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Positive signs suggest the economy is back on course

This is my final contribution to the Herald as director of the David Hume Institute (DHI).

DANGER ZONE: The Chinese economy is not yet a major cause for concern but is worth watching. Picture: AP
DANGER ZONE: The Chinese economy is not yet a major cause for concern but is worth watching. Picture: AP

I am standing down after nine fascinating years, during which I believe we have added significantly to the informed and constructive debate in Scotland on a number of key policy issues. However, this column is not yet coming to an end. As of May I shall be writing under the designation of adviser to the Strathclyde University International Institute for Public Policy. (I also remain chairman of trustees at the Royal Zoological Society of Scotland but shall try to avoid bringing up the topic of panda breeding in the business columns.)

For this final DHI column I decided that it was time to set the referendum debate on one side for a while and re-focus on what is going on in the UK and indeed global economies. Along with several other countries we are at something of a transition point. Memories of the recession may be receding for some folk, but policy makers will remain only too aware that they are still dealing with the consequences of that dire period and that they must avoid repeating mistakes which might threaten a return of some elements of that difficult time.

Taking the UK first, the story in my view remains very much as it has been for the past year or so. The recovery is certainly well underway but, well there are at least three buts. But number one is can we continue to rely upon consumer driven growth, aided and abetted by the booming London housing market, without running the risk of consumer debt moving out of control once more? But number two is when is business investment going to recover to any noticeable extent and while it remains so subdued will UK productivity growth and hence competitiveness continue to lag way behind key trading partners and competitors? But number three is how sustainable is this potentially toxic mixture of low investment, marginal increases in real incomes (at best) and strong consumer growth, alongside a continuing and extended backdrop of public expenditure cuts and severe gvernment budget restraint? The household savings ratio fell once more last year while the current account (trade) deficit soared to 4.4 per cent of national income. Both are, to me, very worrying signals that sustainability has not yet been secured.

The Chancellor talks boldly about a new Tory target of full employment, all achievable thanks to their "long term economic plan". (Is anyone else fed up with the constant parroting of that content free phrase?) However, my reading is that much of the welcome rise in unemployment is associated with the lack of business investment, meaning more labour retained or employed in lieu of that new investment. Another major chunk of the additional employment is part-time (often for people seeking full-time positions), insecure and low skilled. The target should be achieving increasing competitiveness and hence rising demand for skilled and semi-skilled, and decently paid, employment alongside an upsurge of investment. But that requires business confidence which is lacking - at least so far as a belief in sustainability is concerned.

On the policy front there seems no risk of any early rise in UK interest rates. Inflation is low (compared to the MPC target) and ebbing down rather than high and rising. So if policy action is required it will be specifically to cool the housing market, preferably aimed at London where the source of heat resides. Elsewhere across the UK a gentle increase in real wages alongside a modest tick up in house prices could be consistent with moderate growth in consumption and some improvement in household finances.

Overall there remains a lot to be achieved - without really mentioning the challenge on the public sector deficit and debt. All the necessary tasks will be more readily achieved if the remainder of the global economy provides support and growing markets.

In a positive vein it looks as if the USA is back on course after a slow phase - probably weather-related. One of the key elements of US data each month is the employment report and this proved robust for March, with previous data revised up. Meantime consumer confidence looks fine and productivity is - unlike the UK - motoring upwards. In brief the market there looks sound and secure. However, US companies will be to be feared as competitors across the globe, especially where energy costs matter given all that cheap shale gas and new oil.

Even in the eurozone there are some positive signs, with the key Purchasing Managers Survey suggesting Germany and the countries on the periphery advancing and possibly France moving out of recession. Positive action from the European Central Bank - a strong dose of quantitative easing for example - would help; but maybe the worst is over.

That just leaves China of the key economies. Clearly their economy is slowing and substantial imbalances continue as a fact of economic life. Their currency has depreciated rather than, as has been the norm, appreciating. China remains one to watch with care but not as yet a major cause for concern. Remarkably the "old world" may be our best trading bet in the short term, but longer term eyes have to be firmly on the "new economic world", where Scottish trading links are still inadequate. Investment, innovation, utilising skills, enhancing productivity and diversifying markets remain the keys to sustained success.

Jeremy Peat is director of The David Hume Institute

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