Monday, November 28, 2011

Tough Choices for UK Economy

Many are saying it’s a difficult to time to be a chancellor. This is certainly true, but it’s also difficult time to be a saver (negative real interest rate of -4.5%) or difficult to be an average worker (biggest fall in real incomes – 3.5% since Great Depression.)

It’s not great news if you’re a public sector worker who faces wage freezes and a higher retirement age. It’s undoubtedly hardest for the 3 million unemployed

The OBR may predict growth of 1% in 2012 for UK, but most analysts would choose something closer to 0%.

This prolonged period of slow / negative growth is manifested in record levels of unemployment, especially amongst the youth unemployed. This kind of negative output gap cries out for fiscal stimulus – higher government spending and lower taxes.

But, the UK’s budget deficit is still very high and despite the overly-enthusiastic spending cuts – the deficit is falling at a disappointingly slow rate. (The disappointing deficit reduction caused in part by the fall in GDP caused by the spending cuts themselves)

Historical UK debt as % of GDP might not look so bad. But, with the Euro crisis getting worse almost every day, markets are keenly watching any sign of government debt weakness. It is true the UK’s monetary and exchange rate independence gives us more room for maneuver than Euro members, who are stuck in a perilous deflationary spiral. But, in the current climate, even the bravest Keynesian may baulk at the scale of fiscal expansion necessary to catch up all the lost output.

A sensible solution would be to pursue some short-term infrastructure projects to create some demand, and at least some sense of urgency for growth. To reassure markets, the government could try target long-term fiscal strengthening measures which don’t harm short-run economic growth. Raising pension age, is one way to reduce the structural debt, without cost of short-term unemployment. But, raising pension age has incurred a huge public sector strike. It seems there is no popular way to increase growth and reduce debt.

At least, the UK has an independent Central Bank able to consider the wider public interest and not just the threat of inflation in northern Europe (i.e. Germany) Quantitative easing is far from perfect - banks sit on most of this extra cash, it’s unfair e.t.c. But, I still feel it is better than nothing. At least, we have some monetary stimulus amongst all the other dire news and global deflationary pressures. The Bank of England may have incurred wrath of savers this year, but they've done a big favour to hopes of recovery (and the government)

Another plus, is that the UK has avoided the bond market turmoil of the Eurozone. But, it’s not a time to feel smug for staying outside the Euro. Whether we like or not, a large proportion of our exports (60%) go to Europe. If Europe is dragged into a deep depression (which is increasingly likely, despite all the non-reassuring promises to the contrary), it will harm our prospects. When you have growth forecast of 0% a recession in your main trading partner is bad news.

The government made a mistake in cutting spending so hard on coming to power. To some extent they are perpetuators of their own misfortune. Their recent growth package gives the impression of being political spin, brought out almost as an after-thought.

Yet, they inherited a difficult economic climate, and events in Europe and abroad are largely out of their control. Like so many times, since 2007, we keep saying ‘well I guess it could have been much worse’

Yet, despite their obvious mistakes, and the inequity of the bank bailouts, I have mixed feelings about the upcoming public sector strikes. We can’t afford the luxury of bankrupting the country just so we can help workers gain 35 + years of state pensions. No matter how much we would like to retire at 65, there are unfortunately, more pressing priorities.


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