The UK Economy
This week, with the chancellor presenting the penultimate budget of this Parliament, we are going to be inundated with economic and fiscal analysis and commentary. I don’t know about you, but I’m usually put off by this deluge of comment, because most of it belongs in the realm of what I have called “flat-earth economics”.
As an antidote, I’m going to stand back and give you the big picture as I see it. Here’s a necessary warning for those of a nervous disposition – this isn’t going to be a fun read. In fact, it’s going to be very, very nasty indeed.
There’s really only one positive, so I’ll give you that right now. This positive is that George Osborne is a first-rate finance minister. There are those – myself included – who wish that he had cut public spending even further. But we need to remember that, with a single exception, Osborne is the only post-War chancellor who has reduced state outlays at all. The only other administration which has cut expenditures was Labour in the late 1970s, and this hardly counts because cuts were imposed by the International Monetary Fund (IMF). This aside, the trend in public spending has been a one-way street since 1945, and even Mrs Thatcher could do little more than stem this rise.
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The bad news, of course, is that Britain is going to need all of Osborne’s determination and more if a near-helpless economic situation is to be turned around.
In his budget, the chancellor will tell the public that, whilst the situation is improving, much more needs to be done, and that, by implication at least, this is no time to put the nation’s affairs back into the hands of the profligates of the Labour party.
In fact, the chancellor could hardly overstate the magnitude of the problems that remain to be overcome. The reality is that the British economy remains in very, very deep trouble, and that the public has virtually no idea at all about the real state of affairs.
Let’s start with the public perception, which, roughly speaking, is this:
– The British economy grew strongly between 2000 and 2008;
– Output slumped in 2008-09;
– The economy flat-lined after that; but
– A recovery is now under way.
This perception is wrong in virtually every particular. Properly understood, the economy did not grow at all during 2000-08; the 2008-09 slump inflicted far more damage than is usually recognised; and the recovery that we are supposed to be experiencing now is almost entirely illusory.
To understand why, we need to appreciate, first, that gross domestic product (GDP) is an extremely misleading measure of prosperity. As a measure of income, GDP is analogous to a company’s profit and loss account, and no sensible person would assess a company’s performance on this basis alone. The shrewd investor looks not just at profits and losses, but at cash flow and the balance sheet as well. What this in turn means is that you cannot arrive at a realistic analysis of Britain’s economic performance without taking debt into the equation.
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Let’s start with some debt numbers. At the end of 2000, Britain’s debt totalled £2.99 trillion, or 307% of GDP, comprising government debt of £328bn (34% of GDP), household indebtedness of £677bn (69%) and corporate (including financial sector) borrowings of £1.99 trillion (204%).
Move forward to the end of 2008 and the debt-to-GDP ratio had risen from 307% of GDP to 501%, where it remains today. Whilst nominal GDP had grown by £466bn (from £975bn to £1.44 trillion), there had been a vastly larger increase in debt, which had risen by £4.22 trillion (from £2.99 trillion to £7.22 trillion).
Just think about this for a moment. Adding £4.22 trillion of debt to achieve a GDP increase of £466bn means that each £1 of economic “growth” had been purchased at a cost of more than £9 in new debt.
That isn’t growth.
It isn’t even, stricto senso, an economy.
It’s a Ponzi scheme.
Of course, the subsequent slump made these ratios look even worse. Between 2008 and 2012, nominal GDP increased by £120bn, but debt expanded by a further £600bn.
Now, let’s consider the “growth” that we’re likely to experience in 2014. If the optimists are right, GDP will grow at a real rate of perhaps 2.5% this year, a nominal increase of 4.5% if we add back inflation of 2%. In money terms, this would add about £70bn to GDP, which is less than the government alone is likely to borrow. Add in the probable increases in private debt as well (as mortgage funding expands) and you can see that the “recovery” is a case of “same old same old”, with each £1 increment in economic output purchased at a cost of far more than £1 in additional borrowings.
Nor is this all. As things stand, Britain is running a current account deficit of about £60bn, because our exports no longer cover the cost of essential purchases such as food and fuel. Our “growth”, then, is being financed not just by lenders but by trade creditors as well.
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Before finishing this grim litany, there are two other points to consider.
The first of these is that the absolute scale of British indebtedness is even worse than the formal number (of 501% of GDP, or £7.8 trillion). This number includes government debt on the domestic definition, rather than the more demanding Maastricht one. It excludes potential exposure resulting from the banking bail-out. It also excludes quasi-debt commitments such as public sector pensions (about £1 trillion), PFI contracts, nuclear decommissioning and the debts of state-owned corporations.
Second, any impression of economic normality is surely countered by interest rates which, at 0.5%, are far lower than inflation. Five years of negative real interest rates have been terrible for savers, of course, but the implications go much further than that. Without positive returns on savings, a country cannot invest. And, without investment at levels which at least match depreciation, a country’s asset base deteriorates in a process that is tantamount to cannibalisation of the economy.
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So there you have it. Debts are astronomical, the “growth” of the last decade and more has amounted to nothing other than the spending of borrowed money, the asset base is deteriorating through a lack of investment, and creditor forbearance is keeping us in food and energy.
Good luck, Mr Osborne.
You’re going to need it.