Green shoots emerge from eco­nomic train wreck

The nation had an ex­trav­a­gant Labour govern­ment that was con­stantly rais­ing taxes. There was an over-re­liance on fi­nan­cial ser­vices. The trade and bud­get deficits kept get­ting big­ger.

The Pak Banker - - Editorial5 - Matthew Lynn

Look­ing for a coun­try you can in­vest in that is both po­lit­i­cally sta­ble and likely to grow a lot faster than the global av­er­age in the next five years? For­get the emerg­ing economies of Asia and South Amer­ica: They score fine on the sec­ond point, but not so well on the first. And you can rule out most of Europe: The euro cri­sis will snuff out growth for years. The U.S. won't be much bet­ter with its bud­get and trade deficits.

Its econ­omy has been a mess for the past few years. The nation had an ex­trav­a­gant Labour govern­ment that was con­stantly rais­ing taxes. There was an over­re­liance on fi­nan­cial ser­vices. The trade and bud­get deficits kept get­ting big­ger.

Now there are signs the U.K. is turn­ing the corner. Bri­tain's cur­rency, the pound, has weak­ened faster than those of most other ma­jor na­tions, al­low­ing ex­ports to be­come more com­pet­i­tive. Its new coali­tion govern­ment un­der Prime Min­is­ter David Cameron is prov­ing to be skilled at get­ting the bud­get deficit un­der con­trol. Ex­cept for a few ri­ot­ing stu­dents, the Bri­tish are get­ting used to belt-tight­en­ing mea­sures. And the coun­try can only ben­e­fit from the fi­nan­cial chaos that is emerg­ing in the euro area.

It wasn't a co­in­ci­dence the U.K. econ­omy crashed so badly in the past two years. In re­al­ity, Bri­tain's rel­a­tive po­si­tion had been de­clin­ing for years. For the sec­ond half of the last decade, it was only a prop­erty and bor­row­ing boom that kept the econ­omy grow­ing. The U.K. was a train wreck wait­ing to hap­pen.

Yet this year some­thing strik­ing has hap­pened. The econ­omy has ex­panded at a de­cent rate -0.8 per­cent in the third quar­ter, and 1.2 per­cent in the three months be­fore that. Some credit should go to Gor­don Brown's Labour govern­ment, but which­ever way you look at it, those are good num­bers for a coun­try hit hard by the credit crunch.

It looks set to con­tinue. The Of­fice for Bud­get Re­spon­si­bil­ity, the govern­ment's fis­cal watchdog, now pre­dicts the econ­omy will grow 2.1 per­cent next year, and by 2.6 per­cent in 2012. Again, those are very re­spectable num­bers for an econ­omy emerg­ing from a fi­nan­cial cri­sis.

But the in­ter­est­ing ques­tion is whether the U.K. can out­per­form those ex­pec­ta­tions and grow much faster than most other economies. Here are four rea­sons why it may well do so.

One, the pound de­pre­ci­ated early, slump­ing against the euro as soon as the bank­ing cri­sis hit. Go back to 2007 and the pound was trad­ing at close to 1.50 eu­ros. By the end of 2008, it dropped as low as 1.02 eu­ros. It has re­cov­ered since then, mainly be­cause the euro is so weak. The re­sult, as the text­books would say, has been that the U.K. is ex­port­ing again. Septem­ber fig­ures showed man­u­fac­tur­ing ex­pand­ing, and the trade deficit shrink­ing, as the U.K. sells more prod­ucts to other coun­tries.

It is, of course, just a start. But once a trend gets es­tab­lished, it tends to ac­quire mo­men­tum. And, as any Ger­man will tell you, there is no bet­ter way for an econ­omy to dig its way out of trou­ble than to ex­port more.

Two, the bud­get deficit is be­ing taken se­ri­ously for a change. The gen­eral elec­tion this year looked messy, with no party se­cur­ing an over­all ma­jor­ity. But the coali­tion put to­gether by Cameron is prov­ing a lot stronger than most peo­ple ex­pected. It has set out a five-year pro­gram of cuts to pub­lic spend­ing that should bring the deficit down to man­age­able lev­els. The coali­tion is find­ing it a lot eas­ier to make tough de­ci­sions than a Con­ser­va­tive govern­ment with a small ma­jor­ity would have been able to.

Three, the U.K. is be­com­ing more com­pet­i­tive. Av­er­age weekly earn­ings are ris­ing at an an­nual rate of 2.2 per­cent. In­fla­tion is run­ning at 3.2 per­cent. So, in real terms, the Bri­tish are ac­cept­ing a cut in liv­ing stan­dards. That's painful when taxes are be­ing raised. But there is no bet­ter way to make your econ­omy more com­pet­i­tive than to re­duce wages. It means the coun­try be­comes more at­trac­tive to global com­pa­nies.

Four, the U.K. is out­side the euro. Bri­tain de­clined the op­por­tu­nity to sign up for the sin­gle cur­rency when it was in­tro­duced. As the euro lurches from cri­sis to cri­sis, that looks like a smart call. The U.K. is con­tribut­ing to the Ir­ish bailout but isn't on the hook to res­cue Spain or Por­tu­gal in the way that Ger­many and France might be.

That will make Bri­tain a great base for global in­vestors. Where's that In­dian or Brazil­ian com­pany go­ing to set up its Euro­pean of­fice? In Spain, where it has no idea what the cur­rency will be in a decade's time? Or Bri­tain? It's not re­ally a very tough choice.

And if that wasn't enough, there is a royal wed­ding to look for­ward to next spring.

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