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February 27, 2013 7:40 pm
Britain’s failure to “rebalance” the economy away from a reliance on government and household spending was underlined on Wednesday by data showing both exports and business investment fell in the final quarter of last year.
The official figures, which came less than a week after Britain’s rating downgrade refocused the world’s attention on the struggling economy, confirmed that output shrank 0.3 per cent in the final quarter of last year, as had been initially estimated.
More significantly, they painted a picture of a very differently shaped economy to the one that policy-makers envisaged two years ago.
At that time, the expected “rebalancing” of the economy was seen as the silver lining of the financial crisis. The official budget watchdog predicted an imminent shift away from private and government spending and towards net trade and investment, helped by the biggest fall in the value of sterling since the second world war. It forecast that in 2012, net trade would contribute 1 percentage point to economic growth and business investment would contribute 0.8 percentage points.
Yet Wednesday’s data show net trade actually subtracted almost 1 percentage point from growth in 2012, while business investment contributed just 0.4 percentage points. In spite of austerity and falling real wages, the biggest drivers of growth were household spending and government spending on goods and services.
“The rebalancing thing is just clearly not happening,” said Michael Saunders, an economist at Citi.
What has gone wrong? One of the main drivers of Britain’s disappointing export performance has been a steep drop in financial services exports, which have lost market share in spite of the decline in the value of sterling. “We are now offering financial services to the world at a 25 per cent discount [compared with before the crisis], and no one wants them,” said Amit Kara, an economist at UBS. “Banking is unloved, but it’s something we excel in: it’s a very specific shock to the UK.”
Goods exports have performed a little better, though they have not increased as much as policy-makers hoped. Sterling has started to fall again over the past few months, which could give an extra boost to exports, though economists warn the cheaper currency will probably increase inflation before it helps net trade.
Business investment has suffered amid huge uncertainty in the corporate world about the future level of demand. The sclerotic banking system has also made it much harder for small- and medium-sized companies to borrow money. However, with the level of business investment still 10 per cent below its level in 2008, many economists think some sort of pick-up will soon be inevitable, simply because buildings and machinery will be wearing out.
Meanwhile, even though households and the government have been the biggest contributors to growth, they cannot do much more as they try to pay down debt and adjust their spending patterns to a new and rather bleaker economic future.
Household spending has been particularly squeezed by Britain’s problem with persistently high inflation, which has eroded real wages. With the Bank of England predicting inflation will remain above its 2 per cent target for the next two years, this problem is unlikely to go away.
“We need households to feel confident enough to reduce their savings to drive any kind of consumption growth at all really,” said Simon Wells, an economist at HSBC.
Finally, government spending is unlikely to provide much support to the economy in the next few years. Britain is only about two-fifths of the way through its austerity programme, and 70 per cent of the planned spending cuts have yet to be made.
Figures mask difficulty of calculating real government spending
The relatively strong increase in real government spending on goods and services in Wednesday’s data seems at odds with Britain’s austerity drive, but the data are not exactly what they seem, Sarah O’Connor reports.
Since the coalition government came to power, government spending in cash terms has grown at an average annual rate of about 1 per cent, compared with an average annual rate of about 6 per cent in the eight preceding years. On this measure, the effects of fiscal consolidation are clear.
But real government spending, which is meant to strip out the effect of rising prices, is more difficult to calculate, since many government activities do not have prices.
Instead, for about two thirds of real government spending, including services such as health and education, the volume of spending is measured directly using indicators of output. For schools, for example, this translates to the number of pupils taught, adjusted by past increases in GCSE scores.
These output indicators tend to move only very slowly over time.
“The fiscal consolidation will result in persistent weakness in nominal government consumption growth over the forecast period,” the Bank of England wrote last year when it studied this issue. “But it may be associated with considerably less change in estimated real government consumption growth, since the majority of government output is measured using direct volume indicators.”
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