Artwork for FTWeekend Comment - issue dated 13.10.18

Weather explains a lot. In the three months to August, UK gross domestic product rose by a better than expected 0.7 per cent, helped by July’s heat and the football World Cup. Growth seems to have recovered from the very poor start to the year, when GDP rose a paltry 0.2 per cent in the first quarter of 2018, partly reflecting the unseasonably cold temperatures.

Looking ahead, the National Institute of Economic and Social Research, a think-tank, projects a 0.7 per cent increase for the third quarter and a perfectly respectable rise of 0.5 per cent for the fourth. If these projections are right, GDP should expand by an acceptable, if unspectacular, 1.5 per cent in 2018, after 1.7 per cent in 2017.

Meanwhile, the labour market looks robust. The unemployment rate was just 4 per cent in the three months to July, the lowest since 1975. Vacancies are at all-time highs. Significantly, real earnings growth, even on the Office for National Statistics’ unadjusted measurement, seems to be picking up after persistent weakness since the financial crisis.

An improved outlook for real earnings, combined with a strong labour market, should sustain consumer spending growth into 2019, even if business investment is a little weaker.

All in all, then, the British economy remains remarkably resilient, despite the uncertainties arising from the Brexit negotiations. Productivity growth will have to improve, of course, though there were signs in the data for the second quarter of this year that this is beginning to happen. As the labour market tightens, reflecting a combination of falling unemployment and slowing net immigration from the EU, employers will have to be smarter about how they use their labour inputs. Employers have been operating labour intensively. This will have to change.

Inflation, meanwhile, has nudged up above 2 per cent, partly reflecting higher oil prices. However, the Bank of England shows absolutely no sign of following the US Federal Reserve by raising interest rates significantly. Rises will be “gradual and limited”. Rapidly-rising interest rates were behind the recessions of the 1970s, early 1980s and early 1990s. But they are highly unlikely to be repeated. Furthermore, it seems reasonable to assume the tighter regulation and closer supervision of the banks in recent years should prevent a repeat of the financial cataclysm that occurred a decade ago. One can never rule out “black swan” events, but it seems unlikely the economy will fall into recession in the short to medium term.

The economy is soldiering on, therefore, even though it will break no growth records. But, and this is a very big “but”, there are potential problems with the long-term public finances, to which the IMF drew attention this week.

Granted, the level of public sector net borrowing has been relatively encouraging so far in the current financial year (April to August). Total borrowing could be £30-35bn in 2018-19, compared with £153bn in 2009-10. The debt-to-GDP ratio is moderating too, falling from last autumn’s 86.9 per cent to “only” 84.3 per cent by the end of August 2018. Debt, however, is still rising and servicing the debt, even at relatively low interest rates, still amounts to more than £50bn a year.

Pressures on the public finances can only intensify. The Office for Budget Responsibility’s latest fiscal sustainability report made for very sobering reading. Without further policy measures, the public finances were projected to deteriorate significantly over the next half-century as the ageing population adds to spending on health, long-term care and pensions, but damps growth in tax receipts. The conclusion surely has to be that fiscal prudence should be regarded as a permanent response to demographic change, and not as a temporary measure to rectify the public finances in the wake of the crisis.

The pressures on taxpayers are already considerable. Taxes account for the lion’s share of public sector current receipts. (This figure has increased since the 1960s and 1970s, reflecting the privatisation of many public corporations and the consequent loss of income.) The tax-to-GDP ratio was, at the time of the spring statement in March, projected to rise to 34.3 per cent in 2018-19, the highest since 1969-70 (when it was 35 per cent).

Meanwhile, public spending grew rapidly in the 2000s, easily outstripping the underlying growth in the economy. This spending trajectory was clearly not sustainable. And the efforts by the coalition government to control spending really should be seen as the normalisation of spending after a splurge, rather than heralding an age of hair-shirt “austerity”. Indeed, with public spending tipping the scales at about 38.5 per cent of GDP, we really do not have “austerity” at all.

The IMF’s recent recommendation that spending should increase to ameliorate any growth slowdown in the event of a “hard” Brexit was questionable. But the fund has form when it comes to foreboding about Brexit, having enthusiastically joined the chorus before the 2016 referendum warning of an immediate recession in the event of a vote to leave the EU.

What is more, the IMF’s recommendation is at odds with the findings of its fiscal monitor. That analysis, which seems broadly in line with the work of the OBR, identified the dire state of the UK’s net long-term public sector liabilities. The UK languishes near the bottom of the international league table.

The moral is clear. However well the economy seems to be doing, fiscal discipline is paramount. We owe it to taxpayers and to future generations.

The writer is economic adviser at the Arbuthnot Banking Group

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