Strategy & economics

Living on the edge


Richard Jeffrey

Richard Jeffrey

Chief Economist

I have a confession to make. I think I have been misleading readers by referring to the current economic environment as the new normal. This is wrong: I should simply refer to this as normal. Not normal in every way, perhaps – the policy framework is far from being normal. But the growth backdrop is much more normal than the period prior to the recession.

Mervyn King, in a speech when he was Governor of the Bank of England, referred to the ten years from mid-1992 as the nice decade (non-inflationary, consistently expansionary). In the end, this unprecedented stretch of uninterrupted growth lasted for fifteen years. It was a period in which the average GDP growth rate was 3.0% per annum and, on an annual basis between 1993 and 2007, never dipped below 2.5%. The average increase in household consumption during the fifteen years was 3.7% per annum, supported by growth in real household disposable income of 3.0% p.a. and an average annual increase in house prices of 9.0%. At the same time, CPI inflation averaged just 1.8% and the number of people in employment rose 0.9% per annum. (And, by the way, my recollection of this period is that we had six weeks of consistent sunshine each and every summer, and proper snow each winter.)

But as wonderful as these numbers might seem, there were others that warned of trouble ahead. During the decade up to the recession, household borrowing rose inexorably from 0.91 times disposable income to a peak in 2008 of 1.54 times. The trade balance deteriorated from a surplus of £5bn in 1997 to a deficit of £40bn in 2007. Simultaneously, the government’s budget also deteriorated. Having been in surplus during each of the three financial years to 2000/01, the deficit in 2007/08 was already £40bn, which was not far short of 3.0% of GDP. Behind this, government spending on goods and services rose from 17.0% of GDP in 1997 to 20.0% in cash terms. This was an era during which we were living on borrowed money and (literally) borrowed time.

It was an abnormal period, in any sense of the word, turning out to be self-destructive and resulting in a recession as deep, and a financial crisis as worrying, as anything any of us had ever experienced (albeit, Mervyn King has referred to this time as being ‘exciting’).

So, how should we characterise what we are experiencing now? The title of this commentary is ‘Living on the edge’. By this I mean that we are living with a persistent fear that things might be about to take a turn for the worse, while at the same time hoping that we are on the verge of something rather more energising. The good news is that a substantial amount of the damage done during the recession has been mended – either completely or partially. The bad news is that this is normal – at least, more normal than the fifteen years up to 2008.

Unfortunately, we were misled by the Treasury and Bank of England into believing that 3.0% growth was sustainable. While the Bank patted itself on the back for its inflation track record (which, in fact, owed more to developments overseas and changes in the supply chain than to effective control of domestically-generated inflation) and Treasury commended itself on how its policies had established a higher level of trend growth, there was an unshakable fact. Average annual productivity growth remained 2.0%. This was the rate in the 1980s, in the 1990s and in the eight years to 2007. So, 3.0% growth demanded rapid expansion in the size of the employed workforce. In part this was achieved by raising the percentage of people in work and in part by expanding the size of the workforce through immigration. Neither of these things can be considered sustainable in the longer term. 3.0% growth also relied on ever-increasing amounts of public and private debt.

Last year, so the ONS tells us, the economy grew by 2.6%. In reality, it was probably a tad more than this, as no doubt the ONS will confirm in a few years time. For 2015, I think we will see a similar growth rate.
But, believe it or not, even this rate of growth is probably a little faster than we can sustain in the longer term. With the employment rate near its all-time high, growth will become restricted to the achieved improvement in productivity (unless, magically, we manage to raise significantly the size of the employable workforce). Indeed, unless productivity improvements revert to their historical trend, even growth above 2.0% will be difficult to maintain.

So, there is still some more normalising to do, and as that process takes place, household incomes should better real growth and there should be some improvement in our sense of wellbeing. But those memories of ever-sunny summer will become more and more distant. Welcome to being normal.

This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

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