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The permanently upturned economy

Updated Monday, 22nd June 2015

The Chancellor’s confidence that he can outlaw budget deficits reflects improbably widespread belief in the length and strength of recovery, writes Alan Shipman.

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Illustration of George Osborne on a throne composing the magna carta Creative commons image Icon Gary Edwards under Creative-Commons license History may be repeating itself over the Magna Carta , and even the Battle of Waterloo, but the economy isn’t threatening a similar re-run. UK national output (GDP) was up by 2.4% year-on-year in the first quarter of 2015, and is set to grow steadily at 2.3-2.4% at least until 2019 according to the independent Office for Budget Responsibility (OBR). Many private-sector forecasts also show steady growth continuing for the foreseeable future. After a brief brush with recession in 2011-12,  we’ve entered a growth phase that experts suggest could last for almost a decade.   

To understand how remarkable this is, look no further than the UK’s real GDP growth record since 1948. Gordon Brown was the only post-war Chancellor of the Exchequer to serve for more than five years and not encounter a recession. George Osborne is now widely predicted to be the next. The exceptional uninterrupted growth phase (1992-2007) over which Brown presided (following Norman Lamont and Kenneth Clarke) was stopped by the biggest global financial crisis for 80 years. Osborne can now bask in expectation of something similar, without the massive meltdown at the end.

If we are indeed living in extraordinarily tranquil economic times, the length and depth of the 2008-9 recession could be the explanation. Real GDP then declined for five consecutive quarters, and only grew for nine before turning down again at the end of 2011. Per-capita GDP fell by 7.2% between first-quarter 2008 and second-quarter 2009, three times the depth of the previous (early 1990s) recession. So perhaps it’s not surprising that the subsequent recovery is also expected  to go on longer than usual, before the next pause.

But not long ago, respected economists were arguing the opposite. The severity of the post-2008 downturn resulted from an unusually bad combination of private and public over-indebtedness, which seemed likely to stall recovery for years to come. The recovery that Osborne has steered since 2012 seemed at first perilously reliant on a re-inflation of house prices and consumer debt, the very ingredients that (in retrospect) cooked up Gordon Brown’s end-of-term crash.

Not so fast

What became of that pessimism? Away from the econometric models used by the OBR and other forecasters, plenty of assessments put the next recession much nearer, maybe even next year.  Some of the most respected (and until now most money-spinning) professional investors are already shifting their assets on that doom-laden basis.

It’s long been observed that Wall Street has predicted 9 of the last 5 recession, and stock-markets this side of the Atlantic have been wrongly pessimistic just as often. But since records began, UK growth has slowed down or stalled during every parliamentary term, even in the unusually strong post-war reconstruction phased of 1950-70. And an unusually large number of stormclouds hang over the UK economy at present. These include uncertainty over the EU renegotiation/referendum that could raise public and private borrowing costs; the fear that years of near-zero interest rates have caused an asset-price and consumer borrowing ‘bubble’ which will burst when the US starts to raise interest rates this year; the  possibility that China will soon encounter its own financial crash and sudden slowdown, as the interest-rate rise undermines ‘emerging markets’ globally; and the rapid obsolescence of decades of investment in the ‘carbon economy’ as the world leaps unexpectedly suddenly into a renewable energy age.

If anything does bring the UK recovery to an early end, recent policy changes may make it hard to revive. The usual response to a downturn is for the government to run a higher budget deficit – deliberately raising its expenditures and/or reducing taxes, or simply allowing outlays to rise and revenues to fall as a result of the cyclical downturn. But Osborne’s “new fiscal framework” rules this out, instead legislating for a “permanent commitment” to run budget surpluses so as to start paying-down the existing public debt.

The 77 prominent economists who warn that this tying of Treasury hands risks inviting “ a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three” are not all die-hard Keynesians. Even the IMF, until now a staunch supporter of the Chancellor, has published research suggesting that public debt repayment should be restricted to times of solid GDP growth - because at other times (as in 2010-11) it causes renewed downturn  that raises the debt: GDP ratio, so that “if fiscal space remains ample, policies to deliberately pay down debt are normatively undesirable”.

As good as it gets?

Underlying present concerns is that, although last year’s 2.8% growth was the strongest among rich industrial economies, it was still disappointing given the depth of the recession that preceded it. The UK achieved an annual growth trend of 2.6% between 1948 and 2014, despite having relatively small budget deficits and strongly positive borrowing costs in most of those years.

For growth to peak at 2.8%, with the budget deficit still nearly 5% of GDP  and interest rates effectively pushed down to zero, suggests there may be vulnerability even to the lightest of headwinds, when official feet finally ease off the fiscal and monetary accelerators. The 2.3% average growth which the OBR forecasts for 2016-19 is already feeble by historical standards. Any downturn before then will ensure that there is only one Prince George.

This blog post is part of Society Matters. The blog seeks to inform, stimulate and challenge our understanding of this changing world and of our humbling role within it. Find out more about the blog and the team.
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