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
JE: British growth has been uprated for this year—is Osborne being proved right on austerity?
AS: When we talk about economic growth, you first of all have to put the UK in the context of the western economies as a whole. And we have to look at the challenges that the western economies are now facing since the financial crisis. When I look back to the progress of the western economies over my working career, there has been a very long wave of growth, that really started to get established in the early to mid-1980s. It was briefly interrupted by the early 90s recession, but most economies got back on track after that, and growth continued until 2007. We had a 25 year expansion period for the western economies, where some economies did better than others. The UK did relatively well and the United States did relatively well. Some continental European economies did better than others.
There were three powerful tailwinds behind this wave of growth. Easy money and a deregulated financial system; a prolonged period in which imports became cheaper because of the globalisation expansion of the world economy to embrace China and other low cost producers; and a confidence that grew in the political and economic system that governments and central banks could keep economies on an even keel by broadly following the right policies.
All three tailwinds have been withdrawn by recent economic and financial developments. The deregulated financial system has been replaced by a more regulated and more constrained financial system, partly because of the shock of the financial crisis. In place of the cheapening of imports, we now find that the growth in Asia Pacific and the emerging world is pushing up food and commodity and energy prices. I think that will continue in various surges as we go through the next few years. And the confidence that we’ve got all the right policies, and the government and central banks will get things on the right track has been eroded by the financial crisis. So the public and the business community don’t have the confidence that they had five or 10 years ago.
In that environment, the fact that we’ve had relatively disappointing growth rates in the western economies is not a great surprise. A similar thing happened from the early 70s to the early 80s when, in the early 70s there were a series of shocks and dislocations which brought the 50s and 60s long growth wave to an end.
We have to look at what’s happening to the UK against that wider backdrop. The UK economy like other western economies is experiencing a low underlying rate of growth which is mainly reflected in low productivity growth and it’s mainly reflected in low productivity growth for two reasons. First, across the West, productivity rates have slowed down, so all western economies are suffering in that way, but we have a relatively flexible labour market and that has enabled more wage flexibility so that we maintain more jobs and better job creation at the expense of some real wage growth.
I think a lot of that picture would have unfolded whoever had been in government but there are things that the government is doing to put things right. They will probably help us get us on a stronger growth track—perhaps not straight away—but over a period of time. One of those is repairing public finances. One way or another, whoever was in government could not have continued with a deficit of 11 per cent of GDP. And while sometimes arguments are made, that if the government did more to help growth in the short term it would help to bring the deficit down more quickly, I don’t think in this low-growth environment that’s the solution.
So I think there is a degree of inevitability of policies that restrain public spending with some selective increases in taxes, and that is part of the process of adjustment the economy has got to go through.
However, one year’s growth over 2 per cent—2014 is probably going to be the first year of over 2 per cent growth we’ve had since 2007—doesn’t necessarily mean that we’re instantly moving into a sustained growth phase, and there were two specific reasons why I would say that.
One is we’ve still got interest rates at rock bottom and at some point we’ve got to make that transition to getting interest rates up to more reasonable levels—hopefully through a slow and gradual transition. And secondly, the global pressures that contributed to rising energy, food and commodity prices haven’t gone away. So it’s quite possible that as the global economy picks up in 2014-15—which is what forecasts currently suggest—then we’ll have another surge in energy and commodity and food prices which will dampen some of the growth of consumer spending that we have seen recently.
Over the medium term, I think we need to look at new sources of economic activity to drive growth, such as exploiting new technology, and developing new service activities. But it’s very difficult to spot where exactly those new sources of economic activity are going to come from. In the early 1980s, when personal computers were developed, nobody envisaged we would have the internet by the 1990s and how that would unfold. So what policy makers have to do is create the conditions for economic growth in terms of making sure the economy is flexible, not too heavily regulated, tax rates are competitive. We also need to ensure that the government makes the strategic investment in education and skills that is needed to ensure the economy remains competitive.
I think that’s the real direction that economic policies need to go—improving the supply side conditions for economic growth. That is the key to improving the economic growth over the medium to long term, rather than small changes in taxation or short term stimulus measures.
JE: From the description you give, it seems as if politicians are tossed on the waves of geo-economic forces that they cannot contain—are they powerless? Is there anything to be done about Britain’s low productivity?
AS: No I think it’s too sweeping, too harsh to say politicians can’t do anything, but their room for manoeuvre is quite constrained. That is particularly true for economies that are relatively small on the global stage. We have to be honest about our position in the UK. We account for 3 per cent of world GDP and less than 1 per cent of world population. So we’re not a United States, not a China. If we’re going to make a big impact on the world stage, it’s through our co-operation with other European countries or other like-minded countries in various ways.
The UK is a small open economy, and that means the bulk of the world’s market is out there in the rest of the world rather than in our own economy. And it means the bulk of the world investment is out there and a lot of the technology and the ideas and the new business developments are out there. So you’ve got to make sure you’re an attractive location for people to bring those ideas and businesses to your shores and to develop business in your country. At the same time we need to be investing in skills and education for people who live here, to make sure that we’re well equipped to compete on the world stage.
So from an analytical framework, that’s the way that I see the UK’s position. Short-term measures to affect our economy, through monetary and fiscal policies, can be helpful in very extreme situations—like trying to mitigate the impact of the global financial crisis. But we have to acknowledge that a lot for the big tides in the global economy are not narrowly within our control. So we have to do the best that we can in these circumstances.
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
JE: British growth has been uprated for this year—is Osborne being proved right on austerity?
AS: When we talk about economic growth, you first of all have to put the UK in the context of the western economies as a whole. And we have to look at the challenges that the western economies are now facing since the financial crisis. When I look back to the progress of the western economies over my working career, there has been a very long wave of growth, that really started to get established in the early to mid-1980s. It was briefly interrupted by the early 90s recession, but most economies got back on track after that, and growth continued until 2007. We had a 25 year expansion period for the western economies, where some economies did better than others. The UK did relatively well and the United States did relatively well. Some continental European economies did better than others.
There were three powerful tailwinds behind this wave of growth. Easy money and a deregulated financial system; a prolonged period in which imports became cheaper because of the globalisation expansion of the world economy to embrace China and other low cost producers; and a confidence that grew in the political and economic system that governments and central banks could keep economies on an even keel by broadly following the right policies.
All three tailwinds have been withdrawn by recent economic and financial developments. The deregulated financial system has been replaced by a more regulated and more constrained financial system, partly because of the shock of the financial crisis. In place of the cheapening of imports, we now find that the growth in Asia Pacific and the emerging world is pushing up food and commodity and energy prices. I think that will continue in various surges as we go through the next few years. And the confidence that we’ve got all the right policies, and the government and central banks will get things on the right track has been eroded by the financial crisis. So the public and the business community don’t have the confidence that they had five or 10 years ago.
In that environment, the fact that we’ve had relatively disappointing growth rates in the western economies is not a great surprise. A similar thing happened from the early 70s to the early 80s when, in the early 70s there were a series of shocks and dislocations which brought the 50s and 60s long growth wave to an end.
We have to look at what’s happening to the UK against that wider backdrop. The UK economy like other western economies is experiencing a low underlying rate of growth which is mainly reflected in low productivity growth and it’s mainly reflected in low productivity growth for two reasons. First, across the West, productivity rates have slowed down, so all western economies are suffering in that way, but we have a relatively flexible labour market and that has enabled more wage flexibility so that we maintain more jobs and better job creation at the expense of some real wage growth.
I think a lot of that picture would have unfolded whoever had been in government but there are things that the government is doing to put things right. They will probably help us get us on a stronger growth track—perhaps not straight away—but over a period of time. One of those is repairing public finances. One way or another, whoever was in government could not have continued with a deficit of 11 per cent of GDP. And while sometimes arguments are made, that if the government did more to help growth in the short term it would help to bring the deficit down more quickly, I don’t think in this low-growth environment that’s the solution.
So I think there is a degree of inevitability of policies that restrain public spending with some selective increases in taxes, and that is part of the process of adjustment the economy has got to go through.
However, one year’s growth over 2 per cent—2014 is probably going to be the first year of over 2 per cent growth we’ve had since 2007—doesn’t necessarily mean that we’re instantly moving into a sustained growth phase, and there were two specific reasons why I would say that.
One is we’ve still got interest rates at rock bottom and at some point we’ve got to make that transition to getting interest rates up to more reasonable levels—hopefully through a slow and gradual transition. And secondly, the global pressures that contributed to rising energy, food and commodity prices haven’t gone away. So it’s quite possible that as the global economy picks up in 2014-15—which is what forecasts currently suggest—then we’ll have another surge in energy and commodity and food prices which will dampen some of the growth of consumer spending that we have seen recently.
Over the medium term, I think we need to look at new sources of economic activity to drive growth, such as exploiting new technology, and developing new service activities. But it’s very difficult to spot where exactly those new sources of economic activity are going to come from. In the early 1980s, when personal computers were developed, nobody envisaged we would have the internet by the 1990s and how that would unfold. So what policy makers have to do is create the conditions for economic growth in terms of making sure the economy is flexible, not too heavily regulated, tax rates are competitive. We also need to ensure that the government makes the strategic investment in education and skills that is needed to ensure the economy remains competitive.
I think that’s the real direction that economic policies need to go—improving the supply side conditions for economic growth. That is the key to improving the economic growth over the medium to long term, rather than small changes in taxation or short term stimulus measures.
JE: From the description you give, it seems as if politicians are tossed on the waves of geo-economic forces that they cannot contain—are they powerless? Is there anything to be done about Britain’s low productivity?
AS: No I think it’s too sweeping, too harsh to say politicians can’t do anything, but their room for manoeuvre is quite constrained. That is particularly true for economies that are relatively small on the global stage. We have to be honest about our position in the UK. We account for 3 per cent of world GDP and less than 1 per cent of world population. So we’re not a United States, not a China. If we’re going to make a big impact on the world stage, it’s through our co-operation with other European countries or other like-minded countries in various ways.
The UK is a small open economy, and that means the bulk of the world’s market is out there in the rest of the world rather than in our own economy. And it means the bulk of the world investment is out there and a lot of the technology and the ideas and the new business developments are out there. So you’ve got to make sure you’re an attractive location for people to bring those ideas and businesses to your shores and to develop business in your country. At the same time we need to be investing in skills and education for people who live here, to make sure that we’re well equipped to compete on the world stage.
So from an analytical framework, that’s the way that I see the UK’s position. Short-term measures to affect our economy, through monetary and fiscal policies, can be helpful in very extreme situations—like trying to mitigate the impact of the global financial crisis. But we have to acknowledge that a lot for the big tides in the global economy are not narrowly within our control. So we have to do the best that we can in these circumstances.
