A new year, a new decade, but what kind of economy? Let me start big and gradually bring it down to size.
The big picture is that the world economy is recovering. That recovery is, however, heavily skewed towards emerging economies such as China, India and Brazil. The International Monetary Fund’s numbers tell the story as well as anybody’s. In 2009 the world economy contracted by 1.1%, the worst performance since the second world war. That was split between a 3.4% drop for advanced economies and a 1.7% rise for the emerging ones.
That gap will be preserved, more or less, during the upturn, so the IMF expects global growth of 3.1% this year, split between a modest 1.3% expansion in advanced countries and 5.1% growth in the emerging world.
Just as advanced economies were hit harder by the financial crisis, so they will be slower to recover. Emerging economies are much better placed. Gerard Lyons of Standard Chartered describes “an arc of growth from China to India and then on to Africa”. Stephen King of HSBC sees the crisis as the “tipping point”, which has made the shift of economic power from west to east irreversible.
One way of looking at this is by comparing the performance of the “E7” — China, India, Brazil, Russia, Mexico, Indonesia and Turkey — with that of the more familiar G7 (America, Japan, Germany, Britain, France, Italy and Canada).
We start this decade with the combined gross domestic product of the G7 comfortably ahead of that of the E7. By the end of it, according to John Hawksworth of Price Waterhouse Coopers, the E7 will be in the ascendancy. “The shift in global economic power is not just reflected in GDP,” he points out. “The G7 has already given way to the G20 as the key forum for global economic decision-making, while it was the G2 [America and China] that took the lead in the Copenhagen climate-change talks.”
That is the big story, for this year and many years to come. We should not, however, confuse the relative and the absolute. Britain was displaced by America as the world’s leading economy long ago but that did not stop our living standards continuing to rise, and at an accelerating pace.
What about the shorter term? There are several questions. Will there be a recovery? Will Britain be flung into crisis by record levels of public borrowing? And, related to this, will those problems be compounded by an indecisive general election outcome? Where will interest rates end the year?
The latest GDP figures did not quite show it, but most of the components were consistent with recovery having started some months ago, as are the unemployment figures. Forecasters usually make the mistake of erring on the side of caution in the early stages of recovery.
Even so, taking the official figures at face value, they make it hard to have a strong number for growth in 2010. If GDP has risen by 0.4% in the final quarter of 2009, and then increases at the same rate in the first two quarters of this year, that is consistent with 2010 growth of about 1%.
Could we get no growth at all? After all, the talk is of at least as many pay freezes this year as last, Vat has just gone back up and higher taxes are on the horizon. The answer is yes, though the latest figures suggested Britain’s households have done a lot of the rebalancing they need to do and incomes have been rising quite strongly.
Darren Winder of Cazenove estimates that for a typical household the income available for discretionary spending rose by 21% during 2009, most of which was used to boost saving, and will rise by a further 4% in 2010.
Businesses seem to be in an even better position, suggesting investment should play its part in the recovery, as should exports if the IMF is right about the global upturn. I would expect a further narrowing of the current account deficit, and a quarter or two of balance or surplus, with the red ink for the full year no more than £10 billion.
The combination of £178 billion of government borrowing, an upcoming election and the critical judgments of the rating agencies and the markets mean we are in for a nervous few months.
The Treasury is keen to point out that not only did Britain start the crisis with lower levels of public debt than elsewhere but that most official borrowing is in long-dated gilts. Britain’s vulnerability to a sudden loss of confidence is overstated, according to officials.
I cannot pretend to see into the minds of the rating agencies but my hunch is that Britain will not lose its AAA rating. The only caveat is that the agencies are not averse to publicity. So, while they appear to have settled on doing nothing until after the election, an earlier move is not out of the question.
One trigger could be if the polls start to point towards a hung parliament. There are, however, a couple of things to bear in mind. One is that, whatever the national polls are saying, UK elections are decided by a tiny number of voters in marginal constituencies. They appear to have swung even more to the Tories than national polling suggests. Only if there is evidence that this has been reversed should people get too worried.
The other point is that, while the parties are keen to emphasise their differences, they all know the numbers. Since the pre-budget report, Alistair Darling has made it clear that the quicker growth comes through, the more aggressive the Treasury will be in taking action to cut the budget deficit. The official briefing papers setting out this strategy will be available to all three would-be chancellors after the election.
Can unemployment continue its recent better-than-expected run? It would be a minor miracle for it to go through this winter without increasing somewhat. The claimant count is now 1.63m. I would look for 1.75m by the end of the year.
Inflation will fall back after its impending rise, though it may not fall too far. For years it was reasonable to assume the Bank would hit its target. That is reasonable again, so 2% is a plausible number for the end of the year.
As for Bank rate, the choice is between the Monetary Policy Committee sticking at 0.5% and nudging it higher in the second half. Though savers would love more, I will go for a gentle nudge only, to 1%.
Originally published at David Smith’s EconomicsUK and reproduced here with the author’s permission.
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