Are we there yet?

The recent good news about renewed growth in the British economy badly needs to be scrutinised and put in context

A strange story has started to emerge about the British economy. Apparently, it’s in recovery! The central plotline boils down to one key statistic: the UK economy is growing. GDP growth in the second quarter of 2013 was 0.7 per cent, following 0.3 per cent growth in the first quarter, the first time there had been two consecutive quarters of growth since 2011. If the preliminary estimate of 0.8 per cent for the third quarter is confirmed next month, it will represent the highest quarterly growth recorded since the third quarter of 2007 (surpassing even the Olympics boost of the third quarter of 2012).

The protagonist of the recovery story has been George Osborne. In a speech in September 2013 he claimed that ‘the UK recovery has strengthened rapidly over the last six months’, and that ‘the evidence increasingly suggests that our macroeconomic plan [the austerity agenda] was the right one and is working’.

The narrator has been the mainstream broadcast media, which is seemingly content to report on certain measures of economic outcomes to a regimented timetable, without seriously questioning either the significance or meaning of slight changes in key measures, and certainly not the validity of the measures themselves.

The story desperately requires a second draft, not least to place the rather meagre growth success in context. Output in Britain remains around 3 per cent below its pre-crisis peak, whereas output in the United States is already more than 3 per cent above its own pre-crisis peak.

By this stage of the recovery after the most recent recession in the UK, in 1990, output was already 12.7 per cent above its pre-recession peak. Output was 7.1 per cent above the pre-recession peak at this stage after the early 1970s downturn, and even after the Great Depression in the early 1930s output was 6.3 per cent above peak by this stage.

Moreover, if UK growth in the third quarter of 2012 had been in line with the second and fourth quarters (for argument’s sake, -0.3 per cent), rather than inflated by the Olympics, then by the middle of 2013 output would not even yet have recovered to its post-recession peak in the third quarter of 2011. That is just how badly the economy has fared since the coalition government took office, and the current bounce – as welcome as it is – must not be taken for granted.

It is little wonder, then, that Osborne’s speech provoked such fury from economic commentators, including Martin Wolf and Tim Harford of the Financial Times, Simon Wren-Lewis of Oxford University and Ha-Joon Chang of Cambridge University. The speech was ruthlessly ‘fisked’ by the otherwise loyal Fraser Nelson of the Spectator, and even Osborne’s Cabinet colleague Vince Cable responded that ‘a few quarters of good economic data’ could not be equated with a robust recovery.

Moreover, it is possible to contest the notion that we have even had ‘a few good quarters’, for two main reasons. Firstly, GDP may be on an upwards trajectory, but, because the population is growing at a rapid rate, GDP per capita is not. It has barely grown at all since 2009, and has actually fallen since the coalition took office.

gdp per cap

Secondly, there is the intriguing possibility that the growth we have witnessed throughout 2013 has, to some extent, been a statistical anomaly (I am grateful to Jeremy Smith for pointing this out, although I use the data slightly differently). There has rightly been a great deal of scrutiny about whether Plan A, namely, the austerity agenda, has been abandoned, led by former chief economist at the Cabinet Office Jonathan Portes. It certainly seems likely a slowdown in cutting public spending has helped the economy to heal.

Yet it is also possible that austerity has artificially produced positive GDP results, through the complex formula used for measuring public sector productivity. As the table below shows, government spending has been largely stable in nominal terms since 2011. This represents austerity, writ large.

But, in real terms, government expenditure has actually increased since 2011 substantially, with the increase equivalent to two-thirds of overall growth experienced over this period.

gov spending table

Why is there such a large discrepancy between nominal and real terms spending? Given inflation, it is logical to assume that the latter would have fallen significantly. The ONS calculates real-terms spending based on data on actual spending, but doesn’t simply use an inflation-based deflator. The deflator is instead based on public sector productivity.

But – and it’s a very important but – the measurement of public sector productivity relies mainly on ‘inputs’ into the public sector by the government. Reductions in headcount or pay would appear initially therefore as improvements in productivity, because the impact of such changes on what is actually delivered by public services is unlikely to be perfectly synchronised. Output will fall, other things being equal, but not at exactly the same time.

This anomaly will clearly not sustain real-terms expenditure growth over the long term without genuine productivity improvements, but has seemingly been sufficiently influential in the short term to contribute towards positive growth results.

Economic growth is in fact almost an immutable law of the economy. It happens almost by default, because human ingenuity coupled with population growth and the logic of the capitalist system means our capacity and incentive to produce more tends to increase all the time.  For this reason alone, the growth we are witnessing now, after such a prolonged period of stagnation, is absolutely nothing to shout about.

The debate about whether the government should have long ago abandoned austerity in favour of Keynesianism is an important one, but it does to some extent overlook the key challenge facing the British economy. This is not about how to make recovery happen, but rather what kind of economy it will be. The rest of this series of posts will therefore consider whether the economy is rebalancing.

Even if we consider the growth now evident as authentic, it is highly unlikely to be sustainable unless it corrects the flaws and the imbalances that caused such a deep recession in the first place.