Who will buy our exports?

George Osborne’s first budget has sparked a heated debate about its effect on jobs. The Government and the Office for Budget Responsibility (OBR) believe private sector employment will increase rapidly enough to bring about a significant reduction in unemployment over the next five years, despite the loss of hundreds of thousands of jobs in the public sector.

George Osborne’s first budget has sparked a heated debate about its effect on jobs. The Government and the Office for Budget Responsibility (OBR) believe private sector employment will increase rapidly enough to bring about a significant reduction in unemployment over the next five years, despite the loss of hundreds of thousands of jobs in the public sector.

Others are sceptical and worry that unemployment will remain permanently high, as it did in the 1980s, scarring the lives of those who are unable to find work for long periods of time.

Rapid employment growth in the private sector will require strong output growth and the OBR looks for this from three sources: consumer spending, business investment and net exports.

Consumer spending accounts for almost two-thirds of total demand in the UK economy, so it is almost inevitable that any recovery in output growth will be accompanied by increased consumer spending. But the OBR expects consumer spending to grow less rapidly than real GDP in every year from 2010 to 2015 (because it thinks households will be focused on gradually reducing their debt). It is not, therefore, expected to pull its weight in driving recovery.

Business investment spending slumped during the last few years, which is normal in a recession, and the OBR expects it to boom over the next five years, which would be normal during an economic recovery. However, it is predicting a growth rate of almost 10 per cent a year between 2010 and 2015, at a time when growth in consumer demand is subdued. That could be a stretch – unless some alternative source of demand comes along to justify renewed business optimism.

Which brings us to the most extraordinary element of the OBR’s forecast: it expects net trade (the difference between the UK’s exports and imports) to add 3.5 per cent to output growth in the UK over the next five years – an average of 0.7 per cent a year.

Net trade over this period will, according to the OBR, contribute just over one-quarter of the UK’s growth. This would be unprecedented in the post-war era. There is no five-year period since 1948 when net trade has added so much to UK economic growth.

Why the OBR should be so optimistic about the UK’s ability to export is a mystery. Some commentators point to sterling’s decline in 2008 as one reason, and it is true that sterling’s exchange rate index is currently around 20 per cent lower than its average level between 2000 and 2007.

But this is not so much greater than the 15 per cent decline that sterling experienced in 1992 after it was ejected from the exchange rate mechanism. Following that experience net trade added just 1.6 per cent to UK growth over the next three years, before detracting from growth in every one of the next ten years.

Note also that sterling is now appreciating against the euro, having risen from a low of €1.02 to €1.21 over the last year and a half. This matters because the euro area is by far the most important market for UK exports. And the reason the euro is weakening is important too.

It is because the outlook for growth in the euro area economy is deteriorating as governments in countries such as Greece and Spain implement austerity budgets and other countries, like Germany, also choose to raise taxes and cut government spending. The UK is not going to experience an export boom to the euro area if demand is weak over the next few years.

Of course, that still leaves a large part of the world, including some large and rapidly growing countries like China and India, to which the UK might be able to successfully export but there are a number of reasons for taking a sceptical view of the notion that they will be our salvation.

First, their growth tends to be export-led; second, we are late-comers to these markets – companies from other countries have already established strong trading links with them; and third, we are not relatively strong in the manufacture of the types of good, particularly investment goods, that these countries want to import.

The OBR has stated that its economic projections represent a central case, but its current view on UK net trade looks very optimistic. It follows that its views on growth in the economy and the outlook for employment must be similarly optimistic. So, those who worry about unemployment increasing further and remaining permanently high while the government makes massive cuts in public spending are right to do so.

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