Top five lessons from 2013: Economy

2013 was the year in which things began to get better for the UK economy, with headline indicators of growth and employment moving in a positive direction. The government has felt empowered to claim its economic plan is working, and argue that now it must be allowed to finish the job. But 2013 has also been the year in which more fundamental questions about the desirable sources and shape of the UK’s recovery have been raised. The opposition has argued that economic recovery means little if it does not feed through into rising prosperity for average workers, or if growth is based on a pre-crisis model of consumer spending and under-investment. Which argument prevails over the next year will do much to influence the character of the election battle in 2015.

1. The outlook is bleak for middle income households

Even as the OBR revised up the UK’s growth forecasts at December’s Autumn Statement, it confirmed a familiar story about average wages. Despite a slightly more positive picture in the recent Annual Survey of Hours and Earnings data, the OBR does not expect wages to recover to their pre-crisis levels until 2017-18. So the picture is bleak for those on average incomes and the least well off in society, as the chart below from the JRF shows, and the squeeze is set to continue.

2. Does economic growth make a recovery?

In 2013 growth returned to the UK economy – it has been the first year in which politicians have dared to say that things are getting better. But this upturn has brought forward secondary questions about the character and reach of recovery.

This can be in interpreted in more than one way. The first is empirical. Although the upward revision to growth gave the Coalition benches something to cheers about at the Autumn Statement announcement, the OBR’s analysis shows that the improvement is cyclical ‘rather than indicating stronger underlying growth potential’.

This means that while the revisions to growth have been welcome, it does not reduce the structural deficit which forms part of the chancellor’s fiscal mandate. As Paul Johnson of the IFS put it in his response to the OBR figures, ‘the growth they were expecting anyway has come along a bit sooner than expected’.

Then there is a second, more philosophical, interpretation of what kind of recovery is underway in Britain. It is one captured by what Labour refer to as the country’s ‘the cost of living crisis’ – that although the headline macroeconomic indicators are moving in the right direction, growing GDP is meaningless if it does not improve the position of average households.

It has been an effective line of political attack this year and one which is borne out by the data. Yet it also points to a more fundamental question about how we define economic success after the crisis in 2008. Over the last 50 years typical living standards have increased less quickly than GDP per capita: on one measure, median incomes increased by 1.4 per cent a year since the 1960s, compared to growth in GDP per capita of 2.2 per cent. With this apparent break in the way rewards have been distributed by the economy, it is now time to ask whether a more diverse suite of indicators are required to measure success.

Source: HBAI, DWP

3. We have abandoned rebalancing

In 2010 George Osborne declared that the UK ‘cannot go back to the last decade’s debt-fuelled model of growth’. None of the main parties would disagree with that. ‘Rebalancing’ matters because the economy was vulnerable when crisis struck in 2007-8.

And there are many candidates for attention, whether promoting diverse sources of GDP, creating a better sectoral mix or reducing the UK’s spatial inequalities. For his part the Chancellor was clear about the government’s priorities in 2010: ‘we will increase saving, business investment and exports as a share of GDP’.

Even before the Coalition’s interventions in the housing market through Help to Buy this year, the extent of the government’s progress towards rebalancing was questionable. 2013 showed the government has abandoned this aim.

I and others have worried that there are a number of similarities between the pre-crisis economic model and the one emerging in 2013. Having increased to 7 per cent from 2009 as result of the recession, in the early months of 2013 the household savings ratio began to fall and was reflected in the rise in household consumption. The drought in private sector investment has not abated. Earlier this year the OBR’s estimated that the errors in its forecasting of real GDP between 2010 and 2013 were due to optimistic assumptions about the rate at which business investment would increase. At the same time government investment fell to 2.3 per cent of national income in 2012 and is set to fall further in coming years, below its average for the 1990s and 2000.

4. There are still significant cuts to come…

It was recently reported that for the first time in three years more people think spending cuts to reduce the deficit is good than those who think it is bad. But the final chapter in this decade of crisis and austerity will be written after the next election – where there remain many cuts to make.

And because the government’s programme of fiscal consolidation is weighted in favour of spending cuts to tax rises (85/15%), and because the work done through tax rises was relatively front-loaded, the majority of the consolidation after 2015 will come from cuts to public services. The chart below from the OBR illustrates shows what is planned for day-to-day spending on public services (‘PSCE in RDEL’) in the next parliament.

Assuming no further tax rises or welfare cuts, and assuming the protections the government has placed on budgets such as the NHS and overseas aid are maintained, the cumulative impact of cuts from 2010 will be huge.

5.The Chancellor is taking the UK back to 1948

The chart above from the OBR contains another lesson from 2013, perhaps one of the most significant for our national life. By the end of the OBR’s forecast period, government consumption will be its lowest on record since 1948. As the OBR calculated in its report accompanying the chancellor’s Autumn Statement, government consumption of goods and services falls from 23.2 per cent of nominal GDP in 2009 to 16.1 per cent.

By 2018, government expenditure will be 38 per cent of national income. The chart below shows how the extent to which projections about the shrinking size of the state have changed. It also includes one path for spending calculated by the Fabian Society’s Commission on Future Spending Choices, which was launched in 2013. It shows that a 2015 government can put borrowing on a falling path to close the deficit within the next parliament, while at the same time increasing spending so as not to endanger the prosperity of the economy or future generations.