The British economy is facing a period of prolonged stagnation. The remedy is an injection of fresh ideas and solutions to attack the problem of productive weakness - and a new role for the state, suggests Ben Hunt.
Few can doubt the fragility of the British economy. Expectations that the economy would continue its recovery and grow have been dashed by figures that show stagnation since last year. While the Office for Budget Responsibility estimates that growth will be 1.7% this year - a figure that itself has been revised downwards twice - more bearish forecasts such as that from Morgan Stanley, an American bank, predict 1.2%.
The observation that inflation is growing faster than wage rises - the much-discussed “squeezing of living standards” - has added to the gloom, with Mervyn King, the governor of the Bank of England, pointing out that Britain has not experienced such a continuous fall in living standards since the 1920s. Political pressure on the government has returned, with opponents and critics calling for a Plan B.
The picture, says Peter Dixon, the chief UK economist at Commerzbank, a German investment bank: “is that we cannot grow our way out of the problem that easily. There are too many dominant headwinds in the near term, such as inflation and the household deleveraging, where consumers continue to pay off debt rather than spend. So the near term is poor. In the medium term we will probably not get back on the growth path we had before the crisis.”
Dixon concedes that the recent downward revisions to growth do not bode well and does not rule out a Japanese-style longer-term stagnation. At present, however, “we just don’t know what will happen. If we stumble along at 2% instead of 3% for five years, keep unemployment from rising, and reduce overall debt, that would be an acceptable recovery and form of economic rebalancing. We cannot expect to get back to normal; we are paying the price for the build-up of debt.”
It is not known if the economic downturn is a mid-cycle event or something more serious, says Alec Letchfield, the manager of the HSBC UK Focus fund. “The government has taken a view that it is far better to have slower growth than the crisis of investor confidence that Greece suffered from. So it is a lesser of two evils. The Bank of England is keeping interest rates low to compensate for tight fiscal policy. The government is unlikely to do a U-turn but if the economy deteriorates in a more serious way we may see some kind of capitulation.” One bright spot says Letchfield is that “the performance of the UK stockmarket has been good given the standing of the UK economy. Given that around 67% of it is related to earnings from abroad it has a high exposure to global growth.” (Cover story continues below)
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