Lord Flight was Shadow Chief Secretary to the Treasury from 2001-2004. He is now chairman of Flight & Partners Recovery Fund.
Three years ago, I commented that I expected to see three per cent growth for the 12 months leading up to the 2015 election. People thought, at the least, that I was extremely optimistic. It now looks as if we might get four per cent! The economy grew by 0.8 per cent in the first quarter, with manufacturing up 1.3 per cent. For the first time in a decade, all three main sectors of the economy – manufacturing, services and construction have grown by at least three per cent over the past year. The “on shore” economy, excluding North Sea extraction which has been in decline because of depletion of reserves, has already surpassed its pre-crisis peak.
With the throttle full on for both monetary policy, in terms of both QE printing of money and artificially low interest rates, as well as fiscal policy, where the deficit is still over £100 billion, it is difficult not to take the cynical view that, at some stage after the election, there will be some unpleasant form of “bust”.
The Bank of England looks to be taking risks in keeping interest rates artificially low – probably with no changes until after the election. As a result, rates may need to rise more than would otherwise be the case in 2015/16. Clearly, mortgage borrowers with unfixed interest rates will hurt, if and when variable mortgage rates double or even treble from their present very low levels. Property prices in Central London and to a large extent the whole of the South East are, again, too high, particularly in terms of earnings’ multiples.
The strongest sector is also, again, services – which suggests an unsustainable build up in consumer borrowing is now in train.
But I am inclined to be more optimistic for three particular reasons.
First of all, what is happening is in essence a catch up on “six lost years”, and because of this the Bank of England may be correct in taking the view that there is still of the order of 1.5 per cent slack in the economy. Social changes are also occurring, adding capacity, particularly with many more people working over 65 – indeed, this has been the largest element in the dramatic growth of self-employment. The catch up process should not be complete until the GDP is comfortably – e.g five per cent – in excess of its previous peak.
Moreover, at least for the foreseeable future, the monetary dangers look to be more of deflation rather than inflation – not just in the Eurozone, but also in the UK.
Secondly, I observe an explosion of entrepreneurial activity taking place, particularly in the new technology sectors and amongst the young as well as the old. 4.5 million people are now self-employed, where the total has risen by 621,000 since 2010. Higher levels of self-employment do not appear to have been associated with inflows of people recently made redundant.
Thirdly, I am hopeful that at last significant catch up increases in investment, in manufacturing and in exports are now in train. This will take pressure off consumption and the service sectors as the main driver of economic growth.
My main negative is that the biggest need is for a long term increase in the savings rate to achieve a better balance in the UK economy, and indeed to head off another “bust”, in due course. Here the evidence is mixed. The forecasts are, alas, for a fall in the savings rate to around three per cent. Hopefully, the Chancellor’s Budget, which was designed to be a Budget for Savers, may serve to boost savings, and, in particular, the increase in the ISA limit to £15,000 p.a. The main problems and boom to bust tendencies of the UK economy since the Second World War can be attributed, largely, to too low a savings rate – in turn, part of the cause of too low a level of investment, as well as unsustainable increases in borrowing.
As regards the fiscal deficit, the Chancellor looks to have been right in largely “talking Hayek” but “doing Keynes”. Welfare and health expenditure (approximately £350 billion a year) now account for nearly half of total public expenditure, and continue to grow at a rate faster than either the economy or tax receipts. This is clearly unsustainable longer term; but the performance of the UK over the last 4 years demonstrates that, where the internal devaluation policies in the Eurozone for southern Europe have been an economic disaster in terms of employment and their impact on government debt and borrowing, the slower process of reducing public expenditure in the UK has been successful, and so allowing the impact of economic growth to contribute to sorting out the public finances.
Looking forward beyond 2015, it is clear that interest rates will need to rise to market levels and public spending will need to be cut significantly further. This will, however, be easier to achieve against the background of a strong economy.