The UK’s national output (GDP) figures for the last quarter of 2010 were a shock. The British economy contracted by 0.5% over the quarter. The apologists were quick to blame the extreme weather that brought transport to a halt in December. But if that is taken out of the equation, the economy still stagnated and is clearly slowing down from the recovery rate of earlier quarters last year. Over the whole of 2010, the UK economy grew just 1.7% after inflation, nowhere near enough to create sufficient jobs to stop unemployment rising or get average incomes improving.
And that’s before the damage to the economy that the planned reductions in government spending and increased taxes hit the economy. VAT was raised to 20% in January and the job redundancies in the public sector are only just being announced in 2010.
In the governing coalition’s plans for the reducing the size of the annual budget deficit over the next four years, the government expects real economic growth to rise by an average of 2.7% a year. This is way too optimistic. As a result, the spending cuts plans just do not add up. Malcolm Sawyer, Professor of Economics at Leeds University, has spelt out exactly why (see M. Sawyer ‘Why the structural budget deficit will not be eliminated by 2015’; http://22.214.171.124/MKB/MalcolmSawyer/budget2010.pdf). Sawyer points out that while domestic private savings is (once again) positive, domestic public savings is negative (the budget is in deficit), so the UK economy runs a current account deficit financed by foreign savings. If both the government and current accounts are to balance (no budget or external deficit), then export growth must recover strongly and private investment must shoot up to match the pool of domestic private savings.
The government reckons it can eliminate the UK’s overseas trade deficit by 2015 because exports will grow by 33% and imports by only 18%. That’s totally at odds with the past decade, when imports have consistently grown faster than exports. Indeed, despite a devaluation of the pound by 23% against other major trading currencies since 2008, export growth in 2010 was still negligible.
To achieve its growth target, the government expects investment to rise by 44% between 2011 and 2015. so that it will rise from 14% of GDP to 19%. That would be the fastest rise in decades, to a higher level than seen in the past decade. And it is to be achieved despite cuts in public sector investment of 40% in real terms over the next four years. So everything depends on private investment growing rapidly to boost exports.
At the same time, there is a major inflation issue. According to the governor of the Bank of England, Mervyn King, British inflation is heading up to a 5% rate this year. As the governor put it so bleakly: “The three factors I described – higher import and energy prices and taxes – have squeezed real take-home pay by around 12%. Average real take-home pay normally rises as productivity increases – money wages normally rise faster than prices. But the opposite was true last year, so real wages fell sharply. And given the rise in VAT and other price rises this year, real wages are likely to fall again. As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.”
Yikes! The average British household has seen their income from work fall for years in a row and we have not even had the government spending cuts, the public sector wage freeze, the VAT rises or the rising inflation bite into real incomes yet. This is misery. It reminds me of what used to be called the misery index. This index was caclulated by adding the unemployment rate to the inflation rate. The higher the sum, the more misery for the average household. Historically, when the index goes into double figures, the pain is pretty severe. Well, the misery index was at 7% in 2009, not too bad. But this year it is going to be nearer 16 – as bad as the early 1990s when many UK manufacturing industries went to the wall.
It won’t be as high as the nightmare figures of the 1970s. But that was because then inflation was nearly always in double figures. The 54-64 year Kondratiev global production prices cycle was reaching its peak in the 1970s (see my book, The Great Recession, chapter 9 for more on this). Now we are near the trough of the cycle, which will probably be reached around 2014-18. Inflation will never get above single figures at worst until the Kondratiev trough is reached. In that sense, a misery index of 16 is really equivalent to 25 as in the 1970s.
In other words, the average Briton has never had it so bad since the second world war.