Andrew Sentence is a former member of the Bank of England Monetary Policy Committee, the body responsible for setting UK interest rates. He is now Senior Economic Adviser at PwC and his latest book Rediscovering Growth, is part of the Perspectives series.
He spoke to the Prospector on a range of economic subjects, ranging from domestic concerns to macroeconomic policy. The interview will be published here in full over the coming days
Jay Elwes: What do you think of the growth that Britain is experiencing. Is it substantial?
Andrew Sentance: Well I think there was a perception, and now it’s turned out to be a mis-perception, that the UK economy was going to have a big rebalancing towards the manufacturing industry. At the time I felt this was somewhat unrealistic because the manufacturing industry depends on quite substantial investments that have to be made over a long period of time. And these are not just investments in capital. There are investments in skills, innovation and new technology which don’t just spring into life, just because you suddenly think “Ah we’ve just had a global financial crisis, let’s pull in the manufacturers.” Global manufacturing is an intensely competitive activity, and every country across the world wants to have a stronger manufacturing base.
So that rebalancing towards manufacturing has not happened to a significant degree. If anything, the share of manufacturing in the UK economy has continued to decline. It’s probably just over 10 per cent now, and that’s fallen from the late 70s and early 80s when it was about 25-30 per cent. We may see some return of manufacturing to the UK, but it’s not going to change the dials in our economy. We’re basically a service sector-orientated economy. Nearly 80 per cent of GDP is accounted for by services and over 80 per cent of employment is in services industries.
But services doesn’t mean low quality or low productivity. We actually have some high productivity services and the UK stands out among the G7 economies—there’s a chart in my book on p87, showing exports of services as a percentage of GDP in G7 economies. For 2012, the figure is 12 per cent for the UK, whereas it’s 6 per cent for continental European economies and 4 per cent for the US. And people say “well that’s all financial services”. We do have competitive financial services industry, though it’s not just banking—it’s insurance, it’s investment management and that’s part of the picture. But there’s a whole range of other business and professional and creative services. Education is another important service activity which we export to the rest of the world. So there’s quite a cluster of service activities where the UK has actually been successful in selling on the world stage and generating high value added, high productivity jobs.
Instead of trying to expect the economy to rebalance in a way that is probably unlikely to happen, we need to encourage and nurture those successful services activities, ensuring the UK is an attractive place to base businesses and develop businesses. We should play to some of our existing strengths, including strengths in the financial sector but also in business and professional services, which has actually been the fastest growing service sector since the financial crisis, according to official figures.
JE: Do you think that a recovery that is based on services could bring with it a certain amount of political heat? If we have a recovery composed of buoyant house prices and strengthening financial activity, do you think that might invite more unwanted political attention?
AS: I didn’t say that I wanted buoyant house prices, and I think we should worry about house price inflation getting too strong. But I suppose the point I’m trying to make is that you can have internationally competitive businesses in the services sector that is good for your economy, just as you can have in the manufacturing sector. And the important characteristic is that you have sustainable, relatively high productivity businesses. The benefits then flow down to the rest of the economy in a wide range of different ways, including supporting purchasing power that then spreads out throughout the rest of the economy.
We didn’t rescue the financial system or even rescue the economy because we wanted to bail out individuals. We wanted to make sure that our economy stayed in good shape in difficult circumstances. And there’s been a process of adjusting the regulation in various parts of the banking sector so that some of the problems that emerged there don’t emerge again in the future.
But that’s about banking, a relatively small part of our economy. If you look in terms of jobs and GDP, in the rest of the economy I think there is a lot more commonality of interest between success in the business world and having successful individuals who prosper in that business environment and the general success of the economy. We don’t make our economies more successful by making the individuals or businesses less successful—it’s the other way round.
JE: Do you think there is a housing bubble?
AS: We could be at the beginning of the housing bubble and we should be alert to that because we’ve actually taken a whole series of measures designed to stimulate demand in the economy, and the danger is that demand manifests itself in terms of rising asset prices, especially in housing. The supply of housing in the UK is relatively inelastic and if we do continue to see strong rates of house price growth, we should withdraw some of the support we’ve provided, and we should be considering raising interest rates rather than keeping than down at current low levels.
Some of the recent house price growth is a reflection of some of the measures that have been taken to support demand. It is also an indication of the need for measures to ensure the supply side of the housing market is as responsive to demand as it can be, and if there is an increase in demand for housing, then house builders can use more sites to build more houses.
JE: It seems the Bank of England and the Treasury don’t see eye to eye on this matter. Government spokesmen reject the idea of a bubble.
AS: We are not right in the middle of a great big housing boom, though we may be in the early stages of one. And given that house price ratios relative to earnings are relatively high by historical standards, this could start undoing the measures that have taken to support the housing market. If all that happens is prices of houses rise even further out of reach for new first-time buyers, that’s not necessarily a very helpful thing.
Within the Bank of England there’s been more concern on the Financial Policy Committee perhaps about the financial implications of an unbalanced housing market. But I think it’s well recognised that if you do provide a lot of monetary support to an economy in various ways and support for various forms of lending there is a risk that this spills over into various assets markets and I think that this is a very legitimate economic concern.
JE: Are members of the FPC worried about a systemic risk from house prices?
AS: Well certainly, the recent Financial Stability Report had quite a few warnings on it, and the Bank of England has announced that they are not going to continue with the funding for lending to households as a result. I can also understand a shorter-term perspective that says “let’s see how this unfolds.” But it wouldn’t take much before house price inflation gets into double digit levels and that’s not going to be healthy.