The Bank of England’s pronouncements last week about the economy were some of the gloomiest it has uttered in recent times. Is it right to be so downbeat?
On one key issue I think that it is. Economic growth in the third quarter will have been boosted by the Olympics and the bounceback from the second quarter’s extra bank holiday. The third quarter figures came out even better than expected and, just as I feared, the Government promoted them to the public as the beginning of recovery.
I readily concede that the Government could be proved right. Let us hope so. But since the release of the third quarter figures, almost all the news about the economy, particularly the various business surveys, has turned negative. The retail outlook for Christmas doesn’t look good either. So it is perfectly plausible that the fourth quarter GDP figure, released in January, will be negative. We could have a triple-dip recession on our hands, which would surely deal a serious blow to confidence.
The more important question, though, is about longer term prospects. It is important to distinguish between demand and supply factors. There is little doubt about the demand factors holding the economy back. The public sector and consumers are both caught up in a prolonged episode of deleveraging made necessary by previous excess, but made worse by the current economic weakness to which their very austerity drive contributes. Their financial plight has been exacerbated by the squeeze on current incomes brought about by the sharp rise in oil and other commodity prices.
One sector is not so badly placed namely companies, or at least large ones but they are unlikely to step up their spending while final demand is held back by the problems afflicting the other two sectors. Meanwhile, the banks, which provide a vital source of support for extra spending by smaller companies, are also engaged in deleveraging.
There is one big sector left namely overseas. In principle, a sharp recovery of net exports could lift the economy. But recent news here too has been downbeat, as the world economy continues to struggle.
The upshot is that I cannot see any room for optimism about a strong recovery next year. Indeed, my own forecast has long been more downbeat than the Bank’s. I have pencilled in growth of only 0.5pc for next year.
Even so, in the years after 2013, unless something goes badly wrong with oil prices, even I, the uber pessimist, think that things should get better. By that stage, earnings growth should be clearly outpacing price inflation, leading to gains in real incomes.
But whether it is a painfully slow economic recovery or something better depends upon things over which we have no control. The cause of much of our current weakness is the major imbalances in the world economy. Admittedly, the aggregate size of these trade imbalances has fallen over recent years. But this is largely because the deficit countries are in an extended depression.
The roll-call of today’s surplus countries consists of all the usual suspects. In emerging Asia, China’s surplus is the biggest, at just under 3pc of GDP. Within Europe, some countries continue to run huge surpluses Germany at more than 5pc of GDP, the Netherlands at 8pc, Norway at 15pc and Switzerland at 10pc. Meanwhile, in the Middle East, Kuwait’s surplus is over 40pc of GDP. For OPEC as a whole, the surplus is 14pc of GDP.
Yet this scene is not without hope. The key is to get the surplus countries to spend more or for the sources of their surpluses to diminish. Instead, at the moment, the adjustment is happening through the deficit countries spending less.
Who knows how the new Chinese leadership will perform? Might it succeed in shifting the balance of the economy away from net exports and investment and towards consumption?
Lower oil prices would transfer real incomes from those countries which, for a variety of reasons, don’t seem keen to spend it, to those countries which, like the UK, have a natural tendency to spend, and have weak balance sheets to repair. There is a distinct possibility that prices could fall back next year. In due course, they could fall a good way as the shale revolution tips the energy supply and demand balance.
Europe (Chicago Options: ^REURUSD - news) may be the most troublesome bit to get right. The eurozone is caught up in an orgy of austerity. If, one way or the other, the euro crisis was solved then this could lead to a resurgence of eurozone growth. But achieving decent growth would still depend upon the surplus countries, led by Germany, acknowledging that they must rebalance their economy away from net exports and towards consumption.
Supply pessimism is a different thing altogether. In a subsequent article I will explain why I think that there is still ample scope for a return to decent rates of economic growth once the current depression of aggregate demand has run its course.
Roger Bootle is managing director of Capital Economics. email@example.com