8 September 2015

Consistent 2.4% UK growth is a fantasy


The informed consensus, shared by the government, the Office for Budget Responsibility and the Bank of England, is that economic growth in the UK is likely to continue at about 2.4% per annum until 2020. There are, however, strong arguments for believing that this relatively rosy scenario entails much too much optimism – and for two partially overlapping reasons.

The first is that it may take insufficient account of developments in the world economy which, if they occur, would have a heavy negative impact on the UK. One is the potential break-up of the EU’s Single Currency, which would almost certainly plunge the Eurozone into a severe depression, thus reducing our exports to what is still by far our largest single market. Another is a severe banking crisis, possibly associated with the strains of the Single Currency, as the huge loans which have been made to the weaker Eurozone economies have to be written down or written off completely, although the triggers may be similar problems in the Ukraine or even China.  A third is a recession centred in the West as one economy after another tries to reduce its deficits by implementing austerity policies whose cumulative effect is further to depress the already very under-stretched western economic world. There is also the possibility of governments being elected on ill thought through anti-austerity platforms which finish up – as recently in Greece – by making the situation worse than it was before.

Even if we are lucky enough to avoid any of these highly adverse events occurring, however, the heavily unbalanced state of the UK economy at present may well make growth at 2.4% unsustainable. For a start, the proportion of our GDP which we reinvest each year, at 14% excluding R & D, is one of the lowest in the world, where the average is 24% while in China it is 46%. Furthermore, barely a quarter of what we do invest goes into the areas of the economy, such as manufacturing, which are capable of producing significant increases in output per head. Indeed, net of depreciation and allowing for our rising population, there is now almost no net investment of any kind per head taking place in the UK at all. This must be the main reason why productivity is virtually static. Without increases in output per head, growth is unsustainable.

Another problem is that we have deindustrialised to a point where, by a wide margin, we are unable to pay our way in the world in trading terms although actually our balance of payments position is much worse than it would be just on a net trade basis. This is partly because our net income from abroad, which used to be strongly positive, is now heavily negative and partly because our net transfers overseas – payments to the EU, migrants’ remittances abroad  and our foreign aid programmes – are also large and growing. The result is that we are now running a balance of payments deficit which is already well over £100bn a year and still on a rising trend, allowing us to enjoy a standard of living about 6% more than we are actually earning.

All current deficits have to be exactly matched by capital inflows – either net sales of assets or borrowing. To finance ours, the UK has sold off its ports, airports, rail franchises, football clubs, energy companies, utilities and about two thirds of all our major manufacturing companies, on a scale unmatched by any other developed country. A recent report, in addition, showed that about 75% of all new build housing in London is sold to people living abroad. The UK used to have more assets than liabilities, but these days are long gone, which is why our net income abroad has turned so strongly negative. If the gross return on capital averages about 5% and we have a payments deficit of £100bn per annum, our underlying net income from abroad is bound to get increasingly negative at the rate of about £5bn every year.

Not only is the country’s borrowing a big problem. The government’s is too and because the government’s need to borrow is largely the mirror image of the foreign payments deficit, it will be impossible to get one down without the other. If this is the case, government borrowing will continue growing at a much faster rate than the economy, producing yet another unsustainable outcome. As Herbert Stein said, “Trends that can’t continue, won’t”.

Finally, what growth we have seen recently has been almost entirely based on rising consumption, driven by ultra-low interest rates for those well placed to take advantage of them, and the consequent asset inflation which has driven up the price of capital assets far more rapidly than consumer prices.  The upside is that, with almost no productivity growth, more demand has pulled more and more people into employment, which is clearly a benefit, but it is at the cost of yet another trend which is clearly unsustainable. Once unemployment drops far enough, there will no longer be a sufficient number of people available to be drawn into working to keep the economy growing.

For all these reasons, even if there are no international catastrophes with heavy negative impacts on our economy, there are good reasons for believing that growth in the UK economy is likely to run up against domestic constraints – because it is so unbalanced. This is especially likely to happen if serious attempts to impose austerity programmes – cutting government expenditure and raising taxation along the lines we have been promised, but which we have not yet really seen – shift enough demand out of the economy to push it into a depression. There is always a tendency to assume that whatever conditions there are at the moment are likely to persist, but in the end they never do. Those who believe that the UK economy will go on growing at 2.4% per annum until 2020 will very probably find that suspending the laws of economic gravity is more difficult than they thought it would be.

John Mills is a British businessman and the founder of JML.