Why is UK growth so slow?

4 July 2012

Reform roundtable seminar on “why is UK growth so slow?” on Monday 2 July2012. Introduced by Richard Jeffrey, Chief Investment Officer, Cazenove Capital Management.

Earlier this week Richard Jeffrey, Chief Investment Officer at Cazenove Capital Management, introduced the first of three austerity debates hosted by Reform. This debate was on the topic of “why is UK growth so slow” and was held under the Chatham House Rule.

The answer to the question was straightforward but politically tough – over recent “boom years” the economy had accumulated debt at a rate faster than could be matched by income growth. The wealth that was being consumed had not yet been earned, and after the party the UK found itself burdened with onerous amounts of public and private debt. This increase in debt reflects failures in fiscal and monetary policy. Interest rates were too low for too long and spending increased too quickly.

Looking forward as well as back the messages are just as hard. The UK needs to reduce its historically high levels of debt. Domestic demand needs to grow at a lower rate than GDP and fiscal policy must rebalance. Importantly, expectations for growth will need to be more realistic. The economy will be doing well to have a real rate of growth of two per cent, prolonging a recessionary feel. In short, austerity will be the new normal.

So what does this imply for government policy? A key implication is that the task of delivering growth is not just for the Government. Indeed, the best thing the Government could do for growth is to create the conditions for the private sector to expand. This should come from supply side reform. Efforts to prop up demand would either be too small to have a material impact or would need to be so large as to damage overall fiscal credibility. Curbing the overreach of the Government will also help reduce the degree to which it crowds out private activity (evidence of this crowding out can be seen through lower capital investment).

There are a number of supply side reforms that the Government could look to. The four main pillars that affect investment and growth in the private sector are: access to skills, the tax environment, regulatory burdens, and the quality of infrastructure. On skills, standards in schools must be raised so that employers do not have their productivity stifled. On tax the emphasis must be on creating an environment that is stable and consistent. Rather than increasing regulatory burdens, the Government should try to reduce them, particularly for small businesses. And finally, it is necessary to find a way to encourage private sector investment in infrastructure projects in the UK.

The picture for growth in the UK has changed. The UK is likely to experience shorter economic cycles where inflation plays an important role in shaping the real rate of growth. The next few years will require a prolonged and severe period of deleveraging. In simple terms, people need to spend less than they are earning. This may sound straightforward but following a decade of overspending, it will feel tough.



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