The Bank of England revised down its growth forecast for 2012 to virtually zero last week, reinforcing the raft of weak economic data released recently. The UK economy has now contracted in 5 out of the last 7 quarters and net growth since the end of the recession in 2009 has been negligible.
Austerity, inflation and the Eurozone crisis have each been cited as key factors holding back UK economic growth over that period and many, including the both the Bank and the Office for Budget Responsibility (OBR), have consistently projected a return to a reasonable level of growth during 2013 and 2014, as such factors become less prominent. Yet, just as similar projections for 2012 failed to be realised, the projections for 2013/14 fail to take account of the fact that, amidst a new global slowdown strikingly similar to that preceding the demise of Lehman Brothers in 2008, the UK economy has presented a series of structural frailties, each of which, represent the underlying factors contributing to the lack of economic growth since 2008.
1/ Private Demand
Without a doubt, the UK's key weakness at present is private demand. Consumption has yet to return to its pre-recession peak, striking, when you consider that it was 4, 6 and 8 per cent higher at this stage after the 70's, 80's and 90's recessions. Investment also remains 7 per cent down on its pre-recession peak - again much below its level at this stage after previous recessions.
Robust employment data are often used to question GDP figures, yet once again this overlooks the underlying factors. If we look at both GDP and the rate of unemployment at this stage after previous recessions, we note that both GDP and unemployment have been recorded at a much lower rate. Yet output per worker is also much lower at present when compared with this stage after previous recessions and real unit wage costs are much higher.
In essence, wages have been falling, but not by nearly enough to clear the labour market post-recession and improve household's disposable income; this, coupled with inflation, has crippled consumption. Falling productivity has meant that businesses are forced to retain workers, which has driven up costs, just as prices have been driven down by falling demand, meaning that cash flow, margins and therefore confidence to invest, have all been relentlessly suppressed.
Inflationary pressures have clearly acted as a drag on growth and while the Bank's projection of a short-term return to target will, in all likelihood, prove to be correct, there are underlying inflationary pressures that will once again become a factor in the medium term, calling into question the Bank's forecasting.
Oil prices have remained stubbornly high recently, despite the global slow-down; that should offer some indication that price pressures from the cost of oil will return. With the global population projected to grow significantly in the coming decades and with environmental factors also becoming more influential, food prices are another source of concern.
Service sector price increases have also remained fairly stable throughout the recession, suggesting resilience that becomes a critical inflationary factor when you consider that the UK's economy is heavily biased toward the sector. In addition, the £375 billion of quantitative easing pumped into the economy by the Bank of England will also become a factor.
The UK faces a severe housing shortage. House prices have risen 192% since 1997, meaning that the cost of buying a home is now prohibitive to many. Worse still, the rapid increase in prices has led to households accruing significant levels of debt and property being bought as an investment, further exacerbating the problem.
The higher the percentage of household income spent on the cost of housing (either mortgage repayments or rent), the lower household disposable income becomes - yet another drag on consumption.
5/ International Trade
The continuing Eurozone crisis has depressed demand in the UK, owing much to the fact that the European Union (EU) remains, as it has for 40 years, our most important trading partner. Worse still, the future of the EU hangs in the balance, as torpor has beset a political class yet to summon the courage to present to the wider world, the true scale of the task facing EU members. The financial crisis exposed the fact that the both the EU and Eurozone are a work in progress, an acknowledgement of the fact that the populations of member countries are not yet ready to accept full integration. Such a scenario can no longer persist, meaning that a comprehensive, workable and lasting solution must be enacted by the EU and Eurozone, in order to avoid the calamity of a Euro exodus or collapse.
This leaves the UK, a member of the EU, but not the Eurozone, with an interesting choice. McKinsey, a consultancy, believes that by 2025, annual consumption in emerging economies will rise to £19 trillion - that's nearly half the global total. Yet even the largest of British companies derive less than 20 per cent of revenues from emerging markets.
Indeed the GDP of the Commonwealth will soon overtake that of the Eurozone. Africa, the Indian sub-continent and the Pacific, will all contribute to a healthy growth rate of 7 per cent a year over the next five years, while the best the EU can hope for, is stagnation.
Appropriate reforms in the EU and Eurozone will undoubtedly lead to a treaty change, thus forcing the Conservative-led coalition to offer a referendum on the UK's membership of the EU. The debate that must ensue in the meantime, is whether this actually presents the UK with an opportunity to re-orient its exports toward those areas of the World experiencing sustained growth, improve the competitiveness and productivity of its business stock and return to its heritage as a truly global trading nation.
While access to finance remains a problem for small business, debt overhang is the underlying frailty. The cost of new credit for corporates has fallen significantly since the end of the recession and when asked which factors are most effecting investment decisions, uncertainty of demand and an inadequate net return are by far the two most pressing concerns.
The debt burden on households meanwhile, is again suppressing disposable income and thus consumption. The UK mortgage write-off rate is roughly 1%, while it is 2.5% in the US - thus US household debt as a percentage of income is roughly 110%, while it exceeds 140% in the UK.
In short, the lack of growth and weakening GDP figures ought not to be passed off as either temporary nor as a consequence of unreliable data. The UK economy now bears the scars of a number of its frailties, each of which must be addressed before it can enter a sustained period of growth. The consequences of inaction could well render talk of a 'lost decade' optimistic.
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