating trend in the UK’s trade position. The current account deficit has recently been running at around 2% of GDP. Admittedly, this is still modest by the standards of the US current account deficit, which stands at over 6% of GDP. Note, however, that the UK’s deficit has been held down by the strength of investment income. The trade in goods deficit has steadily widened to around 5% of GDP.

Part of this deterioration in the UK’s trade position no doubt reflects the general weakness of global demand in recent years and the dampening effects on exports. Meanwhile, the strength of domestic demand has prompted strong growth in imports. If household spending growth were to slow in line with the housing market, import growth would slow and this may prompt some improvement in the trade position.

But an additional factor has been the strength of the exchange rate, which appreciated strongly in the mid to late 1990s and has remained at high levels ever since. This is sometimes seen as a reflection of the UK economy’s strength, but it has undoubtedly made life very hard for UK exporters in recent years. Again, this problem could ease somewhat if a slowing housing market leads to falling interest rates and a falling pound over the next year. But much will depend on the speed and the extent of any drop in sterling. Previous falls in the pound have often come in sharp drops, forcing the policymakers to raise interest rates to head off inflation, with adverse results for growth.

Public finances on the brink?

The third area of vulnerability is the public sector. The public borrowing numbers have been allowed to shift from a surplus of some £15 billion a few years ago to a deficit in 2004-05 of £34.5bn, a turnaround of about 5% of GDP. Like the strength of the housing market and household spending, this has recently been a major contributor to economic growth, helping to offset the weakness of the external sector.

The path of public spending has been anything but stable. It has been a roller-coaster, and the ride is not yet over. Current plans involve the growth of spending slowing considerably and the taxtake rising in order to reduce the deficit. This will slow the economy. But it is perfectly possible that the deficit will remain obstinately high. In that case, taxes will have to go up and/or expenditure plans scaled back at just the time that the economy might be under pressure from a weakening housing market. Add in the growing concerns over the Government’s balloon ing offbalance sheet debts in the form of PFI-related guarantees and unfunded pension liabilities and it becomes clear that the fiscal situation will be extremely challenging.

Productivity improvement still elusive

These factors – the over-valued housing market, the poor trade position, and the budget deficit – all suggest that the underlying health of the economy is rather poorer than the latest published GDP numbers might suggest and could act as a constraint on the economy’s performance in the next few years.

But there is a more important issue for the UK economy which could have long term implications; namely, the weakness of productivity. The Government has paid much lip-service to the need for the UK to close the "productivity gap" with its key competitors but the evidence of such a development is patchy at best. Productivity has spent much of the last decade growing rather less quickly than its long-run average growth rate of 2.1% per annum.

Admittedly, productivity growth has accelerated somewhat over the last year, averaging 2.3% in 2004 compared to 1.3% in 2003 and a feeble 0.7% in 2002. But this may simply reflect the stronger performance of the economy over the last year. Firms appear to have hoarded labour during the period of weak demand in 2002 and 2003, with the result that employment has expanded relatively modestly as the economy has strengthened over recent quarters.

There are reasons to be hopeful that a more fundamental improvement may be in store, or even already underway. After all, business investment has been expanding rapidly in recent years and investment in ICT in particular has been growing almost as quickly as in the United States.

What’s more, it’s worth remembering that the celebrated "productivity miracle" which has occurred in the US since the late 1990s was not evident from the published data in its early stages, but has become visible only as the data has been revised. The sustained combination of strong growth and low inflation in the UK in recent years might suggest that a similar under-recording of the economy’s true productivity performance may be taking place here. For now, though, the behaviour of productivity is one area of any end-of-term report on the economy which is likely to draw an assessment of "could do better" or "must try harder".

Conclusions

We have not attempted to discuss and assess every single aspect of the UK economy’s performance in this short piece. Our focus, for example, has rested primarily on the economy’s behaviour at the macro level, while ignoring developments in the micro-economy.

Likewise, we have not sought to widen the discussion of the economy’s performance out from an examination of the published economic statistics, despite growing concerns that such statistics tell us little about the true quality of life. This may be one reason why, despite the apparent strength of the economy, there appears to be little of the "feel-good factor" at the moment.

Recognising these limitations, however, our assessment is that the economy’s recent track record has been extremely good – albeit less impressive than the bare numbers suggest. There are some aspects of its behaviour which are a vast improvement on that seen in many previous periods, the relative stability of economic activity and, in particular, inflation, being the most obvious.

But there are also areas of concern in the form of the over-valuation of the housing market, the external deficit, the state of the public finances and the disappointing performance of productivity. While none of these factors point to the imminent return of the bad old days of high inflation, unstable growth and dependence on the IMF, now that the election is over there are major challenges still to be faced. 

To read the next page of this article please click on the Next Page link below

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

This article is part of a series: Click Economic Review - Second Quarter 2005 (continued) -Analysis for the next article.
Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.