What killed the UK recovery?
It is now fairly widely acknowledged that the British recovery has stalled in 2011. Whilst Britain may yet avoid a double dip recession growth looks set to be sluggish.
Given the more pessimistic outlook it is important that policy makers are clear about the reasons for this slow down, otherwise we risk a misguided policy response.
George Osborne is relatively clear that the slower growth profile of theUKeconomy, and the reasons that 2011 growth may well miss the OBR forecasts, is because of a more troubled global outlook – the debt standoff in the United Statesand the ongoing Eurocrisis in particular.
The left meanwhile are mainly focussed on the impact of austerity.
Both answers risk missing the point – what is killing the UK recovery is actually falling real wages.
Each month he Treasury publishes a compilation of independent forecasters views on the UK economy. The table below shows the median forecast from back in January (when optimistic observers expected growth of 2.0%) and the most recent forecasts from July, when the estimate had fallen to just 1.3%.
For completeness sake I have also included the OBR’s own numbers.
Whilst there has been a lot of attention (rightly) paid to the falling headline number, I have seen less comment on the make up of that falling growth forecast.
The first thing to notice is that since January independent forecasters have revised up their export growth forecast and revised down their import forecast (as a result of domestic weakness meaning less imports). The end result is that the contribution of net trade to GDP growth was expected to be 0.5% in January but is now expected to be 1.3%. In other words – for all George Osborne’s talk of global headwinds hitting growth independent forecasters now expect Britain’s export performance to be better than they did in January. A questionable assumption maybe – but weaker external is not a fact explaining the downgrades to the growth forecast.
What has caused growth to be revised down is dramatic collapse in domestic demand forecasts from an expected 1.5% contribution to growth in January to just 0.1% now.
The chart below demonstrates this:
What has caused this collapse in domestic demand? A huge fall in private consumption forecasts from expected growth of 1.2% in January to an expected contraction of 0.3% in July.
Whilst the government has talked up exports and investment for the past year and the opposition has focused on spending cuts, the consumer outlook has become dire.
Why has consumer spending been revised down so heavily?
A substantial part of the answer can be found in falling real wages. Back in January independent forecasters expected RPI inflation to be 4.0% in 2011 and average earnings to grow 2.6%, implying real wages would fall by 1.4%. They now forecast RPI of 5.3% and average earnings growth of 2.5%. Real wages are now expected to fall by 2.8% – double the estimate of January.
Because of this consumption estimates have been radically revised down and GDP with it.
If one wants an answer to why the recovery is faltering, one would do well to start looking at real wages – an area policy makers haven’t spent anywhere near enough time talking about.