This article is the third of three pieces in our special report on the recovery. Click to read the first. Click to read the second.
The UK economy is finally in full recovery. It has expanded by a little over 3 per cent in the past year, and the last five quarters have all seen a pace of growth above our historic average. Economic output is back to the pre-recession peak (although the picture is rather less favourable in terms of output per head, down over 5 per cent, since the UK’s population has been rising). This revival, and the strong job creation that has accompanied it, are very welcome. But there are mutterings that it is “unsustainable.”
The pace of growth probably won’t be sustained. Fiscal policy has been more or less neutral this year but is set to tighten, and whoever takes office after the next election will not find much scope for easing these plans. Monetary policy has been extremely supportive of the economy but may now start to be less so. There are concerns about encouraging too much debt to be taken on while the bank rate—the interest charged on loans made by the Bank of England to domestic banks—is low, and about whether the economy is operating at its full potential capacity. However, even if the bank rate rises as high as 1.5 per cent by the end of 2015, policy will still be pretty positive for growth. Savers, who have had several lean years, will benefit from higher interest rates and their behaviour will offset in part the adverse impact on borrowers.
But asking whether an economic situation is sustainable is perhaps not a good question: a big enough global shock—from commodity prices, or default in a major nation—can knock any economy off course. A better question is how resilient an individual economy is to such shocks.
The UK’s resilience would benefit from the slightly tighter policies that are anticipated and a modest slowdown. The Financial Policy Committee at the Bank of England is clearly concerned to avoid an increase in the number of mortgaged households who are vulnerable to higher interest rates. And there is a risk that further rapid pick-up in activity here, while much of Europe is still sluggish, might result in a decline in our exports when the UK already has a considerable current account deficit, largely due to financial flows.
A slowing in the pace of growth would not then be bad news. It would be worrying if the growth we were enjoying were unsustainable in a more fundamental sense, for example, because we were building up too high a level of debt as a nation.
On investment there are positives and negatives. Investment in formal education has continued to be strong. However, with fewer younger people moving easily into the labour force after they have taken degrees, there will be a weakness in building up the skills learned in employment. On infrastructure the UK continues to under-invest relative to other countries. But the story is more positive for business investment, which rose by over 10 per cent in the year to the first quarter of 2014. Business surveys suggest the outlook is also favourable.
Debt sustainability is a mixed picture, too. The household sector as a whole had increased its savings following the financial crisis, but more recently has again been taking on debt as the mortgage market has eased. Households have very varying circumstances but it is likely that for some debt is uncomfortably high. And the UK’s government debt remains at a high level, although there is no difficulty in financing this.
The doomsayers are partially right. Although this is a pretty robust and broad-based recovery, maintaining resilience might mean a slowdown in 2015. The investment picture is improving, but there are worries that young people are not acquiring skills, and about infrastructure investment. These trends may make it harder for the UK’s productivity growth rate to return to pre-recession levels, and that would constrain the pace of recovery in future years.
There is another sour note. The story above is mostly about averages. Beneath these there has been little progress, indeed rather the reverse, in tackling inequalities of income and wealth. It hasn’t as yet been a recovery for all.
The UK economy is finally in full recovery. It has expanded by a little over 3 per cent in the past year, and the last five quarters have all seen a pace of growth above our historic average. Economic output is back to the pre-recession peak (although the picture is rather less favourable in terms of output per head, down over 5 per cent, since the UK’s population has been rising). This revival, and the strong job creation that has accompanied it, are very welcome. But there are mutterings that it is “unsustainable.”
The pace of growth probably won’t be sustained. Fiscal policy has been more or less neutral this year but is set to tighten, and whoever takes office after the next election will not find much scope for easing these plans. Monetary policy has been extremely supportive of the economy but may now start to be less so. There are concerns about encouraging too much debt to be taken on while the bank rate—the interest charged on loans made by the Bank of England to domestic banks—is low, and about whether the economy is operating at its full potential capacity. However, even if the bank rate rises as high as 1.5 per cent by the end of 2015, policy will still be pretty positive for growth. Savers, who have had several lean years, will benefit from higher interest rates and their behaviour will offset in part the adverse impact on borrowers.
But asking whether an economic situation is sustainable is perhaps not a good question: a big enough global shock—from commodity prices, or default in a major nation—can knock any economy off course. A better question is how resilient an individual economy is to such shocks.
The UK’s resilience would benefit from the slightly tighter policies that are anticipated and a modest slowdown. The Financial Policy Committee at the Bank of England is clearly concerned to avoid an increase in the number of mortgaged households who are vulnerable to higher interest rates. And there is a risk that further rapid pick-up in activity here, while much of Europe is still sluggish, might result in a decline in our exports when the UK already has a considerable current account deficit, largely due to financial flows.
A slowing in the pace of growth would not then be bad news. It would be worrying if the growth we were enjoying were unsustainable in a more fundamental sense, for example, because we were building up too high a level of debt as a nation.
On investment there are positives and negatives. Investment in formal education has continued to be strong. However, with fewer younger people moving easily into the labour force after they have taken degrees, there will be a weakness in building up the skills learned in employment. On infrastructure the UK continues to under-invest relative to other countries. But the story is more positive for business investment, which rose by over 10 per cent in the year to the first quarter of 2014. Business surveys suggest the outlook is also favourable.
Debt sustainability is a mixed picture, too. The household sector as a whole had increased its savings following the financial crisis, but more recently has again been taking on debt as the mortgage market has eased. Households have very varying circumstances but it is likely that for some debt is uncomfortably high. And the UK’s government debt remains at a high level, although there is no difficulty in financing this.
The doomsayers are partially right. Although this is a pretty robust and broad-based recovery, maintaining resilience might mean a slowdown in 2015. The investment picture is improving, but there are worries that young people are not acquiring skills, and about infrastructure investment. These trends may make it harder for the UK’s productivity growth rate to return to pre-recession levels, and that would constrain the pace of recovery in future years.
There is another sour note. The story above is mostly about averages. Beneath these there has been little progress, indeed rather the reverse, in tackling inequalities of income and wealth. It hasn’t as yet been a recovery for all.
