The eagerly awaited GDP figures for the first quarter of 2011 show that output is only back to the level of the third quarter of 2010. In effect, economic growth has ground to a halt.
The eagerly awaited GDP figures for the first quarter of 2011 were released by the Office for National Statistics (ONS) this morning. They show the economy expanded by 0.5 per cent. This follows a 0.5 per cent contraction in the final quarter of 2010. Output is only back to the level of the third quarter of 2010.
The ONS’s statisticians believe that December’s appalling weather resulted in a loss of output equal to 0.5 per cent of the total. If they are right, then the underlying rate of growth was zero in both the final quarter of 2010 and the first quarter of 2011. In effect, economic growth has ground to a halt. Nowadays, economists define a recession as a period of at least two consecutive quarters of contraction in real GDP. After adjusting for the effects of the weather, the UK has just come as close as it is possible to come to a recession without actually being in one.
According to George Osborne, this was not supposed to happen. He has said on many occasions, including in an FT article (£) last March co-authored with Jeffrey Sachs, that fiscal retrenchment would stimulate the economy through increased consumer and business spending as a result of higher confidence and reduced borrowing costs.
The belief that confidence would be increased by the announcement of tax increases and public spending cuts always looked to be the weak link in this argument, and so it has proved. Consumer confidence has fallen back close to the levels seen during the depths of the recession. In part, this is due to factors outside the chancellor’s control, particularly higher food and petrol prices. But a higher rate of VAT, an increase in national insurance contributions, the freezing of child benefit payments and the prospect of deteriorating public services have also played a major part. It is hard to believe that anyone really thought such a litany of negative news would do anything other than severely dent confidence.
It is true that business confidence in some sectors, particularly among manufacturers who are benefiting from strong overseas demand, has held up better. But the softness of demand on the High Street is now beginning to affect retailers. Some will fail, others will survive only by cutting back their expansion plans and investment programmes. Either way, investment demand will be weaker, not stronger as a result of the cuts.
There is an indication of this in today’s figures, which show construction spending fell by 4.7 per cent in the first quarter of 2011 after a 2.3 per cent decline in the previous quarter.
Whether the chancellor’s aggressive deficit reduction programme has reduced borrowing costs, compared to what they would otherwise have been, remains a matter of debate. He is adamant that the economy was on the brink of bankruptcy when the coalition took power and that a slower pace of fiscal retrenchment would have led to soaring interest rates and a crisis similar to those endured by Greece, Ireland and Portugal. There is, however, little evidence to support this view. The fiscal position of the UK, in terms of the level of debt and its average maturity, which are just as important as the current deficit in this regard, is very different from that of these countries.
The yield on UK government bonds is lower now than it was, on average, in the first half of 2010 but it would be wrong to ascribe this decline solely to the coalition’s fiscal strategy. Bond yields are also determined by the medium-term outlook for growth, inflation and short-term interest rates. It is just as reasonable to say that bond yields are lower in the UK now because output growth forecasts have been cut as it is to say that they are lower as a result of a shift in fiscal policy. Look at Japan, which has the highest public debt in the developed world. It also has the lowest bond yields because growth and inflation expectations are so low.
It is inevitable that today’s figures focus attention on how close the UK has come to a double-dip recession. But the real worry should be the medium-term and the possibility that the UK will experience several years of low growth, as Japan did in the 1990s. If this happens, the debate about how much the Chancellor’s fiscal plans contributed to this outcome will be with us for many years.
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