Pre­dic­tions for the UK econ­omy may be gloomy

Enterprise - - Contents - By Chris Giles

From Pollyanna to Cassandra in un­der a day, the UK gov­ern­ment’s in­de­pen­dent eco­nomic fore­caster has learnt how quickly its rep­u­ta­tion can change. Crit­i­cised for its de­luded op­ti­mism, econ­o­mists united to say the Of­fice for Bud­get Re­spon­si­bil­ity was too gloomy.

At stake is the OBR’s judg­ment that the UK econ­omy can only grow 1.5 per cent a year with­out run­ning into trou­ble. As re­cently as July 2015, it thought 2.5 per cent was pos­si­ble, so its out­look has al­most halved in just over two years. The fig­ure — the po­ten­tial growth rate of the econ­omy — is both the most im­por­tant and least cer­tain judg­ment OBR chair­man Robert Chote and his Bud­get Re­spon­si­bil­ity Com­mit­tee make.

It is vi­tal be­cause if the UK econ­omy av­er­ages 2.5 per cent growth, liv­ing stan­dards will rise close to historical norms and suf­fi­cient rev­enues will be col­lected to fund an age­ing pop­u­la­tion with­out higher tax rates. But at 1.5 per cent a year, none of this ap­plies. Av­er­age pay and in­come growth will be fee­ble and Bri­tain will have to choose between worse pub­lic ser­vices and higher taxes.

The ques­tion is whether the OBR has spilled too much red ink over the longer-term eco­nomic fore­casts, as most in­de­pen­dent fore­cast­ers seem to be­lieve. Sadly, it is on pretty firm ter­ri­tory.

Any rea­son­able fore­caster might start by look­ing at Bri­tain’s per­for­mance over the past decade to gain a sense of the fu­ture. The econ­omy has grown at an av­er­age an­nual rate of 1 per­cent, yet un­em­ploy­ment is lower now than be­fore the cri­sis in 2007. Since un­em­ploy­ment can­not fall for­ever, the past decade’s sus­tain­able growth rate has there­fore been less than 1 per cent.

Look­ing at more re­cent trends also sug­gests a strug­gling Bri­tish econ­omy. While the per­for­mance of the rest of the G7 league of lead­ing economies has been im­prov­ing, Bri­tain has ex­pe­ri­enced a slow­ing growth rate this year, with com­pa­nies re­luc­tant to in­vest and ex­ports ris­ing slowly de­spite ster­ling’s fall. Mov­ing from the top of the G7 growth league ta­ble to the bot­tom is more than sug­ges­tive that all is not well with the UK econ­omy.

Tak­ing a dis­ag­gre­gated view does not im­prove the out­look ei­ther. Part of an econ­omy’s po­ten­tial growth rate comes from in­creased labour re­sources. This has been a boon for Bri­tain in re­cent years with high in­ward mi­gra­tion, a record em­ploy­ment rate and in­crease in av­er­age hours worked. But the lat­ter two can­not keep ris­ing for­ever and it is now pol­icy to re­duce mi­gra­tion.

The other build­ing block of sus­tain­able growth rates is Bri­tain’s pro­duc­tiv­ity — the amount of out­put pro­duced for every hour worked. It has not in­creased in the past decade, so an OBR fore­cast that it will re­cover to grow at half its his­toric rate is far from un­duly pes­simistic.

All of th­ese sense checks ig­nore Brexit and as­sume things will carry on much as be­fore. That is an op­ti­mistic bias, since it is easy to ex­plain how a de­te­ri­o­ra­tion in Bri­tain’s trad­ing re­la­tion­ship with the EU will hit the ef­fi­ciency of sup­ply chains and pro­duc­tion, but dif­fi­cult to see pro­duc­tiv­ity gains from Brexit.

As a fi­nal check, peo­ple mak­ing sen­si­ble judg­ments might look at the UK and ask the sim­ple ques­tion whether prospects should be better, about the same, or worse than those in sim­i­lar coun­tries. Un­less you are sure Bri­tish peo­ple are su­pe­rior to those in the US or Europe, you would want to sup­port the OBR. The Fed­eral Re­serve thinks the US can grow at about 1.8 per cent a year sus­tain­ably, while the Euro­pean Com­mis­sion thinks 1.5 per cent is the right fig­ure for the euro­zone.

Of course, some­thing might turn up over the next few years show­ing the OBR’s judg­ment to be too gloomy. We should all cling on to that hope, but not count on sal­va­tion just around the next cor­ner. Re­mem­ber, Cassandra’s affliction was to see the dim fu­ture ac­cu­rately, but to be be­lieved by no­body.

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