THE BLOG

What Kind of Growth Do You Want?

21/08/2014 18:00 BST | Updated 21/10/2014 10:59 BST

The only problem with leaving an economics degree in your final year is that you worry about what you may have missed; some missing piece of information that would explain the inexplicable things going on in our economy and make sense of them.

Other eminent economists [most of whom completed their degrees] cannot explain it either. I think it's because the recovery we are told we are in the middle of is illusory; a mere rumour.

On the face of it the news looks good. Inflation down to 1.6% in July 2014, 6.5% unemployment and falling and growth projected at 3%+; all alongside a rising housing market. Compared with continental Europe where zero growth, deflation and high unemployment abound, Britain appears to be leading the region out of recession.

However, economists at the Bank of England are confused. As unemployment falls, they say wages should begin to rise. It's obvious that as you reach full capacity, the laws of supply and demand start to kick in and force wages up. The fact that this is not happening speaks of high employment but not necessarily maximum employment capacity.

The Bank of England Governor Mark Carney made reference to this in his recent forward guidance update pointing to the capacity that still remains within the workforce arising from the numbers of part time contracts.

Not only is there capacity within our employed workforce that continues to help keep wages down but you must also look at the quality of employment on offer. Self-employment has surged and is a notorious cover for exploitation of workers on zero hour contracts (especially in the care sector), abuse of IR35 taxation rules and welfare abuse. However, including them without verification within the national figures just confuses the picture.

This leaves the bank of England with a dilemma concerning interest rate hikes that a healthy economy, in full recovery needs to happen. First, the Bank said rates would rise when unemployment fell below 7%. Now they are at 6.5% and the Bank will not raise rates because wage inflation is stagnant. Some Economists say that wage inflation is a lagging indicator and that a rate hike will follow in March. Surely there is an argument that wage inflation is in fact a forward indicator and when combined with the general inflation trends actually points the way to a further rate cut as they have done in Europe.

Other indicators than wages

Yes house prices are up and now rising more or less across the country. Help to buy has certainly been successful in driving sales and with house building nowhere near the level it needs to be, house prices will only go one way. But we all know this is not sustainable. Effectively the government has bypassed the need to save for a deposit from the home buyer to us the tax payer, even though the liability is still on the homebuyer's balance sheet.

Private borrowing is effectively a Keynesian solution masquerading as genuine economic activity and you can see it present in other sectors too; borrow some money and buy a car, liberate your pension, nothing seems to be off limits. There is nothing in principle wrong with this approach, if it works, and this brings us down to a sustained period of growth and low inflation.

However, with the main driver of this being contrived private borrowing arrangements rather than genuine wage growth, there does not seem to be any genuinely new money coming into our economy with which to stimulate new growth through demand.

It's not just that inflation is low. We need a certain level of inflation within our economy, it helps to shrink the national debt and if linked to wage inflation helps us to shrink our own private debts. The bank of England is 2%. Not, you will note, below 2%. We are currently at 1.6% but more worryingly the inflation rate has been slowly falling since Q4 2014.

It flies in the face of the current growth figures. The UK economy grew by 0.8% in the second quarter of 2014, maintaining its rate of growth in the first quarter of the year, according to the latest estimates from the Office for National Statistics (ONS). So with that sustained growth inflation should be at least standing still and not falling away.

What type of growth do we actually have?

With the figures on employment and wage inflation still difficult to reconcile with the fact that inflation is falling we must ask some questions about the fundamental nature of the growth we have.

All the indicators suggest to me that the growth that we have is almost entirely due to the velocity of cash within the economy. The more times a pound is spent and re spent the greater the flow and this has an upward effect on growth. The jobs data tells us that more people are working but the general inflation rate tells us that this is not matched by more money in the economy. More people are now effectively spending the same money and increasing transaction numbers. This looks like growth.

It is a viable temporary fix if we can properly engage with international trade and get some real growth back before the money runs out or before the cost of living crisis creates more unbearable casualties than those it has already hit. In April 2014 Food Bank charity the Trussell Trust said it had sent out almost one million parcels in the last year; three times the amount in 2012.

However, despite great moves being made to establish new export opportunities in China, Africa and the Far East, these are far from making up for a stagnant European economy and a deepening dispute with Russia. The route to genuine growth may require further stimulus. My concern is that we have little capacity left to maintain he fix should we need to do so.

So what have I missed?