Current economic trends suggest the UK may need to be prepared for a period of weak, and potentially zero economic growth
It is now almost eight years since the collapse of Lehman Brothers heralded the global financial crisis (GFC), roughly the length of a normal business cycle. Over that time interest rates have been held at record low levels and the Bank of England has augmented this with a major programme of quantitative easing. Yet economic recovery in the UK remains fragile and anaemic.
In 2013 former US Treasury Secretary Laurence Summers raised the spectre of secular stagnation, the apparent inability of developed countries to resume past growth rates and remain in a state of minimal or zero growth, even with very loose monetary policies. Recovery from the GFC is not simply a case of fixing the financial system, instead there is the prospect of slow growth for the foreseeable future. To add to this pessimistic prognosis, this year Robert Gordon’s ‘The Rise and Fall of American Growth’ argued that there has been a slowdown in long run growth rates so that the improvements in living standards the US enjoyed in the twentieth century will not be sustained in the twenty-first.
For Summers, developed economies have found it increasingly difficult to achieve adequate growth with financial stability. Periods of economic expansion, he argues, have been limited and based on bubbles in housing and other asset markets and associated unsustainable growth in debt. Meanwhile private investment remained low and companies have accumulated cash surpluses rather than borrowing to expand. Even during the ‘Great Moderation’ period before the GFC, activity was not especially high so that even a major asset bubble scarcely led to over-heating in the real economy. Low investment and high corporate savings could be counteracted by lower interest rates, but the zero lower bound may limit central banks’ ability to achieve this, and in any case the resulting low interest rates are likely to undermine the achievement of financial stability. As developed economies have struggled to generate sufficient levels of demand, Summers argues that policies brought in as emergency responses to the GFC – ultra low interest rates, quantitative easing – are likely to remain for the foreseeable future.
The notion of secular stagnation dates back to the 1930s and versions of the thesis have periodically resurfaced in economics ever since (although it is important to note that use of the term varies between authors). While much of the contemporary discussion around secular stagnation has focused on the US, there are a number of strong similarities with Britain.
The Great Moderation saw UK growth sustained by private consumption through a housing boom and associated fall in household savings. As a result outstanding household debt relative to income soared in the 2000s to levels that were high both by historic standards and relative to other developed economies. British households consolidated their savings in the initial aftermath of the GFC, but in the current decade with the resumption of house price rises, they have fallen to historic lows relative to household income, and household debt remains at higher levels than other developed economies.
The era of low interest rates since the start of the GFC has kept borrowing costs low, but households remain vulnerable to even a modest rise in interest rates. The UK has experienced its slowest recovery from a recession for over a century and again this appears to have been driven by debt-fuelled private consumption. By contrast, private investment has remained low, whilst the corporate sector has been in surplus almost continuously since 2002; non-financial companies are saving, rather than borrowing to expand.
Further, as has been widely noted the UK has latterly seen stagnant productivity levels against pre-crash norms of around 2 per cent annual growth. Expectations that the recovery would lead to relatively rapid improvements in productivity as idle capacity returns to activity have not been met.
Britain narrowed the productivity gap in the 1990s and 2000s, in part reflecting the investment in new technologies and improvements in human capital, but by 2014 UK labour productivity was 20 percentage points below the G7 average. Numerous explanations have been advanced for this puzzle, without a clear consensus emerging.
This can, though, be seen in terms of austerity and aggregate demand deficiency, so that productivity would be expected to revive with any sustained recovery. In particular, Martin and Rowthorn show in detail that the UK economy has suffered from aggregate demand deficiency since the onset of the GFC and propose that it is this, rather than widely proposed supply-side explanations, that accounts for the productivity slump.
More generally, some critics of the secular stagnation thesis have located demand deficiency in the global economy in key economies running persistent surpluses (China, Germany for the European economy) and imparting a deflationary bias rather than more fundamental developments.
Nevertheless, developments in the UK mirror much of the secular stagnation story for the US economy over the longer term. The UK has a longstanding tendency for relatively low investment, with corporate cash surpluses and a secular decline in the propensity for firms to invest their retained profits. Some US commentators have located these trends in terms of rising inequality – as wages stagnated, households attempted to maintain their consumption through lower saving and higher borrowing.
In Britain the dynamics are somewhat more complex than the wage-productivity decoupling story, though. Since the GFC, the problem has been stagnating productivity rather than decoupling. Although overall the evidence on decoupling for the UK is mixed, the real incomes of median and lower income households stagnated even before the GFC.
The current period of sluggish recovery can be seen as reverting to the prior UK growth model of house price bubbles and associated ‘privatised Keynesianism’ credit boom. Such booms are typically associated with lower subsequent growth, higher consumption and a worsening current account position (now recording a record peacetime deficit even in the face of sluggish activity). Past experience indicates this is not sustainable. There is little sign of a sustained recovery in private investment, let alone net exports. A sustained recovery in demand might promote investment and productivity growth, but current trends appears worrying consistent with the secular stagnation account.
If the spectre of secular stagnation does become the ‘new normal’ then this raises fairly fundamental questions for productivity, living standards and the public finances that UK policymakers will need to urgently address. Moreover, if the Cassandras are proved right and the warning signs of another global financial crisis are indeed beginning to flash red then those answers may be required sooner rather than later.
The Coming Crisis SPERI blog series: In next week’s blog – published on May 18th – Andrew Baker looks at creating an investment state. Read all of the blogs in the series so far http://speri.dept.shef.ac.uk/tag/the-coming-crisis/