Economics – Trender bender: Why we need a new economy

This is not a good time for economists to make predictions.
The old adage that if you have to forecast, you should forecast often, was never
more appropriate. But one claim it seems safe to make in the current climate is
that this recession will end, because, statistically, recessions always end. It
is still not clear how long this recession will last, or how deep it will be.
Between five and seven quarters has been the usual length since the mid-1970s
downturn, and the current dip in activity will be as bad as anything the UK has
experienced since 1945.

The end of the recession, however, is not the same thing as getting back to
normal. There is a big difference. The recession will technically end when the
economy stops shrinking, or when the quarterly GDP figure stops being negative.
A growth rate of 0.0% is enough to declare the recession at an end. Given the
extent to which policy has been loosened recently (interest rates at a 314-year
low, record levels of government borrowing and a much weaker currency), not to
mention quantitative easing, that could happen by the fourth quarter of this
year, making it a five-quarter recession.

But this will not be enough to stop unemployment rising, nor will it generate
the tax revenue the government needs to stop its deficit continuing to escalate.
For this, we need to get back to our trend of sustainable growth rate, thought
by most economists to be an annual rate of around 2.5%, or 0.6% to 0.7% a
quarter. From the technical end of recession to the trend rate of growth is
quite a big jump, and it could take most of 2010 to get there.

What sort of economy emerges from the recession is not an issue which yet
features on policymakers’ radars. With constant media glare and political
attention on the housing market, and using high street activity as the
weathervane of activity, it seems the authorities are trying to kickstart growth
by triggering the mechanisms that got us into trouble in the first place. The
quick fix out of recession may be to persuade consumers to start spending again
and to see house prices and transactions start to move upwards, but it is also a
sure-fire route to the next downturn. Goodbye stability and welcome back boom
and bust.

Some idea of the extent of the economy’s problems can be gauged from a look
at the industrial composition between 2001 and 2007, when GDP rose by 16.5%. The
largest contribution to growth came from the property and business services
sector. This sector, which accounts for 24% of GDP, contributed 39% of the
increase in output. The second largest share, 20%, was from distribution
(wholesale and retail, plus hotels and catering) representing 15% of the
economy. The biggest mismatch between the share of activity and contribution to
growth, however, was in financial services: contributing 3% of GDP, it was
responsible for 17% of the rise in the size of the economy.

The unbalanced nature of the growth in industry terms is very clear. A little
over three-quarters of the jump in GDP between 2001 and 2007 came from three
industries that, together, accounted for 42% of the economy.

The remaining 58% added just 24% of growth. The contribution from industrial
production was actually negative. What makes this particularly worrying as far
as future growth is concerned is that the three industries which were at the
heart of the robust growth are the three which have fallen furthest in the
recession. They are likely to remain in the doldrums, moreover, long after GDP
growth stops being negative. So to get back to trend growth, the UK needs faster
growth from other sectors.

If rebalancing the economy in spending terms means less consumption and more
exports and investment, there are obvious implications in industrial terms. An
industry traditionally export-intensive and requiring investment is, of course,
manufacturing. For years, the UK has experienced the phenomenon common to most
advanced economies of ‘de-industrialisation’ but, after years of being on the
sidelines, manufacturing once again could move centre stage.

There is no point going head-to-head with China in many product markets. But
there are areas in which the UK could have an important comparative advantage
globally, where competition is about being smart, not cheap: pharmaceuticals
rather than basic chemicals, aerospace rather than old-fashioned metal bashing.
There are also parts of services, such as education, that can step up their
exports contribution.

The government has a role in this process, but as an enabler rather than a
producer. Improved communications, better infrastructure links, less regulation,
freer labour markets ­ these are the sort of supply side issues within the
government’s remit that would restore the UK’s reputation as a good place to do
business. If the major firms in the key industries are not already in the UK, we
should try to attract them and persuade them this is where they should be
located. It might be a long haul, but building something sustainable does tend
to take time.