The BBC reported on Tuesday that government borrowing for the 2017-18 financial year fell to its lowest level in eleven years, at £42.6bn. This was lower than forecast and represents 2.1% of GDP. However much of this reduction is accounted for by reduced spending rather than increased tax revenue. This is because economic growth remains sluggish, at 0.1% in the first quarter of 2018 according to the latest figures, and is failing to generate buoyant tax receipts.
So austerity continues, while growth is faltering. The Chancellor, Philip Hammond, claimed today that “our economy is strong and we have made significant progress.” This is surely breathtaking arrogance. The deficit may be down, but the economy is struggling.
According to economist and entrepreneur John Mills, the UK economy could be doing much better and significant imbalances remain, which are constraining growth and improvements in productivity and wages.
The sectoral financial balances approach to analysing the economy was pioneered by the late post-Keynesian economist Wynne Godley. One implication is that the sum of government, corporate and household net borrowing for a particular economy is equal to net lending from the rest of the world, as a matter of accounting. Net lending from the rest of the world is equal to the current account deficit of the economy in question.
This approach allows one to see how, for example, falling government borrowing relates to falling savings in other parts of the economy or abroad.
It also shows where growth in demand is coming from and how sustainable it is. If the economy is growing rapidly, but debt is growing even more rapidly, then when the growth in debt slows or reverses, a period of stagnation or recession will result.
According to the April bulletin of The £ Campaign, of which Mills is the Chairman:
“the most striking feature is the huge change from Households as net lenders to the rest of the economy to being net borrowers – a swing of over £30bn between 2016 and 2017. Corporations, however, borrowed £30bn less in 2017 than in 2016. These two changes allowed government borrowing to fall by about the same amount as the reduction in the overall balance of payments deficit…
Households are currently borrowing very heavily to support living standards they are not earning while substantially decreased Corporation borrowing reflects low levels of investment. The UK economy is far too dependent on consumer demand instead of net trade and expenditure on new machinery and factories.”
He goes on to say that
“Another major imbalance is also cause for serious worry. This is our huge balance of payments deficit with the EU27…In 2017, whereas we had a balance of payments surplus with the Rest of the World of £12.7bn, we had a deficit with the EU27 of £95.6bn – more than the UK’s total overall deficit of £82.9bn. This is because sterling is…much too strong against the euro to enable us to hold our own in our trade with the EU.”
A lower exchange rate is therefore needed, particularly against the euro. Initially at least, this would be bad news for households, as it would mean lower household income as a share of GDP. In fact this is what has happened since sterling fell following the vote for Brexit, as inflation rose and real wages continued to stagnate. These trends are only now beginning to subside.
Mills argues for an even lower exchange rate than at present, in order to rebalance the economy towards net exports and investment. If the economy did rebalance in this way, then faster growth and falling debt shares in GDP, both public and private, would result. Households as a whole would initially lose, but gain in the longer run as higher investment and productivity feed through into higher real wages.
“Because of the increases in productivity which would be achievable from much higher levels of the types of investment typical of light manufacturing – mechanisation, technology and power, the sectors which produce large increases in output per hour – it would be possible to get the economy to expand cumulatively at 3% to 4% per annum…[enabling] there to be real wage and salary increases for almost everyone, net of inflation. By concentrating new industry mostly out of London and the South East, we would then be able to start redressing the huge regional imbalances from which the economy currently suffers. By combining industrial with social investment – in schools, hospitals, road, rail and housing – and providing a much better range of jobs – we should be able to alleviate at least the worst of the problems faced by the millennial generation.”
Something needs to change if we are to achieve more widely shared and sustainable prosperity, Brexit or no Brexit. Mills makes a strong case that a weaker exchange rate is part of the solution. However, it may be politically difficult to overcome the resistance of the Treasury and the financial sector to sustaining a weaker pound. To make it a policy priority in a way that avoids losing face could be difficult. But it needs to be done.