Is the UK’s “Strong Economic Performance” a Myth?

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Not according to the IMF, who appear to believe otherwise – that the UK is, economically speaking, on the right track. On paper, this seems like good news. But is it really?

If we scratch beneath the surface, it doesn’t take long to realise that cracks in the economy have the potential to be giant yawning chasms. Our current economic performance is founded on strong consumer spending. Don’t get me wrong – strong consumer spending is good – it indicates consumers have increasing disposable income, fuelled by a rise in real wages, low inflation and unusually low interest rates (with the Bank of England, pictured above, having recently opted to keep base interest rates at 0.5% – for what is now the 6th year running). But having rising real wages, low inflation and low interest rates is a rare scenario to have, since you would expect, in a growing economy, for inflation to be rising. Low inflation can be attributed to falling oil prices, which in turn would reduce commodity prices, including the price of the basket of goods the CPI uses to calculate inflation. Hence, under normal circumstances, with normalised oil prices, we would expect consumer spending to be lower. What we can gain from this is that consumer spending is volatile, and if our long-term economic growth relies on this, we could be heading for stormy waters.

High consumer spending will have the added unfortunate consequence of increasing our consumption of imports, which spells bad news for the trade gap (our trade gap will worsen so greater imports than exports). If we want sustainable growth, we need to focus on export-led growth – but for this, we need a strong manufacturing and R&D sector. While growth in the manufacturing sector has soared to a 16-month high recently, it is clear there still needs to be investment to discourage companies from downsizing and cutting jobs, boosting output. Investment is required in the R&D and science sector to encourage students to study STEM subjects, and to make more internships available, perhaps preventing a ‘brain drain’. But, with a focus on cutting the budget deficit, this is unlikely to happen in the short term.

A lack of investment in other areas of the economy is likely to further undermine the UK’s strong economic performance – in particular, a lack of investment in affordable housing. Our social housing stock needing a boost, because it is keeping rents artificially high and preventing people from entering the housing market. And as for housing schemes that try to help such as right-to-buy, that only benefits the middle class.

It isn’t just rents that are suffering – house prices continue to rise as well, with London house prices continuing to outstrip national house prices by a considerable margin, despite the rate of increase slowing recently. Rising house prices are not all bad – they have the potential to make some homeowners ‘paper millionaires’ which they may want to cash in on by releasing equity from the property. For many homeowners, low interest rates have helped greatly with mortgage repayments, especially in households with a high household debt-to-income ratio, but for those on variable rate mortgages, a rise in interest rates could hurt them and limit consumer spending from these households. This perhaps explains why the Bank of England have decided to keep base interest rates low, but this is an unsustainable situation, particularly as the economy continues to ‘grow’, where there will be no option but to raise interest rates – with consequences for the household debt-to-income ratio and consumer spending.

It must be a concern for the Government that there are too few variables influencing the economy, and the key for the Government is to diversify the economy – consumer spending is important, but it would take very little to destabilise an economy that relies on it.

 

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