Jeremy Peat
SUPERFICIALLY, the latest UK economic data certainly look encouraging. GDP is estimated to have risen by 0.7 per cent in the second quarter of this year while GDP per head could be back to pre-recession levels. However, economists are placed within society in order to worry for you all. We should not always expect the worst to prevail, but we should be aware of, and help others to be likewise aware of, those pervasive downside risks. Allow me to spell out two of those risks as of now. First, the unconvincing structure of UK growth, which makes its doubtful. Second, the global risks of substance, including Greece where the epic tale remains to be finalised.
Consider first those unbalanced UK data. Both the service sector and the production industries made significant contributions to growth. However, within the latter growth was concentrated on oil and gas, which bounced back sharply, perhaps as a result of the incentives announced in the latest Budget. Meantime manufacturing declined, after a negligible rise in Q1. Further, construction was flat after a fall in Q1. On the positive side, the Office of National Statistics suggests that GDP per head could be ‘broadly equal to the pre-economic downturn peak in Quarter 1 (Jan to Mar) 2008’. It has only taken a touch over seven years but we may – on average – be as well off as we were before disaster struck.
Looking forward from where we are now there are two broad scenarios. The optimists suggest that as we have used up most of the spare capacity in the labour market, business investment will pick up, innovation will be encouraged, productivity will improve again (at long last) and manufacturing and exports will both expand. There may be mild inflation pressures and as a consequence the Monetary Policy Committee (MPC) will start raising interest rates from later this year, with sterling tending to appreciate against at least the euro as slow but steady monetary tightening continues. That will not hamper sustained GDP growth because of the upsurge in productivity and hence competitiveness, with domestic consumption underpinned by high levels of employment and steady real increases in earnings. Everything in the garden looks rosy and fiscal tightening can continue unconstrained.
For those of us who worry there is an alternative view. This is essentially based upon a concern that investment, innovation, productivity and competitiveness may not improve as the optimists expect. Even under this scenario, there remains the prospect of perceived risks of inflation at the MPC bringing rising interest rates and appreciating sterling. Without increasing productivity and competitiveness this combination of higher rates and a strengthening currency – reinforced by Mr Osborne’s fiscal tightening – could bring growth to a grinding halt.
The critical factor will be what happens to productivity – as I have mentioned many times before. The optimists simply assume that improvement will come, because it always has in the past. I do hope that they are right but …….
Now let me turn to Greece, where the saga is incomplete. As the latest ‘final’ deadline approached towards the end of July I read two highly persuasive assessments by distinguished and informed observers. Nobel Laureate Lord Meghnad Desai was clear that Grexit was the only solution. “Greece needs to get out of this hideous contract. Print its own money – and renounce its debts.” Meantime Denis MacShane, a former Minister for Europe, saw Greece giving up the euro as: “The quickest way to political suicide”.
What all are agreed upon is that Greece needs to return to a high growth path in order to be able to claw her way back towards economic and fiscal viability. Lord Desai sees the necessity of a sharp devaluation, rather than maintaining the euro and being landed with massive debts. McShane believes that there is a way forward within the eurozone, given the appropriate reform agenda.
The numbers related to Greek external debt and the public finances are horrendous. The ‘reform agenda’ required to return to sustainability would be almost too awful to contemplate. If we in the UK face austerity then the Greeks would face austerity XXXL. Without substantial debt write-offs this degree of austerity would be faced for many years. But to leave the eurozone and renounce debts would have similarly dire consequences. There is no easy way out.
I suspect that Greece will remain in the eurozone despite all. I very much hope that the IMF, European Central Bank and European Union can see their way to a major re-negotiation (reduction) of Greece’s debt. As Desai reminds us: - “The only country which has gained from this cosy arrangement [the eurozone as operated] is Germany with its built-in exchange rate depreciation.” Frau Merkel should be more generous towards the major loser.
This story of Greece matters to us for two reasons. First, the continuing trauma may well delay recovery in our key markets and keep sterling strong and the euro weak. Second, it is a reminder that being part of a currency union may well not be compatible with running very different economic policies. Greece should never have been allowed in, for the sake of all involved, but politics outweighed economic and financial considerations.
Jeremy Peat is Visiting Professor the University of Strathclyde International Public Policy Institute
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