If you glance at the breakdown for growth forecasts for the UK this year you will see what an economic system looks like as it starts to climb back out of recession.
If we achieve 1.5% GDP growth this year, it will have been driven mainly by public sector growth - likely to be around 1.7% - with a small contribution by private sector spending - around 0.7% - and some offsetting reductions in investment: investment spending has collapsed over the last two years and appears to be declining at a rate of 2.4% this year. Oddly, while exports are expected to grow pretty well this year on the back of a more competitive exchange rate (forecasts suggest an expansion of some 4.5%), these are likely to be matched by higher imports so that there is only a very small net contribution to growth from trade.
The most recent estimated figures for UK GDP growth in Q1 make two issues clear. Firstly, to use the
'sickly patient in intensive care' metaphor, the economy is emerging from unconsciousness but still needs life support (government support) while it regains full strength. Secondly, and this is where the metaphor is maybe a bit too graphic, there are self sustaining signs of life, but we are wondering whether someone has stolen a few vital organs that need to be replaced. A striking piece of good news in the figures showed that manufacturing as well as the energy sector (oil, gas and electricity) grew strongly in the quarter. Private sector spending is returning, but companies are operating well below the capacity levels they had in 2007. If this continues, we will next see inventories grow as they start to re-stock and then investment will start to come back as companies rebuild capacity. That is when we can be convinced of a return to a strong and sustainable recovery. At this rate of recovery, we will be back to pre 2007 levels of activity by the end of 2012.
In the meantime, there are still risks to recovery. My sense is that the main risks are those associated with the disconnection between financial markets and the 'real' economy. The recovery is highlighting for us that 'the markets' do not like uncertainty and demand that changes that are required be executed quickly. The dilemma is that the kind of re-structuring that is taking place in the real economy is taking longer and carries a degree of uncertainty that is unsettling the markets; the state of the Greek economy, the size of government debts in the US and EU and whether companies can access new export markets are all questions that the markets want answers to 'now' but which take longer for real people in real jobs in the real economy to provide.
We cannot of course un-invent the market system we have so we will have to live with the reality that market sentiment will drive volatility in the short term. Indeed it could actually provide a self fulfilling outcome of a return to recession if the market bears overwhelm the bulls: in normal growth times, I would be the first to argue that open markets and speculation provide stability within the system, but in this phase of recovery the opposite is true. There is a risk of a rumour of a problem in, say, a bank or a country such as Greece, will cause a defensive run on that institution or economy that then has a domino effect throughout the system.
So, what does all this mean for the immediate economic outlook? In the short term in the EU and US it is about focussing on the points of growth in the market - domestic hotspots as well as export market opportunities - and planning for growth in these 'recovery times'. The fundamentals suggest that interest rates are unlikely to rise by very much if at all until the latter part of the year. The dollar appears to be re-gaining some of its strength and the euro is weakening, but the uncertainty we see in the markets will translate into volatility in the exchanges for the rest of the year. At the same time the growing global role of China, India and other 'emerging markets' is starting to paint a picture of a post recession world that will look quite different to that of the last twenty years, but more of that for another blog.....
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