The dismal decade
Earlier today, the Governor of the Bank of England, Andrew Bailey, gave a speech at the Resolution Foundation outlining the nature of the Covid-19 crisis and the challenge that it poses for monetary policy. But as his speech progressed, it became clear that the Bank faces a much larger challenge. Covid-19 hit the UK economy at the end of a dismal decade. Returning to "where we were" before the pandemic won't be good enough.
Just how dismal the 2010s were is evident in this chart from Andrew Sentance:
There's quite a lot of noise in the figures, particularly prior to the financial crisis, so the Bank of England has helpfully added lines showing average RGDP growth for three key periods: 2000-2007, 2010-2016, and 2017-19. It is evident that the average in each period is lower than in the one before. The growth rate appears to be trending downwards.
But let's look through those lines and see what the chart itself tells us. Firstly, and obviously, GDP growth was on average stronger before the financial crisis than afterwards. And it was also considerably more volatile. We don't know why, but one factor might be the light regulation of the financial sector at that time. Bank lending is known to be pro-cyclical, so variations in banks' appetite for risk might be expected to cause swings in the GDP growth rate. Since the financial crisis, the financial sector has been much more tightly regulated. This dampens the procyclicality of bank lending, so might reduce the volatility of GDP growth. But does it also dampen the average GDP growth rate?
Secondly, the post-financial crisis recovery tailed off quickly and GDP growth slumped to less than 1% in 2011-12. Was this solely because of the impact of the Eurozone crisis, or did the front-loaded austerity of the Coalition government play a part? In my view, an under-appreciated factor is the tax increases on energy in 2010-11, which combined with a sharp rise in oil prices to cause energy price rises of 20% or more for households and businesses.
The economy recovered to a post-crisis high by 2014. But then growth tailed off again. What caused this? And why has the GDP growth rate been pretty much stuck at a measly 1.5% since 2016?
Much of Bailey's speech is devoted to the economic reasons for this long slump. The political issues understandably didn't get an explicit mention, but they were there under the surface, and the French economist Helene Rey didn't hesitate to spell them out in her response. It is not just the Covid-19 crisis from which the UK economy must recover. And although the financial crisis threw a long shadow, it was not responsible for the GDP growth rate flatlining in 2017-19. That was caused by Brexit.
It has become taboo to say, or even imply, that the Brexit vote of 2016 was in any way negative for the UK economy. If the Bank of England governor had dared to say openly that the primary reason for four years of stagnation prior to the Covid-19 shock was investment collapse due to Brexit, he would have been accused of making political statements. But it is the truth.
Here's the evidence from Bailey's speech:
The effect of this weakness in investment can also be seen by looking at capital services – a measure of the value of the flow of services which are derived from the capital stock, including machinery, equipment, software, structures, and land improvements. This may better capture the drivers of supply growth than looking at growth in investment alone. It shows a sharp decline following the collapse in investment during the global financial crisis, and a subsequent recovery, which flattened off as a result of the weak investment in the period prior to Covid.
The chart actually shows that the recovery in capital services growth was partially reversed by the Brexit vote. But I guess that is too "political" for the Governor of the Bank of England to say openly.
Image: The Slough of Despond from Pilgrim's Progress by John Bunyan.
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Interesting article, but I'm not sure about the argument in the second last para, namely that because the private sector invests less, ergo the public sector should invest more. If oil companies invest less in oil rigs and pipelines, is that really evidence that government should spend more on roads, hospital building or similar? If the private sector invests less, that will cut demand all else equal, which means we need a bigger deficit. But that bigger deficit can take the form of tax cuts, more public spending on current or capital items.
ReplyDeleteVery helpful piece - thank you. You don’t mention productivity, however. My reading of the data is that, in tandem with the drop in business investment, company spend on skills & training also dipped in the last decade. Some have argued that it has been ‘ rational’ for businesses in some sectors to be profit-maximising rather than productivity- maximising. This means taking advantage of low real wages & plentiful labour supply to reduce capital investment & maintain or grow profits. Do you have any reflections on this and where it leaves our prospects for the next decade?
ReplyDeleteCovid-19 has shown us that much of the UK’s economy is reliant on what I would call “discretionary spending”. People are not going to pubs or restaurants, not going shopping, not going to theatres or concerts, not staying in hotels, not travelling to work, and not going on holiday. Consequently everybody who works in these industries has lost income. Happily some of those whose employment looks conventional have perhaps been able to receive furlough support from the government.
ReplyDeleteThis isn’t going to change quickly, despite the arrival of vaccines. Recovery in these areas will not occur until people feel confident about reverting to their previous social behaviour. I doubt that this will happen quickly, for the following reasons:
• Vaccines are as yet not widely and freely available, and given the mutation rate they might never be.
• At present we are reasonably certain only that the available vaccines reduce the severity of the disease in those who become infected. This is confirmed by the recent reduction in hospitalisation and death rates attributable to Covid-19.
• It is not yet clear whether a vaccinated and subsequently infected person is less likely to infect others.
• There may be individuals for whom vaccination is dangerous, perhaps more deadly than catching the disease.
It follows that the load on the NHS may not reduce very much, and might remain at an elevated level for some time.
At the same time, there are many people who are not spending money. Intuitively this is the same amount of money that would be needed to support all those out of work because of the forced closure of their places of work. How do we resolve this conundrum?
Obviously some of it is saved “for a rainy day”. But the people who should most obviously save for emergencies are the very people who have no income at present and who have already exhausted what little savings they might have had.
For the rest, they have no incentive to save productively because interest rates are so low. Money therefore sits in current accounts, doing nothing. Potentially this might benefit the government because it could borrow cheaply to support furlough payments and grants. But all that this money does is to prevent situations that are even worse and potentially more costly: civil unrest arising from long-term lack of income, overload of the NHS, and the like.
Productive saving would develop those industries and businesses that can thrive despite a restricted social environment.
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ReplyDeleteConsider the long term future of working from home. In the past I have sometimes struggled to work productively at my employer’s premises. Distraction from noise and interruptions from colleagues meant that I would take work home and deal with it there; but I had space at home and no family members there during office hours. Contrast this with the people currently working from home who have been obliged to educate their children there at the same time. But employers have seen the benefit and I imagine have put in place management practises which give them confidence that staff continue to be productive while working from home. It follows that there will be a change in the demand for housing in terms of properties with suitable space for home working; and this demand could well help small and large builders.
Consider the high street. This was already dying with large shops struggling because of out-of-town shopping malls, and more recently with the increase in on-line shopping. Unless major online suppliers are hit with punitive taxes this decline is going to continue. In my mind the solution is to redevelop shops into living accommodation, so people can live in a city environment without the need to commute to work. This should help small builders as well as helping the environment by reducing the need for fossil fuels to keep cars on the road.
Consider the banking industry. In my time I’ve worked for several different employers in high-tech industries. In general, they all had cash flow problems; and one of the common factors was that the people controlling their money supply – the banks – did not understand the businesses and did not agree to lend money where it would have proved the most profitable. What generally happened was that the most innovative members of staff left and set up their own businesses. I was one of them, and I invested my own money rather than borrowing anything from a bank. I’ve talked to many others who have been successful for the same reason.
Consider the transport industry. Have you noticed that while stuck behind a biscuit lorry in a traffic jam, there’s another biscuit lorry stuck on the other side f the road, pointing the other way? Covid-19 and brexit have shown us that moving goods and people about is an unnecessary burden, both on society and the environment. So we should be wary of investing in unproductive things like transport and look at alternatives such as technology that reduces the need for travel. I realise this is rather a negative statement, but I think it important to point out things we should not do as well as recommending things we should do.
One of the lessons from Covid-19 was that we were hopelessly underprepared in terms of test and vaccine manufacturing capacity; and worse that the government had no understanding of this. So there’s a twofold requirement: more biochemical research, development, and manufacturing capability; and more education of politicians and others within government of our reliance on good science to anticipate difficulties and resolve problems. I think this relies on good education so it’s certainly a long-term issue.
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