Rebalancing is still an issue

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In the run up to the financial crisis, much of the growth in the UK economy was driven by consumption and borrowing which – as recent history has shown – was not sustainable. Rebalancing the economy to improve economic resilience became a hot topic. Now growth has returned to the UK economy, but rebalancing should remain at the front of policymakers’ minds.

 

As the economic recovery is taking hold, there is now a need to put our economy on a more stable footing to ensure sustainable economic growth. We need a better balanced economy, one where growth is driven more by investment and exports, and less by spending and debt.

 

This matters for growth, it matters for living standards, and it matters for economic resilience

We need more investment (such as investment in capital equipment and R&D) because it is key to boosting productivity. More productivity means making more things with the same number of resources, and it’s central to improving our economy’s competitiveness and living standards over the long term.

We also need more exports, because growing exports means growing opportunities for sales above and beyond the domestic market, and therefore more opportunities for growth. In addition to growing exports, we need to grow exports to more diverse markets as this supports resilience to a downturn in any particular market.

 

There is considerable room for improvement on investment and exports

Since we pulled out of the recession, the UK’s performance on investment hasn’t been too bad. For example, business investment has grown at an average rate of 5.2% a year for the last five years, and reached its pre-recession peak back in 2013 Q3. However, the longer term trends leave much more to be desired. In 2014 the UK had the second lowest level of investment as a percentage of GDP of any country in the G7.

investmentasapercentageofGDP

When it comes to exports, the only word you need is ‘flat’. There has been extremely limited growth since 2011. As I’ve mentioned before, this has been the result of some trying economic trends (most notably the protracted weakness in the Eurozone). Positively, there are some underlying trends, which show manufacturers are successfully expanding into new markets, but this cannot hide the fact that the outlook for export growth is pretty weak. In their forecasts released alongside the Budget last week, the OBR said that net exports (that’s exports minus imports) are likely to act as a drag on growth in each of the next five years.

OBRchart

Consumption has fared better

Despite challenging economic conditions, and limited increases in earnings, the juggernaut that is the Great British consumer has kept ploughing away. Indeed, figures released by ONS today show that retail sales have seen their longest period of sustained growth since before the recession, increasing 5.7% between February 2014 and February 2015.

This isn’t bad news in itself, in fact the strength of domestic demand has been something of a boon in the last couple of years, and has played a part in the UK’s strong growth relative to most other advanced economies. The news that inflation has dipped to zero puts real average earnings growth firmly on the table this year for consumers, which should mean that new spending isn’t fuelled by growing debt, but it remains a risk to watch out for.

All this means the economy is no more balanced than it was a decade ago

What with growing consumption and a weak export performance, the balance of the UK economy has really changed very little. In 2004 consumption (largely household spending) accounted for 61.4% of the economy. In 2014 it accounted for 61.5% of the economy.
Investment’s share of the economy has fallen slightly, from 18.1% to 17.0%, and net exports are detracting a little less from the total. But essentially the picture looked very much the same in 2014 as it did in 2004.

GDPrebalance

Rebalancing was never going to be easy

We knew rebalancing was not going to be an easy task. There is no magic policy lever that can be pulled and “hey presto!” rebalanced economy! It’s also fair to say that this has not been an easy environment to rebalance in, particularly given the weakness in Europe, our main export market.

If we want a faster, stronger more competitive country it’s going to take coordinated effort, and it’s going to take time. It’s a bit like exercise. A person trying to improve their fitness must exercise in a number of different ways – cardio, resistance, flexibility – in order improve overall fitness and avoid injury. They cannot expect one gym session to make the difference, they must stay the course. And too many distractions and missed opportunities to exercise can undermine progress. It is the same with achieving a better-balanced economy. A range of policy mechanisms are needed, combined with policy stability, and a sharp focus on rebalancing.

It just so happens we have some recommendations on how best to do this in our manifesto.

Personal training tips not included.

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