The following 12 months will be the year where the consequences of policymakers' decisions and indecision are felt by all. Five questions will dominate economic discourse in 2011.
Will Straw reviews the economics of the year ahead
After the rollercoaster of the financial crash of 2008 and global recession of 2009, the last 12 months have been dominated by a fierce debate over the role of policy in delivering economic recovery.
In Britain, the Tory-led Government is pursuing a policy of fiscal austerity coupled with loose monetary policy. The industrial policy revolution, commenced by Lord Mandelson, appears to have ground to a halt with little – aside some would argue from a programme of corporation tax cuts – appears to be aimed at encouraging growth.
The following 12 months will be the year where the consequences of policymakers’ decisions and indecision are felt by all. Five questions will dominate economic discourse in 2011.
1) Can the private sector create enough jobs to more than offset the losses in the public sector?
The June Budget set out spending cuts of £22 billion in 2011-12 on top of the £5.2bn in 2010-11. Some of this will come directly through public sector job losses but the read across from the recent CIPD report suggests that 400,000 jobs could be lost next year in total.
If this happens, it will compound the bad employment news earlier this month. While the jobless total rose for only the first time in six months, employment has fallen for six consecutive months. Youth unemployment is another persistent problem while the number of people forgoing hours by taking on part-time work is at a record 1.16 million.
George Osborne’s economic philosophy, known as ‘expansionary fiscal contraction‘, suggests that the private sector will step in where the public sector is withdrawn. So far the signs do not look good. Even after a year of recovery, private sector employment growth has only been 296,000 – just 0.5 per cent. The key metric in 2011 will be whether unemployment does or doesn’t rise above 2.5 million.
2) Will rising inflation further erode living standards?
The Bank of England’s Monetary Policy Committee has effectively ignored rising prices in 2010 with inflation above target in every month. The increase in VAT to 20 per cent on January 1st and rising food and oil prices is likely to exacerbate the problem.
The Government has a perverse incentive to retain modest inflation since it erodes the value of government-held debt. And loose monetary policy is effectively acting as Osborne’s Plan B in light of the biggest fiscal policy tightening since World War II. But as inflation heads towards 4 or 5 per cent it also erodes living standards – especially as many people in work are facing pay freezes or reduced hours. The ‘squeezed middle‘ are particularly badly affected. The Resolution Foundation think tank have shown that real wages will fall for three years for this group. Expect growing calls for higher interest rates, if inflation stays above 3%.
3) Where will growth come from?
Economic activity comes from either consumption, investment, government spending, or net exports. The signs are not good. The most recent figures show that consumer confidence is at a 20-month low and likely to worsen following January’s VAT rise. The latest business investment figures showed a 0.2 per cent fall in the third quarter of 2010. We all know the direction of government spending which leaves export-led growth as the country’s main hope for growth.
George Osborne has talked up the importance of trade. The OBR has predicted a 0.7% contribution from net trade next year, reversing a 0.9% negative contribution in 2010. This view is not universally held. Simon Kirby, economist at the National Institute of Economic and Social Research, said “We think [the OBR’s] projection for GDP growth next year is still too strong given the weak prospects for Europe.” If further eurozone instability caused a further strengthening in sterling’s value, this could drive down exports. Duncan Weldon has set out an alternative and arguably more realistic strategy of “re-balancing domestic demand and, in the final analysis, being less import-reliant.” The first estimates of Q1 growth at the end of April will take on huge political importance coming as they do in the middle of the Scottish, Welsh, and local election campaigns.
4) What will happen to the eurozone?
Although the pain caused by the straight-jacket of euro membership is clear for all to see, a break-up could be even worse. In either scenario – weak members like Greece or Ireland leaving or Germany restoring the Deutschmark – “the costs would be enormous” according to The Economist. Former French Prime Minister, Laurent Fabius, predicted earlier this month that if Germany withdrew, the new Germany currency would “multiply in value by two compared with the present level” resulting in drastic consequences for German exports.
But the pain shows little sign of letting up. After Greece and Ireland, Spain has been warned that it’s debt may be further downgraded while Portugal is also in trouble. The head of the International Monetary Fund has said that EU leaders’ piecemeal approach to Europe’s debt crisis has encouraged markets to pick off weak countries one by one. EU leaders agreed to set up a permanent ‘bail-out’ system akin to a European Monetary Fund at the December summit, but no details have been provided on where the money will come from or how it will work in practice.
What happens matters for three reasons. First, as Britain’s major trading partner, there is little scope for export growth while the eurozone remains unstable. Second, further bailouts are likely to have fiscal implications for Britain. Finally, default in other European countries will have a knock on effect for British industry. For example, Spanish companies own Britain’s airports and a large portion of our banking sector.
5) What will China do?
Exacerbating, and in many ways overshadowing, domestic and regional economic uncertainties are the tensions between China and US. The spectre of currency wars overshadowed the G20 summit in Seoul. The US wants further Chinese appreciation of the renminbi while China is concerned about the impact of the US’ quantitative easing policy.
A meeting in mid-December between U.S. Treasury Secretary Timothy Geithner and Chinese Vice Premier Wang Qishan appeared to calm tempers. But the key question is whether both parties can be persuaded to accept a gradual, managed and peaceful transition of economic power and rebalancing or whether there will be flashpoints with unpredictable economic and political consequences. The ultimate economic power duel is unlikely to be resolved in 2011, but we should know more about the direction of travel as the year unfolds.
With thanks to Duncan Weldon, Adam Lent, Tony Dolphin, and Ben Fox.
43 Responses to “A year of economic uncertainty lies ahead”
Anon E Mouse
Matthew Fox – The “Happy news squad” is only out in force because of this article from the “Delusional No Story Here squad”.
The fact is the number of times the writers of these articles on this fine blog have been proven right is probably less than the 1.3% win the dithering Ed Miliband beat the better candidate by.
What happened to the coalition falling apart by the close of 2010? The Double Dip recession? And on and on…
Instead of the constant incorrect doom sayer speculation why don’t the contributors to this blog actually make their items “Evidenced Based”?
Why not give that a try – oh and dump the current useless Labour leader at the same time…
matthew fox
@ Anon E Mouse
Sticks and Stones old chap, Sticks and Stones, that is all you have in your locker.
With the 80,000 PRIVATE SECTOR jobs losses predicted in 2011 alone, I seem to be struggling to find the good news in this announcement.
I take it your aware, that the Government overshoot, it borrowing requirements in November, and Vat receipts where down 0.1%?
Things are that bad, Grant Snape was complaining when public sector unions listed all the public sector job losses due at the beginning of next year.
We are talking about a man who invented the term ” Spending Power ” and now is running away from the consequences of his actions.
Why you need to bring up the election of Ed Miliband?, what has that got to do with the price of tea in china?
The only dithering I see at the moment is people choosing whether to eat or leave their heating on, the only dithering I see, is the motorist who drives past a petrol station, and tries to work out, how they are going to pay for the next tank.
If I was you, you should hang out at Conservativehome, they even allow swearing.
Éoin Clarke
1. House prices are now in double dip territory
2. Growth for Q3 was downgraded
3. VAT is about to hita generational high
4. Inflation is stubornly high..
4. Wages are in real terms less than inflation
6. November saw record borrowing
7. Unemployment took its sharpest spike since the recession ended
8. Government spending is about to be reined in
9. We have a looming Euro crisis on our doorstep
10. Retail sales in Nov/Dec are very sluggish
11. 60% of retailers expecting to do worse next year
12. There are currently 87,374 public secotr redundnacy letters in the post
13. Interest rates are set to start rising again
14 Petrol in 2011 will break through to all all time high
15. Growth forecasts have been revised down by every credible body
Question:
Should George Osborne have a plan B?
Will Straw
Happy new year everyone. A few comments in response.
Mike – Labour had a policy of spending cuts but made no suggestion that this would lead to economic growth. David Cameron and George Osborne have claimed that cutting the deficit and growth go hand in hand. Fair point on (2) but this is not a Labour party blog and we weren’t in existence at the time of the last boom. I agree on your 2011 point. The next election won’t take place before 2015 IMO.
Anon – Thanks as ever for the kind words about the blog. How about providing your own evidence. We publish a lot of stories on here but I don’t remember a single piece predicting that a ‘double dip’ would definitely take place. In fact unlike some on the left, we’ve been careful to point out that it’s unlikely. Similarly we’ve been consistent in suggesting that the Coalition would last a full five years and have focused instead on the anomaly of creating five year fixed parliaments.
Eoin – Thanks for sharing that information. You paint a very depressing picture which reinforces the central argument that Britain’s economic policy is unprepared for the challenges ahead.
Will
Éoin Clarke
Will,
Thanks for that. Happy new year to you also 🙂