How should we view the UK’s recent economic performance and prospects for the next decade? A recent paper, published by the Cambridge Centre for Business Research (CBR) at the Judge Business School is more pessimistic than the forecasts of the independent Office for Budget Responsibility (OBR). It also paints a bleaker picture, perhaps unsurprisingly, than the government.
The UK government has been a little quiet about its management of the economy in recent weeks, as much economic data has pointed to a gradual slowdown from a recovery that was publicized ad infinitum as being the strongest in the G7 in 2014. It is par for the course for governments to try to take credit for the good times, and blame the bad times on previous governments or global events, apparently beyond their control.
The report mentioned above suggests that, in the absence of changed policies, growth to 2025 will slow gradually. GDP and productivity growth will not recover to their pre-financial crisis trends. Private debt as a proportion of GDP will rise to unsustainable levels, helping to maintain growth for a while before potentially leading to another financial crisis as house prices fall, dragging the economy into recession. Growth over the medium term will be constrained by the effects of austerity and sluggish growth in world trade. Unemployment will rise slowly, though more quickly if a new recession takes place.
An alternative scenario is put forward by the writers of the CBR report: a fiscal expansion involving a growth in government spending and an increase in the deficit. While this will lead to a rise in the national debt as a proportion of GDP, growth will be faster and unemployment lower over the next decade. The authors admit that this policy shift has some risks, but it may be less so than the baseline described above, as household borrowing will tend to be lower, reducing the potential for a new financial crisis.
Finally the report suggests that a coordinated reflation across the globe would be the first best solution to the sluggishness of the world economy. In the absence of another serious crisis, and with high public debt levels in many countries, this policy shift seems unlikely.
However, there is a fourth scenario not considered by the authors who, with their Keynesian model of the economy, seem limited in their focus on fiscal policy as the only tool to promote economic expansion and reduce unemployment.
The optimum scenario for the world economy, and one which would be more sustainable in the medium term, is for a rebalancing of the major economies, as the economist Michael Pettis has advocated many times. The economies running the largest current account surpluses and deficits need to enact policies which move their economies towards a closer balance between savings and investment. By definition this would also rebalance those economies running current account deficits, since the sum of all surpluses and deficits at the global level is zero.
The relevant economies running large current account surpluses, and thus with an excess of domestic savings over investment, are Germany, China and Japan. In Germany, the corporate and household sectors are saving too much. Rising wages, consumption and badly needed investment, by both the public and private sectors, are necessary. It has quite a high public debt ratio, so unless the government deficit rises, the private sector will need to be encouraged to invest far more of its profits to restore more of a balance between savings and investment. This would also stimulate demand and growth across Europe, helping to reduce more rapidly the scandalously high unemployment which blights many countries, particularly in the eurozone.
Japan also need its firms to save less. Private investment is already relatively high as a percentage of GDP, so improving its allocation may be more important than raising its level. Policies which raise wages and consumption, and increase dividend payments to shareholders, would help in this regard. In fact the government is trying to move in this direction already.
In China, which is currently suffering a gradual slowdown from its three decade long growth ‘miracle’, private sector investment and saving need to fall, the latter more than the former, and consumption to rise, as a proportion of GDP. As Pettis argues, there needs to be a shift of income from the state controlled sector, to the household sector. This could take many years, but it is vital to the future prosperity of China and the rest of the world.
This is not the place to go into all the policy details, but the desired outcomes are clear. A rebalancing of these major economies would help to boost net exports among deficit countries such as the UK, which needs to increase domestic saving relative to domestic investment while sustaining a decent rate of recovery. This will reduce its current account deficit and slow or reverse the rise in public and private debt. Barring a large devaluation of the pound, this is out of the government’s hands.
Politicians and citizens do not often like being told what to do by foreign leaders. What is needed is a wide dissemination and a victory for the sorts of ideas outlined here, so that world leaders can take account of the global effects of domestic policies. They are ultimately answerable to their own people, so these sorts of messages can be difficult to convey. But the changes proposed here are likely to have global benefits, far beyond the less sustainable ones which go-it-alone policies may promote.
Unfortunately, the ideal rebalancing scenario outlined seems remote at present. In the absence of global coordination, citizens fed up with the outcomes of austerity are being drawn to parties promising a reversal of recent policies, but on a narrow national rather than global basis. This may lead to faster growth and lower unemployment for a number of years, but it will also add to public debt levels, potentially constraining future fiscal flexibility.
Thus major policy shifts are needed in those countries with large current account surpluses. These surpluses are deflationary for the global economy as a whole, putting continuous downward pressure on global demand, inflation and interest rates. They also run the risk of provoking another serious financial crisis before we have recovered from the last one.
Expansionary fiscal and monetary policies are not the only way to expand demand: the same thing can come from the private sector. In the surplus countries, the excess of domestic savings over domestic investment needs to fall. If the major economies mentioned above do not change course to promote this rebalancing, then it will happen anyway, but through slower growth as net exports to deficit countries such as the UK fall and unemployment rises. This scenario would clearly be undesirable, but it may well be on its way.