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Unsustainable growth

The UK economy probably sped up at the end of last year, but this might not last
January 18, 2018

UK economic growth might be picking up. If next Friday’s official figures confirm the NIESR’s estimate, they’ll show that real GDP grew by a seasonally-adjusted 0.5 per cent in the fourth quarter, slightly up on the third quarter’s 0.4 per cent.

What you make of this depends upon how you frame it. Viewed from the perspective of post-EU referendum gloom about the economy, it’s good. From the perspective of the UK’s pre-2008 average growth, however, it’s lacklustre: in the 50 years to 2008, GDP grew 2.7 per cent per year. Reactions to the news, then, will tell us less about the real economy and more about the ubiquity and importance of contrast effects.

What we can say, though, is that economists fear that such growth might be unsustainable. This is because it was bolstered in 2017 by two developments that might not last.

One of these has been the strength of our main trading partner, the eurozone. Purchasing managers say manufacturing growth there last month was the strongest since their survey began in 1997. This hasn’t only supported net exports. It has also helped sustain business confidence and hence hiring and investment intentions.

Such growth, however, might not last. More forward-looking surveys such as those conducted by Germany’s Ifo and ZEW research institutes show that business optimism isn’t as impressive as current trading conditions. This points to a moderation in economic activity, although not a dramatic slowdown.

The second support to growth has come from the consumer. Households have increased their borrowing or dipped into their savings this year, thus increasing consumer spending in the face of falling real wages: so far this year the households savings ratio has averaged 5.2 per cent, which puts us on course for the lowest such ratio since 1959.

At some time, however, households will want to rebuild their savings. As they do so – unless we see an improbable boom in incomes – spending growth will slow. Independent forecasters expect real consumer spending growth to slow this year to 1.1 per cent after 1.7 per cent growth last year.

This point here is not that consumers have gone on an irrational binge. Standard macroeconomics – the sort that assumes rational agents – says that when faced with a temporary shock to incomes, people smooth their spending by adjusting their savings or borrowing. Last year’s fall in savings is consistent with this.

All this raises the question: if growth last year – moderate as it was by long-term standards – was only possible because of temporary supports, how might we return to sustained decent growth?

One thing we need is productivity growth; if workers produce more they can earn and spend more (yes, it is that simple). And here we have had good news: latest figures show that hours worked fell by 0.6 per cent in the three months to October, implying that productivity rose by over 1 per cent. That sort of growth is almost certainly unsustainable; it’s twice the pre-2008 trend growth rate. It does, however, hint that we might finally be pulling out of the decade-long stagnation in productivity. If we are – and it is only an if – then we have genuine reason for optimism. Ultimately, in fact, this is our only reason for optimism.