Seven years on from the start of the Great Recession the slump looks set to go on and on. Even David Cameron who seldom mentions the economy was stirred this week to reinforce the message that - the worst may not be over.
Certainly, in the UK we have had some growth but we still have high levels of government debt and a crippling trade deficit and our main trading partner is in real trouble. It is now certain that the major economies in the developed world will never recover the lost demand that has opened up between actual GDP and the trend line established over the last 20 years. This puts us in new territory, as in every other recent recession the global economy has always been able to close gap in “temporary” lost demand during the expansion phase of the economic cycle. In real terms, people in virtually every developed country will be poorer at the end of this economic cycle than in 2007! This is a pretty stunning revelation – we have forgotten how to grow!
It’s pretty easy to agree that this recession was triggered by the financial crisis, which was caused by a loss in confidence in over-leveraged banks; that had greedily lent money to undeserving borrowers on an unimaginable scale. It quickly became clear that this accumulation of debt that can’t be honoured (distressed debts) was not just a banking problem as governments found their budget deficits spiraling out of all proportion as recession reduced income from taxes and raised expenditure.
The Great Recession is a consequence of aging populations and this deleverage: people, businesses, banks and governments have all been learning to live within their means and this has decimated aggregate demand. This austerity has had three important impacts on the real world economy, it has driven up unemployment, it has caused a drop in real incomes and it has devastated investment. The fall in employment and wages is terrible for those concerned, the scars will be deep but we know they can be healed. But the really worry is the lost investment as the wealthiest in society hang on to their money rather than invest in productive capacity and this results in decline in productivity.
Productivity is the most important building block in long term wealth creation – between 1990 and 2007 the UK increased productivity more than any other advanced economy, this had a wondrous effect on living standards; but since 2007 there has been a tragic decline in investment and this is despite negative real interest rates. In addition to the reduction in investment from both the private sector and the government to help meet austerity targets, The investments that have been have been made have been in existing assets like property and financial products rather than capital expenditure in projects that will improve productive capacity.
This significant drop in investment could normally be corrected by lower interest rates but we have, already, had to slash interest to zero in order to keep the lights on, so there is no way to further loosen of monetary conditions. If businesses are flush with cash won’t invest at current interest rates, what needs to change? There are only two courses of action open to us. We can wait for the deleverage to complete, which could take another year or two and would have a high cost in lost capacity and higher unemployment or we can try to bridge the investment gap by increasing government expenditure on capital projects, which will further increase public debts. Both approaches have associated risks, but for the most part I have supported the need for deleverage to run its course rather than add further to public spending and government debts. This is because higher government debt will put the brakes on private spending and investment; people and businesses are risk averse to economies flirting with default or very high long term interest rates. More recently I have been thinking that I may have got this wrong and that the real danger is the long-term loss of productive capacity caused by low investment. The consequences of low investment are plain to see already; falling wages, growing inequality, increasing migration, falling demand and lower growth. It is our number one duty to arrest this decline in investment and productivity – we need to think the unthinkable. The only way trigger up-tick in investment this is for Government to take the lead.
What is needed now is a significant re-balance away from government spending on services, that cost money but have no impact of productivity, into capital projects that can drive productivity and don’t weigh on future spending requirements. Government should not pick the projects, but should enable private companies to take centre stage building on those things where we already lead the world - Design, Research and Further Education, Communications and Finance. The building blocks would be:
1. Ensure future access to low costs energy / electricity
2. Secure the UK as Europe’s main transport hub to the rest of the world and improve links between London and other regions
3. Become the global leader in super-fast internet
4. Build an integrated research capability based on our leading companies and universities
These investments need to be funded by cuts to non-productive public services and matched by investment from the private sector partners. In the UK the government spends about £60bn a year on capital programmes against £600bn of total spending on day to day services (Welfare, Pensions, Health, etc.) rather than capital projects. By shifting the balance from a 9:1 split to a more sensible 8.5:1 split we would be able to create a £30bn investment fund, which if matched by private companies could see over £60bn being pumped into future productive capacity. Investment on this scale would help current aggregate demand as well as providing the boost to future productivity that is so urgently required. Finding a further 5% cut in government spending will require politicians to do the unthinkable but the consequences of doing nothing are even less palatable, we need prepare for a future in which the UK can win the productivity race.
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