No recovery in 2013

Britain’s economy was again a disappointment last year, in an environment marked by a deepening eurozone crisis. Will 2013 bring the long-awaited recovery? It is hard to foresee a strong rebound, as demand both at home and abroad will probably remain weak.

The consensus among economists is that national output will grow by around 1 per cent. Yet there are some positive signs in the labour market. Combined with close fiscal oversight from organisations including the Office for Budget Responsibility and continuing reform of policies such as welfare and land-use planning, these raise hopes that a robust economy will eventually emerge from the deepest recession in nearly a century.

Britain’s economic output remains well below its pre-crisis level. But the government is constrained in what it can do to boost activity. Slow growth has delayed Britain’s return to a balance between income and expenditure, and this has left little room for the government to increase spending.

The budget deficit is still more than 8 per cent of GDP, one of the largest among industrialised nations. The government will probably fail to meet the objective it set itself—to start bringing down its debt as a percentage of GDP by 2015-16. Of course, if the interest paid on government debt is excluded, the deficit has shrunk by nearly 4 percentage points of GDP since 2009. But although Britain can still borrow money at favourable rates as financial markets are confident it can pay its debts, the deficit needs to be reduced further.

The Bank of England, which usually stimulates economic activity by lowering interest rates, cannot lower them any further. Quantitative easing—buying up assets to inject money into the economy—has had a significant positive impact on GDP since 2009. More may be needed if growth fails to gather momentum but other tools can increase access to credit, especially for households and small and medium-sized businesses.

For example, the Funding for Lending Scheme, where the Bank lends money to banks at cheap rates, is pushing down mortgage rates and increasing available credit. In September, the government announced it would promote affordable homes and infrastructure projects, which could help revive housing sales, rentals and construction. Investment in residential property remains about 40 per cent below its pre-crisis peak. Given the shortage and high cost of housing, building homes would generate activity and jobs, and improve social conditions.

But there is only so much that short-term policies can achieve. The need to pay off debts, a shortage of credit and lack of appetite for risk all hinder recovery. Even the successful reforms to restore competitiveness and fiscal sustainability in the Nordic countries and Canada in the 1990s were slow to bear fruit, and these were carried out under much more favourable economic conditions.

For Britain to return to growth that is socially inclusive and environmentally sustainable, the government will have to make structural reforms. Britain can build on its strengths, such as its flexible labour and product markets, its business-friendly environment and openness to foreign investment. It also has top-class universities and one of the world’s major financial centres.

Despite its sluggish growth in output, more than half a million jobs have been created since the end of 2011. Unemployment has declined from a peak of 8.4 per cent in the last quarter of 2011 to 7.7 per cent in the three months to November 2012, in sharp contrast with most eurozone countries.

The flexibility of Britain’s labour market makes stagnation slightly more tolerable in the short-term than in countries where rigid labour markets have contributed to very high unemployment. Yet there is a price to pay, as many jobs are part-time or temporary; when you take account of inflation, wages overall are declining. If economic weakness lingers, there is a risk of further polarisation between full-time employees and those in part-time, insecure, often low-paid work.

The government could do more to raise the number and quality of jobs. Vocational training must be designed in close cooperation with employers, as in Austria and the Netherlands, where youth unemployment is much lower. The welfare system should protect the most vulnerable but not be an alternative to work. The universal credit reform, rolling several benefit payments into one, will streamline welfare and improve work incentives; it is expected to boost employment. Potential inroads into poverty will, however, be offset in the short-term by other changes, such as cuts to housing benefit and scaling back of benefits. Lowering childcare costs, too often an obstacle for parents in taking up work, is crucial; the government’s announcements in this direction are welcome.

Improved welfare and labour policies could raise the number of better-qualified employees. Making workers more productive will help boost output. A workforce with enhanced skills tends to foster entrepreneurship and encourages firms to create jobs. But this can only help to increase employment and raise living standards when implemented alongside structural reforms to enhance growth. Some are included in the government’s Plan for Growth, which contains a wide range of measures to improve the UK’s economic health and competitiveness.

Going further, infrastructure investment, notably in transport and power generation, is essential for a more competitive and greener economy. Planning restrictions must be loosened to boost construction, create jobs and help make housing more affordable. Britain’s competitiveness must be strengthened and business innovation encouraged through streamlining regulations and tax. Reforms of R&D and corporate taxation should focus on rewarding social returns above private ones. An OECD report to the recent G20 finance ministers’ meeting argues that corporate tax systems need to be modernised at the international level to stop multinationals shifting their profits offshore, depriving the countries in which they operate of tax revenue.

UK firms, with support from government, need to be more ambitious abroad, especially in high-growth emerging countries. British exports to the eurozone’s periphery (Greece, Italy, Ireland, Portugal and Spain) are twice as large as those to the BRIC nations. OECD-World Trade Organisation research suggests the UK’s relationship with emerging economies could be improved.

It is important to remember that about half of Britain’s exports go to EU countries, and that is likely to remain so for some time. The destiny of Britain is intimately linked to Europe; it should engage actively in the construction of a stronger and more resilient EU.